Islamic finance

In addition to conventional instruments, the Central Bank of Bahrain (CBB) has introduced various Islamic products to support sharia-compliant banking. The kingdom has a high penetration of Islamic financial institutions, comprising six sharia-compliant retail banks and 18 wholesale banks, along with seven takaful (Islamic insurance) companies.

A New Tool

The CBB launched a new sharia-compliant liquidity management instrument for Islamic retail banks, known as wakala, during the second half of 2015. This aims to help local Islamic retail banks park their surplus liquidity with the CBB. The CBB announced that the wakala instrument is based on a standard contract of the International Islamic Financial Market. The Accounting and Auditing Organisation for Islamic Financial Institutions defines wakala as the act of one party delegating the other to act on its behalf. Islamic retail banks need to sign a wakala agreement which appoints the CBB as an agent (wakil) to invest cash on behalf of the bank ( muwakkil). Accordingly, the wakil will invest these funds in the investment portfolio allocated in advance, which contains sukuk (Islamic bonds). Typical duration of the instruments is seven days, and they are available for Islamic retail banks on a designated day of the week.

Due to lack of alternative liquidity management tools available for sharia-complaint banks, inter-bank unrestricted wakala – and more recently, collateralised liquidity management products – are gaining a higher degree of acceptance. Sharia-compliant finance companies are well-versed with unrestricted wakala products, and accordingly they find a place in most Islamic banks’ balance sheets and are accepted by most jurisdictions. They have also become an important investment/liquidity management tool that can be used by central banks.

Collateralised liquidity management tools are now being used by Islamic banks as an alternative to conventional repos (sale and buy-back). However, more clarification and understanding is needed on these collateralised transactions, as when the sharia-compliant banks receive or provide collateral, the credit of the institution should not be impacted. Rather, it should function as a liquidity management tool which also provides risk management capability.

Guarantee

Banks are using this product either for active liquidity management, or keeping it as an approved product for contingency planning. This repo-like collateralisation product is the best alternative to repo in Islamic finance. It is based on a murabaha contract, since the product cannot be structured on mudaraba or wakala (which are trust-based contracts) since the very definition of rahn requires a debt-tied contract such as murabaha. Rahn is a contract that makes something as a guarantee to the completion of settlement of a debt. Usually the collateral is requested by the creditor to the debtor during the commencement of the contract to avoid default by the debtor of not paying the debt.

In the past, the CCB has also introduced similar sharia-compliant financial instruments. In June 2008, the CBB collaborated with the Bahrain-based Liquidity Management Centre, which provides asset sourcing, structuring and market making capabilities, to develop Islamic sukuk liquidity instruments. These were designed to enable financial institutions, both conventional and Islamic, to access short-term liquidity against government of Bahrain Islamic leasing (ijara) bonds (sukuk), issued by the CBB. In 2001, the CBB became the first sovereign in the world to develop and issue sukuk. Since then, it has established a calendar of Islamic debt paper, which comprises short-term as well as medium- to long-term sukuk.

Bahrain also plans to further strengthen its position as an Islamic finance centre. As part of this strategy, the Bahrain Bourse launched the Bahrain Islamic Index on September 14, 2015. The index includes stocks of listed sharia-compliant companies.