SHARIAH FINANCE

Starting in 2026, Azerbaijan will begin the phased introduction of Islamic banking products—a step that could significantly transform the country's financial sector, enhance its stability, and create additional sources of income for banks.

According to the latest Moody's report, the Central Bank of Azerbaijan (CBA) is preparing the regulatory and legal framework for the launch of Islamic financial services, including amendments to the Civil Code, the Law On Banks, and the Tax Code.

Following the approval of the relevant regulatory changes, traditional banks will be able to offer services compliant with Sharia norms through so-called "Islamic windows."

The initial goal of the reform is to familiarise the market with products that adhere to Islamic banking principles and to prepare the ground for their broader adoption.

The Central Bank, in turn, will oversee the launch process, adjusting regulations as the product line expands.

The mechanisms for applying this new financial instrument for Azerbaijan, as well as its prospects, were discussed at the Islamic Financial Forum-2025 held in Baku.

The experience of neighbours

Islamic banking is a system of financial operations and services built in accordance with Sharia norms, which prohibit the charging of interest, speculative transactions, and investments in industries contrary to Islamic ethical principles (alcohol, gambling, the tobacco industry). The foundation of such financial operations rests on the principles of fair risk and profit sharing, as well as asset-backing.

According to data from the International Institute of Islamic Banking and Finance, as of the end of 2024, the volume of Islamic financial assets exceeds $2.7 trillion, with an annual growth rate of 10-12%. The main market share is held by the Gulf countries, Malaysia, Indonesia, and Türkiye. The asset structure is dominated by Islamic banking products and investment funds focused on adhering to Sharia principles.

As previously reported by Abdelilah Belatik, the Secretary General of the General Council for Islamic Banks and Financial Institutions (CIBAFI), the total volume of the Islamic finance market is expected to reach $5.3 trillion by the end of 2025, with projected growth to $9 trillion by 2030. "For comparison, this figure was $1 trillion in 2010, and by 2024, it had grown to $4.5-4.7 trillion—a 4-fold increase in 14 years," Belatik stated.

The experience of neighbouring Central Asian states shows that the development of Islamic finance in the region is in its formative stages but is demonstrating sustainable growth dynamics.

Particularly notable successes in this sphere have been achieved in Kazakhstan and Kyrgyzstan, which, according to the international rating agency Fitch Ratings, possess the greatest potential for the development of the Islamic finance industry in the medium and long term.

As noted in the Fitch report, interest in Islamic financing in the region is intensifying against the backdrop of growing economic cooperation and investments from the Gulf Cooperation Council (GCC) countries. Thus, the volume of the Islamic financial industry in Central Asia exceeded $500 million by the end of 2024 (excluding multilateral financing).

Despite these positive shifts, Islamic banking still occupies a modest place in the financial systems of the region's countries. According to Fitch, at the end of 2024, the share of Islamic banking services in Kazakhstan and Kyrgyzstan was only about 1%.

However, Kazakhstan is aiming for more ambitious figures. The country has set a goal to increase the share of Islamic financing to 3-5% by the end of 2025.

In Uzbekistan, the country's Central Bank also approved regulations in 2024 permitting microfinance organisations to provide Islamic services.

Simultaneously, legislation is being developed that will allow traditional banks to open "Islamic windows," which will become the next stage of the sector's development.

From theory to practice

As for Azerbaijan, discussions about the need to introduce Islamic financial services have been ongoing for quite some time. In 2013, such attempts were even made by the International Bank of Azerbaijan, but the project was closed two years later due to a lack of legislative support.

Nevertheless, due to the real potential for this market and Azerbaijan's growing economic interaction with countries of the Islamic world, the issue of applying financial instruments based on Sharia principles has periodically arisen.

This is why the CBA eventually moved from conceptual plans to practical measures for implementing Islamic banking in the country.

As part of a phased strategy, a roadmap for the "Islamic window" model has already been prepared, which will form the basis for integrating Islamic financial products into the banking system.

It outlines four main directions. The first is identifying the products to be introduced at the initial stage. To this end, the CBA studied customer and market needs and held consultations with banks, associations, and experts. This stage is already complete.

The second direction is the creation of a regulatory and legal framework, including amendments to laws. In this regard, the CBA has prepared a package of amendments to the Civil and Tax Codes, as well as the Law On Banks and a number of other regulatory acts. After discussions with financial sector participants, the documents will be submitted to the government for consideration.

The third direction is capacity and knowledge building. For this, the Central Bank has established cooperation with relevant structures in Türkiye, Pakistan, Kyrgyzstan, and other countries.

The fourth component of the roadmap is the introduction of Islamic banking products through the "Islamic Window" after the minimum regulatory requirements are established.

