Bosnia and Herzegovina might not be considered a heartland of the Ummah, but Islamic banking has nonetheless established itself there, as Professor Rodney Wilson reports
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As Europe’s only state with a Muslim majority, the potential for Islamic banking and finance in Bosnia and Herzegovina would appear promising. In practice, the spread of Islamic banking has been limited, despite the enthusiasm of the Muslim community to undertake their financial transactions in a Shari’ah compliant manner.
Much of the explanation for the failure of Islamic finance is political, given the continuing tensions between the different ethnic and religious groups, despite the ending of the civil war and the Dayton Peace Accords.
However, it is also economic, legal and financial, given the small size of the economy, the existing banking law, uncertainties over property rights and the fragmented nature of the financial system.
However following a seminar on Islamic banking and finance sponsored by Bosnia Bank International on 8 May, attended by government ministers, including the Prime Minister, Minister of Finance and Central Bank Governor, their appears to be a new commitment to take the agenda for Islamic finance forward. It was stressed that it provides opportunities for the Muslim majority, but does not in any way constitute a threat to the Serb Orthodox or Croatian Catholic communities, as Shari’ah compliance in financial transactions is an option, rather than being compulsory, and is not a precursor for the more universal application of Shari’ah law.
Economic and financial issues
Bosnia and Herzegovina emerged from the former republic of Yugoslavia as Europe’s smallest economy with a gross national income of just over $8 billion and a per capita income of around $2,000. The population numbers 3.9 million, more than half of whom are Muslims, but this means the size of the Muslim community is much smaller than that of France or Germany, and although larger than the Muslim community in the United Kingdom, it is much less affluent. The market for retail banking and financial services is therefore limited overall, and even smaller for the potentially Shari’ah compliant segment.
Sarajevo the capital, was a major centre on the trade routes through the Balkans at the time of the Ottoman Empire, when most of the Bosnian population converted to Islam, but today Sarajevo is isolated, with its airport accommodating only short take off and landing aircraft because of the restricted runway and surrounding hills. There are however, daily flights to neighbouring countries, and a good service by Turkish Airways from Istanbul, but no direct flights from the Gulf. For Sarajevo to revive as a trade and communications centre substantial investment in infrastructure would be needed, including the airport and road network. Sukuk issuance could be one way forward as far as Islamic finance is concerned, although at present Bosnia and Herzegovina have yet to issue any Islamic securities.
The fragmentation of the banking system with over 20 banks partly reflects the country’s ethnic and religious divisions, but there has been a degree of consolidation, with major Austrian and Italian banks entering the market through the acquisition of local institutions. The Raiffeissen Bank of Vienna has become the largest bank, with over 600,000 savings accounts and a network of 60 branches throughout the country, but this is a conventional bank, with no experience of offering Islamic windows. The bank nevertheless has a substantial Muslim client base. It entered the Bosnian market with the acquisition of Market Banka, a local bank, in which the European Bank for Reconstruction and Development (EBRD) had an equity stake as its contribution to post-war reconstruction. Unicredit Zagrebacka Bank, an Italian bank with branches also in neighbouring Croatia, is the second largest bank in terms of assets, with 74 branches and 337,000 account holders. It also has no knowledge or experience of Islamic banking, but its customer base is in any case concentrated in the Roman Catholic community.
The only Serbian banks are in the semi autonomous enclave of Republic Srpska, where any Islamic bank development is unlikely given local suspicions and hostility. The Turkish Ziraat Bank Bosnia is represented in Sarajevo, and handles trade finance with respect to imports and exports from and to Turkey. The Turkish Ziraat Bank is a conventional rather than an Islamic bank however, Shari’ah compliant finance being rather limited in Turkey, with only a few small dedicated Islamic banks. Although many Bosnians stay in Turkey to study, and some have family connections there, relatively few work there. In contrast, there are substantial numbers of Bosnians working in Austria and Germany, and their remittances, which exceed $2 billion each year, make a major contribution to the economy of Bosnia and Herzegovina. These remittances are handled through institutions such as the Raiffeissen Bank. This lucrative money transfer business gives the Austrian banks a considerable advantage, and in addition they feel comfortable dealing with the Balkan region generally, given their historical involvement dating back to the time of the Austrian Hungarian Empire.
The major Gulf involvement in Bosnian finance has been through BBI, which is jointly owned by the Islamic Development Bank, with 45.46% of the shareholding capital and Dubai and Abu Dhabi Islamic Banks, each with a 27.27% share of the capital. All the financial dealings of these founding shareholders are of course Shari’ah compliant, and the BBI is also expected to conduct its operations in a Shari’ah compliant manner, but at present, the range of Shari’ah compliant financial products offered by the bank is limited.
