In early August 2020, Bilal Kurbanov, a top official at the Dagestan Development Corporation, announced that his agency and the Dagestan Agency for Entrepreneurship and Investment would soon launch an Islamic banking project aimed at business customers. Dagestan is a region of rich history and heritage in Russia’s North Caucasus along the Caspian Sea. Over 80% of its three million people are Muslims. Kurbanov noted that his team had studied the experience of Islamic banking pilot programs in Chechnya as well as in Tatarstan, which with nearly four million inhabitants is Russia’s largest Muslim-majority region. VLADISLAV ZABRODIN writes.

Kurbanov’s announcement was the latest in a series of high-profile Islamic banking initiatives publicized in Russia since late 2019. Russian state-owned retail banking behemoth Sberbank had announced that it would be pursuing a four-pronged strategy to introduce and expand its Shariah compliant and Islamic world-focused products and service offerings. Recently, Sberbank announced that it would open a representative office in the UAE — likely in Abu Dhabi given Russia’s close ties with Mubadala Development Company.

The president of Tatarstan proposed that the Kremlin support the creation of a nationwide Islamic bank (AK BARS Bank, a bank considered to be very close to the Tatarstan regional government, already offers a line of Islamic banking products). Russia’s first delegation to the annual AAOIFI conference in Bahrain presented a plan to issue wheat-backed Sukuk in export finance.

There are four main reasons why Islamic banking has become a hot topic in Russia of late:

• Russia has a very large Muslim minority estimated at 20 million people, and projected to increase by seven million in the next 15 years. These Muslims are underserved by Islamic banking products compared to countries like Thailand and the Philippines with much smaller Muslim minorities but much more developed Islamic banking sectors.

• Russia’s Muslims are, along with members of all other religions in Russia, experiencing a religious revival and a trend of increased religious observance that has continued since the fall of the Soviet Union, which officially discouraged religion saying that it was the “opium of the masses”. As increasing numbers of Russia’s Muslims become observant, they have been expressing more interest in Shariah compliant banking.

• The local political administrations of Muslim-majority Russian regions have been establishing independent relationships with institutions and investors in the Islamic world, particularly the Gulf Arab states. This has had the effects of educating local officials about Shariah compliant financing instruments, as well as inspiring those officials to facilitate a business environment they feel will be more hospitable to foreign Muslim partners.

• Parallel to bridge-building between Muslim-majority regions and the Islamic world, the Kremlin has been actively strengthening Russia’s geopolitical and commercial ties with Gulf Arab states as well as other important Muslim countries like Indonesia and Malaysia. This is partly driven by Russia’s need to find new investment and business partners due to sanctions, and also due to Russia’s increasing prominence as a Middle East powerbroker.

However, there are also four key factors that are slowing down the adoption of Islamic banking in Russia:

• As mentioned previously, Russia’s Muslim population, while large, is overwhelmingly secular. Although religious observance is trending upwards, a large number of Muslims in Russia still either do not know or do not mind that standard banking products are at odds with Islamic law. Surveys show that less than 15% of Russia’s Muslims are ready to switch to Islamic banking.

• A widespread education campaign to popularize Islamic banking would not only be politically problematic, but also commercially fraught, as presumably Russian Muslim customers would abandon standard Russian banking products in favor of Shariah compliant banking products, resulting in little-to-no net growth in services in the short term.

• Because the Russian banking sector has limited interest in growing Shariah compliant banking by cannibalizing their existing banking business, most of the expected growth is in international investments and import–export transactions with the Islamic world, where a well-developed Islamic finance industry already exists and has deep relationships with Russia’s business partners in Muslim countries.

• Russia’s banking laws and the Central Bank of Russia have not yet become hospitable to Shariah compliant banking instruments, and in particular banking regulations tend to forbid or restrict banks from engaging in investments for their own account, which is a fundamental element of Shariah compliant ‘partner’ banking.

Of the aforementioned four limiting factors, the first three are the most difficult to address as they represent externalities that are difficult for Russian federal and local policymakers to change.

However, if the regulatory obstacles are removed, at least on an experimental (possibly region-specific) basis according to a regulatory sandbox concept, then Islamic banking can begin to grow organically, with the support of national and local government authorities where appropriate.

Once Russia’s Muslims see the convenience and benefits of Shariah compliant banking, that will be the best advertisement for its further adoption, development and growth. And once the central bank sees that Islamic banking instruments can be implemented without any negative effects on the stability of the banking system, a more conducive regulatory environment can begin to bloom.

With a population of almost 150 million and vast natural resources, Russia will remain one of Europe’s largest financial services markets for the foreseeable future. And with a fast-growing Muslim population of over 20 million (more than the entire combined populations of Albania, Bosnia-Herzegovina and Kosovo that are considered interesting from an Islamic financing perspective), Russia also potentially represents Europe’s largest retail market for Shariah compliant financial services.

Geopolitical and economic ties between Russia (including Muslim-majority Russian regions) and the Islamic world are strengthening day by day. We expect that this should lead to further regulatory liberalization on a regional basis aimed at facilitating Shariah compliant financial instruments, and to be rolled out nationwide as soon as practicable.

Vladislav Zabrodin is the managing partner of Capital Legal Services. He can be contacted at [email protected]