Islamic banking was first launched not very long ago – 40 years ago. However, Islamic principles have become in focus of the world financial sector after the global recession because Islamic financial institutions, unlike conventional ones, have proved to be stable.
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In Kyrgyzstan, Islamic banking was launched in 2006, when the management of the Islamic Development Bank and the National Bank of the Kyrgyz Republic, in their joint efforts, launched pilot EcoIslamicBank, the first bank working under the Islamic window principles. For 12 years, it has been the only financial institution in the republic working according to the Sharia principles. However, since 2017 other commercial banks of Kyrgyzstan have started to launch new financial instruments or at least think about it. Public interest has increased significantly.
Many people would relate it to the Islamisation of society and see it as a negative factor, however, according to experts, development of the Islamic banking has serious prospects that can spur the national economy. What are the differences? Islamic banking is first attractive for people who profess Islam since they cannot use the conventional banking services due to their religious views. However, it doesn’t mean that Islamic banking is available to Muslims only. It can be used by anyone who is interested in alternative financial instruments. First, let’s see the differences. The key aspect of the Islamic banking is a prohibition of interest, i.e. predetermined rate. This prohibition can be explained by Islamic laws on social justice and equity. However, the Islam doesn’t disapprove profit-making generally. If a conventional bank adds a trade margin and other costs, in Islamic banking mark-ups depend only on the time period. There’s one mark-up rate for one month, and another mark-up rate for one year. Moreover, according to the Sharia laws, it is forbidden to provide funds for the trade in tobacco, alcohol, weapons, as well as activities related to gambling and so-called “dirty money.” Global practices The global volume of Islamic banking has already exceeded 2 trillion dollars. Islamic banking is well-developed in Muslim countries. Moreover, it has gained a foothold on the financial markets of secular states. “The United Kingdom is an example of active development of Islamic principles of financing in Europe. There are over 25 Islamic windows and two full-fledged Islamic banks there. Islamic banking is fairer as it takes into account the interests of all parties, compared to the conventional banking that takes into account only banker’s interests,” Rinat Gabbasov, chairman of the Sharia Board of Bakai Bank, said. Besides, Islamic banks develop in other European countries such as Germany. According to experts, the Islamic principles of financing develop fast across the globe, at a 15-20 per cent rate annually. Kyrgyzstan The first pilot bank working on the Islamic window principle was launched in 2006. EcoIslamicBank immediately attracted large numbers of customers who have not used banking services before for religious purposes. However, from the first months of its performance, the bank has followed its closed policy and for many years it has not been covered in media. The bank didn’t reply to our request regarding their experience of introducing Islamic principles in Kyrgyzstan.
“Once EcoIslamic entered the market, it attracted many customers. The first thing the bank encountered was the lack of qualified specialists. There were no specialists at the moment who knew the nuances of Islamic principles of financing. More recently, the bank has started to lose its customers because it has monopolised the market for many years and the quality of services has deteriorated. The closed policy followed by the bank is not in its favour because new competitive players have emerged in the market”, former employee of EcoIslamicBank said.
The pilot project has played a great role for the market development in general, Tolkunbek Abdygulov, head of the National Bank of the Kyrgyz Republic, said. “We should give a credit to EcoIslamicBank. When it was developing, the National Bank and the government analysed the gaps and deficiencies that prevent the market development. For example, we have encountered a problem of double taxation of the same trading transaction. According to Islamic principles, the bank, when it finances a trading transaction, buys a commodity, documents it as its property, and then resells it. If the transaction followed the Islamic principles, it was double taxed. It didn’t influence the banking legislation, but was a serious problem. We used to have a lot of problems, they were identified and entered into the laws,” the head of the National Bank explained.
For 12 years, Kyrgyzstan has had only one Islamic window, which gave the impression that the rest of banks don’t find this alternative way of financing interesting. However, Abdygulov said there was another reason for that.
“It’s not only the banking legislation that makes the Islamic principles of financing work in the country. We have amended the Tax Code, Customs and Civil Codes, and many others. It took us almost three years to pass all these amendments in the parliament and adopt them in 2016. Today the laws encourage the development of Islamic principles,” Tolkunbek Abdygulov explained. Right after the adoption of the new legislation, commercial banks of Kyrgyzstan started to take interest in Islamic financial services. In June 2018, the Islamic Financial Centre was established in Bakai Bank in Kyrgyzstan.Many people came and asked for help because they thought that Islamic bank is a charity organisation. We’ve had many situations like that,” Kerimbaev said.