Dr. Ahmad Mohammad Ali, President of the Islamic Development Bank, serves as Chairman of the General Assembly of BBI, but in practice, although Dr Ali has visited Sarajevo, he is usually represented by his deputies at the annual meetings. The day to day management of BBI is by Said Mohamed, its director general, with Amer Byukvic serving as his deputy, Mrs. Vildana Skaljic as executive director and Salih Purisevic as secretary general. The management are all local nationals with previous extensive banking experience.
BBI claims to be the first Islamic Bank in Europe, as it was established on 19 September 2000, four years before the Islamic Bank of Britain was granted a licence. Like the Islamic Bank of Britain, it is a small institution, with a paid-up capital of $75 million. There is no stock market in Sarajevo, and therefore BBI cannot emulate the Islamic Bank of Britain in seeking additional equity finance through having a listing on a local Alternative Investment Market (AIM), although it would be possible for BBI to obtain an AIM listing in London, as some other banks from Eastern Europe have done.
BBI faced some difficulties in getting a license due to negative perceptions amongst non-Muslims, but on 13 March 2002 it received a permit from the Banking Agency of the Federation of Bosnia and Herzegovina to participate in internal payments operations, which meant its cheques and electronic payments were accepted by other local banks. In November 2002 BBI received a deposit insurance licence from the Deposit Insurance Agency of Bosnia and Herzegovina, but this raises some Shari’ah compliance issues, as although guarantees are acceptable for current accounts that pay no return, they are not acceptable for investment mudarabah accounts where the client shares in the bank’s declared profits. Depositors with the Islamic Bank of Britain are offered a waiver to sign to opt out of this guarantee that is required by the Financial Services Authority, but in Bosnia and Herzegovina such a waiver is not offered, and there seems to be a lack of awareness of this issue, although BBI does have a Shari’ah committee to advise on its operations.
Islamic finance in Bosnia and Herzegovina
As BBI is a very small institution with only four branches, the scope for Islamic finance is very limited in Bosnia and Herzegovina. At present most of the banks operations are retail, as it provides current accounts with debit cards and cheque books, as well as overdraft facilities of up to two months salary provided these are paid directly into the client’s account. From a Shari’ah perspective overdraft facilities are questionable however, especially if charges are applied that are related to the amount and duration of the overdraft, as this amounts to Riba. However because other banks in Bosnia and Herzegovina provide overdraft facilities, BBI fees obliged to compete by offering the same credit.
Savings accounts are offered to those of limited means, these account holders being issued with passbooks to manage their accounts. Investment accounts on the Mudarabah profit sharing principle are offered to clients of higher net worth with at least $30,000 to deposit. The return paid is modest, as the Bosnian currency, the convertible mark, a legacy currency related to the former German mark, is pegged to the Euro.
Returns are higher however than those paid on Euro deposits reflecting the risk of devaluation, ranging from a minimum of 2.37% for one month deposits to 4.89% for deposits of 3 years or more. For large deposits returns vary from 2.88% for one month deposits to 5.39% for three year deposits. Varying returns according to the duration and size of deposits is standard practice amongst Islamic banks and this is approved by Shari’ah scholars as long as the rates and rate spreads are not guaranteed and vary in relation to the institution’s underlying profitability.
One of the more interesting product offerings by BBI is a Hajj and Umra Investment Account. Depositors are assured that the funds raised will be invested in a Shari’ah compliant manner in Bosnia and Herzegovina, and through an arrangement with other banks, deposits can be paid into any bank in the country and transferred to the client’s account in BBI. The depositor shares in the profits of the bank for the duration of the deposit, and withdraws the funds to meet the travel and accommodation costs associated with Hajj and Umra. The clients are however responsible for making their own travel arrangements rather than the bank, and there is no link up with travel agents to secure discounted prices through bulk ticket purchases as is the case with Tabung Haji in Malaysia.
BBI offers a range of retail financing facilities, the focus, as with many Islamic banks, being on home and car finance. Home finance is available for up to 70% of the purchase price or the construction cost in a designated area for new building. Repayments, collected monthly through direct debit, should not exceed one third of the clients’ salary. The cost of financing is variable, calculated on the basis of 6 month and one year EURIBOR (Euro Inter-Bank Offer Rate), plus a profit margin of 5 percent for the bank. The financing structure is based on diminishing Musharakah, with the client entering a partnership with the bank to jointly purchase the property. The monthly payments by the client is divided into two components, a rental element for the share the bank owns, and a repayment so that over a period of 15 years the bank’s share is bought out. In the case of older clients the period of the partnership cannot extend beyond their 65th birthday. If the client wants to accelerate their repayments there is flexibility in the contract to permit this. A processing fee of 1% is charged, or 2% if the property is more than 100 kilometres distance from Sarajevo.
