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Islamic banking in Kazakhstan


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A dissertation paper studying demand and commercial viability of Islamic banking in Kazakhstan. A business plan of an Islamic bank in Kazakhstan. The paper won the Worshipful Company of International …

A dissertation paper studying demand and commercial viability of Islamic banking in Kazakhstan. A business plan of an Islamic bank in Kazakhstan. The paper won the Worshipful Company of International Bankers Prize 2013 amongst Cass business school finance projects and was nominated for the Lombard Prize competition between the top universities around the UK.

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  • 1. 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
  • 2. 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 Situation: Growth and Significant Milestones..............................................27 Situation: Supportive Infrastructure.............................................................28 Situation: Outperformance and Resilience ..................................................29 3.3.2. COMPLICATION .......................................................................... 31 Complication: Overcoming Challenges.........................................................31 Complication: ‘Reverse Engineering’............................................................31 Complication: Sharia-Compliant Versus Sharia-Based.................................33 3.3.3. PERSPECTIVE ............................................................................. 35 Perspective: Reshaping.................................................................................35 Perspective: Bright Future If Only…..............................................................36 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
  • 3. 4 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 PEST ..............................................................................................................71 Porter’s Five Forces ......................................................................................77 Competitors Analysis....................................................................................79 5.1.2. INTERNAL FACTORS ..................................................................... 80 Vision, Mission and Values ...........................................................................81 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 Shareholding.................................................................................................87 Board of Directors.........................................................................................87 Council on Principles of Islamic Finance.......................................................88 Management Board......................................................................................89 Internal Control, Risk Management and Audit.............................................89 Business Ethics..............................................................................................92 Organizational Chart.....................................................................................92 5.2.2. PRODUCTS AND SERVICES .............................................................. 93 Deposit Products...........................................................................................93 Financing Products........................................................................................93 Sukuk.............................................................................................................94 E-banking ......................................................................................................95 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
  • 4. 5 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
  • 5. 6 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
  • 6. 7 BIBLIOGRAPHY Agency of Statistics of the Republic of Kazakhstan (KazStat) (2012) Statistic reports [Online] Available from: [Accessed 31 August 2012]. ____________________ (2011) The General Census of the Republic of Kazakhstan in 2009. Analytical Report (Russian language edition), Astana, Kazakhstan. Al Hilal bank (2012) “Al Hilal” Islamic Bank” JSC Financial Statements Year ended 31 December 2011 Together with Independent Auditors’ Report. Almaty, Kazakhstan. Ali, S. S. (2011) Islamic Banking in the MENA Region. The World Bank, Islamic Development Bank (IDB),Islamic Research and Training Institute (IRTI), Working Paper, February. Asaria, M. I. (2012) Islamic Economics: Unit 8 Islamic Economics and Islamic Banks. Cass Business School, Dubai EMBA programme, Course Material, March. Asutay, M. (ND) Conceptualisation of the Second Best Solution in Overcoming the Social Failure of Islamic Banking and Finance: Examining the Overpowering of Homoislamicus by Homoeconomicus. School of Government and International Affairs, Durham University, United Kingdom (UK), Working Paper. Ayub, M. (2007) Understanding Islamic finance. John Wiley & Sons, Chichester, England. Azimkanov, B. (2012) IFR Comment: What is BTA Bank worth? International Financing Review, Thomson Reuters [Online] Available from: is-bta-bank-worth?/20044622.article [Accessed 16 August 2012]. Balabanis, G. (2010) Marketing: Unit 2 Analyzing markets and customers. Cass Business School, Dubai EMBA programme, Course Material, December. Banking Law (2012) The law on banks and banking activity in the Republic of Kazakhstan, # 2444, dated 31 August 1995 with amendments as of 05 July 2012 (Russian language edition). Astana, Kazakhstan. BCC-Invest (2012) Banking Sector Report. Almaty, Kazakhstan, Working Paper (Russian language edition), 20 June 2012, p.18. Benninga, S. (2008) 'Bank Valuation.' Financial Modeling. Massachusetts Institute of Technology, Third edition, The MIT Press, Cambridge, Massachusetts, London , England, pp. 177-196.
  • 7. 8 Bloomberg(2012)Kazakh Development Bank Swaps Ringgit Sukuk Proceeds to Dollars. [Online] Available from: development-bank-swaps-ringgit-sukuk-proceeds-to-dollars.html [Accessed 20 August 2012]. Bowerman, B. L., O’Connell, R. T., Orris, J. B., Murphree, E. S. (2010) Essentials of Business Statistics. McGraw-Hill/Irwin, New York, NY, United States of America (USA). Businessislamica (2012) Islamic Finance Set To Reach US$5 Trillion By 2016 [Online] Available from: trillion-by-2016/ [Accessed 04 August 2012]. Caba-Maria, F. (2011) The Islamic Banking System: From the crisis’ threats to the future’s opportunities. Middle East Political and Economic Institute [Online] Available from: futures-opportunities [Accessed 05 August 2012]. Carmassi, J., Luchetti, E. and Micossi, S. (2010) Overcoming Too-Big-To-Fail. A Regulatory Framework to Limit Moral Hazard and Free Riding in the Financial Sector. Report of the CEPS-Assonime Task Force on Bank Crisis Resolution. Center for European Policy Studies, Brussels, Belgium, Working paper. Damodaran, A. (2011) Applied Corporate Finance. Third edition. John Wiley & Sons, Inc., Hoboken, NJ, USA. Dar Al Sharia Consulting (2012) Islamic banking and finance. Cass Business School, Dubai EMBA programme, Course Material, May. Dawn Newspaper (2007) Dr Israr says Islamic banking un-Islamic [Online] Available from: [Accessed 11 August 2012]. DiVanna, J. (2011) 'The New Value Plan For Islamic Finance. Trends'. The Banker, Supplement, November, pp.25-27. El-Gamal, M. (2006) Islamic Finance Law, Economics, and Practice. E-book. Cambridge University Press, New York, NY, USA. EmailStatCenter (2012) Email response metrics [Online] Available from: [Accessed 31 August 2012]. Ernst & Young (2012) 'The customer takes control. Global Consumer Banking Survey 2012'. Ernst & Young Global Limited, Survey Report, UK.
  • 8. 9 Eurasianbank (2012) “Eurasian bank” JSC Financial Statements Year ended 31 December 2011 (Russian language edition). Almaty, Kazakhstan. Financial Market and Financial Organizations Regulation and Supervision Agency of the Republic of Kazakhstan (FMSA) (2012a) Committee History [Online] Available from: [Accessed 18 August 2012]. FMSA (2012b) Banking Sector Statistics [Online] Available from: [Accessed 18 August 2012]. Goud, B. (2011) Kazakhstan Sukuk [Online] Available from:!posts/2011- 05/20046/kazakhstan-sukuk [Accessed 29 August 2012]. Grant, R., M. (2010) Contemporary Strategy Analysis. John Wiley & Sons Ltd, Chichester, United Kingdom. Habib, S., Oliyath, R., Rebelo, R. (2009) Corporate Governance for Islamic Banks and Financial Institution “A Middle East and North African Perspective”, Cass Business School, The Institute for Corporate Governance ‘Hawkamah’, Dubai, UAE, Business Mastery Project. Hall, C. (2012) Islamic banking: Impressive growth underscores success. The Financial Times, 27 March [Online] Available from: 9be9-00144feab49a.html#axzz22PMM4u7t [Accessed 31 July 2012]. Hancock, M. (2012) 'Islamic Finance’s Rate of Change. Interbank Rate.' The Banker, January, pp. 46-47. __________ (2011) 'A growth story that is just beginning. Growth opportunities.' The Banker, November, Supplement, p. 22-24. Haneef, R. and Smolo, E. (2010) Reshaping the Islamic Finance Industry. Applying the Lessons Learnt from the Global Financial Crisis. International Sharia Research Academy for Islamic Finance (ISRA), Kuala-Lumpur, Malaysia, Research Paper No : 11 /2010. Hasan, M. and Dridi, J. (2010) The Effects of the Global Crisis on Islamic and Conventional banks: A comparative study. International Monetary Fund (IMF)Working Paper, September. IDB (2012) IDB Experience in Kazakhstan [Online] Available from: [Accessed 18 August 2012]. Imam, P., Kpodar, K. (2010) Islamic Banking: How Has it Diffused? IMF Working Paper, August.
  • 9. 10 IMF (2012a) World Economic Outlook Database, April 2012 [Online] Available from: [Accessed 15 August 2012]. IMF (2012b) Republic of Kazakhstan, 2012 Article IV Consultation. Washington, DC, USA, Country Report No.12/164, June. Islamic Financial Services Board (IFSB), IDB and IRTI (2010) Islamic Finance and Global Financial Stability. Task Force Report, April. Islamic Finance Law (2009) The law on amendments to some of legislative acts regarding Islamic banks and their activity and organization of Islamic finance, # 133-IV, dated 12 February 2009 (Russian language edition). Astana, Kazakhstan. Joint-Stock Law (2012) The law of the Republic of Kazakhstan on Join-stock companies, # 415-II dated 13 May 2003, with amendments as of 05 July 2012 (Russian language edition). Astana, Kazakhstan. Kara, H. (2011) 'Islamic Banks Hold Basel III Advantage. Regulation.’ The Banker, June, pp. 38-40. Kaspi bank (2012), “Kaspi bank” JSC Financial Statements Year ended 31 December 2011 (Russian language edition). Almaty, Kazakhstan. Kazinform (2010) Amanah Raya Financial Group of Malaysia, Development Bank of Kazakhstan and FATTAH FINANCE sign agreement to launch a second Islamic bank in Kazakhstan. Press-release, June 19 2010, as cited by the Government [Online] Available from: [Accessed 31 August 2012]. King, M. (2010) ‘Banking: From Bagehot to Basel, and Back Again’, the Second Bagehot Lecture Buttonwood Gathering, New York City, USA, October. KKB (2012a) 2011 Company Annual Report (Russian language edition). Almaty, Kazakhstan. KKB (2012b) Kazkommertsbank: 1H 2012 Results, Investors Presentation [Online] Available from: [Accessed 30 September 2012]. Kotler, P. and Keller, K. L. (2009) Marketing Management. Pearson Education, Inc., Upper Saddle River, New Jersey, USA.
  • 10. 11 Marketingprofs (2012) Adoption of Facebook's Social Ads Grows Fourfold [Online] Available from: ads-grows-fourfold [Accessed 31 August 2012]. McKenna, E., Beech., N. (2008) Human Resource Management. A Concise Analysis. Second edition. Pearson Education Limited, Harlow, England. Miller, N. (2012) Islamic Finance & Maqasid Al Sharia. Where is the industry today? KPMG presentation, March. Minsky, H. (1992) The Financial Instability Hypothesis. The Jerome Levy Economics Institute of Bard College. Working paper No 74, May. Mirakhor, A. (2011) Epistemological foundation of finance; Islamic and Conventional. Keynote Address, Foundations of Islamic Finance Conference Series, March. Mirakhor, A. and Krichene, N. (2009) The Recent Crisis: Lessons for Islamic Finance. IFSB 2nd Public Lecture on Financial Stability, Kuala Lumpur, Malaysia. Monks, R. A. G. and Minow, N. (2011) Corporate Governance. John Wiley & Sons, Chichester, UK. Mustafa, S. A. (2009) Are Saudi Islamic banks really promoting equitable distribution among stake holders? An empirical study to investigate whether the largest Islamic bank in Saudi Arabia is underpaying depositors. Cass Business School, Business Mastery Project. National Bank of Kazakhstan (NBK) (2012a) Information about the National Bank [Online] Available from: [Accessed 18 August 2012]. NBK (2012b) Statistical Bulletins 2007-2012 [Online] Available from: [Accessed 15 August 2012]. NBK (2012c) Comparison Table on Amendments to Banking and Insurance legislation, draft law (Russian language edition), Almaty, Kazakhstan. ____ (2011), Financial Stability Report of Kazakhstan, December [Online] Available from: [Accessed 12 August 2012]. Nyazee, I., A., K. (2009) The Prohibition of Riba Elaborated. Institute of Advanced Legal Studies, The Federal Law House, Rawalpindi, Pakistan. Pew Research Center (2012) The World’s Muslims: Unity and Diversity. The Pew FORUM on Religion & Public Life. Survey Report, Washington, D.C., USA, August.
  • 11. 12 Prudential Regulation (2009) FMSA’s Regulation on prudential standards for Islamic banks, # 66 dated 27 March 2009 (Russian language edition). Almaty, Kazakhstan. Risk Regulation (2005) FMSA’s Regulation on corporate governance and risk management system in second tier banks, # 359 dated 30 September 2005 (Russian language edition). Almaty, Kazakhstan. Sandwick, J. and Polson, T. (2012) Throw It and See What Sticks. The State of Islamic Asset Management and a Prescription for Change. (5 March 2012) [Online] Available from: [Accessed 05 August 2012]. Sberbank (2012), “Subsidiary of Sberbank of Russia” JSC Financial Statements Year ended 31 December 2011 Together with Independent Auditors’ Report (Russian language edition). Almaty, Kazakhstan. Schwarcz, S. (2010) ‘Too big to fail?: recasting the financial safety net’. In: .Mitchell, L., Wilmarth, A. (ed.) The Panic of 2008 Causes, Consequences and Implications for Reforms. Edward Elgar Cheltenham, UK; Northampton, MA, USA,pp. 94-115. Tashimov, T. and Kalabin, V. (2007) ‘ИскусствофинансированияпоКорану’ (Financing Art by Al Qu’ran). «ЭкспертКазахстан» (The Expert Kazakhstan), June(Russian language edition)[Online] Available from: [Accessed 20 August 2012]. The Banker (2012) Top 500 Islamic Financial Institutions. [Online] Available from: Institutions?gclid=CMXJt9eF0LECFURNpgodehsAGQ [Accessed 07 August 2012]. The Government (2012) The Resolution of the Government of the Republic of Kazakhstan # 371 dated March 29, 2012, on approval of the Road-map of Islamic finance development until 2020 (Russian language edition). Astana, Kazakhstan. The President (2010) The Order of the President of the Republic of Kazakhstan from February 01, 2010, on approval of the Conception of the financial sector development in the post-crisis period (Russian language edition). Astana, Kazakhstan. The World Bank (2012) Data, Domestic credit provided by banking sector (% of GDP) [Online] Available from: [Accessed 31 August 2012].
