CIS is the next frontier for Islamic banking expansion: Moody’s
A view of Kazakhstan’s capital Astana. Islamic banking assets account for negligible shares in total banking assets in CIS countries. Image Credit: Bloomberg

Dubai: Islamic banking will grow substantially in Commonwealth of Independent States (CIS) countries in the next five years from a very low base, driven by government initiatives to nurture the sector according to a report by global rating agency Moody’s.

“Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan are set to lead this expansion of Islamic banking,” said Svetlana Pavlova, AVP-Analyst at Moody’s. “These countries have large Muslim populations, and are notable for their governments’ commitment and progress in establishing better legal and regulatory infrastructure for Islamic finance.”

They see the development of Islamic finance as a way to foster investment ties with fast-growing economies in the Gulf and Asia.

- Svetlana Pavlova | AVP-Analyst at Moody’s

What differentiates these countries from other CIS countries the most is the level of government commitment to developing the sector and the degree of advancement in establishing legal and regulatory infrastructure. Based on these factors, Kazakhstan and Kyrgyzstan have the strongest growth potential.

Kazakhstan’s government aims to boost the share of Islamic banking assets to 3 per cent of total banking assets in the country by 2025 from the current 0.2 per cent. In Kyrgyzstan, the national bank aims to expand the share to 5 per cent by 2021 from the current 1.4 per cent.

3%

Kazakhstan’s target for Islamic banking in total market by 2025

Currently, Islamic banking remains underdeveloped in the region. Islamic banking assets account for negligible shares in total banking assets in CIS countries. Even in Kyrgyzstan, which has the largest proportion of Islamic banking assets in total banking assets in the region, this share is smaller than 2 per cent followed by Kazakhstan at 0.2 per cent. Also, since Development Bank of Kazakhstan sold $76 million of five-year sukuk, to become the region’s first-ever issuer of sukuk in 2012, no other bank, sovereign or corporate has followed suit.

Regulatory hurdles

Some governments in the CIS are intensifying efforts to reduce these regulatory hurdles and develop Islamic banking, in line with global trends that have gathered momentum in the past decade. “One reason they are keen on expanding Islamic finance is to meet the cultural and religious needs of their Muslim populations. Another reason is that they see the development of Islamic finance as a way to foster investment ties with fast-growing economies in the Gulf and Asia that have large Muslim populations with large pools of capital,” said Pavlova.

5%

Kyrgyzstan’s target for Islamic banking in total market by 2021

According to Moody’s, regulatory disadvantages, along with weak public awareness, are the biggest obstacles to Islamic banking growth. Among other regulatory hurdles, in most CIS jurisdictions, asset purchases and resales, which are part of many standard Islamic finance transactions, are subject to value-added taxes, unless authorities grant an ad hoc exemption. Also, in some countries, including Kazakhstan, Islamic banks’ deposits are not covered by state deposit insurance systems. Further, Islamic banks cannot use central banks’ conventional liquidity and funding facilities because they all bear interest. These disadvantages result in higher funding and operating costs for Islamic banks than for mainstream lenders.

Although Russia has the weakest growth potential, some individual banks are seeking to meet potential demand for Sharia-compliant products and services under existing laws, according to Moody’s. Sberbank, the largest commercial bank by assets in Russia, for example, is looking to offer such services and it launched an Islamic payment application in 2019. AK BARS, the largest bank in the Republic of Tatarstan, introduced a pilot Islamic mortgage product in 2019.

Moody’s expects the participation of majority of CIS countries in China’s Belt and Road Initiative will provide an impetus for the development of Islamic finance for infrastructure projects in Central Asia with Muslim majority population. Further, the increasing use of internet and mobile devices will help expand the reach of financial services in general, including Sharia-compliant ones.