The Current State of Islamic Finance in the Gulf Co-operation Council

by Michael Diaz Jr. - Diaz Reus International Law Firm

Shari’ah-compliant finance and banking has mushroomed in recent years despite its prohibition on accepting interest on loans and its application of other limiting Islamic principles. Let’s briefly examine the current state of Islamic finance in the Gulf Co-operation Council (GCC), explore the GCC as a platform for Islamic finance, and suggest how the GCC states might succeed as a center for Islamic finance.Gulf Cooperation Council

General Background

Some 500 Islamic banks now operate in 75 countries around the world. Although Islamic finance began with projects such as Mit Gamyr in Egypt in 1963 and Tabung Hajj in Malaysia in 1967, the first Islamic bank, the Dubai Islamic Bank, one of the world’s largest, wasn’t incorporated until 1975 in the United Arab Emirates (UAE). Kuwait Finance House, established in 1977, had 54 branches by 2011 and was ranked one of the best Islamic banks globally. Saudi Al Rajhi Bank is currently the largest Islamic bank. 

In terms of asset base, the GCC Islamic banks’ share constitutes 70 percent of the global total, with assets of $445 billion at the end of 2012, up from $390 billion in 2011—a 14 percent jump. What started as a small rural banking experiment in remote Egyptian villages has now reached a level where many international mega-banks are offering Islamic banking products. In 2008, Saudi Arabia had 127 Shari’ah-compliant funds, Kuwait 45, Bahrain 29, UAE 27, and Qatar two. In terms of sukuk, or the Islamic equivalent of bonds, Bahrain has been the most active in the GCC. The UAE leads in the value of sukuk issuance, while Saudi Arabia is the GCC market with the highest issuance-potential.

GCC Banking Centers

Although Qatar remains a small market, its major banks have established Islamic affiliates, such as the Qatar National Bank, which has an Al Islami subsidiary; the Commercial Bank of Qatar, with its Al Safa Islamic banking subsidiary; and Doha Bank, with its Doha Bank Islamic subsidiary. The Qatar Islamic bank branched overseas and owns European Finance House and the Asian Finance Ban and has subsidiaries in Lebanon, Bahrain, Yemen, and Kazakhstan. 

Bahrain has functioned as a major regional banking center since 1976, hosting the Association of Accountants of the Islamic Finance Industry (AAOIFI), the Bahrain Institute of Islamic Banking and Finance (BIBF), the International Islamic Finance Market (IIFM), and the Bait al Bursa of the Bahrain Financial Exchange (BFX). In contrast to other GCC states, Bahrain has kept its market open to foreign banks, while, for example, Saudi Arabia and Kuwait have licensed only majority-locally-owned institutions. As a result, Bahrain has the most Islamic Banks in the GCC, with 24 Islamic banks and 11 Takaful companies. Oman boasts two full-fledged Islamic banks, Bank Nizwa and Al Izz International Bank, and a plethora of conventional banks with Islamic windows, including Bank Sohar, Bank Dhofar, Bank Muscat, Ahli Bank, and National Bank of Oman (NBO). According to Oman’s rules, a single branch cannot operate both an Islamic window and conventional banking services, while the windows must disclose the sources and the uses of their funds.

Regulatory and Legal Environment

Currently, the UAE is taking measures to promote itself as the hub of Islamic finance, such as establishing the Dubai Global Sukuk Center and the Dubai Center for Islamic Banking. However, the UAE and GCC are not equipped with a sufficient regulatory and dispute-resolution framework to sustain itself as a global center of Islamic finance. Although the UAE has a law allowing Islamic banks to exist—UAE Federal Law No. 6 of 1985 Regarding Islamic Banks, Financial Institutions, and Investment Companies—it currently does not have an Islamic banking law. One was proposed in 1985, but never implemented. Furthermore, the UAE and Dubai International Financial Center (DIFC) lack a centralized Shari’ahboard. All GCC states have passed some sort of legislation related to Islamic banking, however, Saudi Arabia has been the least active, with no mention of Islamic banking in its banking legislation or even in the Capital Markets Law of 2003. According to Wilson (2009:7), SAMA and Capital Markets Authority have not issued a single document pertaining to Islamic finance.

Wilson (2009:25) purports that there is little regulatory convergence in the GCC. Each state has developed its own regulatory system for banks and financial institutions, and in the UAE and Qatar the financial centers have their own laws and regulations. There does not exist an avenue to apply Shari’ahin the DIFC or Qatar Financial Center (QFC). The local courts in the GCC may apply Shari’ahto matters, however, in reality this is relegated to family and inheritance matters. Although several arbitration centers exist in the UAE and GCC, none are effective for Islamic finance. As with the entire international Islamic financial industry, the Islamic finance industry in the UAE and the GCC lacks sufficient regulation, standardization, harmonization, financial reporting, and an adequate dispute resolution mechanism to regulate the industry and ensure its survival as a viable financial platform into the future.

Reporting Inconsistencies

Inconsistency in the financial reporting of Islamic banks across the GCC is also resulting in uncertainty for the investor and weakening the GCC position in the industry. For example, Kuwait Finance House (KFH), except KFH Bahrain, does not use the International Financial Services Board (IFSB) and AAOIFI standards for capital adequacy. As a result, KFH financial statements (except KFH Bahrain) may not truly reflect KFH’s capital structure and stakeholders may not be able to truly assess whether capital-structure decisions are made to maximize shareholder equity.

Currently, even though all six GCC states host Islamic financial institutions, Bahrain is the only GCC nation that hosts a centralized national Shari’ah board. Even the DIFC and QFC, both of which serve as platforms for Islamic financial business, are not equipped with a central Shari’ah board. Furthermore, on a regional basis, there are conflicting decrees regarding interpretations of the Shari’ah. Such conflicts might be resolved—and Islamic finance advanced—should each GCC state possess a national Shari’ah Board (as does Bahrain, which extends jurisdiction over its financial free zones) and should a central Shari’ah Board be created for the GCC, along with the GCC monetary union and uniform currency.

Paving the Way for GCC states To succeed as a center for Islamic finance

For now, GCC states are competing with each other for prominence in Islamic finance with each issuing different laws, regulations, and interpretations of the Shari’ah. Although seemingly strong in Islamic finance in terms of numbers, the GCC lacks regulation, standardization, harmonization, an effective dispute resolution mechanism, coordination between member states, and a centralized Shari’ah Board. However, this might be remedied if the UAE would implement a plan for the Dubai World Islamic Finance Arbitration Center (DWIFAC) and Jurisprudence Office (DWIFACJO) as an initial attempt to put in place a dispute resolution framework for the UAE and GCC; and if the GCC states—including all financial free zones, the DIFC and QFC—would adopt the AAOIFI standards in its financial reporting as does Bahrain. That would pave the way for the GCC to emerge as a unified bloc in the Islamic finance industry.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Michael Diaz Jr. - Diaz Reus International Law Firm | Attorney Advertising

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Michael Diaz Jr. - Diaz Reus International Law Firm

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