Islamic banking in Kazakhstan

2
How attractive is
setting up an
Islamic Bank in
Kazakhstan?
Business plan
 Presented by: Madi Akmambet, # 100054097
 In partial fulfilment of the: Executive Master of
Business Administration Degree (EMBA)
 Submitted for: Business Mastery Project
 Presented to: Professor Mohamed Iqbal Asaria
 Cass Business School, City University London
 Date: 14 October, 2012
 Word count: 17,892

3
TABLE OF CONTENTS
BIBLIOGRAPHY .................................................................................... 7
LIST OF TABLES AND FIGURES ...............................................................14
ACKNOWLEDGMENTS ..........................................................................16
LIST OF ABBREVIATIONS ......................................................................17
LIST OF ARABIC TERMINOLOGY...............................................................19
1. EXECUTIVE SUMMARY .....................................................................20
2. INTRODUCTION ..............................................................................24
3. LITERATURE REVIEW .......................................................................26
3.1. ISLAMIC BANKING RATIONALE ...............................................................................................26
3.2. ISLAMIC BANKING PRODUCTS ................................................................................................27
3.3. ISLAMIC BANKING: SITUATION – COMPLICATION -PERSPECTIVE...................................................27
3.3.1. SITUATION ................................................................................ 27
3.3.1.1. Situation: Growth and Significant Milestones..............................................27
3.3.1.2. Situation: Supportive Infrastructure.............................................................28
3.3.1.3. Situation: Outperformance and Resilience ..................................................29
3.3.2. COMPLICATION .......................................................................... 31
3.3.2.1. Complication: Overcoming Challenges.........................................................31
3.3.2.2. Complication: ‘Reverse Engineering’............................................................31
3.3.2.3. Complication: Sharia-Compliant Versus Sharia-Based.................................33
3.3.3. PERSPECTIVE ............................................................................. 35
3.3.3.1. Perspective: Reshaping.................................................................................35
3.3.3.2. Perspective: Bright Future If Only…..............................................................36
3.3.3.3. Perspective: Summary Using SWOT.............................................................39
3.4. KAZAKHSTAN BANKING SECTOR BACKGROUND .........................................................................40
3.5. OUTSET OF ISLAMIC FINANCE IN KAZAKHSTAN ..........................................................................43
3.6.APPLYINGSTRATEGIC AND MARKETING MANAGEMENT ...............................................................46
3.6.1. KEY SUCCESS FACTORS ................................................................. 46
3.6.2. SEEKING A NEW VALUE PROPOSITION ............................................... 47
4. DEMAND STUDY .............................................................................49
4.1. MARKET PENETRATION ........................................................................................................49
4.2. RELIGIOUS FACTOR..............................................................................................................50
4.3. MARKET SURVEY.................................................................................................................51

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4.3.1. METHODOLOGY OVERVIEW ............................................................ 51
4.3.2. RESPONSE RATE ......................................................................... 53
4.3.3. SAMPLE DISTRIBUTION ................................................................. 54
4.3.4. SURVEY RESULTS ANALYSIS ............................................................ 57
4.3.5. STATISTICAL INFERENCE ................................................................ 63
4.4. CASE STUDY: FIRST ISLAMIC BANK IN KAZAKHSTAN....................................................................65
4.5. CUSTOMER BEHAVIOR..........................................................................................................67
4.6. SUMMARY .........................................................................................................................68
5. BUSINESS PLAN ..............................................................................71
5.1. BUSINESS STRATEGY ANALYSIS...............................................................................................71
5.1.1 EXTERNAL FACTORS ...................................................................... 71
5.1.1.1. PEST ..............................................................................................................71
5.1.1.2. Porter’s Five Forces ......................................................................................77
5.1.1.3. Competitors Analysis....................................................................................79
5.1.2. INTERNAL FACTORS ..................................................................... 80
5.1.2.1. Vision, Mission and Values ...........................................................................81
5.1.2.2. Who – What – How.......................................................................................82
5.1.3 FINDINGS USING SWOT ................................................................ 84
5.1.4 STRATEGY FORMULATION ............................................................... 85
5.2. BUSINESS DEVELOPMENT PLAN .............................................................................................87
5.2.1. CORPORATE GOVERNANCE ............................................................. 87
5.2.1.1. Shareholding.................................................................................................87
5.2.1.2. Board of Directors.........................................................................................87
5.2.1.3. Council on Principles of Islamic Finance.......................................................88
5.2.1.4. Management Board......................................................................................89
5.2.1.5. Internal Control, Risk Management and Audit.............................................89
5.2.1.6. Business Ethics..............................................................................................92
5.2.1.7. Organizational Chart.....................................................................................92
5.2.2. PRODUCTS AND SERVICES .............................................................. 93
5.2.2.1. Deposit Products...........................................................................................93
5.2.2.2. Financing Products........................................................................................93
5.2.2.3. Sukuk.............................................................................................................94
5.2.2.4. E-banking ......................................................................................................95
5.2.2.5. Pricing Policy.................................................................................................95
5.2.3. IT INFRASTRUCTURE .................................................................... 98
5.2.4. BRANCH NETWORK PLAN ............................................................ 100
5.3. FINANCIAL PLAN ...............................................................................................................107
5.3.1. MAIN ASSUMPTIONS ................................................................. 107

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5.3.2. BALANCE SHEET AND INCOME STATEMENT ....................................... 109
5.3.3. KEY PERFORMANCE INDICATORS .................................................... 109
5.3.4. MEASURING RETURN ON INVESTMENT ............................................ 110
6. CONCLUSION ................................................................................ 111
7. RECOMMENDATIONS ..................................................................... 113

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LIST OF APPENDICES
Appendix A: Core Islamic Banking Products Description........................... 117
Appendix B: IMF on Kazakhstan Banking Sector....................................... 119
Appendix C: Kazakhstan Islamic Finance Road-Map ................................. 120
Appendix D: Survey Form and Questionnaire .......................................... 123
Appendix E: Screenshot of the Survey Banner ......................................... 127
Appendix F: Organization Chart ............................................................. 128
Appendix G: Financial Projections: Main Assumptions ............................. 129
Appendix H: Financial Projections: Balance Sheet and Income Statement . 131
Appendix I: Financial Projections: Key Performance Indicators ................ 133
Appendix J: Financial Projections: Measuring Return on Investment......... 134

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LIST OF TABLES AND FIGURES
List of Tables:
Table 1: SWOT Analysis for Islamic Banking Industry ................................. 39
Table2: Kazakhstan Macroeconomics, Selected Indicators, 2007-2017 ........ 73
Table3: PEST for Kazakhstan .................................................................... 76
Table4: Competitors Analysis: Top 10 Banks in 2011 ................................. 79
Table 5: ‘Vision, Mission And Values’ Analysis .......................................... 81
Table 6: ‘Who – What – How’ Analysis...................................................... 82
Table 7: SWOT Analysis for a New Islamic Bank......................................... 84
Table8: NIM and Interest Spread Distribution among Kazakh Banks
(01 July 2012) .......................................................................... 96
Table 9: Variation of Loan and Deposit Rates for Selected Banks
(September 2012) ..................................................................... 97
Table 10: IT Structure and Budget ............................................................ 99
Table 11: Branches Opening Indicative Plan............................................ 103
Table 12: Marketing Expenses for Selected Banks in 2010-2011 ............... 105
Table 13: Marketing Indicative Budget for 2013 ...................................... 106
List of Figures:
Figure 1: Core Islamic Banking Products ................................................... 27
Figure 2: Islamic Finance Developments ................................................... 28
Figure 3: DJIMin Comparison with DJIand S&P 500 .................................... 30
Figure 4: Composition of Financing Modes in Islamic Banking Sectors, 200832
Figure 5: Kazakhstan Banking Sector Development, 2002-2011 .................. 40
Figure 6: Affected Loan Portfolio of Kazakh Banks, 2004-2012 ................... 42
Figure 7: Readiness Chart: Market vs. Industry ......................................... 46
Figure 8: Identifying Key Success Factors ................................................. 47
Figure 9: Banking Credit-to-GDP Ratio in Selected Countries, 2011, (%)...... 49

15
Figure 10: Islam Religion in Kazakhstan and Other Countries ..................... 50
Figure 11: Respondents’ Distribution by Gender ....................................... 54
Figure 12: Respondents’ Distribution by Age ............................................ 55
Figure 13: Respondents’ Distribution by Occupation ................................. 55
Figure 14: Respondents’ Distribution by Income Size................................. 56
Figure 15: Responses Distribution on Question 1 ...................................... 57
Figure 21: Tolerance to Premium Price on Islamic Banking Products........... 60
Figure 24: Islamic Banking Premium Price Tolerance in Kazakhstan ............ 64
Figure 25: ‘Al Hilal Bank Kazakhstan’ Performance Indicators, 2010-2012 ... 66
Figure 26: Life Expectancy vs. Income per capita among
Rich and Poor Countries............................................................ 75
Figure 27: Porter’s Five Forces for Kazakhstan Banking Sector ................... 77
Figure 28: Strategic Groups and Market Segments .................................... 86
Figure 29: Map of Kazakhstan ................................................................ 100
Figure 30: Branch Numbers Comparison (September 2012) ...................... 101
Figure 31: Geographical Distribution of Total Banking Loans
(September 2012) ................................................................... 102
Figure 32: Geographical Distribution of Small Business Banking Loans
(September 2012) ................................................................... 102
Figure 33: Marketing Communication Mix............................................... 104

