## _cr0691 ## Source details **Canonical URL:** [_cr0691](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0691.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0691.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0691.pdf.json) --- ### Executive summary — system-wide findings - Bahrain’s financial sector is enjoying good results and growth in a favorable environment, and soundness indicators suggest that the system is robust. - The banking sector is well-capitalized. Asset quality has been improving and provisioning is high. - Profitability surged in 2004–05, but historically, return on equity has been moderate for many institutions. - The insurance sector is also well-capitalized. - Household debt relative to disposable income is low but rising; the corporate sector on average is not highly leveraged. - Consumer lending grew rapidly, slowed in 2005 following a tightening of loan to income limits. - Regional geo-political disturbances are a risk factor; Bahraini financial institutions have withstood such shocks previously. - Comprehensive stress testing (accounting for Islamic institutions’ risk-sharing features) suggests the banking system as a whole could withstand even a severe shock, though individual banks may be vulnerable to credit booms/busts or adverse interest rate or equity price movements. - Since 2002 the Bahrain Monetary Agency (BMA) has supervisory authority over the entire financial system, has modernized prudential requirements, and is enhancing supervisory capacity. - Payments and securities settlement systems are reliable and efficient and are being upgraded. - Under current legislation the BMA is not formally fully independent; proposed Central Bank of Bahrain Law (CBBL) and the integrated licensing framework are expected to address many shortcomings. ### Major risks and supervisory implications - Rising exposures from rapid credit growth, especially consumer lending, warrant close monitoring; preemptive tightening of prudential requirements may be warranted. - High entry of new banks; licenses should be granted mainly on careful analysis of applicants’ business plans and sector-wide competition. - BMA needs sufficient resources: competitive remuneration and ongoing training to retain and develop supervisory staff. - Supervision effectiveness could be raised by better management, reconciliation, and analysis of available data, and compilation of indicators for nonfinancial sectors. - BMA should develop supervisory capacity for new market activities (e.g., trading in derivatives) and market risk management. - BMA has broadly adequate enforcement and bank resolution powers, but more contingency planning would be valuable given potential future consolidation. ### Key policy recommendations — short term - General: - Pass the CBBL, with provisions to strengthen central bank independence and powers, and refinements to provisions on payments and settlements. - Banking: - Introduce averaging in the fulfillment of reserve requirements. - Modernize the liquid asset requirement. - Insurance: - Complete schedule of on-site supervision of all insurance companies. - Continue guidance to companies to comply with new regulations. - Payments and Securities Settlement Systems: - Require that BMA credit in the payment system be fully collateralized. - Strengthen legal framework regarding assets pledged as collateral and protection of custodian arrangements in event of bankruptcy. - AML/CFT: - Pass legislation criminalizing terrorist financing in itself. ### Key policy recommendations — medium term - General: - Develop on-site supervision expertise for new market activities and complex regulations. - Improve data management to identify system-wide concerns and compile financial soundness indicators; begin tracking nonfinancial sector indicators and property prices. - Monitor country and transfer risk more closely. - Banking: - Prepare criteria/procedures for assessing mergers and bank exit. - Define criteria for assessing acquisitions/investments for undue risk or hindrance to supervision. - Establish limits/conditions for liquidity support under the integrated licensing framework. - Review scope for privatizing government stakes in commercial banks. - Enhance capacity to supervise market risk management and set appropriate market risk limits. - Insurance: - Prepare for possible consolidation and exit (procedure guides for mergers). - Payments and Securities Settlement Systems: - Set pricing for RTGS use to ensure large-value payments are channeled through RTGS. - Study alternative risk management systems in the securities settlement system to balance safety and efficiency. - Securities Markets: - Expand bilateral international MOUs with regulators and exchanges, particularly with cross-trade links. - Consider privatizations via share issues on the BSE and cross-listing to increase trading volume and depth. - Streamline debt issuance procedures to shorten documentation and placement time. - Increase liquidity in debt secondary markets by issuing larger amounts of government securities on a pre-announced schedule and encouraging qualified nonbanks to participate in the repo market. - AML/CFT: - Establish regulatory framework for capital markets licensees comparable to other financial institutions. - Intensify AML/CFT inspection program for capital markets and insurance licensees. - Further develop AML/CFT system for non-financial entities and non-profit organizations. ### Structural and market-development issues - Shortage of appropriate local investment vehicles limits sector development. - Introduction of a market-based financing system for lower and middle-income housing would be desirable. - Securities trading remains thin due to buy-and-hold investor behavior. - Opportunities to make Bahrain more attractive for issuance of private tradable securities and to invigorate the secondary market by introducing new players. - Legislation needs amendment to criminalize terrorist financing and to strengthen legal status of pledged assets and custody arrangements in connection with passage of the CBBL. ### Financial center status, market structure, and Islamic finance - Bahrain is a regional financial center; OBUs, IBLs, and other institutions base regional operations in Bahrain for location and regulatory environment advantages. - Islamic institutions follow AAOIFI standards; conventional institutions follow IFRS; corporate accounting follows IAS. - Prudential regulations for Islamic and conventional institutions are closely aligned; “credit,” “loans” and “deposits” include analogous Islamic items where no confusion results. - BMA Law of 1973 is main law; draft CBBL before parliament to reinforce BMA independence and clarify powers; early passage recommended. - BMA consolidated regulation and supervision and prepared comprehensive rulebooks and an integrated licensing framework. - BMA banking supervision divisions together have about 40 professionals; described as “barely adequate.” Turnover and non-competitive remuneration have been problems. - Authorities plan staged introduction of Basel II provisions over the next four years. - Consolidated capital adequacy requirement is 12 percent. ### Payments, liquidity policy, and bank resolution - Liquidity regulation: current 25 percent liquid asset requirement (LAR); regulations need modernization because they do not fully account for asset/liability liquidity profiles and drain liquidity from government securities secondary market. - Reserve requirement: unremunerated reserves equal to 5 percent of end-of-month BD deposits; recommended allowing averaging and measuring reserve base as an average over the period; medium-term aim to reduce reserve ratio and/or remunerate required reserves, with caution. - Lender of last resort: quasi-currency board limits emergency liquidity support; internal guidelines and published accountability for any support recommended. Market understanding is that BMA is not responsible for offshore banks; under integrated licensing, BMA should introduce explicit limits on responsibilities. - Bank resolution: BMA has legal powers to discipline banks; current law contains provisions on administration/liquidation but few on less drastic steps; proposed CBBL would increase flexibility. - Deposit insurance reform: proposed ex ante levy-funded scheme to provide up to BD 7,500 compensation per depositor (roughly twice GDP per head); differentiate charges by bank riskiness and define treatment of Islamic investment accounts. ### Stress testing — methodology and results (coverage and shocks) - Coverage: - Sample: locally incorporated banks on a worldwide consolidated basis. - Conventional sample: eleven locally incorporated entities — four FCBs, three OBUs, three IBLs (≈40 percent of conventional bank assets). - Islamic sample: ten locally incorporated entities — two FCBs, one OBU, seven IBLs (over 85 percent of Islamic bank assets). - Data as of end-2004; results in millions of U.S. dollar. - Risks considered: credit risk, market risk, liquidity risk, interbank contagion. - Credit shocks: - Credit shock 1: A five percentage-points increase in the loan-to-assets ratio. - Credit shock 2: Asset quality deterioration per transition matrix; provisions charged at 0 percent for standard, 20 percent for substandard, 50 percent for doubtful, and 100 percent for loss. - Market shocks: - Interest rate shocks: parallel upward shift of 200 basis points (various horizons and portfolios). - Equity price shock: 30-percent decline in worldwide equity prices. - Foreign exchange shock: 20-percent appreciation/depreciation of bilateral rates US$/EUR and US$/GBP. - Liquidity shocks: - Liquidity shock 1: Structural outflow of 10 percent of qualifying liabilities; interbank liabilities suffer 50 percent outflow. - Liquidity shock 2: Liquidity shock 1 plus 30 percent decline in listed equity prices. - Liquidity shock 3 (conventional banks): Liquidity shock 2 plus decline in mark-to-market value of listed debt securities from a 200 bps yield increase. - Interbank contagion scenarios: - Interbank contagion 1: default on largest single interbank exposure (100 percent loss). - Interbank contagion 2: defaults endogenous to banks whose CAR falls below zero. ### Stress testing — key results (conventional banks) - Initial CARs (in percent): FCBs 23.9; IBLs 25.1; OBUs 19.1; Total 20.7. - Reduction in CAR due to individual shocks (ppts) — average / largest / total (as presented): - Credit shock 1: -2.0, -1.3, -1.4, -1.5 - Credit shock 2: -5.2, -0.2, -2.9, -2.6 - Interest rate shock 1: -0.1, -0.2, 0.6, 0.4 - Interest rate shock 2: 0.1, -0.2, 0.9, 0.6 - Interest rate shock 3: -1.2, -0.7, -2.2, -1.9 - Interest rate shock 4: -0.2, 0.0, ..., 0.0 - Equity price shock: -1.2, -14.5, -1.2, -3.2 - Foreign exchange rate shock: 0.0, 0.1, 0.1, 0.1 - Scenario impacts (ppts): - Boom and bust (Scenario 1): -9.4, -1.8, -5.0, -5.0 - World recession (Scenario 2): -10.0, -16.2, -6.3, -8.2 - Interbank contagion impacts: - Interbank contagion 1: -3.7, 0.0, -0.5, -0.7 - Interbank contagion 2: 0.0, 0.0, 0.0, 0.0 - Resulting CAR minimum levels after (10) World recession and (11) Interbank contagion 1: 10.3, 8.9, 12.4, 11.9. - Observations: - Conventional banks are strongly capitalized but heterogeneous; credit shocks are pronounced but small relative to high capital bases; FCBs most affected. - Interest rate flow effects small; valuation effects could cause up to 2 percent equity loss. - Equity price risk important for OBUs and IBLs; foreign exchange cross-rate risk negligible. ### Stress testing — key results (Islamic banks) - Islamic banks initial CARs and scenario impacts presented under two treatment extremes for investment account loss absorption (no DCR / full DCR). - Findings: - Islamic banks are strongly capitalized (initial CARs reported as 39.1 25.9 27.9 39.1 25.9 27.9 in the table excerpt). - Under no DCR, credit shocks have small impact relative to capital base; under full DCR impacts become larger for certain banks but generally capital buffers absorb individual shocks. - Equity price shock is important, particularly for Islamic IBLs; under full DCR equity shock can produce substantial losses. - Liquidity shocks erode Liquid Asset Ratios (LAR) substantially for some OBUs and IBLs dependent on wholesale funding. - Liquidity stress results (conventional banks — initial LAR): 25.5 44.9 47.3 44.1; reductions from liquidity shocks up to -26.1 ppts and total shortage figures presented in thousands of U.S. dollars. - Islamic banks — initial LAR: 16.6 26.0; reductions under shocks and total shortage figures presented (e.g., Total shortage after (2): 070,1200 in thousands of U.S. dollars under assumptions). ### FSAP assessments — Basel Core Principles (banking supervision) - Overall: banking supervision in Bahrain meets high standards; compliance with Basel Core Principles is strong, especially in areas relevant to current banking activities. - Key institutional points: - BMA Law provides adequate powers but weaknesses: objectives not defined in detail; BMA independence limited by requirement to obtain MOF approval in key areas; sanctioning powers not fully detailed — expected to be addressed in CBBL. - Licensing and definition of regulated activities need clarification; integrated licensing framework targeted for implementation. - Prudential regulations generally conform to Basel standards; minimum capital requirements monitored on solo and consolidated basis and are above Basel minimum. - Liquidity risk controlled through 25 percent liquid asset requirement; suggestion to build framework for stress testing capital adequacy. - Off-site supervision unit for Islamic banks established; need continuous enhancement of risk measurement for Islamic banks amid innovation. - Recommended action plan highlights (selected): - Adopt draft CBBL, enhance BMA autonomy and clarify legal powers; specify minimum term for Governor, grounds for removal, and staff protections. - Implement integrated licensing framework; detailed licensing procedures and corporate governance emphasis. - Develop criteria for ownership changes and major acquisitions/investments. - Build on-site supervisory capacity and skills, especially for market, liquidity, interest-rate-in-banking-book risks, and consolidated supervision. - Extend arm’s-length/board approval requirements for connected lending. ### Securities markets — IOSCO assessment and recommendations - BSE market valuation: US$13.5 billion, or 130 percent of GDP in 2004; average turnover 70 to 100 daily trades worth about $1.8 million. - Settlement and infrastructure: - Automated quote system; delivery-versus-payment on T+2; CSDR as central depository; cash leg settles on multilateral net basis on T+2. - Legal gaps: settlement finality, custody protection, and insolvency-related protections not embedded in primary law; recommended embedding in CBBL/SER. - Operational resilience improvements recommended: relocate back-up servers, business continuity plan, regular testing and training. - Regulatory findings: - Securities market regulation and supervision generally high; refinements needed as market uses more complex instruments. - Independence of BMA somewhat compromised by Prime Minister and Finance Minister serving as BMA Chairman and Deputy Chairman; proposed CBBL seeks to establish a seven-member Administrative Council. - Enforcement and information-gathering powers should be made comprehensive and explicit (proposed CBBL Article 123 drafted to help). - Recommend BMA become signatory to IOSCO Multilateral MOU once CBBL passed and expand bilateral MOUs. - Define insider trading in primary legislation; clarify offences and enforcement powers. ### Insurance sector — assessment and supervisory priorities - On-shore insurance: 22 licensed companies (12 locally incorporated), 30 brokers, 7 consultants; gross premiums slightly under 3 percent of GDP; total assets of domestic insurers reached US$2 billion at end–2004; investments US$1.2 billion (10.9 percent of GDP). - Off-shore insurance: 73 companies (57 insurance firms, 13 brokers, 3 consultants) at end–April 2005. - The BMA issued a comprehensive Insurance Rulebook in early May 2005; implementation and supervisory capacity remain challenges. - Key supervisory recommendations: - Increase on-site inspections and market analysis; develop procedures for consolidated/group supervision; strengthen evaluation of technical provisions and actuarial reviews. - Address fronting: identify and regulate arrangements where domestic insurers front for foreign insurers. - Enhance AML/CFT awareness and inspections in insurance; amend Rulebook for non-face-to-face verification procedures. - Consider priority for policyholders and beneficiaries in insolvency/winding-up arrangements. ### AML/CFT — findings, deficiencies, and recommended action plan - Legal framework: - Decree Law 4/2001 criminalizes money laundering; financing of terrorism is not yet a criminal offense; draft law to criminalize terrorist financing is before parliament but has deficiencies (does not criminalize providing funds to terrorists/organizations independent of actual terrorist act). - AMLU (FIU): - FIU received 330 STRs since inception; 24 STRs (constituting 18 cases) forwarded to the Public Prosecutor; 4 cases related to money laundering. - AMLU does not have a high profile with all reporting entities; outreach and guidance needed. - Preventive and supervisory gaps: - Capital market licensees and some DNFBPs lack AML/CFT measures comparable to banks and insurance; rulebooks for capital markets need enhancement to meet FATF CDD requirements. - MOIC’s supervisory powers over DNFBPs may be insufficient for effective AML/CFT supervision; resources and enforcement powers need strengthening. - NPO supervision limited: 386 registered societies including 80 charities; Directorate of Development and Local Societies has staff of 4 and insufficient resources for inspections. - Recommended action plan (selected priorities): - Criminalize financing of terrorism and ensure FT becomes a predicate offence for money laundering; amend draft FT law to criminalize funding of terrorists/organizations irrespective of occurrence of terrorist act. - Extend corporate criminal liability and criminalize additional predicate crimes where appropriate. - Designate a 1373 designation agency and implement fund-freezing and notification mechanisms. - Enhance FIU guidance and outreach; increase STR forwarding and case development to build jurisprudence. - Upgrade AML/CFT regulations and supervisory coverage for capital markets licensees, money changers, money brokers, insurers, and DNFBPs; intensify on-site inspections. - Develop a disclosure/declaration system for cross-border cash movements (Special Recommendation IX) and strengthen customs interception legal basis. - Improve inter-agency coordination; Policy Committee to lead legal revisions and inspection coordination, particularly for lawyers as DNFBPs. ### Cooperation, governance, and authorities’ response - Cooperation: - Cooperative efforts among AMLU, BMA, and supervisory agencies are currently based on custom and practical considerations rather than specific legal provisions; legal gateways for information exchange recommended. - Mutual legal assistance and extradition frameworks exist; dual criminality generally not required for assistance but extradition without treaty is possible with limitations; absence of FT offence limits extradition on FT grounds. - Authorities’ response and actions taken: - BMA welcomes assessments, endorses findings, and plans steps to address them over 12–18 months. - Draft CBBL before parliament expected to address many legislative shortcomings (target hoped mid-2006). - Regulatory initiatives: integrated licensing framework to be introduced in early 2006; Basel II implementation over coming years; liquidity requirement review in 2006. - BMA has increased recruitment, plans IT/data warehousing improvements over 2 years, and undertaken supervisory training (insurance staff pursuing ACCI, CPA exams, external seminars). - AML/CFT: government will review draft anti-terrorist financing law and strengthen national policy committee; capital market licensees to be brought into Rulebook structure and AML/CFT on-site examinations initiated for capital markets and insurers. - Insurance supervisory actions: withdrawal of 10 insurance licenses in April 2005 and further withdrawals; consulting actuary retained to evaluate technical provisions; Insurance Rulebook updated in October 2005 to realign Financial Crime modules. ### Selected macroeconomic and financial statistics (2000–2005 and June 2005) - Total population (2004): 707,160 - GDP per capita (Bahraini dinars, 2004): 5,857 - Nominal GDP (BD millions, year end): 2000 2,997; 2001 2,981; 2002 3,176; 2003 3,612; 2004 4,141; 2005 1/ 4,886 - Real GDP (percent change): 2000 5.3; 2001 4.6; 2002 5.2; 2003 6.8; 2004 5.4; 2005 6.9 - Consumer price index (period average percent change): 2000 -0.7; 2001 -1.2; 2002 -0.5; 2003 1.7; 2004 2.3; 2005 2.7 - Private savings ratio (in percent of GDP): 2000 7.3; 2001 3.6; 2002 10.9; 2003 13.4; 2004 15.0; 2005 17.1 - Domestic credit (percent change): 2000 6.0; 2001 2.2; 2002 13.9; 2003 9.2; 2004 23.9; 2005 16.0 - Interest rate (money market rate, in percent): 2000 6.9; 2001 3.9; 2002 2.0; 2003 1.2; 2004 2.8; 2005 4.0 - Bahrain Stock Exchange (index, percent change, end of period): 2000 -18.4; 2001 -2.5; 2002 3.4; 2003 28.8; 2004 30.2; 2005 23.8 - Overall fiscal balance (in percent of GDP): 2000 9.8; 2001 0.8; 2002 -3.9; 2003 -2.0; 2004 0.3; 2005 1.9 - Gross official reserves (in billions of U.S. dollars): 2000 1.2; 2001 1.4; 2002 1.4; 2003 1.4; 2004 1.6; 2005 1.7 - Reserve cover (months of imports): 2000 3.1; 2001 2.9; 2002 2.7; 2003 2.4; 2004 2.0; 2005 2.0 - Exchange rate (Bahraini dinars per US dollar): 2000–2005 0.3760 - Table 2 (Financial System Structure, June 2005) — selected items: - Full Commercial banks - FCBs: Number of Institutions 24; Asset share Total assets 15,531; Assets as percent of GDP 100.0; Onshore GDP percent 141.0 - Domestically owned: 11 institutions; 12,025 asset share; 77.4; 109.2 - Foreign owned: 13 institutions; 3,506 asset share; 22.6; 31.8 - Islamic (of which): 6 institutions; 2,217 asset share; 14.3; 20.1 - Investment Banks - IBLs: Number 3; Asset share 6,464; Assets as percent of GDP 100.0; 58.7 - Offshore Banks - OBUs: Number 52; Asset share 100,137; Assets as percent of GDP 100.0; 909.3 - Insurance companies: Number 20; Asset share 2,052; Assets as percent of GDP 100.0; 18.7 - Memorandum: Stock market valuation (in millions of U.S. dollar) 16,679; 151.4 *Source: _cr0691 — IMF staff report excerpts from the Bahrain FSAP (Executive Summary; sections 6, 33, 54; Appendix II; and selected assessment and statistical tables).