TRUST AS THE KEY ASSET

Until recently, Islamic financial instruments in Azerbaijan were regarded as a potentially lucrative source of new banking products. The situation is undergoing a fundamental change at the present time. The development of the legislative framework, the launch of Islamic banking windows, the creation of the first sukuk, the interest shown by international financial institutions and the readiness of the private sector all indicate that the country is gradually moving from discussing the concept to establishing a fully-fledged Islamic finance ecosystem.

The 20th Global Forum of the Islamic Development Bank, which was held as part of the IsDB Group's annual meetings in Baku, was dedicated to this topic for good reason. The majority of participants in the discussions focused on the economic function of Islamic finance, rather than its religious aspects. They emphasised its capacity to attract long-term capital, mitigate investment risks and provide financing for the real economy.

A new logic of development

In recent years, the global economy has faced several structural challenges simultaneously. Geopolitical tensions, the restructuring of global supply chains, rising interest rates and increased competition for investment resources have all had a significant impact on approaches to development finance.

In his address, Taleh Kazimov, Governor of the Central Bank of Azerbaijan, noted that the increasing fragmentation of world trade and growing uncertainty call for the creation of adaptive and inclusive financial systems. In this regard, Islamic finance, based on risk-sharing and ethical principles, offers practical tools capable of contributing to the creation of such systems.

This concept significantly influenced the forum's overall content. Until recently, Islamic finance was perceived primarily as an alternative to traditional banking for countries with predominantly Muslim populations. However, it is now beginning to be viewed in a much broader context. In particular, it is being recognised as a mechanism for diversifying financial markets and attracting long-term capital amid the growing instability of the global economy.

A distinctive feature of the Islamic financial model is that it is geared not towards speculative transactions, but towards the financing of real assets, the sharing of risks among transaction participants, and the long-term sustainability of projects. Consequently, interest in it is being shown not only by Middle Eastern states, but also by major international financial organisations.

For Azerbaijan, this trend creates new opportunities. The country's economy has already transitioned beyond a stage where government spending and oil and gas revenues were the primary sources of investment. In the current business environment, the primary objective is to attract private capital, expand business financing instruments and develop new investment markets.

The CBA Chairman emphasised that the further development of Islamic finance is impossible without comprehensive institutional changes. “Firstly, we need to improve the legal framework and ensure transparency in the regulatory environment. Secondly, we need to build and develop professional human capital to ensure the effective functioning of the Islamic finance system,” he said.

From concept to legislation

It is encouraging to see that the discourse on Islamic finance in Azerbaijan has progressed beyond conceptual debates. Today, the focus is on specific legislative changes and the first practical instruments.

As Mr Kazimov reported, the Central Bank of Azerbaijan, in collaboration with international partners, is already implementing a comprehensive programme to develop the national regulatory framework. "To expand the application of Islamic finance instruments, amendments are being prepared to the Civil Code, the Tax Code and financial legislation. Our aim is to create an equal and neutral regulatory environment for both conventional and Islamic finance," he said.

The next stage in this process will be the issuance of Azerbaijan's first sukuk, the Islamic equivalent of bonds. This development is significant not only for the banking sector. In many countries, it is the sukuk market that has become the foundation for attracting major institutional investors, financing infrastructure and developing the capital market.

The head of the Central Bank of Azerbaijan has confirmed that the joint project with the Islamic Development Bank will provide for the creation of all the necessary infrastructure for this process. The project is expected to establish a robust legal and regulatory framework, strengthen the capacity of financial institutions in the field of Islamic finance, create monitoring and evaluation mechanisms, and facilitate the first sukuk issue in Azerbaijan.

As Kazimov noted, Azerbaijan has integrated the principles of environmental, social and corporate governance into its national development strategy. In this respect, Islamic finance, which prioritises the real economy, is fully in line with our country's development objectives.

One of the most interesting aspects of the forum was the assessment of the current state of the Islamic finance market in Azerbaijan.

Shahin Mahmudzade acknowledged that, just a few years ago, the regulator was not entirely certain that there was genuine demand for such products.

The research yielded somewhat unexpected results. "Around 80 per cent of participants noted a need for Islamic finance in Azerbaijan. At the same time, around 70 per cent of citizens viewed this as a charitable activity and believed that banks were providing money without requiring repayment," said Mahmudzade.

These figures clearly illustrate one of the main challenges facing the new system. There is significant potential for demand, but at present there is a very limited understanding of the underlying principles of this form of finance. Azerbaijan must tackle two challenges head-on: establishing a regulatory framework and fostering a financial culture.

Ecosystem vs individual projects

Another key feature of this year's forum was the realisation that the development of Islamic finance cannot be achieved solely through the efforts of banks.

The creation of a fully-fledged ecosystem requires the participation of insurance organisations, development institutions, business support agencies, international consultants and technology companies.

It is noteworthy that the Islamic Corporation for Investment and Export Credit (ICIEC), of which Azerbaijan became a member in 2023, is already demonstrating concrete results. According to Khalid Khalafalla, CEO of ICIEC and Acting CEO of the Islamic Corporation for Private Sector Development, business insurance transactions totalling $164 million have been carried out since the country's accession. Among the most significant projects are the insurance of a transaction in the telecommunications sector aimed at infrastructure restoration, as well as support for the supply of locomotives to Azerbaijan Railways CJSC.

This demonstrates that the Islamic financial infrastructure is beginning to function not only as a source of capital, but also as a mechanism for mitigating investment risks.

In this regard, considerable attention was paid during the forum to the role of small and medium-sized enterprises (SMEs), which in many countries are the primary users of Islamic financial products.

Orkhan Mammadov, Chairman of the Board of the Agency for the Development of Small and Medium-sized Enterprises, is convinced that the SME sector has the potential to become one of the main drivers of development in this new segment of the financial market.

He is convinced that Islamic financial instruments, especially murabaha, musharaka and ijara, can create new financing opportunities for SMEs operating in Azerbaijan, both domestically and internationally, and help to partially reduce the current shortfall.

Mammadov highlighted that the Central Bank of Azerbaijan's (CBA) special regulatory regime already permits the local market to test new financial products. "This is a significant development, and local banks have already begun offering Islamic banking products," he emphasised.

It is also interesting to note that the international consultancy firm IFAAS has announced its intention to create Azerbaijan's first Islamic digital finance platform. The platform is scheduled to offer fully digital products that are in compliance with Shariah principles, encompassing financing for equipment, working capital, trade and pre-export financing for small and medium-sized enterprises, along with products tailored for private individuals.

The primary outcome of the forum is that Islamic finance in Azerbaijan is now viewed as a mainstream banking instrument. In the current business climate, the development of a new financial ecosystem is a key priority. This ecosystem is designed to expand sources of long-term capital, support the growth of small and medium-sized enterprises, accelerate the implementation of infrastructure projects, and strengthen the country's position as a regional financial centre.