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How attractive is setting up an Islamic Bank in Kazakhstan? Business plan

Presented by: Madi Akmambet, # 100054097

In partial fulfilment of the: Executive Master of

Business Administration Degree (EMBA)

Submitted for: Business Mastery Project

Presented to: Professor Mohamed Iqbal Asaria

Cass Business School, City University London

Date: 14 October, 2012

Word count: 17,892

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TABLE OF CONTENTS

BIBLIOGRAPHY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

LIST OF TABLES AND FIGURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

ACKNOWLEDGMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

LIST OF ABBREVIATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

LIST OF ARABIC TERMINOLOGY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

1. EXECUTIVE SUMMARY ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

2. INTRODUCTION ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

3. LITERATURE REVIEW .... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

3.1. ISLAMIC BANKING RATIONALE ............................................................................................... 26 3.2. ISLAMIC BANKING PRODUCTS ................................................................................................ 27 3.3. ISLAMIC BANKING: SITUATION – COMPLICATION -PERSPECTIVE ................................................... 27

3.3.1. S ITUATI ON ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 3.3.1.1. Situation: Growth and Significant Milestones .............................................. 27 3.3.1.2. Situation: Supportive Infrastructure............................................................. 28 3.3.1.3. Situation: Outperformance and Resilience .................................................. 29

3.3.2. COM PLICAT ION ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 3.3.2.1. Complication: Overcoming Challenges ......................................................... 31 3.3.2.2. Complication: ‘Reverse Engineering’ ............................................................ 31 3.3.2.3. Complication: Sharia-Compliant Versus Sharia-Based ................................. 33

3.3.3. PER SPE CTIVE .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 3.3.3.1. Perspective: Reshaping ................................................................................. 35 3.3.3.2. Perspective: Bright Future If Only… .............................................................. 36 3.3.3.3. Perspective: Summary Using SWOT ............................................................. 39

3.4. KAZAKHSTAN BANKING SECTOR BACKGROUND ......................................................................... 40 3.5. OUTSET OF ISLAMIC FINANCE IN KAZAKHSTAN .......................................................................... 43 3.6.APPLYINGSTRATEGIC AND MARKETING MANAGEMENT ............................................................... 46

3.6.1. KEY SUCCE SS FA CTOR S .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 3.6.2. SEE KING A NE W VALUE PROPOSIT I ON ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

4. DEMAND STUDY ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

4.1. MARKET PENETRATION ........................................................................................................ 49 4.2. RELIGIOUS FACTOR .............................................................................................................. 50 4.3. MARKET SURVEY................................................................................................................. 51

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4.3.1. METHOD OLOGY OVERV IEW ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 4.3.2. RESPONSE RATE .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 4.3.3. SAM PLE DIST RIB UTION ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 4.3.4. SU RVEY RE SULT S ANALY SI S . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 4.3.5. STAT IST I CA L INFE RENCE ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

4.4. CASE STUDY: FIRST ISLAMIC BANK IN KAZAKHSTAN .................................................................... 65 4.5. CUSTOMER BEHAVIOR.......................................................................................................... 67 4.6. SUMMARY ......................................................................................................................... 68

5. BUSINESS PLAN ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

5.1. BUSINESS STRATEGY ANALYSIS ............................................................................................... 71 5.1.1 EXTER NAL FA CTOR S .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

5.1.1.1. PEST .............................................................................................................. 71 5.1.1.2. Porter’s Five Forces ...................................................................................... 77 5.1.1.3. Competitors Analysis .................................................................................... 79

5.1.2. INTER NAL FA CTORS .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 5.1.2.1. Vision, Mission and Values ........................................................................... 81 5.1.2.2. Who – What – How....................................................................................... 82

5.1.3 FINDINGS US ING SWOT .... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 5.1.4 STRATEGY FORMU LATI ON ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

5.2. BUSINESS DEVELOPMENT PLAN ............................................................................................. 87 5.2.1. CORP ORATE GOV ERNANCE ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

5.2.1.1. Shareholding ................................................................................................. 87 5.2.1.2. Board of Directors ......................................................................................... 87 5.2.1.3. Council on Principles of Islamic Finance ....................................................... 88 5.2.1.4. Management Board ...................................................................................... 89 5.2.1.5. Internal Control, Risk Management and Audit ............................................. 89 5.2.1.6. Business Ethics .............................................................................................. 92 5.2.1.7. Organizational Chart ..................................................................................... 92

