ское банковское дело: Islamic Banking and Finance ожности сегменте в across Opportunities микро, Micro, Small, средних х иand предприятий Medium Enterprises in the Kyrgyz Republic ызской Республике Wichtiger HINWEIS ! Innerhalb der Schutzzone (hellblauer Rahmen) darf kein anderes Element platziert werden! Ebenso darf der Abstand zu Format- resp. Papierrand die Schutzzone nicht verletzen! Hellblauen Rahmen der Schutzzone nie drucken! Siehe auch Handbuch „Corporate Design der Schweizerischen Bundesverwaltung“ Kapitel „Grundlagen“, 1.5 / Schutzzone www. cdbund.admin.ch IN PARTNERSHIP WITH: IFC, a member of the World Bank Group, creates opportunity for people to escape poverty and improve their lives. We foster sustainable economic growth in developing countries by supporting private sector development, mobilizing private capital, and providing advisory and risk mitigation services to businesses and governments. This report was commissioned by IFC through its Financial Institutions Group in Europe, Middle East and North Africa to highlight the need for Islamic Banking across the region. The conclusions and judgments contained in this report should not be attributed to, and do not necessarily represent the viewsof, IFC or its Board of Directors or the World Bank or its Executive Directors, or the countries they represent. IFC and the World Bank do not guarantee the accuracy of the data in this publication and accept no responsibility for any consequences of their use. This report can be obtained in print or electronic format at the following address: IFC in the Kyrgyz Republic Orion Business Center, 4th floor, Erkindik boulevard, 21, Bishkek, 720040, Kyrgyz Republic Tel.: +(996 312) 62 61 62 www.ifc.org Contents 01. Executive Summary 9 02. Overview of Business and the MSME sector in the Kyrgyz Republic 15 Definitions 15 Structure of Kyrgyz commercial establishments 15 Contribution of MSMEs to the Kyrgyz economy 16 Small- and medium-sized business distribution by economic activity 17 MSME distribution by geography 18 Enablers of business growth 19 Key concerns for businesses 21 03. Current Status of Islamic Banking in the Kyrgyz Republic 23 Overview of the banking sector in the Kyrgyz Republic 23 Islamic banking in the Kyrgyz Republic 28 Non-performing loans within the Kyrgyz banking system 31 Challenges facing Kyrgyz Islamic banking 33 Overview of micro-finance institutions in the Kyrgyz Republic 34 04. Islamic Banking Opportunities pertaining to MSMEs 37 Access to finance for the MSME sector 37 Obstacles for financial institutions lending to MSMEs 40 Supply-side analysis – Islamic banking penetration into the MSME sector 40 Potential for Islamic banking in the MSME sector 41 05. Conclusion 45 Research Scope and Methodology 46 Appendix 48 Fundamental Concept behind Islamic Laws & Principles 48 Questionnaire 50 Bibliography 52 3 Index of Figures and Tables Figure 1: Islamic funding and depository potential 8 Figure 2: Reasons cited by MSMEs for not applying for loans 10 Figure 3: Islamic financing potential – ‘new to bank ’ 12 Figure 4: Depository potential 13 Figure 5: Classification of commercial establishments in the Kyrgyz Republic (2014) 16 Figure 6: MSMEs share of the Kyrgyz economy (2014) 17 Figure 7: Small and medium enterprise classification by economic activity 18 Figure 8: Geographic concentration of MSMEs in the Kyrgyz Republic 19 Figure 9: Recent IFC investments in the Kyrgyz Republic 20 Figure 10:  Significant Kyrgyz-focused advisory services provided by IFC 20 Figure 11: Major constraints facing businesses 22 Figure 12: Kyrgyz banking structure (2014) 24 Figure 13: Market share of the country’s commercial banks (2013) 26 Figure 14: Total commercial bank loans and deposits in the Kyrgyz Republic ($ billions) 26 Figure 15: Classification of loans by sector (2014) 27 Figure 16: Classification of deposits with Kyrgyz commercial banks (2014) 27 Figure 17: Islamic bank penetration in the Kyrgyz Republic (by number of branches) 30 Figure 18: Growth in Islamic loans and deposits ($ millions) 31 Figure 19: Non-performing loans as a percentage of total lending in the country 31 Figure 20: Growth in micro finance institutional assets and loans ($ millions) 35 Figure 21: Classification of MFI loans by sector (2014) 36 Figure 22: Purposes of loans sought by MSMEs 38 Figure 23: Reasons cited by MSMEs for not applying for loans 39 Figure 24: Funding potential 42 Figure 25: Depository Potential 42 Table 1: Definition of MSMEs in the Kyrgyz Republic 15 Table 2: Kyrgyz banking penetration (2013) 25 Table 3: SME loans and deposits in the Kyrgyz Republic 28 4 Abbreviations and Glossary ATM Automated Teller Machine CAGR Compound Annual Growth Rate FINSAC Financial Sector Adjustment Credit GDP Gross Domestic Product IDB Islamic Development Bank IFC International Finance Corporation KFG Kompanion Financial Group KGS Kyrgyzstani Som KICB Kyrgyz Investment and Credit Bank MFIs Micro Finance Institutions MoU Memorandum of Understanding MSME Micro, Small, and Medium Enterprises NBKR National Bank of the Kyrgyz Republic NPL Non Performing Loan NSO National Statistical Office OJSC Open Joint Stock Company USD United States Dollar WTO World Trade Organization Conversion Rates used in the report (KGS/USD) 2014 0.0188 2013 0.0206 2012 0.0213 2011 0.0217 2010 0.0218 2009 0.0233 5 Foreword Islamic banking refers to a system of banking consonant with the basic principles of Islamic Shariah (the rules and values set by Islam). Essentially this means interest-free financing. Shariah principles disallow ‘riba’ or interest on the lending of money. Islamic banking offers the same facilities as the conventional banking system does globally. The difference is Islamic banking’s strict adherence to Shariah rules or Fiqh al Muamlat (Islamic commercial jurisprudence). Until now, however, the presence and reach of Islamic banking institutions is not as widespread as that of conventional banks. This can pose a supply gap issue for Islamic products and services. The World Bank Group has conducted several studies to more exactly define and quantify this financing gap, and the overall use of banking services among businesses in the Kyrgyz Republic. In fact, though, little clarity has been achieved in determining how many of these businesses have been excluded owing to the unavailability of Shariah-compliant banking products. To correct this lack of information, IFC commissioned this study to better understand the levels of actual business demand that exist (especially among MSMEs) and the supply of Islamic banking products (asset and liability products along with other banking services) that are available to address it. The scope comprises: (i) gaps in the banking needs of businesses (particularly MSMEs) in the Islamic products space; (ii) supply-side benchmarking to review the current capacity of financial institutions to offer Islamic products to businesses; (iii) demand-side benchmarking to identify key MSME needs for Islamic products to see how well they are being served; and (iv) the current enabling environment, reviewing its readiness levels taking into consideration its regulatory framework and the legislation in place to govern Islamic banking and Shariah compliance. In particular the report reveals an emergent ‘new-to-bank’ Kyrgyz Islamic funding and depository opportunity, highlighting the un-served and underserved MSMEs who do not borrow from conventional banks owing to the unavailability of Shariah- compliant banking products. In other words, even though there is very strong latent demand for Islamic banking products, this potential is untapped because banks and financial institutions lack the necessary operational capabilities with the extra burden of having to deal with other constraints such as narrow product offerings, limited outreach, and high costs. This report offers recommendations as to what Islamic banks and other financial institutions need to do in order to capitalize on the nascent opportunities represented by the country’s MSME sector. Almost 80 percent of the country’s MSMEs have indicated their strong preference for and interest in Islamic banking products and services. Thus if banks successfully implement customer acquisition strategies by focusing on financially un- served and underserved MSMEs, they can capitalize on this “new-to-bank” potential, as quantified below: Funding Potential Deposit Potential Description Min ($mn) Max ($mn) Min ($mn) Max ($mn) Un-served MSME population – (a) 236.3 315.1 278.0 370.7 Under-served MSME population – (b) 73.3 97.8 86.3 115.0 Total “New to Bank” (a+b) 309.6 412.9 364.3 485.7 In addition to the “new-to-bank” potential there is also a conversion/cannibalization opportunity for “well-served” MSMEs which have access to the formal financing system. This opportunity could be worth an estimated $38.3-51.1 million over the next few years, understanding that these MSMEs might shift their loyalties once Shariah-compliant products are readily available. 6 Preface Micro, small, and medium enterprises (MSMEs), are the drivers of Kyrgyz economic growth and key contributors to sustainable gross domestic product (GDP). Since the country achieved independence from the Soviet Union in 1991, MSMEs became one of the prime supports of the economy as the number of industrial enterprises declined. Most MSMEs are engaged in the trade and trade-related sectors. These generate significant employment opportunities for skilled and unskilled labor alike. Despite their importance to economic development, however, the growth of the country's MSMEs has been hindered by their limited access to banking services, along with high tax rates, and inconsistent policies. Thus, government support programs and assistance from multilateral agencies and policy makers are essential to MSME growth. The Bank Advisory Services of IFC’s Financial Institutions Group provides advisory services to banks in aid of strengthening their capacity and increasing their outreach to the MSME sector. This is achieved through capacity building, training, knowledge sharing, and dissemination of best practices in MSME banking and risk management. IFC’s primary goal is to increase the number of banks that offer banking services to MSMEs in a profitable and sustainable manner. The organization is globally recognized as a market leader in MSME banking, through its various regional engagements. IFC is also recognized for its global expertise and knowledge in this area. In response to growing market demand, IFC has recently enhanced its advisory services to include Islamic financing. In this respect, the National Bank of Kyrgyz Republic has also expressed an interest in exploring this segment of the market. Indeed, the NBKR is already looking at the possibility of putting regulations for Islamic banking in place. As a first step, IFC commissioned this study to better understand the demand for and supply of Islamic banking products (asset, liability, and other banking products and services) for the MSME sector in the Kyrgyz Republic. In this study, demand-side benchmarking was conducted to identify key MSME needs for Islamic products and to gauge how well they are being served. Furthermore, IFC made a quick review of the current enabling environment and readiness levels in the country in terms of its regulatory framework and Shariah compliance. Also surveyed were the current capacity of Kyrgyz financial institutions to offer Islamic products to MSMEs. The study reveals a funding potential of $342.2 to 456.3 million for Islamic financing to MSMEs, with a corresponding depository potential of $402.6–536.9 million over the next few years. This funding potential exists due to the ‘new-to-bank’ funding opportunity within the un-served and underserved MSME segments. These are either partially served by financial institutions or do not borrow at all for various reasons. Findings include ‘new-to-bank’ funding potential of $309.6–412.9 million, which is untapped as banks and other financial institutions lack adequate the strategic focus needed on this segment to offer Shariah-compliant products. In addition to the ‘new-to-bank’ funding and depository potential, Islamic banks could convert or cannibalize the existing funding/lending and deposit portfolios of conventional banks that serve MSMEs (primarily mid-sized enterprises). These mid-sized enterprises deal with conventional banks mostly because of the unavailability of the appropriate Islamic banking products. The funding potential within this category of well-served MSMEs could be around $30.1 to 41.1 million. 7 ince the country lending and deposit portfolios of conventional banks that serve in 1991, MSMEs MSMEs (primarily mid-sized enterprises). These mid-sized my as the number enterprises deal with conventional banks mostly because of the s are engaged in unavailability of the appropriate Islamic banking products. The primary source of funding potential within this category of well-served MSMEs be around could and Figure 1: Islamic funding $30.1 depository to 41.1million. potential visory services to Figure 1: Islamic funding and depository potential d increasing their through capacity emination of gement. IFC’s BEAR CASE ($mn) BULL CASE ($mn) s that offer banking ble manner. The leader in MSME 309.6 New to bank 412.9 ents. IFC is also ge in this area. mic finance, IFC 32.6 Conversion of well- 43.5 served MSMEs nclude support for rgyz Republic has ment of the market. bility of putting 342.2 Total Funding Potential 456.4 better understand 85% products (asset, Total Depository 402.6 536.9 es) for the Potential udy, demand-side MSME needs for e being served. A ent and Thereadiness The report highlights strategic measures that conventional and report highlights strategic Islamic banks could that measures conventional undertake and Islamic banks to successfully tap the could undertake to successfully tap the Islamic Islamic ramework and banking potentialbanking C review as was the potential of the country's of the country’s MSMEs. MSMEs. r Islamic It products is expected that is expected Itthis nowthis study willthat formstudy a basiswill fornow form a basis understanding the for need for Islamic banking and finance based on market demand. It also provides anthe understanding need outline of for steps thatbanking the Islamic and need to be finance taken basedIslamic banking and finance in the to introduce 42.2 to country, something on market which the demand. GovernmentIt also provides of the an Kyrgyz Republic outline of is very the steps keen that to promote. SMEs, with a need to be taken to introduce Islamic banking and finance in the 02.6–536.9 IFC acknowledges country. the commitment and cooperation of Israa Capital Management Consultants, Dubai, who carried out this study on their behalf. potential exists due IFC acknowledges the commitment and cooperation of Israa n the un-served Tomasz A. TelmaCapital Management Consultants, Dubai, who carried out this ther partially on studyfor IFC Regional Director their behalf. Europe and Central Asia w at all for various g potential of nks and other Tomasz A. Telma focus needed on ts. Regional Director IFC – Europe and Central Asia Islamic Banking and Finance. Opportunities across MSMEs in the Kyrgyz republic 7 8 01. Executive Summary Given the fact that just one bank offers Shariah-compliant products in the Kyrgyz Republic despite the strong preference for Islamic finance by a large segment of the business clientele there, this study aims to determine the number of businesses (particularly MSMEs) that do not borrow from financial institutions due to this preference, and simply because of limited availability; this would seem to underscore an unmet need. How many of these enterprises prefer Islamic banking, but opt for conventional banks due to the limited availability of adequate Islamic banking products? What is the potential for Islamic finance in the country once Islamic banking regulations are strengthened? This study objectively qualifies and quantifies such aspects. The importance of MSMEs in the Kyrgyz Republic grew significantly after the dissolution of the Soviet Union, primarily because MSMEs generated considerable numbers of employment opportunities for the local population. As well, though, MSMEs can be characterized as the major drivers of economic development. The country’s mountainous terrain limits industrial growth. This, in turn, increases the society’s dependence on smaller businesses. In 2014, MSMEs employed more than 19 percent of the total Kyrgyz population, a significant rise from the 14.8 percent reported in 2010. The MSME contribution to the country’s GDP has been almost constant at around 29 percent since 2010, and the sector accounted for 31.61 percent of total exports in 20112. Although a number of initiatives have been undertaken to promote MSME development, however, a number of challenges remain, preventing companies in this sector from capitalizing on their full potential. The biggest are inadequate access to finance, corruption and bureaucratic sand traps. Bank lending to SMEs in the Kyrgyz Republic remained fairly stable at around 10 percent3 between 2010 and 2014. And in the latter year, total SME lending in Kyrgyzstan stood at $148.1 million, while deposits from SMEs totaled $174.2 million4. Over the same period, MFIs advanced loans to more than 500,000 borrowers, with an aggregate value $370.1 million. Nevertheless, the banking sector’s low penetration of the MSME subsector and the small ticket size of MSME loans have restricted bank lending to these small businesses over the years. Banks perceive MSMEs as risky and unattractive, given that MSMEs typically find it difficult to present adequate credit histories, collateral, guarantees, and cash flow projections, all of which are essential for procuring funds from formal financial institutions. Moreover, although 80 percent5 of Kyrgyz MSMEs are interested in borrowing under the aegis of Islamic principles, most refrain from approaching any banks (conventional or Islamic) to help with their funding needs because of the reasons cited in Figure 2 below. 1. Brief Statistical Handbook 2011-2013: National Statistical Committee of the Kyrgyz Republic, 2014 2. Private Sector Assessment Update - The Kyrgyz Republic: Asian Development Bank, 2013 3. Primary research 4. Primary research and National Bank of the Kyrgyz Republic 5. Primary research 9 ers of employment from approaching any banks (conventional or Islamic) to help lending ra though, with their funding needs because of the reasons cited in Figure 1 that offere ers of economic below. Furthermo n limits industrial Enterprise pendence on Figure 1: Reasons cited by MSMEs for avoiding loans in th more than 19 Figure formal 2 : Reasons cited loans by MSMEs for avoiding formal loans 187 percen cant rise from the constraine ribution to the 0% 10% 20% 30% 40% 50% around 1.5 und 29 percent associated percent of total High interest rates 36% enforced. Already have loans 28% Additiona dertaken to the applica ber of challenges No requirement of loan 21% developme m capitalizing on Religious beliefs 9% not have t ccess to finance, from all ba Collateral issues 9% Nearly a te emained fairly Dissatisfaction with loan terms and procedures 4% convention 2014. And in on loans is stood at $148.1 many of th Source: Primary Research Source: Primary Research .2 million . Over 4 being able than 500,000 Around 95 percentAroundof Kyrgyz 95 percent MSMEs have Kyrgyz ofto rely on MSMEs have to informal lenders to rely on access informal needed financial backing (20-25 percentbecause of Sh on. Nevertheless, these enterprises havelenders to access only partial accessneeded to formalfinancial backing financial channels;(20-25 percent the remaining of these 70-75 not percent have no access to these proper ME subsector resources andat all) And enterprises have only partial access to formal financial channels; banks and other financial a mere 5 percent of Kyrgyz MSMEs have adequate access to commercial either way cted bank lending institutions 6 . the remaining 70-75 percent have no access to these resources at transactio perceive MSMEs all). And a mere 5 percent of Kyrgyz MSMEs have adequate access Banking in pically find There it are no separate laws for Islamic finance in the country at present to commercial banks and other financial institutions. MSMEs lateral, guarantees, procuring ntial forThe government has There made are no separate efforts laws for to strengthen the Islamic finance regulatory in theby environment country way ofat amendments that laid down key - Their i principles of Islamic present Banking in 2009 and 2013. Detailed instructions and regulations relating to Islamic finance, credit numbe institutions and transactions are provided in the normative and legal acts of the NBKR (30 normative and legal acts). As of withou today, the normative and legal acts of NBKR stipulate requirements on licensing, corporate governance, risk management, model agreements standardization and Procedure for specific types of transactions, which comply with the Islamic principles of financing. To implement the pilot project on introduction of Islamic banking and finance principles, a separate package in normative Committee and legal of the Kyrgyz acts, including Republic, 2014 taxation issues, has been developed since 2006 for EcoIslamicBank CJSC. 6 Asian Development Bank, 2013 7 While the general perception of the nascent Islamic banking industry is positive, the high cost of credit and limited 8 lic knowledge of Islamic banking products are the major factors contributing to weak MSME access to Islamic finance 9 10 Almost 86 percent of the Kyrgyz population is Muslim. Furthermore, about 80 percent7 of MSMEs have expressed a desire to acquire the financial assistance they need under Islamic principles. Statistically, the demand for Islamic finance is estimated at 5–6 percent of the total banking industry. Considering this untapped potential, many conventional banks in the country, such as Kyrgyzkommertsbank), RosinBank and Bai-Tushum Bank had expressed interest in setting up Islamic operations as of April 2015. However, high borrowing cost and collateral requirements are restricting development of the sector. The average lending rate charged by banks is about 22.4 percent, whereas that offered by microfinance organizations is 38.5 percent8. Furthermore, according to the results of the 2013 World Bank Enterprise Survey, 89 percent of those MSMEs that received loans in the Kyrgyz Republic had to provide collateral averaging 187 percent9 of their loan’s value. MSMEs are even more credit-constrained as their average collateral requirement is usually around 1.5 times that of large corporates10. Also, the terms associated with collateral requirements are rigid and strictly enforced. 