* ### Executive Summary ...................................................................................................... ### _cr0691 - Executive Summary ### Executive summary: system-wide findings - Bahrain’s financial sector is enjoying good results and growth in a favorable environment, and soundness indicators suggest that the system is robust. - The banking sector is well-capitalized. Asset quality has been improving and provisioning is high. - Profitability surged in 2004–05, but historically, return on equity has been moderate for many institutions. - The insurance sector is also well-capitalized. - Available indicators for nonfinancial sectors show that household debt relative to disposable income is low but rising, and the corporate sector is on average not highly leveraged. - Favorable liquidity conditions have caused regional equity and real estate markets to surge; consumer lending has grown rapidly, although it slowed in 2005 following a tightening of loan to income limits. - Possible regional geo-political disturbances constitute another risk factor, although Bahraini financial institutions have withstood such shocks in the past. - Results from a comprehensive stress testing exercise, where due allowance was made for the risk-sharing features of Islamic institutions, suggest that banks as a whole could withstand even a severe shock. Nonetheless, individual banks may be vulnerable to a “boom and bust” in credit, or adverse movements in interest rates or equity prices. - The Bahrain Monetary Agency (BMA) has had supervisory authority over the entire financial system since 2002, has modernized prudential requirements, and is enhancing supervisory capacity. - The regulatory framework accommodates both conventional and Islamic institutions and is largely in conformity with relevant regulatory standards. - Payments and securities settlement systems are reliable and efficient and are in the process of being upgraded. - A significant challenge is to ensure that the BMA has the staff and skills to keep up with expansion of the financial sector and product innovation. - Under current legislation, the BMA is not formally fully independent, and some of its powers are not comprehensively specified in law; several shortcomings should be largely remedied once the proposed Central Bank of Bahrain Law (CBBL) is passed and the new licensing framework is introduced. ### Major risks and supervisory implications - Rising exposures from rapid credit growth, especially consumer lending, warrant close monitoring; eventual preemptive tightening of prudential requirements may be warranted. - Entry of new banks is high; licenses should be granted mainly on the basis of a careful analysis of applicants’ business plans, taking into account competition in the sector as a whole. - The BMA needs sufficient resources: staff quality must be supported by competitive remuneration and on-going training to maintain effective supervision of a growing and increasingly sophisticated financial system. - The effectiveness of supervision could be raised by better management, reconciliation, and analysis of available data, and the compilation of indicators for nonfinancial sectors. - The BMA should develop supervisory capacity for new market activities (e.g., trading in derivatives) and for market risk management as the system develops. - The BMA has broadly adequate powers of enforcement and bank resolution, but more contingency planning would be valuable given potential future consolidation in banking and insurance where many institutions are small. ### Selected quantitative and institutional facts - The Bahraini dinar (BD) has been effectively pegged to the U.S. dollar since 1980 (at US$2.659 for BD 1). - Since the start of the 1990s, annual real non-oil GDP growth has fluctuated between 13 percent and about 1 percent. - At end-2004, 113 banks were licensed, up from 101 at end-2000. - The total assets of OBUs are very large; the total assets of the on-shore sub-sector exceed GDP. - Consumer lending growth slowed in 2005 following a tightening of loan to income limits. - The BMA plans in 2006 to introduce its integrated licensing framework, rework certain regulations (e.g., on liquidity requirements), and to enhance its supervisory capacity through reorganization and improved data management. ### Key policy recommendations (short term) - General: Pass the CBBL, with provisions to strengthen central bank independence and powers, and refinements to provisions on payments and settlements. - Banking: - Introduce averaging in the fulfillment of reserve requirements. - Modernize the liquid asset requirement. - Insurance: - Complete schedule of on-site supervision of all insurance companies. - Continue to provide guidance to companies in complying with the new regulations. - Payments and Securities Settlement Systems: - Require that BMA credit in the payment system be fully collateralized. - Strengthen the current legal framework, especially with respect to explicit provisions on assets pledged as collateral and the protection of custodian arrangements in event of bankruptcy. - AML/CFT: - Pass legislation criminalizing terrorist financing in itself. ### Key policy recommendations (medium term) - General: - Develop on-site supervision expertise in line with new market activities, risk management practices, and the complexity of new regulations. - Improve the management, reconciliation, and analysis of data to identify incipient system-wide concerns and to compile financial soundness indicators; begin tracking indicators for the nonfinancial sector; monitor more closely country and transfer risk. - Banking: - Prepare criteria and procedures for assessing mergers and possible exit by banks. - Define explicit criteria for assessing the extent to which acquisitions and investments may expose banks to undue risk or hinder effective supervision. - Establish limits and conditions for liquidity support in connection with the introduction of the integrated licensing framework. - Review scope for privatizing government stakes in commercial banks. - Develop greater capacity to supervise market risk management, and establish appropriate limits for market risk. - Insurance: - Prepare for possible consolidation and exit, for example, by elaborating procedures guides for evaluating applications for mergers. - Payments and Securities Settlement Systems: - Set pricing for use of the real-time gross settlement (RTGS) system to ensure that all large-value payments are channeled through the system. - Undertake a study of alternative risk management systems in the securities settlement system to strike a better balance between safety and efficiency. - Securities Markets: - Expand bilateral international Memoranda of Understanding (MOUs) with regulators and exchanges, particularly those with cross-trade links. - Consider privatizations via share issues on the Bahrain Stock Exchange (BSE) to increase trading volume and depth in the equity market, and the cross-listing of shares with other regional exchanges. - Streamline debt issuance procedures to shorten the documentation and placement process. - Increase liquidity in debt secondary markets by issuing larger amounts of government securities on a pre-announced scheduled, and encouraging qualified nonbanks to participate in the repo market. - AML/CFT: - Establish a regulatory framework for capital markets licensees comparable to that for other financial institutions. - Intensify inspection program for AML/CFT for capital markets and insurance licensees. - Further develop the AML/CFT system for non-financial entities and non-profit organizations. ### Structural and market-development issues - Many financial institutions face a shortage of appropriate local investment vehicles, which limits sector development. - Introduction of a market-based system of financing lower and middle-income housing would be highly desirable. - Trading in securities markets remains thin because most investors follow a “buy and hold” strategy. - Efforts could be pursued to make Bahrain a more attractive location for the issue of private tradable securities, and to invigorate the secondary market by introducing new players. - Legislation needs amendment to make terrorist financing in itself an offense, and to support payments and clearing systems; provisions on the legal status of pledged assets and custody arrangements should be strengthened in connection with passage of the CBBL. *Source: _cr0691 - Executive Summary (IMF).* ### 6. Bahrain is a regional financial center. The OBUs, IBLs, and other financial ### _cr0691 - 6. Bahrain is a regional financial center. The OBUs, IBLs, and other financial ### Regional financial center and market structure - Bahrain’s OBUs, IBLs, and other financial institutions base regional operations in Bahrain because of Bahrain’s geographical location and the prevalence of a modern regulatory environment, rather than regulatory or tax arbitrage (no corporate taxes are levied in Bahrain, but that advantage obtains elsewhere in the region). - Commercial financial institutions offer comprehensive Shari’a-compliant services including banking services and insurance (takaful); the market for government and corporate Islamic securities (sukuks) is developing. ### Islamic finance and regulatory alignment - Islamic institutions are mandated to follow AAOIFI standards; conventional financial institutions follow IFRS; corporate accounting follows IAS. - The text notes: “For convenience, the terms ‘credit,’ ‘loans’ and ‘deposits’ will be understood to include the analogous items in Islamic finance where no confusion results.” - Prudential regulations for Islamic and conventional institutions are closely aligned to ensure as far as possible a “level playing field.” ### Legal, institutional, and supervisory framework - Main law: BMA Law of 1973; shortcomings exist, including in ensuring formal independence of the supervisor, but de facto the BMA acts with considerable autonomy. - A draft new CBBL (Central Bank and Bahrain Monetary Agency Law) is before parliament; the draft would reinforce the BMA’s independence and clarify responsibilities and powers. The report strongly recommends early passage of this legislation and suggests upgrading accountability arrangements (e.g., a process for reporting to parliament). - The BMA is integrating regulation and supervision (banking, insurance, securities), has prepared comprehensive rulebooks, and is preparing an integrated licensing framework for all financial institutions. - Cooperation among regulators (BMA, MOIC, BSE, MOF) is described as good; the BMA has established MOUs with foreign regulators and will need expanding cooperation as interlinkages develop. ### Supervisory capacity, staffing, and implementation - The BMA’s banking supervision and regulation divisions together have about 40 professionals; this is described as “barely adequate” given the number and complexity of institutions. - Turnover has been a problem; remuneration is not fully competitive with the private sector. - The BMA is to be reorganized and additional staff with expertise are being hired; the reorganization will be broadly along the lines suggested by a recent IMF technical assistance mission. - The Fund provided technical assistance in developing the integrated licensing framework. - The authorities plan to introduce provisions of the Basel II capital accord in stages over the next four years. - The consolidated capital adequacy requirement is 12 percent. ### Liquidity and payments systems - Current liquidity regulation is based on a 25 percent liquid asset requirement (LAR); the report finds these regulations need modernization as they do not fully account for asset/liability liquidity profile and they drain liquidity from the secondary market for government securities. The BMA is working to update liquidity regulation. - Payments system: end-of-day netting of payments between BD clearing accounts of the FCBs at the BMA; systemic risk managed through the liquidity requirement and credit extensions by the BMA (including uncollateralized clearing accounts overdrafts as a last resort). - Recommended steps for RTGS implementation: - Require that extension of BMA credit be fully collateralized. - Implement a pricing policy and close coordination so all large-value payments are channeled through RTGS. - Close gaps in the legal framework (e.g., comprehensive provisions related to bankruptcy and status of assets pledged as collateral). ### Securities settlement - CSDR (Clearing, Settlement, Depository, and Registry System) limits settlement risks via a guarantee fund and settlement limits. - Current practice blocks securities as soon as a trade is initiated; recommendation to study alternative mechanisms to balance safety and efficiency given delivery-versus-payment protection. ### Insurance sector and reinsurance risk - New rulebook section establishes comprehensive regulatory framework for all insurance companies; expanded reporting requirements being implemented. - Reinsurance risk: Bahraini market for some insurance products is non-diversified; many insurers have low absolute capital bases and rely heavily on reinsurance for large projects. Companies should assess and provision for the reliability of reinsurance providers to avoid seeking low-cost, less reliable reinsurance. ### AML/CFT - Bahrain has a Decree Law 4/2001 anti-money laundering framework; money laundering offense extends to any type of property and applies to persons who commit the predicate offense. - There are currently four cases of money laundering before the courts, all generated from local investigations. - Financing of terrorism is not currently a criminal offense in Bahrain; a draft law to create this offense is before parliament. The draft law should be amended to ensure full compliance with international standards. - The Anti-Money Laundering Unit (AMLU), Bahrain’s FIU, performs typical FIU functions but “does not have a high profile with all reporting entities”; measures are recommended to address this deficiency. - Capital market licensees have been subject to specific AML regulations since 2004, but these are not comparable in scope to those covering other BMA licensees; the report recommends an equivalent supervisory regime for capital market licensees and finalizing upgraded regulations for money changers and brokers. - MOIC is the primary regulator for DNFBPs, has issued AML guidelines and undertaken visits; however, MOIC’s general supervisory powers may not be fully effective for AML/CFT purposes. Measures to strengthen regulation of non-profit organizations have been taken but effective implementation challenges remain. ### Data, monitoring, and sectoral recommendations - Emphasized need to enhance implementation of regulations by both the BMA and financial institutions after the current round of issuing regulations is complete. - Development priorities: - Enhance supervisory capacity for derivatives operations and structured products as they gain importance. - Strengthen accountability and transparency (e.g., develop a quality assurance function for on-site/off-site supervision; consider publishing the BMA code of conduct). - Improve management, reconciliation, and analysis of data to identify system-wide concerns; planned construction of a comprehensive data management system is expected to help. - Use raw data and credit bureau information to compile financial indicators for the nonfinancial sector and begin tracking property prices. - Develop procedures for dealing smoothly with mergers and exits and a policy on competition in the financial sector. - Expand international MOUs with regulators and exchanges, particularly those with cross-trading links. - Retain qualified staff and implement formal corporate governance code and takeover rules for listed companies. ### Selected macroeconomic and financial statistics (2000–2005 and June 2005) - Total population (2004) 707,160 - GDP per capita (Bahraini dinars, 2004) 5,857 - Nominal GDP (BD millions, year end): 2000 2,997; 2001 2,981; 2002 3,176; 2003 3,612; 2004 4,141; 2005 1/ 4,886 - Real GDP (percent change): 2000 5.3; 2001 4.6; 2002 5.2; 2003 6.8; 2004 5.4; 2005 6.9 - Oil sector (percent change) 2/: 2000 11.2; 2001 0.8; 2002 1.3; 2003 1.1; 2004 -11.5; 2005 -7.5 - Non-oil sectors (percent change): 2000 4.1; 2001 5.5; 2002 6.0; 2003 7.9; 2004 8.6; 2005 9.0 - Consumer price index (period average percent change): 2000 -0.7; 2001 -1.2; 2002 -0.5; 2003 1.7; 2004 2.3; 2005 2.7 - Private savings ratio (in percent of GDP): 2000 7.3; 2001 3.6; 2002 10.9; 2003 13.4; 2004 15.0; 2005 17.1 - Money (M1) (percent change): 2000 4.6; 2001 23.9; 2002 17.2; 2003 26.9; 2004 4.8; 2005 13.7 - Broad money (M3) (percent change): 2000 10.2; 2001 9.2; 2002 10.3; 2003 6.3; 2004 4.2; 2005 13.7 - Domestic credit (percent change): 2000 6.0; 2001 2.2; 2002 13.9; 2003 9.2; 2004 23.9; 2005 16.0 - Foreign currency deposits/total deposits (percent): 2000 32.8; 2001 31.3; 2002 28.6; 2003 25.4; 2004 25.2; 2005 25.8 - Interest rate (money market rate, in percent): 2000 6.9; 2001 3.9; 2002 2.0; 2003 1.2; 2004 2.8; 2005 4.0 - Bahrain Stock Exchange (index, percent change, end of period): 2000 -18.4; 2001 -2.5; 2002 3.4; 2003 28.8; 2004 30.2; 2005 23.8 - Contribution to GDP (in percent of GDP): Total financial corporations: 19.0 (2000), 16.4 (2001), 15.9 (2002), 18.9 (2003), 24.2 (2004) - Domestic financial institutions (contribution to GDP): 5.7; 5.0; 5.9; 5.9; 6.7 - Offshore financial institutions (contribution to GDP): 9.2; 8.4; 7.2; 8.8; 12.0 - Insurance (contribution to GDP): 4.2; 3.0; 2.8; 4.2; 5.4 - Oil and gas (contribution to GDP): 17.8; 17.2; 16.5; 15.6; 13.1 - Overall fiscal balance (in percent of GDP): 2000 9.8; 2001 0.8; 2002 -3.9; 2003 -2.0; 2004 0.3; 2005 1.9 - Government external debt (in percent of GDP): 2000 4.3; 2001 4.7; 2002 5.8; 2003 12.1; 2004 10.9; 2005 9.9 - Government domestic debt (in percent of GDP): 2000 25.0; 2001 25.5; 2002 26.5; 2003 25.0; 2004 24.2; 2005 21.6 - Exchange rate (Bahraini dinars per US dollar): 2000–2005 0.3760 - Real effective exchange rate (percent change): 2000 2.7; 2001 2.0; 2002 -0.5; 2003 -7.9; 2004 -6.2; 2005 -1.5 - Current account balance (in millions of U.S. dollar): 2000 846; 2001 239; 2002 -352; 2003 194; 2004 428; 2005 29 - Capital and financial account balance (in millions of U.S. dollars): 2000 13; 2001 -318; 2002 -1,130; 2003 543; 2004 -340; 2005 -710 - Gross official reserves (in billions of U.S. dollars): 2000 1.2; 2001 1.4; 2002 1.4; 2003 1.4; 2004 1.6; 2005 1.7 - Reserve cover (months of imports) 3/: 2000 3.1; 2001 2.9; 2002 2.7; 2003 2.4; 2004 2.0; 2005 2.0 - Table 2: Financial System Structure, June 2005 (assets as percent of group and of GDP; numbers preserved as in source) - Full Commercial banks - FCBs: Number of Institutions 24; Asset share Total assets 15,531; Assets as percent of GDP 100.0; Onshore GDP percent 141.0 - Domestically owned: 11 institutions; 12,025 asset share; 77.4; 109.2 - Foreign owned: 13 institutions; 3,506 asset share; 22.6; 31.8 - Of which: Islamic: 6 institutions; 2,217 asset share; 14.3; 20.1 - Domestically owned Islamic: 5 institutions; 2,164 asset share; 13.9; 19.7 - Foreign owned Islamic: 1 institution; 53 asset share; 0.3; 0.5 - Investment Banks - IBLs: Number 3; Asset share 6,464; Assets as percent of GDP 100.0; 58.7 - Domestically owned: 3; 6,450; 99.8; 58.6 - Foreign owned: 0; 140; 0.2; 0.1 - Of which: Islamic: 1; 3,025; 46.8; 27.5 (domestically owned Islamic: 1; 3,025; 46.8; 27.5) - Offshore Banks - OBUs: Number 52; Asset share 100,137; Assets as percent of GDP 100.0; 909.3 - Domestically owned: 11; 33,975; 33.9; 308.5 - Foreign owned: 41; 66,162; 66.1; 600.8 - Of which: Islamic: 3; 1,214; 1.2; 11.0 - Domestically owned Islamic: 1; 670; 0.7; 6.1 - Foreign owned Islamic: 2; 544; 0.5; 4.9 - Insurance companies 3/: Number 20; Asset share 2,052; Assets as percent of GDP 100.0; 18.7 - Domestically owned: 12; 2,020; 98.4; 18.4 - Foreign owned: 8; 32; 1.6; 0.3 - Of which: Islamic: 2; 131; 6.4; 1.2 (domestically owned Islamic: 2; 131; 6.4; 1.2) - Investment advisory and other financial services: Number 25; Asset share 3; Assets as percent of GDP 2100.0; 0.3 - Domestically owned: 22; 3; 199.1; 0.3 - Foreign owned: 3; 0; 0.9; 0.0 - Of which: Islamic: 2; 92; 8.1; 0.1 (domestically owned Islamic: 2; 92; 8.1; 0.1) - Financing Companies 4/: Number 4; Asset share 11; Assets as percent of GDP 100.0; 1.0 (Only one was operational at June 2005) - Licensed money changers/brokers: Number 22; Asset share 12; Assets as percent of GDP 91 00.0; 1.2 - Memorandum: Stock market valuation (in millions of U.S. dollar) 16,679; 151.4 *Source: Bahrain authorities; and IMF staff estimates and projections.