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The global recession has prompted the business world to take a closer look at the mechanism of the Islamic financial system, because the Muslim world has been affected by the crisis least of all. Whereas the positions of leading western banks were weakening by the day, the cumulative assets of Islamic banks increased by 30 per cent last year and are expected to reach $1 trillion by the end of 2010, or 1 per cent of the global financial system's total capital. In the last 10 years Islamic banking has played a significant part in the financial circles of the world's developed countries. In this light, calls to align Shari'ah banking with the global financial system have become more frequent of late. The pressing nature of this issue was also emphasized during the 35th annual meeting of the Islamic Development Bank Group's Board of Governors, which was held in Baku for the first time.

Islamic banking proposes an alternative capable of ensuring greater stability in financing all projects at an international level, says IDB President Ahmed Mohammed Ali. The global economic downturn has brought about a confrontation between developed and developing countries. At a closer examination of the issue, "we will all agree that the way out is by more rapid development".

Taking this into consideration, the IDB president suggests that Shari'ah-based practices of the Islamic financial system be applied globally. Islamic financing, he says, provides great advantages to serious financial systems. The key objective, the bank president believes, must be the understanding of all aspects of the Islamic financial industry, which will lead to the formation of a mixed financial system. He added that following a study by a special working group ways will be identified for Islamic financial facilities to access the international financial system. This will eventually reduce the likelihood of another crisis or another wave of the current crisis.

The IDB head stressed that he was not calling for a complete replacement of the traditional financial system globally, although, he said, the application of certain aspects of Islamic banking would certainly produce good results. This has been confirmed at the G20 meeting.

Ahmed Mohammed Ali also expressed the bank's interest in expanding cooperation with Azerbaijan. He added that the IDB was ready to assist Azerbaijan in introducing the principles of Islamic banking provided that the country was also interested.

Azerbaijani banks and "Islamic funds" 

It is worth mentioning that Islamic banks operate far beyond the Persian Gulf. Of CIS countries, Kazakhstan has initiated the introduction of Islamic financial instruments.

Interest in doing business in accordance with Shari'ah laws has increased significantly in Azerbaijan as well. And this is not by chance, because representatives of Islamic financial institutions are also coming here. Of course, our banks are more interested in applying Islamic financial instruments to the private sector.

Today, many Azerbaijani banks are already considering introducing the system, because for banks it would first of all mean access to new sources of funding, the creation of an extensive new client base and an advantage over banks not applying the system.

As for investment potential, Islamic banks have long demonstrated their capabilities to the world. Therefore, the attraction of this volume of investment to Azerbaijan's banking sector, with subsequent re-investment into economic development, is certainly one of the most important incentives for both government and national banks.

Azerbaijan is a country with a mostly Muslim population. Thus the presence of banks capable of coordinating the norms of applicable laws with those of Shari'ah would enable that segment of the population who did not trust their savings to commercial banks to trust them to an Islamic bank.

And of course, one of the key factors for the Azerbaijani market is that of precedence. By becoming the first to introduce the new system, the bank would receive a number of advantages, which would strengthen its market standing considerably.

However, for the fully-fledged financing of Islamic banking, Azerbaijan needs an appropriate legal framework. Therefore, one of the top concerns for interested Azerbaijani banks is the preparation and submission of proposals to the Central Bank.

At the same time, the existing legal framework does allow the introduction of certain Islamic banking products, which has already enabled some banks to start providing a limited spectrum of Islamic banking services to their clients.

The Azerbaijani banks interested in Islamic banking practices include the International Bank of Azerbaijan, the Kauthar Bank, Amrah Bank and Texnika Bank. The Kauthar Bank is already providing Islamic banking services within the framework of existing laws. The Amrah Bank has just started introducing the system, while the IBA plans to introduce an "Islamic window" shortly.

For banks not interested in switching fully to Islamic banking there is an alternative - an Islamic window. This is an entity within a bank dealing with activities according to Shari'ah laws and its financial reports are separate from those of other subdivisions. It may be expected that the adoption of relevant laws in Azerbaijan would arouse interest in "Islamic windows" in particular, because they would enable traditional banks to introduce Islamic banking in part.

Today, when the world's leading banks are opening "Islamic windows", which is proof of the growing interest and demand for Islamic banking, the introduction of Islamic banking to countries such as Azerbaijan becomes particularly relevant.

So far, however, there is no legal framework in Azerbaijan to regulate the development of this sector. Azerbaijan's Central Bank is studying the possibility of introducing Islamic banking principles.

