Unlike conventional finance, Islamic finance builds and regulates its activities based on the principles and philosophy of Islamic legal jurisprudence, and its development in Kazakhstan dates back to the end of the 1990s. At that time, Arab banks showed interest in investing in shariah-compliant private and state projects in the country, with Saudi billionaire businessman, Sheikh Saleh Kamel, founder of Dallah al Baraka Group, being the first foreign investor in Kazakhstan’s economy following independence.
Encouraged by promising early indications, the Kazakh government took steps to improve the infrastructure for the development of Islamic finance in the country. Despite this, Islamic finance in Kazakhstan remains in its infancy.
State regulators defined four key components of the national financial ecosystem:
Figure 1: Four key components of the national financial ecosystem
Figure 2. Development of Islamic finance in Kazakhstan
Source: Alfiya R. Salikhova, head of research committee, Association for Development of Islamic Finance.
1. International relations
While Kazakhstan organised several international banking forums and conferences, the National Bank of Kazakhstan acquired several memberships in international financial bodies, becoming a full-fledged member of the Islamic Development Bank (IDB) in 1995. In 1998, the IDB opened a regional office in Almaty. Remarkably, it was, and remains, the first and only branch in Central Asia and the Commonwealth of Independent States (CIS). The inauguration of IDB’s branch in Almaty was a key step in linking Kazakhstan with international Islamic finance markets and institutions. Today, IDB is one of Kazakhstan’s key and strategic partners in the development of the Islamic finance and banking industry.
In 2012, the government and IDB Group agreed to and signed a country partnership strategy aimed at strengthening interaction within the state programme of mandatory industrial and innovative development. On June 1, 2014, the National Bank of Kazakhstan signed the Memorandum of Cooperation and Interaction with IDB Group, as well as an Agreement for Technical Assistance (grant) on enhancing Kazakhstan’s laws concerning Islamic financing. The personal involvement and support of President Nazarbayev accelerated the international initiatives.
Prior to the 2008 financial crisis, several large Kazakh banks approached the international market for Islamic finance. Between 2005 and 2008, Islamic banks provided a number of loan packages totalling US$238 million to Kazakh banks. At that time, all international transactions and agreements between foreign and Kazakh financial institutions were processed under traditional and international banking regulations. Although the Kazakh legislation was then in force, it did not specify an option to use Islamic banking or prohibit it.
2. Legislation and regulation of Islamic finance
In a discussion among the representatives of local banks during a 2006 conference held in Almaty, the banks stated there were no obstacles to the conclusion of deals with Islamic banking partners. Moreover, local regulators visited Islamic banks in Malaysia to learn from their experience. They claimed that it was a matter of time before special ‘Islamic Windows’ were opened at traditional banks for Islamic banking transactions. In the autumn of 2007, the conference that followed became the forum for heated discussions on Islamic finance. At that time, the subprime mortgage crisis was erupting in the United States, with Western banks suffering from diminished liquidity ratios, resulting in expensive external borrowing for Kazakh banks. This conference became a platform for discussions on the future of Islamic finance in Kazakhstan.
Having determined the necessity of introducing an official basis for Islamic banking, President Nazarbayev, on February 12, 2009, signed off on a specific legal framework for Islamic finance. As a result of this historic step, Kazakhstan became the first government in the CIS to adopt legal measures for Islamic finance. The act created the legal infrastructure necessary to introduce and develop Islamic financial instruments in Kazakhstan. The main amendments to the laws on banks were as follows:
a. Basic requirements for Islamic banking transactions, based on the principles of Islamic financing (prohibition on interest-based lending, or investment in businesses considered unlawful or haram – contrary to the norms of Islam);
b. The removal of restrictions on the participation of Islamic banks in the share capital of legal entities, as well as restrictions prohibiting Islamic banks from engaging in other activities in addition to personal banking, for example the financing of production and trading activities. Thus, Islamic banks are allowed to engage in commercial operations and share profits and losses with their clients;
c. The introduction of Councils on Islamic Finance Principles, which are equivalent to Shariah advisory councils in Islamic banks located overseas.
Despite the amendments made to the legislation allowing Islamic banking activities, the regulators did not adequately analyse the specifics of Islamic banking instruments. This led to ambiguities in the interpretation and application of the laws. The main problems relating to the ongoing development of Islamic finance are as follows:
Initially, Islamic banks managed transactions in accordance with Article 52 (11) – ‘Conduct of Agency Activity in the Conduct of Banking Operations of an Islamic Bank’. However, the regulatory agency considered such Islamic finance transactions to be an ‘investment activity’, according to Article 52 (6), ‘Deposit Accounts in Islamic Banks’.
Currently, there are no specific tax regimes for Islamic financial instruments. All income taxes from Islamic finance are regulated according to general taxation, with certain qualifications and amendments. According to the Kazakhstan Tax Code, any transactions of a bank, including trading mechanisms (the purchase and sale of stocks, fixed assets, etc.), i.e. all basic instruments, are subject to value-added tax (VAT). At the same time, the margin earned by a banking product is treated as the income of the Islamic bank, which is exempted from income tax. Thus, according to the current tax code, although the margin earned from products is exempt from tax, the main sum of the loan is subject to VAT. This makes the financial instruments of Islamic banking unattractive for both clients and the banks.