Islamic finance is growing at a considerable pace throughout the world. Whether to attract capital from the Gulf region to diversify the investor base, or due to distrust to conventional banking following the global economic crises, countries are investing more in Islamic banking and finance. Turkey is one of the countries that is aiming to lead the market. Just recently, the World Bank launched its first representation office on Islamic finance which is the Global Islamic Finance Development Center, in Istanbul. With the support of the government to develop Islamic finance in Turkey, Turkish and foreign investors are becoming more and more aware of Islamic financing methods and products in Turkey; but what are some of the legal and practical issues investors face and the level in terms of legislative progress?
The main legislation regulating Islamic banking in Turkey is the Banking Law No. 5411 (the "Banking Law"). The financial institutions whose activities are in compliance with the Islamic rules are called participation banks (katılım bankası). Today there are four participation banks in Turkey: Bank Asya, Albaraka Turk, Kuveyt Turk and Turkiye Finans. The conventional banks and the participation banks are both governed by the Banking Law and monitored by the same authorities (Banking Regulation and Supervision Agency and the Savings Deposit Insurance Fund). Regulated under the same legal framework, participation banks must establish their own financing models approved by the shariah Islamic finance is growing at a considerable pace throughout the world. Whether to attract capital from the Gulf region to diversify the investor base, or due to distrust to conventional banking following the global economic crises, countries are investing more in Islamic banking and finance. Turkey is one of the countries that is aiming to lead the market. Just recently, the World Bank launched its first representation office on Islamic finance which is the Global Islamic Finance Development Center, in Istanbul. With the support of the government to develop Islamic finance in Turkey, Turkish and foreign investors are becoming more and more aware of Islamic financing methods and products in Turkey; but what are some of the legal and practical issues investors face and the level in terms of legislative progress?
The main legislation regulating Islamic banking in Turkey is the Banking Law No. 5411 (the "Banking Law"). The financial institutions whose activities are in compliance with the Islamic rules are called participation banks (katılım bankası). Today there are four participation banks in Turkey: Bank Asya, Albaraka Turk, Kuveyt Turk and Turkiye Finans. The conventional banks and the participation banks are both governed by the Banking Law and monitored by the same authorities (Banking Regulation and Supervision Agency and the Savings Deposit Insurance Fund). Regulated under the same legal framework, participation banks must establish their own financing models approved by the shariah scholars,1 to the extent it is in compliance with the Turkish laws. Due to lack of specific regulations on Islamic finance, financing offered by participation banks has its own obstacles.
One of the main legal issues to tackle concerns the legislation applicable to different types of Islamic finance contracts. In an Islamic financing model, the financing is always based on a real transaction, as a method of addressing speculation and interest concerns2 and common types of Islamic finance contracts have evolved to serve this purpose. The Turkish banking legislation lists the types of loan participations banks may extend,3 except for few exceptions (e.g., the minimum content of a revenue-loss participation contract), the legislation does not provide guidance regarding the content of these contracts. The trick of Islamic financing documentation is to establish a financing relationship, whereby the underlying transaction of the financing is subject to general contract law provisions. As there is no specific legislation regulating the concepts of Islamic finance contracts, the main piece of law applicable to contracts is the Turkish Code of Obligations. For instance, the provisions regarding the sale contracts to murabaha4 (e.g., certain ownership and defect related liabilities, rules regarding the transfer of asset), the provisions regarding ordinary partnerships (adi ortaklık) to musharakah5and mudarabah6(e.g., representation of the partnership before third persons, adoption of partnership decisions, termination of partnership) will be applicable. At the end of the day, it must be kept in mind that even though the parties may freely regulate their rights and obligations pursuant to the freedom of contract principle, the general rules applicable to contracts under the Turkish Code of Obligations will be applicable to the extent they do not breach the mandatory rules of Turkish laws.
Another practical consideration are potential tax liabilities. Participation banks are subject to the same tax regime as conventional banks. In principle, if the financing is deemed one of the types of loans under the Banking Law, the tax regime for loans should be applicable. However, for an Islamic financing model, the financing is always based on a real transaction. The taxation problem occurs if the authorities apply separate taxes on the underlying transactions. Do taxes arise on a musharakah partnership formed between a participation bank and the customer? How will the income and profit of the partnership be taxed? Do taxes arise on the acquisition or sale of an asset under a murabaha agreement? The tax authorities cannot provide clear opinion on these questions.
Despite such legal and practical issues yet to be resolved, Turkey is determined to work on any obstacles to increase its standing in the Islamic finance market. This year, a notable legislation was introduced by the Capital Markets Board regarding lease certificates (sukuk). This new Communiqué on the Principles on Lease Certificates introduces new forms of sukuk, improving the scope of the previous Communiqué adopted on 2010.7 The Turkish Treasury and several Turkish banks have already been heavily involved in sukuk issuances and are planning to be involved in more. Islamic banking and finance in Turkey is increasing steadily. There are still issues that need to be solved practically and legislatively as mentioned above; yet, these are now like birthing pains, and the new is on the road to improvement.
Footnotes
1 Legally, participation banks cannot form shariah boards in Turkey, but they usually take advice from consultancy boards or outside scholars.
2 As one of the main principles of Islamic banking, the payment and receipt of interest (riba) is prohibited. In addition, the contracts cannot also involve speculation (maisir).
3 Under Article 19 of the Regulation on Credit Transactions of Banks, the following are listed as the types of loans participation banks may extend: corporate finance support (kurumsal finansman desteği); individual finance support (bireysel finansman desteği); revenue-loss participation contract (kar-zarar ortaklığı); financial lease (finansal kiralama) finance.
4 Murabaha (cost plus financing) is the most popular Islamic financing technique used amongst Islamic banks. It refers to the sale and purchase of assets in which the cost and profit margin (mark-up) are made known to the buyer. In a murabaha arrangement, the financier will buy the asset from a supplier (directly or through an agent -the agent may be the customer itself acting in the capacity of agent-) and will then sell the asset to the customer at an agreed mark-up sale price.
5 Musharakah (equity financing) is a type of profit sharing joint venture partnership arrangement. In musharakah, the financier and the customer provide financing for a project in agreed proportions either in cash or in kind. Profits generated by the partnership are shared in accordance with the percentage specified in the musharakah agreement, whereas the losses are shared in proportion to each partner's share of capital.
6 Mudarabah (participation financing) is a type of partnership between a capital provider and a skilled manager (mudarib), whereby the capital provider would contribute capital to the partnership, which is to be managed by the mudarib.
7 According to the new Communiqué, sukuk can be based on ownership, management agreement, sale-purchase, partnership, contractor agreements. Other types of sukuk can also be approved by the Capital Markets Board, therefore this list is not exhaustive.
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