6. Primary research 7. Primary research 8. Asian Development Bank: Private Sector Assessment Update – Kyrgyz Republic 2013 9. The Kyrgyz Republic Strategic Assessment of the Economy: Promoting Inclusive Growth: Asian Development Bank, 2014 10. Asian Development Bank: Private Sector Assessment Update - Kyrgyz Republic 2013 10 Additionally, Islamic leasing attracts double taxation, increasing the applicant’s borrowing costs. This acts to hinder the development of new Islamic banking products. Most MSMEs do not have the capacity to incur such high costs and thus refrain from all banking (conventional as well as Islamic). Nearly a tenth of Kyrgyz MSMEs prefer not to deal with conventional banks because they believe that paying interest on loans is fundamentally at odds with their values: Although many of these MSMEs are creditworthy, they are excluded from being able to access funds from Islamic financial institutions because Shariah-compliant products are either not available or not properly understood by the owners of these businesses; and either way they involve lengthy processes. Executing Islamic transactions tends to be cumbersome. The recommendations regarding Islamic finance products to be introduced in the Kyrgyz Republic is available on page 45 of the report. Applying for Shariah-compliant products as compared to conventional banking products can be a lengthy process due to the documentation; the amount of agreements and the sequence of signing these documents often prolong the overall approval and process time as compared to a Conventional bank’s process. Banking institutions in the country face obstacles in servicing MSMEs Their informal way of conducting business: A significant number of MSMEs operate informally (which is to say without registering the business and lacking proper documentation). As well most under-report or simply do not report revenue to regulating bodies. Furthermore, operations of these MSMEs generally lack transparency and have virtually no internal controls. As a result, they are unable to secure financing since banks insist on verifying a business’ financial health through registration, title documents and tax reporting. Banks tend to avoid lending to such businesses because the risk of default on such loans is very high. This drives such enterprises to depend on informal channels such as moneylenders, friends, and family to meet their financing needs. It is recommended that MSMEs follow formal business practices by reporting accurate revenue information to regulatory authorities. This would allow for more transparency. Accessibility issues hinder expansion: The country’s mountainous terrain also amounts to a major hurdle for banks as it restricts their efforts to expand beyond large accessible cities. Adding to the obstacles, poor financial infrastructure prohibits the country’s commercial banks from effectively utilizing technology to implement mobile or branchless banking services. As a consequence, banks are unable to service the majority of MSMEs operating outside the major urban centers. The limited capacities of Kyrgyz banks: Due to low financial literacy, MSMEs in Kyrgyzstan lack the necessary knowledge and information regarding financial products and solutions, especially in terms of Shariah-compliant products. Also, the banking sector has not increased its investment in marketing activities and consumer education to address the issue. For instance, investment in marketing activities by EcoIslamicBank, the only Islamic bank operating in the country, is very low. This directly translates into its slow pace of customer acquisition. These banks also do not have an adequate number of skilled employees or the technological resources required to either scale-up operations or improve operational efficiency. Limitations on the availability of shariah-compliant products also restricts the generation of MSME business by Islamic financial institutions Shariah-compliant products offered by Islamic financial institutions are largely restricted to working capital and trade financing based on Mudarabah and Murabaha principles. However, other financing products based on more complex Shariah structures such as Istisna'a, Ijara, Diminishing Musharaka are not available. For instance, Supply Chain Financing (SCF) is a short-term credit facility that optimizes working capital by allowing businesses to lengthen payment terms to their suppliers. It facilitates business expansion and mitigates payment risk benefiting international and local trade. 11 Non-availability of complex products is due to lack of knowledge and expertise in structuring such products. Consequently, MSMEs must either approach conventional financial institutions to access a wider range of financing options or rely on informal channels to meet their financing needs. The growth in demand for Islamic finance in the MSME sector could result in a funding opportunity of $342.2–456.3 million over the next few years Currently, 70-75 percent of the MSMEs operating in the Kyrgyz Republic do not have any access to finance from formal only financial institutions. And of the able to partially remainder, meet another their financing 20-25 requirements percent are only able from Strategic to partially meet their operational adjustments can help bo financing requirements formal financial institutions. If Islamic financial institutions were and Islamic banks to target MSMEs more effe from formal financial institutions. Islamic financial institutions could penetrate around 60%-80% of the financially un-served to focus on generating business from these financially un-served and underserved MSMEs (which represents 95% of they the total Regulatory and legislative in There i framework: and underserved MSMEs, potentially which couldMSMEs), could attract a translate funding into a funding opportunity to develop a Sharia Governance Regulatory F the range of $309.6–412.9 million next in thein opportunity few years. the range of $309.6 to $412.9 million over the next and thereby create guidelines to oversee legisl few years. bodies, Islamic banks and thos financial instit Additionally, if Islamic financial institutions Additionally, were financial if Islamic also able to diversify institutions weretheir alsoproduct able to portfolio and customize would these like to establish offerings Islamic windows withi diversify to suit the requirements of those medium-sized portfolio and their productenterprises customize now bankingthese offerings only conventional with conventional banking financial operations. institutions, the to suit the requirements of those medium-sized enterprises now funding potential inherent in these bankingwell-served could amount enterprisesfinancial only with conventional to between institutions, $30.1 and the funding $41.1 Human million capital andin the development: short- to talent There mid-term. quality talent in the Kyrgyz Islamic finance in potential inherent in these well-served enterprises could amount must, therefore, focus on developing the right to between $30.1 and $41.1 million in the short- to mid-term. developmental opportunities, providing adeq Figure 3: Islamic finance potential – ‘new-to-bank Figure ’ 2: Islamic finance potential – ‘new-to-bank’ on retaining their human capital. Reducing loan-processing times: The time tak to process and disburse loans (from 2 weeks t MSME on average) in the Kyrgyz Republic is a major UNIVERSE MICRO, SMALL & MEDIUM ENTERPRISES inhibits quick access to finance for MSMEs. S administrative process using predictive tools support would ensure that the loan applicatio cumbersome. UNSERVED UNDERSERVED WELL SERVED Effective targeting and evaluation of MSMEs: resorting to a one-size-fits-all model, banks m 70-75% 20-25% 5% Current Market Scenario differentiated customized process for MSMEs ~329,737 ~11,750 797 need to proactively approach and engage MSM Avg. Loan rather than relying on them to approach the b 1,500 1,500 3,000 Amount (USD) banks need to develop a more MSME-specific Bear Case model in assessing the credibility of MSMEs, Penetration 60% 60% 60% financial approaches such as behavioral scorin Bull Case 80% 80% 80% Increased focus on extended services: To help Penetration overcome the challenges they face (for instan Bearish Market $223.3mn $69.3mn $30.8mn adequate knowledge of financial products, an Scenario financial management), banks should conside $293mn $31mn New to bank Conversion increased assistance in the form of extended s instance, MSME toolkits, helping them to fra Total Funding Potential: $323.5mn plans, and providing guidance on legal issues Bullish Market $297.8mn $92.4mn $41.1mn MSMEs to function more effectively, and at th improve their creditworthiness. Scenario $390.2mn $41.1mn New to bank Expanding branch networks and offering non Conversion Total Funding Potential: $431.3mn and services: Branch penetration in the Kyrgy relatively low, meaning smaller towns and rur Islamic banks could potentially generate deposits of $402.6–536.9 not have bank branches in their immediate vi Islamic banks could potentially generate deposits of $402.6–536.9 million from the MSME sector there is a shortage of quality talent in the Kyrg million from the MSME sector finance industry. By addressing these issues, b Assuming the Assuming the average loan-to-deposit average ratio in theloan-to-deposit Kyrgyz banking ratiosector in the Kyrgyz banking remains around the 85 percent realize over markpart a significant the next ofthe untapped pote sector remains around the 85 percent mark over the next few few years, the deposit potential for years, Islamic the deposit banks within potential the MSME for Islamic sector banks within in the In addition, banks should also the country would fall between $402.6 expand MSME and their n banking services and products, such as curren $536.9 million. sector in the country would fall between $402.6 and $536.9 accounts, cash management services and othe million. transaction banking services. Figure 3: Depository potential Figure 4: Depository Potential 12 Assuming the average loan-to-deposit ratio in the Kyrgyz banking realize a significant pa sector remains around the 85 percent mark over the next few In addition, banks sho years, the deposit potential for Islamic banks within the MSME banking services and sector in the country would fall between $402.6 and $536.9 accounts, cash manag million. transaction banking s Figure 3: Depository potential 10adjustments Strategic operational Executive help both conventional and Islamic banks to target MSMEs more effectively canSummary Regulatory and legislative framework: The Kyrgyz banking laws were amended in 2009 and 2013 through the creation of the normative and legal acts of the NBKR which discuss: licensing, corporate governance, risk management, model agreements standardization and procedures for specific types of transactions, which comply with Islamic finance principles. These principles discuss the creation of a Shariah Council within Islamic banks and those that would like to establish Islamic windows in their existing conventional bank operations. The Shariah Council is responsible for conformity of transactions (contracts) of the bank with the Islamic principles of banking and financing. However, the Shariah Governance Regulatory Framework (SGRF) in the Kyrgyz Republic remains under development due to the amendment being silent on the governance of such committees. In large Islamic finance markets such as Pakistan and Malaysia, banking regulators have set up Shariah Advisory Councils at the Central Bank level for effective monitoring and governance of Shariah councils at individual banks. These advisory councils are positioned as apex bodies to interpret Shariah principles and ascertain adherence to these principles by Islamic banks in the country. From a practitioners’ perspective, developed Islamic Economies follow a best practice approach where governing parties create a working partnership with banks. Due to the lack of Robust Islamic banks in Kyrgyzstan, this partnership is still in an early stage of development. Thus, it is recommended that the SGRF sets out specific Shariah governance policies to regulate and monitor Islamic financial institutions in the Kyrgyz Republic. It should provide a comprehensive guidance to the governing bodies, Shariah committees and bank management in discharging duties in matters related to offering Islamic banking products. The SGRF should define policy formulation and directives in addition to the guidelines for compliance of policies required by the Central bank. The deadlines for each Islamic financial institution to comply with the framework should also be elaborated in the SGRF. The Kyrgyz Republic, being a relatively new entrant into the Islamic Finance Market, can look to more developed Islamic Banking Economies in order to formalize an eco system that promotes Islamic finance in the country. Human capital and talent development: There is a shortage of quality talent in the Kyrgyz Islamic finance industry. Banks must, therefore, focus on developing the right talent, offering developmental opportunities, providing adequate training, and on retaining their human capital. Reducing loan-processing times: The time taken by banks to process and disburse loans (from 2 weeks to 1.5 months on average) in the Kyrgyz Republic is a major hurdle that inhibits quick access to finance for MSMEs. Streamlining the administrative process using predictive tools and back-end support would ensure that the loan application procedure is less cumbersome. Effective targeting and evaluation of MSMEs: Rather than resorting to a one-size-fits-all model, banks must adopt a 13 differentiated customized process for MSMEs. Branch staff need to proactively approach and engage MSME entrepreneurs rather than relying on them to approach the banks. Moreover, banks need to develop a more MSME-specific risk assessment model in assessing the credibility of MSMEs, adding non-financial approaches such as behavioral scoring. Increased focus on extended services: To help MSMEs overcome the challenges they face (for instance, a lack of adequate knowledge of financial products, and inefficient financial management), banks should consider providing increased assistance in the form of extended services. For instance, MSME toolkits, helping them to frame their business plans, and providing guidance on legal issues would help MSMEs to function more effectively, and at the same time improve their creditworthiness. Expanding branch networks and offering non-loan products and services: Branch penetration in the Kyrgyz Republic is relatively low, meaning smaller towns and rural areas often do not have bank branches in their immediate vicinities. Moreover, there is a shortage of quality talent in the Kyrgyz Islamic finance industry. By addressing these issues, banks would realize a significant part of the untapped potential cited above. In addition, banks should also expand their non- borrowing banking services and products, such as current and savings accounts, cash management services and other fee- based transaction banking services. 14 02. Overview of Business and MSME sector in Kyrgyz Republic Commercial establishments, particularly MSMEs, are an important driver of the Kyrgyz Republic’s economy. They also play an important role in its development. In the years following the country’s independence in 1991, MSMEs supported the economy while the number of industrial enterprises dwindled. The development of the MSME sector is supported by the government’s regulatory reforms and various other initiatives. However, challenges such as inadequate access to finance are hampering its growth. Definitions Like most other countries, the Kyrgyz Republic does not have a standard definition by which it classifies micro, small, and medium enterprises (MSMEs). Even though the criteria used in defining these enterprises are similar (for example, metrics detailing the numbers of employees and turnover), various government bodies and ministries have different definitions. For the purposes of this study, we have considered the legislative interpretation provided by the National Statistical Office (NSO). Table 1: Defining MSMEs in the Kyrgyz Republic Nature of Business Number of Employees Monthly Turnover Micro Enterprises Production Sector up to 15 up to KGS 150,000 Services Sector up to 7 up to KGS 230,000 Small Enterprises Production Sector up to 50 up to KGS 500,000 Services Sector up to 15 up to KGS 500,000 Medium Enterprises Production Sector 51 to 200 up to KGS 2 million Services Sector 16 to 50 up to KGS 2 million Source: Statistical Yearbook of the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2013 Structure of Kyrgyz’s commercial establishments The MSME sector now accounts for approximately 99 percent of commercial establishments in the country; and microenterprises dominate the MSME sector The fall of the Soviet Union in 1991 had a severe impact on large industries in the Kyrgyz Republic. Most filed for bankruptcy and were forced to either shut down or drastically reduce the scale of their operations. This was largely due to the fact that the country’s economy and that of the Soviet Union were closely interlinked. Most of the industrial facilities in the country had major clients in other Soviet republics, especially Russia. 15 With the disappearance of the Soviet Union, however, MSMEs started to play a major economic role in the Kyrgyz Republic by generating employment opportunities for the local population and upholding the country’s economy. In 2014, around 11,500 registered small and medium entities, approximately 350,000 individual entrepreneurs11, and 2,42712 large corporations operated in the Kyrgyz Republic. Of all enterprises in the country, 97.8 percent are privately owned; another 2.2 percent are state-owned13. Despite their collective significance, most MSMEs continue Although most (65 percent14) of the Kyrgyz workforce was their Despite to collective operate significance, on a small most scale. This is MSMEs largely due to continue to operateengaged the business on a small scale. farming in peasant in 2014, due This is largely to the MSMEs business employed more than environment environment in the country, in the country, which which has become has become harsher, harsher, mostly mostly because percent 19of the of the cost andcountry’s total population, administrative burden up from now 14.8 percent needed because of the cost and administrative burden now needed to in 201015. The contribution of MSMEs to GDP has been almost to comply with the standards as entities grow. comply with the standards as entities grow. constant, amounting to about 29 percent since 201016. Moreover, the sector contributed 31.6 percent of total exports in 201117. Figure 5:Figure 4: Classification Classification of commercial of commercial establishments in the Kyrgyz Republic (2014) establishments in the Kyrgyz Republic (2014) The MSME share of Kyrgyzstan’s total GDP and employment might be much higher, though. Many operate informally and are unregistered. They do this to avoid compliance with regulations and their related costs, particularly taxes, and social contributions for workers. According to the Ministry of Economic Development, 96.2% as of 2009, almost 100 billion Kyrgyz som ($2.1 billion) were in 350,700 circulation in the country’s shadow (informal) market. Even more remarkably, almost 70 percent of the total employed population in 2011 worked in the informal sector18. 0.2% 2.9% The percentage of the MSME share of the national economy does 754 Commercial establishments 10,709 not include the contribution of peasant farms19, as most of them in 2014 are likewise unregistered. In 2013, there were around 383,000 peasant farms 20 . «Once regarded as peripheral to 0.7% the national economy, MSMEs Figure 5: MSME share of the national have become a key factor economy (2014) in Kyrgyz 2,427 economic development,» Blackburn and Schape in ‘The Growth of Export-oriented Small and Medium Enterprises in Afghanistan, Kyrgyzstan and Tajikistan’ Source: Annual publication on Small and Medium Businesses in the Source: Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Kyrgyz Republic: 2014 Statistical Committee of the Kyrgyz Republic, 2014 National Republic, Contribution of MSMEs Contribution of MSMEs to the Kyrgyz economy to the Kyrgyz economy Over the years, the MSME sector has been the major driver of economic growth in the Kyrgyz Republic Over the years, the MSME sector has been the major driver of Source: Brief Statistical Handbook 2011-2013: National MSMEs are considered economic the growth in major the drivers Kyrgyz of Kyrgyz economic development, Republic Statistical as the country’s Committee mountainous of the Kyrgyz terrain limits Republic, 2014 industrial growth, rendering its economic well-being dependent on smaller businesses. MSMEs are considered the major drivers of Kyrgyz economic Although most (65 percent development, 14 ) of the as the country’s Kyrgyz workforce mountainous was engaged in peasant farming in 2014, MSMEs employed more terrain limits percent of than 19 industrial the country’s growth, renderingtotal population, its economic up from well-being 14.8 percent in 201015. TThe contribution of MSMEs to GDP has dependent on smaller been almost businesses. constant, amounting to about 29 percent since 201016. Moreover, the sector contributed 31.6 percent of total exports in 2011 . 17 11. National Statistical Office Kyrgyzstan 12. Extrapolated from statistics provided by Sector Assessment (Summary) - Private Sector and Finance: Asian Development Bank, 2010 13. National Statistical Office Kyrgyzstan 14. Country profile – 14 Country Kyrgyzstan: profile New Agriculturist, – Kyrgyzstan: September, New Agriculturist, September,2010 2010 15. Brief Statistical Handbook 15 Brief Statistical 2011-2013: Handbook National 2011-2013: Statistical National Committee Statistical Committeeof the of theKyrgyz Kyrgyz Republic, 2014 Republic, 2014 16. Brief Statistical Handbook 16 Brief Statistical 2011-2013: Handbook National 2011-2013: Statistical National Committee Statistical Committeeof the of theKyrgyz Kyrgyz Republic, 2014 Republic, 2014 17. Private Assessment 17 Sector Private Sector Assessment Update Update - The - The Kyrgyz Kyrgyz Republic: Republic: Asian Asian Development Bank, 2013 Development 2013 18 Private Sector Assessment Update - The Kyrgyz Republic: Asian Development Bank, 2013 16 19 An independent entity that produces agricultural goods on a plot of land owned or rented by members of the peasant farm 20 Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 ommercial Kyrgyz SMEs, excluding indiv z Republic (2014) in trading activities. That beg The MSME share of Kyrgyzstan’s total GDP and employment Growth in this area has been might be much higher, though. Many operate informally and are manufacturing giants. unregistered. They do this to avoid compliance with regulations and their related costs, particularly taxes, and social contributions for workers. According to the Ministry of Economic Development, Unsurprisingly, this market h 96.2% as of 2009, almost 100 billion Kyrgyz som ($2.1 be billion) were in consumer products, such as a The MSME share of Kyrgyzstan’s total GDP and employment might much higher, though. Many operate informally 350,700 circulation in the country’s shadow (informal) market. Even more China. Clothing and footwea do this to avoid and are unregistered. They remarkably, 70 percent of with almost compliance regulations the total employed and their related population in costs, particularly taxes, retail trade, and for 26 accounting social contributions for workers. According to the Ministry 2011 worked in the informal sector . 