  • 12. 13 The World Economic Forum (2012) Global Competitiveness Report for 2012-2013 [Online] Available from: [Accessed on 07 September 2012]. Travers,T. J. (2010) Shari’ah Governance System: International Comparative Study of Islamic Financial Institutions. Cass Business School, Business Mastery Project. Tripp, C. (2006) Islam and the Moral Economy: The Challenges of Capitalism. Cambridge University Press, New York, NY, USA. Tsesnabank (2012a) “Tsesnabank” JSC Financial Statements Year ended 31 December 2011 (Russian language edition). Almaty, Kazakhstan. Tsesnabank (2012b) “Tsesnabank” Branch budget for 2012; Interest rates on deposits and loans. Management reports. Vicary Abdullah, D. and Chee, K. (2010) Islamic finance: Why It Makes Sense. Marshall Cavendish Business, Singapore. Wilkinson, R. and Picket, K. (2009) Level of Spirit, Why More Equal Societies Almost Always Do better. Equality Trust Presentation, UK. Zhanibekov, Y. (2011) ‘ИсламскоефинансированиедляпрограммыФИИР’ ‘Islamic Finance for the programme of forcing industrial-innovative development’. Деловойеженедельник ‘Капитал’ (Business-week ‘Capital’)(Russian language edition).[Online] Available from: fiir.html [Accessed 31 July 2012].
  • 13. 14 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
  • 14. 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 16: Responses Distribution on Question 2 ...................................... 57 Figure 17: Responses Distribution on Question 3 ...................................... 58 Figure 18: Responses Distribution on Question 4 ...................................... 58 Figure 19: Responses Distribution on Question 5 ...................................... 59 Figure 20: Responses Distribution on Question 6 ...................................... 60 Figure 21: Tolerance to Premium Price on Islamic Banking Products........... 60 Figure 22: Responses Distribution on Question 7 ...................................... 62 Figure 23: Responses Distribution on Question 8 ...................................... 63 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
  • 15. 16 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.
  • 16. 17 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
  • 17. 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
  • 18. 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
  • 19. 20 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.
  • 20. 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.
  • 21. 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.
  • 22. 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.
  • 23. 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.
  • 24. 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.
  • 25. 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).
  • 26. 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 Situation: Growth and Significant Milestones Since its inception in 1963 Islamic banking and finance has achieved many significant milestones.
  • 27. 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). Situation: Supportive Infrastructure The industry is supported by well-established institutions:  IDB, IFSB, ISRA, IRTI,
  • 28. 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). 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.’.
  • 29. 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
  • 30. 31 limited use of derivatives as compared to conventional banks (Kara, 2011). 3.3.2. Complication 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. 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.
  • 31. 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).
  • 32. 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). 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.
  • 33. 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-
  • 34. 35 run breeds instability in the long-run as debt accumulates to unsustainable levels’ (Haneef & Smolo, 2010, p. 1). 3.3.3. PERSPECTIVE 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.
  • 35. 36 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 -
  • 36. 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).
  • 37. 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.
  • 38. 39 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)
  • 39. 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).
  • 40. 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
  • 41. 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
  • 42. 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.
  • 43. 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
  • 44. 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.
  • 45. 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.
  • 46. 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
  • 47. 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.
  • 48. 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.
  • 49. 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
  • 50. 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 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
  • 51. 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 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 - 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 ( ) 6 The portrait of audience is available on
  • 52. 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)
  • 53. 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
  • 54. 55 Figure 12: Respondents’ Distribution by Age Figure13: Respondents’ Distribution by Occupation
  • 55. 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.
  • 56. 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. Figure 16: Responses Distribution on Question 2 ‘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.’.
  • 57. 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. Figure 17: Responses Distribution on Question 3 ‘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. Figure 18: Responses Distribution on Question 4 ‘Do you think that Islamic banks are the same commercial and for-profit organizations as traditional banks?’:
  • 58. 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. Figure 19: Responses Distribution on Question 5 ‘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.
  • 59. 60 Figure 20: Responses Distribution on Question 6 ‘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
  • 60. 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.
  • 61. 62 Figure 22: Responses Distribution on Question 7 ‘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.
  • 62. 63 Figure 23: Responses Distribution on Question 8 ‘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.
  • 63. 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.
  • 64. 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.
  • 65. 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
  • 66. 67 contracts. As we can see the biggest proportion of the bank’s financing portfolio falls under Murabaha, which is the most criticized and disputable product. As a pioneer in the market the bank has faced some practical obstacles in regard to the banking and tax legislation that was discussed in Section 3.5 of Chapter 3. The bank is actively working with regulators suggesting improvements in the law. Being a part of ‘Al-Hilal Group’, the bank receives support from the head-office in Abu-Dhabi in terms of Sharia supervision, risk management and funding base. 4.5. CUSTOMER BEHAVIOR While conducting a demand study it is worth looking at customers’ behavior, their preferences and intentions. The customer purchase process usually consists of the following five stages (e.g. Balabanis, 2010): 1. Problem recognition and understanding of needs; 2. Information search on the value required; 3. Search of alternative values; 4. Purchase decision; 5. Post-purchase behavior. Islamic banking can be a good alternative within this buying process for both Muslims and non-Muslim customers. The recent global financial crisis has a certain impact on the mind-set of banks’ customers in regard to the financial system. Ernst & Young conducted the Global Consumer Banking Survey in 2012 among 28,560 banking customers in 35 countries (Ernst & Young, 2012). The following findings were highlighted:  12% of people are most likely to change their banks (it was only 7% in 2011);  22% of customers want their banks to improve pricing structures;
  • 67. 68  40% of customers globally are losing confidence in the banking industry;  44% of respondents use social networking sites to find out more on banking services;  47% of customers prefer to use internet banking for simple transactions like money transferring and account statements;  50% of respondents were dissatisfied with high banking fees;  70% of people globally are ready to provide their banks with more information if this can result in better service;  71% of customers seek advice on banking products from their friends, family and colleagues. These findings are also important to take into consideration for an Islamic bank project in Kazakhstan. Specifically, we can see that less confidence and dissatisfaction with their current banks make customers open to alternatives, including other conventional and Islamic banks. Price sensitivity and quality of service are still the most critical moments for banking customers. Readiness for higher transparency is necessary for risk-sharing products of Islamic banking. It is crucial for a bank to form correct customer’s expectations and meet these expectations in full. Benefits on the word-of-mouth, Internet-banking and social networking technologies are important to know for planning a marketing communication mix. We can see that these channels of communication can be effective to gain a market share by spreading a unique value proposition and reputation of the bank. But this also can work in the other way around when in the post-purchase stage the customer, if left not satisfied, spreads negative information about the banking experience. 4.6. SUMMARY The demand study, including the market penetration analysis, the market survey and the case-study of the first Islamic bank as well as religious and customer behavior has provided us with valuable findings.
  • 68. 69 The market penetration of the banking sector in Kazakhstan (41%) looks very low as compared to other developing countries. The great potential market implies a strong demand on banking services in the long-run. The majority of Muslim population of the country is a real prerequisite to high demand on Islamic banking. However, the share of people committed to religion is only 18%. On the basis of the survey we have found a positive attitude to the new industry among the society in general.Only 5-6% of the voters do not support the government policy on developing the Islamic banking in Kazakhstan. A very few people (3.6%) denied a possibility to ever use Islamic banks. It was found that despite the majority of respondents knows about the existence of Islamic banking in Kazakhstan the industry awareness must be created at a better level among the population of the country. This will increase the potential market for Islamic products. We observed a certain degree of confusion about Islamic banking profit and social goals. Understanding Islamic banking principles, its mission and goals is paramount for the industry success. Otherwise, a wrong market expectation from Islamic banking might lead to a negative experience, thereby damage the industry reputation. Another very important finding is about the key success factors for Islamic banks. The majority of the web respondents (52.4%) said they would use Islamic banking mainly due to ‘the specifics of Islamic banks’ that stand for moral and ethical values and Sharia-compliance of the business. On the contrary the control-survey’s vast majority (76.3%) do matter ‘the better price’ as a main reason of their willingness to use Islamic banking products. But this controversy was almost negated by the next question of the questionnaire that directly tested the price sensitivity. The vast majority of both polls (67-78%) are not ready to pay a premium price on Islamic banking products comparing to conventional banking. The price premium tolerance tends to be minimal with concentration of respondents in the range below 10% extra.
  • 69. 70 Based on the survey we forecast the available market of Islamic banking in Kazakhstan 21%– 45% of the total banking market. The lower limit somewhat corresponds to the proportion of devout Muslims in the country. At the same time, as we discussed, Islamic finance around the world serves non-Muslim customers as well. In terms of organizational form the most preferable one would be ‘Islamic bank as a standalone financial institution’. This might be partially due to the decreased trust in large conventional banks during the crisis. The most demanded products in the banking market are personal and business financing. Saving, current and deposit accounts are also important for potential clients. We also observed a risk-aversion among respondents that might restrain Islamic banking deposit products based on risk-sharing mechanism. The riskier investment instruments would be required for only one out of five people in the market. Only 3% said they do not need banking at all. The case of ‘Al Hilal’ in Kazakhstan shows that during two years the bank has established its customer base, opened two branches apart from the head-office and achieved the breakeven point. Overall, the case demonstrates that Islamic banking in Kazakhstan is in demand. At the same time the bank’s target is limited by corporate and national companies, ignoring SME and retail segment. Furthermore, the bank’s product offering is concentrated on the controversial Murabaha, while the risk-sharing instruments have not been practiced yet. The customer purchase process and the Global Consumer Survey 2012 by Ernst & Young show us that Islamic banks can be a real alternative for both Muslims and non-Muslim clients. Nowadays the chances for Islamic banks are higher when overall trust to banking system is in decline due to the global financial and debt crisis. But success will depend on a particular value proposition and customer satisfaction. All these findings are important to know for the strategy and business planning that will be covered in the next Chapter.
  • 70. 71 5. BUSINESS PLAN In this Chapter, first, we will formulate a business strategy for an Islamic bank based on analysis of current external environment and desirable internal factors. Then we will look at the required ingredients for business development such as corporate governance, products and services, infrastructure and human resources. Finally we will prepare financial projections to see if the bank can achieve sustainable profitability and, thus can interest investors. 5.1. BUSINESS STRATEGY ANALYSIS 5.1.1 EXTERNAL FACTORS PEST Political: Twenty years of the President's power provided Kazakhstan with stability needed for economic and structural reforms after the USSR collapse. However, the current political situation does not seem as stable as recently. In 2011 there was a labor strike in the oil industry where workers required a higher salary. That resulted in unprecedented bloodshed and arrests of many participants. This only increased an underlying social discontent. In 2012 also several unprecedented mass crimes happened that raised questions on adequate security in the society. In May 2011 the Government established the new Authority on Religious Affairs in the wake of so called ‘religious extremism’ danger. A new law was adopted later in October 2011 restricting prayer rooms in governmental offices, educational organizations, army and penal colonies. At the same time the President Nazarbayev himself promotes inter-confessional and inter-ethnic peace and spiritual values in the society. Under his personal supervision a new ‘Hazret Sultan’ mosque in Astana, the biggest mosque in Kazakhstan, was constructed and opened in 2012.
  • 71. 72 The changing socio-political environment is one of main sources of country’s vulnerability (IMF, 2012b). Economical: Kazakhstan along with Russia and Belarus has formed a Customs Union that unified the export-import duties and opened borders of the countries for free goods flow. It is planned to develop it into the Economic Union and, probably, the Currency Union in future. Although benefits for Kazakhstan are currently disputable the Union provides the countries a chance to compete in the bigger domestic market. It requires the Governments to develop the country’s economic competitiveness. In general the economic environment in the country is favorable for a start-up (See Table 2 below). The easy rebound from the crisis was achieved mainly due to recovery in oil prices in 2010. The stable economic growth is projected over the next 5 years (IMF, 2012b). The surplus of the current account will continue to accumulate reserves of the Central bank and National oil fund, making the exchange rate relatively stable and gradually depreciating in nominal value. In contrast, in 2009 when the current account had negative balance and accumulated deficit for previous years NBK conducted a once-off devaluation of tenge to increase competitiveness of the export-oriented industries. The budget surplus will keep the public external debt at manageable level. Monetary and exchange rate policies are expected to support economic activity, mainly export-oriented, while targeting low inflation rate. The GDP structure is quite diversified and the main industries are following: Mining - 18.2%, Construction - 8.5%, Agriculture – 5.5%, Manufacturing - 11.6%, Real estate -13.9%, Trade – 12.7%, Transportation and Communication – 8.7% (IMF, 2012b). As we can observe from the table below rate of growth of non-oil production in GDP is higher since last year than oil- production. This might partly be a result of the Government’s Industrial and Innovative Development Programme, aiming to diversify the economy and increase competitiveness of the country.
