10 august 2015
Alternative Finance in a Time of Crisis: How Russia is Looking to Introduce Islamic Banking
Сотрудник Национального Банка Абу-Даби
проходит мимо карты филиалов банка
в мире. 3 апреля, 2013.
Islamic finance, an area of banking in the Middle East and Southeast Asia that offers Sharia-compliant products, is going through a major growth period right now. Islamic banking offers services and products that must comply with a set of rules where no interest is permissible and where all deals must comply with Sharia law. Some of the no-interest products include sukuk (Islamic bonds) as well as musharaka (where the lender and customer own an asset together) and murabaha (where the lender buys an asset for the customer who pays back the principal and an agreed-upon markup).
Even though the principles of Islamic finance are rooted in major Islamic tenets over 1000 years old, the idea of Sharia-compliant banking services was first applied in practice in India in the 1930s. The country’s large Muslim population feared becoming marginalized by the British as well as the Hindus and were at risk of losing their land. Calls by Muslim scholars to return to true Islam of India gave birth to what came to be known as Islamic finance.
The first experimental bank following Sharia law which did not charge any interest on its lending opened in independent Pakistan in the late 1950s. The first Islamic bank to prove its viability, however, was launched in Egypt in 1963. The institution had a goal of appealing to poor Egyptians who lacked confidence in state-run banks and opened nine branches throughout Egypt, but was shut down by the Nasser government in 1968 due to its perceived links to Islamic fundamentalism.
Islamic banks as we know them today developed in the Middle East thanks to the oil boom of the 1970s. Oil tycoons, particularly in the Gulf, were looking to massively expand their business at the same time that that some of them had little confidence in Western banks whose interest-based operations run contrary to Sharia law.
Calls by Muslim scholars to return to true Islam of India gave birth to what came to be known as Islamic finance.
Islamic banking in Qatar, Indonesia, Saudi Arabia, Malaysia, UAE and Turkey (the so-called QISMUT that account for 80% of this market) amounted to $625 bn in 2013. A year later in 2014, the total value of the Islamic assets of these countries reached $750bn.
Growing by an average of 19% per year, the volume of the Islamic financial market in the QISMUT countries could reach $1.8 tn by 2019. Increasing demand for Islamic financial products, opportunities for expanding business, the successful experience of Islamic banks, increasing confidence in this type of service and economic growth in the region - all of these factors may help explain the steady growth of Islamic assets around the world.
Due to strong demand from both corporate and private clients, Saudi Arabia is now considered a major market for Islamic banking. The country accounts for more than a third of all Islamic finance assets or approximately $290bn. By 2019, the value of KSA’s Islamic assets could reach $683bn.
There are currently over 400 Islamic financial institutions in 58 countries worldwide, and they are not exclusive to only Muslim countries in the Middle East and Southeast Asia. The idea of Islamic finance does not contradict the banking laws of countries that historically have not professed Islam; in fact, 5% of total Islamic assets are based in non-Muslim countries today.
Islamic banks as we know them today developed in the Middle East thanks to the oil boom of the 1970s.
After the 2008 financial crisis, Islamic banking came to prominence as an alternative financial domain. Several non-Muslim countries amended their laws to allow Sharia-compliant finance, giving the green light to Islamic banks. These countries included the UK, Hong Kong, Luxembourg and South Africa; Japan and the United States are also exploring the possibility of allowing this type of banking. The United Kingdom, for instance, not only saw a number of Islamic banks opening branches in the country but also several domestic banks, such as Citi and Barclays, opening so-called “Islamic windows.”
While Islamic financial transactions include a payment plan and a certain markup, some Islamic economists argue that technically they are indistinguishable from traditional interest-based ones. To an outside observer, Sharia-compliant transactions look similar to ordinary commercial banking. The significance of these transactions for Muslims, however, is underpinned by the fact that a board of Muslim scholars needs to approve each one of them. This practice is called a financial fatwa and includes an opinion by a qualified Islamic scholar on the compliance of a certain product with Sharia law. Normally banks would set up their own board of scholars that would assess products offered to customers or refer to outside Islamic scholars for fatwas.
Islamic finance may appeal to Muslims and others during times of crisis, since its underlying principle is to invest in tangible products and not financial instruments based on speculation. Islamic banks are tolerant to customers who have missed payments and tend not to impose financial penalties as, they are considered unlawful under Sharia law.
The viability of Islamic finance in non-Muslim countries was successfully proven in 2014 when the UK issued its maiden Islamic bond with a value of £200 million and attracting £2.3bn, ten times higher than the amount sold. That same year Hong Kong issued a $1bn sukuk attracting $4.7bn, two-thirds of which came from outside the Muslim world .
The prospects of Islamic banking in Russia
The idea of introducing Islamic banking in Russia first arose during the 2008 financial crisis when cash-strapped banks started looking for alternative sources of financing. The first Russian bank to consider issuing a sukuk was VTB. In cooperation with Kuwait Finance House, VTB planned to issue a sukuk worth $200mln in 2009 but because of the complexity of the rules, the deal fell through. The first Russian bank that managed to attract funds through Islamic banking was Ak Bars from Tatarstan, which attracted $60mln in 2011 and $100mln in 2014 from Middle Eastern investors. Additionally an “Islamic window" was launched in the Bashkir branch of the Nizhniy Novgorod-based Ellipse Bank.