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ACKNOWLEDGMENTS
‘In The Name of God, Most Gracious and Most Merciful!’
First of all I would like to express my deepest gratitude to my parents, Gulzhan Sadyr-kyzy
and Kadyrbek Alpysbai-uly for fostering of zeal and purposefulness in my life.
My sincere thanks go to the beloved ones: my wife Almagul, and sons Adi, Akan and Ali for
their support during the whole course of the EMBA and the project.
Very special appreciation is to my supervisor Professor Iqbal Asaria for critical advice and
guidance on the dissertation.
I would also like to thank very much all of my friends and colleagues, who helped me one
way or another in the planning, writing and completion of this project:
Serik Akhanov – Chairman of the Council of the Financial Institutions’ Association of
Kazakhstan;
Damir Karassayev – Chairman of ABA Bank, Cambodia;
Askhat Azhikhanov – CEO of ABA Bank, Cambodia;
Kuat Kozhakhmetov – Chairman of the Financial Market and Financial Organizations
Supervision Committee of the National Bank of Kazakhstan;
Anuar Kaliyev – Director of the Banking Supervision Department of the National Bank of
Kazakhstan;
Daurzhan Augambay – General Director of ‘Akyl-Kenes Consulting’, Kazakhstan;
Mars Aldashov – Deputy Chairman of the Management Board of ‘Tsesnabank’, Kazakhstan;
Galymzhan Temirov – CTIDO of ABA Bank, Cambodia;
Zokhir Rasulov – CMO of ABA Bank, Cambodia;
Igor Zimarev – Marketing Officer of ABA Bank, Cambodia.
Last but not least, a grateful acknowledgment is dedicated to our course Director Professor
Roy Batchelor, Cass Business School of the City University London and Dubai International
Financial Center, for the given opportunity to go through this unique and first-class EMBA
programme.

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LIST OF ABBREVIATIONS
AAOFI Accounting and Auditing Organization for Islamic Financial Institutions
ALCO Assets and Liabilities Management Committee
ARR Accounting rate of return
BOD Board of Directors
CTR click-through ratio
DBK Development Bank of Kazakhstan
DJI Dow Jones Industrial
DJIM Dow Jones Islamic Market World Index
EMBA Executive Master of Business Administration
FMSA Financial Market and Financial Organizations Regulation and Supervision
Agency of the Republic of Kazakhstan
CIBAFI General Council for Islamic Banks and Financial Institutions
HCB Housing and Construction Bank
IDB Islamic Development Bank
IFSB Islamic Financial Services Board
IIFM International Islamic Financial Market
IIRA International Islamic Rating Agency
ILMC Islamic Liquidity Management Centre
IRR Internal Rate of Return
IRTI Islamic Research and Training Institute
ISRA International Sharia Research Academy for Islamic Finance
IT Information Technologies
KazStat Kazakhstan Statistics Agency
KYC Know Your Customer Policy
KZT Kazakhstan currency tenge

18
MENA Middle East and North Africa
MB Management board
NBK National Bank of the Republic of Kazakhstan
NIM Net Interest Margin
NPL Non-performing loans
NPV Net Present Value
PBUH Peace be upon him
RFCA Agency on Development of the Regional Financial Centre of Almaty City
ROAA Return on average assets
ROAE Return on average equity
ROE Return on Equity
RK Republic of Kazakhstan
SME Small and Medium Enterprises
SSB Sharia Supervisory Boards
UAE United Arab Emirates
UK
USA/US
US$
United Kingdom
United States of America
US Dollar
VAT
p.a.
Value-added tax
per annum
avg. average
ths thousands

19
LIST OF ARABIC TERMINOLOGY
Al-Qur’an Divine Holy Book
Gharar Uncertainty
Halal Permitted in Islam
Haram Prohibited in Islam
Ijara Islamic lease
Istisna Islamic debt-based contract
Maisir Gambling
Maqasid al-Sharia Objectives of Islamic law
Mudaraba Islamic equity-based contract
Murabaha Islamic debt-based contract
Musharaka Islamic equity-based contract
Qard-Hassan Islamic loan with no interest
Qimar Game of chance
Riba Usury, any form of interest
Salam Islamic debt-based contract
Sharia Islamic law
Sukuk Islamic bond
Sunna the Prophet Muhammad’s (PBUH) words and acts
Takaful Islamic insurance
Wadiah Safe custody
Wakala Islamic agency contract

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1. EXECUTIVE SUMMARY
The purpose of this report is to answer the question ‘How attractive is setting up an Islamic
bank in Kazakhstan?’. This persuades us to find out whether there is a demand for Islamic
banking products or not. Also we need to prepare a business plan of a new Islamic banking
venture in the country and analyze its feasibility.
Since 1960s Islamic finance has been growing fast and already achieved many significant
milestones. Sharia-compliant assets under management of Islamic banks and financial
institutions have grown up to US dollars (US$) 1.1 trillion globally (Hall, 2012). The industry
has established its own regulatory authorities and standard-setting bodies. Islamic finance
has been evolving in many Muslim countries as well as in countries with majority of non-
Muslim population.
Kazakhstan is one of the recent countries, who opened doors for Islamic finance. In 2008 the
Banking Law was amended making a path to the alternative banking system. Ever since the
only Islamic bank started operations in Kazakhstan is a subsidiary of Abu Dhabi state-owned
Al Hilal Bank. This bank was opened based on an intergovernmental agreement between the
Republic of Kazakhstan (RK) and the United Arab Emirates (UAE) (Kazinform, 2010).
Therefore, some analytics are in the opinion that this is more political decision rather than a
commercial business project. In 2010 there were some other public announcements about
new interested entrants such as Amana Raya from Malaysia and Qatar Islamic Bank (Goud,
2011). However, due to unknown circumstances these banks are not yet to be seen in the
market.
How comes it? Is there no demand? Is it commercially inviable to open an Islamic bank in
Kazakhstan? Are there any issues with regulations and the Government’s support? Are there
any unmanageable risks? Or maybe Islamic finance itself is not ready to offer a viable
alternative to the market, where 38 banks already compete heavily. All these questions we
address throughout the report, although not speaking for the above mentioned banks.

21
We started our analysis from an overview of Islamic finance globally. This provided us with a
quite controversial position on the industry perspectives. Although the industry has
achieved a lot in terms of growth and development, it put itself in jeopardy by losing its
uniqueness and mimicry conventional banks.
In the wake of the recent global financial crisis and still ongoing economic uncertainty many
regulators around the world are revising underlying principles and goals of the modern
financial system. Many of them expressed necessity to seek alternative ways of doing
banking (e.g. King, 2010). Predatory loans, speculation with derivatives, excessive debt,
moral hazard and too-big-to-fail dilemma are among the main reasons of the crisis
discussed. Moral and ethics became high on the agenda of many financial institutions and
investors creating a new movement of socially responsible investments.
In turn Islamic finance has a good opportunity to come up as an economically wealthy
alternative to conventional finance. Being based on the Divine religion it has all the ethical
and moral principles already ingrained in its core. Prohibition on interest (riba in Arabic),
uncertainty (gharar) and gambling (maisir) makes Islamic banking free of all the weaknesses
unveiled by the recent crisis.
Furthermore, Islamic finance, being an integral part of Islamic economics, at its high level
goals must aim for social justice and distributional equity. To achieve it banks must
stimulate economic activity in a just and fair way (primarily through risk and profit sharing
mechanisms) and increase financial inclusion of all members of community.
However, the main criticism and reputational risks of Islamic finance are originating from
the statement that it is Islamic only in name. In average for selected countries in the Middle-
East and North Africa (MENA) 77% of the Islamic banks' assets comprise of Murabaha and
deferred sales (Ali, 2011). Being Sharia-compliant, however, these instruments create debt
just like conventional loans and therefore do not meet the Islamic economics goals.
Therefore, for further successful development of the industry this critique must be
overcome through proposing a genuine alternative on the basis of moral values and social
benefits orientation.