* ### 33. As in the case of the payment system, the primary legislation governing the securities ### _cr0691 - 33. As in the case of the payment system, the primary legislation governing the securities ### Securities settlement, custody, and insolvency - Primary legislation governing the securities settlement system lacks explicit guidance related to bankruptcy and insolvency. - There is no explicit legal protection for custody arrangements for securities. - Mitigating factors: the quasi-public status of the CSDR and the fact that ownership of securities in the CSDR is established at the level of the individual investor. - Policy recommendation: - It is desirable that all custody arrangements be protected, in primary legislation, from third-party claims in case of insolvency or bankruptcy of the custodian. ### Market support — monetary instruments and liquidity management - The BMA has available a range of powers and instruments to manage domestic liquidity, but, in the context of what amounts to a currency board regime, they are dormant. - Key issues: the reserve requirement and the BMA’s role as lender of last resort. - Reserve requirement: - Current reserve requirement mandates banks to maintain on a continuous basis unremunerated reserves at the BMA equal to 5 percent of end-of-month BD deposits and analogous liabilities. - Characterized as a tax on intermediation in the national currency that does not effectively serve a monetary policy or liquidity maintenance purpose. - Recommendations: - Allow fulfillment of the requirement on an average basis to facilitate liquidity management by banks. - Preferable to measure the reserve base as an average of the positions over the period to secure a more representative figure. - Medium-term aim: reduce the required reserve ratio, and/or remunerate required reserves to promote use of the national currency and the competitive position of FCBs. - Caution: reduction should be gradual because a reduction in the reserve requirement ratio in current circumstances would probably result in banks placing the released liquidity in dollar assets. - Alternative income source for the BMA (such as fees for banking supervision) would have to be found. - Lender of last resort and emergency liquidity support: - The quasi-currency board limits the scope for emergency liquidity support; the open capital account implies that financial flows could be large and rapid. - Limited operations could be envisaged for on-shore banks, since foreign reserves are currently well above currency in circulation. - Authorities may wish to establish internal guidelines for emergency liquidity support. - Accountability would be enhanced by publishing the amounts and conditions of any support after the situation has normalized. - Market understanding: BMA is not responsible for liquidity support of the off-shore banks. - Upon introduction of an integrated licensing framework (no “off-shore” banks), the BMA should introduce an explicit limit on its potential responsibilities in line with available resources (for example, clarifying that support does not extend to all overseas activities). ### Bank resolution - The BMA has legal powers to discipline banks and to intervene. - Current BMA Law contains many provisions on taking a bank into administration or liquidating it, but rather little on less drastic steps. - The proposed CBBL includes provisions creating a more appropriate degree of flexibility. - Past interventions: BMA has intervened in three small banks in recent years without much impact on the system as a whole. - Recommendation: - BMA may wish to identify principles of prompt corrective action to reduce the likelihood that a failing bank will engage in risky and potentially expensive gambles for redemption. - Deposit insurance reform: - Authorities plan to modify the existing deposit insurance scheme. - Proposed new scheme would be funded by an ex ante levy on banks, and provide up to BD 7,500 compensation per depositor (roughly twice GDP per head). - The new scheme seems well designed. - Considerations: - Differentiate charges on banks according to the riskiness of their operations. - Precisely define the conditions under which investment accounts at Islamic banks would be covered while making allowance for sharing of commercial risks between investment account holders and shareholders. ### Financial sector soundness — overview and FSIs - Overall assessment: - FSIs and stress testing point to robustness of the financial system. - Regional geo-political events could be a source of disturbance, but the Bahraini financial system has successfully weathered such events in the past. - Greatest economic vulnerability: a regional “boom and bust” cycle coinciding with a rise in world interest rates and a fall in equity prices; system as a whole could withstand even a large shock, though some individual banks may be more vulnerable. - Capital adequacy: - Banks incorporated in Bahrain are well-capitalized; most have a risk-weighted capital adequacy ratio (CAR) well above the 12 percent minimum. - The CAR for IBLs has tended to decline in recent years as they expanded risk-weighted assets; CARs for other banks have been approximately stable. - Asset quality and provisioning: - Loan portfolios are diversified by sector and geographically. - Some banks have increased shares of personal lending and commercial real estate lending (personal lending growing rapidly; real estate lending exposes banks to regional property boom risk). - Quality of loan portfolios improving; provisioning is high and rising. - Islamic banks reportedly do not place significant funds in profit equalization and investment risk reserves; they should be encouraged to build these reserves. - Profitability and liquidity: - With favorable business conditions and low marginal provisioning needs, bank profitability was strong in 2004 and H1 2005. - Profitability expected to slip slightly in H2 2005 due to rising interest rates. - Conventional FCBs recorded the highest ROE in recent years; ROE of Islamic banks depressed by excess liquidity and very high capitalization. - Banks traditionally maintain high levels of liquidity, higher than prudential requirements. - A large proportion of both lending and deposits by FCBs are denominated in U.S. dollars; viewed as unproblematic given the currency regime. - Banks’ net positions in securities and, for some categories, equity constitute more significant exposures to market risk. - Insurance and nonbank FSIs: - FSIs for the insurance sector mostly stable or improving. - Capital to asset and capital to reserves ratios are high in international comparison. - Non-life insurance has achieved a good ROE; ROE for other sub-sectors less satisfactory (notably takaful companies) in part due to newness and start-up costs. - Relatively few FSIs available for the nonfinancial sector; larger corporations show quite low leverage, though individual deviations exist. - Household indebtedness to banks has been increasing relative to disposable income from a low base; no information available on household wealth. ### Stress testing — methodology and results - Stress testing complemented FSI analysis; shocks were calibrated with reference to historical events (recessions associated with falls in the oil price or regional disturbances). - Methodology accounts for differences between conventional and Islamic institutions in treatment of deposits and investment accounts and structuring of financing and investment transactions (Islamic banks not directly affected by interest rate risk). - Results: - Because banks start out highly capitalized and liquid, only isolated instances would see capital fall below regulatory minimum even after a very large shock. - Largest and most widespread impact occurs when deterioration in credit quality is combined with negative market shocks (scenario: global and regional return to stagflation). - Conventional FCBs have greatest exposure to credit risk; interest rate risk is important for IBLs and some OBUs due to possible revaluation of fixed-income securities. - Some Islamic banks have quite large exposure to equity price risk. - Across bank types, the largest impact often found in smaller, newer banks, but their initial capitalization is typically very high. - Limitations and extreme scenarios: - Stress testing cannot capture effects of very large shocks (e.g., a major political disruption in the region). - In a remote event where the peg to the U.S. dollar is abandoned, the banking system might face a liquidity drain and deterioration in borrowers’ creditworthiness, but current indicators of liquidity and capitalization are strong. ### Structural issues and financial sector efficiency - Opportunity: Current favorable circumstances provide a good opportunity to take measures to maintain Bahrain’s position as a leading regional financial center and enhance the financial sector’s contribution to the domestic economy. ### Bahrain’s status as a regional financial center - Bahrain remains an attractive location for financial institutions, evidenced by continued growth in number of institutions and expansion of incumbents. - Advantages include geographical location, reputation for being well-regulated, innovation in Islamic finance, institutions promoting Islamic market deepening, availability of well-qualified workforce, and reasonable operating costs. - Competitive dynamics: - Other financial centers are trying to catch up; this need not be a threat if Bahrain continues to offer an environment attractive to institutions wanting to operate in a well-regulated jurisdiction. - Regional integration: - Bahrain is a member of the GCC, which is planning to institute a monetary union from 2010; remaining barriers between financial sectors of member countries are gradually being removed. - Monetary union not expected to have a major impact because GCC currencies are already more or less tightly tied to the U.S. dollar. - True financial integration involving regulatory convergence and reduction in market barriers could lead to structural shifts. - Bahrain would probably benefit if integration is governed by market-friendly principles and resistance to heavy state intervention and subsidization. _ Source: _cr0691 - 33. As in the case of the payment system, the primary legislation governing the securities (IMF staff report excerpt) _ ### 54. Under the integrated licensing framework, off-shore banks are expected to be allowed ### _cr0691 - 54. Under the integrated licensing framework, off-shore banks are expected to be allowed ### Integrated licensing and off-shore banks - Off-shore banks are expected to be allowed to undertake more on-shore business under the integrated licensing framework. - Recommendation: A phased approach is needed to dampen potential short-term competitive pressures on local banks. - Operational requirements: - Individual banks wishing to expand the range of their activities will need time to build up relevant risk management capacity. - The BMA will need time to establish effective supervision. ### Islamic Finance - Recent developments and outlook: - The variety and popularity of Islamic instruments has surged in recent years. - Growth is driven mainly by the supply of funds from savers who wish to invest in Islamic vehicles, and to a lesser extent by entrepreneurs seeking financing using Islamic instruments. - The growth is likely to remain rapid over the near term. - Key challenges: - Glut of savings: - Savings are often placed in the interbank market using “commodity murabaha.” - Procedures are somewhat cumbersome and returns low. - Investment opportunities are limited, especially for institutions that are too small to participate in the financing of major projects. - Available investments are often of much longer term than the financing received from savers. - Takaful issues: - Takaful insurance companies, especially “family takaful” companies, lack investments that match the risk profile of potential claims. - These companies have to use conventional reinsurance due to scarcity of Islamic reinsurance. - Shari’a risk: - Compliance is judged by the board of Shari’a scholars established by each Islamic institution. - The valuation of an instrument can be affected if another institution’s Shari’a board deems it noncompliant. - Expectation that conflicting judgments will become less common as experience is gained. ### The Banking Sector — Domestic banking - Recent performance and risks: - Benign macroeconomic conditions have encouraged the on-shore banking system to expand rapidly in recent years. - Expansion has not yet produced marked strains, but recent acceleration suggests that “overheating” may become a problem if it does not soon moderate. - Primary risk: misallocation of resources and social costs rather than systemic disturbance; reputational risk must be considered. - Recent policy: Lowering of the maximum ratio of household lending to disposable income has been effective in moderating growth in credit to this sector. - Housing finance: - Current state: - Lower-end residential property is provided mostly through government housing projects or financed by loans from the government-owned Housing Bank at subsidized interest rates. - Housing Bank loans have frequently been forgiven by government edict. - Subsidized housing is severely rationed; saving for house purchase and mortgage financing are weak. - There is a substantial shortage of lower-priced housing. - Planned reform: - Authorities plan to move to a more market-based system whereby the Housing Bank would guarantee mortgages provided by commercial banks. - Expected advantages: - Supply of lower-priced housing should expand. - Financial system (and in particular Islamic institutions) would benefit from the availability of longer-term savings and investment instruments. - Further development to consider: securitization of mortgages to make the market more liquid. - Supervision: - The specialized Housing Bank and the Bahrain Development Bank are subject to limited BMA supervision. - If they begin undertaking commercial activities and intermediating funds from the public, they should be subject to tighter supervision. - Management of structural change and consolidation: - Competition in the Bahraini banking market is vigorous. - Banks can be adequately profitable when conditions are favorable, but may face pressure if market conditions deteriorate or alternative investment returns rise. - Potential reactions: reduce capitalization through share buybacks or mergers; consolidation expected as Islamic institutions mature; possible cross-sectoral mergers to create financial conglomerates. - Authorities’ preparedness: - Procedures should be in place to evaluate applications for mergers and acquisitions in a timely fashion, including those involving partners from abroad. - To facilitate consolidation, authorities may consider divesting some equity stakes in commercial financial institutions while environment is favorable—a policy already under consideration—to facilitate teaming up and transfer of expertise. ### Insurance - Aggregate and structure: - Gross domestic insurance premiums are under 3 percent of GDP, somewhat low for Bahrain’s stage of development but higher than in most GCC countries. - Premium income has been growing relatively fast; the Islamic insurance (takaful) sector has been especially vigorous. - On-shore insurance sector is fragmented. - Recommendations and contingency planning: - BMA must be prepared for consolidation and possibly exit in the insurance sector. - Suggested actions: - Prepare in advance a procedures guide on how to evaluate in a timely manner a request for approval of a merger. - Undertake contingency planning for rapid intervention if an insurance company requires it. - Prime regulatory objective for both mergers and exits: implement smooth transfer of policies-in-force and outstanding claims (regulatory framework is in place). ### Development of Securities Markets - Debt market development: - Upgrading legal, regulatory, and market infrastructure for debt issuance could accelerate growth of off-shore debt markets. - Example opportunity: attract Arab issuers of Eurobonds by streamlining issuing procedures. - Comparison of issuance timing: - Documentation and placement process takes four months in Bahrain. - In the Eurobond market the issuance process usually takes eight weeks for a new issuer, and for frequent issuers, the process can be shortened to a few days. - Domestic debt market measures: - Increase liquidity of both short-term and long-term instruments by: - Larger issues of BB-denominated government securities to increase “free float” (currently government securities tend to be hoarded by banks and others, in part to meet the liquid asset requirement). - Auctioning medium-term government securities according to a pre-announced calendar to stimulate secondary market trading. - Encouraging competent nonbank financial institutions to originate, distribute, and act as market makers of money market instruments. - Extending repo market participation to qualified nonbank financial institutions (especially those which are significant holders of securities) to increase volume available for repo operations and enable flexible investment of temporary surplus funds. - Equity market development: - Channel privatizations through the BSE to increase the number of investable securities and potentially improve trading volume and market depth. - Cross-listing of shares in other regional exchanges could widen and diversify the investor base, subject to matching regulatory standards. ### Structure of the Bahraini Financial System — Overview - Financial sector characteristics: - Despite small economy size, the financial sector is well diversified and well developed. - Bahrain hosts over 360 financial institutions, including commercial and Islamic banks, off-shore banking units, insurance companies, pension funds, financial advisory groups, and money brokers. - There are currently 28 Islamic financial institutions licensed and active in Bahrain, including 6 full commercial banks, 15 investment banks, and 3 off-shore banking units. - The financial sector is open to foreign investors with no restrictions regarding foreign ownership of financial institutions. - Most financial institutions are privately owned. - Cross-sectoral activities remain limited; no financial conglomerates operate in Bahrain. ### The BMA (Bahrain Monetary Agency) - Roles and legal framework: - The BMA is the central bank with responsibilities for monetary and exchange rate policy, management of international reserves, fiscal agency for the government, supervision of the entire financial system and the payments system. - The BMA Law grants wide discretionary powers in use of monetary instruments, issuing regulations, and taking enforcement actions. - The law stipulates the fixed exchange rate of the BD against the U.S. dollar, and a requirement that international reserves exceed currency in circulation. - Operational details: - The BMA stands ready to buy or sell BD liquidity on demand at the official buy and sell rates BD 0.375 and BD 0.377 per U.S. dollar, respectively, which it has maintained since 1980. - Under quasi-currency board arrangements, demand for BD liquidity is fully accommodated by foreign reserves variations and consequent base money variations. - Available monetary policy instruments include primary issuances of conventional and Islamic government securities, repo facilities, an overdraft facility, and secured loan facilities against BD bank deposits. - Reserve requirement: Banks are required to maintain 5 percent of end-of-month BD deposits (including unrestricted investment accounts in Islamic banks) in unremunerated reserves at the BMA; reserve balances must be maintained continuously throughout the subsequent month. - Reserves can be allowed to fall to three quarters of currency in circulation in exceptional circumstances and with the permission of the Council of Ministers. ### Banking system structure and concentration - Bank categories and BD business permissions: - Full Commercial Banks (FCBs): - Carry out all retail and other commercial banking activities in BD and any other currencies with residents and nonresidents of Bahrain, subject to conditions agreed with the BMA. - Both Bahraini-owned and foreign banks operate as FCBs. - Off-shore Banking Units (OBUs): - May undertake all banking activities with nonresidents. - Unless agreed with the BMA, activities must be in foreign currency, except for normal business operations’ requirement. - OBUs may not deal with residents of Bahrain other than the Government of Bahrain and its agencies, and with licensed banks. - With specific BMA