Implementing Islamic banking practices – a system that emerged in most Muslim countries and many other countries in Europe, the United States and Asia in the 1960s – has become particularly relevant for the Russian economy. The project became a national strategic priority as the pressure of Western sanctions intensified after the beginning of the special military operation. Russia was compelled to dramatically revise its development paradigm, turning further away from the West and toward the East. Most Islamic investors from the Middle East and Southeast Asia that Russia is comfortable to cooperate with prefer Shariah-compliant financial models, so it was of the essence to create Islamic financial infrastructure including banks, insurance companies and stock trading platforms, which was impossible without an appropriate legal framework.
The State Duma, the Russian parliament’s lower house, adopted a relevant act in its final version on July 19, 2023 – albeit only a pilot project to introduce the Islamic banking system in the country’s four mostly Muslim-populated regions. The law appointed the Central Bank of the Russian Federation as the regulator fully responsible for licensing, registering and providing regulatory and methodological support for Islamic financial institutions, referred to as “partnership-based finance companies.”
What is different about Islamic banking, and how will the new legislation influence this financial model’s development in Russia? In a nutshell, Islamic banking operates under the religious law and is generally based on four types of prohibitions:
- Transactions involving usury (known as riba in Arabic), or charging of interest on loans;
- Instruments involving uncertainty, such as derivatives (gharar);
- Excessive risk-taking as in speculation (maisir);
- Investment in and deriving income from industries that are considered harmful to society or contrary to Islam (alcohol, tobacco, pork, adult entertainment, sweepstakes, casinos, betting, and conventional financial institutions because they derive income from usury).
Islamic Financial Institutions (IFIs) have their own Shariah compliant financial instruments. Those include partnership-based models such as mudarabah and musharaka where profit and risks are shared between the bank and the client; murabahah – a cost-plus model where the investor retains ownership of the asset until the borrower repays the loan over time with a markup. Other models include ijarah, an arrangement similar to lease; wakalah (agency) agreement; and salam, a forward contract with advance payment for goods to be delivered. There is also Qardh-ul Hasan, essentially an interest-free loan where the borrower is expected to voluntarily pay an extra amount known as a hibah, or gift. But Shariah scholars describe this type of financing as charitable lending.
Islamic finance includes insurance models that are based on mutuality. There are rules for screening securities for Shariah compliance, and quasi-bonds, sukuk, for trading at Islamic platforms.
Islamic finance is implemented in many countries. Some of them (Iran, partly Sudan) do not use conventional finance at all, with all industry participants operating under Shariah, but most countries (such as Malaysia, Saudi Arabia, Qatar, Bahrain, UAE, and others) have flexible systems that allow conventional financial companies to operate alongside Shariah-compliant ones, usually with a single regulator.
Key benefits and advantages of Islamic banking and finance:
- greater sustainability due to dual risk controls (conventional risk management and Shariah controls) and cautious approach to investment;
- a fairer system of access to and distribution of financial resources (the risks are shared between the investor and the borrower. The investor cannot withdraw the funds in case of project failure, or charge higher interest and penalties. The investor participates in the project, being directly interested in the project success);
- fewer opportunities for fraud and manipulation due to the Shariah-based prohibitions;
- contributors to takaful insurance funds are not just entitled to compensation in case of loss; they also receive any profits from the fund’s investments and, as shareholders, can influence the decisions of their takaful company;
- Islamic stock brokers do not invest in high-risk assets, which lessens the occurrence of losses for their clients and ensures regular investment income;
- Islamic financial institutions are more resilient to crises; the IMF, Bank for International Settlements, PWC and other reputable consulting companies have repeatedly confirmed that.
Some of the small disadvantages of the Islamic financial model include multitransactionality, or having to conduct several transactions within one product, which sometimes results in excessive taxation, as well as the extra costs related to the services of external and internal Shariah advisers. The first disadvantage may be compensated by amending tax legislation, while implementing digital technology in the Shariah compliance process should cheapen advisers’ services and eliminate the second problem.
In Russia, the market of Islamic financial institutions is primarily represented by micro-finance companies and funds that operate as limited partnerships or cooperative societies with a group of affiliates. The most commonly known include Special Partnership La Riba Finance (Dagestan) and the Amal Finance House (Tatarstan). There are also Islamic funds in Chechnya.
I believe the newly adopted law will intensify the development of Islamic financial infrastructure necessary for attracting Islamic investment. The conventional state-run banks such as SBER and VTB could be among the channels. SBER has already opened an Islamic branch (“Islamic window”) in Kazan. Major regional banks could also get involved, such as Ak Bars that already boasts qualified professionals and experience in Islamic finance.
Whether it is possible to solve the second vital problem, which is attracting the funds of Russian Muslim population and labor migrants to the Russian financial system, is a rather complicated question because it will depend on creating comfortable and beneficial conditions by Russian Islamic financial institutions and on the available information, technical and financial support from government authorities.
Using FinTech by Islamic banks, takafuls and finance companies (P2P, blockchain, neo-banks, OpenAI and other internet platforms for payments, transfers, currency exchange, gold transactions, etc.) could attract more customers to Russian Islamic finance institutions. Successful cooperation and benefits for customers will expand the customer base by engaging non-Muslim clients as well, which is common in other countries. For example, 60% of clients using the services of Malaysian Islamic banks are ethnically Chinese.
By Ilyas Zaripov, Ph. D. (Economics), Master of Islamic Finance, Associated Professor at the Department of World Finance Markets and FinTech at the Plekhanov Russian University of Economics