22
In regard to Kazakhstan market we found that there was a clear interest for Islamic finance
products. We conducted a survey in forms of the web questionnaire and the e-mail poll for a
control. The available market share was assessed 21% - 45% of the total banking market.
Other factors, such as the banking sector penetration, religious matters and consumer
behavior as well as a case-study of Al Hilal in Kazakhstan corroborate our findings in the
survey and promise a good opportunity for new Islamic finance ventures.
Further we prepared a business plan of a new Islamic bank in Kazakhstan to see if we can
put all the ingredients together to make the project commercially viable and interesting for
potential investors. Also through analysis of external and internal factors we derived a
business strategy for the bank with focus on small and medium enterprises (SME) and retail
market segments.
On the basis of our discussion and analysis we came up with a value proposition of the new
bank: the Sharia-based banking products with clear evidence of socio-economic
improvement for a client and the country. A prerequisite for successful delivery of this value
will be comprehensive education and marketing communication programs in order to
increase awareness and understanding of Islamic finance in the market. Extensive branch
network, strong 'Know Your Customer' (KYC) and risk management systems must be also
put in place.
Through our financial projections we concluded that the project can attract potential
investors promising the Internal Rate of Return (IRR) of 25.1%.
We proposed a list of recommendations for investors, regulators and for further market
researches. The most important are the following:
1. The business strategy with the formulated value proposition should be considered
seriously by potential shareholders to minimize a reputational risk of Islamic finance
overall and the new bank in particular. Thus a ‘Socio-Economic Better-Off Test’ for each
and every transaction needs to be introduced along with existing in practice Sharia
compliance control and risk reports.

23
2. The bank to a larger extent should use genuine and unique Islamic finance partnership
mechanisms, where both risk and profit are shared.
3. Not only Islamic banks, but also the regulators should take actions in informing and
educating the market on Islamic finance goals and mission, principles and mechanisms.
4. The bank and the regulators must ensure that the Islamic finance legislation framework
is being improved as it is planned in the Road-map of the Government of the RK and the
recent draft law.
5. The infrastructure of the market should be set-up for effective assets and liabilities
management.
These recommendations obviously require some efforts and costs. But the benefits will
overweight them as soon as an effective market place with well-informed potential
customers, harmonized regulation in banking, tax and civil law and appropriate
infrastructure in interbank and capital markets is created. Islamic banks will benefit from
correct value perception and increasing the potential market by higher awareness level. In
turn, the Government will benefit from higher financial inclusion and more sukuk
investments through developing the local component of Islamic finance.
We are confident that our findings and proposals will be considered seriously by potential
investors and regulators. The collected data may be applied for subsequent researches on
different marketing and product strategies.
A potential of the banking sector, a macroeconomic outlook of RK, the Government and the
National Bank programmes on Islamic finance are critically discussed throughout the
dissertation.
Finally the business plan provides the main guidelines and checklist of all the necessary
components for a successful start-up in Islamic banking in Kazakhstan.

24
2. INTRODUCTION
Nowadays Islamic banking and finance is recognized as a fast growing industry and
increasingly important part of the global financial system. Emerged in early 1960s the
industry has grown into US$ 1.1 trillion of Sharia-compliant assets (Hall, 2012). Countries
across the world adopt special legislation to allow Islamic banks and financial institutions
operate as alternative to conventional finance. While this growth primarily comes from
Muslim countries, Islamic banks can also be seen in countries with majority of Non-Muslim
population. UK, France, Australia, China and Singapore have their financial centers’ doors
open for the Islamic finance.
Kazakhstan adopted the legislative foundation for Islamic banking in 2008, being one of the
first among Commonwealth of Independent States. Some initiatives are taking place also in
Kyrgyzstan, Azerbaijan and Russia.
The main motivation for Kazakhstan government is to attract more foreign investments,
especially from the oil-rich Middle East. At the second Conference on Islamic Finance in
Kazakhstan the Prime-Minister Karim Massimov emphasizes an important role of Islamic
finance in implementation of the country’s new industrial programme and calls upon Islamic
countries businessmen to participate in the prioritized projects (as cited by Zhanibekov,
2011). Furthermore, ‘over the next 5-10 years the government is aiming to attract up to US$
10 billion by issuing Islamic securities’ (Zhanibekov, 2011).
A religious aspect also exists. Kazakhstan is historically a Muslim nation. Despite suppression
of the religion during the Soviet era, a growing number of people recover their national and
religious values now.
On the other hand, since the legal frame had been put in place Kazakhstan has welcomed
one Islamic bank only. In spite of several investment forums and conferences, where Kazakh
market was actively promoted, other new players are yet to be seen.

25
The objective of this dissertation is to answer the question "How attractive is setting up an
Islamic bank in Kazakhstan?". This question implies two other sub-questions such as "Is
there a demand for Islamic banking in Kazakhstan?" and "Is it a commercially viable
project?".
To deal with these questions we review the Islamic banking industry and Kazakhstan
banking sector in the following chapter. Next we present a demand study for Islamic
banking in Kazakhstan, where both primary and secondary data is used. The business plan
chapter provides the strategic analysis, business development plan and financial projections
of a new Islamic bank.
Finally we conclude that a new Islamic bank in Kazakhstan is a viable business idea and can
be interesting for potential investors.
This paper can be helpful for additional discussion, analysis and decision-making by
investors interested in Islamic banking in Kazakhstan. Also the derived conclusion and
recommendations can be useful for further development and improvement of the
regulatory framework in the country.

26
3. LITERATURE REVIEW
3.1. ISLAMIC BANKING RATIONALE
A good point to start is an emphasis that Islamic banks are profit-oriented enterprises just
like their conventional counterparts. The key difference is that Islamic banks must operate
within the boundaries, clearly established by Sharia or Islamic law (Ayub, 2007).
The main rules of Sharia forming the boundaries and distinguishing Islamic banks from
conventional are the following (e.g. Asaria, 2012; Ayub, 2007):
 Prohibition of riba that means usury and includes all forms of interest.
 Prohibition of gharar, maisir and qimar that means uncertainty, gambling and game of
chance. In this sense financial speculation is not permitted and all financial transactions
must be backed by a tangible asset.
 Prohibition of risk transferring and risk selling. Instead, risk must be shared amongst
business partners.
 Restrictions on sale of debt and financial assets and their pledge as collateral.
 Prohibition of finance for haram businesses. This means businesses that are repugnant
to Sharia Law including, but not limited, alcohol, tobacco and pork production,
entertainment related to gambling and vulgarity, as well as interest-bearing financial
services.
At first glance the Sharia guidance may seem rather technical instruction what is allowed
and what is not. However, Sharia is a code of laws based on the Divine book Al-Qur’an and
Sunna, which are the Prophet Muhammad’s (PBUH) words and acts. Therefore, the Sharia
guidance for Islamic finance is not only a letter of the law, but also a direct reflection of
spiritual and moral values of the religion.
Being an integral part of Islamic economics, Islamic finance through its principles and
mechanisms aims for distributional equity and social justice (e.g. Asaria, 2012; Ayub, 2007).

27
3.2. ISLAMIC BANKING PRODUCTS
Islamic banks offer their clients a wide range of banking services just like conventional
banks: deposit products, debit and credit cards, personal finance as well as business, trade
and project finance. Insurance (Takaful), investments and asset management are also
among Islamic finance products. However the latter is out of scope of this paper as we focus
on a commercial Islamic bank’s business project.
Figure 1: Core Islamic Banking Products
Source: Author’s work based on Vicary Abdullah & Chee (2010) and Dar Al Sharia Consulting (2012).
Figure 1 shows the main types of Islamic banking contracts both for deposit and finance
products. The description of all these products is given in the Appendix A. In practice these
provide a base for certain sub-types and hybrids (structured products).
3.3. ISLAMIC BANKING:
SITUATION – COMPLICATION -PERSPECTIVE
3.3.1. SITUATION
3.3.1.1. Situation: Growth and Significant Milestones
Since its inception in 1963 Islamic banking and finance has achieved many significant
milestones.

