07.09.2023
News
The law on Islamic banking in Russia came into force

Recently, the demand for Islamic financial instruments has been increasing worldwide, including in the post-Soviet countries. This trend is due to the rising business activity of players from developing Muslim countries and the general growth of the Muslim population in various countries. Russia’s increasing collaboration with the Middle East and Asia entails the development of legal conditions for the implementation of Islamic financial institutions.

 

WHAT IS ISLAMIC FINANCE?

Put simply, Islamic financial instruments differ from conventional instruments by requiring compliance with the precepts of Islamic law (fiqh) based on religious, including ethical, norms. Such fundamental precepts include, inter alia:

▪ Prohibition of charging interest on transactions (riba);

▪ Prohibition of transactions whose terms contain uncertainty (gharar);

▪ Prohibition of financing of reprehensible activities (e.g., alcohol and tobacco production, arms trade, gambling);

▪ The need to fairly allocate losses and profits between the parties based on entrepreneurial risk; and

▪ The need to transact only in real assets and to identify the underlying real assets.

Islamic law has developed various contractual structures that allow full-fledged commercial activities to be cinducted while complying with religious precepts. Islamic finance instruments are available for everyone and not only for Muslims, as many people mistakenly believe.

 

EASTWARD TURN. ISLAMIC FINANCE IN RUSSIA

In the context of growing sanctions pressure and the resulting shift in the vector of economic cooperation from the West to the East, the Russian Federation began legislative work to create legal conditions for attracting foreign investment related to Islamic banking – a dynamically developing sector in the Middle East and Asia.

On September 1, 2023, Federal Law 04.08.2023 N 417-FZ “On Conducting an Experiment to Establish Special Regulation for the Purpose of Creating the Necessary Conditions for Partnership Financing Activities in Certain Constituent Entities of the Russian Federation and on Amending Certain Legislative Acts of the Russian Federation”[1] (the “Law”) came into force, which provides for an experiment on partnership (Islamic) financing in a number of federal subjects of the Russian Federation. Instead of the term “Islamic financing”, the Law uses the synonymous but more neutral term “partnership financing”.

The experiment on the introduction of Islamic legal institutions began on September 1, 2023 and will be held for 2 years in Tatarstan, Bashkortostan, Dagestan and Chechnya. Based on the results of the experiment, the legal regime of Islamic finance may be extended to the entire territory of the Russian Federation[2]. The relevant subjects have already developed roadmaps for the development of Islamic finance, including activities to popularize new financial instruments and educate employees and entrepreneurs in the field of Islamic banking.

The main regulator in the field of partnership financing will be the Central Bank of Russia, which has been granted broad rule-making and administrative powers[3].

At the federal level, an expert council will also be formed under the Government of the Russian Federation, which will monitor the progress of the experiment and propose new legislative initiatives. Given the attention paid by the authorities to this experiment, as well as the general direction of Russian foreign policy, Islamic finance in Russia is expected to undergo intensive legal and economic development.

Partnership financing under the Law involves[4]:

▪ raising money by means of loans, issuing bonds, taking property into trust management, accepting contributions to the authorized capital of the participant of the experiment;

▪ granting of loans;

▪ financing through purchase and sale with installments;

▪ financing through contribution of funds to the authorized capital, leasing, implementation of activities under a simple or investment partnership agreement; and

▪ issuing sureties for third parties.

However, partnership financing prohibits the charging of a fixed percentage, but allows for a variable amount depending on the success of the transaction. It is also prohibited to finance the production of tobacco, alcohol, arms, ammunition and trade in them, as well as gambling[5].

Legal entities (including business companies) registered in the territory of the relevant subjects of the Russian Federation in which the experiment is being conducted, or which have opened a branch there, and which meet the requirements set out in the Law for shareholders and management bodies of a legal entity, the financial condition of the organization, the authorized capital, etc., will be able to participate in the experiment[6]. It will not be necessary to obtain the status of a credit or non-credit banking organization.

To participate in the experiment, a company must submit documents to the Central Bank of Russia to register in a special register of experiment participants[7].

***

Even prior to the enactment of the Law, various financial institutions in Russia, supported by certain region’s authorities, were actively engaged in Islamic finance projects. Given the active development of legal regulations in this industry, as well as the increasing demand for Islamic financial instruments worldwide, Islamic banking may play a significant role in the financial system of the Russian Federation in the foreseeable future, particularly in collaboration with investors from Muslim countries.

 

This material is for reference only and does not constitute advice or legal opinion. If you have any questions regarding this communication, please contact us at partners@whitesquarepartners.com.

[1] See: https://sozd.duma.gov.ru/bill/198584-8.
[2] Subcl. 2 of cl. 1 of part 2 of art. 1 of the Law. Also, the Central Bank of Russia pointed out: “based on the results of the experiment, the necessity of creating a new type of financial organizations of partnership financing, which will have a special approach to risk management, capital adequacy, corporate governance will be assessed” (Perspective Areas of Development of Banking Regulation and Supervision, 2022. p. 40).
[3] See art. 1, 4, 5, 6, 7, 10 of the Law.
[4] Part 1 of art. 2 of the Law.
[5] Part 2, 3 of art. 2 of the Law.
[6] Art. 3, part 2 of art. 4 of the Law.
[7] Part 5 of Art. 1, Art. 4 of the Law.