Fitch says SAMA regulations enhance Islamic banks' governance

Logo of the Saudi Central Bank (SAMA) 

Fitch Ratings said that the Islamic finance-specific rules issued by the Saudi Central Bank (SAMA) from 2020 for H1 2024 are enhancing Islamic banking regulations to some extent, through better transparency and reporting requirements, standardization and sharia governance, and increased consumer confidence in the products’ sharia-compliance.

"While the Saudi Islamic banking market is the largest globally, and we expect the operating environment to be favorable over H2 2024–2025, persisting issues include low standardization, still-developing Islamic-finance regulations, and fragmented disclosures," it added.

There is still no centralized sharia board, which could further harmonize industry practices, the report said. One of the goals of the government’s Financial Sector Development Program Charter 2021 is to enhance the sharia governance structure and increase transparency. The regulations issued cover profit-sharing investment accounts (PSIAs), aiming to enhance sharia compliance, raise transparency, and set minimum regulatory requirements.

Saudi Islamic banks have included PSIA-related disclosures in their financial statements since end-2023. While the bank would bear losses in the case of its default, or negligence or violation of any terms and conditions of the PSIA agreement, losses otherwise could be borne by investors (depositors).

Fitch believes that depositors will not bear losses due to the impact this would have on confidence in the banking system.

The central bank has also released a sharia governance framework for local banks and finance companies, with the aim of strengthening sharia-governance procedures and boosting confidence in the Islamic finance sector. SAMA also issued a standard retail consumer finance contract, which covers Murabaha and Tawarruq, and is likely to aid standardization.

SAMA previously regulated Islamic banks in the same way as it regulates conventional banks. The new rules are a slight change on this approach. There have been further changes in previous years, such as the fact that all residential mortgages in Saudi Arabia must be sharia-compliant, in accordance with the Real Estate Finance Law. This, along with strong public demand, has supported the strong Islamic financing growth in Saudi Arabia, according to the ratings agency.

Fitch added that a further planned government initiative is to set up a centralized sharia board to harmonize all banks approaches to sharia compliance. Many of these regulations are on back of SAMA implementing the Islamic Financial Services Board standards.

In 2020, SAMA laid out a supervisory framework for the banks providing Islamic banking services, with the aim of reducing the risks of non-compliance with sharia provisions and principles, data available to Argaam showed.

The move aims to support the stability of the Islamic banking industry and economic growth, and improving operational efficiency and decision-making for the banking activity and industry.