18 Economy, as of 2009, almost 100 billion Kyrgyz som ($2.1 of of non-food items. This is inf billion) were in circulation in the country’s shadow (informal) market. Even more remarkably, almost 70 percent Kyrgyz population falls into t of the total 2.9% population in 2011 employed worked in the informal sector18 major product categories incl The percentage of the MSME share of the national economy does . and consumer electronics. Commercial tablishments 10,709 not include the contribution of peasant farms19, as most of them in 2014 The percentage of the MSME are likewise share unregistered. of the doeswere In 2013, there national economy around 383,000 not include the contribution of peasant farms19, as most of peasant farms 20 . them are likewise unregistered. In 2013, there were around 383,000 peasant farms20. The most popular distributio Kyrgyz Republic is the bazaar 0.7% Figure 5: MSME share of the national retail space. Other major dist Figure 6: MSME share of the national economy (2014) 2,427 economy (2014) malls, grocery stores, and stre percent24 of the society’s reta city of Bishkek, where the nu stores is noticeably on the ris Real estate and related service Small and Medium Businesses in the real estate brokerage and agen of the Kyrgyz Republic, 2014 second largest SME category. by the increased demand for centers, and warehouses, part of MSMEs center Issyk-Kul. z economy Manufacturing and processin sewing industry, is the third l Source: ctor has been the Brief major Statistical Source: driver of Handbook Brief Statistical 2011-2013: Handbook National 2011-2013: Statistical National Committee of the Kyrgyz Republic, 2014 in which SMEs are engaged. C Statistical Committee of the Kyrgyz Republic, 2014 (10.3 percent) and transport gyz Republic form the fourth- and fifth- lar respectively25. SME major drivers economic by economic activity distribution of Kyrgyz s mountainous terrain limits Classifed its economic economic activity, an estimated 26.1 percent21 of Kyrgyz SMEs, excluding individual entrepreneurs, are by dependent well-being engaged in trading activities. That began in earnest after the Soviet years. Growth in this area has been robust, mainly due to the absence of manufacturing giants. Unsurprisingly, this market has leaned heavily toward less costly consumer products, such as apparel, mainly imported from China. Clothing and footwear products dominate the Kyrgyz retail trade, accounting for 26 percent22 of the total trade w Agriculturist, turnover September, 21 the of non-food items. This is informed by the fact that most of the Kyrgyz population falls into 2010 low-income Annual publication on Small and 2013: National Statistical Committee of the Kyrgyz Republic, 2014 category. Other major product categories include cosmetics, furniture, jewelry, and consumer electronics. 22 Consumer Goods Market in Kyrg 2013: National Statistical Committee of the Kyrgyz Republic, 2014 23 Consumer Goods Market in Kyrg e - The Kyrgyz Republic: Asian Development Bank, 2013 24 Consumer Goods 23 Market in Kyrg The e - The Kyrgyz popular most Asian Republic: distribution Development channel for consumer goods in the Kyrgyz Republic is the bazaar, which makes25 Bank, 2013 up 70 percent Annual publicationof on Small and the retail uces agricultural goods onspace. Other a plot of major land owned ordistribution rented by membersavenues include of the peasant shopping malls, grocery stores, and street kiosks. As well, farm more 26 Annual than 40 publication -- Small and Medium Businesses in 24 the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 27 Annual publication -- Small and percent of the society’s retail trade is concentrated in the capital city of Bishkek, where the number of shopping28 malls and grocery Annual publication -- Small and stores is noticeably on the rise. Real estate and related services (24.1 percent)21, including all real estate brokerage and agency transactions), accounts for the d the MSME sector second Kyrgyz in theSME largest republic category. These services are primarily driven by the increased demand for residential property, hotels, retail centers, and warehouses, particularly in Bishkek and the tourist center Issyk-Kul. 18. Private Sector Assessment Update - The Kyrgyz Republic: Asian Development Bank, 2013 19. An independent entity that produces agricultural goods at land plot owned or rented by members of the peasant farm 20. Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 21. Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 22. Consumer Goods Market in Kyrgyzstan: BISNIS, 2008 23. Consumer Goods Market in Kyrgyzstan: BISNIS, 2008 24. Consumer Goods Market in Kyrgyzstan: BISNIS, 2008 17 Manufacturing and processing (14.0 percent), mainly led by the sewing industry, is the third largest economic activity by volume in which SMEs are engaged. Construction and related fields (10.3 percent) and transport and communication (9.2 percent) form the fourth- and fifth- largest SME sectors in the country respectively25. by Figure 6: SME classification by economic activity Source: Figure 7: SME classification by economic activity estimated 26.1 percent21 of entrepreneurs, are engaged earnest after the Soviet years. t, mainly due to the absence of ned heavily toward less costly l, mainly imported from ducts dominate the Kyrgyz ent22 of the total trade turnover d by the fact that most of the w-income category. Other osmetics, furniture, jewelry, Annual publication pertaining to small and medium businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Repub- lic, 2014 Source: Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 nnel for consumer goods in the h makes up 70 percent23 of the MSME distribution by on avenues include shopping MSME osks. As well, more distribution than 40 geography by geography e is concentrated in the capital Over of shopping 65 percent malls 26 and grocery OverRepublic 65 percent of Kyrgyz SMEs 26 of Kirgyz Republic are located SMEs are mirroring in Bishkek, located in the country’s economic distribution. Despite Bishkek, mirroring the country’s economic a myriad of political and social disruptions, Bishkek is decidedly the country’sdistribution. Despiteeconomic center and its most dynamic a myriad of political and social disruptions, Bishkek is decidedly and rapidly- developingthe city. It boasts four main bazaars: Bishkek-Dordoi, Osh, Orto-Sai, and Alamedin. The geographic country’s economic center and its most dynamic and rapidly- location 1 percent) , including all 21 is made more desirable developing by the city. boasts fourconnection It country’s to Bishkek-Dordoi, main bazaars: Siberia via the Turk–Sib railway line; other attractions ansactions), accounts for the Osh, Orto-Sai, include its developed infrastructure andandreadyAlamedin. The geographic availability location of skilled human is made These factors have made the Bishkek resources. are primarily driven e services environment more fertile ground fordesirable growth.by the country’s Moreover, connection to modernization Siberia via the development initiatives proposed by the government are ntial property, hotels, retail Turk–Sib railway line; other attractions include its developed concentrated in Bishkek, which adds further luster to its appeal. ly in Bishkek and the tourist infrastructure and ready availability of skilled human resources. These factors have made the Bishkek environment fertile ground Other places in the country for with a sizable growth. Moreover,SME population include modernization Chui Province development (11.0 percent) and Osh city (6.2 percent)27. initiatives remaining The remaining country’sproposed by SME roster is spread the government across various are concentrated provinces in Bishkek, whichwith no distinct concentration pattern. 0 percent), mainly led by the adds further luster to its appeal. economic activity by volume Interestingly, ruction and related fields micro enterprises are mainly concentrated in Osh city (19.4 percent), followed by Bishkek (12.0 percent), and Issyk-Kul (11.9 ommunication (9.2 percent) percent) 28 . Other places in the country with a sizable SME population SME sectors in the country include Chui Province (11.0 percent) and Osh city (6.2 percent)27. The remaining country’s remaining SME roster is spread across various provinces with no distinct concentration pattern. Interestingly, micro enterprises are mainly concentrated in Osh city (19.4 percent), followed by Bishkek (12.0 percent), and Issyk- Kul (11.9 percent)28. 25. Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 m Businesses 26.in Annual the Kyrgyz National Republic: on publication Small Statistical and Medium Committee of the Businesses inKyrgyz Republic, the Kyrgyz 2014 National Statistical Committee of the Kyrgyz Republic, 2014 Republic: BISNIS, 2008 27. Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 BISNIS, 2008 28. Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 BISNIS, 2008 18in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 m Businesses m Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 m Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 Figure 8: Geographic concentration of MSMEs in the Kyrgyz Republic Figure 7: Geographic concentration of MSMEs in the Kyrgyz Republic As of 2015, the Kyrgyz of more than $123 mill in 1993. As of June 30, some $27.4 million, wi financial and real secto Figure 8: Recent IFC in Source: Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 Source: Annual publication Enablers on Small of and Medium business Businesses in the growth TheKyrgyz Republic: Kyrgyz government also National Statistical adopted a more Committee of the Kyrgyz business- and investment-friendly tax regime (effective January 2009). Under Republic, 2014 this code, a unified sales tax replaced several previous taxes while The Kyrgyz government has introduced several regulatory reforms many others were either reduced or abolished. For instance, the to bolster the country’s business environment and encourage value-added tax (VAT) was reduced to 12 percent from growth, particularly in the MSME space 20 percent29. The new code also improved provisions related to collection of duties, introduced automation and e-filing, and Enablers of business growth The Kyrgyz Republic joined the World Trade Organization established the presumption of innocence regarding taxpayers. As a result, the IFC-World Bank Doing Business Report ranked (WTO) in 1998, and remains the only member among the group The Kyrgyz government of Central Asian has introduced countries. In accordanceseveral regulatory with the terms of that reforms the to bolster Kirgyz Republic the the third- and second-best globally in 2009 and 2010 respectively. country’s business reformer status environment and agreement, the Kyrgyz government has funded several special encourage growth, and programsin particularly initiatives MSME thegrowth to spur among space private businesses. These include supporting infrastructure (business incubators and IFC has consistently extended its development support for the technology parks), launching consultation and training centers, Kyrgyz private sector through various investment and advisory The Kyrgyz Republic joined and introducing thetax special World Trade regimes, providing financial (WTO) Organization as well as in 1998, and remains the only member among theSource: support initiatives group IFC website support through loans and grants. In 1999, The Kyrgyz Republic of Central Asian countries. amended In accordance its constitution with to allow the private the terms ownership of land, of that agreement, the Kyrgyz government has funded several To improve financial ed (by passing a new Land Code). main impetus The growth in making this The IFC’s main priority in the Kyrgyz Republic is to support to funds, IFC has focus special initiatives and programs to spur move was support for small businesses. among private businesses. These include supporting the development and diversification of the private sector. The infrastructure (business those in rural areas. Th incubators and technology parks), launching consultation andoverriding training goal in this is increasing the country’s competitiveness centers, and introducing special and employment opportunities. IFC aims to improve corporate tax regimes, microfinance organizat as well MSMEs. It has also col as providing financial support In 2009, establishing through new businessesloans was made and eliminating the minimum capital requirement, reducing grants. easier by In 1999, The businesses Kyrgyz practices Republic to be able toamended the better its forge a favorable constitution to allow Kyrgyz Investment and business environment for private businesses, and especially to Financial Group. These the private ownership oftime registration land, (by frames, and passing eliminating newpost-registration acertain Land Code) provide The mainMSMEsimpetus with increasedinaccess making this move to the finance was support for they need. small access by expanding th fees and the requirement that applicants open a bank account to MSMEs, including s businesses. before registration. management services. In 2009, establishing new businesses was made easier by eliminating the minimum capital requirement, reducing registration time frames, and before eliminating certain post-registration fees and the requirement that applicants open a bank account 30 29 Asian Development Bank: Private Sector Assessment Update – The Kyrgyz Republic 2013 IFC website registration. 14 Overview of Business and the MSME sector in the Kyrgyz republic The Kyrgyz government also adopted a more business- and investment-friendly tax regime (effective January 2009). Under this code, a unified sales tax replaced several previous taxes while many others were either reduced or abolished. For instance, the value-added tax (VAT) was reduced to 12 percent from 20 percent29. The new code also improved provisions related to collection of duties, introduced automation and e-filing, and established the presumption of innocence regarding taxpayers. As a result, the IFC-World Bank Doing Business Report ranked the Kirgyz Republic the third- and second-best reformer status globally in 2009 and 2010 respectively. IFC has consistently extended its development support for the Kyrgyz private sector through various investment and advisory support initiatives 29. Asian Development Bank: Private Sector Assessment Update – The Kyrgyz Republic 2013 19 IFC’s main priority in the Kyrgyz Republic is to support the development and diversification of the private sector. The overriding goal in this is increasing the country’s competitiveness and employment opportunities. IFC aims to improve corporate businesses practices the better to be able to forge a favorable business environment for private businesses, and especially to provide MSMEs with increased access to the finance they need. As of June 30, 2015, IFC’s Kyrgyz portfolio was valued at some $27.4 million, with the bulk of that investment deployed in the financial sectorand real sectors30. Figure 9: Recent IFC investments in the Kyrgyz Republic 2014  FC granted a $4 mn loan to Bank Bai Tushum to expand the bank's SME portfolio, including gender finance component, and • I provided cross currency swaps 2013  FC extended a $12 mn financing package (a $10 million loan and a $2mn credit line under its Global Trade Finance Program) • I to Kyrgyz Investment & Credit Bank for expanding the bank's SME portfolio and trade finance business • I  FC provided currency swap to Kompanion Financial Group for hedging its currency risk and a $6 mn loan to expand its SMB lending facilities 2012  FC extended a loan of $2 mn to Demir Kyrgyz International Bank for supporting the bank's trade finance • I 2011  FC extanded a loan of $2 mn to Demir Kyrgyz International Bank for supporting the bank's trade finance • I 2009 • I  FC extended a loan of $5 mn to Magic Box, Kyrgyzstan's largest producer of cardboard packages, to assist in expansion Source: IFC website IFC Advisory Services in the Kyrgyz Republic: Figure 10:  Year of Operation Project Description 2014-present Agri Finance Project Improves access to finance and market for farmers through improved capacity of farmers, supply chain aggregators and financial intermediaries. Donor partner is the Austrian Ministry of Finance.Implements by WBG Finance and Markets Global Practice Group. 2012-present Central Asia Tax Project Helps government reduce tax compliance costs for businesses, and promote tax transparency and financial disclosure. Donor partners are the governments of Switzerland and UK. Implements by WBG Trade and Competitiveness Global Practice Group. 2012-present Housing Microfinance Helps improve housing conditions for low-income Kyrgyz households by introducing an Advisory Services Project innovative housing microfinance lending product to local financial institutions, enabling them to provide funding for home improvements to low-income residents. Donor partner is the government of Switzerland.Implements by WBG Finance and Markets Global Practice Group. 2009 – present Financial Markets Aims to expand secure access to finance for individual consumers and MSMEs by improving Infrastructure Project the financial infrastructure of and regulatory environment for credit bureaus and by developing a Risk Certification Program. Donor partner is the government of Switzerland. Implements by WBG Finance and Markets Global Practice Group. 30. IFC website 20 2009 – present Investment Climate Project Helps the government establish transparent and effective business regulations and create a favorable environment for entrepreneurs. Donor partners are the governments of Switzerland and UK. Implements by WBG Trade and Competitiveness Global Practice Group. 2008 – present Micro and Responsable Provides advisory services to microfinance institutions in Azerbaijan and Central Asia to Finance Project support their transformation processes. Donor partner is the government of Switzerland. Implements by WBG Finance and Markets Global Practice Group. 2006 – present Corporate Governance Project Helps local companies and banks strengthen their corporate governance practices with a view to improving their operations and increasing ability to attract investment and financing. Donor partners are the governments of Switzerland and UK. Source: IFC website To improve financial education standards and ensure better access to funds, IFC has focused on MSMEs in the country, and especially those in rural areas. The organization has done this by encouraging microfinance organizations to reach out to a larger number of MSMEs. It has also collaborated with major lenders such as the Kyrgyz Investment and Credit Bank (KICB) and Kompanion Financial Group (KFG). These collaborations aim to improve financial access by expanding the portfolio of financial products available to MSMEs, including savings plans, money transfers, and cash management services. «Through its investment and advisory Specifically, IFC has significantly contributed to the development of sustainable support to local banks, IFC aims to micro-finance facilities in the Kyrgyz Republic by assisting in setting up FINCA expand the array of financial services Kyrgyzstan, the largest microfinance institution in the country, and Bai-Tushum offered to business owners and in 1995 and 2000 respectively. entrepreneurs,» Edward Strawderman, IFC’s Associate Director Through its advisory services aimed at bettering the investment climate, IFC for Financial Markets in Europe and Central helps identify and remove regulatory barriers to the entry and operations of Asia private businesses. Key concerns for businesses Political instability ranked as the biggest hurdle for businesses The Kyrgyz Republic has experienced significant political tension since independence. Its first two post-Soviet presidents were ousted in the wake of popular discontent in 2005 and 2010. The Kyrgyz Republic had a political instability index31 of 7.1 in 2009–10, and according to the Economist Intelligence Unit,, a rank of 3 in 2013; both underscored its high political risk32. Businesses, especially MSMEs, have been severely affected by this political tension. Among other uncertainties, they have produced a demand slump. This has been particularly true in the trade segment, plus the real estate and tourism sectors, which together account for the majority of MSMEs. A high crime rate and inventory carrying costs during periods of political instability have also had a negative effect on competitiveness. And taken together, these things have generally dissuaded entrepreneurs from expanding their businesses. Limited access to finance has constrained the development of businesses, especially micro and small enterprises, in the Kyrgyz Republic  he Political Instability Index shows the level of threat to a particular country’s government due to social protest. The index scores were derived by 31. T The Economist by combining measures of economic distress and underlying vulnerability to unrest 32. The Economist – Intelligence Unit 21 Kyrgyz MSMEs find it difficult to procure finance for medium- and long-term investment. This limits their expansion. The high collateral requirement (which on an average was pegged at 187 percent in 2013, but in fact has gone as high as 237 percent), plus, the lending rates charged by commercial banks (~22.4% on average) has put a decided damper on private entrepreneurs approaching banks in aid of securing credit. Instead, they prefer informal sources of funds, such as traditional moneylenders, regardless of the interest rates such lenders demand, which can be as high as 2 percent per month. Rampant corruption and nepotism are additional and serious barriers to growth for private businesses businesses High tax rates, unstable economic