Kazakhstan has made a noticeable progress in recent years with developing Islamic financial system. Presently the system holds less than 0.01% of total banking assets but it has the potential to grow over medium term to US$3-5 billion comprising 3-5% of total banking assets. The return on banking assets for the top Kazakh banks has averaged 2.7 – 3.5% per annum in the last decade not counting for the crisis 2008-2010 years. Most of the business for Islamic finance will come from serving the corporate sector and providing financing to well-defined projects and activities in a Shari’a-compliant way. The profitability of financing the Kazakh corporates given the right structure and risk profile may be at least twice higher than the profitability of financing similar corporates in Malaysia and GCC. In terms of sukuk issuance Kazakhstan has a lot of unrealized potential as well. If one takes the last sovereign Eurobond issuance in October 2014 as an example, Kazakhstan has placed Eurobonds in two tranches for the amount of US$2.5 billion: 10-year US$1.5 billion Eurobonds and 30-year US$1 billion Eurobonds yielding 4.07% (150bps to US$ interest rate swap) and 5.11% (200bps), respectively. The initial book was oversubscribed with order totalling over US$11 billion. Similar interest was shown to the bonds of the Kazakh corporates rated on par with sovereign. However, the challenges remain and further work should be done to establish the country as a regional leader in Islamic finance.
Kazakhstan started the work on developing Islamic finance less than six years ago. The first legislation to introduce Islamic financial intermediaries was approved in February 2009. The second package of amendments came into force in July 2011. The amendments paved the way for opening Islamic banks and other intermediaries and provided for some limited operations. The third amendments were approved this summer. They clarified the issues with commodity murabaha in terms of accounting and tax treatment, and allowed for proper functioning of Islamic insurance and leasing. The forth amendments were recently approved by both chambers of the parliament allowing for conversion of traditional to Islamic banks, and they should come into force before the yearend.
So far the Kazakh authorities favoured a gradual and a piecemeal approach by issuing amendments to the legislation every time there are substantial problems. It worked satisfactorily as long as there were few Islamic financial institutions, and there was the lack of knowledge and qualified cadres among the financial elite. However, this approach might no longer be sufficient. This spring, during his inauguration speech, the President of Kazakhstan, His Excellency Nursultan Nazarbayev, announced that the country’s capital Astana would become the regional hub for conventional and Islamic finance, similar to the model of Dubai International Financial Centre (DIFC). Later during the year the relevant legislation was drafted by the National Bank of Kazakhstan (the central bank) and the government, and approved by the parliament. It laid the ground for establishing the International Financial Centre of Astana (IFCA) and allowed for the use and prevalence of English law albeit at the territory of the centre. It is expected the centre will start operations in the beginning of 2016, and it will become fully operational in the next three years. Astana is expected to become the focal point for bringing conventional and Islamic finance investments to Kazakhstan and the region.
To make the plan a success the country may need an entirely different approach to developing Islamic finance. Instead of patching the present legislation every time, it has to go for a unified and systemic legislation to lay the firm ground for establishing a sustainable Islamic financial system and to make necessary amendments to the civil, tax and other relevant codes, and the legislation altogether. Like other countries, Kazakhstan needs its own model of Islamic banking and finance, the one that fits its economic, social, legal and financial system. This will help to develop Islamic finance in Kazakhstan and the region in a short time span, and it will provide long-lasting benefits to economic agents and population at large.
FINANCIAL SYSTEM IN KAZAKHSTAN
This article will discuss the most important issues facing Islamic banking and finance industry in Kazakhstan. Let us start by briefly describing the financial system in Kazakhstan. It is an open and well-developed economy. As of September 1, 2015 there are 35 second-tier banks, out of which 16 are foreign banks, among them are 14 foreign subsidiaries. Total assets of the Kazakh banks equalled 19,497 billion Kazakh tenge (US$82 billion) as compared to 18,239 billion Kazakh tenge (US$100 billion) as of January 1, 2015, having increased by 6.8% in the local currency from the beginning of the year. The decrease in dollar terms is due to recent tenge devaluation.
As of September 1, 2015, the credit portfolio takes the lion’s share in banking assets (63.6% of total assets) followed by other assets (17.4% of total), and cash and cash equivalents (14.6% of total). The credit portfolio comprises loans to legal entities (44.5% of total portfolio), loans to individuals (28.1% of total), out of which consumer loans represent 19.5%, mortgages 78% As of September 1, 2015, the credit portfolio takes the lion’s share in banking assets (63.6% of total assets) followed by other assets (17.4% of total), and cash and cash equivalents (14.6% of total). The credit portfolio comprises loans to legal entities (44.5% of total portfolio), loans to individuals (28.1% of total), out of which consumer loans represent 19.5%, mortgages % of total, and loans to SME 26.4%.