  • 72. 73 Table 2: Kazakhstan Macroeconomics, Selected Indicators, 2007-2017 Indicators Actual Projections 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Real GDP growth per annum (p.a.), % 2.9 3.2 1.2 7.3 7.5 5.9 6.0 6.2 6.3 6.3 6.4 - incl. oil n/a n/a 7.1 7.3 1.0 1.6 1.3 1.9 5.6 5.9 5.6 - Non-oil n/a n/a 0.5 7.2 8.3 6.4 6.5 6.7 6.4 6.3 6.5 GDP, US$ billion 106.8 132.9 114.6 147.9 184.2 206.4 227.5 252.5 282.5 316.2 355.2 GDP per capita, current prices, US$ 6.6 8.6 7.1 9.0 10.7 11.9 13.2 14.6 16.2 18.4 20.9 Unemployment, % 7.3 6.6 6.6 5.8 5.4 5.3 - - - - - Consumer Price Index p.a., % 10.8 17.0 7.3 7.1 8.3 5.6 7.2 6.6 6.3 6.0 6.0 NBK refinancing rate, % average (avg.) p.a. 9.5 10.8 8.6 7.0 7.4 6.0 - - - - - Current account, % of GDP -7.9 4.7 -3.6 1.6 7.6 7.1 5.3 4.0 3.3 2.9 3.0 Fiscal Balance, % of GDP -1.7 -2.1 -1.4 1.4 5.5 4.9 4.5 4.1 3.9 3.7 3.6 Public external debt, % of GDP 2.0 1.62 3.2 3.5 3.0 2.8 3.0 3.0 2.9 2.8 2.8 Total External debt, % of GDP 92.4 80.9 97.9 79.9 66.6 65.2 62.3 56.4 51.1 46.9 43.6 National Fund, US$ billion 21.0 27.5 24.4 31.0 43.7 54.9 64.6 73.0 82.5 91.4 101.2 NBK gross international reserves, US$ billion 17.6 19.9 23.1 28.3 29.3 35.3 38.4 42.8 44.8 48.5 54.2 Nominal exchange rate, KZT/US$ 120.3 120.79 148.46 147.5 148.4 149.7 - - - - - Memorandum items: Crude oil and gas condensate production (million tons) n/a n/a 75 80 81 82 83 85 90 95 100 Oil price, US$ per barrel ~60.0 ~120.0 61.8 79.0 104.0 114.7 110.0 102.8 97.2 93.3 91.0 Source: NBK, 2012b; IMF, 2012a On the other hand, there are several serious challenges as well. The most critical one is an economic dependency on volatility of energy prices and global demand slowdown. Also the total external debt seems high with 67% to GDP in 2011, although it has a 96% non- government share.
  • 73. 74 The weakness of the banking sector after the crisis is another important economical challenge as we discussed in Section 3.4 of Chapter 3. In 2010 Kazakhstan adopted the Conception of the financial sector development in the post-crisis period (The President, 2010). This document identified the main directions of the financial sector of Kazakhstan in order to improve its quality after the crisis, strengthen resilience for future shocks and increase financial inclusion of the country to achieve the pre-crisis level of the banking sector to GDP ratio. One of the directions arising from the Conception is a further stimulation of Islamic finance development as additional source of external capital and domestic savings. An empirical analysis by IMF suggested that 'the probability for Islamic banking to develop in a given country rises with the share of the Muslim population, income per capita, and whether the country is a net exporter of oil' (Imam & Kpodar, 2010, p. 20). From this perspective Kazakhstan has quite favorable conditions for Islamic banking penetration. Social: The country population is expected to grow from 16.5 million in 2011 to 18.5 million in 2020 (KazStat, 2012). Country in general and regions with high rural population in particular, which is 45%, require significant public spending in terms of infrastructure development, machineries and equipment, education and medical care. In the wake of the recent social unrests the Government announced increase in pensions and social benefits, new investment projects and facilitation of employment (IMF, 2012b). The next graph demonstrates Kazakhstan’s position among other developing and developed countries in terms of life expectancy and national income per capita. Despite similar head income the life expectancy in Kazakhstan is well below the one in countries like Thailand, Turkey, Malaysia and Mexico. Even the countries with lower national income per capita have higher life expectancy (Indonesia, Vietnam and Albania). It challenges the Government to spend more on health and education.
  • 74. 75 Figure 26: Life Expectancy vs. Income per capita among Rich and Poor Countries Source: Wilkinson & Picket, 2009 Technological: The country’s infrastructure needs to be upgraded. It supposes generating of public spending as well as private investment projects in road construction, electricity, telecommunications and manufacturing. It is positive to note that the country has progressed in terms of mobile and Internet penetration as well as application of modern technologies like 3G, LTE, CDMA-450/800 and fiber-to-the-building. Banks introduce all the available technologies such as I-banking, mobile-banking and plastic cards. The Government and NBK stimulated the population, including pensioners, to open a banking card account. Number of the cardholders almost doubled from 5.3 million in 2007 to 10 million as of 01 July 2012 (NBK, 2012b).
  • 75. 76 Table3: PEST for Kazakhstan Political Economic Social Technological  20 years of the stable Presidency have become a key of economic and structural reforms;  Current political situation is alarmed with 2011 labor strike in oil-industry and several mass crimes in 2012;  The changing socio- political environment is a source of risk  Easy economic rebound;  Favorable domestic macroeconomic environment;  Robust forecast over next 5 years;  Strategy of diversification from oil & gas;  S&P sovereign credit rating: investment grade BBB+  Still high dependency on oil prices and global demand  Health and education are among the main challenges remaining;  More social safety net is expected;  Growing population, although with high rate of ageing;  Significant rural population  More infrastructure investment projects are expected;  Progress in mobile and Internet penetration as well as application of modern technologies;  Banks introduce new technologies  Overall, Kazakhstan looks attractive for an investment, owing to its macroeconomic conditions, mineral resources and financial reserves. The examination of social and technological aspects revealed needs for significant investments in infrastructure. However, the main risks for the mid-term perspective are: 1. Viability of the ruling party to sustain the political stability and improve social safety net; 2. Recovery of the banking sector; 3. Stability of oil prices and global demand. The Global Competitiveness Report for 2012-2013 ranked Kazakhstan up to 51st from 72nd two years earlier (The World Economic Forum, 2012). The report marked some improvements in macroeconomic stability and technological readiness. The report also emphasizes important challenges related to health and education, business sophistication and innovation.
  • 76. 77 PORTER’S FIVE FORCES Figure 27: Porter’s Five Forces for Kazakhstan Banking Sector Source: Author’s work based on financial market statistics(FMSA, 2012b). The banking sector’s concentration has been gradually decreasing over the last several years, but still out of 38 banks Top 5 captures more than 60% of the assets. The high NPL
  • 77. 78 ratio and provisioning resulted in dramatic losses in the banking sector in general and for the major banks particularly. The best profit mainly belongs to several mid-sized banks and subsidiaries of foreign banks. They were more conservative before the crisis and escaped from significant exposure to construction and real estate sector. Also they did not depend on the external borrowings. These banks are currently capturing market share from the large banks that are having problems with loans quality. The competition requires extensive branch network across the country and sales force as well as costly advertising. Speed and quality of service are also a critical success factor for banks. The deposit insurance system is important for growth of deposits. The system protects not only small depositors, but also large amounts up to approximately US$ 33 thousand (KZT 5 million) while the estimated average deposit is between US$15 to 20 thousand. From Islamic banks perspective, lack of insurance mechanism for depositors is a competitive disadvantage. Institutional investors such as pension funds and insurance companies are other stable sources of funding in local market. Assets of these two sectors are more than 10% of GDP as of 01 July 2012. However, allocation of these assets is a restricted subject to credit rating. Pension assets, for instance, require banks to have at least ‘BB-‘ rating from S&P or another international rating agency. Therefore the credit rating is a key success factor in terms of funding from institutional investors. Commercial banks compete with other financial institutions such as state-owned DBK, Housing and Construction Bank (HCB) and Agro-Credit Corporation. On certain niche of the markets the substitution for banking service is also provided by leasing and mortgage companies as well as microfinance organizations. Their role is quite perceptible comparing to the banking sector. The loan portfolio of DBK to the total loan of banking sector is 2.7%, while shares of HCB and mortgage companies in the banks’ mortgages and housing construction loans are 14.7% and 6.6% respectively (NBK, 2012b).
  • 78. 79 During the last three years a few new licenses were issued, including one for the first Islamic bank ‘Al Hilal’. Malaysian ‘Amana Raya’ and ‘Qatar Islamic Bank’ have postponed their decision to enter the market. The minimum capital requirements were raised by the regulator increasing the financial entrance barriers. COMPETITORS ANALYSIS Table 4: Competitors Analysis: Top 10 Banks in 2011 Selected Indicators, 2011 KKB HBK BTA BCC ATF ALB SBR TSB KAS EUA Capital, US$ billion 2.9 1.9 -1.6 0.6 0.4 0.06 0.3 0.2 0.3 0.2 Assets, US$ billion 16.7 14.9 10.9 7.2 6.6 3.6 3.3 2.9 2.8 2.5 Growth in Loan, % p.a. -3 12 27 12 2 -2 103 123 25 19 Growth in Deposits, % p.a. -5 9 10 -12 9 41 100 94 25 -3 Retail deposits in total deposits, % 40 37 41 54 30 39 18 29 70 28 Change in Market Share, % of total assets -0.8 0.5 -4.0 -1.8 -0.5 0.1 1.5 1.5 0.4 -0.1 Return on Equity (ROE), % 0.3 12.6 -9.7 3.8 -59 141 15.2 11.8 25.6 20.4 Net Interest Margin (NIM), % 5.57 4.5 -1.0 2.3 3.2 3.0 5.8 4.8 9.9 6.0 Provision to Loan, % 35 24 62 16 20 45 5 4 16 10 No of Branches and Outlets 157 549 247 197 109 126 98 119 235 76 Source: FMSA, 2012b. For purpose of this table: KKB – Kazkommertsbank, HBK –Halyk Bank of Kazakhstan, BTA – BankTuranAlem, BCC – BankCenterCredit, ATF – ATF Bank, ALB – Alliance Bank, SBR – Sberbank, TSB – Tsesnabank, KAS – Kaspi Bank, EUA – Euarsian Bank. As a result of the crisis the majority of large banks (like KKB, BTA, Alliance and ATF) were experiencing bad loans burden and losing their market share in 2011 as they restricted lending and focused on recovery. In contrast, the mid-sized banks Tsesnabank and Sberbank, having fewer problems, demonstrated remarkable growth in deposits and loans. It resulted in the gained market share and good profit.
  • 79. 80 We can predict that this situation will continue in the next couple of years. Big banks will try to solve their issues with bad loans and clean the balance sheets while mid-sized banks will try to capture the market leveraging on higher flexibility. And again we see that the extensive branch network across the country is required to penetrate the market and support the bank growth. On the other hand, Islamic banks were found to be rather a complement than a substitute to conventional banks (Imam & Kpodar, 2010). This corresponds with our survey findings about price tolerance. Thus Islamic banks have a unique opportunity to capture a certain niche in the market without a direct competition with conventional banks. However, the potential market can grow even higher as Islamic banks are competitive. 5.1.2. INTERNAL FACTORS We used the ‘Vision, Mission and Values’ and ‘Who, What and How’ tools to propose a business strategy based on our literature review and analysis of external environment in Kazakhstan.
  • 80. 81 VISION, MISSION AND VALUES Table5:‘Vision, Mission and Values’Analysis VISION: Analysis: A new Islamic bank needs to focus on effective social benefits it delivers without compromising on its financial sustainability. This will be in accordance with Sharia rules and values and also will position the bank at its unique place in the market. Proposition: To be the country’s number one supplier of most dependable and most socially effective banking services. To be the bank that while doing banking business is committed to society. MISSION: Analysis: To be truly an Islamic bank and avoid a reputational risk the bank must see its mission in helping businesses and individuals to support their financial needs and thereby stimulate an economic activity for the benefit of society. A fruitful long- term relationship with customers will be achieved through a sense of partnership. Proposition: The bank stands to help Kazakh businesses and people build a greater and brighter future for themselves and their country by providing highly professional, modern and Sharia-based banking services for all. As a truly Islamic bank it sees itself as a partner of private businesses, individuals and the Kazakhstan community as a whole. VALUES: Analysis: The bank needs to be closer to the society as a real partner. Quality of service is a success factor for any bank. Sharia fundament will provide the bank with exceptional ethics and moral standard, which will be valued by customers over time. The same level of commitment to staff, customers and future generations will provide a sustainable growth of the bank. Proposition: Honesty and Respect – the bank makes it a responsibility to treat each and every customer with honesty and respect. Trust and Partnership – the bank is a partner that customers can always trust. Quality of Service – the bank intends to provide the most reliable banking services and find solutions to every banking need. Contribution – the bank aims to make a positive contribution to Kazakhstan through a beneficial Islamic banking mechanism. Sustainability and Growth – the bank thinks about the future of the bank, the Kazakhstan people and the country. Ethics and Morals – the bank is based on highest ethical and moral standards of Sharia that makes the bank socially responsible in every relationship - with the customers and communities as well as the staff.
