What steps should be taken to introduce Islamic banking in Azerbaijan?

Islamic banking is an economic system, in which financial transactions are conducted under the rules of Islam. Under a grant agreement signed in January 2017, the Islamic Development Bank provided $200,000 in technical assistance to implement this mechanism in Azerbaijan. The Small and Medium Business Development Agency (SMBDA) has been appointed as the body responsible for implementing a technical support project to develop a legal framework for Islamic banking in the country. Ekvita Consulting LLC has been selected to develop proposals for the system.

The head of Ekvita Consulting LLC, Ilgar Mehdi, told Report that they had made proposals to the government to introduce Islamic banking in Azerbaijan:

"The purpose of our project was to protect the legislative system and legal framework. There must be a system that can stimulate the development of Islamic banking in the country. Our current legal framework is based solely on traditional banking. It is forbidden to receive and pay interest in Islamic banking. Traditional banking is based on interest. In Islamic banking, it is possible to make a profit by participating in entrepreneurs' businesses. But we do not have a legal framework for this. As a rule, the bank is not allowed to operate in the non-financial sector. Therefore, we had to write the legislative framework in such a way as to remove this ban. It is not a question of granting any privileges to banks operating with Islamic principles. We are talking about creating the same conditions for all types of banking."

According to him, currently, banks operating under Islamic principles are unable to function in Azerbaijan.

"Conditions must be created so that banks operating on both principles have the same legal competitiveness. Our project was aimed at developing this. We prepared our proposals and submitted them to SMBDA last year."

Ilgar Mehdi noted that according to the tax legislation in Azerbaijan, Value Added Tax (VAT) must be paid in any asset transactions:

"One of our proposals was related to tax issues. According to Islamic banking, a bank buys an asset, finances it, and then gives it to the entrepreneur. In this case, the transaction takes place twice, and VAT is applied in both transactions. One of the proposals is to eliminate the use of double VAT."

The head of Ekvita Consulting said that other proposals include the development of prudential rules:

"The governing mechanism of Islamic banking is such that a religious council must approve the bank's activities. The members of this religious council are experts in the financial sector and people with a deep knowledge of Islamic banking. Well-known specialists in Islamic banking do not have to be Muslims. For example, the most famous lawyer in the London market specializing in Islamic banking is a Jew. There should be such a board that checks and approves whether banks' products comply with Islamic banking regulations. It is very important for a religious citizen who applies to the bank. If a citizen comes to the bank and buys a product, he must be sure that the religious council has approved it. We have difficulty in establishing such a system. The issue of different religions also arises here. The members of the religious board must be specialists in the financial sector. Some people know the religious field but do not know the financial sector, and there are people who have a financial education but lack religious knowledge. We need people who are knowledgeable in both these fields. We have few such specialists."

"Loan interest rates in Azerbaijan's banking system are still high. It is due to high operating costs, the presence of risks in the banking sector, a weak competitive environment, etc. If alternative financial services, such as Islamic banking, come to the country, it will lower the interest rates."