“It’s a complicated process to get a license for transactions on the Islamic principles of financing. There are a lot of criteria that should be met. It took us more than six months to get it. The results were immediate. Customers have taken much interest as we expected. In experimental mode, we started financing in February, and the centre was officially opened in June. Now it’s the end of August and we have fulfilled our annual plan,” Talant Kerimbaev, director of Islamic Financial Centre, said.
Despite positive results, the new financial centre has encountered some problems.
“Some customers misunderstood the way the Islamic bank works. Many people came and asked for help because they thought that Islamic bank is a charity organisation. We’ve had many situations like that,” Kerimbaev said.
New opportunities for business
“It’s a suicide to take loans for business development in Kyrgyz banks,” Temirbek Azhykulov, head of JIA business association, once said. This is the opinion of other business representatives in the Kyrgyz Republic. According to International Financial Corporation (IFC), about 80 per cent of representatives of small and medium enterprises are interested in Islamic principle-based loans, whereas the growing demand for the Islamic financing in the SME sector of Kyrgyzstan can create a potential for 400 million dollar financing in the next few years.
“Islamic financing differs because it grants unsecured loans, which is important for business. If an entrepreneur wants to expand their business, they will need some money. In average, small and medium enterprises need 200 thousand dollars for restocking of equipment or expansion of current assets for development. To raise this money, an entrepreneur has to apply to a bank because there is no other way of financing: no investment funds, investors at an early stage, the entrepreneur cannot enter the stock market to place bonds or shares. The only place they can apply to is a bank. The bank will provide 200,000 dollars if the company pledges property that costs the same. However, the majority of SME entrepreneurs have no such pledges,” financier Umbriel Temiraliev said.
In addition to the lack of interest rates, another peculiarity of the Islamic banking is in its favourable conditions of extension of funds for business funding. Since the bank doesn’t charge interest for provision of money, it becomes, in fact, the investor, not a creditor. Thus, the capital owner and entrepreneur share the risks related to the project implementation.
“Islamic methods of financing are a financial instrument, which is a good alternative to conventional, common to us, banking activity. First, no interest or pledges, the bank acts more as a business partner, not a loan provider. Second, task sharing can take place, when the bank acts as an investor, and the borrower acts as the project implementer. In both cases, both parties earn dividends from business activity proportionally to their respective contributions. Third, the grant mechanism gives those in need an opportunity to get a non-refundable subsidy. Just carry out a comparative analysis of conditions provided by conventional banks and everything becomes clear,” Daniyar Mederov, deputy managing director of International Business Council, explained.
Future prospects
There’ s a growing interest in Islamic banking, however, it’s too early to say that this type of financing is actively developing in Kyrgyzstan.
In 2016, a share of Islamic banking in the banking sector of Kyrgyzstan was 1.5 per cent, in microfinancing sector – 0.3 per cent. In 2018, these figures increased up to 1.6 per cent and 6 per cent, respectively. If we look at the figures, the share is miserable. However, Kyrgyzstan has prepared a good base for the development of the Islamic financing sector. The first full-fledged Islamic bank, which will soon appear in the country, can catalyse this development.
“The Islamic bank establishment project started in December 2014, when the president of Kyrgyzstan met the president of Islamic Development Bank. Since then, the development process has begun. Jointly with IDB, we have done a great job, studied the market, prepared a business plan. At this stage, we are very close to have the bank finally opened. Now we are looking for a strategic investor who would be working here. We are ready to invest into the equity of this bank since the National Bank’s credibility with investors is great,” chairman of the Kyrgyz National Bank [NBKR] said.
Not long ago another bank has obtained a license for transactions on the Islamic principles – BTA Bank. A few more commercial banks are waiting for the NBKR’s approval. The conclusion is that banks understand that the market is being shaped now and it’s high time to enter it and find a niche.
“I am sure that in a few years Islamic banking will become a separate sector in the economy with growing jobs, growing tax revenues, attraction of foreign investments,” the head of Islamic Financial Centre said. “However, we should develop these principles in a right and systematic way. It should not take on religious overtone because Islamic banking is, first of all, the financial structure that works in compliance with the Sharia standards.”
Banks are known as conservative and passive organisations that are slow to introduce new solutions. However, now private banks invest their own money they can risk in order to introduce the Islamic banking. It means that they see future prospects in the development of Islamic financing principles.
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Aziza Berdibaeva – CABAR.asia School of analytic journalism alumnus
This article was prepared as part of the Giving Voice, Driving Change – from the Borderland to the Steppes Project implemented with the financial support of the Foreign Ministry of Norway.