  • 81. 82 WHO – WHAT – HOW Table 6: ‘Who – What – How’ Analysis Analysis Proposition: Who …Not Although the bank is positioned to serve as many clients as possible, targeting profitability and social benefits, the main target segment should be SME and Retail. Very small business will be left as area of microfinance institutions. Too large clients are already banked by big local and foreign banks and also will be limited by the single borrower limit that is 20% of bank’s net worth.  Retail clients  Small business (assets size from US$ 0.2 million and 5 employees minimum)  Medium Business (up to US$ 3.5 million assets and 250 employees)  Corporate business (more than US$ 3.5 mil assets and 250 employees)  In main 16 cities of the country  Activities repugnant to Sharia  Micro-Business  Too small business (less than US$0.2 mil assets and 5 employees)  Too large corporate clients  In rural area Analysis Proposition: What …Not The Islamic bank will provide full range of banking products and services within the Sharia requirements. As discussed, the key success factor for Islamic banking will be in truly social orientation of the business. Hence, all transactions must be subject not only to Sharia-compliance approval, but also to a ‘Socio- Economic Better-Off Test’. In future it might be considered to set up subsidiaries in other financial segments such as Takaful, investment  Sharia based banking products with evidence of socio-economic betterment for a client, the bank and the country:  Deposits and Cards  Financing (Lease & Investment products)  Cash management and Remittance  E-service (email and Internet-banking)  Financial consultancy on projects financed by the bank  Conventional riba-based products  Insurance  Securities  Investment banking  Murabaha should be used in limited supply
  • 82. 83 banking and leasing as majority of competitors established their financial groups and cross-sell their products. Analysis Proposition: How …Not Creating brand equity of the bank as well as Islamic finance in whole will require significant efforts in terms of educating both staff and society on Islamic finance principles, mission and goals. Advertising and other marketing mix tools will be used to communicate the value proposition to potential customers. High quality service and Personal Client Relationship is a key to attract mid-sized and large clients. Strong KYC and Risk policies need to be applied to mitigate financial and business risks, fraud and moral hazard.  Personal client relationship  Approaching new customers (direct marketing)  Marketing communication mix, including advertising  Internet, email and mobile phone  Cross-selling  Strict KYC and Risk policies  Educating and training staff  Educating society on Islamic finance, public relations  ‘Better-off’ test on socio- economic benefits  Waiting for a walking customer
  • 83. 84 5.1.3 FINDINGS USING SWOT Table 7: SWOT-Analysis for a New Islamic Bank Internal Strengths Weaknesses  New Islamic bank with the new value proposition – socio-economic benefits for customers and the country  Clean balance sheet, lack of problematic assets that have hugely affected large banks in the market  Tested demand for Islamic banking with certain share of extra price tolerable clients  Ethical and moral values inevitably ingrained to Sharia principles will differentiate the bank from majority of the market players  Target segment: SME and Retail  Potential resources and capabilities to execute the bank’s strategy  Human capital deficit, comprehensive training required  Sharia scholars deficit  Risk-sharing instruments require extensive resources for due-diligence with customers  Liquidity management due to virtually lack of Sharia short- term investment in the domestic market  Additional cost involved due to Sharia supervision  Lack of branch network  Misunderstanding Islamic finance principles by clients → wrong customer expectations  Lack of Deposit Insurance system for Islamic banks → disadvantage to conventional competitors  Legislation adaptation needed: Tax issues (VAT for commodity Murabaha), Banking law definitions (Wakala, partnerships for retail etc.)  Risk-aversion of potential clients  Need minimum credit rating ‘BB-‘ for institutional investors External Threats Opportunities  Reputation risk if conventional products are imitated  Reputation risk if social benefits are invisible  Regulatory risk if the Government plans (Road- Map) are not implemented properly  Possible entry of big players would increase competition  Political stereotype risks ‘associated’ with Islam  Exploit the potential of the banking sector and macroeconomic environment to grow in the long-run  Educating potential customers and increase awareness of Islamic finance products, hence boosting future demand and increasing potential market  Grow in momentum to capture a market share while only one Islamic bank is in the market and large conventional banks are in hangover from the crisis  Meeting current demand and satisfying loyal customers, boost future demand and spread across the country and beyond Muslim audience  Financial inclusion strategies of the Government include Islamic finance alternative  Significantly increase in efficiency over time upon the Government Road-Map implementation, including improvement of regulation, tax issues, liquidity framework and deposit guarantee scheme  Diversify in Islamic finance with Takaful and Investment bank subsidiaries forming an Islamic financial holding  Expand to neighbor countries (Russia, Uzbekistan, Kyrgyzstan, Tajikistan and Turkmenistan)
  • 84. 85 5.1.4 STRATEGY FORMULATION Putting together our findings in literature review, demand study and the external and internal factors summed up in SWOT (Table 7), we have derived the business strategy of the bank as follows. Target segments: SME and Retail across the country. The corporate clients also will be within the focus, although in less priority. Value proposition: The Sharia-based banking products with clear evidence of socio- economic betterment for a client and the country. Delivering Value:  Educating the market;  Marketing communication mix;  KYC and Risk screening;  High ethics and moral standards;  ‘Socio-Economic Better-Off Test;  High quality standards;  Modern technologies;  Branch network. Figure 28 depicts the desired strategic position of the bank in the market in terms of ROE and market segments. However, the value proposition will significantly differentiate the bank from the majority of players, providing the bank with a source of competitive advantage.
  • 85. 86 Figure 28: Strategic Groups and Market Segments Source: Author’s work based on banking statistics as of 01 July 2012 (FMSA, 2012b). An important area of concern is time to enter market. Since there is a legislation imperfection it is better to have the law fully adapted and the market informed for Islamic banking. The pioneers of the market have to take disproportionate costs on lobbying the legislation improvement and educating the market. At the same time it will give the bank a chance to skim and penetrate the market building strong brand equity before new entries occur. From this perspective, internal resources and capabilities providing effective operational and risk management are crucial for the successful entry.
  • 86. 87 5.2. Business Development Plan 5.2.1. Corporate Governance Shareholding Regarding Corporate Governance, the bank will follow the local legislation and best international practices. According to Article 15 of the Banking Law of the RK commercial banks including Islamic banks can be established only in form of a joint-stock company (Banking Law, 2012). Foreign organizations or banks can perform as major shareholders of banks in Kazakhstan (more than 10% of total shares) if only they have credit rating equal or above the sovereign rating of Kazakhstan. The current rating of Kazakhstan is BBB+ by Standard and Poor’s. Common law on joint-stock companies shall be applied to the banks activity, shareholders and corporate governance. Public companies listed on the Stock exchange must approve and publish Corporate Governance Code. Shareholders of the bank conduct the general meeting at least once a year to assess the bank’s performance, approve its annual report and consider the dividend distribution. The governance system in Kazakhstan supposes the dual board structure with the Board of directors as senior supervision board and the Management board as executive body. Shareholders appoint the Board of Directors as a senior management of the bank who represents shareholders’ interests and is accountable to shareholders. The Board of Directors, in turn, appoints the Management board as executive body. Board of Directors The Board of Directors (BOD) will be elected and approved by the shareholders. The BOD must include 3 members minimum. At least 30 percent of total number of the BOD
  • 87. 88 members must be independent directors (Joint-Stock Law, 2012, article 54). The Chairman of the BOD is elected and appointed by the BOD from its members. The main objective of the BOD is to ensure that the bank is managed properly in accordance with the law and regulations and in interest of the shareholders and all other stakeholders. The BOD reviews and approves strategic and business plans of the bank, oversee and advise the management board. For carrying out its functions the BOD will set up sub-committees, such as the Audit committee, the Risk committee and the Nomination and Remuneration committee. The BOD and its committees will conduct meetings at least once every quarter. Council on Principles of Islamic Finance In accordance with Article 52-2 of the Banking Law an Islamic bank must establish a Council on principles of Islamic finance (Banking Law, 2012). The Council is an independent body appointed by shareholders of an Islamic bank upon recommendations of the BOD. The law does not stipulate the size of the Council and qualification requirements to its members, leaving these at discretion of shareholders. The role of the Council is supervision over the bank’s policies and transactions to ensure the banking activity is in compliance with the Banking law and Sharia. The bank’s internal regulations (the General Rules on banking transactions and the Credit Policy) are subject to approve by BOD only upon the Council’s prior approval. Daily banking transactions and the Credit committee decisions conducted in accordance with the General Rules and the Credit Policy are not subject to approve separately by the Council. However, the Council has an authority to examine any transactions conducted by the bank making sure it is in compliance with the Law and Sharia.
  • 88. 89 The bank will set up the Council according to these requirements of the Banking Law in Kazakhstan and international practice of Islamic banks. Management Board The Management board (MB) is elected and appointed by the BOD as executive body of the bank. The Chairman of the MB is appointed by the BOD and cannot be the Chairman of the BOD. Other members of the MB will be Deputies of the Chairman and other selected top managers. There will be at least 3 members of the MB. The MB will meet at least once a month. The MB will cooperate with the BOD on all strategic issues. The MB is accountable to the BOD on monthly basis. The MB is responsible for overall and operational management of the bank and execution of its strategy and business plan agreed with the BOD. To carry out its functions the MB will establish committees such as the Credit Committee, the Assets and Liabilities Committee (ALCO), the Compliance Committee and the Business Development Committee. Internal Control, Risk Management and Audit Based on Article 40-5 of the Banking Law (Banking Law, 2012) the bank must set up the internal control and risk management system, including: 1. Authorities, functions and responsibilities of the BOD, the MB and the bank departments regarding the internal control and risk management; 2. Internal regulations such as policies and procedures on internal control and risk management; 3. Limits on acceptable size of risks for every type of banking transactions, different industries exposure, separate products and financial instruments; 4. Internal procedures regarding management reporting system, including reports on internal control and risk management;
  • 89. 90 5. Internal criteria of effectiveness of the risk management system (self-assessment). The internal control system must ensure security of the bank’s assets and effectiveness of operations through the ‘Plan-Do-Check-Act’ cycle. The system should include the following elements: 1. Preventive control mechanisms such as physical security of assets (cash, buildings), information security, segregation of duties, dual control, transaction authorizations, limits on single transaction, staff, client and product; 2. Directive control mechanisms such as regulations, manuals, policies, procedures and product descriptions; 3. Detective control mechanisms such as monitoring and reporting, reconciliation of data and audit trails; 4. Corrective control mechanisms such as back-up, database rollback and graceful exit in information system. The main types of risks are the following: 1. Financial risks: Credit risk, Market risk, Liquidity risk; 2. Business risks: Operational risk, Legal risk, Regulatory risk, Reputational risk. The bank will follow the NBK requirements for the internal control and risk management system(Risk Regulation, 2005) The Risk department will be set up to assess all main risks attributable to the bank’s operations and report to the BOD on a monthly basis. The ALCO will monitor and manage all financial risks related to the assets and liabilities management. Treasury transactions will be problematic for the time being due to lack of Sharia-compliant instruments on the local money market and the capital market. Opportunity to seek instruments abroad will be limited by the currency position prudential standards. On the other hand, we see a little progress in this area. In July this year DBK issued sukuk for about US$ 77 million with 38 percent purchased in Kazakhstan. ‘AlHilal Kazakhstan’ signed an agreement with ‘Citi bank Kazakhstan’ based on commodity Murabaha for interbank deposit transactions.
  • 90. 91 The Credit committee will design a credit process separately for corporate, SME and retail products. To standardize the process and effectively assess the credit risk the Credit Committee will develop a rating system for corporate and SME clients and a scoring system for retail products. A data from the Credit Bureau and the State Pension Center will be used for credit appraisal. The former provides credit history of a client and the latter is a source of salary statement for all citizens in Kazakhstan. Islamic banks must comply with the following prudential standards (Prudential Regulation, 2009): 1. Capital adequacy ratios; 2. Single borrower limits; 3. Liquidity ratios; 4. Currency open position limits and net position limit; 5. Maximum investments in fixed and non-financial assets; 6. Capitalization in regard to liabilities to non-residents (foreign debt leverage). The Compliance control department and Compliance Committee will be established as a part of the integral system of internal control and risk management. The compliance control must ensure that the bank’s operations and employees’ behavior are in compliance with business ethics, regulations and laws. The anti-money laundering law is one of the main areas where the Compliance department will focus on. The Internal audit and External audit are important parts of the Bank’s overall control system. The Internal audit department must conduct internal audit on a regular basis with focus on effectiveness and efficiency of business process and internal control system. The External audit of the financial statement as well as audit of internal control and risk management systems must be conducted on an annual basis minimum. According to the Banking Law the bank must conduct external audit by one of the ‘big four’ international audit organizations. The BOD is ultimately responsible for putting the internal control and risk management systems in place. The Heads of Risk, Internal Audit and Compliance while working with the
  • 91. 92 MB on a daily basis will report to the BOD directly on a monthly basis and/or in case of emergency. Business Ethics Being a part of corporate values and underlying principles of Islamic finance, business ethics are a cornerstone of the bank’s corporate governance. They also underpin the bank’s value proposition for customers. Business ethics norms must be declared and promoted among the bank’s staff by the business ethics code or within the corporate governance code. The main areas of the business ethics will include: 1. Compliance with Sharia principles and standards; 2. Compliance with corporate values; 3. Compliance with laws and regulations; 4. Rights of employee; 5. Rights of customer; 6. Moral hazard and conflict of interests; 7. Professionalism; 8. Corporate social responsibility; 9. Environment and sustainability; 10. Transparency and confidentiality; 11. Anti-Corruption and anti-money laundering. The BOD and the MB must ensure that the business ethics are not only declared, but also followed. Organizational Chart The organizational chart is outlined in Appendix F. The structure suggests that there will be separated business lines for corporate, SME and retail segments. It will let the business arms
  • 92. 93 focus on the particular market segment, identify customer needs carefully and standardize business processes and procedures, hence achieve higher effectiveness and efficiency of the operations. Other departments such as IT, Accounting, Marketing and Sales will be universal and supportive to all the business arms. 5.2.2. Products and Services Deposit Products The bank will offer its clients, legal entities and individuals, the following deposit products: 1. Current account based on Qard-Hassan contract. This will provide customers with money saving, payment and cash management mechanism. 2. Investment account based on Mudaraba contract. This will provide customers with opportunity to invest their money and earn some income. This product will vary for different terms and currencies, mainly KZT, US$and Euro. Also the bank will develop restricted and unrestricted Mudaraba variations of the deposit investments depending on risk appetite of potential customers. 3. Card account. The debit and credit cards will be designed in compliance with Sharia. Financing Products The bank will offer its clients, legal entities and individuals, the following financing products: Mudaraba – the bank will invest into business projects, expecting pre-agreed proportion of profit. Musharaka - the bank will invest into business projects and retail transactions based on the partnership. For retail products a diminishing Musharaka will be used. Murabaha – the bank will finance purchase of fixed and movable assets for customer purpose. However, this type of products must be limited as it creates debt and is most disputable on hidden riba issue.
