Why is Russia implementing Islamic banking?

With Russia’s sizeable Muslim population of 20-25 million, President Vladimir Putin signed a law introducing Islamic Banking in four Muslim republics last month to test the feasibility of the Islamic finance model. If the program succeeds, the model will be implemented in the rest of the country.

Russia launched the Islamic banking system in four major Muslim-dominated regions – Chechnya, Dagestan, Tatarstan and Bashkortostan – as part of a two-year pilot program on September 1.

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This long-awaited initiative has come to fruition due to the recent geopolitical turmoil and with Russia being hit by severe Western sanctions. Under the prevailing circumstances, the “diversifying opportunities created by Islamic banking have become particularly timely,” according to an academic adviser at Oxford University, Dr Diana Galeeva.

“Extensive geopolitical transformations have been put in motion by the Ukraine war, including Russia seeking more economic relations with the East, with new opportunities for both sides,” Galeeva said. “Serious consideration of Islamic finance and banking as an alternative to the Western system is in part driven by this reorientation.”

Energy is the key to Russia’s economy, and as Moscow looks more towards the East, including the world’s major energy powers such as the Gulf states, “Islamic banking is an important platform in building these relationships and encouraging greater investment,” Galeeva added.

The idea to introduce Islamic banking first arose in Russia during the financial crisis in 2008, when banks faced a liquidity shortage and began looking for alternative sources of cash, Galeeva explained. Then, in 2014, after the annexation of Crimea, Russian banks felt the additional squeeze of Western sanctions.

“In response, the Association of Russian Banks proposed allowing Islamic banking and establishing a committee within the Central Bank to regulate the activities of Sharia banks,” she said.

While some experts believe that Russia’s implementation of Islamic banking is a well-thought-out initiative to counter Western sanctions and foster economic development, others consider the program to be more of a publicity stunt and an effort to moderate the poor Muslim regions in the country.

“It is probably about PR more than anything else. [Russia] is introducing elements or allowing for Islamic banking within its banking system, but it is not going to be the dominant player in Russia,” Associate Fellow at the UK thinktank Chatham House’s Russia and Eurasia program, Timothy Ash told Al Arabiya English.

“A lot of the soldiers who have been dying in Ukraine have been from poor Muslim regions in Russia that lack social stability. Maybe this is an attempt to moderate potential social unrest in southern Russia,” Ash reasoned.

Impact of Islamic banking on Russia’s economy

Islamic banking is expected to raise $11-$14 billion in joint projects with Muslim countries, Anatoly Aksakov, the head of the financial market committee of Russia’s State Duma, the lower house of the Russian legislative assembly, said in July.

“We expect, at the same time, an inflow of investments to different projects from Turkey, Iran and the Asian countries. That is the serious potential,” Aksakov was quoted as saying by Moscow’s state news agency TASS.

According to Sberbank, Russia’s largest lender, the Islamic banking sector has an annual growth of 40 percent and is reportedly expected to reach a value of $7.7 trillion by 2025.

Experts predict Islamic banking to yield promising results in Russian markets but say it will require time and proper implementation to become successful.

“The consumer base is growing. All the funds accumulated in Islamic finance projects are actively utilized and all these factors constitute a very good ground for the new market to grow,” Kalimullina said. “However, a lot will depend on the effective work and fruitful interaction between the regulator – the expert council being formed under the government – and the market players,” she added.

According to Kalimullina, Islamic finance can play the role of a “sound financial bridge,” enhancing and promoting trade and investment.

Creating a successful Islamic banking system in Russia will be a long road and Moscow will need to create a proper legal framework to be embedded in its wider business practices.

“Russia has good strategic motivations to develop itself as a center (for Islamic banking), but it will require time, expertise and a mutual understanding between Russia and the Muslim world on how to build this for mutual interests,” Galeeva said.

Al Arabiya