growth, and weak The Kyrgyz Republic has consistently scored poorly on the Transparency International Corruption Perception Index. The infrastructure add up to impaired businesses country ranked 136th among 174 countries in 201433. The rampant corruption, which penetrates all levels of the bureaucracy, ggest hurdle for businesses Other major hurdles to private sector growth include high 03. The Current St and nepotism taxationto have combined create rates and a harsh the business environment. administrative burden involved This discourages entrepreneurs from expanding in paying d significant tension politicaland operations, The Kyrgyz taxes. impedes thus severely Republic has witnessed several bouts of growth. st-Soviet presidents were macroeconomic instability, as evidenced by fluctuating GDP Highand ntent in 2005 tax2010. rates,The unstablegrowth economic growth, since and weak independence infrastructure (from a low of -20.1 add inup to a high businesses to impaired 1994 ability index31 of 7.1 in 2009– of 10.5 in 201334). Furthermore, economic growth slowed to 3.6 The Islamic banking ind Intelligence OtherUnit, a rank major of 3 to private hurdles in 2014 percent sector a decline due to include growth in production high taxation at the rates Kumtor and the gold administrative burden MSMEs. involved Fully 80 percen in paying political risk32 . mine (which taxes. The Kyrgyz Republic has witnessed 35has contributed an average of 12 percent to GDP several bouts of macroeconomic instability, as evidenced by fluctuating GDP address their financing n been severely affected by this each year since 1997 ). GDP growth is expected to slow to 1.7% in depends on increased pe growth since independence (from a low of -20.1toin 1994in to a high. of 10.5 in 2013 ). Furthermore, economic growth slowed 34 ertainties, they have produced 2015 before recovering 2.0% 2016 36 to 3.6 icularly true tradein 2014 due percent in the to a decline in production at the Kumtor gold mine (which has contributed an average of 12 The country faces infrastructure issues such as unreliable access percent to GDP urism sectors, which together each year since 1997 to electricity 35 (due).GDP growthpower to numerous is expected cuts) andto slow to 1.7% the absence of in 2015 before recovering to 2.0% in 2016 rate A high crime 36 . and effective coordination in industrial development. iods of political instability have itiveness. And The taken together, country Due to the faces infrastructure factors issues suchmentioned above, as unreliable the Kyrgyz access Republic to electricity has (due to numerous power cuts) and the absence d consistently ranked poorly in World Bank of effective coordination in industrial development. Doing Business Reports. In 2014, the country Finance in the country is expensive ranked 102nd of 189 countries, dropping three andDueshort-term to the factors mentioned above, the Kyrgyz places37Republic in 2013. ranked poorly in World Bank Doing Business has consistently from its standing Reports. In 2014, the country ranked 102nd of 189 countries, dropping three places37 from its standing in 2013. all enterprises, in the Kyrgyz Overview of th Figure 11 : Major constraints 10 businesses facing ocure finance for medium- Figure : Major constraints facing businesses sector its their expansion. The high 54% Since independence, the Ky average was pegged at 187 38% significant challenges, such e as high as 237 percent), 31% 21% 20% 23% 15% 19% 14% 19% crises, domestic political tur ommercial banks (~22.4% sector. Owing to these event er on private entrepreneurs sector remains underdevelo g credit. Instead, they prefer raditional moneylenders, Political Access Corruption High tax rates Macro- enders demand, which can be instability to loans economic The Kyrgyz banking system instabilities stages of development since are additional and serious Individual entrepreneurs SME Republic (NBKR), the coun esses after independence in 1991. country’s transition into a m y scored poorly on the on the banking sector, and l ion Perception Index. The commercial banks. untries in 201433. The rampant Source: IFC Investment Climate Project in the Kyrgyz Republic els of the Source: IFC Investment bureaucracy, and Climate Advisory Services Project in Kyrgyzstan harsh business environment. In 1996, the government int m expanding operations, and Adjustment Credit (FINSAC from the World Bank. This w banking system. The progra 33. Corruption Perceptions Index: Transparency International, 2014 restructured state-owned ba 34. GDP growth (annual %) - The World Bank website administrative reforms aime 35. Kyrgyz Gold-Mine Debate Pits Poor Country Against Its Richest Taxpayer : Radio Free Europe Radio Liberty, June 2015 However, in 1998, the Russi 36. Kyrgyz Republic: Economy - Excerpted from the Asian Development Outlook 2015: Asian Development Bank the Kyrgyz banking sector, l 37. Doing Business 2015: Going Beyond Efficiency - The World Bank Group currency (mainly Russian ru commercial banks. 22 03. The current Status of Islamic banking in the Kyrgyz Republic The Islamic banking industry has a strong positive image, especially among the country’s MSMEs. Fully 80 percent of them are interested in obtaining Shariah-compliant products to address their financing needs. However, the development of Islamic banking in the country depends on increased penetration, as well as the development of a strong regulatory regime. Overview of the Kyrgyz banking sector Since independence, the Kyrgyz banking sector has overcome significant challenges, such as the Russian and global financial crises, domestic political turmoil, and corruption within the sector. Owing to these events, growth has been sluggish and the sector remains underdeveloped. The Kyrgyz banking system has undergone several important stages of development since the National Bank of the Kyrgyz Republic (NBKR), the country’s central bank, was established after independence in 1991. Over the period from 1991–95, the country’s transition into a market economy had a direct impact on the banking sector, and led to the establishment of several commercial banks. In 1996, the government introduced the Financial Sector Adjustment Credit (FINSAC) program, with funding support from the World Bank. This was mandated to reform the Kyrgyz banking system. The program downsized the banking system, restructured state-owned banks, and implemented several administrative reforms aimed at increasing operational efficiency. However, in 1998, the Russian financial crisis adversely affected the Kyrgyz banking sector, largely due to the huge foreign currency (mainly Russian ruble) loan portfolios of Kyrgyz commercial banks. These measures sparked an initial credit boom. However, the Tulip Revolution of 2005 -- which led to the ouster of President Askar Akayev – bolstered by the global economic crisis of 2008–09, delivered a heavy blow to the country’s banking system. To prevent any further crisis development and improve its overall health, the NBKR, in cooperation with the government, introduced the Banking System Development Strategy in 2009. This strategy was activated to enhance the overall growth of the banking sector by means of restructuring insolvent banks and strengthening bank credit policies. In 2010, despite facing political turmoil after the overthrow of the government led by President Kurmanbek Bakiyev, the interim government initiated some further decisive measures to improve the operations and internal controls of banks reeling under the influence of widespread corruption and the lack of corporate governance. Special regimes were introduced, placing the country’s then-largest bank, Asia Universal Bank, and several smaller banks, under NBKR control. This led to the uncovering of numerous irregularities and legislative violations by these banks, such as the distortion of financial statements, to conceal suspicious transactions. The result, in 2011, was that the central bank tabled measures to prevent commercial banks from engaging in such unhealthy practices. 23 In 2012, the newly-elected parliamentary government undertook several measures once again intended to improve the banking system. The most significant was the introduction of the Medium-Term Development Program, which primarily focused on: • Enhancing the sustainability of the banking system, and extending overall accessibility to its financial services; • Improving this new accessibility through the introduction of various new financial instruments, including Islamic finance instruments; • Preparing the Banking Code of the Kyrgyz Republic; and • Developing a strategy for the privatization of state-owned banks – among them Zalkar Bank, RSK Bank, and Aiyl Bank – to assure their better management. The result was improved stability with positive growth among major performance indicators: • The total assets of the Kyrgyz banking system increased 8.7 percent YoY to $2.5bn in 2014 38. • As well the banking sector’s capital adequacy and liquidity ratios, Figure 11: Banking as ofof structure May 2014, were reported as The the Kyrgyz resultabove being the stability wi was improved Republic (as of June 2015) major performance indicators: minimum regulatory requirements of 12.0 percent and 30.0 percent, respectively . 39 - The total assets of the Kyrgyz ban • Non-performing (NPLs) loansstructure Figure 11: Banking Republic (as of June 2015) declined of the Kyrgyz to 4.8 percent in May 2014, The result 2% as compared was improved with stability with major performance indicators: positive 18% percent 6.7growth in 2012. among Table 2: Ban percent YoY to $2.5bn in 2014 . 38 The Kyrgyz banking system comprised 24 commercial banks, all licensed assetssupervised and - The total by the of the Kyrgyz banking NBKR system - increased 8.7 As well the banking Region sector’s capi ratios, as of May 2014, were repo percent YoY to $2.5bn in 201438. 2% 18% minimum regulatory requiremen Uzbekistan As of end of 2014, 24 commercial banks operated in the Kyrgyz Republic. This included 16 commercial banks - As well the banking sector’s capital adequacy and liquidity with percent, foreign respectively 39 . share capital. Ten of these have foreign shareholdings of more than 50.0 percent. ratios, as 40 of May 2014, were reported as being above the Azerbaijan - Non-performing loans (NPLs) d minimum regulatory requirements of 12.0 percent and 30.0 percent, respectively39. May 2014, as compared with 6.7 Kyrgyzsta The two state-owned banks – Aiyl Bank and RSK Bank – account for 18 percent of the total banking sector by assets. Taken Tajikistan Figure 11: Banking structure of the Kyrgyz The result was improved stability with positive growth among together, these foreign banks accounted for 35.8% of authorized capital of the banking - Non-performing system. loans (NPLs) declined to 4.8 percent in The Kyrgyz banking system compris Republic (as of June 2015) major performance indicators: licensed and supervised by the NBK May 2014, as compared with 6.7 percent in 2012. Kazakhsta Figure 12: Banking structure in Kyrgyzstan (2014) - The total assets of the Kyrgyz banking 2014, increased system 8.7 b The Kyrgyz banking system comprises 24 commercial banks,By allthe end of 24 commercial Source: Financia 2% 18% percent YoY to $2.5bn in 2014 38 . Republic. This included 16 commer licensed and supervised by the NBKR capital. Ten of these had foreign sha 50.0 percent 40 . Optima Bank - As well the banking sector’s capital adequacy and liquidity than 15 percen By the end of 2014, 24 commercial banks operate in the Kyrgyz ratios, as of May 2014, were reported as being above the Republic. This included 16 commercial banks with foreign share minimum regulatory requirements of 12.0 percent and –30.0 capital. Ten of these had foreign shareholdings of more39than The two state-owned banks The Kyrgyz Aiyl B 50.0 percent40. percent, respectively . account for 18 percent of the totalba b banks Taken together, the foreign banks ac account 56% 24% - Non-performing loans (NPLs) percent of 35.8 declined tototal Optima assets. in 4.8 percent Bank, The two state-owned banks – Aiyl Bank and RSK Bank – the assistance May 2014, as compared with 6.7 percent in 2012. Bank, (all of w account for 18 percent of the total banking sector by assets. Taken together, the foreign banks account for approximately The last few years have a signifi seen operatin banks 56% 24% DKIB 35.8 percent of total assets. The Kyrgyz AMANBANK banking system comprises branches24 plus stationarybanks, commercial and fieldall ca licensed and supervised by the commercial NBKR banks. ByFigurethe end 12:of 20 Mar Bank of Asia Capital Bank and nearly 800 commercial bank cas Halyk Bank The last few years have seen a significant rise in the number of Kyrgyzstan Bank «Bai-Tushum» DKIB AMANBANK branches plus stationary and field By thecashendoffices of the of 2014, 24various commercial banks operate in the Kyrgyz Rosinbank of 2014, commercial banks. By the end Republic. there This were 293 branches included This noted, 16 commercial however, banks the concentrat with foreign share Bank of Asia BTA Bank Capital Bank Optimaand nearly 800 commercial bank Bank capital. offices cash Ten nationwide of these had foreign 41 . remains low withof shareholdings just more7.98 branches than 50.0 Dos-Kredobank percent40. compared with 39.8 and 10.3 branch Halyk Bank Kyrgyzstan Bank «Bai-Tushum» Azerbaijan, respectively42. Moreove KICB Rosinbank This noted, however, the concentrationTolubay of bank branches are mostly centered in urban areas. BTA Bank National Bank oflow with just 7.98 branches remains The two per 100,000 adults, state-owned banks – Aiyl Bank and RSK Bank – Optima Bank compared with 39.8 and 10.3 branches Commercial bank and in Uzbekistan Dos-KredobankPakistan Bishkek Branch account for 18 percent of the total banking sector by assets. Additionally, March 2013 the Kyr in approximately KICB Azerbaijan, respectively . Moreover, 42 KYRGYZSTAN Kyrgyz banking Taken together, the foreignfacilities banks account for 56% Tolubay Kyrgyz-Swiss Bank are mostly 24% centered in urban areas. 35.8 percent of total assets. introduced mobile banking services National Bank of Bakai Bank time. Nevertheless, mobile banking Commercial bank Finca Bank especially in rural areas. Pakistan Bishkek Branch Kyrgyzkommertsbank KYRGYZSTAN Additionally, in March 2013 the The Kyrgyz Investment last few years have Credit seen a Bank significant rise in the number of Kyrgyz-Swiss Bank DKIB introduced mobile banking services AMANBANK branches to the pluscountry stationary FinanceCreditBank for theand first field cash offices of the various Bakai Bank time. Nevertheless, mobile banking penetration commercial banks. is By still quite the This endlow, explains of 2014, there whywerea considerable 293 branchespa Finca Bank Bank of Asia Capital especially Bankareas. in rural and KyrgyzCredit Bank nearly 800 commercial – and bank cash most notably offices in rural nationwide 41 areas – . Annual R Kyrgyzkommertsbank services offered by the Source: informal ban Halyk Bank Kyrgyzstan Bank «Bai-Tushum» common being currency exchange Source: National Bank of the Kyrgyz RepublicRosinbank FinanceCreditBank This explains why a considerable This part of the noted, country’s however, theeconomy concentration of bank branches In 2014, bank – and most Bank in rural areas BTA notably – stilllow remains relies onjust the 7.98 with financial branches per 100,000 adults, their highest g KyrgyzCredit Bank Optima Bank services offered by the informal Dos-Kredobank banking sector, compared with 39.8theandmost 10.3 branches in Uzbekistan and 38. Annual Report: National Bank of Kyrgyz Republic, 2014 common being currency exchange and ex-officio Azerbaijan, lending. respectively 42 . Moreover, Kyrgyz banking facilities KICB From 2009–11 39. Kyrgyz Republic Partnership Program Snapshot: The World Bank Group, October 38 Annual 2014 Tolubay Report: National Bank of Kyrgyz Republic, are 2014 mostly centered in urban areas. due to structu National 40. Annual Report: National Bank of Kyrgyz Republic, Bank of 2014 39 Kyrgyz Republic Partnership Program Snapshot: The World Bank Group, October 2014 National Bankbank 40 Annual Report:Commercial of Kyrgyz Republic, 2014 Pakistan Bishkek Branch KYRGYZSTAN 41 Annual Report: National Additionally, Bank of Kyrgyz Republic, 2014 in March 2013 the Kyrgyz Investment Credit Bank 24 Kyrgyz-Swiss Bank 42 Financial Access Survey: International Monetary Fund, 2013 mobile banking services to the country for the first introduced 38 Annual Report: National Bank of Kyrgyz Republic, 2014 39 Kyrgyz Republic Partnership Program Snapshot: The World Bank Group, October 2014 Bakai Bank time. Nevertheless, mobile banking penetration is still quite low, Finca Bank The last few years have seen a significant rise in the number of branches plus stationary and field cash offices of the various commercial banks. By the end of 2014, there were 293 branches and nearly 800 commercial bank cash offices nationwide41. This noted, however, the concentration of bank branches remains low with just 7.98 branches per 100,000 adults, compared with 39.8 and 10.3 branches in Uzbekistan and Azerbaijan, respectively42. Moreover, Kyrgyz banking facilities are mostly centered in urban areas. Additionally, in March 2013 the Kyrgyz Investment Credit Bank introduced mobile banking services to the country for the first time. Nevertheless, mobile banking penetration is still quite low, especially in rural areas. This explains why a considerable part of the country’s economy – and most notably in rural areas – still relies on the financial services offered by the informal banking sector, the most common being currency exchange and ex-officio lending. Table 2: Banking penetration in the Kyrgyz Republic (2013) Region Bank Branches ATMs per 100,000 Adults per 100,000 Adults Uzbekistan 39.8 8.2 Azerbaijan 10.3 33.5 Kyrgyzstan 7.9 21.0 Tajikistan 6.6 10.6 Kazakhstan 3.3 71.6 Source: Financial Access Survey: International Monetary Fund, 2013 Optima Bank is the country’s largest bank, accounting for more than 15 percent of all loans and deposits The Kyrgyz banking sector is highly consolidated. The top five banks account for more than half of the total loans and deposits. Optima Bank, Demir Kyrgyz International Bank, and Kyrgyz Investment and Credit Bank, (all of which are foreign-owned), are the three largest banks operating in the country. Other major players include the state-controlled RSK Bank and privately-owned Kyrgyzstan Commercial Bank. Optima Bank is the leading Kyrgyz banking institution, contributing 17 percent to the sector’s loan portfolio and 18 percent to its depository base. The bank also accounts for 15 percent of the total banking assets, plus with 12 percent of total capital, and 28 percent of the banking sector’s net profit43. Figure 13: Market share of commercial banks in Kyrgyzstan (2013) 41. Annual Report: National Bank of Kyrgyz Republic, 2013 42. Financial Access Survey: International Monetary Fund, 2013 43. Optima Bank website 25 banks account for more than half of the total loans and deposits. contributing 17 percent to the sector’s loan portfolio and 18 Optima Bank, Demir Kyrgyz International Bank (established with percent to its depository base. The bank also accounts for 15 the assistance of IFC in 1996), and Kyrgyz Investment and Credit percent of the total banking assets, plus with 12 percent of total Bank, (all of which are foreign-owned), are the three largest capital, and 28 percent of the banking sector’s net profit43. banks operating in the country. Other major players include the Figure 12: Market share of commercial banks in Kyrgyzstan (2013) Total Loans Total Deposits Optima Bank Kyrgyz Investment and Credit Bank 17% 18% 22% 33% Aiyl Bank 13% Demir Kyrgyz International Bank 4% RSK Bank 8% 3% 9% 6% Kyrgyzstan Commercial Bank 8% 13% 9% 16% 8% Aman Bank Others $1.4 billion Source: Annual Reports of Commercial Banks Source: Annual Reports of Commercial Banks In 2014, bank loans and deposits in the Kyrgyz Republic showed their highest growth in absolute terms since 2010 In 2014, bank loans and deposits in the Kyrgyz Republic showed the banking system. However, regulatory reform initiatives by the their highest growth in absolute terms since 2010 central bank, particularly after 2011, as well as the introduction From 2009–11, banking activity in the country remained stagnant due of a new to structural development deficiencies program and the lack by the government of internal in 2012, controls in the banking system. However, regulatory reform initiatives by the central bank, particularly after 2011, strengthened the sector overall. As a result, banking activityas well From 2009–11, banking activity in the country remained stagnant regained traction, particularly over the 2013–14 period. as the due introduction to structural of a new deficiencies development and program the lack of internal by the controls in government in 2012, strengthened the sector overall. As a result, banking activity regained traction, particularly over the 2013–14 period. Figure 13: Total Kyrgyz commercial bank loans and Time and demand deposits together acco deposits Figure 14 : Total Kyrgyz commercial in ($ bank billion) loans and deposits in ($ billion) of total deposits The total deposit base of Kyrgyz commer 2 43 Optima Bank website billion47 in 2014. Significantly, however, m CAGr 1,51,6 the country preferred to keep their mone loans: 25.7% 1,4 in banks. This is changing, though, due i 2 Deposits: 23.0% 1,1 impact of financial literacy programs suc Islamic Banking 1,1 and Finance. Opportunities across MSMEs in the Kyrgyz republic 19 IFC and the European Bank for Reconstr 1 0,8 0,9 0,7 0,7 (EBRD). Such programs have led to an in 0,6 of bank accounts and the overall value of 1 the large number of Kyrgyz migrants sen abroad has encouraged consumers to ope banks. Inward remittances to the country 0 from 31 percent in 2013 to 34.1 percent i 2010 2011 2012 2013 2014 marked contribution to the expansion of Total Loans Total deposits base along the way. Source: National Bank of the Kyrgyz Republic Source: National Bank of the Kyrgyz Republic The trade and agriculture sectors account Time deposits accounted for 45 percent o The trade and agriculture sectors account for more than half of the for more loans than half disbursed by ofKyrgyz incommercial banks 2014, up from 39 percent in 2013. Mea the loans disbursed by Kyrgyz commercial banks demand deposits declined to 22 percent In 2014, the total credit portfolio value of the country’s commercial banks increased by 33.2 percent to $1.5 billion44. Figure 15: Classification of deposits in K This rise was mainly due toIn 2014, the the total buildup credit portfolio of agricultural value loans andofincreased the country’s trading sector. exposure to the commercial Together these banks (2014) commercial banks increased by 33.2 percent to $1.5 billion accounted for almost 54 percent of the total loans disbursed by Kyrgyz commercial banks in 2013 . 