The provisions equal 10.5% of total credit portfolio. The growth of credit portfolio has slowed in the last years due to unfavourable macroeconomic environment caused by regional instability, slowing economy, and the authorities’ and the banks’ consorted efforts to improve the quality of portfolio after the last global financial crisis.
The liabilities side of the Kazakh banking system at the same date comprises client deposits (74.3% of total), securities (10.4%) and liabilities to non-residents (9.2%). In recent years the system has largely become an internally funded one with the share of external debt finance reduced significantly. This improves banking system stability and resilience to external shocks.
At the macro level the share of total banking system assets equals 47.2% of GDP, the share of lending portfolio 33% of GDP, share of deposits 30% of GDP. The share of five largest banks in total banking system assets constitutes 58.8%. The size of banking system in Kazakhstan is less than that in Russia, Malaysia or GCC countries. The domestic banking system remains concentrated and plays limited role in overall economic development. Due to geographical factors (large territory and scattered population) it is better developed in the largest cities like Almaty, Astana characterized by good infrastructure, higher economic activities and population incomes, or Atyrau – unofficial petroleum capital of Kazakhstan. On the other hand, most of the native Muslim population resides in rural areas and small towns where access to modern banking services remains difficult.
As far as Islamic financial intermediaries are concerned, presently there is one Islamic bank, Al Hilal Bank Kazakhstan, and few other smaller financial companies in Islamic insurance, leasing and microfinance. Total assets and liabilities of Islamic financial institutions are insignificant, so they are not separately reported in the central bank’s statistics.
WAY FORWARD
Let us now discuss how to develop Islamic banking in the country. Corporate Islamic banking does not require substantial initial investment and may become profitable in the short term. To boost it, Kazakhstan has to level the playing field for Islamic local and international banks on par with their conventional counterparts. However, developing retail Islamic banking may prove a real challenge for Islamic banks, both domestic and foreign ones. The authorities of Kazakhstan will insist, and rightly so, on developing Islamic retail products for population and SME. It has been one of the prime drivers on introducing and developing Islamic financial system in Kazakhstan. On the other hand, potential foreign players and investors in Islamic finance have limited experience and exposure to the banking in this part of the world and may not be able to commit themselves readily to retail Islamic banking, at least at early stages. Local financial groups and investors keen to develop Islamic finance do not have necessary human and intellectual resources, and market experience to develop and introduce Islamic banking corporate and retail products.
There may be two complementary ways to deal with the situation.
The first one is to introduce Islamic windows in conventional banks. The largest banks may easily serve Islamic retail products for population and SMEs across Kazakhstan. They will effectively exercise economies of scale and provide universal access to modern Islamic financial instruments in the best commercial way. The key objectives for the National Bank of Kazakhstan to allow the Islamic windows are cost efficiency and policy goals. As the experience of other countries shows the Islamic window may be a good instrument to develop Islamic banking quickly and broadly at the early stages. If the policy goals are to motivate the population to adopt the Islamic finance products faster by providing various incentives, the commercial banks may be well positioned to provide competitive and tailored Islamic retail products.
The second one is to establish joint ventures or strategic alliances between local financial institutions and foreign counterparts. This may take form of legal incorporation in the form of local Islamic bank (newly established or converted one), or in a less formal way of revenue sharing via agreements to transfer technological and human knowhow from foreign to local banks. As an example one may recall a successful twinning programme run by EBRD at the early stages of financial transition in the countries of eastern and central Europe and CIS in the 1990s. Most of the leading domestic banks in Kazakhstan with the exception of foreign banks and foreign subsidiaries have successfully passed through this programme. The National Bank of Kazakhstan and foreign donors may jointly establish a similar programme in Islamic finance. The NBK may administer the programme itself or appoint the special supervisor.
An Islamic banking twinning programme, similar to the successful twinning programme run by EBRD at the early stages of financial transition in the countries of eastern and central Europe and CIS in the 1990s, is required for the development of IBF in Kazakhstan.
Let us now turn the attention to business operations. Presently Islamic financial institutions in Kazakhstan encounter numerous challenges in everyday operations. To their credit, the authorities, in particular the National Bank of Kazakhstan, are committed to resolving them but the work and efforts should intensify to provide a real impetus to Islamic banking and finance in Kazakhstan.