28
Figure 2: Islamic Finance Developments
Source: IFSB et al, 2010.
The mode of banking has attracted attention of many policy-makers and practitioners
around the globe. It is not only local banks in Muslim countries, but also well-known
financial institutions of the Europe and America, including HSBC, Deutsche Bank, Credit
Suisse and Citigroup, who offer the Sharia services.
The Banker magazine (2012, web-page) stated a firm growth of the sector:
‘Since the publication of the first Top 500 Islamic Financial Institutions by The Banker
in 2007, Islamic finance has continued to demonstrate upward growth despite
growing pains and a loss of confidence in global financial systems.
The 2011 survey of financial institutions practising Islamic finance reveals that
sharia-compliant assets rose by 21.45% from US$895billion in 2010 to
US$1,087billion in 2011.’.
The number of financial institutions offering Islamic finance products grew from 525 in 2007
to 675 in 2011 operating across 55 countries (The Banker, 2011).
3.3.1.2. Situation: Supportive Infrastructure
The industry is supported by well-established institutions:
 IDB, IFSB, ISRA, IRTI,

29
 General Council for Islamic Banks and Financial Institutions (CIBAFI),
 Accounting and Auditing Organization for Islamic Financial Institutions (AAOFI),
 International Islamic Financial Market (IIFM),
 Islamic Liquidity Management Centre (ILMC),
 International Islamic Rating Agency (IIRA),
 International Arbitration and Reconciliation Centre for Islamic Financial Institutions.
The standard-setting, regulation development and industry facilitation are among the key
functions of these authorities. They play a vital role for Islamic finance momentum. (e.g.
Auyb, 2007).
In order to facilitate the capital market for Islamic finance a number of indexes such as Dow
Jones Islamic Index, Al-Meezan Islamic Investment Index and the Malaysian Islamic index
have been introduced (e.g. Auyb, 2007).
Another important milestone is the Islamic interbank benchmark rate launched by Thomson
Reuters on November 22, 2011 (Hancock, 2012).
3.3.1.3. Situation: Outperformance and Resilience
The IMF analysts (Hasan & Dridi, 2010) conducted a comparative research on 120
conventional and Islamic banks that comprised about 80% of the global Islamic banking
(except Iran). The study showed that Islamic banks had better profitability on cumulative
basis (pre- and post-crisis 2008-2009) than conventional banks. The authors also mentioned
that it is Sharia that protected Islamic banks from investing in the instruments that seriously
damaged its conventional counterparts and triggered the global crisis.
The IDB analysis on the MENA region echoed to the IMF findings (Ali, 2011, p.40):
‘The Islamic banking sector has demonstrated more resilience against the financial
crisis mainly due to avoidance of interest. The requirement to abstain from interest
made their financing activities more tied to real economy and also required them to
avoid exposure to toxic financial derivatives.’.

30
On the asset management side Sandwick and Polson (2012, p.10) concluded after
performance test of both Islamic and conventional portfolios:
‘We can observe Islamic portfolios appearing to consistently outperform
conventional portfolios during highly stressed downward market conditions. Equally,
the same Islamic portfolios seem to enjoy performance equal to similar conventional
portfolios during upward-moving markets.’.
The following chart drawn from Google-Finance shows: from 2005 to date the Dow Jones
Islamic Market World Index (DJIM) gained 34.07%, whereas Dow Jones Industrial (DJI) and
S&P 500 (INX) up only 24.55% and 18.51% respectively.
Figure 3: DJIMin Comparison with DJI and S&P 500
Source: Author’s chart from Google-Finance (2012).
Furthermore, Islamic banks were found better prepared for new Basel III capital
requirements due to stronger capital structure, higher than average capital ratios and

31
limited use of derivatives as compared to conventional banks (Kara, 2011).
3.3.2. Complication
3.3.2.1. Complication: Overcoming Challenges
Having many inspired opinions and very promising trends on one hand, there is some
criticism of the industry on the other. Also, there are some natural obstacles due to the
sector’s infancy and the environment. These issues cannot be ignored by the market
participants and have to be tackled to ensure a new impetus for the sector.
Hasan and Dridi (2010, p.33) suggested that ‘while the global crisis gave Islamic banks an
opportunity to prove their resilience, it also highlighted the need to address important
challenges.’. As these key challenges they discussed a need for improvement of liquidity risk
management, bank resolution legal framework and human capital development.
3.3.2.2. Complication: ‘Reverse Engineering’
One of the major criticisms of Islamic banking is about so called ‘reverse engineering’ based
on conventional products and reluctance of Islamic banks to develop the risk-sharing
instruments (Asaria, 2012; El-Gamal, 2006).
Figure 4 depicts that the most preferable instrument of Islamic banks is debt-creating
Murabaha and deferred sales, with average proportion of 77% of total financing portfolio
across the selected countries. In some countries like Kuwait, Yemen and UAE this type of
financing is above 95%, whereas it is below 50% only in Bahrain.

32
Figure 4: Composition of Financing Modes in Islamic Banking Sectors, 2008
Source: Adapted from Ali (2011, p.18).
In turn, the share of the risk-sharing products based on Musharaka and Mudaraba contracts
is marginal. The maximum proportion of 30% is observed in Saudi Arabia.
However, there are certain reasons of the current situation:
 Firstly, the partnership requires from clients a full transparency to banks, which is
not always achievable.
 Secondly, the partnership implies risks-sharing along with profit-sharing condition,
which is also not always welcomed by clients in upward markets.
 Thirdly, it is more risky and expensive for Islamic banks.
 Besides, it is about ‘the dearth of secondary markets and lack of deep capital
markets’ (Asaria, 2012, p. 6).
‘Equity based methods are not easy for banks to implement because they have to
perform an enhanced level of due diligence and put in place stringent risk-
management controls while joint projects are ongoing. It is also difficult at the start
of a project to determine who would be a good business partner and who is
unsuitable. In the end, the bank has to utilize more resources, not only to perform
due diligence but also to be more actively involved in the running of the joint-venture
businesses.’ (Vicary Abdullah & Chee, 2010, pp. 190-191).

33
Overall, the competition from conventional banks and the market environment to a large
extent force Islamic banks to replicate conventional products and make them Sharia-
compliant.
‘The drive towards similarity with conventional banks is less by volition than a result
of the current operating and regulatory environment which does not provide all the
necessary support and infrastructure institutions that are needed for a well-
functioning Islamic banking industry.’ (Ali, 2011, p. 34).
3.3.2.3. Complication: Sharia-Compliant Versus Sharia-Based
Sharia governance efficiency along with shortage of Sharia scholars are another critical, if
not the most important, area for the sector.
Each of the top six Sharia scholars hold positions in the large number of Boards ranging from
38 to 78 (Travers, 2010). Accordingly this gives them availability to spend in one Board from
6 to 3days per year maximum, which is obviously not enough for the effective governance.
A research on corporate governance of Islamic banks in the MENA region (Habib et al, 2009)
casted doubt on Sharia Supervisory Boards (SSB) working integrity and long term viability of
the existing practices. The research discovered large discrepancies among banks in status of
SSB, namely their role, span and authority. Lack of independent supervision over SSB in
banks is another point of consideration.
A case-study analysis on Islamic banks in Saudi Arabia (Mustafa, 2009) found that while
Islamic banks in the country are more profitable than conventional competitors, they
significantly underpay their depositors. The profitability advantage was resulted from higher
proportion of demand deposits that are unremunerative. In turn, this is due to religious
clients’ behavior, who bring deposits to an Islamic bank to avoid riba, while getting no or
less income comparing to those who open accounts with conventional banks. This led the
author to a question on Sharia governance role since the study indicated a contradiction to
Sharia goals on just and fair income distribution.

34
It is important to note a distinction between the Sharia-compliant and Sharia-based activity.
As we discussed in the previous section, Murabaha prevails on balance sheets of Islamic
banks by approbation of the scholars. Although there is no riba in Murabaha contract, it
creates debt that is not encouraged in Islamic economics. What might be permitted by
Sharia is not always good and does not always meet the final goals of Sharia (Maqasid al-
Sharia). Here is a Life Example: a fast food made from allowed ingredients will have Halal
label, however, it would be barely healthy for consumers to have it every day.
As a result, some critics (e.g. El-Gamal, 2006, location 2760-62) blamed existing Sharia
governance system on the ground of ‘the form-above-substance’ approach in compromising
with Islamic legal restriction and copying conventional banks. El-Gamal (2006) also raised an
issue that Islamic finance should be re-branded. The idea was that having very noble aims of
Islamic economics, namely social justice and distributional equity, today’s Islamic financial
institutions are far from bringing benefits to society and economical value to their
customers. He suggested being truly an Islamic bank there is no need to name itself ‘Islamic’
rather it needs to be really socially oriented.
Mustafa (2009) also expressed a concern on future reputation of Islamic banking if existing
Sharia approach continues. He critically cited quite tough statements: ‘In two of the most
populous Islamic countries Pakistan and Egypt Islamic banking is already under suspicion of
being nothing more than ‘marketing ploy’ (Tripp, 2006, p. 146) and ‘not less than a fraud’
(Dawn, 2007).’. Some scholars even argued that the modern Islamic banking products, such
as Qard-Hassan, Wadiah, Murabaha were not free of riba (Nyazee, 2009).
As suggested by Asutay (ND) the power of ‘homoeconomicus’ prevailed over behavioral
norms of ‘homoIslamicus’, because profit maximization goals of Islamic banks overwhelm
social justice goals of Islamic economics (Asutay, ND, p. 16).
If we put Hyman Minsky’s ‘The Financial Instability Hypothesis’ (Minsky, 1992) at all of the
above, we would find Islamic banks being in potential danger as the growth of the industry
was resulted mainly from the debt-based financing. According to the hypothesis ‘the
accumulation of debt is the initial trigger for financial crisis. Economic stability in the short-

35
run breeds instability in the long-run as debt accumulates to unsustainable levels’ (Haneef &
Smolo, 2010, p. 1).
3.3.3. PERSPECTIVE
3.3.3.1. Perspective: Reshaping
Many agree that the Islamic finance industry is in urgent need of a specially designed and
globally unified ‘regulatory-prudential-supervisory framework’ (Mirakhor & Krichene, 2009,
p.71).
The Task Force on Islamic finance and Global Financial Stability under auspices of IFSB, IDB
and IRTI (IFSB et al, 2010) based on the latest global financial crisis lesson recognized all the
current issues and derived strategies for improvement, including areas of liquidity
management, macro-prudential regulation, infrastructure, accounting and auditing
standards, crisis management, rating process and talent development.
Mirakhor (2011) suggested that the lack of risk-sharing instruments within the today’s
Islamic finance market is comparable to a market failure and calls for government
intervention, specifically in development of and participating in a well-functioning stock
market. The stock market with long-term higher-return and higher-risk equity instruments
can be supportive for Islamic banking industry providing liquidity and promoting risk-sharing
culture.