44 . 45 This rise was mainly due to the buildup of agricultural loans and increased exposure to the trading sector. Together these Agriculture is the major source of income accounted for 65 for almost 54percent percentofofthe thecountry’s total loansworkforce. disbursed by This drives the high demand for agro loans . Similarly, trade is an 46 essential Kyrgyz elementbanks commercial of theinKyrgyz 2013 . economy, in large part a function of the 45 country’s traditional 22% strength in this area, because of its strategic location at the commercial crossroads between Russia and China. Agriculture is the major source of income for 65 percent of the 45% Figure 15: Classification of deposits in Kyrgyz commercial banks (2014) country’s workforce. This drives the high demand for agro loans . 46 Similarly, trade is an essential element of the Kyrgyz economy, 44. National bank of Kyrgyz Republic website in large part a function of the country’s traditional strength in 45. National bank of Kyrgyz Republic website this area, because of its strategic location at the commercial 46. Country profile – Kyrgyzstan: New Agriculturist, September, 2010 33% crossroads between Russia and China. 26 Figure 14: Classification of loans by sector (2014) Source: National Bank of the Kyrgyz Republic country’s workforce. This drives the high demand for agro loans46. Similarly, trade is an essential element of the Kyrgyz economy, in large part a function of the country’s traditional strength in this area, because of its strategic location at the commercial 33% crossroads between Russia and China. Figure 14: Classification of loans by sector (2014) Source: National Bank of the Kyrgyz Republic The SME sector accounts for 10 percent o all commercial banks in the Kyrgyz Repu 13% 6% 36% SME lending forms only a small part of b 8% and Islamic banking loan portfolios at pr loans make up approximately 10 percent5 8% disbursed by commercial banks each year to the small ticket size of SME lending. Th loans and Time and demand deposits together 11% account for over two-thirds borrowed by SMEs is about $1,500 collectively 51 . mo valued at 18% of total deposits over 11,000 MSMEs. Ho Trade Agriculture Mortgage was limited In 2012 the government as only launched abou a three which MSMEs were SMEs could acquire provided loan with loans The total deposit Consumer base of Kyrgyz loans commercial banksConstruction Industrials totaled $1.6 why2012 interest rates. From until 2015, the program hasprefe be billion inOthers 47 2014. Significantly, however, most households in more SMEs to borrow fr 1,51,6 the country Source: preferred National Bank keep toof money at home rather than theirRepublic the Kyrgyz 1,4 Source: National Bank of the Kyrgyz Republic in banks. This is changing, though, due in no small part to the Table 3: SME loans a 1,1 impact 44of financial National bank literacy programs of Kyrgyz Republic such as those conducted by website 49 National bank of republic Kyrgyz Republic website Time and demand deposits IFC and45together account the European National bank forRepublic Bank of Kyrgyz over two-thirds for Reconstruction website of total and deposits Development 50 Primary research (EBRD). Such programs 46 Country have led profile – Kyrgyzstan: New to an increase Agriculturist, in the 2010 September, number 51 Primary research The total deposit base of Kyrgyz of bank47 National accountscommercial bank of Kyrgyz banks Republic and the overall website$1.6 billion47 in 2014. Significantly, totaled value of deposits. Moreover, 52 The preferentialmost however, loan households Region program is a government s 48 World Bank is changing, though, due in no small part loans at b stimulate capital investment by providing the large in the country preferred to keepnumber their of Kyrgyz money at migrants home rather sending than in money banks. home This from rates to the impact of financial abroad literacy programs consumers such as those has encouraged to conducted open savings IFC. Such by accounts programs have led to anSME with lending increase in the as a banks. number of bank accounts 20 Inward and The remittances the Current overall Status to value of the country of deposits. Islamic Banking have Moreover,in grown the steadily Kyrgyz the large number of Kyrgyz migrants percentage republic sending money of total lend home from abroad hasfrom 31 percent encouraged in 2013 to consumers to34.1 open percent savings inaccounts 2014 , making 48 a Inward remittances to the country have with banks. 2013 grown 2014 marked contribution to the expansion of the steadily from 31 percent in 2013 to 34.1 percent in 2014 , making a marked contribution to the expansion of the 48country’s deposit Total SME lending ($m eposits base country’s deposit base along along the the way. way. Total SME deposits ($m Time for Time deposits accounted 45 percent deposits of the for accounted total 45deposit percentvalue in 2014, of the up from total deposit 39 percent in 2013. Meanwhile, the share value for more than half of l banks of demand deposits in 2014, up declined to from 39 percent 22 percent in 2013. from 25 Meanwhile, percent 49 . the share of demand deposits declined to 22 percent from 25 percent49. Islamic bank Figure 16: Classification of deposits in Kyrgyz commercial banks (2014) the country’s Figure 15: Classification of deposits in Kyrgyz Kyrgyz repu ent to $1.5 billion44. commercial banks (2014) f agricultural loans Certain divine restriction tor. Together these activities as per Islamic p al loans disbursed by balance is maintained in 22% Time deposits wealth into the hands of Islamic finance does not for 65 percent of the 45% natural ebb and flow of t Settlement demand for agro loans46. considered acceptable, al the Kyrgyz economy, accounts hip is likewise not totally aditional strength in Demand deposits at the commercial 33% There is a basic differenc Islamic economy, namely motive or private owners or (2014) make economic decision Source: National Bank of the Kyrgyz Republic divine caveats. And if the Source: National Bank of the Kyrgyz Republic imposed by the society a The SME sector accounts for 10 percent of the loans disbursed by all commercial banks in the Kyrgyz Republic democratically determin 47. National bank of Kyrgyz Republic website This has generated a num 6% 48. World Bank SME lending forms only a small part of both the conventional imbalances: for example, andRepublic 49. National bank of Kyrgyz Islamicwebsite banking loan portfolios at present. SME segment transactions tend to conc loans make up approximately 10 percent50 of the total loans Human instincts27 are exp disbursed by commercial banks each year. This is mainly due injurious products or act The SME sector accounts for 10 percent of the loans disbursed by all commercial banks in the Kyrgyz Republic SME lending forms only a small part of both the conventional and Islamic banking loan portfolios at present. SME segment loans make up approximately 10 percent50 of the total loans disbursed by commercial banks each year. This is mainly due to the small ticket size of SME lending. The average amount borrowed by SMEs is about $1,50051. In 2012 the government launched a three-year program under which MSMEs were provided with loans at lower-than-market interest rates. From 2012 until 2015, preferential loans52 collectively valued at more than $150 million53 were issued to over 11,000 MSMEs. However, the coverage of this program was limited as only about 3 percent54 of the total number of SMEs could acquire loans on these preferential terms. That is why the program has been extended to 2016–17, to encourage more SMEs to borrow from formal sources. Table 3: SME loans and deposits in the Kyrgyz Republic Region 2012 2013 2014 SME lending as a 10% 10% 10% percentage of total lending Total SME lending ($mn) 85.4 111.2 148.1 Total SME deposits 100.5 130.8 174.2 ($mn)* Source: Primary research and National Bank of the Kyrgyz Republic * based on average loan to deposit ratio for 2012-14 (85%) Islamic banking in the Kyrgyz Republic Certain divine restrictions have been imposed on economic activities as per Islamic principles. The intent is to ensure that balance is maintained in the economy, and the concentration of wealth into the hands of a few is avoided Islamic finance does not negate active market forces nor the natural ebb and flow of the economy. The profit motive is considered acceptable, albeit with some limitations. Private ownership is likewise not totally negated. There is a basic difference, however, between a capitalist and Islamic economy, namely that in secular capitalism the profit motive or private ownership are given unrestrained power to make economic decisions. Their liberty is not constrained by any divine caveats. And if there are some restrictions, they are those imposed by the society and thus always subject to change through democratically determined legislation. This has generated a number of practices which result in social imbalances: for example, interest, gambling, and speculative transactions tend to concentrate wealth in the hands of the few. Human instincts are exploited to gain through immoral and injurious products or activities. Furthermore, uncontrolled profit seeking creates monopolies which ultimately paralyze market forces or, at least, hinder their natural operation. Thus, the natural ebb and flow of supply and demand is disturbed as these forces can only function properly in an atmosphere of free competition. They are antithetical to a monopolistic environment. 50. Primary Research 51. Primary Research 52. Preferential loan program is a government sponsored initiative to stimulate capital investment by providing loans at below market interest rates 53. Primary Research 54. Primary Research 28 After the tacit recognition of private ownership, the profit motive and market forces, therefore, certain divine restrictions have been input as per Islamic principles. These cover economic activities in particular and economic structures in general. Believers hold, as an article of faith, that such restrictions are imposed by Allah the Almighty, whose knowledge has no limits, and so cannot be abridged or removed by any human authority. The prohibition of riba (usury or interest), gambling, hoarding, dealing in unlawful goods or services, short sales and speculative transactions are some examples of these divine restrictions. And taken together, all have the cumulative effect of maintaining the balance, justice and equality of opportunities. Asset-backed financing is one of the most important characteristics of Islamic finance Conventional financing assumes that the banks and financial institutions deal in money and monetary papers only. That is why they are forbidden, in most countries, from trading in goods and accumulating inventories. Islamic finance, on the other hand, does not recognize money as the subject matter of trade, except in some special instances. Money has no fundamental utility; it is only a medium of exchange. Each unit of money is 100 percent equal to another unit of the same denomination; therefore, there is no scope for making profit through the exchange of these units. Profit is generated when something having an intrinsic utility is sold for money, or when different currencies are exchanged, one for another. The profit earned through dealing in money (of the same currency) or the papers representing them is interest, and hence prohibited. The real and ideal instruments of financing in Shariah-compliant banking are Musharakah and Mudarabah. When a financier contributes money on the basis of these two instruments, it is bound to be converted into the assets. Profits are generated through the sale of these real assets. Financing on the basis of Salam and Istisna also creates real assets. The financier, in the case of the former, receives real goods and can profit by selling them in the market. In the latter instance, financing is affected through the manufacture of real assets; and as a reward for doing this the financier earns his or her profit. The instruments of leasing, Ijara and Murabahah, are likewise fully backed by assets and financing through these instruments, and are therefore clearly distinguishable from interest-based financing. It is evident that every financing in an Islamic system creates real assets. It is known, on the other hand, that interest-based financing does not necessarily create real assets. Hence, the supply of money via loans advanced by financial institutions, does not normally equate with the real goods and services produced in the society. This alludes to loans creating the illusion of an increase in money, without creating real assets in the same quantity. This gap between the supply of money and production of real assets creates and fuels inflation. Hence, financing in an Islamic system is always backed by real assets. The success of Islamic finance in several Asian and Middle Eastern countries encouraged EcoIslamicBank launched Islamic financing services in 2006. However, the country’s Islamic banking sector is still relatively nascent. After the dissolution of the Soviet Union, the Kyrgyz Republic became the first Central Asian country to join the Islamic Development Bank (IDB) in 1993. Nevertheless, this introduction of Islamic banking in the country faced obstacles that were. mainly due to initial apprehensions concerning Islamic finance among the secular elite population and government officials. Nevertheless, the success attained by Islamic finance principles in other Asian and Middle Eastern countries, particularly Malaysia, encouraged the government to introduce Islamic banking in the Kyrgyz Republic in 2007. Furthermore, IDB, which has funded several key Kyrgyz projects, has manifestly assisted the country in implementing a dual banking system (namely Islamic banking in conjunction with traditional banking). The Kyrgyz Republic signed a memorandum of understanding with IDB and Eco Bank to develop the country’s Islamic banking system back in 2007. The MoU was specifically aimed at introducing and implementing the principles of Shariah- compliant finance in the country. Following the signing of the MoU, EcoIslamicBank was established as the pilot project for Islamic banking in the Kyrgyz Republic. 29 After the dissolution of the Soviet Union, the Kyrgyz Republic EcoIslamicBank is the only commercial Islamic bank licensed by Despite its slow g became the first Central Asian country to join the Islamic NBKR to offer Shariah-compliant financial products and services EcoIslamicBank’s The Kyrgyz Islamic banking Development system Bank (IDB) comprises in 1993. just Nevertheless, thisone commercial introduction bank, in the Kyrgyz with 12 Republic. The branches licensed bank is regulated and regulated and supervised by by NBKR by its loan book a of Islamic banking in the country faced obstacles that were. NBKR. EcoIslamicBank provides several Islamic banking and mainly due to initial apprehensions concerning Islamic finance financial services, including deposit and investment accounts, EcoIslamicBank amongis the commercial onlyelite the secular population and Islamic governmentbank licensed officials. by and NBKR financing andto offer credit Shariah-compliant facilities financial products and to individuals and businesses, The asset base of Nevertheless, the success attained by Islamic finance principles in particularly MSMEs. percent from 201 Kyrgyz services in the other Republic. The bank is regulated and supervised by NBKR. EcoIslamicBank provides several Islamic Asian and Middle Eastern countries, particularly Malaysia, accounts for 3 pe This expansion c banking and financial services, including deposit and investment encouraged the government to introduce Islamic banking in the accounts, and financing and credit facilities to individuals Growth in the number of EcoIslamicBank branches has been slow, limiting the bank’s outreach. As of 2013, it had 1255 branches financing activity Kyrgyz Republic in 2007. Furthermore, IDB, which has funded and businesses, particularly MSMEs. several key Kyrgyz projects, has manifestly assisted the country in providing Islamic banking products and services nationwide. The implementing a dual banking system (namely Islamic banking in number of branches increased at a CAGR of 5.92 percent from 9 conjunction with traditional banking). in 2008 to 12 in 201356. Figure 17: Gro Growth in the number of EcoIslamicBank branches has been slow, limiting the bank’s outreach. As of 2013, it had 1255 Still, the concentration of EcoIslamicBank’s branches remained at The Kyrgyz Republic signed a memorandum of understanding branches providing with IDBIslamic banking and Eco Bank products to develop and the country’s services nationwide. Islamic The per just 3.23 branches number of branches million adults increased in 201357.The at a CAGR of 5.92 bank’s branch banking system back in 2007. The 56MoU was specifically aimed network is sparse and concentrated in economically important percent from 9atin 2008 to 12 in 2013 . introducing and implementing the principles of Shariah- provinces. 60 compliant finance in the country. And after the MoU was signed 50 Eco Bank became the pilot project for Islamic banking in the Within these provinces, branches are located in major ities; rural Still, the concentration of EcoIslamicBank’s branches remained Kyrgyz Republic causing it to be renamed EcoIslamicBank. at areas, dojust 3.23 not have easybranches per access to Islamic 2013 . Bank’s million adults in finance. 57 40 branch network is sparse and concentrated in economically important provinces. Within these provinces, branches are 30 The Kyrgyz Islamic banking system comprises just one located in major cities; bank, commercial rural areas, with do not 12 branches have licensed andeasy access regulated by to Islamic finance. 20 NBKR 10 Figure 16 : The Figure 17 : The penetration ofpenetration of Islamic Islamic banking banking in the in the Kyrgyz Kyrgyz republic Republic (number (number of branches) of branches) 0 4 Source: National Ba Bishkek 1 2 Talas Chui 1 Non-per 1 Issyk-Kul banking Jalalabat The number of N in recent years; b 2 banking sector 1 Osh Batken The proportion o is low as compar countries such as Total branches ratios of over 10 9 11 12 2008 2010 2013 58 National Bank of 59 National Bank of Source: National Bank Source: of the National BankKyrgyz Republic of the Kyrgyz Annual Reports Reports Republic Annual 60 National Bank of 61 OUTLOOK 2014 55 National bank of the Kyrgyz Republic 62 Primary research 56 National bank of the Kyrgyz Republic Despite its slow57 growth in National bank terms of the Kyrgyz of theand Republic number of branches, EcoIslamicBank’s business has grown substantially, as evidenced the World Bank 63 Primary research 22 and by its loan book the volume The Current of deposits Status of Islamic Banking init has the attracted. Kyrgyz republic The asset base of EcoIslamicBank expanded at a CAGR of 15.9 percent from 2010 through 2014, or to the point where it now accounts for 3 percent of the total banking system’s assets58. This expansion could be ascribed to growth in the bank’s financing activity. The value of financing increased at a CAGR of 18.9 percent over the same time frame. The bank’s loan book accounted for 1.6 percent59 of the loans provided by all Kyrgyz commercial banks last year. Moreover, consumer loans make up the majority of EcoIslamicBank’s loan portfolio. The average size of a loan advanced by the bank is about $1500. 