  • 93. 94 Ijara – the bank will provide lease of assets required by customers. Variations of operating and financial lease contracts will be available. Istisna – the bank will finance manufacturing or construction of future assets. Salam – the bank will finance immediate cash needs of customers. This type of products also must be limited as it is a debt-based instrument. Wakala –agency contract will be used for trade finance and in hybrid with other products for the process of assets purchase and sale. All these types of financing will be designed for both legal entities (business) and individuals (retail) except Mudaraba that will be used for the business financing purpose only. Collateral against negligence of customers will be applied for all as a general rule. Mudaraba and Musharaka as risk-sharing mechanisms will be in priority of the bank’s product development and sales target. However, currently according to the Banking Law the products based on partnership are assumed only for business purpose and limited to the retail clients. The draft law we reviewed in Section 3.5 of Chapter 3 is supposed to improve this legal drawback. Sukuk Sukuk will be an important and additional source of funding for the bank’s expansion. The pension funds and insurance industry as institutional investors by their assets size represent more than 10% of GDP as of 01 July 2012. As their assets grow they are continuously interested for new financial instruments in the market. However, allocation of the assets is restricted subject to credit rating and listing requirements of Kazakh stock exchange. The bank can be listed for sukuk only in 2 years of business9 . 9
  • 94. 95 E-banking Electronic banking will be in priority of the bank as a modern and technology-based way of customer service. The bank will provide the following services: 1. Internet banking (with options of account statement, money transfer within the bank as well as to other banks and abroad); 2. Email-banking with account statement and customer care; 3. SMS-banking providing customers with information about transactions on their account; 4. Plastic cards with debit and credit card as well as virtual cards based on current account. Pricing Policy The objective of the Bank’s pricing policy will be based on the business goals such as bringing a new value proposition in the market with strong ethical and socio-economic benefit for all– the bank, the customer and the country. The bank will aim for a sustainable return that would be attractive enough for shareholders and supportive for the bank’s expansion plans. At the same time the profit rate on the financing products should be high enough to pay a competitive return to depositors. The next table demonstrates the net interest margin and interest spread distribution among banks in Kazakhstan. The indicators are based on all interest-bearing asset and liabilities nevertheless the overall picture reflects a difference in pricing and interest rates policies.
  • 95. 96 Table 8: NIM and Interest Spread Distribution among Kazakh Banks (01 July 2012) # Name of the bank Yield of assets Cost of funds Net Interest Margin Interest Spread 1 Kazkommertsbank 8.5% 5.7% 5.61% 2.80% 2 Halykbank 6.7% 3.8% 4.06% 2.96% 3 BTA 4.3% 7.5% -1.58% -3.25% 4 BankCenterCredit 7.5% 5.9% 2.50% 1.64% 5 ATF (Unicredit) 6.8% 4.6% 3.25% 2.15% 6 Alliance bank 7.2% 7.7% 3.16% -0.47% 7 Sberbank 8.8% 3.8% 5.50% 5.00% 8 Tsesnabank 11.4% 6.2% 5.57% 5.26% 9 Kaspi 14.8% 9.0% 8.22% 5.82% 10 Eurasian bank 12.2% 6.4% 6.64% 5.71% 11 Citi bank 1.5% 0.2% 1.37% 1.36% 12 Nurbank 6.5% 6.0% 2.81% 0.49% 13 Temirbank 7.3% 8.3% 2.63% -1.03% 14 Housing and construction bank 4.5% 2.6% 3.10% 1.91% 15 HSBC Kazakhstan 5.3% 0.7% 4.77% 4.61% 16 RBS Kazakhstan 1.2% 0.4% 0.84% 0.79% 17 Alfa bank 7.3% 3.4% 4.53% 3.90% 18 Delta bank 13.7% 6.1% 9.50% 7.63% 19 Exim bank 10.9% 6.7% 6.03% 4.24% 20 Kazinvest bank 7.5% 5.0% 3.57% 2.54% 21 VTB 9.6% 4.9% 6.06% 4.70% 22 Bank of China 1.0% 0.1% 0.90% 0.88% 23 Astana finance bank 8.2% 2.7% 6.42% 5.48% 24 Home credit 32.0% 6.3% 29.48% 25.70% 25 RBK 8.8% 4.5% 4.86% 4.33% 26 Forte bank 6.4% 2.9% 4.59% 3.54% 27 Industrial bank of China 1.5% 0.4% 1.28% 1.15% 28 AsiaCredit Bank 10.7% 4.0% 8.33% 6.64% 29 Shinhan Kazakhstan 5.6% 1.7% 4.98% 3.94% 30 Bank Positive 5.4% 0.6% 5.54% 4.78% 31 Kazakhstan Ziraat bank 5.0% 0.0% 5.25% 5.02% 32 Kassa Nova 14.5% 5.3% 11.36% 9.16% 33 Punjab National Bank Kazakhstan 3.6% 3.6% 2.89% -0.02% 34 Islamic bank Al Hilal 4.3% 0.1% 4.13% 4.16% 35 Senim bank 9.6% 7.7% 4.77% 1.90% 36 Taib bank 4.5% 4.6% 2.72% -0.11% 37 National bank of Pakistan 9.0% 4.1% 8.47% 4.85% 38 Zaman bank 7.0% 2.2% 6.28% 4.79% Total 7.1% 5.4% 3.83% 1.67% Minimum 1.0% 0.0% -1.6% -3.2% Maximum 32.0% 9.0% 29.5% 25.7% Mean 7.9% 4.1% 5.2% 3.8% Median 7.2% 4.5% 4.8% 3.9% Standard Deviation 5.2% 2.6% 4.7% 4.4% Source: FMSA, 2012b
  • 96. 97 The analysis of the assets yield and cost of fund shows that there is a significant difference between the loan and deposit rates of commercial banks in Kazakhstan. The extreme values are far from average. The standard deviation is comparable with average rates of return on assets and liabilities. This reflects strong differentiation of the banks in terms of market segment, product offering and value proposition. We would like to test if we can apply the 10% premium that was found tolerable in our demand survey. If we apply 10% extra over the average yield of assets (7.9%) would be only 0.79% that is far below the standard deviation (5.2%). The same thing is with the liabilities. Another test of price differentiation in the market is presented in the table below where we compare three banks, competing in the same market segments, SME and retail. Table 9: Variation of Loan and Deposit Rates for Selected Banks (September 2012) Deposits effective rates, % Tsesnabank Sberbank Eurasianbank Standard Deviation KZT US$ KZT US$ KZT US$ KZT US$ 6 month 5.10 3.10 3.60 2.80 1.30 3.00 1.91 0.15 12-13 month 7.50 3.90 6.40 3.80 8.30 3.00 0.95 0.49 10% discount test 6 month 0.51 0.31 0.36 0.28 0.13 0.30 12-13 month 0.75 0.39 0.64 0.38 0.83 0.30 Loan to Small business, % Tsesnabank Sberbank Eurasian Standard Deviation Minimum annual effective rate 11.30 12.00 14.00 1.4 processing fee 0.50 - - 10% premium test 1.13 1.20 1.40 Source: Published banks rates 10 as of 13 September, 2012. As we can see the 10% supposed premium of the Islamic bank is well below the standard deviation of the banks’ rates, except the US$ deposits with the minimal variance. 10 Websites:;;
  • 97. 98 Overall, we can conclude 10% premium price for Islamic banking products we derived from the demand survey analysis seems acceptable in the market and will be hardly considered as a marked difference. However, our analysis of the industry has shown quite high competition in the market, especially in the SME and retail segments. Therefore, the bank should accept a competitive pricing policy. Thanking to its differentiation advantage and unique selling points of the value proposition the bank will not use a market penetration pricing rather it will follow the market at the first stage. This means the ‘going-rate pricing’ method (Kotler and Keller, 2009, p.433). Under this method the bank will price its products similarly (more or less) to the main competitors. Later, upon the marketing efforts, educating the market and increase of awareness of Islamic banking principles and the bank’s particular value proposition, the bank can gradually transfer to the customers’ ‘perceived-value pricing’ (Kotler and Keller, 2009, p.432). Under this method the bank would differentiate itself from majority of the players and thereby charge tolerable premium 5-10% over the main competitors. However, socio- economic benefits should be weighted carefully before the bank uses premium pricing. 5.2.3. IT INFRASTRUCTURE The bank will require a robust Information Technologies (IT) architecture to record, integrate and keep transactions data. The system should provide a flexible toolkit for analysing, reporting and timely management intelligence. In the table below we plan the bank’s IT structure and budget, based on research through potential vendors and advice from IT-specialists.
  • 98. 99 Table 10: IT Structure and Budget Item Specifications Indicative price, US$ 1. Core system Flex Cube (FC), Oracle 400,000 Software FC license – 150 concurrent users 20,000 Data base Oracle DBASF – 10 licenses 240,000 Hardware 16-core 3.7 GHz POWER7 IBM Power 750 Express server 64 GB of memory, two 146 GB 2.5" hot-swappable disk drives, AIX Standard Edition license Operating System included 65,000 Standby server and Test server, 3 Application servers IBM x3650 M4 124,000 Data storage IBM DS3524 DC Model (8Gb FC 4 Port Daughter Card, 5 discs 300GB 15,000 rpm 6Gb SAS 2.5” HDD for RAID 10, 2GB Cache ) 30,000 Card system integration server x3650M4; DWH Server (reports) 60,000 Implementation Team: 1 project manager, Database admin and experts for parameterization, 27 week plus 4 week post live support 396,000 2. Card system Software Compass Plus, TranzWare, 200K trnx., 50 ATM, 200 POS, 50K card holders 300,000 Membership Principal Membership to MC &VISA 250,000 Data Base Oracle - ASF for TWO, 24000; Oracle - ASF for TWS, 15000 310,000 Hardware TWCMS servers, 2 Main 8-core 3.7 GHz POWER7 IBM Power 730 Express server, 32 GB; Stand by 8-core 3.7 GHz POWER7 IBM Power 730 Express server, 32 GB; Test IBM x3630 M4 and Application Server; Main IBM x3650 M4 and Stand By IBM x3650 M4 136,000 Equipment for card issuance 100,000 Implementation 500$ man-day* 4 weeks, 1 project manager plus 1 expert 125,000 Total 2,556,000 Source: Vendors’ web-sites, and consultations with IT professionals. These IT characteristics are indicative and based on the desired capacity of the system and equipment, specifically number of licenses, processors, servers and users. The proposed IT profile will be sufficient for potential growth of the bank during the projected period if required maintenance is provided. A cost-saving can be achieved if the parent-bank software is used.
  • 99. 100 5.2.4. BRANCH NETWORK PLAN Kazakhstan is number 9 in the world in terms of territory that spans to 2,727,300 square kilometers. In terms of administrative units the country is comprised of 14 regions, 84 cities, 159 districts, 241 settlements and 2,042 rural counties. Figure 29: Map of Kazakhstan Source: Google, 2012 This land size and administrative-territorial structure of Kazakhstan require banks to develop an extensive branch network not only in the capital, but also across the country. Below is the branch number distribution of the banks, which have more than 10 branches.
  • 100. 101 Figure 30: Branch Numbers Comparison (September 2012) Source: FMSA, 2012b These numbers include full scale branches and small outlets, usually retail and SME oriented. We see that banks with large branch network focus on SME and retail. Specifically Halykbank, BTA, Kaspi, BCC, Tsesnabank. As we discussed in the Porter’s Forces analysis the Top 5 banks in terms of assets hold 55% of the total branch number in the country (2,282). As we realized in our previous analysis the bank needs to develop a branch network large enough to cover at least main cities, and 14 region centers. Based on the main branch in each region center smaller branches will be opened around. In order to prioritize the locations we should have a look at the banking loan distribution between the regions.
  • 101. 102 Figure 31: Geographical Distribution of Total Banking Loans (September 2012) Source: NBK, 2012b Figure 32: Geographical Distribution of Small Business Banking Loans (September 2012) Source: NBK, 2012b The two charts above show that the geographical distribution of both total loan and small business loan is identical. More than half of the loans were issued in Almaty, former capital and now a commercial center of the country. Astana, present capital, won the second place. Karaganda, East and Pavlodar regions are the next, completing the Top 5 largest economical regions.
  • 102. 103 Taking into consideration these data as well as the resources required for opening branches we propose the following indicative plan: Table11: Branches Opening Indicative Plan # Region/City Number of branches Time frame Full scale Service center 1 Almaty city, incl. head office 2 3 2013 2 Astana 1 2 2014 3 Karaganda 1 1 2014 4 East (Ust-Kamenogorsk) 1 1 2015 5 Pavlodar 1 1 2015 6 South (Shymkent) 1 1 2015 7 Kostanai 1 1 2016 8 Aktubinsk 1 1 2016 9 Atyrau 1 1 2016 10 Mangystau-Aktau 1 1 2016 11 North (Petropavlovsk) 1 1 2017 12 Zhambyl - Taraz 1 1 2017 13 West (Uralsk) 1 1 2017 14 Almaty region 1 1 2017 15 Akmolinsk - Kokshetau 1 1 2018 16 Kyzylorda 1 1 2018 17 Other 1 5 2019 18 Other 1 5 2020 19 Other 1 5 2021 20 Other 1 5 2022 Total 21 39 60 By the end of 2018 the bank will cover all the main cities in the country. Until 2022the bank will have 60 outlets. However, it is still below the top 10 banks in terms of number of branches while the 10th bank has 98 outlets. Therefore, the bank will continue to analyze needs in branches depending on effectiveness of the existing branch network and capacity and potential markets in a particular city. 5.2.5. MARKETING COMMUNICATION MIX The marketing communication mix will play a vital role in communicating the value proposition of the bank and promotion of unique selling points of its products and services
  • 103. 104 in the market. It will help to build long-term customer relationship and create strong brand equity. Furthermore, Islamic banking in whole is a new concept for Kazakhstan and as we have seen in the survey results there is a certain part of population(9-28%), who know nothing about Islamic banking in the country. Islamic banking principles and goals are confused by a third of the respondents (32-36%). All these require a comprehensive education of people about Islamic finance. This is also in line with the Road-map of Islamic finance in Kazakhstan. However, the pioneers in the market have to take a leading role in educating the society. Therefore, the bank will use a whole range of tools of the marketing communication mix, as presented in the figure below: Figure 33: Marketing Communication Mix Source: Kotler and Keller (2009, p.513). Advertising will cover TV, radio, newspapers and outdoors. Also some corporate and product materials such as brochures and leaflets will be used by sales force. Sales force will be involved in direct sales process, meeting clients and making presentations. Sales
  • 104. 105 promotion comprises participation in fairs and exhibitions of financial organizations. Events and public relations will form an educating program about Islamic finance in general and the bank’s value proposition in particular. Seminars and publications will be actively put into practice. Direct and interactive marketing will be employed using E-banking instruments. Also, social networking and word-of-mouth ways of spreading of information should be taken into account as we know that these are in preference of respectively 44% and 71% of banking customers globally (Ernst & Young, 2012). In turn, it will increase awareness of Islamic banking not only among Muslims, but also non- Muslim customers, hence extending potential market and boosting future demand. Table 12 portrays marketing and advertisement expenses in 2010-2011 for 6 selected banks: KKB, the largest bank, four mid-sized SME and retail banks, which demonstrated good growth in 2011, and the first Islamic bank. Table 12: Marketing Expenses for Selected banks in 2010-2011 (US$, million) Banks, 2011 % of total Opex % of total Assets 2010 % of total Opex % of total Assets KKB 11.2 4% 0.07% 8.0 5% 0.05% Tsesnabank 2.5 4% 0.08% 2.2 2% 0.14% Eurasian 4.7 5% 0.19% 1.4 2% 0.06% Sberbank 2.6 3% 0.08% 2.6 5% 0.14% Kaspi 8.1 7% 0.29% 6.8 7% 0.28% Al Hilal 0.01 0.1% 0.01% 0.03 0.8% 0.07% Average 4.8 4% 0.12% 349% 4% 0.12% Source: Annual reports of the banks for 2011 (KKB, 2012a; Tsesnabank, 2012a; Eurasianbank, 2012; Sberbank, 2012; Kaspi bank, 2012; Al Hilal bank, 2012). These banks, except Al Hilal, are well-established financial organizations in the market, thus they benefit from scale economies. We see that Al Hilal, being a pioneer in the market, does not spend enough to promote Islamic finance in the society. This again reflects its strategy, focusing mainly on large corporate clients, which are targeted by the direct sale.