approval, a bank may participate in domestic development projects. - Banks with Investment Bank Licenses (IBLs): - May deal in foreign currency with nonresidents and with other banks in Bahrain. - May undertake investment and merchant banking activities directed toward securities’ business (mergers and acquisitions, bond issues, underwriting, financial advice), subject to BMA conditions. - Loans and advances, but no overdraft, may be made to nonresidents. - IBLs may take deposits only from nonresidents and only in foreign currency, or from BMA-licensed banks; in certain cases, with BMA permission, dealing may be undertaken with nonbank residents. - Market concentration and growth: - Assets concentrated among a few players: - Top five OBUs and two IBLs account for more than 75 percent of the total assets in the respective sub-sectors. - Growth: - Number of institutions has been growing; many small players active. - Consolidated assets of Islamic banks grew from US$3.2 billion at end–2000 to US$6.1 billion at end-2004. - Structural notes: - Some banking groups hold several different licenses (e.g., OBU parent of an IBL and an FCB). - Some foreign OBUs have Islamic subsidiaries or windows. - State ownership: - Two state-owned specialized banks: the Housing Bank and the Bahrain Development Bank, established by legislation. - Public sector holds majority ownership of one of the two large conventional FCBs (with about a 30 percent share of the on-shore market). - Government owns minority stakes in several banks; no recent evidence of government intervention in commercial decisions among non-specialized banks. - Some foreign governments own shares in certain institutions. ### Insurance sector details - Scale and composition: - On-shore insurance industry collects on average slightly under 3 percent of GDP in gross premiums annually. - General insurance accounts for some three-quarters of total domestic insurance underwritten. - Motor insurance accounted for 38 percent of the total in 2004. - Life products for on-shore companies accounted for 32 percent of total gross premiums. - Total assets of domestic insurance companies reached US$1.9 billion at end-2004. - Investments reached US$1.2 billion (10.9 percent of GDP). - Takaful: - Demand for Islamic insurance growing especially strongly. - Two on-shore takaful companies operate under Islamic principles. - Takaful insurers offer general and family takaful and follow: - Al Wakala model for underwriting operations (imposing a set fee to cover the management). - Al Mudharaba model for investment activities of the takaful fund. - Off-shore insurance: - At end-April 2005 comprised 73 companies: 57 insurance firms, 14 insurance brokers, and 2 insurance consultants. - Off-shore companies mainly offer insurance products in Saudi Arabia but must have functioning offices in Bahrain. - Off-shore companies may relocate to Saudi Arabia following promulgation of an insurance law there; BMA withdrew several licenses in 2005. - Outcome of relocation process depends on completion of regulatory changes in Saudi Arabia. ### Securities markets and payment/settlement systems - Bahraini Stock Exchange (BSE): - Began operating in 1989. - Market valuation grew by some 40 percent, exceeding US$13.5 billion, or 130 percent of GDP in 2004. - Daily turnover low: average of 70 to 100 daily trades worth about US$1.8 million. - Listings comprise 46 companies, 25 mutual funds, and 20 Bahraini government corporate bond issues (including sukuks). - Trading through 13 exchange member brokers with combined capital of US$207 million. - Uses automated quote system and modern settlement ensuring delivery versus payment on a T+2 basis. - Empirical evidence: - Local stock market index highly correlated with other stock market indices in the region. - Econometric evidence suggests the market is informationally efficient relative to others in the region. - Core investor base composed of large institutional investors, including pension funds, which usually follow buy-and-hold strategies, reducing free float and contributing to low trading volume. - Payment systems: - Fund Transfer System (FTS): - Operated directly by the BMA; main payment system in Bahrain. - Based on clearing accounts at the BMA of on-shore FCBs (the only direct participants). - Operates only in BD; fully automated; uses SWIFT standards; settles on a multilateral net basis at end of day. - Large-value checks over BD 10,000 are settled directly on a gross basis through the FTS. - Total settlement in the FTS is ten-fold that of the checking clearinghouse. - Central Securities Depository and Registration (CSDR): - Functions as internal department of the BSE. - Corporate shares must be deposited at the CSDR to be traded at the BSE. - Individual accounts exist for each investor at the CSDR. - No principal risk: securities transactions settled on delivery versus payment basis; securities are blocked until final settlement on T+2. - Liquidity risk remains because cash leg settles on a multilateral net basis on T+2. - Liquidity risk mitigation: - Guarantee fund for settlement financed with contributions from broker-dealers. - Limits on settlement obligation any broker may accrue in one day: currently set at BD 1,000,000. - If a broker exceeds the limit, it must deposit 30 percent of the excess by 9:30 a.m. on T+1. *Source: _cr0691 - 54. Under the integrated licensing framework, off-shore banks are expected to be allowed* ### 82. This appendix describes the methodology and results of the stress tests that were ### Appendix II — Stress tests: methodology and results ### Coverage — institutions and risks - Institutions covered: - Sample includes locally incorporated banks on a worldwide consolidated basis (including all domestic and overseas subsidiaries of the locally incorporated parent). - Conventional segment: eleven locally incorporated separate legal entities — four FCBs, three OBUs, and three IBLs. The sample represents approximately 40 percent of the assets of all conventional banks, including the large foreign OBUs. - Islamic segment: ten locally incorporated separate legal entities — two FCBs, one OBU and seven IBLs. The sample represents over 85 percent of the assets of all Islamic banks. - Data are as of end-2004. All results presented are in millions of U.S. dollar. - Risks considered: - Credit risk, market risk, liquidity risk, and the significance of interbank contagion. - Shocks calibrated with reference to historical events: the first Gulf War, the drop in oil prices during the 1990s, September 11, 2001, and the second Gulf War. ### Methodology - General approach: - Same shocks applied to all banks (Islamic and conventional, on-shore and off-shore, investment banks and full commercial banks) to identify relative vulnerabilities. - Losses from shocks translate immediately into equity capital and, as applicable, risk-weighted assets. Banks assumed to have no profitability buffers. - Treatment of Islamic banks: - Attention to distribution of losses between bank shareholders and holders of unrestricted investment accounts (URIA) and restricted investment accounts (RIA). - Two extreme cases for each shock: - No DCR / investment account holders bear all losses (bank shareholder equity fully shielded). - Full DCR / bank held fully liable as guarantor (bank bears losses). - Regulatory capital measured following AAOIFI guidelines: a 50-percent credit conversion factor applies against assets financed by URIA and RIA holders. - Implicit interest rate risk for Islamic banks not quantified due to lack of data; scenarios place a higher burden on conventional banks. - Liquidity measurement: - Focused on stock of cash and balances with the central bank, marketable securities, and short-term placements to satisfy liquidity needs. Absolute liquidity levels should be interpreted with caution. ### Shocks (calibrations) - Credit risks: - Credit shock 1: A five percentage-points increase in the loan-to-assets ratio. All additional lending categorized as ‘standard’. - Credit shock 2: Asset quality deterioration according to transition matrix (share of column migrating to row). Transition matrix (each cell = percent): - Standard → Standard 90 - Standard → Substandard 4 - Standard → Doubtful 4 - Standard → Loss 2 - Substandard → Standard (blank) 90 - Substandard → Substandard (blank) (matrix as printed: Substandard row shows "4 90") - Doubtful → Standard 4, → Substandard 7, → Doubtful 90 - Loss → Standard 2, → Substandard 3, → Doubtful 10, → Loss 100 - Provisions charged at: 0 percent for standard, 20 percent for substandard, 50 percent for doubtful, and 100 percent for loss. - Credit shock 2 applied after Credit shock 1. - Market risks: - Interest rate shock 1: Parallel upward shift in the yield curve of 200 basis points (bps.) on net interest income at the three-month horizon. - Interest rate shock 2: Parallel upward shift of 200 bps. on net interest income at the one-year horizon. - Interest rate shock 3: Parallel upward shift of 200 bps. on the entire debt securities portfolio, assuming an average duration of 2.5 years. - Interest rate shock 4: Parallel upward shift of 200 bps. on the hold-to-maturity portfolio of fixed-rate debt securities, using residual maturity buckets (1-3 years, 3-5 years, ..., 13-15 years, over 15 years). Applied to conventional banks for which data were available. - Equity price shock: A 30-percent decline in worldwide equity prices, applied to both listed and unlisted equities. - Foreign exchange rate shock: A 20-percent appreciation and depreciation of the bilateral rates between the US dollar and the euro, and between the US dollar and the British pound (focus on cross-rates). - Interbank contagion: - Interbank contagion 1: For each bank individually, default on its largest single exposure to an interbank borrower in the sample; exposure assumed loss with 100 percent provisioning. - Interbank contagion 2: For each bank, default on its outstanding exposures to interbank borrowers in the sample where default follows endogenously from banks whose CAR falls below zero. - Contagion channel considered only among sample banks; exposures to other entities not captured. - Liquidity shocks: - Liquidity shock 1: Structural liquidity outflow of 10 percent of all qualifying liabilities, except interbank liabilities which suffer a 50 percent outflow. - Liquidity shock 2: Liquidity shock 1 plus a 30 percent price decline for listed equity securities. - Liquidity shock 3 (conventional banks only): Liquidity shock 2 plus a decline in the mark-to-market value of all listed debt securities (trading, available-for-sale, and hold-to-maturity). ### Scenarios - Basic scenarios: - Scenario 1 (Boom and bust): Credit shock 1 and Credit shock 2 applied simultaneously — calibrated to a boom in domestic credit growth followed by collapse and drastic deterioration in credit quality. - Scenario 2 (World recession): Credit shock 2 + Interest rate shock 2 + Interest rate shock 3 (or shock 5 if shock 6 data unavailable) + Interest rate shock 4 (where available) + Equity price shock applied simultaneously. - Interbank contagion scenarios tied to Scenario 2 as described above. ### Results — sensitivity analysis and scenarios - General: - Stress tests are partial equilibrium exercises and ignore institutions’ reactions to shocks. - Results provide vulnerability assessment as of end-2004. - Conventional banks — capital and risk sensitivity: - Initial CARs (in percent): - FCBs 23.9 - IBLs 25.1 - OBUs 19.1 - Total 20.7 - Reduction in CAR due to (ppts): - (1) Credit shock 1: -2.0, -1.3, -1.4, -1.5 (Average impact / Largest impact as in table) - (2) Credit shock 2: -5.2, -0.2, -2.9, -2.6 - (3) Interest rate shock 1: -0.1, -0.2, 0.6, 0.4 - (4) Interest rate shock 2: 0.1, -0.2, 0.9, 0.6 - (5) Interest rate shock 3: -1.2, -0.7, -2.2, -1.9 - (6) Interest rate shock 4: -0.2, 0.0, ... ,0.0 - (7) Equity price shock: -1.2, -14.5, -1.2, -3.2 - (8) Foreign exchange rate shock: 0.0, 0.1, 0.1, 0.1 - Scenario impacts (ppts): - (9) Boom and bust: -9.4, -1.8, -5.0, -5.0 - (10) World recession: -10.0, -16.2, -6.3, -8.2 - Interbank contagion impacts: - (11) Interbank contagion 1: -3.7, 0.0, -0.5, -0.7 - (12) Interbank contagion 2: 0.0, 0.0, 0.0, 0.0 - Resulting CAR minimum levels: - After (10) and (11): 10.3, 8.9, 12.4, 11.9 - After (10) and (12): 13.9, 8.9, 12.9, 12.5 - Key observations: - Conventional banks in the sample are strongly capitalized but heterogeneous. - Credit shocks are pronounced in absolute terms but small relative to high capital bases; FCBs most affected. - Interest rate flow effects (Interest rate shock 1 and 2) are small; about half of banks experience positive effects due to faster re-pricing of assets. - Interest rate valuation effects (Interest rate shock 3) could cause the system to lose up to 2 percent of its equity base. - Equity price risk important for many banks, particularly OBUs and IBLs; cross-currency foreign exchange risk negligible. - Islamic banks — capital and risk sensitivity (no DCR and full DCR cases): - Islamic banks are strongly capitalized in part because assets financed by URIA and RIA attract lower risk weights. - Credit shocks: - Impact of credit shocks is small relative to capital base under no DCR; in full DCR the impact becomes large for certain banks but generally capital buffers absorb individual shocks. - Market risks: - Equity price shock more pronounced, particularly for Islamic IBLs. - Under no DCR, one investment bank shows large losses, but overall banks can withstand the shock. - Under full DCR, potential losses are substantial for most Islamic banks, suggesting significant exposure to equity price risk on behalf of investment account holders. - Foreign exchange cross-rate movements generally limited, with exceptions for banks with large open positions. - Scenario results (conventional banks): - Scenario 1 (Boom and bust) sharply reduces capital bases of many conventional banks; only a few would fail to meet regulatory requirements. - FCBs are particularly affected by rapid credit growth followed by rapid asset quality deterioration due to their higher exposure to lending. *Source: Appendix II — stress testing methodology and results, Bahrain FSAP (data as of end-2004).* ### 111. A world economic recession (Scenario 2) has the potential to decapitalize a wider ### _cr0691 - 111. A world economic recession (Scenario 2) has the potential to decapitalize a wider ### Stress testing results — Islamic banks - Initial CAR: 39.1 25.9 27.9 39.1 25.9 27.9 - Reductions in CAR due to (ppts): - (1) Credit shock 1: 1/-2.5-1.3-1.4-2.5-1.3-1.4-2.6-2.6 - (2) Credit shock 2: 2/-1.3-0.8-0.9-3.8-2.9-3.1-1.9-10.1 - (3) Equity price shock 3: /-2.2-3.4-3.2-6.8-11.2-10.4-9.2-30.3 - (4) Foreign exchange rate shock 4: /0.31.81.60.31.81.60.00.0 - Scenarios: - (5) Boom and bust 5: /-3.8-2.1-2.4-6.1-4.1-4.4-3.0-11.0 - (6) World recession 6: /-3.7-4.4-4.3-11.1-14.7-14.1-11.6-41.2 - Interbank contagion: - (7) Interbank contagion 1: 7/-7.0-1.5-1.9-7.8-1.7-2.1-28.9-48.6 - (8) Interbank contagion 2: 8/0.00.00.0-8.80.0-1.40.00.0 - Resulting CAR: - After (6) and (7): 28.3 19.9 21.7 20.1 9.5 11.6 5.4 -59.2 - After (6) and (8): 35.3 21.4 23.5 19.1 11.2 12.4 13.9 -10.6 - Notes/assumptions: - 1/ A 5 percentage points increase in the receivables-to-assets ratio. - 2/ An asset quality deterioration according to transition matrix (c.f. text). - 3/ A 30 percent decline in equity prices. - 4/ A 20 percent depreciation of bilateral rates. - 5/ Scenario 1 = (1) + (2). - 6/ Scenario 2 = (2) + (3). - 7/ Given default on largest single interbank exposure, excluding credit to group entities. - 8/ Given actual default by all banks that fail, excluding credit to group entities. - Key findings: - Islamic banks seem well-protected against the boom and bust scenario (Scenario 1) due to high capitalization and limited involvement in risky lending activities; "No bank breaches prudential capital requirements." - If losses from a world economic recession are distributed to investment account holders (Scenario 2), Islamic banks appear well-protected; if owners deplete equity to smooth returns or due to operational risk, "two isolated cases would face capital problems," driven almost entirely by an equity price shock (30 percent decline), which reduces economic value of listed and unlisted equities and may only become apparent if banks are forced to sell assets. ### Interbank contagion - Conventional banks: - Loss given default on the largest interbank exposure (Interbank contagion 1) could be significant, especially for FCBs that place interbank funds with other sample banks. - Correcting for the likelihood such losses materialize given the applied macroeconomic shocks reduces effects (Interbank contagion 2); stress tests did not produce actual bank failures, so chances of default on interbank loans are considered minimal. - Islamic banks: - Losses given default on largest interbank exposures are a source of vulnerability (Interbank contagion 1). - Islamic banks have been active in placing interbank funds with conventional banks on a commodity murabaha basis. - Under full displacement, a few banks would become insolvent; if failures occur under full displacement and defaults on interbank obligations happen, "especially the FCBs would loose a significant amount of their capital base" (Interbank contagion 2). ### Liquidity risk and stress testing results (Table 5c) - Conventional banks — Initial LAR: 25.5 44.9 47.3 44.1 - Reduction in LAR due to (ppts): - (1) Liquidity shock 1: 1/-14.8-8.5-20.0-17.9-17.3-19.2-24.7 - (2) Liquidity shock 2: 2/-15.6-16.5-20.3-19.2-17.7-21.9-25.0 - (3) Liquidity shock 3: 3/-16.1-16.5-21.7-20.3-18.0-22.0-26.1 - Total shortage of liquidity after (3): 004,5754,575 0.004,575 (in thousands of U.S. dollars) - Islamic banks — Initial LAR: 16.6 26.0 - Reduction in LAR due to (ppts): - (1) Liquidity shock 1: 1/-4.8-13.9-8.0 - (2) Liquidity shock 2: 2/-8.1-17.1-8.1 - Total shortage of liquidity after (2): 070,1200 (in thousands of U.S. dollars) - Notes/assumptions: - 1/ 10 percent liquidity outflow for all qualifying liabilities, except for bank liabilities that suffer a 50 percent outflow. - 2/ Cumulative effect of (1) and a 30 percent decline in listed equity securities. - 3/ Cumulative effect of (2) and a decline in the mark-to-market value of all listed debt securities, due to a 200 bps parallel increase in the yield curve. - 4/ Assuming no DCR. - Key findings: - The three liquidity shocks cause progressive deterioration in banks' liquidity positions; initially comfortable positions can be eroded quickly. - Largest changes occur with OBUs dependent on potentially volatile wholesale funding. - For Islamic banks, impact is more heterogeneous; largest reduction among OBUs and IBLs in event of outflows from demand deposits and investment accounts and reduction in marketable value of listed equity securities. ### Summary assessment — Compliance with the Basel Core Principles for Effective Banking Supervision (BCP) - Assessment context and timing: - The assessment was part of the FSAP mission during April-May 2005; assessments were undertaken from 24 April to 7 May 2005. - Laws, regulations and policies in force at time of assessment included: BMA Law 1973, Commercial Companies Law 2001, BMA Rulebook volumes on conventional and Islamic banks; references made to draft Central Bank of Bahrain Law (CBBL) and Consultative Papers. - Institutional and market overview: - Bahrain: small but comparatively well diversified economy; maintains a tight peg to the U.S. dollar; no exchange controls or restrictions on capital movements. - End-2004: over 300 financial institutions in operation. - Banking system categories: Full Commercial Banks (FCBs); Investment Banking License institutions (IBLs); Off-Shore Banking Units (OBU). - Islamic sector growing; Islamic securities (sukuks) issued by government and corporations. - Capitalization generally strong; sector profitable; deposit insurance scheme in operation. - BMA is single financial sector regulator since 2002; BMA Rulebook volumes issued for conventional and Islamic banks; passage of CBBL awaited; licensing system review intended to move to new system in 2006. - Preconditions for effective supervision: - Legal and institutional arrangements broadly satisfactory for bankruptcies and liquidations; need for more financial expertise among judges and possible specialized courts. - Corporate accounting follows International Accounting Standards; conventional institutions follow International Financial Reporting Standards (IFRS); Islamic institutions follow AAOIFI standards. - Clearing, payments, and settlement system efficient and reliable. - Main findings: - Banking supervision in Bahrain meets high standards; compliance with BCP is strong, especially in areas most relevant to current banking activities. - System needs refinement in several respects to keep regulations and supervision up to date with more sophisticated bank operations. - Objectives, autonomy, powers and resources (CP 1): - BMA Law provides adequate powers but has weaknesses: does not define BMA's objectives in detail; BMA independence limited by requirement to obtain MOF approval in key areas; BMA's sanctioning powers beyond suspension/cancellation not detailed. These weaknesses expected to be addressed in CBBL. - BMA is increasing number and quality of supervisory staff; significant supervisory challenges ahead (integration into single regulator, implementation of Basel II, growth in complex products); importance of competitive remuneration to retain experienced supervisors. - Licensing structure (CPs 2-5): - Under BMA Law 1973, banking and scope of regulated activities not clearly defined, creating difficulties fitting some institutions into licensing framework. - BMA proposals for an integrated framework nearing completion with target implementation by end of year. - Licensing process would benefit from clearer procedures and emphasis on corporate governance provisions (currently consultation status in Rulebook). - Recent BMA proposals regarding major acquisitions and investments by banks aim to improve capital treatment and clarify "close links" provisions. - Prudential regulations and supervision (CPs 6-15): - Capital adequacy rules generally conform to Basel standards and include a capital charge for market risk. - For Islamic banks, BMA requires adoption of AAOIFI recommendations on computation of capital adequacy, recognizing risk undertaken by investment holders. - Minimum capital adequacy requirements are monitored on solo and consolidated basis and are above the Basel minimum. - Suggested: a framework to stress test capital adequacy would provide additional supervisory comfort. - Credit risk management: BMA prescribes rules including board policies on large exposures and connected lending; loans to connected parties from conventional banks not strictly required to be on non-preferential terms. - Banks required to adopt IFRS for loan impairment and provisioning; external auditors largely responsible for ensuring adequacy of loan loss provisions and review bank risk management systems. - Liquidity risk controlled through a 25 percent liquid asset requirement. - BMA monitors compliance via on-site exams and quarterly prudential information reports verified by external auditors; supervision could extend prudential analysis to banks' individual country risk exposures. - Off-site supervision unit established to oversee Islamic banks; need to continuously enhance risk measurement framework for Islamic banks amid ongoing innovation. - BMA intends to issue "High Level Controls Environment" (currently under consultation) to set minimum standards and best practice for locally incorporated banks, including establishment/composition/role of board committees (nomination, remuneration, board risk management, and audit committees) and definition of independent committees. *Sources: BMA; and IMF staff estimates.