55. National bank of the Kyrgyz Republic 56. National bank of the Kyrgyz Republic 57. National bank of the Kyrgyz Republic and the World Bank 58. National bank of the Kyrgyz Republic 59. National bank of the Kyrgyz Republic 30 rvices EcoIslamicBank’s business has grown substantially, as evidenced accounted for 1.6 percent of the loans provided by all Kyrgyz ed by by its loan book and the volume of deposits it has attracted. commercial banks last year. Moreover, consumer loans make up nd the majority of EcoIslamicBank’s loan portfolio. The average size ts, of a loan advanced by the bank is about $1500. sses, The asset base of EcoIslamicBank expanded at a CAGR of 15.9 percent from 2010 through 2014, or to the point where it now accounts for 3 percent of the total banking system’s assets58. EcoIslamicBank’s deposits increased at a CAGR of 42.1 percent n This expansion could be ascribed to growth in the bank’s from 2010–14. And these deposits accounted for 3.7 percent of anches financing activity. The value of financing increased at a CAGR the deposit base of all commercial banks in the country last year60. EcoIslamicBank’s deposits increased at a CAGR of 42.1 percent from 2010–14. And these deposits accounted for 3.7 e. The om 9 percent of the deposit base of all commercial banks in the country last year60. Figure 17: Growth in Islamic loans and deposits ($ million) ned at Figure 18 : Growth in Islamic loans and deposits ($ million) anch ant 60 52 51 53 50 CAGr rural 40 loans: 18.9% Deposits: 42.1% 30 24 24 20 19 20 20 12 13 10 0 2010 2011 2012 2013 2014 Total Loans Total Deposits Source: National Bank of Source: National the Bank Kyrgyz of the Republic, Kyrgyz Republic, EcoIslamicBank EcoIslamicBank Annual Reports Annual Reports Non-performingloans s in the banking systemThe ratio of Kyrgyz NPLs to total loans decreased from 6.7 Non-performing loans s in the percent in 2012 to 4.3 percent in 2015 . This was largely due 62 to the in The number of NPLs in the Kyrgyz banking system has improved recent years; it remains butadopted commercial high in the abnormally banking Islamic banking sector system selective lending practices by most banks. Given that the demand for financing exceeds the availability of funds, the country’s, banks can simply choose The number of NPLs in the Kyrgyz banking system has improved clients with a low chance of non-repayment. The proportion non-performing of years; in recent loans inhigh but it remains abnormally Kyrgyz the in Republic the Islamic is low as compared to the levels seen in other Central Asian banking sector countries such as Kazakhstan and Tajikistan, which carry NPL At ratios of over the same 10 percent 61 time, EcoIslamicBank . one of the highest NPL has ratios among Kyrgyz banks. In 2015, the firm’s ratio of NPLs to The ratio ofThe proportion Kyrgyz of non-performing NPLs loans to total loans in the Kyrgyzfrom decreased Republic 6.7 percent 2012 in was total loans to 4.3 pegged percent at 19.5 percent, in 2015 down from62 24.5 . percent This was largely due is low as compared to the levels seen in other Central Asian in 201263. This is mainly because the lion’s share of the bank’s to the selective lending countries practices such as Kazakhstan adopted and Tajikistan,by most which carrycommercial NPL banks. portfolio Given is made that up of smallthe demand consumer loans,for financing in particular for exceeds the ratios of over 10 percent61. availability of funds, the country’s, banks can simply choose clients withof the purchase low household a small chance of non-repayment. appliances. These carry a greater risk of default. At the same time, EcoIslamicBank has one of the highest NPL ratios among Kyrgyz banks. In 2015, the firm’s ratio of NPLs to total loans was pegged at 19.5 percent, down from 24.5 percent in 201263.This is mainly because the lion’s share of the bank’s portfolio is made up of small consumer loans, in particular for the purchase of small household appliances. These carry a greater risk of default. Figure 58 National18 : NPls Bank as a of the Kyrgyz percentage of total lending in the Kyrgyz republic Republic ID Figure 19 : NPLs as Bank 59 National a percentage of total lending in the Kyrgyz Republic of the Kyrgyz Republic sc 60 National Bank of the Kyrgyz Republic ac 61 OUTLOOK 2014: Eurasia to stand on the shoulders of giants: bne IntelliNews th 62 Primary research in 30,0% 63 Primary research ag 25,0% K Islamic Banking and Finance. Opportunities across MSMEs in the Kyrgyz republic 23 24,5% 20,0% 15,0% 20,0% 19,5% C 10,0% b 5,0% 6,7% 5,6% A 0,0% 4,3% es ba 2012 2013 2014 w Overall banking NPL (%) Islamic banking NPL (%) an Source:Research Source: Primary Primary Research L n 60. Factors driving Kyrgyz Islamic National bank of the Kyrgyz Republic as Kaz-Komerz) already have significant experience in setting up and operating Islamic banking windows in their home countries. th 61. OUTLOOK 2014: Eurasia to stand on shoulders of giants: bne IntelliNews A 62. banking growth Primary Research And many of them have been exploring ways to leverage this experience to set up Shariah-complaint Kyrgyz banking th 63. Primary Research operations. Additionally, several traditional banks in the country of are looking to attract funds from wealthy Russian Muslims E A increasingly positive perception of Islamic banking among seeking to invest in Shariah-compliant products/opportunities 31 Th the Kyrgyz population; a simultaneous increase in the interest outside of their home country. to conventional banks now have in Islamic operations; aid via the co Factors driving Kyrgyz Islamic banking growth A increasingly positive perception of Islamic banking among the Kyrgyz population; a simultaneous increase in the interest conventional banks now have in Islamic operations; aid via the IDB’s support initiatives; all are driving the visible growth of Islamic banking in the Kyrgyz Republic A positive perception of Islamic banking: Almost 86 percent64 of Kyrgyzstan’s population follows Islam. Potential customers are mostly private businesses, with their natural need for banking products. However these generally seek to avoid the offerings and services of conventional banks because they see paying interest as not being aligned with their values. Around 80 percent of the MSMEs surveyed expressed a desire to borrow, or obtain financing, under the aegis of Islamic principles. This amounts to significant untapped potential, as there is just one Islamic bank operating in the Kyrgyz Republic at present, and it accounts for only 1.6 percent65 of all commercial bank lending. Conventional bank interest in Islamic banking is growing: Considering this untapped potential, many conventional banks in the country, such as Kyrgyzkommertsbank), RosinBank, and Bai-Tushum Bank, had expressed their interest in setting up Islamic banking operations in the Kyrgyz Republic as of April 2015. In fact these banks have already started the process, conducting relevant feasibility studies and appointing experts on regulatory compliance. Additionally, some foreign banks operating in the country already have significant experience in setting up and operating Islamic banking windows in their home countries. And many of them have been exploring ways to leverage this experience to set up Shariah-complaint Kyrgyz banking operations. Additionally, several traditional banks in the country are looking to attract funds from wealthy Russian Muslims seeking to invest in Shariah-compliant products/opportunities outside of their home country. IDB’s contribution to Islamic finance’s development: IDB has contributed to the development of Islamic finance in the country through various initiatives dating back to when the Kyrgyz Republic became a member in 1993. These development initiatives are aimed at forging a suitable regulatory environment likely to increase the presence of Islamic banking and finance. They include: • Reviewing the existing legal framework pertaining to banking and financial activities, and proposing amendments or drafting a new stand-alone law to enable Islamic finance to operate efficiently; • Assisting EcoIslamicBank to introduce new Islamic banking products; • Widespread training at EcoIslamicBank, NBKR, the Ministry Finance, the Ministry of Economy, and the Ministry of Justice as well as at the Financial Market & Supervision Service covering the operation and supervision of Islamic banking; and • Creating a suitable environment in which to launch Sukuk (the Islamic equivalent of bonds) and Takaful (contributory communal insurance for members against future loss or damage) as further aids in the development of Islamic products in the country. IDB has been active in financing the construction of Islamic schools and vocational centers. Furthermore, IDB has been an active participant in the social and economic development of the country, and is involved in co-financing important projects in various sectors such as energy, transport infrastructure and agriculture, while at the same time providing credit lines to Kyrgyz banks. Expansion of the Kyrgyz Islamic financial industry is a key IDB strategic thrust 64. Islam in Kyrgyzstan: Wkipedia 65. National bank of the Kyrgyz Republic 32 Challenges facing Islamic banking As Islamic banking expands, the sector must compete with established conventional banks already entrenched in the Kyrgyz banking system. At the same time they have no choice but to deal with a weak regulatory environment and a shortage of products and funds Taking steps towards the development of a robust regulatory environment: Due to regulatory provisions for Islamic finance in the Kyrgyz Republic, being in the developmental stages, it has restricted growth of the sector. Although the first Islamic bank was established in 2007, EcoIslamicBank had to include operational governance provisions for Shariah compliance in its Articles of Association, due to lack of specific governance laws and local knowledge of Islamic Finance. Also, the bank currently operates as a pilot project on the basis of a Memorandum of Understanding between Kyrgyz Republic, Islamic Development Bank and EcoIslamicBank which was signed in 2006 with a view to introduce and develop Islamic banking in the country. However, the necessary procedures to convert it into a full-fledged Islamic bank were never implemented due to lack of reflection of the Islamic principles. Certain amendments to the banking law were introduced in 2009 and 2013 to the Law of the Kyrgyz Republic known as the normative legal acts of NBKR. These laws provided detailed instructions and regulations relating to Islamic finance, credit institutions and transactions. Given the low market share Islamic banking has garnered to date, regulators have not paid much attention to this issue. Even the Kyrgyz taxation system does not have provisions to support Islamic banking. Moreover, Islamic leasing attracts double taxation, which naturally increases the applicant’s borrowing costs. This, in turn, translates into another hindrance in terms of developing new Islamic banking products. Limited reach and lack of competitive products: Just one Islamic bank services the entire country’s Islamic finance requirements. And that bank’s reach is limited because of its few branches and the inadequacy of its menu of fully Shariah- compliant products. Thus, in the absence of more operators, Islamic banking growth potential in the country is limited. There is a clear need to increase the number of banks offering the critical mass of Shariah-compliant products required to establish a strong presence for this kind of banking in the Kyrgyz Republic. Effective profit is usually higher in Islamic banks compared with interest rates charged by conventional banks. So despite the strong demand for Shariah-compliant products, customers are deterred by the higher costs involved. This disparity of costs is bound up with the high cost of structuring Islamic products. Furthermore, the Islamic finance products now offered in the country cannot compete with the product portfolio of the conventional banks. Shortage of working capital: Obtaining Shariah-compliant funds for working capital requirements has proven a challenge for EcoIslamicBank, since Islamic banks cannot use non-Shariah-compliant funds. Such funds now come from donors and/ or other international financial institutions such as IDB. This limits Islamic bank flexibility in terms of financial operations and the replenishment of funds. Shortage in the skilled workforce: Additionally, Kyrgyz banks and financial institutions find it difficult to hire qualified managers and staff with some level of expertise in Islamic banking. In some instances, recruiting experts, such as accountants and product managers, among others, is challenging because such personnel are simply unavailable locally. Without the necessary know-how and skilled workforce capability at their disposal, Islamic banks cannot maximize their product portfolio by developing. 33 The Kyrgyz Islamic banking industry is underdeveloped, primarily due to the lack of legislative and regulatory support from the government and the country’s central bank. Although the latter amended its banking rules to permit the operation of Islamic banks and windows, it has not yet been able to establish the stand-alone legislation which would encourage development of the sector. The current banking rules -- created for conventional banks -- also need to be followed by Islamic banks, restricting their ability to manage investments and raise capital through avenues that are compliant with Shariah principles. Although several existing foreign banks operating in the country have been evaluating the possibility of setting up an Islamic bank (or window), the present environment does little to encourage them in accelerating their plans. Overview of micro-finance institutions in the Kyrgyz Republic The establishment of FINCA in 1995 signaled the arrival of microfinance in the Kyrgyz Republic. Even so, the industry was largely characterized by foreign institutions providing grants on the basis of international agreements until August 2002, when the government adopted the legislation ‘On Microfinance Organizations in the Kyrgyz Republic’. Historically, microfinance developed swiftly dating back to the latter part of 1990s; in fact, the country is among Central Asia’s leaders in this segment. Since 1995, international financial institutions and donor organizations, such as The Foundation for International Community Assistance (FINCA), have been focused on improving the loan access which would enable many more micro enterprises to obtain financing. Microfinance institutions are an important part of the Kyrgyz credit sector as they are generally the sole finance providers in rural areas. This is mainly because MFIs offer unsecured loans, whereas banks focus on urban borrowers who can put up collateral. Kyrgyz MFIs are well-regulated; the NBKR is responsible for licensing and supervising all MFIs in the country. The law ‘On Microfinance Organizations in the Kyrgyz Republic’, introduced in June 2002, led to the mandatory registration of all MFIs and the need for appropriate certification or a license from NBKR for all legal entities conducting microfinance activities. Furthermore, the Kyrgyz government passed a law in 2012 to address the parallel loans issue (multiple borrowings by the same customer) in the MFI sector. This piece of legislation was intended to limit such parallel loans by mandating the MFIs providing them to make clients aware of the possible negative effects. The regulation also mandated MFIs to regularly report loan details to the Credit Bureau. This resulted in an 8 percent66 reduction in the number of parallel loans, yet without disrupting MFI operations. To address growing concerns over rising interest rates, the government passed a Law On Restrictions on Usury Activities in the Kyrgyz Republic in 2013 to protect the rights of borrowers by capping interest rates in excess of the maximum allowable percentage as prescribed by the NBKR. This sparked a sharp decline in the interest rates charged by MFIs, to 31.0 percent in 2013, down from 38.8 percent in 2010.67 This law has also affected the number of MFIs in the country. The Kyrgyz MFI sector is highly concentrated; around 5 percent of the total 277 licensed micro finance institutions account for more than 85 percent of total MFI loans, and boast of having about 90 percent of the total number of borrowers 277 MFIs have been operating in the Kyrgyz Republic since October 2013,. That is a considerable reduction from the 454 reported in 2011. Of these, 21268 were microcredit companies (MCCs)69, among which two were Islamic institutions, while 6570 were microcredit agencies (MCA)71. 66. Microfinance Barometer – Convergences, 2014 67. Sector Assessment (Summary) – Multisector for Private Sector Development: Asian Development Bank, 2013 68. Microfinance in Kyrgyzstan: Legal Barriers to Development, Kalikova Associates, 2014 69. A licensed MFI established as a legal entity in any organizational and/or legal form of a commercial organization 70. Microfinance in Kyrgyzstan: Legal Barriers to Development, Kalikova Associates, 2014 71. A licensed MFI established as a non-commercial entity 34 Kyrgyz MFIs now service over 500,000 borrowers; and an estimated 16 percent of these borrow from more than one MFI. The 15 largest institutions account for 87 percent of the total MFI loan portfolio and 93 percent of the total number of micro borrowers.72 The top MFIs are relatively well-capitalized, having access to wholesale funding from domestic and international markets. MFI assets and loans have been growing since 2012, largely in lock-step with an expanding customer base From 2012–14, MFI assets grew at an average annual rate of 8.4 percent to $467 million. Despite strong growth, however, MFIs currently account for a modest 20 percent market share in the Kyrgyz financial sector by asset value. MFI assets amounted to 6.8 percent of Kyrgyz GDP in 2013. During the 2012–14 period, the value of loans provided by such institutions increased at an average annual rate of 11.4 percent, up to $370.1 million. This growth was mainly driven by the expansion of the MFI customer base, given that the average individual loan size has remained fairly flat. The quality of loans disbursed by MFIs have also improved in recent years, as evidenced by the marked decline seen in the NPL rate from 11 percent in 2012 to 7 percent in 2014. Figure 20 : Growth of MFI assets and loans ($ million) Figure 19 : Growth of MFI assets and loans ($ million) Assets ($mn) loans ($mn) 467 440 398 358 370 300 Number of MFIs 320 277 215 NPL Rate 11% 7.7% 7.0% Year 2012 2013 2014 Agricultural lending dominates MFI loan portfolios, with over a one-third share by value Agricultural lending dominates MFI loan portfolios, with over a one-third share by value In 2014, the agriculture sector accounted for around 37 percent of the total loans disbursed by microfinance organizations, compared with 18 percent for banks. This was followed by trade (20 percent), consumer loans (13 percent), the service sector (6 percent), and the In 2014, the agriculture construction sector industry (4 accounted for around 37 percent of the total loans disbursed by microfinance organizations, percent). compared with 18 percent for banks. This was followed by trade (20 percent), consumer loans (13 percent), the service sector (6 percent), and the construction industry (4 percent). Figure 20: Classification of MFI loans by sector (2014) Agriculture 20% Trade and commerce 37% 4% Consumer loans $370 million 6% Services 72. Sector Assessment (Summary) – Multisector 13% for Private Sector Development: Asian Development Bank, Construction 2013 and Mortgage 20% Others 35 In 2014, the agriculture sector accounted for around 37 percent of the total loans disbursed by microfinance organizations, compared with 18 percent for banks. This was followed by trade (20 percent), consumer loans (13 percent), the service sector (6 percent), and the construction industry (4 percent). Figure 21: Classification of MFI loans by sector (2014) Figure 20: Classification of MFI loans by sector (2014) Agriculture 20% Trade and commerce 37% 4% Consumer loans $370 million 6% Services Construction and Mortgage 13% 20% Others Islamic Banking and Finance. Opportunities across MSMEs in the Kyrgyz republic 27 36 04. Islamic Banking Opportunities among MSMEs Because 95% of MSMEs are unable to meet their financial needs through formal channels, a significant opportunity for Islamic banks exists in the Kyrgyz Republic. And over the next few years, the Islamic financing opportunity represented by these MSMEs is projected to be worth $342.2 to $456.3 million, with deposit potential in the range of $402.6 to $536.9 million. Access to finance for the MSME sector MSME penetration of formal financing channels in the country is low. Moreover, the banking facilities are largely concentrated in urban areas. Thus, easy access to finance is a major constraint for the MSME sector Kyrgyz MSME lending has picked up momentum over the last few years, driven by certain government initiatives, such as the introduction of preferential loans. Nevertheless, banking activity in the country remains weak because of the relatively small number of bank branches and ATMs. In addition, a pronounced lack of financial literacy and low confidence in the banking system has led the majority of the Kyrgyz population to opt for keeping their money at home rather than in banks. Bank funding in the country is among the lowest in Eastern Europe and Central Asia. According to a 2011 World Bank Group study, the Kyrgyz Republic ranked 24th among 2973 Eastern European and Central Asian countries pertaining to its access to bank credit for investment. Moreover, the country had the lowest levels of credit provided to the private sector over the same vast region (12.9 percent of GDP in 201174). Simply put, businesses rely less on bank financing and more on internal sources of funding. As a consequence, access to finance is a major issue for MSMEs in the country. Only 5 percent75 of MSMEs are able to adequately meet their financing needs through banks and other formal financial institutions. Moreover, those MSMEs able to do so are generally mid-sized enterprises concentrated in urban centers. The other two MSME categories, classified by their access to finance, are as follows: Under served MSMEs: Barring a few small enterprises with established track records, the financing needs of a •  significant portion of the country’s MSMEs are only partially met. These enterprises (representing 20–25 percent76 of the total number of MSMEs) avail themselves of formal financing (Islamic or conventional), which amounts to less than 20 percent of their requirements. Unserved MSMEs: These are the mostly small enterprises in either rural or urban areas with no access to formal •  sources for loans and funding. That is simply a result of banking products and services being unavailable in their locales. Thus this category of MSMEs largely relies on informal sources, such as family and friends. And it represents some 70–75 percent77 of the MSME population, who do not borrow at all for various reasons. Included among these is the fact that their Islamic beliefs prohibit them from paying interest on loans. 