36
3.3.3.2. Perspective: Bright Future If Only…
The milestones and trends so far achieved by the Islamic finance provide a solid ground for a
promising future of the industry.
By recent estimation the global industry will be growing at rate of 25 percent annually with
leading to the total assets value at US$5 trillion in 2016 (Emerald Insight, 2012 as cited by
Businessislamica, 2012).
‘Growth rates should be strong in near future’ (Vicary Abdullah & Chee, 2010, p. 273).
In favor of these projections we can claim the following:
1. Simple comparison of proportion of the total Sharia-compliant asset under
management, which is about 1% of global financial asset size, and proportion of
Muslim population in the world, which is about 20%, gives us a strong argument that
there is a huge room for the industry to grow. It is estimated that nowadays only
12% of Muslim population use Islamic Finance (Hancock, 2011).
2. The Middle–East cash flow from oil is a strong support for expansion of Islamic
finance in the region and beyond. The region has more than half of the world’s
proven oil reserves (53%1
).
3. Economic growth in Asia will also be supportive due to significant Muslim population
in the region, especially in countries like India, Malaysia and Indonesia.
4. Ethical and social responsible investments are on increasing demand in the West in
the light of economic crisis and social unrests, banking corporate scandals and
environmental issues.
5. Governments and financial centers are aiming for growth and diversification of
investments in their countries and therefore have to open doors for Islamic finance.
In the wake of the ongoing financial and economic turmoil across the globe, many scholars,
regulators and policy-makers consider Islamic finance as a viable alternative to the
1
Source: OPEC website - http://www.opec.org/opec_web/en/data_graphs/330.htm

37
conventional financial system. Furthermore, some of them see Islamic banking as a recipe
from the key problems existing in the modern financial system such as uncontrolled money
issue, lack of ethical limits and reliance on the market efficiency, focus on growth without
consideration of wealth distribution, weak role of the state in allowing greed and excessive
profits (eg. Ayub, 2007).
In fact, some warnings for conventional finance were even before the crisis, especially
regarding derivatives called as ‘financial weapons of mass destruction’ (Buffett, 2003 as
cited by Caba-Maria, 2011, p.5). The recent financial crisis unveiled a whole range of
imperfections of the conventional banking and financial system, such as ‘too-big-to-fail
dilemma’, ‘moral hazard’ and weak ‘market discipline’ attached to it, ‘money-multiplying
capacity of the banks’ and ‘unsustainable leverage’, ‘issuers of toxic assets’ and cost of
‘taxpayers’, who pay for bankers’ losses (Carmassi et al, 2010, p.1-13; Schwarcz, 2010;
Monks & Minow, 2011).
Indeed the new phenomenon was created by the modern banking system, whereby profits
are privatized and losses are socialized. The discussion on conventional banking and recent
crisis in details is beyond of this paper. However, it is worth to quote the Governor of the
Bank of England Mervyn King:
‘Of all the many ways of organising banking, the worst is the one we have today.’
(King, 2010, p.16).
Overall, the Islamic banking and finance industry is on the rise and has a great potential. It
has essential internal as well as external prerequisites for future growth.
Nevertheless, it requires a significant course of corrections, primarily, regarding the revision
of its initial objectives of social justice and distributional equity. Then implementation and
all technical issues as governance, legal framework and product development must be
subordinated to those objectives. We need a transformation of the industry ‘from the mere
halal stage to the halalan-tayyiban stage’ – from Sharia-compliant to Sharia-based (Haneef
& Smolo, 2010, p. 19).

38
Sharia governance system should be revised as well. Not only capacity of Sharia scholars for
effective participation in SSB, but also all disputable issues regarding products and
regulations of Islamic banks must be resolved teamwise.

39
3.3.3.3. Perspective: Summary Using SWOT
Table 1: SWOT-Analysis for Islamic Banking Industry
Internal
Strengths Weaknesses
 High and continuous growth over the last four
decades: assets up 21.5% in 2011
 International recognition and opening doors
even in countries with majority of Non-
Muslim population
 Spread of geographical scope
 Institutional infrastructure in place (IDB, IFSB,
AAOFI etc.)
 Strong demand for riba free and ethical
finance
 Outperformance over conventional banks and
asset management
 Higher resilience to shocks and crisis
 Ethical and moral values, increasingly
demanded around the globe, already
ingrained to Sharia principles
 Problems recognition and the industry road-
map in place
 Human capital deficit
 Sharia scholars deficit
 Reverse-engineering of conventional
products
 Focus more on debt-based products than
equity-based instruments
 Liquidity management due to lack of short
term investments, sovereign papers and
illiquid secondary market of Sukuk
 Additional cost involved due to Sharia
supervision
 Lack of absolute standardization across the
board (among countries, schools of thought)
 Inactive role of Governments in some
countries
External
Threats Opportunities
 Reputation risk due to conventional products
imitation
 Reputation risk due to yet invisible social
benefits
 Path-dependency on conventional model
 Cannibalism if authenticity lost
 Support from economic growth and oil
reserves in Muslim countries
 Spread across the globe and grow to cater
for needs of growing Muslim population of
1.6 billion2
 Increase in efficiency by regulation and
governance, product development
standardization, economy of scale and
market infrastructure development (liquidity
framework and capital markets)
 Revival with very unique and authentic value
proposition based on strong ethics and social
justice goals
 Delivery a viable alternative to conventional
system as more resilient to crisis and ethical
mode of finance
2
Pew Research Center (2012)

40
3.4. KAZAKHSTAN BANKING SECTOR BACKGROUND
Since Kazakhstan declared its independence in 1991 it has been carrying out a lot of reforms
towards a market-oriented economy. The Soviet era Kazakhstan Republic’s Gosbank was
transformed to the National Bank of the Republic of Kazakhstan in 1993 and Russian ruble
was replaced by Kazakh tenge (KZT), the national currency. The two-tier banking system was
introduced with the National Bank as its first tier and all other commercial banks as the
second one. The National Bank was empowered to fulfill traditional central bank’s functions
including money issue, currency control, monetary policy and banking regulation and
supervision (NBK, 2012a).
The latter function was transferred to the FMSA in 2004. Prior to it all segments of the
financial market, including banking, insurance, pension funds and securities firms, were
unified under auspices of NBK. This agency had operated until 2011 and then was rejoined
back to NBK (FMSA, 2012a).
Currently, NBK oversees 38 commercial banks, including one Islamic bank opened in 2010
(FMSA, 2012b).
Figure 5: Kazakhstan Banking Sector Development, 2002-2011
Source: Author's work based on banking statistics (NBK, 2012b; FMSA, 2012b).

41
Over the last decade Kazakhstan banking sector has experienced a rapid growth until 2008,
when the total assets reached 91% of GDP. Before then the banking sector had been one of
the most dynamic industries of the economy. NBK facilitated growth by strategies aimed
towards international banking and finance standards in terms of accounting and reporting,
information technologies and risk management, infrastructure and regulation. Specifically,
in 1999 NBK established the Kazakhstan Deposit Insurance Fund to facilitate savings in the
banking system. To facilitate and support the mortgage and house financing the Kazakh
Mortgage Company and Kazakh Mortgage Guarantee Fund were introduced in 2000 and
2003 respectively. In 2004 the First Credit Bureau was established to provide a stronger
credit discipline among borrowers.
The global financial crisis has affected the sector heavily. Several systematically important
banks such as BTA, Alliance, Halykbank, KKB and Temirbank were bailed-out by the
Government. Some of them like KKB and Halykbank bought their shares back after a critical
period of credit crunch. Others like BTA and Alliance are still under the Government
management and underwent through a tough process of their foreign debt restructuring.
Unprecedented 70% haircut of the US$16.65 billion debt in 2010 by BTA deeply damaged
the banking industry reputation and credibility. In 2012 the bank defaulted again on its
external liabilities offering another 80% haircut to the investors (Azimkanov, 2012).
Since 2008 the role of the banking sector in the economy decreased significantly. The total
Assets-to-GDP ratio fell down as much as twice to 47% at the end of 2011. This can be
explained by three main factors:
1. Due to mineral resources export-oriented economy the GDP has rebounded
relatively quickly and continued to grow in 2010-2011 at 7.3-7.5% rate in constant
prices (NBK, 2012b; IMF, 2012a). At the same time the major companies of oil and
mining industries do not rely on the local banks preferring to finance their
operations by internal sources, equity and bond issuance.
2. The growth of the banking assets has stopped due to the impeded access to
international capital market that was a significant driver of the growth before the
crisis. Kazakh banks easily borrowed abroad around US$ 45 billion or 53% of total

