At the International Islamic Business and Finance Summit, which took place on 25-26th of June 2009 in Kazan (Russia), IFC Linova presented a model of a Russian Islamic financial system consisting of financial institutes for large, medium and small businesses.
A credit cooperative institution was presented as one of the basic elements of the system, which is aimed at providing deposit and credit services, and small business financing to the public. The institutions can have different forms: credit, consumers’, agricultural, and housing cooperatives.
The main idea of a credit cooperative consists in that funds of the public are pooled in order to manage them in the most effective way to generate profit and meet the needs of the public in obtaining credits, getting commodities or services.
The history of development of credit cooperatives dates back to 1849, when a mayor of a small Bavarian city, Friedrich Raiffeisen, established the first credit cooperative. Today the Movement of Raffeisen includes 90,000 cooperatives in almost 100 countries across the world with around 500 million shareholders and total capital of over US$ 4.3 trillion.
Today the world movement of credit cooperatives is as follows: France – 90% of the population use services of credit cooperatives, USA – 30% of adult population are members of credit cooperatives (9,935 cooperatives with US$ 659 billion in their assets), Ireland – 70% of the population is involved in 534 cooperatives, Poland – 4.5% of the population is involved in credit cooperatives (90 cooperatives and over 1,400 branches with more than US$ 80 million in their assets), Lithuania – 1.2% of the population is involved in 53 credit cooperatives with 53 million euro in their assets.
Before the revolution in 1917 Russia used to take leading positions in the world in the number and diversity of credit cooperative institutions. In 1883 there were 981 small credit institutions, and in 1914 – 13,000 cooperatives with the total number of shareholders of about 8 million people. To date there are some 750 credit consumers’ cooperatives with more than 450,000 shareholders.
In general development of microfinance organizations is supported by governments of the Russian Federation, Republic of Tatarstan, as well as by international public organizations. Thus, during the 72d plenary session of the UN General Assembly on 19th of June 2008 a resolution was adopted on Role of microcredit and microfinance in poverty eradication No63/229, where member states of the United Nations, the Bretton-Wood institutions (World Bank and International Monetary Fund), and regional development banks were invited to support financially and technically in a coordinated manner the efforts of developing countries in capacity-building for microcredit and microfinance institutions.
The Islamic economic model, like the traditional one, has in its store mechanisms of microcrediting: credit cooperatives are well developed in countries such as Egypt, Morocco, Indonesia and Malaysia. This is due to the fact that regulations of activities of a credit cooperative are of optional character – these, unlike banking institutions, can accept deposits and extend loans on interest-free basis, if there are corresponding provisions in their charters.
In the Russian Federation activities of a credit cooperative are regulated by the Civil Code, federal laws on credit and consumer’s cooperatives, agricultural and consumers’ cooperatives, housing cooperatives and consumers’ cooperatives. In addition, there is being prepared a law on credit cooperatives.
Economic activities of a credit cooperative, like of any other financial institution, have 2 lines: funds raising (contributions of members, external borrowings, sponsorship, etc.) and placement of the funds (loans to members, external investments).
Despite the fact that credit cooperatives are microfinance institutions, internal process of their economic activities, like of a banking institution, must be strictly defined. Thus, the management of a credit cooperative in its work should not only be guided by its own experience and the Charter, but follow internal regulations, which define share, debt, investment, dividends, reporting and tax policies of the cooperative.
Disregarding of this requirement will inevitably lead to bankruptcy of a cooperative, with its directors made accountable; this can well be seen if one analyzes activities of financial pyramids, which were just attracting funds, without further placement of the funds to generate profits.
According to the prohibitions under Sharia law, members of a cooperative – shareholders and borrowers – are in fact parties of its investment activities; they share both profits and losses with the cooperative and should be made aware of this before actually becoming members of the cooperative, in order to avoid further claims.
As for Islamic finance principles, these are realized in a cooperative in the following way.