* ### 136. The BMA has been active in ensuring that banks have adequate policies and ### _cr0691 - 136. The BMA has been active in ensuring that banks have adequate policies and ### AML/CFT and "Know Your Customer" - The BMA has been active in ensuring that banks have adequate policies and procedures on “know your customer.” - The BMA had implemented AML/CFT requirements, and in April 2005 further updated requirements in line with the June 2003 revisions to the FATF 40+ 9 Recommendations. - The Compliance Unit in the BMA: - monitors banks’ compliance with the AML regulations, - receives copies Suspicious Transaction Reports, - conducts follow-up to re-assess the adequacy of the relevant bank’s AML compliance system. ### Methods of on-going supervision (CPs 16-20) - The BMA undertakes off-site and on-site supervision, supplemented by “reporting accountants” arrangements for detailed information on specific issues. - Risk assessment and inspection prioritization: - Based on a risk profiling system to prioritize on-site inspections. - Consolidated supervision: - Arrangements are satisfactory, but closer attention might be given to overseas operations of Bahraini banks outside major markets. - System-wide monitoring: - Generally comprehensive and high quality approach to on-going supervision. - Monitoring and analysis of overall trends in the banking system could be enhanced. - The growing number of licensed banks puts strain on supervisory capacity. ### Information requirements (CP 21) - Locally incorporated banks are required to publish annual audited accounts. - No specimen bank model is prescribed by the BMA for publication of annual audited statements, but banks must prepare audited accounts in accordance with the IFRS. - Disclosure requirements: - The requirement for disclosure are the same for all locally-incorporated banks, whether FCBs, IBLs, or OBUs. - The minimum disclosure requirements prescribed by the BMA for Islamic banks are not as extensive as for conventional banks. - External auditors: - Required to review and report on the bank’s risk management and risk exposures. - Must be approved by the BMA and are drawn from the big international audit firms. - Have access to the BMA by law and frequently report to the BMA on issues requiring attention. - Approval by the BMA is required for declaration of dividend distributions. - BMA officers are required by law to keep confidential certain types of information. ### Remedial Measures (CP 22) - The BMA’s authority to take remedial actions is prescribed in the BMA Law and set out in the Enforcement Module of the Rulebook. - The future CBBL will give the BMA a wider range of explicit enforcement powers, particularly to give directions and impose penalties. ### Cross-border banking (CPs 23-25) - Information sharing and supervision: - The BMA has authority to share information needed by the home country for consolidated supervision. - Branches of foreign banks are subject to similar regulations as locally incorporated banks (with variations in capital, large exposures and disclosure requirements). - The BMA has authority to supervise the foreign branches/subsidiaries of locally incorporated banks. - Limitations: - The BMA does not conduct on-site examination of overseas units and relies on: - discussion with head office in prudential meetings, - external auditor's reports, - submissions of returns, - visits to the host supervisors. - Information sharing activity: - The BMA actively pursues information sharing with regulators from the GCC and one other foreign regulator. - Given Bahrain’s position as a financial center, there is room for more extensive information sharing arrangements with other regulatory authorities. ### Recommended action plan to improve compliance with the Basel Core Principles - Core Principle 1 — Objectives, Autonomy, Powers and Resources: - Adoption of the draft CBBL would enhance the autonomy of the BMA and clarify its legal powers. - More formal arrangements for assessing the BMA’s performance against its objectives are recommended. - Public disclosure of such an assessment and other information about the BMA’s activities would enhance transparency and accountability. - Removal of the current requirement for prior approval of the Ministry of Finance in certain areas such as licensing and budget is recommended; adoption of the draft CBBL would achieve this. - A minimum term of office for the Governor should be specified in law. - Legislation should specify possible grounds for the removal from office of the Governor and a requirement to publish grounds in that event. - The BMA should maintain its effort to further increase the number and quality of its supervisory staff; increased flexibility over salary scales is needed to recruit staff with appropriate banking experience and skills. - Legal powers specifying a more clearly elaborated range of sanctions is recommended; adoption of the draft CBBL would help achieve this. - While legal protection is currently provided generally for government employees via the Civil Code, specific protection for BMA staff exercising their duties in good faith is recommended; adoption of the draft CBBL would achieve this. - Assurances regarding protection of BMA staff against the cost of defending their actions while discharging their duties are recommended. - Procedures manuals on information sharing and confidentiality should be finalized and implemented. - Core Principle 2 — Permissible activities: - The new licensing framework proposed by the BMA should be adopted as soon as possible to clarify the definition of regulated activities. - Core Principle 3 — Licensing criteria: - Continue priority on corporate governance initiatives to establish best practice on responsibilities, qualifications and independence of directors. - Detailed internal policies and procedures for processing license applications are recommended. - Core Principle 4 — Ownership: - Develop criteria for judging whether to approve proposed changes in significant ownership. - Core Principle 5 — Major acquisitions and investments: - Establish explicit criteria for assessment and treatment of major acquisitions and investments, especially pre-approval of major investments in nonbank enterprises. - Core Principles 9, 11, 12, 13 — Large exposure, country risk, market risk, other risk: - Continue efforts to build up adequate skill and resources for on-site supervision to enhance assessment of banks’ information systems and risk management. - Further develop framework for interest rate (rate of return) risk in the banking book and liquidity risk management (for the conventional banks). - Core Principle 10 — Connected lending: - Extend requirement that loans to connected parties be at arm’s length and on non-preferential terms to conventional banks. - Make Board approval a mandatory precondition for granting a loan to a connected party. - Core Principle 14 — Internal control and audit: - Establish a high level control environment to facilitate effective board oversight (e.g., establishment of board committees and definition of independent directors), taking into account nature and scale of business operations. - Core Principle 15 — Money laundering: - Legislation needs to contain provisions ensuring the BMA can share all relevant information, even when not directly related to the BMA’s responsibilities. - The BMA needs to make efforts to implement effectively all new provisions in this area. - Core Principle 16 — On-site and off-site supervision: - Maintain efforts to further enhance the number and quality of on-site and off-site supervisory staff. - Core Principle 17 — Bank management contact: - Extend contact with banks’ management to regular contact with members of banks’ boards. - Core Principle 20 — Consolidated Supervision: - All overseas operations of subsidiaries and branches of Bahraini banks should be given due attention in consolidated supervision. - Core Principle 22 — Remedial measures: - A wider range of explicit enforcement powers is recommended; adoption of the draft CBBL would provide for this. - Core Principles 23, 24, 25 — Global consolidated supervision, host country supervision and supervision over foreign bank establishments: - Give greater attention to global consolidated supervision of large locally incorporated banks, including nonbank activities and information sharing with host supervisors. - For foreign bank establishments, conduct periodic assessments of the home country supervisor’s practices in consolidated supervision. ### Authorities’ response to the assessment - The BMA: - welcomes the assessment that banking supervision in Bahrain meets high standards and that compliance with the Basel Core Principles is strong, particularly in areas relevant to current bank activities in Bahrain. - endorses the findings, most of which cover areas already identified for further strengthening. - will continue on-going efforts to develop banking supervision capabilities and believes these will substantially address the points raised over the next 12-18 months. - Legislation and timing: - Several findings (Core Principles 1, 15, and 22) relate to the BMA Law; its replacement, the draft CBBL, is before parliament and would address most of these. - The BMA and Government cannot prejudge adoption timing; it is hoped the legislative process will be completed by mid-2006 at the latest. - Regulatory initiatives and timelines: - New integrated license framework (Core Principles 2 and 3): draft regulations are advanced and expected to be introduced in early 2006 after final industry discussion. - Existing rules on major acquisitions and investments are being reviewed as part of the Basel II project; proposals to be finalized over the course of 2006. - Liquidity requirements to be revisited as part of the 2006 work plan; other minor updates to the BMA Rulebook to be addressed during 2006 via routine quarterly updates. - Resourcing and IT: - Senior management recognizes need to ensure adequate resourcing of supervisory functions; some improvements already achieved via hiring staff with industry experience and an overall increase in numbers. - Plans to develop a more capable IT infrastructure over the next 2 years, ultimately delivering full data warehousing capabilities and more automation of data retrieval and assessment. ### Insurance sector — summary assessment and main findings - Assessment basis: - Regulation and supervision assessed relative to the IAIS Insurance Core Principles and Methodology issued October 2003, as part of the FSAP assessment for Bahrain. - Assessment drew on laws/regulations, a self assessment by the Insurance Directorate at the BMA, interviews and meetings with industry participants, and review of marketing documents and insurance contracts. - Institutional and macroprudential overview: - Bahrain is a middle-income country, closely integrated with GCC neighbors; growth rates in recent years have been high; exchange rate tightly pegged to the U.S. dollar. - Bahrain has emerged as a major regional financial center with over 300 financial institutions. - On-shore insurance sector (at end–April 2005): - 22 licensed insurance companies (of which 12 were locally incorporated; not all licensees were yet operational), - 30 insurance brokers, - 7 insurance consultants. - Two on-shore companies operate under Islamic principles (takaful). - The on-shore insurance industry collects on average slightly under 3 percent of GDP in gross premiums annually. - General insurance accounts for some three-quarters of total domestic gross premiums. - Motor insurance accounts for about half of all non-life business. - Life products for on-shore companies accounted for a fifth of total gross premiums. - Total assets of domestic insurance companies reached US$2 billion at end–2004, and investments reached US$1.2 billion (10.9 percent of GDP). - Off-shore insurance sector (at end–April 2005): - 73 companies, including 57 insurance firms, 13 insurance brokers, and 3 insurance consultants. - Total gross premiums for the off-shore sector was in excess of US$1 billion in 2003. - Off-shore companies may relocate to Saudi Arabia following promulgation of an insurance law; BMA withdrew licenses of 10 off-shore companies in March and April 2005, with more licenses withdrawn subsequently. - Financial condition and activities: - Insurance companies are mostly well-capitalized and generally profitable, though return on equity has been moderate due to high capitalization and limited remunerative investment vehicles for some companies (especially takaful). - Some companies offer reinsurance domestically on a small scale, with significant use of reinsurance from abroad. - Supervisory structure: - The BMA is the insurance supervisor; the Insurance Directorate handles majority of supervisory tasks. - Licensing conducted by the Licensing and Policy Department; on-site inspections by the Inspection Department; the Compliance Unit handles AML/CFT regulation and supervision. - Legal and regulatory framework: - Key instruments include Amiri Decree No. 3 of 1987, Amiri Decree No. 17 of 1987 (the Insurance Law), The Law Establishing the Monetary Agency of Bahrain of 1973 (the BMA Law), and the Amendment to the Insurance Law, 2002. - In early May 2005 the BMA issued a Rulebook containing a comprehensive set of insurance regulations, substantially more rigorous than previous regulations. - Transition and implementation challenges: - Assessment undertaken during a period of transition with significant regulatory changes and introduction of new Islamic insurance products. - Immediate outstanding challenge: full and effective implementation of the Insurance Rulebook given BMA resources. - General preconditions for effective supervision: - Economic stability, supporting infrastructure, legal system, company and insolvency laws, and accounting standards (IAS/IFRS and AAOIFI for Islamic institutions) are broadly adequate. - Identified need: more judicial expertise in financial matters and establishment of dedicated commercial courts for timelier judgments. *Source: IMF staff assessment content provided in the supplied document excerpt.* ### 158. The BMA has responsibility for the regulation and supervision of the entire financial ### _cr0691 - 158. The BMA has responsibility for the regulation and supervision of the entire financial ### Supervisory mandate and legal powers - The BMA has responsibility for the regulation and supervision of the entire financial system, and its objectives are clearly stated. - It is not formally fully independent, although in practice it operates with considerable autonomy. - The BMA has extensive powers established by law, on which basis it has promulgated comprehensive, detailed regulations. - The BMA has powers to license all relevant institutions, verify compliance with the regulations through on-site and off-site supervision, and to impose sanctions. ### Ongoing supervision and Rulebook implementation - The Rulebook sets out how the BMA will conduct its functions, and it describes a clear, transparent and consistent regulatory process. - The BMA conducts on-site and off-site supervision, and market analysis. - At the time of the assessment, the BMA had conducted few on-site supervisory visits, and had limited staff resources available for off-site insurance supervision and market analysis. - The data management challenges created by the more extensive reporting requirements will themselves take some time to be sorted out. - It is therefore critical that the promulgation of the Rulebook is followed up with training and strengthening of staff. ### Cross-border cooperation and information exchange - The BMA has in place or is about to finalize several bilateral exchange of information agreements with supervisors in other countries. - Given Bahrain’s role as a financial center, it is important that the BMA continue to strengthen cooperation with supervisors from the home countries of the insurers that are operating branches in Bahrain. - The BMA law provides satisfactory exemption from the confidentiality requirements to allow closer cooperation with foreign supervisors, but the rules on the BMA’s right to cooperate and assist other foreign supervisors need to be stronger and clearer. ### Fronting and licensing concerns - There have reportedly been instances where a domestic insurer “fronts” for foreign insurers; the foreign insurers is effectively selling insurance and the local insurer is effectively a broker. - The Rulebook recognizes the concern, and warns companies that the BMA will scrutinize closely the management by firms of the risks associated with possible fronting. - The BMA should determine whether foreign re-insurers under fronting arrangements with domestic insurers in reality are insurers that need to be licensed. - The BMA should include in its on-site inspection procedures the identification of “fronting,” evaluating attendant risks, and giving appropriate guidance to the companies concerned (including possibly advice on how to end the practice). - The guidance in the Rulebook could be redrafted to make clear that the BMA does not condone “fronting.” ### Enforcement, insolvency priority, and prudential toolkit - Primary legislation (the Insurance Law and the BMA Law) does not set out preventive or corrective powers in much detail, but BMA’s general power to regulate and to withdraw the license is accepted as satisfactory authority to impose specific actions. - The Rulebook lays out a broad range of enforcement measures available, including issuing directions and putting the insurance licensee under administration. - The BMA has the legal power to withdraw the license from an insurer should certain conditions obtain, but the protection of the rights and entitlements of policyholders and other policy beneficiaries in case of insolvency are not given priority in primary legislation. - Passage of the CBBL will further strengthen the legal basis for enforcement action. ### Prudential requirements and supervisory priorities - With the promulgation of the Rulebook, the BMA has provided the insurance industry with satisfactory regulations in most areas. - The most demanding rules include: - corporate governance for insurers; - insurer’s regular reporting requirements to BMA; - the risk management measures that must be implemented by insurers; - the new prudential requirements involving calculation of the insurer’s liabilities; - investment standards; and - the capital adequacy rules. - The BMA expects that supervision in these areas will intensify following the promulgation of the Rulebook. - The legal framework does not contain substantial regulation regarding use of derivatives because the insurance industry did not now use financial derivative instruments. - It is anticipated that use of financial derivatives could begin in the future, so regulations on the use, accounting, and