London / Dubai: Islamic finance-specific rules issued by the Saudi Central Bank (SAMA) over 2020–1H24 are enhancing Islamic banking regulations to some extent, says Fitch Ratings, through better transparency and reporting requirements, standardisation 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 favourable over 2H24–2025, persisting issues include low standardisation, still-developing Islamic-finance regulations, and fragmented disclosures.

There is still no centralised sharia board, which could further harmonise industry practices. 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). This is in line with rated Islamic banks in other jurisdictions, and Fitch would view PSIAs bearing a loss as a default. In practice, Fitch believes that depositors will not bear losses due to the impact this would have on confidence in the banking system. PSIAs grew to 7.1% of sharia-compliant deposits at end-2022 (2021: 6.4%).

SAMA also issued additional capital adequacy requirements for sharia-compliant banking. It intends to ensure risks associated with Islamic banking products and contracts are appropriately captured, with capital requirements for credit risk and market risk. We do not expect a material impact from the adoption of this rule as there is no material change in the treatment between SAMA’s existing framework applicable for conventional banks and that for Islamic banks.

SAMA also released a risk-management framework for banks practicing Islamic banking, including establishing minimum principles for risk management. Financial statement disclosure shows that Saudi Islamic banks are required to maintain profit equalisation reserves or investment risk reserves to mitigate displaced commercial risk and smooth out returns to depositors. This could also help ensure that Saudi Islamic banks do not share losses on PSIAs.

The regulator has 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 standardisation.

Rules on new banking products and services include the need for sharia committee approvals for new Islamic products, among other requirements. Guidelines on repurchase agreements were also issued, with provisions related to late payment amounts and that parties will not claim any dispute on the grounds of sharia-compliance of the repo agreements. Related-party rules for banks were also updated to include sharia committee members.

A further planned government initiative is to set up a centralised sharia board to harmonise all banks approaches to sharia compliance. Many of these regulations are on back of SAMA implementing the Islamic Financial Services Board standards.

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.

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Matt Pearson
Senior Associate, Corporate Communications
Fitch Group, 30 North Colonnade, London, E14 5GN
E: matthew.pearson@thefitchgroup.com