  • 105. 106 Obviously for a start-up, focusing on SME and retail, the cost in relation to total assets and operational expenses will be higher than in the established and matured banks. Based on these indicators the bank will plan the marketing and advertisement cost as follows: Table 13: Marketing Indicative Budget for 2013 # Marketing budget US$ % of Budget 1 Advertisement 850,000 57% 1.1. TV 600,000 40% 1.2. Radio 50,000 3% 1.3. Outdoors 150,000 10% 1.4. Other 50,000 3% 2. Public Relations & Publicity 200,000 13% 2.1. Seminars 150,000 10% 2.2. Other 50,000 3% 3. Direct & Interactive Marketing 200,000 13% 3.1. Web-site 150,000 10% 3.2. Other 50,000 3% 4. Promotion & Events 150,000 10% 5. Direct Sale 100,000 7% Total 1,500,000 100% It corresponds to 13-60% of the leaders’ budget, but dramatically higher than AlHilal’s. Every year onward the budget will increase gradually depending on the branch network and sales effectiveness. 5.2.6. HUMAN CAPITAL MANAGEMENT As far as the shareholders of the future bank have got all the necessary ingredients for a start-up it will all depend on quality of project implementation and execution. Human resources become the highest priority. The bank needs to build a professional, committed and inspired team. Within the Strategic Human Resource Management a combination of the ‘best-fit’ and the ‘resource-based’ approaches will be implemented (McKenna & Beech, 2008, pp. 31-36). The former will help to create a corporate culture through selection, appraisal, rewarding and
  • 106. 107 development processes. The latter will consider the human resources as an asset and source of competitive advantage of the bank rather than costs to be minimized. The bank will develop a Balanced Scorecard System and Performance Appraisal. They will allow the management to align staff activities to the vision and strategy of the bank, improve internal and external communications and monitor organizational performance against strategic goals. The appraisal results will influence the decisions on pay and reward, career promotions as well as training and development. The bank will follow the Labor Code of Kazakhstan that regulates rights and obligations of employee and employer, relationship between the two. In recruitment and selection process the bank will cooperate with headhunters, sufficiently operating in Kazakhstan. Due to the relatively high level of the banking sector development, especially before the crisis, it seems easy to find professionals in banking in the market. However, a special training program on Islamic finance should be provided for the employees on a regular basis. 5.3. FINANCIAL PLAN 5.3.1. MAIN ASSUMPTIONS 1. It is assumed that the team, the banking IT core system and the main products are ready to launch operations prior to beginning of the projected period. 2. The financial projections are computed over the period of 10 years. This is longer than normally practiced in business with average projected period of 3-5 years. First reason for longer time horizon is social underlying orientation of Islamic finance and this should manifest itself in longer-term business plan. Secondly the entry barrier (capital requirements) that was lifted up by NBK requires a longer payback period. 3. The minimum paid-up capital according to NBK requirements is about US$ 70 million.
  • 107. 108 4. Deposit and financing portfolios growth is based on average of seven selected banks for the first half of 2012 and equal to US$ 367 thousand and US$ 680 thousand per month per branch respectively (FMSA, 2012b). 5. Cash reserves for liquidity position is based on selected banks’ benchmark and equal to 5 % of the total liabilities (Tsesnabank, 2012a; KKB, 2012a). 6. The interbank deposits, sukuk and borrowings are used as plugs of the projection model, depending on funds excess or needs to support the loan portfolio growth and the liquidity position. 7. Expected profit rates on financing and deposits are based on average interest rates in foreign currencies in the market according to NBK Statistical Bulletin #6, June 2012 (NBK, 2012b). These rates were verified with actual average rates in US$ of one of the mid-sized banks (Tsesnabank, 2012b). We did not apply any price premium over the average rates though it was found applicable and tolerable in our previous analysis (See Section 4.3.4. of Chapter 4 and Section of Chapter 5). Therefore, we were conservative in our projections. 8. The branch network plan, IT investments, and marketing budget are taken into account as discussed in sections 5.2.3 -5.2.5 of Chapter 5. 9. Administrative expenses are computed in the following way:  Cost benchmark was derived based on the actual branch budget for 2012 of one of the mid-sized banks (Tsesnabank, 2012b);  The head office expenses were computed including the operational part, back office staff and depreciation. The growth rate of 2% was applied every year for inflation (in US$) and expansion.  Head office and branches budget was multiplied by 25% as additional costs attributed to specifics of Islamic banking. Particularly additional cost may occur due to higher needs of human resources for due-diligence procedure in partnership
  • 108. 109 instruments. Also Sharia control is an additional cost over conventional banks’ expenses.  Another margin of safety rate was applied for contingency as 5% over the head office and branches budget. 10. Provisioning allowances are benchmarked against 3 selected banks and equal to 1.3% of gross loan every year. This allows us to accumulate provisions against the 6.8% NPL level (Tsesnabank, 2012a; Sberbank, 2012; Eurasianbank, 2012). 11. The income tax in Kazakhstan is 20%. In case of losses the tax benefit is carried forward over 10 years. 12. No dividends are assumed during the planned period. Details on assumptions are indicated in Appendix G. 5.3.2. BALANCE SHEET AND INCOME STATEMENT The Balance sheet and Income statement are indicated in Appendix H. Overall, the total assets of the bank will grow to US$ 2,629million over the projection period. The equity of the bank will go up to US$ 250 million with initial capital injection just US$ 70 million. The break-even will be achieved in the fourth year and in the fifth year the bank will turn to profit, growing continuously year-on-year because of economies of scale. The net profit for the last projected year is expected to reach US$ 64 million. 5.3.3. KEY PERFORMANCE INDICATORS As it will take time to achieve economies of scale the profitability ratios will continuously improve over the projected period. The return on average equity (ROAE) and on average assets (ROAA) in 2022 will reach 29.4% and 2.7% respectively. The net interest margin will grow at the beginning of projections to 6.5% and then decline to 5.5% as more borrowings planned to support the growth of the bank. The cost-to-income ratio due to the scale effect will gradually decline from 116% to 25%. This seems feasible comparing to other Kazakh banks, for example KKB’s ratio was 20% as of 01 July 2012 (KKB, 2012b). Another feasibility
  • 109. 110 test of the bank’s operations capacity is the amount of loans served by one employee. We have got US$ 2.3 million that is similar to KKB’s indicator - US$2.4 million (KKB, 2012b). The liquidity, capital adequacy and asset quality ratios are taken into account considering the average indicators in the market and the regulation standards. The growth rate of the assets reflects the different stages of the bank’s life-cycle. The start- up, expansion and high growth stages will be started to transfer to the mature growth at the end of the projected period. The maximum growth rate of 95% in 2015 will continuously decrease to 25% in 2022.See Appendix I for details. 5.3.4. MEASURING RETURN ON INVESTMENT As a result of the financial projections we have measured the return on investment attributed to shareholders, who invested US$ 70 million as a paid-up capital. The free cash flow was computed based on the financial modeling formulas (Benninga, 2008, pp. 177- 201). The Terminal Value is assumed as 1.5 multiple to Book Value (Shareholders capital at the end of 2022). Using MS Excel we found the following (See Appendix J):  The payback period is 8 years.  The Accounting rate of return (ARR) is 16.4%.  The Net Present Value (NPV) is USD 128.0 million with required rate of 12.5%.  IRR is 25.1% for the projected period. The pay-back period seems to be quite long; however ,the Islamic finance itself as a social- oriented business needs longer than usual time horizon. Also quite high paid-up capital requirements in Kazakhstan make the business project viable in the longer term. Overall, the ARR, NPV and IRR look attractive over the projected period. The NPV is positive and promises to increase the value of the bank’s shareholders significantly. The IRR 25.1% is twice higher than the current discount rate used in the market for Kazakhstan banks (12.5%11 ). 11 Investment banks practice in Kazakhstan (e.g. BCC-Invest, 2012, p.18)
  • 110. 111 6. CONCLUSION The overview of Islamic finance industry in the world and the steps taken by the authorities in Kazakhstan, including the legislation framework, the Road-map, the debut sukuk issuance and opening of the first Islamic financial institutions, promise a good opportunity for Islamic banking in the country. The demand study, including the web and email surveys, banking penetration analysis, religious factors, customer behavior and case-study of the first Islamic bank in Kazakhstan allows us to forecast the available market share of Islamic banking in the country 21%-45% of the total banking market. At the moment decrease in trust to the banking sector globally and in Kazakhstan particularly provides firm grounds for Islamic finance to become a viable alternative to conventional banking. However, this requires the former to distinguish itself from the latter. The strong criticism overwhelms Islamic finance for its mimicry of conventional products and losing its uniqueness and authenticity. Therefore, every new ventures as well as existing institutions must revise Islamic finance underlying principles, its mission and goals. Specifically, Islamic finance, being an integrated part of Islamic economics, is supposed to promote social justice and distributional equity as its high level goals. On micro-level a bank must increase financial services’ accessibility to all the population and stimulate economic activity in a just and fair way that is primarily sharing risks and profit. Keeping this idea in mind and after the external and internal factors analysis we derived a business strategy of an Islamic bank with focusing on SME and retail segments. The value proposition should include the Sharia-based banking products with clear evidence of socio- economic betterment for a client and the country. A prerequisite to the successful delivery of this value will be in comprehensive education and marketing communication programs in order to increase awareness and understanding of Islamic finance principles in the market. Branch network, strong KYC and risk management systems must be put in place also.
  • 111. 112 The business development plan and the financial projections show us that the project is supposed to be commercially viable and can be interesting for potential investors. Although the payback period will take 8 years, the longer than usual time horizon of the project is justified by large initial investments according to the minimum capital requirements and, on the other hand, by social orientation of the business that should not expect some fast money. It is expected to reach IRR 25.1% over 10 years. This is two times higher than the current cost of capital of the Kazakh banks. This research has suggested that the specific mission of Islamic finance could successfully fit with the common business goals, whereby following Maqasid al-Sharia will equally lead to the socio-economic improvement and decent return on investment. The main risks, nevertheless, underlie in effective execution of the business plan, adoption of the draft law on regulation improvements and further support and development of the industry by the Government. Therefore we suggest some recommendations in Chapter 7.
  • 112. 113 7. Recommendations A. On the basis of the research has been done we recommend potential investors the following: 1. The business plan with its strategic analysis, value proposition and financial projections can be considered as fundamentals for a new Islamic banking venture in Kazakhstan. 2. The new bank should focus on SME and retail segments. 3. The bank should use more genuine and unique Islamic finance partnership mechanisms where both risk and profit are shared. The use of the debt-based instrument should be limited. 4. In order to ensure that the value proposition is being delivered the bank should introduce a ‘Socio-Economic Better-Off Test’. This can be in addition to Sharia compliance control and Risk management process, being already in banking practice. Thereby, the bank should assess betterment for its customers and overall contribution to the country prosperity from socio-economic perspective. 5. To increase awareness of Islamic finance principles, its mission and goals, and to communicate the bank’s value proposition to the market the bank will need to conduct a comprehensive marketing and educational programs. 6. At the first stage the new Islamic bank should accept a competitive pricing policy and follow the market with the ‘going-rate pricing’. Upon the marketing efforts and increase in awareness of Islamic banking principles the bank can gradually transfer to the customer ‘perceived-value pricing’, where a premium price of 5-10% is considered acceptable by potential customers and found being within the range of price standard deviation among the banks in Kazakhstan. However, a premium pricing should be carefully weighted from an angle of social mission of Islamic finance.
