Gary Kleiman of Kleiman International -
Islamic finance, once hailed in the wake of the 2008 global financial crisis as an answer to the speculative excesses of Western banking, is finding its development stalling – the result of emerging market economic and credit corrections, as well as absent, muddled and often inimical government approaches.
Islamic finance, with an estimated $2 trillion in global assets according to rating agency Standard & Poor’s, has been championed in the Eurasian region by especially Turkey and Kazakhstan, which have both just unveiled new pushes to restart faltering initial efforts to develop the business.
At a conference in advance of the Istanbul G20 summit in October, Turkish President Recep Tayyip Erdogan praised the contributions of the Islamic Development Bank (IDB) and the domestic “participation banks”, as the specialized Islamic banking institutions are called in Turkey, in helping to finance small business. He called for greater Sharia-compliant competition and instrument innovation, and hailed a report prepared by the IDB and World Bank charting future regulatory and training paths such as Istanbul Stock Exchange promoting no-interest sukuk bond listings.
And at Kazakhstan’s “Investment Forum” in May, President Nursultan Nazarbayev announced plans to establish Astana as an international financial centre with a preliminary 10% Islamic component for capital markets and wealth management.
Yet Turkey’s share of the worldwide $1.5bn no-interest banking market stands at just 3%, behind Iran (40%), Saudi Arabia (19%), Malaysia (9.5%) and the United Arab Emirates (7.5%) according to the Organization of Islamic Cooperation (IOC). Among major emerging economies, Turkey is ahead of Indonesia, Egypt and Pakistan with 1% each. The biggest Islamic lenders with assets from $25bn-$75bn are in the Gulf and the annual growth rate of the Islamic finance market between 200914 was 15%. But with the global economic slowdown from the collapse in commodity and oil prices in particular, S&P expects the annual market increase to be in single digits through 2016.
Sukuk issuance also dropped 40% through October from the recent $100bn yearly totals. Governments have traditionally represented half of this issuance, yet Malaysia’s central bank, the biggest participant, discontinued instruments for liquidity management several months ago. The industry’s key auditing and regulatory bodies in Bahrain and Kuala Lumpur also continue to clash, as scholars differ over religious principles and product eligibility. Safety nets are in the early stages of development, and the infrastructure and supervisory “ecosystem” is not yet sustainable, the OIC cautions, although the global size of the market could reach $3 trillion by the end of the decade.
Turkey has five Islamic banks with a 5% industry share, and the government aims to triple that portion over the next decade. State-owned Ziraat Bank is the latest entrant to the Islamic finance segment, and launched its first branch for Islamic finance in Istanbul earlier this year. Turkey’s second largest bank intends to expand its balance sheet to TRY30bn (€9.65bn) over the medium term, and to also diversify into insurance, leasing, pensions and securities brokerage. Ziraat is the linchpin in Turkey’s official participation banking strategy, which envisions a $300bn sector by 2025. Ziraat also has an extensive Balkans and Central Asian network, including in Turkmenistan and Uzbekistan.
But in the same month that President Erdogan was hailing the benefits of Islamic banking in the country, on October 15 the state-run Halkbank shelved its Islamic lender application amid poor industry earnings and the government takeover of Islamic lender Bank Asya under murky circumstances
Islamic banking profits in Turkey fell 50% from January-May, according to the country’s banking association. By contrast, conventional bank earnings grew by 8% over the same period, although they are also expected to fall by year-end due to a rise in non-performing consumer and business loans.
A main cause of the setback in the participation bank sector was the chill from the crackdown on pioneer Bank Asya, founded two decades ago by followers of the US-based cleric Fethullah Gulen, a former ally of Erdogan and his Justice and Development Party (AKP), who has been accused of conspiring to unseat the Erdogan regime. Pro-government media began reporting problems at the institution, prompting massive depositor exit and then a takeover by the deposit insurance fund. Under the rescue, regulators demanded a full disclosure of shareholders, but less than half complied, fearing investigations and reprisals.
Kazakhstan’s Sharia-observant rules were first drafted in 2009, but have spurred minimal participation, especially since conventional banks enjoy tax advantages. The sole player in the country is Al Hilal, owned by the Abu Dhabi government, though the local Zaman Bank is seeking permission to convert its operations to Islamic banking. Al Hilal’s corporate business has grown 50% annually, but retail banking remains off-limits pending legal changes.
The Astana International Financial Centre that the Kazakh government is developing is designed to overhaul the onshore and offshore frameworks using Dubai as a model, and to set its own precedent for nearby Azerbaijan, Kyrgyzstan and Tajikistan to follow.
The financial centre is scheduled for launch in January 2018 and will incorporate English law and specialized investor courts. The central bank and stock exchange will relocate from Almaty, and the sovereign wealth fund could divest prize holdings through the latter in the tax-exempt hub.
However, domestic banks considering a presence there decry the fiscal privileges and broader prudential inconsistencies between their existing and promised non-resident treatment. They also believe the 10% Islamic finance target is unrealistic in view of the meagre legal foundation since 2010, as the stagnation in the wider banking sector is unlikely to change without stronger post-crisis clean-up policies, including a possible central bad debt resolution agency as recommended by the International Monetary Fund (IMF).
In neighbouring Azerbaijan, progress in developing the sector has also been fitful. International Bank of Azerbaijan, 50% owned by the state, shuttered its dedicated unit that had been in operation since 2013 due to a lack of concrete policy progress. International Bank cited both external and internal difficulties in closing its arm, but especially the lack of government policy support.
Turkey and Kazakhstan have stifled aspirations through neglect and targeted opposition, and have been slow to tackle wider credit monitoring and banking sector rehabilitation. Instead of grand strategy blueprints, leaders there should focus on simple incremental steps, like clear and fair tax treatment, as well as practical commercial and oversight training, for Islamic finance to regroup from its self-inflicted stall.
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