73. Asian Development Bank: Private Sector Assessment Update - Kyrgyz Republic 2013 74. Asian Development Bank: Private Sector Assessment Update - Kyrgyz Republic 2013 75. Primary Research 76. Primary Research 77. Primary Research 37 MSMEs in Kyrgyzstan mostly borrow byworking to meet followed loans forcapital requirements working capital purposes (54 percent), trade such informal lenders req financing (14 percent), and loans for capital expenditures, such as flexible repayment terms The needs of Kyrgyz MSMEs in terms of banking land, buildings services and and financial machinery requirements (11 percent) 78 . are basic. For most (irrespective of their business category) this means current accounts for day-to-day transacting and cash management services are their top The time taken by banks priorities, followed by loans for working capital purposes (54 percent), trade financing (14 percent), and loans for capital Other forms of financial support, such as leasing and factoring, 2 weeks to 1.5 months, w expenditures, such as land, buildings and machinery (11 percent) 78 . issuing letters of credit, payment cards, and guarantees have urgent funding requirem not yet become prominent. Hence, only a few banks offer such such as (and Other forms of financial support,services on and leasing factoring, a limited issuing scale). letters Moreover, oflow credit, the payment cards, and guarantees financial have not yet become prominent. Hence, only literacy quotient among MSME entrepreneurs in general, scale). Moreover, a few banks offer such services (and on a limited High collateral and guara the low financial literacy quotient among MSME entrepreneurs and their ambiguity in terms ofand in general, their ambiguity understanding applying to in terms of understanding operational and mi banks operational requirements, help to keep the demand for such financial requirements, products help to keep to a minimum. the demand for such financial products to a minimum. Figure 22: Purposes of loans taken out by MSMEs Figure 21: Purposes of loans taken out by MSMEs Figure 22: Why MSM 21% High interest rate d in urban centers. Already have loan by their access to 11% 54% No requirement of loa mall enterprises with needs of a significant 14% Religious belief y partially met. These of the total number Collateral issue nancing (Islamic or an 20 percent of their Problem with repaymen Working Capital schedule Trade Financing Loans for incurring capital expenditure Source: Primary Research small enterprises in ss to formal sources for Others (including personal loans) The high lending rate is t lt of banking products Source: M-Vector Survey of MSMEs, March 2015 not availing themselves o ocales. Thus this Source: M-Vector Survey of MSMEs, March 2015 The average lending rates ormal sources, such as Reasons behind the popularity of informal funding channels among Kyrgyz MSMEs organizations in 2014 we me 70–75 percent of 77 Reasons behind the popularity of informal funding channels among respectively; moneylende ow at all for various perof Because of the low levels of financial literacy in this segment, and their characteristically informal manner Kyrgyz MSMEs month . conducting 79 ct that their Islamic business (particularly in the rural areas), a large segment of Kyrgyz MSMEs prefer to acquire any additional funds they st on loans. require through informal channels. These business owners are more comfortable in dealing with informal aregiven lenders, MSMEs subject to ev Because of the low levels of financial literacy in this segment, and that funding by this route is based on acquaintanceship and trust. In addition, such informal lenders require limited-to-no- their characteristically informal manner of conducting business requirement is usually ar t working capital and offer flexible repayment paperwork terms, unlike financial institutions. (particularly in the rural areas), a large segment of Kyrgyz According to the results MSMEs prefer to acquire any additional funds they require Survey, 89 percent of the The time taken by banks to disburse loans varies from 2 weeks to 1.5 months, which is not an ideal fit vis-à-vis the often Republic had to provide through informal channels. These business owners are more nking services urgent and funding requirements of MSME businesses. comfortable in dealing with informal lenders, given that funding loan value80. The average irrespective of their by this route is based on acquaintanceship and trust. In addition, for firms in the services s High collateral and guarantee requirements prevent MSMEs from applying to banks and microfinance companies unts for day-to-day manufacturing and proce are their top priorities, 78. M-Vector Survey of MSMEs, March 2015 38 78 M-Vector Survey of MSMEs, March 2015 repreneurs in general, High collateral and guarantee requirements prevent MSMEs from erstanding operational applying to banks and microfinance companies and for such financial taken out by MSMEs Figure Figure 23: Why MSMEs avoid 22: Why applying MSMEs avoid applying for loans for loans 0% 10% 20% 30% 40% 50% High interest rates 36% Already have loans 28% 54% No requirement of loan 21% Religious beliefs 9% Collateral issues 9% Problem with repayment schedule 4% Source: Primary ResearchSource: Primary Research apital expenditure sonal loans) The high lending rate isThe mainlending the high reason ratecitedisby main reason theMSMEs cited for not by MSMEs availing for themselves of loans from financial institutions. The average lending not rates availing charged themselves by banks of and loans from microfinance financial institutions. organizations in 2014 were 22.4 percent and 38.5 percent, h 2015 The average lending rates charged by banks and microfinance respectively; moneylenders, on the other hand, charge 2 percent per month . 79 organizations in 2014 were 22.4 percent and 38.5 percent, ormal funding channels respectively; moneylenders, on the other hand, charge 2 percent among to even MSMEs are subject 79 terms. Their average collateral requirement is usually around 1.5 times that of large stricter per month . corporations. According to the results of the 2013 World Bank Enterprise Survey, 89 percent of the MSMEs receiving loans in the Kyrgyz Republic had to provide collateral averaging 187 percent of the loan value80. The average collateral value l literacy ranged in this segment, MSMEs are subject to even stricter terms. Their average collateral from 164and for firms in the percentrequirement services is usually to 237 sector1.5 around times that offor percent those large in the manufacturing and processing sector.81 corporations. nner of conducting business rge segment ofresult, Kyrgyz According to the results of the 2013 World Bank Enterprise As a the majoritySurvey, cameof 89 percent of the funds the MSMEs from receiving the retained loans earnings ofin the Kyrgyz existing enterprises and household savings, rather onal funds they require than banks and other formal financial institutions. Republic had to provide collateral averaging 187 percent of the usiness owners are more al lenders, given that funding loan value80. The average collateral value ranged from 164 percent ceship and A significant minority (9for trust. In addition, firms82 percent inofthe services Kyrgyz sector do MSMEs to 237 not percent deal withfor those the in the conventional banking system because their faith manufacturing prohibits them from paying interest on loans. and processing sector 81 . Although many of these MSMEs are creditworthy, they are excluded from being readily able to obtain funds from Islamic financial institutions either because Shariah-compliant products are unavailable or are not properly understood by the owners of these businesses; and in either case such applications tend to involve lengthy processes, making the execution of Islamic transactions cumbersome. Assessment Update - Kyrgyz Republic 2013 preference Bank Promoting of the Economy: for lending Inclusive to the Growth: Asian trade sector, Development Bank, leads 2014 to the lessened availability of funds for MSMEs operating in other of the Economy: Promoting Inclusive Growth: Asian Development Bank, 2014 sectors Of the total bank credit issued in the Kyrgyz Republic in 2014, almost 36 percent 83 was concentrated on the trade sector. Similar inequality Islamic Bankingprevails with respect and Finance. to access across Opportunities to finance for the MSMEs MSME in the sector, Kyrgyz with banks 29 preferring to lend to businesses republic involved in trade. 79. Asian Development Bank: Private Sector Assessment Update - Kyrgyz Republic 2013 80. The Kyrgyz Republic Strategic Assessment of the Economy: Promoting Inclusive Growth: Asian Development Bank, 2014 81. The Kyrgyz Republic Strategic Assessment of the Economy: Promoting Inclusive Growth: Asian Development Bank, 2014 82. M-Vector Survey of MSMEs, March 2015 83. National Bank of the Kyrgyz Republic 39 That is because few MSMEs from other sectors are profitable enough to afford the country’s high financing costs. Moreover, with bank loan terms averaging about two years, only frequent cash-flow investment projects (typically for those engaged in trade) are able to repay this type of short-term loan. Thus, the majority of MSMEs in other sectors are overlooked for financing by the formal financial institutions in the country. Obstacles for financial institutions in lending to MSMEs Their informal manner of conducting business A large number of Kyrgyz MSMEs operate in the informal sector. Most of them either do not report. or under-report revenues to regulating bodies. This effectively bars such businesses from accessing the financing they need since banks need to verify a business’ financial viability through registration, title documents and tax reporting. Most MSMEs (formal as well as informal) are owned and operated by a single individual or their family members. Such businesses rarely have a long-term plan or business strategy. They also tend to lack transparency and internal controls. All of this inclines banks to avoid lending to them, given the perception that the risk of loan defaults is high. Accessibility issues hinder expansion Banks in the Kyrgyz Republic face another major hurdle in the form of the country’s mountainous terrain. This has prevented several of the country’s banks from expanding beyond the few large accessible cities. Additionally, poor financial infrastructure prohibits commercial bank usage of the full technological suite in launching the most effective mobile or branchless banking services in more remote areas. In effect this means that banks are simply unable to service the majority of MSMEs, who operate outside of the major urban centers. Limited capacities of Kyrgyz banks Due to their limited financial literacy, Kyrgyz MSMEs do not have sufficient knowledge and information regarding financial products and solutions, particularly Shariah-compliant products. As well, the banking sector has not increased its investment in marketing activities and consumer education to counter this limitation. For instance, the investment in marketing activities by EcoIslamicBank (the only Islamic bank operating in the country) is noticeably low, as is reflected in its slow rate of customer acquisition. Also, the banking sector generally does not have an adequate number of skilled employees or the technological resources needed to scale up operations or improve operational efficiency. Supply side analysis – penetration of Islamic Banking into the MSME sector The Islamic banking sector in the Kyrgyz Republic is underdeveloped. As noted above, there is only one fully-fledged Shariah-compliant bank along with three Islamic MFIs operating in the country. Thus despite the favorable perception such lenders enjoy (especially among MSMEs), their product portfolio does not match conventional bank offerings. The Islamic banking sector in the Kyrgyz Republic is underdeveloped. As noted above, there is only one fully-fledged Shariah-compliant bank along with three Islamic MFIs operating in the country. Thus despite the favorable perception such lenders enjoy (especially among MSMEs), their product portfolio does not match conventional bank offerings. EcoIslamicBank's banking products are focused on both individual (retail segment) and corporate (especially small businesses) customers. And within the corporate banking segment, the bank concentrates on the MSME group in particular, 40 as is evidenced by the bulk of the loans in its portfolio being small loans. Other products offered include deposit accounts, safety desposit boxes, and currency exchange services plus product financing. The bank also provides trade finance and bank guarantees to businesses operating in the country MFIs, by comparison, offer group loans (the minimum amount being $65 for 3-18 months), unsecured loans (up to $3,200 over the maximum tenure of a year), secured loans (up to $31,200 for 3 months to 3 years), home purchase and home improvement loans (up to $15,500 for a maximum of 10 years), and education loans (in collaboration with USAID). Most of these products are structured based on Mudarabah and Murabaha principles. Other Shariah- compliant financing products based on more complex structures are not available, though, due to the under-developed banking infrastructure and lack of personnel with sufficient know-how pertaining to Islamic banking principles and structures. Islamic banking potential in the MSME sector The Islamic banking sector could potentially fill a funding gap ranging between $342.2 and $456.3 million. At present, there are a total of 362,16384 MSMEs operating in the Kyrgyz Republic. Of these, only 5 percent (generally mid- sized) have sufficient access to finance through formal channels to be considered financially well-served. By contrast, 20-25 percent85 of these enterprises (generally small businesses) have limited financial access and are financially underserved, while another 70-75 percent86 (generally micro and small businesses) have little access to finance to be deemed financially un-served, at least by formal financial institutions. The funding potential for Islamic banking in the MSME sector seen from both bull and bear case standpoints: The bull case scenario: This rests on the assumption that Islamic banking institutions prove capable of implementing a model which extends branch networks to all areas, urban and rural alike; and that they further, improve understanding and knowledge of Shariah-compliant products amongst SMEs, while hiring skilled professionals who can structure Islamic products, and offer competitive Shariah-compliant products under more favorable conditions (for instance with flexible tenure and collateral requirements, at lower cost, and with less documentation) compared to conventional banks. In such a scenario, approximately 80 percent87 of MSMEs have already exhibited their interest in availing themselves of Shariah- compliant financing. • In the above scenario, Islamic bank penetration over the next few years is estimated as capable of reaching 80 percent of the un-served and underserved MSME market (which, again, represents 95 percent of the total number of MSMEs). At an average loan size of $1500 each, the resulting aggregate value would be $412.9 million. The bear case scenario: Assumes that the penetration of Islamic banking remains primarily limited to urban areas, offering more diversity in Islamic-structured products while making loan processing easier for MSMEs. • Given the above conditions, Islamic banking institutions have been estimated as capable of tapping into at least 60 percent of the un-served and under-served market (meaning 95 percent of the total number of MSMEs); thus, with an average loan size of $1500 each, the resulting value would total $309.6 million. Islamic banks may also expect to cannibalize or convert the existing well-served MSME portfolios of conventional banks anticipating that these MSMEs might migrate elsewhere for better products or quality of services. To be able to achieve this, however, Islamic financial institutions would have to ensure that they are able to diversify their product portfolios and 84. Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 85. Primary Research 86. Primary Research 87. Primary Research 41 d banking infrastructure and better products or quality of services. To be able to achieve this, ow-how pertaining to Islamic however, Islamic financial institutions would have to ensure that they are able to diversify their product portfolios and customize these offerings to suit the financing requirements of otential in the customize these offerings this segment, as well as offer an end-to-end banking solution to to suit these the financing businesses. Assumingrequirements of this a penetration ratesegment, of 60–80%,asthe well as offer an end-to-end banking solution fundingapotential to these businesses. Assuming within penetration ratethis category of of 60–80%, MSMEs the fundingcould be worth potential within this category of MSMEs could be worth $32.6–$43.5 million.$32.6–$43.5 million. otentially fill a funding gap Thus, the total funding potential for Islamic banking in million. Thus, the total funding Kyrgyzstan potential forwould likely Islamic range from banking $342.2 million in Kyrgyzstan in alikely would bear case range from $342.2 million in a bear case 6384 MSMEs operating in the scenario to $456.3 million in a bull case scenario. scenario to $456.3 million in a bull case scenario. ercent (generally mid-sized) ough formal Figurechannels to be potential 24 : Funding Figure 23 : Funding potential By contrast, 20-25 percent85 businesses) have limited underserved, while another MSME d small businesses) have little UNIVERSE MICRO, SMALL & MEDIUM ENTERPRISES ncially un-served, at least by nking in the MSME sector UNSERVED UNDERSERVED WELL SERVED andpoints: Current Market 70-75% 20-25% 5% the assumption that Scenario ~262,568 ~81,487 ~18,108 apable of implementing a Avg. Loan 1,500 1,500 3,000 rks to all areas, urban and Amount (USD) mprove understanding and Bear Case 60% 60% 60% oducts amongst SMEs, Penetration ho can structure Islamic Bull Case Penetration 80% 80% 80% riah-compliant products or instance with flexible $236.3mn $73.3mn $32.6mn Bearish Market Scenario at lower cost, and with less $309.6mn $32.6mn New to bank Conversion ntional banks. In such a Total Funding Potential: $342.2mn 7 of MSMEs have already hemselves of Shariah- Bullish Market $315.1mn $97.8mn $43.5mn Scenario $412.9mn $43.5mn New to bank Conversion ank penetration over the next Total Funding Potential: $456.3mn of reaching 80 percent of MSME market (which, again, l numberThe deposit potential of MSMEs). At an for Islamic banking from MSMEs could be $402.6 to $536.9 million over the short- to mid-term future. the resulting aggregate value The deposit potential for Islamic banking from MSMEs could be The loan-to-deposit ratio of the $402.6 tobanking sector over $536.9 million in thetheKyrgyz short- to Republic mid-term averaged future. 85 percent over the last three years (2012– 14). Assuming at the penetration this continues at the same level, the resulting depository potential for Islamic banks within the MSME of Islamic sectoroffering o urban areas, more in a bull The loan-to-deposit case scenario, where Islamic ratio of the penetration banking banking sector in the is high inKyrgyz both the urban and rural environments, and the ucts while making loan remains averaged regulatory environment Republic favorable85 percent for Islamic over the last would banking, three years (2012– be $536.9 million over the next few years. 14). Assuming this continues at the same level, the resulting On the other hand, depository potential for Islamic banks within the MSME sector mic banking institutions haveif Islamic banking continues to lack strong penetration of the country’s rural areas, its deposit potential in a bull case scenario, where Islamic banking penetration is high ping intois at expected of to about $402.6 million, (applying the same loan-to-deposit ratio). to amount least 60 percent in both the urban and rural environments, and the regulatory market (meaning 95 percent Figure 25 : Depository environment Potential remains Figure 24 favorable : Deposit for Islamic potential banking, would be of asset (borrower MSME) q thus, with an average loan $536.9 million over the next few years. collections mechanism to en value would total $309.6 Increased focus on non-fina nnibalize or convert the On the other hand, if Islamic banking continues to lack strong MSMEs overcome the challe os of conventional banks penetration of the country’s rural areas, its deposit potential is lack of knowledge regarding ht migrate elsewhere for expected to amount to about $402.6 million, (applying the same methods of conducting busi loan-to-deposit ratio). management), banks should assistance in the form of non m Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 instance, MSME toolkits, ass guidance on legal and tax ru on other related topics, such help these MSMEs function Islamic Banking and Finance. Opportunities across MSMEs in the Kyrgyz republic 31 creditworthiness. Expanding branch networks 42 and services: Branch penetra Strategic operational adjustments can help both conventional and meaning smaller towns and Strategic operational adjustments can help both conventional and Islamic banks target MSMEs more effectively The regulatory and legislative framework: The government has made efforts to strengthen the regulatory environment by way of amendments that laid down key principles of Islamic Banking in 2009 and 2013. Detailed instructions and regulations relating to Islamic finance, credit institutions and transactions are provided in the normative and legal acts of the NBKR (30 normative and legal acts). As of today, the normative and legal acts of NBKR stipulate requirements on licensing, corporate governance, risk management, model agreements standardization and Procedure for specific types of transactions, which comply with the Islamic principles of financing. To implement the pilot project on introduction of Islamic banking and finance principles, a separate package in normative and legal acts, including taxation issues, has been developed since 2006 for EcoIslamicBank. To address the issue, certain amendments were made in normative and legal acts of NBKR, which mandated the establishment of a Shariah Council at Islamic banks and those banks that would like to establish Islamic windows in their existing conventional bank operations. This council would be responsible for compliance of banking operations with Islamic principles. However, the Shariah Governance Regulatory Framework (SGRF) in Kyrgyzstan is still in the development phase. As discussed earlier, in comparatively matured Islamic finance markets such as Pakistan and Malaysia, regulatory bodies assisted the Central Banks by establishing Shariah Advisory Councils to monitor Shariah operations of banks. This has allowed Central Banks and their Shariah Council to implement the principles of Islamic Banking. A robust and comprehensive SGRF is required to communicate Shariah governing policies to the Islamic financial institutions and closely monitor all operations from management to product development of the Islamic financial institutions assuring strict adherence to its regulations and policies. The framework should also develop a roadmap for policy formulation and implementation, in addition to drafting guidelines for compliance of policies required by the central bank. From a practitioners’ perspective, the Kyrgyz Republic is accurately following the roadmap to building a Robust Islamic Banking eco system. By looking at more developed Islamic Banking economies the Kyrgyz Republic can build on its existing Islamic Banking regulations and work closely with banks in order to formalize said ecosystem. Human capital and talent development: Unsurprisingly, there is a shortage of quality talent in the Kyrgyz Islamic finance industry. Well-educated and experienced human resources within it are, unsurprisingly, in high demand. That is why banks must focus on developing the right talent, offering development opportunities, and providing adequate training if they are to stand the best chance of retaining their human capital. By addressing these issues, they should also be able to realize a significant part of their untapped potential. Reduction of loan-processing time: The time taken by banks to process and disburse loans is a major hurdle miring access to MSME financing. Thus banks need to streamline their administrative processes to ensure that loan application procedures become less cumbersome in terms of both the documents required and processing time taken. To accomplish this, frontline staff need to be provided with predictive tools, and back-end support to ensure faster loan processing. Effective segmentation, targeting and evaluation of MSMEs: Banks need to frame better methods of segmenting and targeting potential MSME customers and evaluating the lending risk they represent. Rather than resorting to a one-size-fits- all business model, they must adopt differentiated customized business models and processes for varied MSME targets. In addition, their branch staff needs to proactively approach and engage MSME entrepreneurs rather than passively relying on these people to approach the banks. In particular, banks need to develop a more MSME-specific risk assessment and underwriting model to assess the credibility of MSMEs via bank statements, utility payments, property lease agreements, technology and/or other such methods. There is also a need to apply cash flow forecasting tools, and non-financial approaches, such as behavioral scoring, to better understand the risks. Effective targeting should parallel continuous monitoring of asset (borrower MSME) quality bolstered by an effective collections mechanism to ensure low default rates. 