  • 113. 114 7. To prevent an adverse selection and a moral hazard, where some customers can expect easing from the bank in terms of collateral, payment discipline and pricing, the bank should introduce a top notch KYC and risk management policies. 8. A new venture in Islamic banking in Kazakhstan should be established as a standalone Islamic bank. It is not only the Law requirements, but also a preference of the majority of the survey respondents. 9. Current situation in the market is favorable for a new Islamic banking entrance owing to recent financial crisis and decline in trust to large conventional banks. Only few mid-sized banks are competing currently and gaining the market share. 10. The Banking Law amendments drafted by NBK should be adopted before the bank starts operations. 11. The business plan execution will require effective asset and liabilities management. It will depend on smooth development of interbank and capital markets locally and abroad. This should be tested prior to starting of the business. 12. The branch network deployment will be critical for a successful business plan execution. The bank should organize required resources for smooth and timely opening of outlets. It should minimize a time lag between expenses for opening and start of generating income by a branch. Therefore, the branches for the next year should start preparing in the current year. 13. The lack of deposit guarantee scheme for Islamic banks might put the business plan at risk. Our survey found a risk aversion among potential customers. However, education of the market and a strong reputation of the bank (its shareholders) may mitigate this risk. Also, the Law amendments suppose introducing an option of a voluntary deposit guarantee fund for Islamic banks. 14. It would be a competitive advantage if the bank is established by existing Islamic financial institution from abroad. This will provide a new venture with support in product
  • 114. 115 development, Sharia compliance control and cost of funds. It may also benefit through economies of scale in terms of IT and back-office expenses. 15. The required investment grade credit rating (at least BBB+) of a parent bank will be an additional competitive advantage in the capital market both in Kazakhstan and abroad. Specifically, in Kazakhstan this will allow attracting funding from the pension funds and insurance companies, which are large institutional investors. B. The government authorities are advised as follows: 1. Since the Government pursues new investments into the country, particularly through the sukuk issuance, the local Islamic finance component has become important for this. More Islamic investments can be attracted if there are local Sharia-compliant financial institutions, investors and projects. Hence the Government should continue to improve the regulation environment and develop the local Islamic finance component. 2. The Government and financial market regulators have certain strategies for financial inclusion, particularly outlined in the Conception of the financial sector development in the post-crisis period from 01 February 2010.And Islamic banking needs to be seriously considered from this perspective. Thus, the Government’s Road-map on Islamic finance must be implemented effectively and in time. 3. As the pioneers of the market will bear disproportionately higher cost for educating the market on Islamic finance comparing to the next entrants the regulators should play also a key role in the information programs. This is in line with the Road-map and must be realized together with the financial institutions. 4. The stock market development in Kazakhstan should be a priority for the regulators. Effectively operating capital 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.
  • 115. 116 C. In addition to our findings, there is a room for further researches: 1. A marketing research can be conducted in terms of decision making process in families, age and genders of decision makers and especially those, who are price tolerated. 2. Income size breakdown of the different groups of potential customers needs to be analyzed. 3. Geographical specifics should also be analyzed, as the main nationalities are distributed differently across regions, cities and rural areas. Thereby, more specific marketing and product strategies can be derived with focus on particular gender, age groups and income size of potential customers, as well as with geographical prioritization. D. Final recommendation A good point to end this paper is a quote from the recent book ‘Islamic finance: Why It Makes Sense’ on moral imperative of Islamic finance: ‘It is not about finding billion-dollar petroleum projects or becoming the next Islamic finance multi-millionaire. Rather, it is to do with alleviating poverty and wealth gaps around the world.’(Vicary Abdullah and Chee, 2010, p.2). We estimate the returns on investment in a new Islamic bank in Kazakhstan to be attractive for potential investors, though it should not be a paramount goal. Attractiveness of Islamic investments must be weighted first of all from the viewpoint of socio-economic betterment of people and the country. When this is achieved, an investor will be rewarded inevitably since Islamic bank supposes a real, trustworthy partnership and participation in mutual sharing the benefits.
  • 116. 117 Appendix A:Core Islamic Banking Products Description 1. Deposit Accounts: Wadiah – in this type of deposit the bank safe keeps the depositor’s money and pays it back to him on demand. There is not a fixed return on this deposit, however, the bank can offer some return in a form of gift (hibah). Mudaraba - in this type of deposit the bank accepts depositor’s money and invests them into agreed (restricted or unrestricted) projects as a fund manager. Then profit is shared as per the pre-agreed ratio, whereas loss is born by the depositor as an investor. Qard-Hassan - in this type of deposit the bank borrows money from depositors and offers no profit on it. The bank is obliged to return money back in full amount. 2. Investment based financing contracts: Mudaraba is a partnership, whereby the bank (as investor) provides the client (as entrepreneur) with a capital needed for his projects. The profit from the project is shared as per the pre-agreed ratio, whereas loss is born by the bank as an investor. Musharaka is a partnership, whereby the bank and the client participate by their equities to finance a project. Profit is shared based on pre-agreed ratio that may not be linked to the equity distribution. In case of loss it is shared by both partners on a pro-rata basis. Wakala is an investment agency contract, whereby the principal appoints an agent to conduct a transaction or make an investment on his behalf. The agent bears no risk and shares no profit; however, he is entitled to an agency fee. Islamic banks can operate on both ends being an agent for a client or appoint a client as its agent for business transactions, such as trade finance and/or purchase and selling assets. 3. Sale-based financing contracts: Murabaha is a fixed-price sale contract, whereby the bank purchases certain goods on the client’s request and resells them to the client at a marked-up price, consisted of cost and profit. While the title is transferred from the bank to the client immediately, the purchase price is paid on a deferred basis. The important condition is that the profit of the bank must be disclosed to the client before signing the contract and cannot be changed over time.
  • 117. 118 Salam is a sale contract, whereby the buyer (bank) purchases goods with up-front price, while the delivery of goods is on a deferred basis in future. Such goods may include any fungible commodities and must be described in the contract. As a result the seller (client) receives cash for the term until the goods delivery. The bank earns profit from reselling the commodity at higher price in the market. Ijara is a leasing contract, whereby the bank (lessor) purchases and leases an asset to the client (lessee). The lease can be operating or financial, where the asset is returned to lessor in the former and is purchased by lessee in the latter upon the lease term completion. Istisna is a contract, whereby the bank finances a construction of building or manufacturing of goods for the client (a buyer of these future assets). Once the contract is signed the bank (seller) starts to finance the production and the client (buyer) is obliged to take delivery in future and pay the purchase price to the bank on a deferred basis or in installments.
  • 118. 119 Appendix B: IMF on Kazakhstan Banking Sector12 12 Extract from IMF Country Reporton Kazakhstan (IMF, 2012b, p.7)
  • 119. 120 Appendix C13 : Kazakhstan Islamic Finance Road-Map The Road-map of Islamic finance development until 2020 approved by the Resolution of the Government of the Republic of Kazakhstan from March 29, 2012 # 371 stipulates the following core directions. 1. Legislation Improvement: a) Conduct an analysis of main problems of Islamic finance development – on a regular semi-annual basis until 2020; b) Develop recommendations on legislation improvement – annually until 2020; c) Prepare a draft law on Islamic finance and Islamic insurance – 2012; d) Consider possibility to grant special conditions for ownership registration of Murabaha, Ijara and Istisna contracts – 2013; e) Sign a convention on double taxation with South-East Asia and Midle-East countries – 2020; f) Taxation synchronization with the banking and insurance law amendments - 2012- 2013; g) Consider necessity of separate legal framework for Islamic microfinance and other financial institutions (leasing and mortgage companies, investment funds, securities companies, etc.) – 2013; 2. Educating market: a) Prepare and execute media-plan – annually until 2020 ; b) Consider creation of a special Internet resource on Islamic finance – 2013; c) Publish in mass-media information on Islamic financial institutions registered in Kazakhstan – annually until 2020; d) Informative distribution on Islamic finance in Kazakhstan among the diplomatic representatives of Kazakhstan abroad - 2013-2014; 3. Islamic Finance Infrastructure Development: a) Consider possibility to establish a central Council on Islamic finance - 2012-2013; b) Support market of short-term liquidity for Islamic financial organizations -2014-2015; c) Introduce Islamic indexes similar to Dow Jones Islamic Index – 2016; 13 Author’s summary on the Government Resolution
  • 120. 121 d) Consider opportunity to develop Almaty city as the regional Islamic finance hub- 2012; 4. International Cooperation: a) Establish cooperation with international Islamic finance organizations, including the IFSB, ILMC, IIFM, AAOIFI, IIRA, CIBAFI – annually until 2020; b) Cooperation with the rating agency of Malaysia (RAM Holding) - 2012-2013; c) Establish cooperation with other international Islamic finance organizations and leading universities, providing Islamic finance education (World Bank, Asian Development Bank, USA and UK universities) - 2013-2014; d) Participate in the main annual events on Islamic finance (IDB annual meeting, IFSB summit in Malaysia, WIBC in Bahrain, WIFC in London and WIEF in Malaysia) - until 2020; 5. Public Sector Development: a) Consider establishment of a committee on Islamic finance development within NBK – 2014; b) Consider necessity of special budget programme – 2013; c) Organize an intergovernmental twinning programme to study and exchange of experience from successful countries in Islamic finance (Malaysia, Bahrain, UAE, UK, USA, Luxembourg) - 2012-2013; d) Issue sovereign Islamic securities - 2012-2014; 6. Islamic Financial Services Development: a) Select appropriate industrial projects and organize Islamic securities for their financing– 2012; b) Facilitate to opening new Islamic banks - 2013-2014; c) Facilitate to Islamic insurance development - 2012-2013; 7. Science and Education; a) Introduce ‘Islamic finance’ module in curricula of economic universities -2012; b) Study experience of Islamic finance by Kazakhstan universities – 2013; c) Organize round-tables and discussions on Islamic Finance with participation of scientists, scholars and practitioners - 2012-2014; d) Conduct seminars for state authorities employees on a regular basis – annually until 2020;
  • 121. 122 e) Establish an educational and analytical centre on Islamic finance study – 2013; f) Consider opportunities of organizing education abroad for Kazakhstan specialists in the field of Islamic finance – 2013; 8. Investors Relations: a) Conduct negotiations and meetings with banks, funds and investors from South–East Asia and Middle-East countries to attract investments in Kazakhstan- annually until 2020; b) Organize events in Kazakhstan – annually until 2020; c) Activate cooperation with IDB Group (Country Strategy) - 2012-2014; d) Consider possibility to increase Kazakhstan share in the international Islamic financial organizations - 2012-2014; e) Prepare information on losses of Islamic financial institutions occurred due to Kazakhstan counterparties; consider further solutions for these investors – annually until 2020; f) Activate role of the Kazakhstan Chamber of Commerce and Industry within its membership in the Islamic Chamber of Commerce and Industry: cooperation on the business and investment opportunities and Islamic finance development in Kazakhstan - 2012-2014; g) Regular update of the list of investment projects for distribution among Organization of Islamic Cooperation members – quarterly until 2020.
  • 122. 123 Appendix D: Survey Form and Questionnaire [Translated from Russian] Islamic Banking in Kazakhstan: Is there any demand? Dear Sir/Madam, Kazakh consulting company "Akyl-Kenes Consulting" would like to ask you to take part in the survey: Islamic banking in Kazakhstan: Is there any demand? This survey is a part of research about demand among the locals and the business community for the services of Islamic banking in Kazakhstan. The results will be used in the scientific and educational process and can also be provided to interested investors, financial market regulators and the Government of the Republic of Kazakhstan. The following survey consists of eight questions and will take an average up to 5 minutes. Thank you for your assistance in conducting the research. Akyl-Kenes Consulting
  • 123. 124 Survey Questionnaire Personal Data Before you answer the questions please provide the following information about yourself to summarize the data about the audience, participating in the survey. Age:  16-20  21-30  31-40  41-50  50+ Gender: M, F Occupation:  Business owner  Employee  Public servant  Priest  Student  Retiree  Unemployed Average annual income (in US$):  up to 5000  5 000 – 10 000  10 000 – 30 000  30 000 – 50 000  50 000 – 100 000  100 000 – 200 000  200 00 and above Question 1: Are you aware of the existence of Islamic banking in the financial market of Kazakhstan?  Yes  No
  • 124. 125 For information: 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. Question 2: 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?  Yes  No Question 3: Do you think Islamic banks due to their specifics need to be more socially oriented than traditional banks?  Yes  No Question 4: Do you think Islamic banks are the same commercial and for-profit organizations as traditional banks?  Yes  No Question 5: At which main condition you would prefer to use the services of an Islamic bank as an alternative to a conventional one?  If the price terms (rates) offered by the Islamic bank for deposit and loan products are more profitable than in the traditional banks in Kazakhstan  The specifics of the bank, because I believe that Islamic banking is a distinctive, more ethical and more equitable way of financial services rather than traditional banking  Other conditions, such as a well-known brand and reliable reputation, professional marketing and quality service, convenient location and parking, comfortable office, a desire to try new products, etc.  Under any circumstances I would not be a client of the Islamic bank Question 6: Would you agree to use the products and services of Islamic banking on less profitable conditions than conventional banking?
  • 125. 126 (That is when the rate of return of an Islamic bank deposit products lower and / or cost of credit products is higher than in a traditional bank).  No  Yes Yes, agree but on condition that the rates will not differ by more than (the percentage refers to the difference between the rate of Islamic bank and a conventional bank): 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Question 7: What are your preferences on the organizational form of the Islamic Bank?  Islamic bank as a standalone financial institution  Islamic window in a well-known traditional bank  Any of the above  None of the above Question 8: What kind of financial services do you need most? (You may choose more than one answer)  Personal financing (mortgage, auto loans, consumer loans, etc.)  Business financing (working capital, project finance, leasing, etc.)  Savings and cash management services (current and saving accounts with no interest)  Deposit products (relatively low risk and low income in the form of interest)  Investment (relatively high risk and high expected return)  None of the above The End! Thank you very much for participating in our survey!