42
liabilities as of 01 January 2008 (NBK, 2011). Now, the banks have switched to local
deposits as more stable funding base.
3. Dramatically deteriorated loan portfolio, especially to construction and real estate
industry, has forced banks to create provisions against bad loans. The non-
performing loans3
(NPL) grew from 2.4% of the total loans in 2006 up to 37.8% in
2009 (See Figure 6). Tough work on the recovery constrains a new credit expansion.
Figure 6:Affected Loan Portfolio of Kazakh Banks, 2004-2012
Source: Author's work based on banking statistics (NBK, 2012b; FMSA, 2012b).
Overall, despite economic recovery of the country and structural changes in the banks’
balance sheet during last few years, the banking sector is still fragile. Already high NPL ratio
may be even higher than official number, as indicated by IMF report (See Appendix B). At
the same time the decreased Assets-to-GDP ratio designates a low penetration of the
banking sector, promising a high potential for growth.
3
For the purpose of this paper NPL includes doubtful loans of the 5th
category and bad loans
according to FMSA classification

43
3.5. OUTSET OF ISLAMIC FINANCE IN KAZAKHSTAN
Islamic finance in Kazakhstan commenced in 1996 when IDB opened its Representative
office in Almaty, then capital of the RK. The regional office in Almaty covers the whole
Central Asia, Azerbaijan and Albania. So far in Kazakhstan the bank has executed 19 projects
for the amount of US$ 90.8 million, including US$ 22.7 million of trade finance facilities for
Kazakh banks in 2000-2002 (IDB, 2012). However, this exposure is quite marginal (0.1%) to
the total banking assets (US$ 86.4 billion as of 2011).
The second step into Islamic finance was taken through external borrowings by few Kazakh
banks. Specifically, BankTuranAlem, then the second largest bank borrowed US$ 50 million
in 2005 and US$ 250 million in 2007 on commodity Murabaha agreement. In the same 2007
Alliance bank received US$150 million Sharia-compliant syndicated loan facility from 19
Middle-East banks (Tashimov & Kalabin, 2007).However, due to the crisis these initiatives
were suspended. Moreover, these two banks were taken over by the Government.
The crisis, on the other hand, became a trigger for another more important step in Islamic
finance development in Kazakhstan. The Government, pursuing a new type of investments
that demonstrated its relative stability during the credit crunch, suggested a special
legislation for Islamic finance. The law was signed by the President Nazarbayev on 12
February 2009 (Islamic Finance Law, 2009). The banking law, tax code and civil code were
amended introducing the new mode of financial intermediation. Not only Islamic banks, but
also Islamic investment funds and Islamic securities were instituted to operate in the
Kazakhstan market.
The decision was in line with a long-distance programme of development of Almaty city as a
Central Asia financial hub. The dedicated Agency on Development of the Regional Financial
Centre of Almaty City (RFCA) started promoting new opportunities for potential Islamic
finance investors through a number of conferences, forums and investors meetings. At the
same time RFCA, FMSA and other vested interest organizations engaged in propaganda
among the population and market participants for the sake of awareness of Islamic Finance
principles.

44
In 2010, a year after the law was passed, the first Islamic bank in Kazakhstan was opened
thanking to an intergovernmental agreement between the RK and UAE. That was JSC ‘Al
Hilal Islamic bank’, a subsidiary of Abu Dhabi state-owned Al Hilal Bank.
Besides, the market has gained two more participants–the Mutual Insurance Society ‘Halal
insurance’ Takaful’ in Islamic insurance and the ‘Fattah Finance’ in investment banking. The
Islamic Finance Development Association has been established to coordinate and follow-up
any issues related to the law and regulations. Consultancies and law firms such as ‘Akyl-
Kenes consulting’, ‘Kausar consulting’ and ‘Grata Law Firm’ have been actively involved in
the business and legal advisory.
The Government and NBK continue to demonstrate a political will to support the new
industry. This year the Road-map of Islamic finance development until 2020 was approved
(The Government, 2012). The Road-map includes main actions to be taken, responsible
parties and time-frame for the following directions4
:
1. Legislation Improvement;
2. Educating market;
3. Islamic Finance Infrastructure Development;
4. International Cooperation;
5. Public Sector Development;
6. Islamic Financial Services Development;
7. Science and Education;
8. Investors Relations.
Three years after adopting the law and applying significant efforts to attract foreign
investors we have still been seeing only one Islamic bank. Some other banks announced
their plans to enter the Kazakhstan market, including Malaysian Amana Raya and Qatar
4
For detailed breakdown see Appendix C

45
Islamic Bank (Goud, 2011). But they are yet to be appeared. Partially it might be because of
general investment activity decay in the light of ongoing economic uncertainty all over the
world. Also, despite the law was signed, it seems there are certain legal barriers on the way
of smooth growth of the industry.
Currently NBK and the Government have prepared a draft law proposing improvements to
the existing legislation (NBK, 2012c). Specifically, the draft is suggesting a number of
amendments regarding clarification of the list of Islamic banks’ activities, including the
commodity Murabaha and equity participation (Musharaka). This would sync the banking
with the Tax code, which allows avoiding value-added tax (VAT) for all financial services in
Kazakhstan. Also currently unavailable for retail market the partnership and the agency
based products need to be clarified in the law. The Wakala product needs clear definition
since the regulator interprets the law differently from common understanding.
Furthermore, the draft provides a legal base for a voluntary Islamic deposits guarantee fund
since conventional deposit insurance scheme is repugnant to Sharia.
Another step forward has been taken recently when the state-owned Development Bank of
Kazakhstan (DBK) successfully issued the first Kazakhstani Sukuk bonds. The Malaysian
ringgit-denominated securities issued in July 2012 were based for the equivalent of US$ 76.7
million. The five-year notes were priced to yield of 5.5 percent (Bloomberg, 2012). This was
the first issuance within the bank’s 1.5 billion ringgit (US$ 480 million) programme. The deal
definitely opens doors for other Kazakh emitters on Sukuk market.

46
Figure 7:Readiness Chart: Market vs. Industry
Source: Adapted from Miller (2012).
Overall, Islamic banking and finance in Kazakhstan has been evolving from its infancy in
terms of regulation, infrastructure and number of market participants. Despite some
progress, the overview shows that Kazakhstan is quite far from a full readiness of the
market and the industry as indicated on the chart above. The Government’s and NBK’s
active role is crucial for further development.
3.6.APPLYINGSTRATEGIC AND MARKETING MANAGEMENT
3.6.1. KEY SUCCESS FACTORS
To succeed in business a company must meet two conditions. First, it must supply what the
customers want to purchase, and, second, it must survive in competition (Grant, 2010). The
Key Success Factors framework helps to analyze demand and competition in the market.

47
Figure 8: Identifying Key Success Factors
Source: Author’s replication from Grant (2010, p.88).
Kotler and Keller (2009, p.53) added that providing customers with what they want is not
enough: ‘to gain an edge companies must help customers learn what they want’. It means
companies must identify demand for specific product not only as a clear stated need of
customers, but also as their other implicit needs such as ‘real, unstated, delight and secret
needs’. Putting all together, companies must form and deliver a value proposition to satisfy
customer needs. This can be applied to Islamic banks as well.
3.6.2. SEEKING A NEW VALUE PROPOSITION
Kotler and Keller (2009, p.163) defined the value proposition as ‘a statement about the
experience customers will gain from the company’s market offering and from their
relationship with the supplier’.
Prerequisites for success
What do customers want? How does the firm survive
competition?
Analysis of demand
• Who are our customers?
• What do they want?
Analysis of competition
• What drives competition?
• What are the main dimensions of
competition?
• How intense is competition?
• How can we obtain a superior
competitive position?
KEY SUCCESS FACTORS

48
Islamic banks have been growing rapidly so far, but to continue successful growth they have
to look carefully at the customer needs. In order to address those needs Islamic banks have
to formulate and communicate to the market a clear value proposition. As was discussed
many factors may affect the value proposition. High competition from conventional finance,
valid criticism on deviation from Sharia goals and weak understanding of the products by
clients endanger the industry. The customers may become unsatisfied when realized that
the products they have purchased were mimicked from conventional market. Yet so called
‘penalty for faith’, when Islamic banking products turn to be more expensive than
conventional, also raised questions on social mission of the industry that has to be
embedded in the business according to Maqasid al-Sharia.
DiVanna (2011) reported that a simple value proposition as no-riba and no-haram activity is
not sufficient any more. The new value proposition of Islamic banks must be far beyond
simple Sharia-compliance. He argued that educating customers on product offerings,
transparency of Sharia board activity and ‘greater array of customized products’ are needed.
After all Muslims as well as non-Muslim customers are looking for ‘the best value for money’
(DiVanna, 2011, p.27).
In the next Chapter we attempt to identify a demand for Islamic banking through a survey
conducted among a sample of potential customers in Kazakhstan. This helps us to formulate
a value proposition for our business project.