43 Increased focus on non-financial extension services: To help MSMEs overcome the challenges they face (for instance their lack of knowledge regarding financial products, their informal methods of conducting business and inefficient financial management), banks should consider providing increased assistance in the form of non-financial extension services. For instance, MSME toolkits, assistance in framing business plans, guidance on legal and tax rules and regulations, and information on other related topics, such as finance and management, would help these MSMEs function effectively while improving their creditworthiness. Expanding branch networks and offering non-borrowing products and services: Branch penetration in the country is relatively low, meaning smaller towns and rural areas often do not have bank branches in their immediate vicinities. Therefore, increasing the number of branches is essential to increase banking opportunities in the Kyrgyz Republic. Additionally, banks should evaluate the viability of offering non-borrowing banking services and products such as current and savings accounts, cash management or payment management, payroll management, and other fee-based transaction banking services. Widen the range of products available: As Kyrgyz MSME sector develops further, the range of Islamic products available in the country would have to become broader. A few examples of Islamic banking products are explained below: • Simple products: Trade finance products such as LC (letter of credit) Musharkah and letter of guarantee which will promote international trading and allow banks to act as guarantors and help facilitate businesses; asset finance products such as securitized loans and lease finance which will allow MSMEs to participate in economic development as well as infrastructure development of the country. Complex products: Complex working capital loans such as supply chain financing (SCF) on Bai Ajal or Murabaha. •  SCF is a short-term credit facility that optimizes working capital by allowing businesses to lengthen payment terms to their suppliers. It facilitates business expansion and mitigates payment risk. 44 05. Conclusion Although Islamic banking in the Kyrgyz Republic is still in its infancy, there is strong interest in Shariah-compliant financing, particularly among MSMEs. With continued development and improvement in the regulatory and legislative environment, and in strengthening institutional capacities to meet growing MSME demand, the Islamic financing market opportunity is estimated to reach between $342.2 and $456.3 million going forward. Despite the political upheavals and volatility within Kyrgyz banking generally as a result of irregularities and legislative violations, the sector stabilized in recent years after the implementation of regulatory measures by the NBKR and the introduction of an effective development initiative (the Medium-Term Development Program) by the government. At present there are 24 commercial banks operating in the country, with a combined asset base of $2.5 billion (as of 2014). Foreign banks account for 45 percent of the total assets. These are followed by private domestic banks (with 34 percent) and state-controlled banks (with 18 percent). Meanwhile, the only Shariah-complaint bank, EcoIslamicBank, accounts for the remaining 3 percent of the assets88. Although the level of banking sector activity from 2009 through 2011 remained stagnant due to structural deficiencies, regulatory and legislative reforms continued apace, strengthening the system as a whole. This resulted in a significant increase in banking activity during 2013 and 2014, with both the industry’s loan book and deposit base growing at an average annualized rate of more 20 percent. The Islamic banking sector, in particular, has likewise witnessed strong growth over the past few years. Its financing activity increased at a CAGR of 18.9 percent, while its deposit base grew at an even more rigorous CAGR of 42.1 percent from 2010 to 201489. Although the Kyrgyz authorities introduced certain changes to the banking law (in 2006, 2009 and 2013) to facilitate the functioning of Islamic banks, the government should attempt to improve the regulatory landscape to boost development of the sector in view of the increasing demand for Islamic finance by local businesses. About 5–6 percent of the total population (about 10 percent in the southern provinces and 5.4 percent in the north)90 have signaled their interest in Shariah-compliant financing. This is even higher among businesses, with 80 percent91 of MSMEs expressing strong interest in borrowing from Islamic financing institutions. As a result, several conventional banks, such as Kyrgyzkommertsbank), RosinBank, and Bai -Tushum Bank, are now evaluating the feasibility of setting up Islamic banking operations within their businesses in the country. At the same time, high costs and their lack of capacities have curtailed penetration of MSMEs by the Islamic banking sector. In fact, even the large conventional banks have not been active in lending to SMEs in the Kyrgyz Republic. Total lending by the banking system to SMEs stands at only about 10 percent of the total ($148.1 million in loans and $174.2 in deposits), despite the remarkable fact that the segment accounts for approximately 99 percent of all commercial establishments in the country. 88. National Bank of Kyrgyz Republic 89. National Bank of Kyrgyz Republic 90. Primary Research 91. Primary Research 45 At the same time, high costs and their lack of capacities have curtailed penetration of MSMEs by the Islamic banking sector. In fact, even the large conventional banks have not been active in lending to SMEs in the Kyrgyz Republic. Total lending by the banking system to SMEs stands at only about 10 percent92 of the total ($148.1 million in loans and $174.2 in deposits), despite the remarkable fact that the segment accounts for approximately 99 percent of all commercial establishments in the country. At the present time, only 5 percent93 of the 362,163 MSMEs have adequate access to formal financing. Otherwise, the financing requirements of the remaining MSMEs are either only partially met by financial institutions (20-25 percent of these businesses are financially under-served) or not met at all (70-75 percent of the total number of MSMEs do not have any access to financial support)94. To effectively target the MSME sector, Islamic banks need to focus on expanding their reach while diversifying product offerings, training their workforces regarding Islamic banking products and MSME banking, and implementing SME-specific risk assessment tools while simplifying loan procedures. However, if Islamic financing institutions are able to capitalize on the positive interest in Shariah-compliant banking through such initiatives, then they stand to tap into a funding opportunity estimated at $342.2 to 456.3 million within these un-served, underserved, and, indeed, well-served categories of MSMEs over the next few years. Research Scope and Methodology IFC, a part of the World Bank Group, provides a combination of advisory and investment services to MSMEs through its Financial Institutions Group (FIG). These services are offered with the following objectives: Advisory Services:  uilding the capacity of financial institutions in strategy, market segmentation, credit risk management, and product • B  development by taking new approaches and introducing new systems to scale up their financing for MSMEs on a sustainable basis Promoting sub-sector focus, especially on women-owned SMEs, sustainable energy SME projects, agricultural SMEs, •  and leasing • Raising awareness about best practices in the SME finance space • Developing credit reporting infrastructure based on country needs • Supporting the development of secured transactions, collateral registries, and legal and regulatory frameworks • Building the capacity of public/private stakeholders through advice and training Investment Services: • Making equity investments in financial institutions/equity funds for SMEs • Funding lines to expand investment and working capital lines, especially in illiquid markets  lending finance options to support the expansion of IFC risk appetites, for example; extending grace periods, • B performance-based pricing, subordination, higher risk/lower security or in limited cases, local currency positions) for selected projects 92. Primary Research 93. Primary Research 94. Primary Research 46 • Increasing the focus on underserved segments, for example pertaining to gender, fragile/conflict, agriculture, climate Providing risk sharing facilities/partial credit guarantees to enhance risk- taking capacity and offer capital relief via low- •  risk weightings; avoiding FX mismatches and encouraging domestic resources for SME financing. The primary objective of this report is to enable IFC to determine the market opportunity for Islamic finance in the Kyrgyz Republic. The main questions the report addresses are: • What is the overall number of MSMEs and businesses in the country and how are these establishments structured? Is Islamic banking there mature enough to adequately cater to the finance and banking needs of MSMEs and other •  businesses? • What are the products and services that MSMEs want from banks? • What is the size of the MSME market opportunity for Islamic finance? To get data on the above, we devised a questionnaire to be used in discussions with industry experts (Appendix – II). 47 Appendix Fundamental Concept behind Islamic Laws & Principles The basic belief around which all Islamic laws and principles revolve is that the whole universe has been created and is controlled by only one God. He created man and appointed him as His vice-regent on Earth to fulfill certain objectives. The assumption behind this belief is that human reason, despite its immense capabilities, cannot claim to have the unlimited power needed to reach absolute truth and justice. Rather it has definite limits beyond which it either cannot function fully or is bound to make mistakes. It is thus evident that the sphere of the work delegated to humanity by its Creator is not unlimited. There are areas where human reason simply cannot give appropriate guidance or may fall prey to errors. And it is in these areas that Allah Almighty, the Creator of the universe, has provided guidance through His revelations sent down to His prophets. On the basis of these divine revelations it is the firm belief of every Muslim that the commands given through the last Messenger are to be followed and cannot be violated or ignored on the basis of one's rational arguments or inner desires. Therefore, all human activities must always be subject to these commands and must work within the limits prescribed for them. Islam is not confined to some moral teachings, some rituals or some modes of worship. Rather it contains guidance pertaining to every sphere of life, including socio-economic fields and activities. Obedience by the servants of Allah is required not only in worship, but also extends to their economic activities, even though this may be at the expense of some apparent benefits -- because these apparent benefits may go against the collective interest of the society. The origin of the Islamic banking system can be traced back to the advent of Islam when the Prophet himself carried out trading operations for his wife. The “Mudarbah” or Islamic partnerships have been widely appreciated by the Muslim business community for centuries; but the concept of “Riba”, or interest, gained very little traction in regular or day-to-day transactions. Early experiments with Islamic banking took place in Malaysia in the mid-1940s and in Pakistan in the late 1950s. However, the first Islamic banking model was introduced by Mit Ghamr Savings Bank in Egypt in 1963. Ahmad Al Najjar was the chief founder of this bank and the key features it introduced were profit sharing on the non-interest based Shariah philosophy. In 1974, the Organization of Islamic Countries established the first fully Islamic bank called the Islamic Development Bank. Its basic business model was to provide financial assistance and support on profit sharing. By the end of 1970s, several Islamic banking systems had been established throughout the world, including the first private commercial bank in Dubai (1975), followed by the Bahrain Islamic Bank (1979) and the Faisal Islamic Bank of Sudan (1977). By 2003 Islamic banks had become increasingly popular in the Arab world and in countries like Malaysia. In more recent times, Shariah-compliant finance has been the fastest-growing area of finance globally and has evolved into two forms: • Restructuring of the whole financial system of the country in accordance with Shariah principles. • Islamic financial institutions operating alongside conventional financial institutions, either autonomously or as ‘windows’ within conventional banking set-ups. By April 2013, there were more than 500 financial institutions worldwide that were either fully Islamic or provided Islamic financial products to their customers. Beyond these, there are several hundred Islamic investment banks and insurance companies, or takaful, 48 The following products are available under Islamic finance: Islamic forms of deposits Mudarabah: This is a partnership between the "capital provider" and the "entrepreneur," whereby the former receives a share of the profit against his capital and the latter receives a share of the profit against his labor and management. Wakala: This is one of the contracts used in Islamic banks to invest money. Under Wakala, the client gives the bank the authorization to invest his money in Islamic activities for a certain percentage of the capital to be deducted from realized profit. Islamic types of financing Murabha: This is defined as ‘a sale at the original price plus a profit’. In Murabaha, the bank buys and owns the commodities identified by the customer, including consumer goods and production assets according to specifications determined by the customer. After assuming ownership, the bank sells these goods to the client for a price including the purchase cost plus a determined profit against the efforts exerted for the purchase and the expenses borne by the bank. The commodity is then delivered to the customer within the required specifications. The client pays for the commodity in periodic installments, subject to the contract of sale. Murabaha sale is offered to companies by providing local or foreign raw materials, equipments and machinery with the aim of establishing and expanding production lines. Musharkah: In Musharkah financing, the client requests financing for a particular project where the bank shares the anticipated profits or losses of the project with the client. The Musharakah contract is done according to a previously arranged, mutually agreed upon set of distribution rules and principles, in compliance with Shariah. Unlike the case of loans, in Musharkah financing, there are no interest rates. The concept of ‘Musharkah financing’ is based on the idea that the bank provides the financing required by the client for a particular project without a fixed interest rate, contrary to loans. The realized financial outcome is shared between the bank and the customer, as per the percentages they have mutually agreed. Ijara: An Ijara lease is defined as a contract that allows the customer to lease a particular asset and utilize it for a specific period of time. After completion of the specified period, the asset can be owned by the customer. This financial lease is adopted in response to the customer's inability to buy a particular asset in cash. Istisna'a: This is a contract under which the client asks the bank for construction of a manufacturing unit with certain specifications. The bank has to meet the desire of the client and to provide that unit according to specifications set by the client who then pays the price in installments. The above products have various applications in diverse fields, including within the corporate sector. Of these, Murabaha and Ijara are particularly used by retail customers for buying or leasing cars, home, electronic appliances and home furniture. 49 Questionnaire MSME access to finance: • How do you define micro, small and medium enterprises in your institution? (by number of employees?) • How do MSMEs typically access finance in the Kyrgyz Republic? Is it easy for a MSME to obtainl financing? • If access to finance is limited, what are the main reasons why? • Does access to finance vary by the type of enterprise, sub-segments or sector? • Does what is required mutate with the various segments? Do micro and medium differ significantly when it comes to getting funded? Are manufacturing units, for instance, less reliable than service enterprises? Products offered by the institution: • What are the comparable market shares of the various banks based on their loans and deposit bases? • Do you offer Islamic banking services? • If yes, what products and services do you offer, and to which segments? • To what degree is your business exposed to MSME’s? (in terms of total loans disbursed/amount of loans disbursed) • If you do not offer Islamic banking products, what other products and services does your institution offer to MSME’s at present? What are the products most eagerly sought by the various MSME segments? • What are the documentation and approval procedures? What guarantees/collateral does your institution demand? • In your opinion, are the products now on offer by the banking adequate to meet MSME needs – presently and in the years to come? • In your opinion what are the products most likely to be in high demand looking out five years? • What challenges do you face when dealing with the MSME sector? Islamic banking and MSMEs: • How many full-fledged Islamic banks operate in the Kyrgyz Republic? What are their names? • How many conventional banks operate Islamic windows? Any detail you can provide on this aspect would be appreciated. • What are the comparable market shares of these Islamic banks (both full-fledged and ‘window’ operations), as informed by loans, financing and deposits? • How far up the development curve is Islamic banking in the Kyrgyz Republic? • To what degree are the businesses of Islamic banks exposed to MSME’s? (for instance, in terms of total loans disbursed/amounts of loans disbursed) • What factors hamper the growth of Islamic banking in the country? • Has the government undertaken any initiatives to promote its development? • What size is the Islamic banking business and presence, as indicated by assets, loans and deposits? • How would you classify Islamic loans, by sector? 50 • What percentage of loans extended become non-performing in Islamic finance? And what is the percentage, among these, of NPLs specifically linked to Islamic loans granted to MSMEs? • What of the current Islamic banking regulatory environment? (We need to understand the current rules, how they compare other markets, and what, if any, amendments might be expected) • What initiatives has the central bank initiated to promote Islamic bank development in the country? Has any effort been made, or plans mooted, specifically to encourage Islamic bank lending to the MSME sector? • Do Islamic banks/financial houses have a significant role to play in MSME sector development? ­ If not, could you cite some of the reasons for the low adoption pace of Islamic finance products in this segment? What might be the best strategy options to counteract these problems? • Do these banks have products specially designed for the MSME sector? What are the different products/services they now offer? • Is there real latent demand for Islamic finance products on the part of Kyrgyz MSME enterprises? (Y/N – and why?). • What do most MSMEs require, by category, in terms of their financing needs? Does this vary much by sub-segments within their sector? ­  • Specifically, what are the most promising MSME sectors where Islamic banking products are most likely to play a major role? • If yes, which specific products would be best suited to which segments, in terms of the overall offering? • What, in your opinion, are the biggest opportunities for banks in the MSME sector, and specifically for Islamic finance products? 51 Bibliography Annual publication on Small and Medium Businesses in the Kyrgyz Republic: National Statistical Committee of the Kyrgyz Republic, 2014 Sector Assessment (Summary) - Private Sector and Finance: Asian Development Bank, 2010 Brief Statistical Handbook 2011-2013: National Statistical Committee of the Kyrgyz Republic, 2014 Private Sector Assessment Update - The Kyrgyz Republic: Asian Development Bank, 2013 Consumer Goods Market in Kyrgyzstan: BISNIS, 2008 The Economist Intelligence Unit Corruption Perceptions Index: Transparency International, 2014 GDP growth (annual %) - The World Bank website The Kyrgyz Republic: Economy - Excerpted from the Asian Development Outlook 2015: Asian Development Bank Doing Business 2015: Going Beyond Efficiency - The World Bank Group Annual Report: National Bank of Kyrgyz Republic, 2013 Kyrgyz Republic Partnership Program Snapshot: The World Bank Group, October 2014 Financial Access Survey: International Monetary Fund, 2013 National Bank of Kyrgyz Republic website Country profile – Kyrgyzstan: New Agriculturist, September, 2010 The Kyrgyz Republic Strategic Assessment of the Economy: Promoting Inclusive Growth: Asian Development Bank, 2014 Microfinance Barometer – Convergences, 2014 Sector Assessment (Summary) – Multisector for Private Sector Development: Asian Development Bank, 2013 Microfinance in Kyrgyzstan: Legal Barriers to Development, Kalikova Associates, 2014 52 Notes 53 Notes 54 Notes 55 Xavier Reille Financial Institutions Group Advisory Services Manager Europe, Midle East and North Africa E-mail: xreille@ifc.org Kaiser Naseem Program Manager Banking Advisory Services Midle East and North Africa E-mail: knaseem@ifc.org Bishkek, Kyrgyz Republic 720040 Business Centre Orion, 4th Floor Tel.: +996 312 626162 Fax: +996 312 626165 February, 2016