5.2.2. PR ODU CTS AND SERVICE S .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 5.2.2.1. Deposit Products........................................................................................... 93 5.2.2.2. Financing Products........................................................................................ 93 5.2.2.3. Sukuk ............................................................................................................. 94 5.2.2.4. E-banking ...................................................................................................... 95 5.2.2.5. Pricing Policy ................................................................................................. 95

5.2.3. IT INFRA STRU CTU RE ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 5.2.4. BRA NCH NET WORK PLAN ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

5.3. FINANCIAL PLAN ............................................................................................................... 107 5.3.1. MAI N ASSUMPTI ONS ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

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5.3.2. BA LANCE SHEET AND INC OME STATEMENT ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 5.3.3. KEY PE RFORMANCE INDI CATORS .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 5.3.4. MEA SURI NG RET URN ON INVESTME NT ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

6. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

7. RECOMMENDATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113

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LIST OF APPENDICES

Appendix A: Core Islamic Banking Products Description ... . . . . . . . . . . . . . . . . . . . . . . . . 117

Appendix B: IMF on Kazakhstan Banking Sector .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

Appendix C: Kazakhstan Islamic Finance Road-Map .... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

Appendix D: Survey Form and Questionnaire ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123

Appendix E: Screenshot of the Survey Banner ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

Appendix F: Organization Chart .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

Appendix G: Financial Project ions: Main Assumptions ... . . . . . . . . . . . . . . . . . . . . . . . . . . 129

Appendix H: Financial Project ions: Balance Sheet and Income Statement . 131

Appendix I: Financial Projections: Key Performance Indicators .. . . . . . . . . . . . . . . 133

Appendix J: F inancial Projections: Measuring Return on Investment ... . . . . . . 134

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LIST OF TABLES AND FIGURES

List of Tables:

Table 1: SWOT Analysis for Islamic Banking Industry ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

Table2: Kazakhstan Macroeconomics, Selected Indicators, 2007-2017 ... . . . . . 73

Table3: PEST for Kazakhstan ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76

Table4: Competitors Analysis: Top 10 Banks in 2011 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

Table 5: ‘Vision, Mission And Values’ Analysis .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81

Table 6: ‘Who – What – How’ Analysis .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

Table 7: SWOT Analysis for a New Islamic Bank ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

Table8: NIM and Interest Spread Distribut ion among Kazakh Banks (01 July 2012) .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

Table 9: Variation of Loan and Deposit Rates for Selected Banks (September 2012) .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

Table 10: IT Structure and Budget ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

Table 11: Branches Opening Indicative Plan ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103

Table 12: Marketing Expenses for Selected Banks in 2010-2011 ... . . . . . . . . . . . . 105

Table 13: Marketing Indicat ive Budget for 2013 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106

List of Figures:

Figure 1: Core Islamic Banking Products .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

Figure 2: Islamic Finance Developments ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Figure 3: DJIMin Comparison with DJIand S&P 500 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Figure 4: Composition of Financing Modes in Is lamic Banking Sectors, 2008 32

Figure 5: Kazakhstan Banking Sector Development, 2002-2011 ... . . . . . . . . . . . . . . . 40

Figure 6: Affected Loan Portfolio of Kazakh Banks, 2004-2012 ... . . . . . . . . . . . . . . . . 42

Figure 7: Readiness Chart: Market vs. Industry ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

Figure 8: Identifying Key Success Factors .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

Figure 9: Banking Credit-to-GDP Ratio in Selected Countries, 2011, (%) .. . . . . 49

15

Figure 10: Islam Religion in Kazakhstan and Other Countries .. . . . . . . . . . . . . . . . . . . . 50

Figure 11: Respondents’ Distribution by Gender ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

Figure 12: Respondents’ Distribution by Age ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

Figure 13: Respondents’ Distribution by Occupation ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

Figure 14: Respondents’ Distribution by Income Size.... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

Figure 15: Responses Distribution on Question 1 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

Figure 16: Responses Distribution on Question 2 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

Figure 17: Responses Distribution on Question 3 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

Figure 18: Responses Distribution on Question 4 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

Figure 19: Responses Distribution on Question 5 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

Figure 20: Responses Distribution on Question 6 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Figure 21: Tolerance to Premium Price on Islamic Banking Products .. . . . . . . . . . 60

Figure 22: Responses Distribution on Question 7 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

Figure 23: Responses Distribution on Question 8 ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