49
4. DEMAND STUDY
In order to conduct a demand study we collected and used both primary and secondary
data.
4.1. MARKET PENETRATION
As a starting point of demand study for Islamic banking it is worth to assess a country
banking penetration. In order to analyze the market penetration we looked at the total
credit of the banking sector in relation to GDP. We compared the ratio with other emerging
and developing economies.
Figure 9:Banking Credit-to-GDP Ratio in Selected Countries,2011, (%)
Source: Authors work based on the World Bank’s database (The World Bank, 2012)
Against the background of the comparable countries the economy of Kazakhstan is
significantly underbanked. This diagram shows that Kazakhstan banks have a high potential
market in the long-run.

50
4.2. RELIGIOUS FACTOR
Kazakhstan population of 16.7 million is represented by more than 100 nations (KazStat,
2012). According to the General census in 2009 the original Kazakh nation is majority with
64% of the population (KazStat, 2011). The Russians is the second largest with 23% of total.
As reported, Muslims are 70% of the country’s population, while Christians are 26%.
At first glance Islamic finance potential in Kazakhstan seems overwhelming to traditional
banking, owing to the majority of Muslim population. However, it is worth saying that due
to some historical reasons, including Soviet era restrictions, the religious commitment of the
population is quite low comparing to other countries.
Figure 10: Islam Religion in Kazakhstan and Other Countries
Source: Pew Research Center, 2012

51
The Pew Forum research found that the religion is really important for only 18% of total
population. This indicator should become a starting point for estimation of Islamic banking
available market share.
On the other hand, we know from practice that Islamic finance is in demand by non-
Muslims as well. Specifically, in Malaysia the share of non-Muslim clients in Islamic banks is
about 40% (e.g. Ayub, 2007).
4.3. MARKET SURVEY
4.3.1. METHODOLOGY OVERVIEW
In order to analyze demand we have conducted a survey (See Appendix D). The survey
included eight questions, 4 of them were dichotomous, 2 were multiple-choice and 1 was
mixed (dichotomous on first level and multiple-choice for sub-questions). The questions
were prepared to test:
1. General knowledge on Islamic banking and its existence in Kazakhstan;
2. Attitude to Islamic banking in Kazakhstan;
3. Willingness to be a client of an Islamic bank in Kazakhstan;
4. Price-sensitivity;
5. Preferences on institutional form and on types of services demanded.
The questionnaire was prepared carefully to mitigate risks of misunderstanding by
respondents on the one hand and to avoid forcing respondents towards any particular
answer on the other. To check the bias risk the questionnaire was shown to friends and
colleagues, then was corrected. The questionnaire was placed on the web-site
http://119.82.251.235 controlled by the author.
First, the web link to the questionnaire was distributed amongst 1,180 people in the
‘Bolashak Group’ on Facebook. This is the group of Kazakhstani alumni who studied abroad
on the Government education program ‘Bolashak’ (The Future). Currently these people

52
work on various positions in public and private organizations. Under this request the
answers were getting from 01 to 22 August 2012.
The core survey campaign was arranged on the most popular5
Kazakhstan news website
www.nur.kz. The banner was placed on the website with frequency of 53,000 shows per day
in average during one week from 22 to 29 August 2012.
Before that we also placed the banner on another news portal - www.zakon.kz. However,
due to ineffective advertising plan this campaign contributed to the survey marginally.
In order to enhance attractiveness of the banner and minimize hesitation of potential
respondents the banner and the survey invitation were launched under the name of
consultancy ‘Akyl Kenes consulting’ (See Appendix E). This company is directly involved in
the industry development, particularly by organizing already two international forums on
Islamic banking in Kazakhstan. The company by courtesy agreed to assist in this survey.
However, all technical issues, including advertising and hosting of the questionnaire, were
under the author’s control.
The website’s audience is quite diverse6
in terms of age, social background, profession,
family status, income and geographic location across the country. This gave us an
assumption that the respondents were randomly sampled.
To confirm or disprove the diversity of the respondents we asked the personal information
of the people such as age, profession, income and gender. We intentionally did not ask
about nationality and religion to avoid any separatist hint and thereby not answering.
However, the web-surveys, although are increasingly popular, suffer from problems of
misunderstanding, low response rate and over-representing ‘people with strong (usually
5
Rank 1st
in the category ‘Internet’ by Count Zero Rating with 202,287 users per day as of 29
August 2012 (www.zero.kz )
6
The portrait of audience is available on http://corp.nur.kz/content/?node_id=12

53
negative) opinion’ as being based on ‘voluntary response samples’ (Bowerman et al, 2010, p.
9).
Therefore we conducted a control survey by email interview among people we know
(relatives, friends, present and former colleagues, student fellows). In turn, these people
asked their network to participate in the survey. These respondents could ask clarifications
on questionnaire, so risk of misunderstanding was mitigated. The control survey was
conducted during the month of August 2012.
4.3.2. RESPONSE RATE
The web-survey collected totally 225 responses, out of which 32 from Facebook campaign
and 193 responses received from the advertising on the news websites.
As far as response rate is concerned, the Facebook response rate was 2.7%. The web-site
advertising campaign provided us with 0.21% of the click-through ratio (CTR), the main web
response measure. These indicate quite adequate response rate comparing to average CTR
of social-media-share links (0.5%7
) and Facebook’s social ads for UK (0.04%8
).
However, out of 728 clicks on the advertising banner on www.nur.kzwe received only 161
completed questionnaires or 22.1%. This might be due to different reasons, specifically the
low speed of Internet connection and/or transition from page-to-page in the questionnaire,
difficulties with understanding and/or reluctance in answering the particular question or
providing personal information.
For the control-survey the response rate was 59%, where 59 responses received out of 100
people approached by email. The summer holidays season affected the rate as some people
were abroad in annual leave.
7
Marketingprofs (2012)
8
EmailStatCenter (2012)

54
4.3.3. SAMPLE DISTRIBUTION
Using the Central Limit Theorem (Bowerman et al, 2010), as sample size (n) is larger than 30
for both the web-based and the control-survey, we can assume that our sample mean is
normally distributed.
The sample represented quite diverse groups of population in terms of gender, age,
occupation and income size. Although there are some variations between the web-based
and the control-survey audience, overall both are diversified similarly.
Figure 11: Respondents’ Distribution by Gender

55
Figure 12: Respondents’ Distribution by Age
Figure13: Respondents’ Distribution by Occupation

56
Figure 14: Respondents’ Distribution by Income Size
For the gender the control-survey is more balanced than the web-survey. The more
significant variation is about the occupation where the control-survey represented mainly
by employees (83%). The majority of the web-survey’s responses came from employees too,
but only 55% of total answers, thus having more other groups such as business owners,
public servants and students. Also the web-survey was represented most (36% of total
respondents) by people with minimum annual income (less than US$ 5,000), whereas the
control-survey had only 14% under this category. The control-survey had more people with
income between US$ 30,000 to 100,000.

57
4.3.4. SURVEY RESULTS ANALYSIS
Figure 15: Responses Distribution on Question 1
‘Are you aware of the existence of Islamic banking in the financial market of Kazakhstan?’:
The majority of respondents in both polls said they knew about Islamic banking in
Kazakhstan. However, the awareness of the industry still has not been created fully among
the population. The significant proportion of people in the web-survey (28.4%) did not know
about the new industry in the financial market.
‘Do you support the policy of the Government of Kazakhstan to introduce Islamic banking as
alternative financial services and attract new foreign investments into the economy?’:
Before we asked the second question we informed those who were not aware of the
industry, putting the notice:
‘In 2008 the Republic of Kazakhstan adopted a package of legislation on the
implementation of Islamic banking as an alternative to traditional banks. In 2010 the
first Islamic bank in Kazakhstan obtained a license and opened.’.