transparency of derivatives should now be developed. - Although currently no true financial conglomerate operates in Bahrain, and the structure of groups of insurance companies is relatively straightforward, the BMA needs to further develop procedures and requirements for consolidated and group supervision and ensure sufficient resources to implement these. ### Markets, consumer protection, and reporting - The Rulebook requires insurers to have in place strategic underwriting, re-insurance and pricing policies approved and reviewed by its Board of Directors. - The BMA must continue to strengthen the supervision in these areas, ensuring that each insurer has a clear strategy to mitigate and diversify risks (including re-insurance risk), and a methodology to set premiums on reasonable assumptions to enable the insurer to meet its commitments. - Bahraini insurance firms are required to publish comprehensive audited, annual reports. - The Rulebook provides rules for valuation of liabilities based on sound accounting and actuarial principles, which the BMA has power to review and amend. - The sufficiency of technical provisions is yet not systematically reviewed by the BMA itself, which so far has relied entirely on the reports of companies’ external auditors. - The Rulebook requires that insurers and intermediaries act with due skill, care and diligence in dealing with consumers, and to have policies on how to treat consumers fairly and provide training to ensure compliance. - The Rulebook requires insurers and intermediaries to ensure high standards of integrity of their business; the Rulebook addresses insurer fraud, and claims fraud is a punishable offense under the criminal law. - The BMA has the authority to cooperate with enforcement authorities, as well as with foreign supervisors, to deter, detect, record, report and remedy fraud in insurance. - Insurance intermediaries are required by law to be licensed by the BMA, must have adequate commercial and professional knowledge, and comply with the fit and proper requirement; the BMA has power to take corrective action, apply sanctions, and revoke the intermediary’s license if needed. ### AML/CFT framework and implementation - The Rulebook incorporates most of the AML/CFT recommendations promulgated by FATF, but implementation of the rules is pending. - The lack of Suspicious Transaction Reports from insurers and other evidence suggest that insurers have only limited working knowledge of the AML/CFT provisions of the Rulebook. - The BMA should begin AML/CFT training and on-site inspections of the insurers. - The AML/CFT rules also need to be amended to specify procedures for verifying customer identity where no face-to-face contact takes place. - Recommended actions include: - Implementation needs to be enhanced following the promulgation of the Rulebook. - The BMA must address the adequacy of AML/CFT measures as part of its supervision of insurers, and promote awareness of AML/CFT in the industry. - The Rulebook may have to be amended in some regards to promote best practices in all aspects of AML/CFT, as per the AML/CFT assessment. ### Recommended action plan to improve compliance with IAIS Core Principles (selected items) - Supervisory authority (Principle 3) - The BMA should consider making adjustments to its pay scale so it can compete effectively with the private sector in hiring and maintaining the best qualified staff. - The forthcoming CBBL should include a provision, requiring that reason be given for the eventual dismissal of the BMA Governor. - Supervisory cooperation and information sharing (Principle 5) - BMA should continue to strengthen its cooperation with supervisors in other jurisdictions. - Licensing (Principle 6) - Determine whether foreign re-insurers under fronting arrangements need to be licensed. - Include identification of “fronting” in on-site inspection procedures and provide guidance to companies. - Redraft Rulebook guidance to make clear that the BMA does not condone “fronting.” - Suitability of persons (Principle 7) - Amend the Rulebook to explicitly disallow directors and senior managers from fulfilling multiple functions that pose a conflict of interest and require appropriate segregation of responsibilities. - Corporate governance (Principle 9) - Regulations in this area should be fully enforced through verification now that the Rulebook has been issued. - Market analysis (Principle 11) - Analysis activities should be increased, requiring additional resources. - Reporting and off-site monitoring (Principle 12) - Develop analytical capacity and a framework for ongoing monitoring; additional staff resources and staff training may be necessary. - On-site inspection (Principle 13) - On-site inspection must be undertaken on a more regular basis for all insurance companies; additional staff resources and staff training may be necessary. - Winding-up and exit (Principle 16) - Authorities should consider how to give priority to claims of policyholders and beneficiaries when liquidating an insurer. - Group-wide supervision (Principle 17) - Reporting requirements and supervisory practice covering groups and conglomerates will need to be developed further as organizational forms become more widespread. - Risk assessment and management (Principle 18) - The BMA intends to intensify monitoring of companies’ risk management systems following the recent promulgation of the Rulebook. - Insurance activity (Principle 19) - Strengthen supervision to ensure each insurer has a clear strategy to mitigate and diversify risks, define limits on retained risk, and use appropriate reinsurance or transfer arrangements consistent with capital position. - Review insurer methodologies for setting premiums and reinsurance arrangements to ensure adequacy and recoverability of reinsurance claims. - Liabilities (Principle 20) - Develop more capacity to evaluate the work of external auditors in assessing adequacy of provisions, including through on-site supervision. - Investments (Principle 21) - Start implementation of investment requirements following the promulgation of the Rulebook. - Keep investment rules for takaful insurance companies under review as the Islamic sector develops. - Derivatives (Principle 22) - Develop rules regarding derivatives in anticipation of future use, for example, to hedge currency exposure. - Any regulations on foreign exchange exposure should take into account a company’s overall net exposure. - Capital adequacy and solvency (Principle 23) - The Rulebook’s capital adequacy and solvency regulation should now be implemented following promulgation. ### Authorities’ response and implementation steps taken - The Executive Summary of the FSSA notes: “the BMA ... has modernized prudential requirements and is enhancing its supervisory capacity.” - The recently issued Insurance Rulebook provides a solid base for the BMA’s insurance regulatory framework. - The BMA has continued recruitment efforts, has added one new staff member in the Insurance Supervision Directorate, and continues searching for qualified candidates. - Staff support and training activities cited: - Insurance Supervision Directorate staff have taken part in several insurance specific courses aimed at obtaining their ACCI designation. - Two staff members attended a three-day session offered by Off-shore Group of Insurance Supervisors (OGIS). - Two staff members attended a two-week onsite training session with the Insurance and Pensions Authority of the Isle of Man. - Two other staff members are in the process of writing their CPA exams. - The BMA has received approval to host a regional seminar on IAIS core principles risk assessment, financial analysis, and remedial action that will take place in March 2006. - Supervisory actions taken in the off-shore insurance sector: - Withdrawal of 10 insurance licenses in April 2005. - Withdrawal of licenses from a further 8 companies (recently). - The BMA is undertaking active consultation with the insurance industry towards the finalization of new reporting forms to form the basis for an improved management information system and comprehensive market analysis. - To improve assessment of technical provisions, the BMA has retained the services of a consulting actuary to evaluate valuation reports and ensure appropriate technical and mathematical reserves. - In its October 2005 update to the Insurance Rulebook, the BMA amended Module FC (Financial Crime) to realign Modules FC across Conventional banks, Islamic banks and Insurance, and to specifically deal with attempted suspicious transactions (FC-4.2.4), non face-to-face business (FC-1.4) and enhanced customer due diligence in several chapters. - The BMA has held several insurance industry information sessions to make licensees aware of expectations under the Rulebook; ongoing implementation will continue as new formal reporting is put in place and as offsite and onsite supervision gain additional experience. ### Context: assessment scope and methodology (brief) - The assessment of the securities regulatory system in Bahrain was performed as part of the Financial Sector Assessment Program for Bahrain and covers legislative and regulatory frameworks, self-regulatory activities of the Bahrain Stock Exchange (BSE), and the responsibilities and functioning of the BMA as regulator of the securities market. - The assessment follows the methodology developed by IOSCO and is concerned with legal powers and exercise of those powers in practice. - The assessment was based upon review of laws, rules and regulations, documentation and reports, interviews with BMA and other officials, and a self-assessment report prepared by the BMA. *Source: IMF Financial Sector Assessment Program — Bahrain (excerpts).* ### 187. With respect to securities markets, the market valuation of the BSE exceeded ### _cr0691 - 187. With respect to securities markets, the market valuation of the BSE exceeded ### Securities market overview - Market valuation of the BSE: US$13.5 billion, or 130 percent of GDP in 2004. - Local stock market index movements are highly correlated with other regional stock market indices. - Turnover: average of 70 to 100 daily trades worth about $1.8 million. - Listings on the exchange: - 46 Bahraini and non-Bahraini companies; - 25 mutual funds; - 20 Bahraini government and corporate bond issues. - Government issuance focus: Islamic securities (sukuks) in forms of medium-term leasing-based (ijara) instruments and shorter term instruments associated with forward (salam) contracts on commodities such as aluminum. - BMA acts as the government’s fiscal agent in issue and management of securities. ### Trading, settlement, and market infrastructure - Stock exchange trading conducted through 13 exchange member brokers, including several relatively large institutions and some individual brokers. - Securities are de-materialized with the exception of certain government instruments. - Quote system is automated; settlement system ensures delivery versus payment on a T+2 basis. - All securities traded in the BSE must be cleared and settled at the Clearing, Settlement, Central Depository and Registry (CSDR) and the clearing bank agreed by brokers-dealers. - Cash leg of securities transactions is settled on a multilateral net basis by 9:30 a.m. in T+2. - Guarantee and limits for defaults: - BSE has established a guarantee for potential defaults due to liquidity shortage. - Limit on net settlement obligation any broker may accrue in one day; if brokers exceed this limit, they must deposit 30 percent of the excess by 9:30 a.m. of T+1. - Operational resilience notes: - Need to strengthen payment and securities settlement systems oversight, focus on settlement systems and infrastructure. - Suggested measures: relocate back-up server(s) to a different location, develop formal business continuity plan with detailed procedures for crisis management and information dissemination, and regular testing and training of both the back-up facilities and personnel. - Legal gaps: - Settlement finality for book-entry transfers and custody arrangements recognized at the level of Resolutions, not primary law. - No explicit legal protection for acceptance, irrevocability, or settlement finality of a payment order; no protection for payments system against bankruptcy procedures for pledged collateral. - Some mitigating factors: CSDR is quasi-public and ownership of securities in the CSDR is established at the level of the individual investor. ### Market participants and products - Approximately 1400 mutual funds and similar collective investment schemes (CIS) are offered in Bahrain, mostly by banks or their subsidiaries and marketed towards wealthy individuals from the region. - Custodial and investment functions cannot be performed by the same entity for CIS. - Regulations require CIS operators to have minimum financial resources, sufficient experience, and professional qualifications. - Conflicts of interest rules: ownership thresholds limit persons involved in scheme operation from owning shares above a set percentage of the total nominal amount of the securities. - Valuation: regulatory framework guarantees valuation of CIS assets is up to date; recommendation to research valuation methods when underlying securities are rarely traded. ### Regulatory structure and institutional arrangements - BMA has overall responsibility for licensing, regulation and supervision of securities markets, and oversight over the BSE; enjoys a high degree of autonomy and is well respected. - BMA became single regulator and supervisor for the entire financial sector in 2002, taking primary responsibility for securities market regulation from the BSE and for insurance from the Ministry of Industry and Commerce (MOIC). BSE and MOIC still retain supervisory and regulatory roles in certain respects. - BSE is a self-regulatory organization (SRO) responsible for day-to-day regulatory and operational business in the capital market. - Ongoing integration efforts: - Series of comprehensive Rulebooks being prepared; those for conventional banks, Islamic banks and insurance had been issued at the time of the assessment; volumes for securities markets are in an advanced state of preparation. - Proposals for an integrated licensing framework applicable to all institutions including securities firms circulating for comments. - Parliament considering the Central Bank of Bahrain Law (CBBL) to clarify and streamline legal framework and BMA independence and powers. - Cooperation and MOUs: - MOU signed in March 2005 between the BMA and the BSE. - A similar arrangement between the BMA and MOIC is in draft. - Staffing: BMA has difficulty offering sufficiently attractive remuneration to attract and retain staff with specialized capital markets skills. ### Legal, accounting, and judicial preconditions - Legislation and institutional arrangements to handle bankruptcies and liquidation of firms are broadly satisfactory. - Company registration and governance, contracts, and registration of movable and immovable property legislation have been in force and implemented for some time. - Need for more judicial expertise in financial matters and the establishment of dedicated commercial courts for timelier judgments. - Corporate accounting: - Conventional financial institutions follow International Financial Reporting Standards (IFRS). - Islamic institutions follow standards set by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). - Accounting and auditing professions include representatives of all major international firms. - Clearing, payments, and settlement system described as efficient and reliable. ### Main findings (standards, supervision, enforcement) - Overall standard of securities market regulation and supervision is generally high; refinements needed and under way. - Anticipated further development required when market uses more complex instruments. - Specific assessments by IOSCO principle clusters: - Principles relating to the regulator (1-5): - Legal and regulatory framework provides clear responsibilities and resources. - Independence somewhat compromised by Prime Minister and Finance Minister serving as Chairman and Deputy Chairman of the BMA; proposed CBBL seeks to address this by establishing a seven-member Administrative Council. - Weaknesses in structure and enforceability of market misconduct provisions may constrain enforcement. - Regulatory process is clear, consultative, and transparent. - Cooperation among BMA, BSE, MOIC acknowledged but not formalized in law. - BMA staff observe high professional standards but face remuneration constraints. - Principles relating to self-regulation (6-7): - BSE is only SRO; BMA supervises BSE to ensure compliance with BSE Law and BMA rules. - BSE retains day-to-day operations and can impose enforceable fines or penalties. - MOU clarifies BMA sets licensing regulation without affecting BSE and CSDR membership rights and powers. - Principles relating to enforcement (8-10): - Regulator has wide powers to inspect business operations, including without prior notice; powers are spread across multiple instruments but expected to be consolidated in proposed CBBL and Securities and Exchange Regulations (SER). - Current power to obtain information does not extend to individuals who are not licensees; proposed CBBL drafted to correct this gap. - BMA, MOIC, and BSE can seek orders, civil proceedings, administrative sanctions, criminal prosecution referrals, or trading suspension; authorities have used these powers in the past. - BMA established an Inspections Directorate and provided broker inspection guidelines; on-site inspection program has begun and all but 3 of the 13 brokers registered in the BSE have been inspected. - BSE monitors trading activity for market and broker risk and inquires into complaints or alleged misconduct. - Principles relating to cooperation (11-13): - BMA and BSE cooperate actively with foreign securities regulators and exchanges. - No specific law vesting authority to share nonpublic information with domestic and foreign counterparts; BMA subject to confidentiality but contends no domestic law impedes international cooperation; proposed CBBL addresses shortcoming. - Anticipated BMA signatory of IOSCO Multilateral MOU once CBBL passed. - Legal restriction on access to information held by non-licensees may impede international cooperation; proposed CBBL to address. - Principles relating to issuers (14-16): - Timely and comprehensive disclosure requirements apply to public offerings, annual and quarterly reports, shareholder voting, and other relevant information; derogations tightly circumscribed. - Rights of shareholders protected; shareholders within a class rank pari passu. - OECD principles on right and equal treatment of shareholders applied in practice for public shareholding companies listed in the BSE. - Financial information publicly available and prepared according to high quality international accounting and auditing standards. - Principles relating to CIS (17-20): - Regulations require CIS operators to meet minimum resources, experience, and qualifications; segregation and protection of client assets required. - Conflicts of interest and disclosure requirements in place; valuation standards assured. - Principles relating to market intermediaries (21-24): - Market intermediaries must be licensed by the BSE; licensing conditions deemed fair and equitable. - Brokers must meet educational, expertise, conduct track record requirements, and participate in a Guarantee Contribution Fund. - Capital requirements adequate for current BSE development. - External auditor must evaluate internal control and risk management systems. - CDSR Rules contain procedures for dealing with failure of a market intermediary. - Principles relating to secondary markets (25-29): - BSE Law, Trading Rules, and CSDR Rules comply with prudential requirements to reduce noncompletion risk. - BSE monitors trading with market surveillance and market control; BMA also monitors day-to-day trading activity and risk. - Pre-trade and post-trade information disseminated in real time by BSE’s trading system. - Insider trading: use of insider information prohibited by regulatory framework, but offence is not defined in primary legislation and exists only in BMA guidelines and standards; BSE acts on “suspicious trading” under Internal Regulations. Offence defined in proposed CBBL. - Principles relating to securities settlement (30): - BSE operates securities settlement system and is supervised by BMA. - Provisions and mechanisms in place to manage and contain risks; system has operated smoothly. - Need to strengthen oversight function and operational reliability measures as noted above. - Legal protections for settlement finality and custody arrangements are incomplete and should be embedded in primary legislation. ### Recommended actions (summary mapped to IOSCO principles) - Principle 1: - Sign draft Memorandum of Understanding to clarify shared roles of BMA and MOIC; complements MOU between BMA and BSE. - Principle 2: - Enhance independence of the BMA by addressing the role of the Prime Minister and Finance Minister; proposed CBBL establishes seven-member Administrative Council of all “expert[s] in financial services.” - Principle 3: - Revise BMA remuneration to attract more staff with capital markets experience as market develops. - Principle 5: - Ensure systems are effectively used to monitor compliance with staff rules of conduct. - Principle 7: - Plan and implement further on-site inspection at the BSE. - Principle 8: - Ensure intrusive powers to obtain information and enforce regulations are comprehensive and explicit; proposed CBBL should achieve this. - Principle 9: - Grant regulator express powers to require information from any persons involved in relevant conduct or who may have information relevant to an inquiry/investigation; proposed CBBL (Article 123) drafted to meet this and should be passed. - Principle 10: - Require companies subject to penalties to take remedial action and ensure monitoring to prevent recurrence. - Principle 11: - Include specific legal provision vesting authority in BMA (or MOIC or BSE) to share nonpublic information with domestic and foreign counterparts; support proposed CBBL. - Principle 12: - Once CBBL is passed, BMA should become a signatory to the IOSCO Multilateral MOU. - Maintain bilateral international MOUs with regulators and exchanges, especially those with cross-trading links. - Principle 13: - Grant BMA and BSE express authority to obtain and share information not held by licensees or regulated entities and requiring information from unregulated individuals or entities. - Principle 20: - Strengthen regulation by requiring mandatory external auditors and that auditor’s report be provided to BMA regardless of audit findings. - Research valuation methods for CIS when underlying securities are rarely traded. - Principle 23: - Eliminate exemption for brokers from completing CDD or identifying source of customer funds when purchasing a share in a collective investment venture. - Finalize and implement Draft Rules for Establishment and Maintenance of Risk Management and Internal Controls for Licensed Securities Business Institutions (issued January 26, 2005). - BMA and BSE to further develop evaluation of internal control and risk management systems. - Principle 28: - Clearly define the offence of insider trading in primary legislation; passage of CBBL as currently drafted would clarify. - Principle 30: - Further develop payment and securities settlement systems oversight focusing on settlement systems and infrastructure. - Implement planned measures to improve operational reliability of the CSDR as soon as possible (including back-up server relocation, business continuity planning, regular testing and training). - Embed settlement finality, transfer of ownership by book-entries, and custody arrangements in primary legislation; clarify acceptance, irrevocability, and settlement finality of payment orders in law. Weaknesses might be corrected through amendment to draft CBBL. *Source: IMF country report content unit _cr0691 - 187.