The most important and salient issues are as
follows:
- Tax and regulatory treatment of Islamic financial instruments and products as financial services and products
Presently only legislatively approved Islamic financial instruments are treated as financial products. It takes time and efforts to amend the legislation for every product. In the meantime, Islamic financial intermediaries are taxed at the level of individual transactions since every transaction in Islamic banking involves purchase and sale of goods. This practice should be stopped. The national legislation should permit purchase and sale of property, goods and commodities by the Islamic banks, and treat it not as separate entrepreneurial activity but as financial transactions. Accordingly, all Islamic financial instruments should have equal treatment with conventional financial instruments. This means:
- No taxation of individual Islamic banking operations or financial instruments. Instead taxation should be done at the level of Islamic financial institution as profit centre as it is done with conventional financial institutions.
- Overall tax regime for Islamic financial institutions should be harmonized and brought on equal terms with tax regime for conventional banks.
- National Bank of Kazakhstan and Ministry of Finance should have the authority to approve or change Islamic finance instruments by internal regulation and not by amending national legislation every time.
- The usual property rights registration mechanism for Islamic finance instruments should be substantially streamlined allowing fast-track procedures for registration of underlying property and assets of Islamic finance instruments.
- Islamic mortgage and leasing should have the same tax and regulatory regime as traditional mortgage and leasing.
Potential annual zakat collection in Kazakhstan exceeds tens of millions of US dollars. Presently the money is not fully collected, accumulated and properly distributed. The Islamic financial system will allow for introduction of efficient and transparent zakat system.
- Amending legislation for government and quasi-government corporates to allow for Islamic banking instruments
At present, government-owned or controlled corporates have hard time to finance their operations through Islamic banking products however competitively they may be priced. Since Islamic banking involves purchase and sale of goods, the Islamic banks have to pass through government tender and procurement procedures. In addition the natural monopolies are not allowed to purchase certain goods at all. This puts Islamic banks at disadvantage vis-à-vis conventional banks that do not have to go through the procedures. There will be no real take-off of large-scale corporate Islamic banking until the legislation is amended to provide for Islamic banks to compete on equal footing with conventional banks for large corporate clients.
- Developing liquid and deep internal market in local currency tenge for Islamic financial institutions
There is no domestic market in tenge for Islamic financial institutions. They are not allowed to use traditional financial instruments, and there is lack of Shari’a-compliant liquidity instruments. This is one of the major impediments to developing tenge-denominated Islamic finance products, and retail products.
- Introducing and streamlining the legislation for sukuk issuance in Kazakhstan
In particular, it should allow for issuance of asset-based sukuk, listing and registration of sukuk at the Kazakhstan Stock Exchange (KASE). The KASE listing and registration procedures should allow for equal treatment of Islamic and conventional financial instruments. It should also be possible to register and list sukuk issued in other domiciles for purchase by domestic investors.
5. Amending the legislation to allow for issuance of fixed fee and covered Islamic banking cards
Presently Islamic banks are unable to issue Shari’a-compliant Islamic banking cards, as there are numerous tax and regulatory implications. Developing retail Islamic banking products that form the ground for Islamic banking cards will involve streamlining and amending the corresponding national legislation.
The above list may seem daunting at a first glance. However, most of the work is technical in nature. As Kazakhstan has done a good progress with laying the foundations for Islamic financial system, now it needs to move fast forward on harmonizing the national legislation with best international practices.
The last by order but not by importance issue is Islamic charitable and social safety nets. It is rarely discussed in the context of developing Islamic finance infrastructure but it has important social and economic implications. Kazakhstan is a relatively rich country. It has one of the highest GDPper capita in the region. According to the conservative estimates, potential annual zakat collection in Kazakhstan exceeds tens of millions of US dollars. Presently the money is not fully collected, accumulated and properly distributed. The Islamic financial system will allow for introduction of efficient and transparent zakat system. Islamic financial intermediaries can play an important role in establishing and running it.
Such system will help the needy and the poor, support important Islamic charitable and developmental projects, provide the funds for education and support of the imams and ulama, and cushion against religious extremism and intolerance. It will promote intra-regional stability and sustainable development of Kazakhstan by providing the funds to the local Muslim population. Moreover this system will complement the state’s existing social safety net. Private sector and wealthy individuals, with minimal government direct costs, should develop it.
Concluding, Kazakhstan has the potential and the ability to become a bright spot and a regional leader in Islamic finance.