58
As we found the majority (94-95%) supports the government policy and appearance of
Islamic banks in Kazakhstan. This would imply a positive attitude to the new industry among
the society.
‘Do you think that Islamic banks due to their specifics need to be more socially oriented than
traditional banks?’:
This and subsequent questions were asked to test understanding and expectations about
Islamic banking mission and goals.
The results demonstrate that the majority of people fairly enough expects higher social
orientation of Islamic banks than this expected from traditional banks. However, more than
a quarter of the sample in the control-survey believes that there is no difference between
the two. This might be due to lack of clear understanding of Islamic banking principles
and/or also high expectations to traditional banks in terms of social responsibility.
‘Do you think that Islamic banks are the same commercial and for-profit organizations as
traditional banks?’:

59
This diagram shows that, as it was assumed above, there is not a public consensus about
Islamic banking principles, its mission and goals. About one third in the both polls (32-36%)
believes that Islamic banks are not for-profit organizations.
‘At which main condition you would prefer to use the services of an Islamic bank as an
alternative to conventional one?’:
The results of this question seem quite controversial. The majority of the web respondents
(52.4%) chose ‘specifics of Islamic banks…’ as a main argument in favor of the services from
Islamic banks. While the email-survey vast majority (76.3%) chose ‘the better price’ as a
main reason of their willingness to use Islamic banking products. This might be explained by
a drawback of the voluntary response samples, which we discussed earlier. Although
Bowerman et al (2010) were talking about over-representing usually negative opinion we
can suspect over-representing positive opinions in the web-survey.
Other factors, such as strong brand and reliable reputation, quality service, convenient
location and professional marketing or willingness to experiment with a new product
offering, were not very significant in both cases (3.1% - 6.8%).
The small proportion of people online (3.6%) expressed their negative attitude by denying
even a possibility to ever use Islamic banks. By contrast, this type of responses was not
found in the control poll.

60
‘Would you agree to use the products and services of Islamic banking on less profitable
conditions than conventional banking?’:
In addition to question 5 this was a testing of the price sensitivity of the potential clients.
The vast majority of both polls’ respondents (67-78%) said they were not ready to pay a
premium price on Islamic banking products. Just one third in the web-survey and one fifth
(22%) in the control one would agree for a premium (lower rate on deposits and higher cost
on credit products than in traditional banks). We gave several sub-questions to this category
of people to test how much extra they can tolerate.
Figure 21: Tolerance to Premium Price on Islamic Banking Products

61
This graph represents the conditional probability for the price tolerance as the sample space
was reduced to the groups of respondents who are ready to tolerate to some extra price.
Overall the chart is skewed more to the right that means the price tolerance tends to be
minimal. The highest classes belong to ‘up to 5%’, where are 28.4% and 23.1% of the
respondents respectively for the both methods. The tolerable premium size is concentrated
within the first two classes ‘up to 5%’ and ‘between 5% and 10%’, where are more than half
of the respondents (55.4%) within this range. The concentration for the control-survey is
much wider, including the first four classes up to 20% premium, which cover 69.3% of the
respondents.
On the other hand, these results are not normally distributed. The web-survey shows
another extreme concentration at the maximum range of the premium ‘up to 50%’ with
23% of the respondents. By contrast, it is only 7.7% for the control questionnaire.
Applying the conditional probability for the whole sample:
 The highest two classes ‘up to 5%’ and ‘up to 10%’ premium comprise of only 18.2%
of all the web-survey voters;
 The four classes ‘up to 20%’ premium are made up of just 15.3% of the whole
control-survey sample size;
 Only 7.6% of potential customers are likely to agree with the maximum range of the
premium ‘up to 50%’ in the web-survey and just 1.7% in the control one.

62
‘What are your preferences on the organizational form of the Islamic Bank?’
The most popular opinion is ‘Islamic bank as a standalone financial institution’ in both
surveys (64.4% and 45.8%), whereas ‘Islamic window’ received only 7.6% and 11.9% votes
respectively. The second place went to the indifferent opinion either for a standalone bank
or Islamic window in a well-known traditional bank. Surprisingly the third opinion in the
web-survey was for ‘None of the above’ (8.9%), which probably means a lack of interest of
Islamic banking products within this group. In the control-survey it is just 5.1%. These
negative opinions do not strongly correspond to Question 5 where only 3.6% respondents
claimed they would never have an interest for Islamic banking.

63
‘What kind of financial services do you need most?’:
The most demanded products are personal and business financing with 62% and 41.6%
votes respectively. Saving, current and deposit accounts are required by 52.6% of the
respondents. Investments with higher risk profile collected 19.6% of votes. Almost 3% needs
nothing. The control-survey generally reflects the same demand pattern.
This question was aimed to test a general demand on the certain types of financial services,
without emphasizing whether it is Islamic banking products or not. However, the results
display a risk-aversion of the voters by choosing less risky and less profitable deposit
products rather than more risky investments with higher expected return (27.5% for
deposits versus 19.6% for investments). The difference is even larger in the control-survey:
42.4% versus 18.6%.
4.3.5. STATISTICAL INFERENCE
The most critical finding for an Islamic bank in Kazakhstan is given in Figure 20 for Question
6 of the survey.

64
Figure 24: Islamic Banking Premium Price Tolerance in Kazakhstan
Agree to pay an extra for Islamic
banking products
Frequency Percentage (%)
Web-survey Email-survey Web-survey Email-survey
YES 74 13 33 22
No 151 46 67 78
Total 225 59 100 100
The sample proportion of potential customers who are ready to pay extra can be used to
estimate an available market for the Islamic banking industry in Kazakhstan. For the purpose
of this analysis we name this category ‘loyal customers’. From the table above the
proportion of loyal customers seems substantially different between the two polls: 33% in
the web-survey versus 22% in the email one.
Therefore, we conducted a comparison between the two population proportions. We used
the formula of ‘A large sample confidence interval for the difference between two
population proportions’ (Bowerman et al, 2010, p.418):
100 (1-⍺) percent confidence interval for p1 - p2 is
.
First, we assume that we have two randomly selected samples of size n1=225 and n2=59.The
proportion of the loyal customers in the first sample is =0.33 and in the second is
=0.22.
We checked that the samples are large enough to use the formula:
n1 =225*0.33=74, n1(1 - )=225*0.67=150.75 and
n2 =59*0.22=12.98, n2(1 - )=59*0.78=46.02.
Since all the products are at least 5, both samples n1and n2can be considered as large.

65
Using the normal distribution table (Bowerman et al, 2010, p.251-252), we found - value
for the confidence interval of 95% equals to 1.96.
Then, the 95% confidence interval for the difference was calculated as follows:
.
This means that we are 95% confident than , the proportion of the loyal customers out of
all potential customers reflected by the web-survey is between over
the , the proportion of the loyal customers out of all potential customers reflected by the
email-survey. Hence, the 95% confidence interval for the proportion was found as:
[ -E, +E] =[0.22-0.0123, 0.22+0.2323]=[0.2077, 0.4523].
This implies that the loyal customers’ proportion based on the web-survey is approximately
between 21% and 45% out of all potential customers. The margin of error is quite significant
due to the substantial difference of the survey results and minor sample size, although
statistically large.
Although the range is large it provides us with good grounds for prediction. We can forecast
that the available market share of the Islamic banking in Kazakhstan can span between 21%
and 45% of the total banking market.
4.4. CASE STUDY: FIRST ISLAMIC BANK IN KAZAKHSTAN
A subsidiary of Al Hilal Bank was established in Kazakhstan in 2010.The bank has opened so
far three outlets including head-office in Almaty, the commercial capital, and two branches
in the capital city of Astana and Shymkent, most populated center on the South of the
country.

66
Figure 25: ‘Al Hilal Bank Kazakhstan’ Performance Indicators, 2010-2012
Particular, US$ million FY 2010 FY 2011 Growth 2011 1H 2012 Growth 1H 2012
Total Assets 62.5 85.3 36.4% 78.7 -7.8%
Loan portfolio 21.2 39.4 85.6% 53.3 35.4%
Total Liabilities 21 16 -21.5% 9 -42.3%
Clients deposits 3.3 3.9 16.3% 3.8 -1.4%
Borrowings 13.7 11.9 -13.0% 0.0 -100.0%
Capital 41.6 68.9 65.5% 69.2 0.4%
Net Income -2.5 -1.3 47.9% 0.7 157.7%
Source: FMSA, 2012b.
The assets of the bank grew by 36% in 2011, but went down by 8% for six month of this
year. The main reason of decrease was in the settlement of US$ 12 million borrowings from
other financial institutions. However, the clients’ funds are not growing this year in contrast
with 16% growth in 2011.
Among positive trends the loan portfolio grows continuously. The shareholders capital
increased significantly in 2011 due to the new capital requirements.
As usual for start-up projects the first two years of the operations were in losses, while in
2012 the bank has achieved breakeven and turned to profit.
The bank’s market share is quite marginal, 0.09% in terms of assets. As announced the bank
is aiming for 1% of the market share during the next 2 years.
The main strategy of the bank is focused on corporate clients especially national companies
where the bank tries to leverage on the Kazakhstan government support thanking the
intergovernmental agreement between Kazakhstan and UAE. In the retail segment the bank
is targeting only wealthy people with minimum deposit amount of US$5,000.
According to the bank’s annual report (Al Hilal bank, 2012) the main products offered to the
corporate clients are commodity Murabaha (58%) and Ijara (42%). The retail banking
presents a current account based on Qard-Hassan and a deposit based on Mudaraba

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