Figure 24: Islamic Banking Premium Price Tolerance in Kazakhstan ... . . . . . . . . . 64

Figure 25: ‘Al Hilal Bank Kazakhstan’ Performance Indicators, 2010-2012 ... 66

Figure 26: Life Expectancy vs. Income per capita among Rich and Poor Countries .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Figure 27: Porter’s Five Forces for Kazakhstan Banking Sector .. . . . . . . . . . . . . . . . . . 77

Figure 28: Strategic Groups and Market Segments ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

Figure 29: Map of Kazakhstan ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

Figure 30: Branch Numbers Comparison (September 2012) .. . . . . . . . . . . . . . . . . . . . . 101

Figure 31: Geographical Distribution of Total Banking Loans (September 2012) .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102

Figure 32: Geographical Distribution of Small Business Banking Loans (September 2012) .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102

Figure 33: Marketing Communication Mix ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104

16

ACKNOWLEDGMENTS

‘In The Name of God, Most Gracious and Most Merciful!’

First of all I would like to express my deepest gratitude to my parents, Gulzhan Sadyr-kyzy and Kadyrbek Alpysbai-uly for fostering of zeal and purposefulness in my life.

My sincere thanks go to the beloved ones: my wife Almagul, and sons Adi, Akan and Ali for their support during the whole course of the EMBA and the project.

Very special appreciation is to my supervisor Professor Iqbal Asaria for critical advice and guidance on the dissertation.

I would also like to thank very much all of my friends and colleagues, who helped me one way or another in the planning, writing and completion of this project:

Serik Akhanov – Chairman of the Council of the Financial Institutions’ Association of Kazakhstan;

Damir Karassayev – Chairman of ABA Bank, Cambodia;

Askhat Azhikhanov – CEO of ABA Bank, Cambodia;

Kuat Kozhakhmetov – Chairman of the Financial Market and Financial Organizations Supervision Committee of the National Bank of Kazakhstan;

Anuar Kaliyev – Director of the Banking Supervision Department of the National Bank of Kazakhstan;

Daurzhan Augambay – General Director of ‘Akyl-Kenes Consulting’, Kazakhstan;

Mars Aldashov – Deputy Chairman of the Management Board of ‘Tsesnabank’, Kazakhstan;

Galymzhan Temirov – CTIDO of ABA Bank, Cambodia;

Zokhir Rasulov – CMO of ABA Bank, Cambodia;

Igor Zimarev – Marketing Officer of ABA Bank, Cambodia.

Last but not least, a grateful acknowledgment is dedicated to our course Director Professor Roy Batchelor, Cass Business School of the City University London and Dubai International Financial Center, for the given opportunity to go through this unique and first-class EMBA programme.

17

LIST OF ABBREVIATIONS

AAOFI Accounting and Auditing Organization for Islamic Financial Institutions

ALCO Assets and Liabilities Management Committee

ARR Accounting rate of return

BOD Board of Directors

CTR click-through ratio

DBK Development Bank of Kazakhstan

DJI Dow Jones Industrial

DJIM Dow Jones Islamic Market World Index

EMBA Executive Master of Business Administration

FMSA Financial Market and Financial Organizations Regulation and Supervision Agency of the Republic of Kazakhstan

CIBAFI General Council for Islamic Banks and Financial Institutions

HCB Housing and Construction Bank

IDB Islamic Development Bank

IFSB Islamic Financial Services Board

IIFM International Islamic Financial Market

IIRA International Islamic Rating Agency

ILMC Islamic Liquidity Management Centre

IRR Internal Rate of Return

IRTI Islamic Research and Training Institute

ISRA International Sharia Research Academy for Islamic Finance

IT Information Technologies

KazStat Kazakhstan Statistics Agency

KYC Know Your Customer Policy

KZT Kazakhstan currency tenge

18

MENA Middle East and North Africa

MB Management board

NBK National Bank of the Republic of Kazakhstan

NIM Net Interest Margin

NPL Non-performing loans

NPV Net Present Value

PBUH Peace be upon him

RFCA Agency on Development of the Regional Financial Centre of Almaty City

ROAA Return on average assets

ROAE Return on average equity

ROE Return on Equity

RK Republic of Kazakhstan

SME Small and Medium Enterprises

SSB Sharia Supervisory Boards

UAE United Arab Emirates

UK

USA/US

US$

United Kingdom

United States of America

US Dollar

VAT

p.a.