This will create conditions for testing market demand, familiarising participants with the products, and applying a wider range of products and solutions in the future.

"The Central Bank will monitor the progress of this initial stage, evaluate the results, and, based on the experience gained, make decisions on the next stages, additional products, and the refinement of the regulatory and legal framework. We are ready for close cooperation with all local and international partners in this process," noted Rustam Tahirov, director of the CBA's financial sector sustainable development department.

One of the elements of the reform will also be the exemption of Islamic financial transactions from value-added tax (VAT), which will help make them more competitive compared to traditional banking products.

According to Mr. Tahirov, several conditions must be met for the effective use of Islamic financing's potential. "It is important to create equal conditions between traditional and Islamic financial services. This requires adapting financial regulation to the specific features of Islamic financial products. At the same time, the harmonisation of operations for Islamic financial products from a taxation perspective is crucial. We know that some financial services are exempt from VAT. Therefore, it is important to apply the same principles to Islamic financial operations as well. We are currently working in this direction together with the relevant state structures," Tahirov reported.

Investment opportunities

As noted, the development of Islamic banking in Azerbaijan is accompanied by active international cooperation and expert support from leading financial institutions of the Islamic world.

The CBA has launched pilot programmes on capacity building for Islamic banking jointly with the central banks of Pakistan and Malaysia, as well as the Banks Association of Türkiye.

"We consider supporting the development of this sphere a strategic goal, not only in Türkiye but throughout the region, especially in Azerbaijan," stated Tarik Akin, a representative of the Investment and Finance Office under the President of Türkiye.

He also remarked that the restoration work in Garabagh opens broad investment opportunities for the application of Islamic financial instruments. "These instruments can become an alternative source of financing for various projects in the region," the Turkish representative said.

Akin added that Azerbaijan's energy potential, strategic location, and sustainable development open up prospects for transforming the country into a regional financial centre capable of integrating Islamic finance into its overall economic strategy.

The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) also declared its readiness to assist Azerbaijan. The chairman of the organisation's board of trustees, Sheikh Ibrahim bin Khalifa, emphasised that Islamic finance, based on asset-backing and risk-sharing, represents an ethical, sustainable, and inclusive instrument that naturally aligns with sustainable development goals. "We at AAOIFI are ready to support Azerbaijan and strive to become a centre for financial activity in this region, which is ideally suited for conducting this type of business," he stated.

In turn, the CBA has officially requested technical assistance from the Islamic Development Bank Institute for the implementation of the "Islamic Financing Grant for Regulatory Framework Development for Capital Market Development in Azerbaijan" project.

The main goal of the initiative is to create a favourable regulatory and institutional environment in the country for Islamic financial instruments, primarily sukuk (bonds). The project involves developing a robust legal and regulatory framework, building national capacity for managing risks associated with Islamic operations, and creating a monitoring and evaluation system to track progress in this area.

According to the document, the successful implementation of the project will pave the way for the first sukuk issuance in Azerbaijan, marking a significant step in the diversification of the country's financial sector. The selection of consulting companies that will undertake the project's execution has already begun.

Earlier, CBA Chairman Taleh Kazimov reported that one local bank has already expressed interest in participating. "We are mainly focused on the issuance of Islamic bonds and, jointly with the World Bank, have begun preparing the relevant legislation. However, it will be difficult without the participation of local banks, as they know the bond clients better. Negotiations are underway with banks to establish work in a test mode. First, the issuance of sukuk is expected, followed by the integration of Islamic banking. The project will require 3-5 years to implement. Our main goal is to enhance financial inclusivity and access to finance," Kazimov noted.

Yunus Abdulov, Executive Director of the Azerbaijan Banks Association (ABA), believes that local banks' interest in Islamic financing already extends beyond theory. Moreover, the process of creating a Sharia Council under the ABA is in its final stages. "Some banks are already working on developing solutions and are concentrating on specific product lines. We see that the interest is stable, the client segments are understood, and the necessary knowledge base for the first stage of implementation already exists. In other words, the market is ready—we just need to complete the creation of the institutional base," Abdulov emphasised.

The primary focus is not so much on the volume of financing, but on the impact that Islamic banking has on the real sector of the economy, particularly on the development of small and medium-sized entrepreneurship.

"The introduction of Islamic financing in the country will benefit infrastructure development, as large-scale construction work is currently underway in the liberated territories," asserts Vusal Gasimli, Executive Director of the Centre for Analysis of Economic Reforms and Communication.

Thus, Islamic banking opens new horizons for financial diversification and international cooperation for Azerbaijan.

This reform will not only strengthen trust in the banking system but also allow the country to integrate into the growing global market for Islamic finance, the volume of which is rapidly approaching the $5 trillion mark.