Russian banks yet again came up with the idea to legalize Islamic banking in Russia after the West imposed economic sanctions against Moscow, essentially cutting off major Russian companies from Western lending. In August 2014, the Association of Russian Banks proposed adopting a federal law on Islamic banking, which would regulate the activities of foreign credit institutions in Russia. It was also proposed to create a committee within the Central Bank of the Russian Federation that would regulate the activities of Islamic banking institutions in Russia and their compliance with Sharia law.
Experts argue that Islamic banking could account for up to 5% of the entire financial market in Russia just five years after its legalization. As of now, several Islamic banks have voiced their intention to open branches in Russia. They include Bahrain’s Al Baraka, Sudan’s Al Shamal, UAE’s Al Hilal as well as leading Malaysian banks.
Islamic finance may appeal to Muslims and others during times of crisis, since its underlying principle is to invest in tangible products and not financial instruments based on speculation.
The development of Islamic finance in Russia is hampered by the absence of a necessary legal framework. For instance, Russian laws do not contain definitions of such terms as “an Islamic financial institution" or “a bank acting in compliance with the principles of Sharia law", as well as a number of other terms specific to this type of banking.
A Russian-Malaysian consortium was formed at the Kazan Sukuk Conference in April 2015 to prepare a feasibility study of Islamic banking in Russia. The consortium includes representatives of the Malaysian state corporation MATRADE, the Central Bank of Malaysia and Unirazak University. It is expected that the study will be completed and presented to the Russian Parliament in autumn 2015. The consortium hopes that by June 2016 the Duma will be able to amend laws, opening the door to Islamic banking in Russia.
The Russian-Malaysian consortium now has high-profile support among top Russian officials. Sergei Glaziev, an advisor to President Putin, recently spoke strongly in favor of Islamic finance saying that Russia would launch a test project on Islamic banking in Russia’s Tatarstan. The Orthodox Church, an unlikely ally of the Islamic banking industry, voiced its support for allowing alternative finance in Russia and said that it is working with the Russian Parliament to develop a system of finance that would abandon the payment of interest.
Learning from Kazakhstan’s best practices
Experts argue that Islamic banking could account for up to of the entire financial market in Russia just five years after its legalization.
Kazakhstan is the leading country in the post-Soviet space in terms of developing alternative finance. Its example is indicative of how the introduction of Islamic finance can attract a whole new group of investors to the country. When the country adopted a law allowing the use of Islamic finance in 2009, Emirati Al Hilal Bank became the first Islamic bank to open a representative office in Kazakhstan.
Today Islamic finance accounts for only 1% of the entire banking industry in the country. Islamic banks in Kazakhstan have opened up a new revenue flow for the local government allowing it to attract new types of investors. The assets of the largest Islamic bank in the country, UAE’s Al Hilal, reached $300mln in 2009. Experts project that by 2020, the share of Islamic banking could reach 10% in Kazakhs.
Challenges ahead for Islamic finance in Russia
Infographics. Basic differences between
Islamic and conventional banking
Since the idea of Islamic finance appeared in Russia in the 2000s, it has suffered significantly due to being mistakenly associated with the issue of Islamic terrorism. The recent upsurge in Islamic State activity in the Middle East has negatively affected the image of the industry as well. Many Russians also fear a close link between Islamic finance and religious teachings, which would surely prevent predominantly Orthodox Christian Russians from using the services of these financial institutions.
Another reason why Moscow is still wary of Islamic finance is the industry’s perceived links to Saudi Arabia. Russia has been trying to limit Saudi influence in the Muslim regions of the North Caucasus and the Volga Federal District since the early 2000s. Some Russian security officials confirmed to this author that they believe the exposure of the Russian banking industry to Islamic finance would lead to an upsurge in covert Saudi influence in the country.
This fear is also underpinned by the role that the Jeddah-based Islamic Development Bank (IDB) plays in the expansion of this industry. IDB is actively involved in the negotiations with the Russian Central Bank to introduce Islamic banking in the country and supports a proposal to transform Tatarstan into a regional hub of Islamic finance.
Some Gulf-based experts believe that up to 85% of sukuk deals do not comply with Sharia law, which raises concerns over the subjective application of Islamic banking rules. Each Islamic bank has a board that assesses individual deals, yet decisions made in various banks may contradict each other. The Gulf States have yet to agree on suitable government institutions that would standardize rules applied by individual Islamic banks. The UAE, for instance, has a plan to create a single committee of Islamic scholars whose task would be to monitor the industry and standardize Islamic banking products, but this plan is still in the works.
Due to significant differences in the Islamic traditions followed in the regions of the North Caucasus and Central Russia, it is likely that the understanding of Islamic banking rules will vary across regions. It is likely to affect decisions made by individual banks in Tatarstan and Chechnya, or Bashkiria and Dagestan. In order to standardize the rules applied in Islamic finance Moscow may have to choose to regulate the industry at the level of the Central Bank as opposed to allowing individual regions to handle decision making related to Sharia-compliant banking products.
The principles of Islamic finance prohibit generating income through corrupt practices and fraudulent activity. Yet due to the Central Bank’s poor oversight over Russian commercial banks, the level of corruption in the country’s financial sector is noticeable. As such, Islamic banks from countries with harsh legal punishments, such as Saudi Arabia, Qatar and Malaysia, will have to adjust the way their banks operate to meet the realities of the Russian financial system should they engage this market.
Yuri Barmin, “Alternative Finance in a Time of Crisis: How Russia is Looking to Introduce Islamic Banking,” Russian International Affairs Council, 10 August 2015, http://russiancouncil.ru/en/inner/?id_4=6458
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