* ### 210. The BMA welcomes the assessment that the standard of securities market ### _cr0691 - 210. The BMA welcomes the assessment that the standard of securities market ### Securities market regulation and supervision — assessment and planned measures - The assessment finds the standard of securities market regulation and supervision is generally high and is compliant with most of the IOSCO Principles of securities regulation. (para. 210) - The legal and regulatory framework provides clear and objective responsibilities and powers supporting the regulator’s work; the BMA and BSE cooperate actively with foreign securities regulators and exchanges. (para. 210) - Disclosure, shareholder rights, and financial reporting: - All requirements for timely and comprehensive disclosure apply to public offerings, annual and quarterly reports, and shareholder voting decisions. (para. 211) - The regulatory framework ensures protection of shareholders’ rights and applies OECD Principles on rights and equal treatment of shareholders in practice. (para. 211) - All financial statements and information are prepared following internationally accepted accounting and auditing standards. (para. 211) - Risk management, settlement, and market infrastructure: - Framework for sound risk management and internal controls is appropriate given market development and transition to a single regulatory model. (para. 212) - The BSE Law, Trading and Clearing and Settlement Rules comply with prudential and other requirements designed to reduce risk of non-completion of transactions. (para. 212) - Strengthening enforcement and consolidation: - Proposed laws and rules (Central Bank of Bahrain Law (CBBL), Securities and Exchange Regulation (SER), and new draft of the CCL) will strengthen provisions relating to market misconduct (market manipulation, price manipulation, insider trading) by providing BMA and BSE more explicit powers for implementation and enforcement. (paras. 213–214) - Consolidation of capital markets provisions across laws, rules, and regulations is expected to minimize overlaps and shared responsibilities among authorities. (para. 214) - International cooperation and IOSCO: - Findings of active cooperation with foreign securities regulators and exchanges will be further strengthened in the new CBBL and SER. (para. 215) - The BMA has forwarded its application to IOSCO to become a signatory of the IOSCO Multilateral MOU, currently being screened by the designated committee of IOSCO. (para. 215) - Information access, criminalization, and legislative gaps: - Proposed CBBL and SER will address gaps identified regarding enforcement powers to obtain information and materials from entities who are not licensees, sharing of non-public information with counterparts, and criminalizing insider trading explicitly (IOSCO Principles 9, 13, and 28). (para. 216) - Corporate governance, settlement finality, and contingency planning: - BMA plans to introduce a corporate governance code for listed companies and rules on mergers and takeovers to enhance shareholder rights. (para. 217) - Settlement finality, irrevocability of transfer of securities, custody arrangements, and protection from bankruptcy are governed by BSE framework and will be strengthened by the proposed CBB Law and SER. (para. 217) - BMA recognizes the need for a solid disaster recovery and contingency plan at the BSE; this is under discussion at the BSE Board. (para. 217) - Payment and settlement oversight and resourcing: - Need to strengthen payment and securities settlement system oversight (monitoring systems and infrastructures) will be addressed in part through the BMA’s RTGS payment system project, currently being implemented. (para. 218) - BMA recognizes the need for adequate resourcing of its capital markets supervisory function, particularly by recruiting additional professional staff and enhancing its capital markets database. (para. 219) ### AML/CFT assessment — scope, timing, and context - Report purpose and basis: - Report covers FATF 40 Recommendations for Anti-Money Laundering and 9 Special Recommendations for Combating the Financing of Terrorism (AML/CFT). (para. 220) - Assessment reviewed AML/CFT laws and regulations, supervisory and regulatory systems for prudentially regulated financial institutions, designated nonfinancial businesses and professions (DNFBPs), nonprofit organizations (NPOs), and criminal law enforcement capacity. (para. 220) - The assessment is based on information available as of May 2, 2005. (para. 220) ### General situation and case load - Authorities believe Bahrain has a relatively low level of domestically generated criminal proceeds; greatest ML risk is from foreign proceeds transiting through Bahrain due to its well-developed banking system and geographic location. (para. 221) - Ongoing prosecutions: - Currently there are four money-laundering prosecutions under way; predicate offenses: fraud, corruption, illegal gambling, and pandering. (para. 222) - All these cases originated from suspicious transaction reports (STRs) filed by banks, with alleged launderers attempting to place illicit proceeds into the banking system. (para. 222) ### Criminalization, confiscation, and legislative gaps - Criminalization of money laundering: - ML is criminalized by Article 2.1 of Decree Law 4/2001 (DL 4/2001). The offence extends to any type of property and applies to persons who commit the predicate offence (self laundering is an offence). Conviction for the predicate offence is not necessary to convict for money laundering. Intent may be inferred from objective facts. Corporate bodies may be fined up to BD 1 million (US$2.65 million). Natural persons may face imprisonment up to 7 years and a BD 1 million fine. Corporate criminal liability does not limit civil or administrative liability; financial institutions may also be sanctioned by the Bahrain Monetary Agency (BMA) and the Ministry of Industry and Commerce (MOIC). (para. 223) - Terrorist financing: - Financing of terrorism is not currently a criminal offence in Bahrain. A draft law amending DL 4/2001 is in parliamentary committee. As drafted, the proposed terrorist financing offence in Article 3.1 would not be fully compliant with international standards because it does not criminalize providing funds to a terrorist or terrorist organization and only criminalizes terrorist financing when the terrorist act actually takes place. The draft offence is drafted in a civil law style and may be open to legal challenge. The assessment recommended addressing these deficiencies and drafting the FT offence in the common law style to mirror the ML offence. (para. 223) - Confiscation and seizure: - DL 4/2001 permits confiscation of all property directly or indirectly derived from criminal activity, substitute assets, and income yields; alternatively, other property of the convicted person, spouse, or minor children may be confiscated up to the value equivalent to laundered assets. Bona fide third parties can claim rights before, during, and after proceedings. Ex parte seizure is provided for in DL 4/2001 and the 2002 Code of Criminal Procedure (CPC) during public prosecutor judicial procedure. (para. 224) - In the absence of a specific terrorist financing offence, confiscation on terrorist financing grounds is not possible except indirectly in some cases based on aiding and abetting offences in a terrorist context. (para. 225) ### Financial Intelligence Unit (AMLU) functions and performance - The Anti-Money Laundering Unit (AMLU) performs typical FIU functions: receiving and processing disclosures of suspected money laundering and related crimes forwarded under DL 4/2001; it de facto receives and processes suspected terrorist-related disclosures despite FT not being an offence. As a police-type FIU, AMLU conducts its own investigations, has access to appropriate information, executes money-laundering court orders, can query disclosing entities directly, but must address the court to obtain information from other persons or entities. It can seize suspect assets on a court order, and in urgent cases can do so on its own authority for a maximum period of three days. (para. 226) - STR statistics and case referrals: - The FIU received 330 STRs since the inception of the reporting system. (para. 226) - 24 STRs constituting 18 cases were forwarded to the Public Prosecutor, of which only 4 cases related to money laundering. (para. 226) - Outreach and profile: - AMLU does not have a high profile with all reporting entities, especially DNFBPs. The mission recommended AMLU raise awareness about its role and issue further guidance on filing STRs. (para. 227) ### Law enforcement, prosecution, and mutual legal assistance - Public Prosecutor’s Office: - Headed by a Prosecutor General, assisted by a Senior Advocate General; responsible for judicial investigation and prosecution of offences and for receiving, investigating, and prosecuting cases forwarded by the AMLU. The office supports AMLU investigations when coercive measures are required, supplies legal advice to police, supervises telephone tapping, and plays a role in mutual legal assistance and extradition. (para. 228) ### Preventive measures — financial institutions and supervisory framework - BMA responsibilities and rulemaking: - BMA assumed responsibility for all financial institution licensees in 2002, including banks, insurance licensees, capital market licensees, and money changers. (para. 229) - The Agency’s Compliance Unit implements the AML supervisory program for banks, insurance, and money changers. BMA’s Capital Markets Division regulates security sector licensees. (para. 229) - BMA issued AML regulations in 2001 to existing licensees (mainly banks and money changers). Capital market licensees became subject to AML regulations in 2004 and insurance licensees in May 2005. Revised Financial Crimes Modules of the Rulebook volumes for banks became effective on April 5, 2005. (para. 230) - Rulebook coverage and governance: - The Rulebook provides broad coverage of AML supervisory issues and establishes a comprehensive framework for the application of the 40 + 9 Recommendations, but the mission recommended enhancements. (para. 231) - The BMA must address the process of Executive Directors issuing regulatory instruments; while regulations have been issued by the Executive Director, authorities lacked documentation that the Board of Directors had agreed to delegate this authority. Legal requirements identified in the CBBL need to be fully addressed regarding circulars, rulebooks, and other "special regulations." (para. 231) - Supervisory consistency and resource needs: - Mission emphasized importance of capital market licensees, money changers, and money brokers being subject to supervisory regimes comparable to banks and insurance companies. Recommendations included strengthening supervision of capital markets licensees in areas such as customer due diligence (CDD), politically exposed persons (PEPs), and monitoring/reporting of suspicious transactions. (para. 232) - Broad challenge: integrating Rulebook provisions and achieving consistency in AML/CFT supervision across banks, insurance, capital market, and money changer licensees. Particular concern that Capital Markets Division does not currently plan to issue AML/CFT regulations equivalent to bank and insurance rulebooks. BMA will need to increase AML supervisory resources and bring insurance and capital markets expertise into the Compliance Unit. (para. 233) ### Preventive measures — DNFBPs, legal persons, and NPOs - DNFBPs coverage and supervision: - Schedule to DL 4/2001 lists real property transactions, bullion dealing, legal practice and advocacy, audit and accountancy as covered activities. Law does not cover casinos, company and trust service providers, and dealers in precious metals and stones; authorities state casinos are not permitted and there are no company and trust service providers. MOIC (supervisor for DNFBPs) determined approximately 1,700 registrants fall into this category. At time of mission, MOIC had undertaken 158 visits to DNFBPs for 2005. (para. 233) - Mission expressed concern about MOIC’s ability to effectively regulate DNFBPs because its general supervisory powers relate mainly to Commercial Companies law and may not provide effective AML/CFT supervisory powers. Concern also expressed about MOIC’s failure to properly consult with MOJ regarding plans to supervise lawyers as DNFBPs. (para. 234) - Legal persons, due diligence, and Rulebook differences: - MOIC registers all businesses and requires personal identification and evidence of beneficial ownership; due diligence is undertaken on directors, shareholders, and partners of applicants. (para. 235) - Measures to prevent unlawful use of legal persons cover banking, insurance, money changers, and money brokers; capital markets licensees are not currently covered. (para. 236) - Rulebooks differ between banks and insurance licensees: bank Rulebooks require signed statements from new customers about acting on their own behalf and signed statements from beneficial owners where customers act for third parties. (para. 237) - Insurance Rulebook lacks certain enquiries about corporate structure to determine provider of funds and principal owners but requires verification of main shareholders holding 20 percent or more of issued capital and applies CDD to beneficiaries of life insurance policies, including establishing relationships between insured and beneficiaries. (para. 238) - Capital markets licensees are subject to Ministerial Order (MO) 7/2001 and Resolution 1/2004; MO covers general client verification but not detailed CDD for legal persons or beneficial-owner determination. Resolution 1/2004 requires particulars of company owners and main shareholders prior to account opening, but clarity is lacking when owners/main shareholders are companies, trusts, or other legal arrangements. (para. 239) - Non-profit organizations: - NPOs are regulated by the Ministry of Social Affairs (MSA) under a legal framework aimed at sound corporate governance. MSA has reviewed the framework and implemented changes to address NPO vulnerability to abuse for financing of terrorism. (para. 240) - At time of mission there were 386 registered societies including 80 charities. (para. 241) - Directorate of Development and Local Societies (DDLS) has a staff of 4 persons; resources are inadequate to review financial information submitted by societies or to undertake inspections, limiting effective implementation of legislative changes. (para. 241) ### National and international cooperation - Coordination and consistency: - Coordination and cooperation between supervisory agencies could be improved. Numerous ministerial orders, regulations, circulars, and rulebooks underpin Bahrain’s AML/CFT program. The high-level governmental AML Policy Committee should take a central role in reviewing these instruments to ensure consistency of approach and a coordinated message. (para. 242) *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 243. Cooperative efforts between the FIU and the supervisory agencies are based on ### _cr0691 - 243. Cooperative efforts between the FIU and the supervisory agencies are based on ### Cooperation between FIU, supervisory agencies, and law enforcement - Cooperative efforts between the FIU and the supervisory agencies are based on custom and practical considerations, not on specific legal provisions. - The AMLU and the BMA are legally bound to a high degree of confidentiality, and there is no legal framework regulating or coordinating any cooperative relationship between these natural allies. - Recognizing that confidentiality remains an important consideration, they should be able to exchange information on non-compliance with the DL 4/2001 requirements by the reporting entities. - Operational cooperation between law enforcement agencies, such as customs and police, is systematic and frequent. ### Mutual legal assistance and extradition - Mutual legal assistance between judicial authorities is generally governed by Article 426–428 of the 2002 CPC (“Letters rogatory”). - In money laundering related matters, Article 8 of DL 4/2001 gives the AMLU a specific responsibility in the execution of foreign assistance requests, that goes beyond the cooperation at FIU level. - Under both regimes the assistance is broad and virtually unrestricted, not only in money laundering cases but also in FT cases. - Dual criminality is not required (also for coercive measures), only that the execution does not violate the public order of Bahrain (Article 427 CPC). - The absence of a formal FT offence does not affect the mutual legal assistance capacity as it is not subject to the dual criminality principle. - Extradition is possible even without a treaty although Bahrain does not extradite its own nationals. - Extradition is subject to the dual criminality principle and reciprocity. - As terrorist financing has not yet been criminalized, no extradition is possible on this ground. - Extradition can be granted however when the facts can be qualified as aiding and abetting, or other complicity to, extraditable crimes that have happened in a terrorist context. ### Recommended Action Plan to Improve Compliance with FATF Recommendations (FATF 40+9 Recommendations) - The Recommended Action (listed in order of priority) covers General; Legal System and Related Institutional Measures; Preventive Measures—Financial Institutions; Preventive Measures—Nonfinancial Businesses and Professions; Legal Persons and Arrangements & Nonprofit Organizations. #### 1. Legal System and Related Institutional Measures - Criminalization of Money Laundering (R.1 & 2) - Criminalize the financing of terrorism so that it becomes a predicate offence for money laundering. - Extend corporate criminal liability to infringements of the AML requirements penalized by Articles 2.6 and 3.5 of DL 4/2001. - Criminalize other predicate crimes, such as market manipulation, insider trading, product piracy, and piracy (on the seas). - Specifically add legal documents or instruments, in electronic or digital form, evidencing title to the definition of property, particularly as Bahrain is a financial center. - Specifically add use or conversion of property to the definition of activity of money laundering. - Criminalization of Terrorist Financing (SR.II) - Enact proposed legislative amendments on criminalizing terrorist financing, particularly for the case of financing terrorist organizations or terrorists who have not committed a specific terrorist act. - Form a drafting sub committee of the AML Policy Committee who can coordinate drafting of all relevant AML/CFT