To qualify for the financing the client’s salary must be paid into a BBI account, and a permanent employment certificate and an income statement for a 3 month period is required, endorsed by the tax authorities.
The structure for car financing is similar and covers new and used vehicles up to 3 years old. The bank pays up to 80% of the value of the vehicle including tax and customs duty in the case of new cars. The financing period is up to 5 years for new vehicles and up to 3 years for used cars. A processing fee of one percent is charged, and the finance is priced at the 6 months EURIBOR cost. BBI also provides Qard Hasan beneficial loans on an interest free basis to those in need for specified purposes including fees for medical treatment, emergency home reconstruction and education expenses.
There is little Shari’ah compliant corporate finance in Bosnia and Herzegovina, the main facilities being provided by BBI including domestic and international payments services, trade financing, usually through Murabahah, and funding for the acquisition of business assets such as premises, equipment, raw materials and stock. For asset financing a business plan is required providing details of the operations envisaged and anticipated cash flows as well as audited balance sheets and income statements for the preceding three years. Other documentation may be required depending on the nature of the business, including land registry certificates, statements from the tax office that there are no outstanding liabilities and details of any other financing.
The future for Islamic finance in Bosnia and Herzegovina
Although Bosnia and Herzegovina would seem a good potential market for Islamic finance there are many constraints on market growth. One obvious way forward would be for conventional banks to open Islamic finance windows or counters providing Shari’ah compliant products, but, as already indicated, the Austrian banks have no experience in this area. Banks such as HSBC Amanah are absent from the market, and as there are no direct flights from London in any case communications are an issue. This is also a handicap in communications from the Gulf, and it is unlikely that other Islamic banks from the region, apart from already those involved in BBI, will enter the market.
Bosnia and Herzegovina has also the potential to attract foreign direct investment from the Gulf, especially given its tourist potential as Sarajevo was a venue for the Winter Olympics before the break up of Yugoslavia, and the mountains are a potentially attractive for summer visitors. However for resort developers such as Emaar to become interested in investing in Bosnia and Herzegovina, the property laws would have to be overhauled as at present there are ownership uncertainties that deter foreign purchasers.
A new Federal Banking Law is to be introduced next year, and it is intended that there will be specific provision for Islamic finance within this law. At present there is much uncertainty over the regulation of Islamic financial products, which could be overcome through greater participation of the Central Bank in the activities of the Islamic Financial Services Board whose remit includes advising regulators how to implement the Basel II standards with respect to Islamic banks. The government of Bosnia and Herzegovina could also encourage Islamic finance by funding its own debt through the issuance of Sukuk securities. There is no securities market in Sarajevo, but sovereign and corporate Sukuk issued on behalf of Bosnian institutions, and presumably denominated in Euros, could be offered to investors in the Gulf and traded there or in other securities markets.
In the longer term Sarajevo could become the major centre for Islamic finance in the Balkans, linking the European Union with Turkey, the Arab Middle East and the Gulf. To some extent this would be a revival of Sarajevo’s historical role during the Ottoman Empire as a trading and commercial centre. Such developments would depend on the government of Bosnia and Herzegovina having the political will to take such a project forward, and gaining support from the Gulf and Turkey.
Although envisaging Sarajevo as an Islamic financial centre may seem far fetched at present, there are hundreds of young and talented students in its university who are enthusiastic about Islamic finance, as was apparent from the attendance at a lecture there on 9 May which the author delivered, and this bodes well for the future. Mohammed Taqi Usmani’s famous Introduction to Islamic Finance was translated into Bosnian and published in 2003, and Professor Fikret Hadzic, the Dean of the Economics Faculty of the University of Sarajevo has written a substantial book in Bosnian on Islamic Banking and Economic Development that was published last year. Bosnians are becoming better informed about Islamic finance, which should facilitate further developments.
Dinner at Professor Fikret Hadzic’s (Professor of Economics, University of Sarajevo) house in Sarajevo.
With the Grand Mufti of Bosnia and Herzegovina cum the President of Shari’ah Board of Bosnia Bank International, Dr. Mustafa Ceric