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Russian banks and companies are constrained at the moment in their access to Western financial markets due to US and European sanctions brought on by the Ukraine crisis, and alternative markets are actively sought. One such market could be the market of Islamic financing. According to official statistics, about 25 million Muslims live in Russia. The population of some of the regions, such as Tatarstan, Bashkiria, Dagestan, Chechnya and Ingushetia, is almost fully Muslim.

Tatarstan is the most developed of the Muslim regions and it is assumed that it will become the capital of Islamic banking in Russia. It is here that the development of Islamic finance institutes has been under discussion for several years already at the KazanSummit international forum.

In March 2015, a legislative bill was introduced in the Russian State Duma, proposing to amend Russia’s banking law. The amendments would allow banking operations based on Islamic law, which are not allowed today. The Duma declined the bill, and later a work group was formed in the Bank of Russia to study the possibilities for introducing Islamic banking in Russia, and in 2016 the group prepared a roadmap to develop partner banking. In March 2017, another legislative bill was declined by the Duma.

Based on the roadmap, an announcement was made on creation of the first Islamic bank in Russia, the Partner Banking Center working within the Tatfondbank and Tatagroprombank. The Center proposed financing for individuals for purchasing automobiles and real estate, opening and closing bank accounts, debit cards and various types of wire transfers. Businesses could use the services of cashier settlements, conversions, letters of credit and currency control. Project financing was also announced. However, within less than a year both banks lost their licenses and the Center ceased its activity.

Currently, the work group is preparing a new legislative bill. However, there is no information as to its content or when it might be ready.

Even though there are no regulations governing Islamic banking, currently there are several companies in Russia that provide Islamic banking services:

• The BKS Fund Khalal Mutual Investment Fund, investing only in securities allowed by Islam;
• Amal Financial House, offering financing under the Murabaha principle;
• Tatarstan International Investment Company, offering investment consulting services;
• LaRiba Finance Trust Partnership, offering financing on the Murabaha and Mudarabah principles.

At the same time, none of these organizations are banks and none offer traditional banking services. Such companies strive to work under the Shariah principles, using the legal instruments provided under Russian civil law. However, this approach restricts their development and makes them uncompetitive within the non-Muslim market.

Sberbank, the largest Russian state bank, has shown interest in Islamic financing. In 2017, Sberbank announced a pilot Mudarabah transaction, where the bank provided funds to a large Tatarstan leasing company. No information is available on the contracting party or the details of the deal which was over a year in the making. The only thing known is that the deal was certified for compliance with the AAOIFI standards by the Shariah Review Bureau, a consulting partner for Sberbank and is in line with the Shariah norms. That said, Mudarabah is not the only Islamic finance instrument that Sberbank could offer in the future. According to Sberbank officials, the bank plans to develop Musharakah, Mudarabah and Murabaha financing. However, no further details are available at the moment. Vnesheconombank, Russian State development and investment bank, has also officially announced the interest in attracting investment based on Islamic financing, but has not provided any specific information on the further projects or plans.

At present, the main gaps between Russian law and Islamic banking principles are the following:

• Unlike a regular bank, Islamic financial institutes undertake deals with real assets, rather than money. Under Russian law, asset deals are subject to 18% VAT.
• A Russian credit organization using Murabaha has tax obligations different from traditional ones. In a sale and purchase operation, tax must be paid on the entire contractual amount, irrespective of whether the buyer fulfills his payment obligations. Such a system poses serious risks for financial organizations.
• Persons making a bank deposit pay interest tax only when the rate exceeds 14%, while in Islamic (and any other) investment companies income tax is paid on all income.
• Russian banking law forbids banks to engage in trade. Therefore, if a bank works in Islamic financing, it must accept assets on its balance sheet which are non-core for a credit institution. Recordkeeping and realization of such assets is made rather difficult.
• The key feature in Islamic financing is that profit and risk are shared by the financial organization and its investors. In this connection, Islamic financial institutions are unable to guarantee return of the principle investment amount. Yet banking law requires the bank to return the principle in full in any event.

To summarize, we should note that the Russian legislation does not currently provide banks with a possibility to fully comply in their operations with the Islamic financing principles. Organizations that already provide certain Islamic banking services are severely limited in their activity and are hardly competitive. Therefore, even though there is  public interest and several organizations already offer certain Islamic banking services, their actual implementation and economical attractiveness in Russia is overly complex due to absence of special legal regulations. For Islamic banking to actually work in Russia, comprehensive reform of banking and tax law is needed. If these measures are taken, new serious players acting on the Islamic financing principles will certainly appear in the Russian financing market. However, at this very moment there is no joint understanding of what this reform will be like and when it will be implemented.