laws with the Legal Affairs Directorate of the Cabinet Office before the bills are submitted to the parliamentary process. - Confiscation, freezing and seizing of proceeds of crime (R.3) - Criminalize corporate liability in the Penal Code and clearly state to which bodies corporate criminal liability applies. - Beside the lacuna created by the absence of an autonomous or predicate FT offence, the seizure and confiscation regime is quite comprehensive but would benefit from certain improvements. - Amend Article 64, par.2 Penal Code in respect of the condition of the property (not) belonging to the accused. - Freezing of funds used for terrorist financing (SR.III) - Criminalize the financing of terrorism. - Designate a committee or agency to be the 1373 designation agency who can make a prompt and binding determination regarding terrorist targets designated by other countries. - Have systems in place whereby notification of such a designation can be disseminated to all parties who may be holding terrorist funds or assets so that such funds or assets can be frozen without delay. - The Financial Intelligence Unit and its functions (R.26, 30 & 32) - The FIU should periodically review the effectiveness of its systems to combat ML and FT. - The FIU should issue guidance on filing STRs to raise awareness and to ensure consistent understanding of its role in the AML/CFT framework. - Law enforcement, prosecution and other competent authorities (R.27, 28, 30 & 32) - Introduce an autonomous and predicate FT offence. - Formally regulate the conditions and modalities for postponing or waiving seizure. - Create jurisprudence that will give direction to law enforcement regarding achieving efficiency in terms of convictions and asset recovery. - Reinforce the human resources of the Public Prosecutor’s Office in the expectation of increased demands related to AML/CFT and the specialization of the prosecution. - Keep statistics on the amount of criminal proceeds seized and confiscated. - Review the effectiveness of the evidence gathering process regarding anti-money laundering. - More cases have to be submitted to the courts, not limited to local events but particularly those with an international connotation where the assets appear in Bahrain but the predicate activity occurred outside the national territory. The ensuing jurisprudence will show if prosecution of ML as an autonomous offence, separated from its predicate criminality, stands a real chance for positive results. - Cash couriers (SR IX) - Develop a disclosure or declaration system for the Bahrain borders. This is being envisaged in Article 5bis of the draft amended AML law. - Address the legal basis of the Customs interception of large cash amounts, which is open to challenge. - Consider adding a legal provision to the amendments planned for DL 4/2001 regarding false declarations/disclosures and lack of declarations/disclosures under the proposed disclosure system. #### 2. Preventive Measures – Financial Institutions - Risk of money laundering or terrorist financing (general emphasis across measures). - Customer due diligence, including enhanced or reduced measures (R.5 to 8) - Banks and insurance companies must implement the regulatory requirements introduced in the new rulebooks. - The BMA must verify implementation efforts related to the new rulebooks through continued (in the case of banks) and new (insurance) on-site inspection programs. - PEP requirements should be included in regulations for capital markets licensees, as well as money changers and money brokers. - Regulations for capital markets must be enhanced to meet the CDD requirements of FATF, as well as meeting the same comprehensiveness standards as applied to other financial sector licensees by the BMA. - Language should be added in the regulations to ensure that financial institutions pay attention to ML/FT risks arising from new technologies. - CDD requirements for non-face-to-face account opening should be established for capital markets licensees, unless this type of account opening is specifically prohibited. - FC 2 should be reviewed and updated to address TF concerns, particularly paragraphs 2.2.1(d), 2.2.1(g), 2.2.2(a), and 2.2.3. - Third parties and introduced business (R.9) - Clarification is required as to the exact circumstances under which a capital markets licensee, such as a broker, could rely on an introducer. - The regulations should specify that consideration will be given to the country where the introducer is based and whether that country abides by the FATF recommendations. - Financial institution secrecy or confidentiality (R.4) - Conduct on-site inspections of insurance and capital markets licensees to confirm that there is no bank secrecy in place in practice with regard to accessing information from financial institutions pursuant to their responsibility under the requirements of DL 4/2001. - Record keeping and wire transfer rules (R.10 & SR.VII) - Implementation of the recordkeeping requirement should be verified for capital markets and insurance licensees through on-site inspection. - Monitoring of transactions and relationships (R.11 & 21) - Requirements should be established for money changers, and money brokers to ensure that due attention is given to unusual, large or complex transactions. - Capital markets, money changes, and money broker licensees should also be required to ensure that the background of large, complex or unusual transactions, including those coming from other countries are reviewed and that the findings of those reviews are put in writing and for money changers and money brokers maintained in the financial institution’s records for five years. - Counter-measures should be established for those situations involving transactions with jurisdictions that do not adequately apply the FATF Recommendations. - Capital markets licensees should be subject to stronger requirements when dealing with clients or transactions from jurisdictions that do not sufficiently apply the FATF recommendations. The BMA must also develop a mechanism to inform the capital markets licensees of the jurisdictions where greater caution should be considered. - Suspicious transaction reports and other reporting (R.13-14, 19, 25 & SR.IV) - STR reporting should be clarified for capital markets licensees in two important ways: it should be made clear that all reports go to both the AMLU and the BMA; and reporting should be for both ML and FT suspicions. - The requirements for money changers and money brokers should be brought up-to-date to make clear when a report must be filed (i.e., not based on a list of examples provided by the BMA). - The BMA should assess the level of awareness and understanding of STR requirements within the capital markets and insurance licensees, given that these two groups have never filed an STR. - The AMLU should also work to raise awareness within the capital markets and insurance licensees regarding STR reporting, and consider applying sanctions for willful non-compliance. - The rate of forwarded cases to the Public Prosecutor should increase, irrespective of the predicate criminality being identified or not, if only to create the jurisprudence necessary to give direction to the investigations and clarify the evidentiary requirements. - The introduction of a formal predicate or autonomous FT offence is required to create the necessary legal context for related STRs. - The definition of suspicious transaction must be made a uniform one. - The immunity clause for reporting to the appropriate authorities should carry the condition of good faith. - There must be a formal and express obligation to report attempted transactions for financial institutions (excluding banks, which are already covered). - STRs should, whenever reasonably possible, be submitted to the FIU before the transaction is executed, to enable immediate law enforcement intervention. - Internal controls, compliance, audit and foreign branches (R.15 & 22) - Money Laundering Reporting Officers (MLRO) for capital markets licensees should be required to monitor transactions, unless that responsibility is specifically assigned to another individual. - The BMA should ensure that audit, training, and internal controls for capital markets licensees, money changers, and money brokers encompass FT, as well as ML. - Capital markets licensees with foreign branches or subsidiaries should be required to inform the BMA when local requirements abroad prohibit them from implementing the BMA regulatory requirements. Implementation of this requirement for insurance companies should be verified through on-site inspection. - The supervisory and oversight system–competent authorities and SROs (R. 17, 23, 29 & 30) - Extend corporate criminal liability to infringements of the AML requirements penalized by Articles 2.6 and 3.5 of DL 4/2001. - Inspections must be undertaken on the capital markets and insurance licensees. - Existing BMA resources, particularly human resources, need to be enhanced to meet its responsibilities as a consolidated supervisor. In particular, expertise in insurance and capital markets should be added to the Compliance Unit for the on-site inspection program. - Clarify or redraft Article 8.2 of MO 7/2001 to specify that the prohibition relates to information concerning the disclosure and the intervention of the FIU. - Establish clear rules and appropriate coordination regarding the criteria to either apply administrative sanctions or criminal penalties. - AML/CFT Guidelines (R.25) - The BMA should address the regulatory weaknesses identified in the assessment, particularly those related to capital markets licensees, since there are no current plans to enhance the existing regulatory framework for AML/CFT for those licensees. - Ongoing supervision and monitoring (R.23, 29 & 32) - The BMA should move forward rapidly with its plans to inspect insurance and capital markets licensees for AML/CFT. #### 3. Preventive Measures – Nonfinancial Businesses and Professions - Customer due diligence and record-keeping (R.12) - The exemptions from customer identification requirements in Article 4 of MO 23/2002 and Article 7 of MO 7/2001 should be reviewed to make them consistent with the FATF recommendations, particularly Recommendation 9. - The requirements in respect of beneficial ownership, PEPs, understanding the nature of a customer’s business, non-face to face customers, introduced business and companies that have nominee shareholders or shares in bearer form should be addressed in law regulation or other enforceable means. - The guidelines on measures to be employed for PEPs should be strengthened to require that registered persons establish systems to identify customers as PEPs and that the activity of such persons be subject to enhanced monitoring. - Provision should be made for persons to undertake CDD measures when there is a suspicion of ML or FT or where there are doubts about the veracity of CDD information previously obtained. - Persons should be required to adopt measures to prevent the misuse of technological developments in ML or FT schemes. - Persons should be required to consider filing an STR in circumstances where they are unable to complete CDD measures in respect of a customer. - Provision should be made for persons to undertake on-going scrutiny of transactions during the course of a relationship to ensure that transactions are consistent with the institutions knowledge of the customer. - MOIC should reinforce with all DNFBPS that the requirements for the retention of customer identification records are those found in MO 4/2001 and not MO 23/2002. - MOIC should intensify its planned program of inspections to verify compliance with AML requirements. - Lawyers should be trained on the application of the DL 4/2001 to their practice of law. - Lawyers should keep client identification records on all their clients pursuant to the DL 4/2001 requirements. - MOIC or MOJ should issue MO for lawyers regarding CDD and record keeping. - Monitoring of transactions and relationships (R.12 & 16) - MOIC needs to intensify its efforts to familiarize DNFBPs with the notion of suspicious transactions and the requirements for monitoring customer activity. - Registered persons should be required to report attempted transactions that are considered to be suspicious. - Registered persons should be required to give special attention to business relationships and transaction with persons from or in countries that do not or insufficiently apply the FATF Recommendations. - Where transactions from countries that do not or insufficiently apply the FATF Recommendations have no apparent economic of visible lawful purpose, the background and purpose of such transactions should be examined and written findings should be available to assist competent authorities. - There should be a requirement that records of suspicious transaction activity be maintained for a period of five years. - MOIC and MOJ should develop systems to advise registered persons of countries with weak AML/CFT systems. - MOIC or MOJ should issue MO to lawyers on above recommendations. - Suspicious transaction reporting (R.16) - MOIC needs to intensify its efforts to familiarize DNFBPs with the requirements for the reporting of suspicious transactions and in particular reinforcing that STRs should be sent to the AMLU. - MOJ should issue regulations and guidance regarding the clarification of requirements to file STRs and how this requirement can be complied with in the face of legal privilege. - Urgent training for lawyers is required regarding the filing of STRs for suspicious transactions or attempted transactions by their clients. - MO should be issued to lawyers by either the MOJ or the MOIC regarding STRs; clarification needed on legal privilege and filing STRs. - MOJ and MOIC should coordinate and decide which Ministry to conduct on-site inspections of lawyers. - Internal controls, compliance & audit (R.16) - DNFPS should be required to undertake audits to assess the effectiveness of their AML systems. - There should be a requirement for compliance officers to have timely access to customer identification information data and other CDD information, transaction records and other relevant information. - There should be a requirement for registered persons to have screening procedures to ensure high standards when hiring employees. - Either the MOJ or the MOIC should issue a MO mandating on-site inspections of lawyers. - Coordination between the MOJ and Ministry of Industry and Commerce to determine who is best suited to conduct the on site inspections is critical. - On site inspections should be carried out on lawyers to ensure compliance with the requirements of the DL 4/2001. - MO should be issued to lawyers regarding the application of DL 4/2001 to their practices. - Regulation, supervision and monitoring (R.17, 24-25) - For the avoidance of doubt, MOIC should have its supervisory powers in relation to MO 23/2002 provided more explicitly in law. It should also ensure that all AML requirements in respect of DNFBPs are addressed through law, regulation or other enforceable means. - MOIC should develop a wider range of sanctions to make the sanction regime more effective. - MOIC and MOJ should agree on a single supervisory arrangement for lawyers as DNFBPs. - MOIC needs to generally intensify its efforts to promote awareness of AML/CFT legislative and regulatory requirements among DNFBPs. - MOIC should consider requesting DNFBPs to return their self-assessment circulars as it could be a useful input as the Ministry tries to establish a risk-based framework for its supervisory responsibility for DNFBPs. - MOIC should amend the certificate signed by compliance officers to include reference to MO 7/2001. - Appropriate civil and administrative sanctions should be created for failure to comply with the DL 4/2001 and any consequent Ministerial Order. - Other designated non-financial businesses and professions (R.20) - Registered persons should be required to pay attention to the threats posed by new technologies. #### 4. Legal Persons and Arrangements & Nonprofit Organizations - Legal Persons–Access to beneficial ownership and control information (R.33) - The capital markets regulations should be enhanced with respect to their approach to beneficial ownership. The regulations should mirror the approach taken in the bank rulebooks, which establishes a more robust requirement for licensees to know the beneficial owners of legal persons. - Nonprofit organizations (SR.VIII) - In terms of its program to address the potential for the abuse of charities for the financing of terrorism, DDLS should develop a more risk-based approach that focuses on potential vulnerability to this risk. - The BMA should consider revising FC 1.5 of the Financial Crimes module of the rulebook for banks to reflect the provision of Article 85 of RD 21/89 (i.e., that charities are required to obtain the approval of MSA before making a foreign transfer of funds in excess of BD 3,000). *Source: _cr0691 - 243. Cooperative efforts between the FIU and the supervisory agencies are based on (extracted content).* ### 6. National and International ### 6. National and International Cooperation ### National cooperation and coordination (R.31) - Clear gateways should be created regulating communication between FIU and supervisory authorities, especially in cases of non-compliance. - Policy Committee to take a policy lead on revisions of DL 4/2001 and the Terrorism Law. - Policy Committee to take a lead in coordination and cooperation matters between ministries. - Appropriate Ministries should coordinate on the issue of inspecting lawyers for AML compliance. ### The Conventions and UN Special Resolutions (R.35 & SR.I) - Fully implement the 1999 International Convention on the Suppression of Financing of Terrorism. - Provide legal mechanisms to allow law enforcement to share information regarding AML/CFT and terrorism issues. ### Mutual Legal Assistance (R.32, 36-38, SR.V) - Devise arrangements for coordinating seizure and confiscation. - Consideration should be given to the utility of creating an asset forfeiture fund. - Statistics should be kept on the MLA requests (investigation, seizure and confiscation) pertaining to ML and predicate offences in order to periodically review the efficiency of the system. ### Extradition (R.32, 37 & 39, & SR.V) - Introduce the offence of financing terrorist activities, terrorist organizations and/or terrorists in criminal law to enable extradition on these specific grounds. - Statistics should detail the extradition grounds and the length of time to complete the MLA process. ### Other Forms of Cooperation (R.32 & 40, & SR.V) - The FIU statistics should also include spontaneous referrals. ### Authorities response - Paragraph 246: - The government of Bahrain welcomes the acknowledgement in the detailed assessment that AML/CFT issues are taken very seriously in the Kingdom and that authorities have worked hard over the past few years to implement an extensive AML framework. - The detailed assessment noted that virtually all the major concerns expressed in the last evaluation, conducted in 2000, have since been addressed. - The Government of Bahrain will address the areas identified for further improvement in this assessment, as part of its efforts to ensure an AML/CFT regime that is compliant with evolving international standards. - Paragraph 247: - The Government of Bahrain will review the proposed changes to the draft anti-terrorist financing law, which is currently before parliament. In the meantime, CFT efforts will continue, based on existing legal powers. - The government is in the process of strengthening the role and membership of its national policy committee, in order to enhance coordination between relevant ministries and other agencies involved in AML/CFT efforts. - This is likely also to include formally tasking the committee as the UNSCR 1373 designation agency. - The range of relevant statistics collected will be developed, and on-going efforts to implement a declaration system in line with Special Recommendation IX will be finalized. - Paragraph 248: - Work to update regulations in line with the revised FATF 40 Recommendations will be completed by the end of 2005, with remaining licensees brought up to the same standards as those applied to banking and insurance licensees. - Capital market licensees (i.e., stock exchange brokers) will be brought into the BMA Rulebook structure, and their existing AML requirements upgraded in line with the recommendations. - Since the assessment was undertaken, focused AML/CFT on-site examinations of capital market licensees have started, and will be extended to insurers from September 2005 onwards. - Paragraph 249: - The MOIC will address all the issues raised in the report, including amending legislation to make its powers to enforce AML/CFT measures explicit – even though the MOIC is of the opinion that its existing enforcement powers are sufficient in this respect. - The MSA has already increased budgeting to recruit additional staff, and will be working to implement effective on-site examination of NPOs. - Clearer legal gateways for the exchange of information at the domestic level, between supervisory and law enforcement agencies, will be developed. *Source: _cr0691 - 6. National and International* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0691.pdf_