Taking into account restrictions on types of activities of credit cooperatives, which may not extend loans, but to members of the cooperative, may not have a share in the authorized capital of business companies or partnerships, issue or buy emissive securities, and trade or produce – the main Islamic finance instruments of cooperatives are mudaraba, salam, wadiah yad damanah, ijara, qard ul hassan, and securitization of these contracts through sukuk issuance.
According to the aims of a cooperative, contributions of the members can be structured in the way of raising funds into their personal accounts within the cooperative (wadiah) and management of the funds by the cooperative (mudaraba). External borrowing is processed in the same way as mudaraba transactions.
The cooperative uses funds, that are actually placed under its management, to provide interest-free social loans (qard ul hassan) to its members, to invest and finance members’ activities – legal entities (murabaha, salam, ijara). Participation of a cooperative in economically advantageous projects of external companies can be done though issuance of state and municipal bonds (sukuk) under a certain project of the issuer, for example federal programmes, Olympiad, Universiade (World Student Games).
As a requirement under Islamic principles, a Zakat fund is established, contributions to which are made upon general consent of cooperative’s members. Their consent is expressed in a special decision made during a general meeting and is reflected in the Charter.
To perform the abovementioned operations, a detailed elaboration of all the procedures and application of banking technologies is required, as the cooperative becomes kind of a small retail and investment bank, save that it does not perform payment operations.
Undoubtedly, it can be quite challenging for founders of a cooperative and representatives of small business to develop this documentation on their own and ensure its proper execution, as they may lack funds, knowledge and experience. Employment of highly skilled banking personnel is also not available and that increases risks of the microfinance institution.
The way out of the situation consists in outsourcing of the most part of cooperative’s functions – this is encouraged by the existing legislation and makes it possible for nonmembers to perform functions of executive, credit, investment, supervising bodies.
Here, the most optimal scheme for interaction would be commercial concession (franchising), where the franchiser (association, union, cooperative of the second level) forms and grants to the user (cooperative) the right to use trademarks, documentation, technologies, for a remuneration, and provides training to the personnel, as well as organizational, supervising and other services.
As a result there can be formed a two-level federal net of credit cooperatives, where cooperatives of the 1st level perform functions of an operational office, and cooperatives of the 2d level perform the main financial functions – this will help considerably reduce management expenses.
Going back to the problem of the Russian Islamic financial system, raised by IFC Linova during the International Islamic Business and Finance Summit, it should be mentioned that an Islamic credit cooperative can not just work on its own. It needs to have a Sharia board, which can pass a valid resolution, to ensure Sharia-compliance of its activities, a Sharia arbitration to settle disputes, a bank or a non-bank credit organization to perform payment operations, as well as specialized educational institutions to provide training to the personnel, and a mutual insurance company.
Director of Legal Department
IFC Linova LLC
About IFC Linova – Islamic finance consulting
Established in 2006 and based in Kazan, Russian Federation, IFC Linova is one the first companies in Russia and CIS countries to carry out activities in the area of Islamic finance. The main objective of IFC ‘Linova’ consists in providing of quality consulting services in Islamic finance: development of Islamic financial products based on local legislation, development of business-models for financial institutions to operate in accordance with Islamic principles in the territory of Russian Federation and CIS countries. An important business activity of the company is giving assistance in attraction and allocation of investments in accordance with Islamic principles in the territory of Russian Federation and CIS countries.
Kazan is the capital of the Republic of Tatarstan and one of the biggest economical, scientific and cultural centres of Russia. Historically, Kazan is considered to be the northernmost Muslim centre of the world, having replaced in this respect the city Bolgar in the 15th century. The defining feature of the city’s life is a peaceful, creative co-existence of representatives of different confessions and nationalities. Kazan is a multi-confessional city. There are 52 mosques, orthodox churches, a lutheran church, a catholic chapel, a synagogue and other religious organizations. It occupies the territory of 425,3 square kilometers and has the population of 1,11 million people, represented by more than 101 nationalities.