  • 126. 127 Appendix E: Screenshot of the Survey Banner The screenshot from the website with the survey banner as of 23 August 2012 (the banner is circled in red):
  • 127. 128 Appendix F: Organization Chart Risk Management Committee Head of Audit Deputy Chairman of Management Board IT Department Administrative Department Human Resources Department Marketing Department Call Center Branch 1, Branch 2, etc. Card Center Clearing & Remittance Department Accounting Department Treasury Department International Relations Department Sales Department Legal Department Planning Department Branch coordination Department Managing Director Managing Director ALCO Credit Committee Business Development Committee Corporate Business Head of Compliance Compliance Committee Deputy Chairman of Management Board SME Business Retail Business Chairman of Management Board Audit Committee Head of Risk Nomination & Remuneration Committee Board of Directors Council on Islamic principles (Sharia Board) Shareholders
  • 128. 129 Appendix G: Financial Projections: Main Assumptions Balance Sheet Currency Unit: US$, thousands (ths) 2013 - 2022 Comments Assets Cash reserves, % of total liabilities 5 Benchmark is based on selected banks (KKB, Tsesnabank) Accounts receivable from banks balance This is the model's plug using the Excel 'Solver' solution to adjust the balance. It means placing excess liquidity in interbank market Securities, % of funds available 70 - 50 Placing funds available after financing disbursement. The securities portfolio is a second line of liquidity Financing portfolio (gross), US$ ths per month per branch 680 Benchmark is derived from average growth of 7 selected banks based on performance for the first six months 2012 Non-performing loans, % of total financing 3.4 – 6.8 Average for 3 selected banks (Tsesnabank, Eurasian, Sberbank) as of end 2011. For the first two years we applied only 50% of the indicator as the portfolio will be new Fixed and Intangible Assets, US$ ths 2,910 See separate budget. The assets value remains constant meaning additional investments every year will be equal to amount of depreciation. Depreciation applied to expenses Other assets, % of total financing 1.7 Average for 6 selected banks Liabilities Liabilities to customers, US$ ths per month per branch 367 Benchmark is derived from average growth of 7 selected banks based on performance for the first six months 2012 Demand deposits from individuals, % of total individual deposits 15 Structure of deposits is based on conventional banks indicators and Islamic banks specifics in terms of interest free accounts Demand deposits from legal entities, % of total corporate deposits 50 Investment deposits from individuals, % of total individual deposits 85 Investment deposits from legal entities, % of total corporate deposits 50 Sukuk (Bonds) balance Sukuk and borrowings are other two plugs of the projection model. Sukuk can be used only after 2 years of profitable performance and assumed as long-term debt Borrowings balance Sukuk and borrowings used when deposits and capital are not enough to support growth and keep liquidity ratios at proper level Other liabilities, % of total deposits 1.5 Average for 6 selected banks Shareholders Equity Ordinary shares, US$ ths 70,000 Capital injection is to comply with minimum capital requirement of NBK Off-Balance Sheet Items, % of total financing 30 Indicative, 30% of total financing
  • 129. 130 Income statement Currency Unit: US$, ths 2013 - 2022 Comments Income from finance activities: financing to legal entities 8.2 Average rates in the market: Statistic bulletin, NBK (2012b) financing to individuals 13.8 Average rates in the market: Statistic bulletin, NBK (2012b) interbank 3.83 Average rates in the market: Statistic bulletin, NBK (2012b) securities 4.45 Al Hilal bank (2012), DBK 2012 sukuk issuance benchmark Expenses from finance activities: deposits to legal entities 1.3 Average rates in the market: Statistic bulletin, NBK (2012b) deposits to individuals 5.5 Average rates in the market: Statistic bulletin, NBK (2012b) sukuk 4.45 Al Hilal bank (2012), DBK 2012 sukuk issuance benchmark borrowings 3.83 Average rates in the market: Statistic bulletin, NBK (2012b) Other operating income (net), % of total deposits 2.1 Average for 6 selected banks as percent of total liabilities. Conservatively we took the same proportion but out of customer deposits General and administrative expenses Head office, US$, ths benchmark +25%+2% Admin costs budgeted based on real budget of one of the mid-sized bank (Tsesnabank). Due to specifics of Islamic banks operations the additional cost applied as 25% over conventional bank's cost. Then 2% growth rate on yearly basis applied for US$ prices and expansion Branches, US$, ths benchmark +25%*No. of branhces Standard branch budget is US$ 577 ths, small branch - US$ 313 ths. The additional cost 25% applied as margin of safety Contingency reserve , % of head office and branches budget 5 5% of head office and branches budget applied as margin of safety for branch expansion (inflation, project management issues etc.) Marketing, US$, ths 1,500 – 3,537 See initial Marketing budget for 2013. In subsequent years annual growth of 10% applied. Loss provisions, % of total financing portfolio 0.67- 1.33 Average for 3 selected banks (Tsesnabank, Eurasian, Sberbank) as of end 2011. For the first two years we applied only 50% of the indicator as the portfolio will be new Income before tax Income Tax, % of profit before tax 20 The corporate income tax in Kazakhstan is 20% Income Tax benefit, % of losses before benefit 20 Losses give a tax benefit (offset in future tax) carried forward for 10 years
  • 130. 131 Appendix H: Financial Projections: Balance Sheet and Income Statement Balance Sheet (US$, ths) 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Assets Cash reserves 559 2,237 7,645 17,119 29,383 42,989 58,713 76,279 96,188 118,939 Accounts receivable from banks 13,458 7,677 2,084 7,421 12,499 15,519 30,097 52,766 90,852 151,578 Securities 42,545 16,557 17,582 30,696 39,056 36,351 34,424 26,432 17,374 12,250 Financing portfolio (gross) 20,406 81,626 187,739 350,990 579,542 857,069 1,175,409 1,542,724 1,959,015 2,424,281 Provisions 136 680 3,183 7,863 15,590 27,018 42,690 63,260 89,380 121,704 Financing portfolio (net) 20,270 80,945 184,555 343,127 563,951 830,051 1,132,719 1,479,464 1,869,635 2,302,577 Fixed and Intangible assets 2,910 2,910 2,910 2,910 2,910 2,910 2,910 2,910 2,910 2,910 Other assets 342 1,367 3,143 5,877 9,704 14,351 19,681 25,831 32,801 40,592 Total assets 80,084 111,693 217,919 407,150 657,503 942,170 1,278,543 1,663,682 2,109,760 2,628,845 Liabilities Liabilities to customers 11,019 44,076 101,375 189,527 312,941 462,800 634,697 833,039 1,057,828 1,309,062 Demand deposits from individuals 708 2,834 6,518 12,186 20,121 29,756 40,808 53,561 68,013 84,167 Demand deposits from legal entities 3,148 12,592 28,961 54,145 89,402 132,214 181,321 237,984 302,202 373,975 Investment deposits from individuals 4,015 16,059 36,935 69,053 114,017 168,617 231,246 303,510 385,410 476,944 Investment deposits from legal entities 3,148 12,592 28,961 54,145 89,402 132,214 181,321 237,984 302,202 373,975 Sukuk (Bonds) 0 0 0 0 0 200,000 280,000 380,000 500,000 700,000 Borrowings 0 0 50,000 150,000 270,000 190,000 250,000 300,000 350,000 350,000 Other liabilities 166 664 1,527 2,855 4,714 6,971 9,561 12,549 15,935 19,719 Total liabilities 11,185 44,740 152,902 342,382 587,655 859,771 1,174,257 1,525,588 1,923,762 2,378,781 Shareholders Equity 68,899 66,953 65,017 64,767 69,848 82,399 104,286 138,094 185,997 250,064 Ordinary shares 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 Retained Profits/Accumulated Losses (1,101) (3,047) (4,983) (5,233) (152) 12,399 34,286 68,094 115,997 180,064 Total equity and liabilities 80,084 111,693 217,919 407,150 657,503 942,170 1,278,543 1,663,682 2,109,760 2,628,845 Off-Balance Sheet Items 6,122 24,488 56,322 105,297 173,863 257,121 352,623 462,817 587,704 727,284
  • 131. 132 Income statement (US$, ths) 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Income from finance activities: 3,404 6,210 12,724 24,664 42,171 64,052 89,517 118,817 152,291 190,381 financing to legal entities 810 3,652 9,579 19,039 32,727 50,296 70,817 94,248 120,835 150,533 financing to individuals 186 838 2,198 4,369 7,511 11,542 16,252 21,629 27,731 34,546 interbank 515 405 187 182 381 537 874 1,587 2,750 4,643 securities 1,893 1,315 760 1,074 1,552 1,678 1,575 1,354 975 659 Expenses from finance activities: 144 654 2,685 7,285 14,010 22,472 32,140 42,649 54,484 68,215 deposits from legal entities 23 102 270 540 933 1,440 2,038 2,725 3,511 4,395 deposits from individuals 121 552 1,457 2,915 5,034 7,772 10,996 14,706 18,945 23,715 sukuk 0 0 0 0 0 4,450 10,680 14,685 19,580 26,700 borrowings 0 0 958 3,830 8,043 8,809 8,426 10,533 12,448 13,405 Net financial income 3,260 5,555 10,039 17,379 28,161 41,580 57,377 76,169 97,807 122,166 Other operating income (net) 229 916 2,107 3,939 6,504 9,619 13,192 17,314 21,986 27,208 Total Operatin income 3,490 6,471 12,146 21,319 34,665 51,199 70,568 93,483 119,793 149,374 General and administrative expenses 4,730 8,360 12,063 16,951 21,857 24,448 27,538 30,652 33,794 36,966 Head office 1,518 1,549 1,580 1,611 1,643 1,676 1,710 1,744 1,779 1,814 Branches 1,558 4,842 8,180 12,631 17,082 19,307 21,986 24,665 27,344 30,023 Contingency reserve 154 320 488 712 936 1,049 1,185 1,320 1,456 1,592 Marketing 1,500 1,650 1,815 1,997 2,196 2,416 2,657 2,923 3,215 3,537 Operating profit before loss provisions (1,240) (1,889) 83 4,368 12,808 26,751 43,031 62,830 85,999 112,408 Loss provisions 136 544 2,503 4,680 7,727 11,428 15,672 20,570 26,120 32,324 Income before tax (1,376) (2,433) (2,420) (312) 5,081 15,324 27,358 42,261 59,879 80,084 Income Tax (20%) 0 0 0 0 1,016 3,065 5,472 8,452 11,976 16,017 Income Tax benefit (carried forward) (275) (487) (484) (62) (1,016) (292) 0 0 0 0 Net income/net loss for the year (1,101) (1,946) (1,936) (250) 5,081 12,551 21,887 33,809 47,903 64,067
  • 132. 133 Appendix I: Financial Projections: Key Performance Indicators Key Performance Indicators 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Profitability & Efficiency ROAE (%) -1.6% -2.9% -2.9% -0.4% 7.5% 16.5% 23.4% 27.9% 29.6% 29.4% ROAA (%) -1.4% -2.0% -1.2% -0.1% 1.0% 1.6% 2.0% 2.3% 2.5% 2.7% NIM (%) 4.3% 6.1% 6.5% 5.9% 5.7% 5.6% 5.5% 5.5% 5.5% 5.5% Cost / Income (%) 135.5% 129.2% 99.3% 79.5% 63.1% 47.8% 39.0% 32.8% 28.2% 24.7% Funding and Liquidity Credit / Deposit (%) 185.2% 185.2% 185.2% 185.2% 185.2% 185.2% 185.2% 185.2% 185.2% 185.2% Cash / Total Liabilities (%) 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% Liquid Assets / Total Assets (%) 70.6% 23.7% 12.5% 13.6% 12.3% 10.1% 9.6% 9.3% 9.7% 10.8% Highly Liquid Assets / Demand deposits (%) 363.5% 64.3% 27.4% 37.0% 38.2% 36.1% 40.0% 44.3% 50.5% 59.0% Long-term Debt in Total Liabilities (%) 0.0% 0.0% 0.0% 0.0% 0.0% 23.3% 23.8% 24.9% 26.0% 29.4% Capitalization Tier 1 Capital/ Total Assets (%) - 6% min 86.0% 59.9% 29.8% 15.9% 10.6% 8.7% 8.2% 8.3% 8.8% 9.5% Total Capital/ Risk-weighted Assets (%) - 12% min 118.1% 95.1% 47.6% 25.7% 17.4% 14.5% 13.7% 14.2% 15.3% 16.7% Asset Quality NPL/Total Financing portfolio (%) 3.4% 3.4% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% Accumulated Provision/Total Financing portfolio (%) 0.7% 0.8% 1.7% 2.2% 2.7% 3.2% 3.6% 4.1% 4.6% 5.0% General Information Asset growth p.a. (%) - 39% 95% 87% 61% 43% 36% 30% 27% 25% No. of outlets: Head Office & Branches 5 10 16 24 32 36 42 48 54 60 No. of Staff 121 210 326 481 636 714 798 881 965 1,049 Loan per staff, ths US$ 168 389 575 729 911 1,201 1,474 1,751 2,030 2,312
  • 133. 134 Appendix J: Financial Projections: Measuring Return on Investment Measuring Return on Investment 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Free Cash Flow Calculation (US$, ths) Profit after tax (1,101) (1,946) (1,936) (250) 5,081 12,551 21,887 33,809 47,903 64,067 Add back depreciation 326 326 326 326 326 326 326 326 326 326 Add back after-tax interest on long-term debt - - - - - 3,560 8,544 11,748 15,664 21,360 Add back loss provisions 136 544 2,503 4,680 7,727 11,428 15,672 20,570 26,120 32,324 Changes in operating Net Working Capital Subtract increases in Cash 559 1,678 5,408 9,474 12,264 13,606 15,724 17,567 19,909 22,751 Subtract increases in fixed assets at cost 326 326 326 326 326 326 326 326 326 326 Free Cash Flow (1,524) (3,080) (4,841) (5,044) 544 13,933 30,379 48,560 69,778 95,000 Terminal Value (1.5x Book Value) 375,097 Period in years:0 1 2 3 4 5 6 7 8 9 10 Initial investments:(70,000) (1,524) (3,080) (4,841) (5,044) 544 13,933 30,379 48,560 69,778 470,097 NPV (r=12.5%) 128,022 IRR 25.1% ARR 16.4% AVG profit 18,006 AVG book value 109,632 Payback period (years) 8 Initial investments 70,000 Still to recover (71,524) (74,604) (79,445) (84,489) (83,944) (70,012) (39,633) 8,927
  • 134. 135 © Madi Akmambet, 2012