The Central Bank gives preference to the classical form of banking sector development. According to CBA chairman of the board, Elman Rustamov, the Azerbaijani mentality is very successful as it combines modernity, European practices and national features. "At the same time, there is a search ongoing because all models must be tested," Rustamov believes. If the national mentality, according to Rustamov, requires this form of banking services, the matter will be considered.

The Islamic Development Bank has also offered assistance to the Central Bank in establishing an Islamic bank in the country. However, the IDB's structural subdivision, the Islamic private sector development corporation, has already established two entities operating on Islamic principles in Azerbaijan - the leasing company Ansar Leasing, with capital of $5 million, and the Caspian international investment company ($40 million).

Caution is the parent of safety

Developing on the basis of classical financial instruments, Azerbaijan's banking system has achieved major successes over 17 years. Despite the risks involved, the banking sector has proved sustainable during the global crisis. Namely, the level of bank system capitalization has been bolstered, managerial potential strengthened and foreign arrears reduced. Over 2003-2008, the country's banking sector grew almost 10 times. Thus the government is highly unlikely, given these achievements, to start experimenting with the introduction of new financial instruments, effective though they might be. 

The CBA's chairman of the board, Elman Rustamov, believes that there should be some research prior to the introduction of Islamic banking in Azerbaijan. He said such studies could commence only in 2011 because the issue requires in-depth analysis.

At present, a new strategy is being prepared to develop the country's financial and banking sectors. It will consider the challenges of the crisis. Under the Azerbaijan economic development programme, in addition to growth in the real economy, the focus is to be placed on the development of the financial industry, which will serve as a catalyst for economic development. The CBA chairman does not rule out either that future stability in Azerbaijan's banking sector may be based on Islamic banking mechanisms. 

According to Rustamov, Islamic banking is already coming to the fore in many countries and attention to Islamic mechanisms of financing has grown during the crisis period.

Using Islamic methodology in the banking sector, "we could achieve even greater economic successes in Azerbaijan". It is beyond doubt that this methodology should be based on the prudent principles of Islamic banking and that Azerbaijan follows these processes carefully. And when a global context is reached in this respect, "we will also use non-conventional banking mechanisms in our country".

Specialists recommend

Sayd Farook, the senior consultant for Dar Al Istithmar, a company providing consultations in the sphere of Islamic banking, believes that there are opportunities in Azerbaijan for the introduction of certain Islamic banking products.

The foreign consultant reached this conclusion following talks with Azerbaijani banks interested in introducing Islamic banking. According to Farook, there are limited opportunities in Azerbaijan, but they do enable certain Islamic banking operations. This is possible with client accounts, commercial retail transactions, leasing and asset-backed financing. However, in the absence of regulations, the process may be complicated. 

The expert believes that there is a demand for Islamic banking in Azerbaijan, there are clients who don't want to keep their money in commercial banks and when the Islamic banking system appears it can open accounts with them. Another reason justifying the establishment of these banks is the high liquidity of the Islamic financial system, especially in the Middle East. This may also be the case in Azerbaijan, because there are many banks interested in diversifying their investment and Azerbaijan is quite a good place to do that, Farook added.   

The president of the International Association of Islamic Economy, Mabid Ali Al-Jahri, also believes that Islamic banks of the Persian Gulf are interested in accessing Azerbaijan's Islamic banking sector. An important role in this process would be played by the creation of a legal framework. After Kazakhstan revised its laws to allow the introduction of Islamic banking, the investment from Muslim world countries there reached $1 billion.  

The regulatory acts required include laws preventing double taxation and recognizing Islamic financial contracts. The head of the Islamic association has expressed his readiness for cooperation with the government of Azerbaijan in developing the legal framework and facilitating the introduction of the process.

According to the president of Dar Al Shari`a (Dubai) and the chairman of the Shari'ah council comprised of the Dubai Islamic Bank, the Emirates Islamic Bank, the Sharjah Islamic Bank, the Ajman Bank and the Dubai Financial Market, Sheikh Doctor Huseyn Hamed Hasan, Azerbaijan has excellent opportunities to become a centre of Islamic financing in Central Asia. Azerbaijan may follow the example of Bahrain, a small country with significant volumes of natural resources, which is a centre of Islamic financing.

According to expert assessments, Islamic banking is developing at a rate of 10-15 per cent a year, i.e. it is growing rapidly. There are around 300 Islamic banks in 51 countries, with total capital exceeding $700 billion.  

The main reasons behind such rapid development are the oil revenues in Muslim countries, which produce considerable liquidity not re-directed into the financing of investment projects and the rapid development of financial infrastructure by way of establishing financial centres in Saudi Arabia, Kuwait, the United Arab Emirates and Malaysia. High liquidity and the growing quality of the financial infrastructures of these countries stimulate investment in projects abroad.