Value-added tax

per annum

avg. average

ths thousands

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LIST OF ARABIC TERMINOLOGY

Al-Qur’an Divine Holy Book

Gharar Uncertainty

Halal Permitted in Islam

Haram Prohibited in Islam

Ijara Islamic lease

Istisna Islamic debt-based contract

Maisir Gambling

Maqasid al-Sharia Objectives of Islamic law

Mudaraba Islamic equity-based contract

Murabaha Islamic debt-based contract

Musharaka Islamic equity-based contract

Qard-Hassan Islamic loan with no interest

Qimar Game of chance

Riba Usury, any form of interest

Salam Islamic debt-based contract

Sharia Islamic law

Sukuk Islamic bond

Sunna the Prophet Muhammad’s (PBUH) words and acts

Takaful Islamic insurance

Wadiah Safe custody

Wakala Islamic agency contract

20

1. EXECUTIVE SUMMARY

The purpose of this report is to answer the question ‘How attractive is setting up an Islamic

bank in Kazakhstan?’. This persuades us to find out whether there is a demand for Islamic

banking products or not. Also we need to prepare a business plan of a new Islamic banking

venture in the country and analyze its feasibility.

Since 1960s Islamic finance has been growing fast and already achieved many significant

milestones. Sharia-compliant assets under management of Islamic banks and financial

institutions have grown up to US dollars (US$) 1.1 trillion globally (Hall, 2012). The industry

has established its own regulatory authorities and standard-setting bodies. Islamic finance

has been evolving in many Muslim countries as well as in countries with majority of non-

Muslim population.

Kazakhstan is one of the recent countries, who opened doors for Islamic finance. In 2008 the

Banking Law was amended making a path to the alternative banking system. Ever since the

only Islamic bank started operations in Kazakhstan is a subsidiary of Abu Dhabi state-owned

Al Hilal Bank. This bank was opened based on an intergovernmental agreement between the

Republic of Kazakhstan (RK) and the United Arab Emirates (UAE) (Kazinform, 2010).

Therefore, some analytics are in the opinion that this is more political decision rather than a

commercial business project. In 2010 there were some other public announcements about

new interested entrants such as Amana Raya from Malaysia and Qatar Islamic Bank (Goud,

2011). However, due to unknown circumstances these banks are not yet to be seen in the

market.

How comes it? Is there no demand? Is it commercially inviable to open an Islamic bank in

Kazakhstan? Are there any issues with regulations and the Government’s support? Are there

any unmanageable risks? Or maybe Islamic finance itself is not ready to offer a viable

alternative to the market, where 38 banks already compete heavily. All these questions we

address throughout the report, although not speaking for the above mentioned banks.

21

We started our analysis from an overview of Islamic finance globally. This provided us with a

quite controversial position on the industry perspectives. Although the industry has

achieved a lot in terms of growth and development, it put itself in jeopardy by losing its

uniqueness and mimicry conventional banks.

In the wake of the recent global financial crisis and still ongoing economic uncertainty many

regulators around the world are revising underlying principles and goals of the modern

financial system. Many of them expressed necessity to seek alternative ways of doing

banking (e.g. King, 2010). Predatory loans, speculation with derivatives, excessive debt,

moral hazard and too-big-to-fail dilemma are among the main reasons of the crisis

discussed. Moral and ethics became high on the agenda of many financial institutions and

investors creating a new movement of socially responsible investments.

In turn Islamic finance has a good opportunity to come up as an economically wealthy

alternative to conventional finance. Being based on the Divine religion it has all the ethical

and moral principles already ingrained in its core. Prohibition on interest (riba in Arabic),

uncertainty (gharar) and gambling (maisir) makes Islamic banking free of all the weaknesses

unveiled by the recent crisis.

Furthermore, Islamic finance, being an integral part of Islamic economics, at its high level

goals must aim for social justice and distributional equity. To achieve it banks must

stimulate economic activity in a just and fair way (primarily through risk and profit sharing

mechanisms) and increase financial inclusion of all members of community.

However, the main criticism and reputational risks of Islamic finance are originating from

the statement that it is Islamic only in name. In average for selected countries in the Middle-

East and North Africa (MENA) 77% of the Islamic banks' assets comprise of Murabaha and

deferred sales (Ali, 2011). Being Sharia-compliant, however, these instruments create debt

just like conventional loans and therefore do not meet the Islamic economics goals.

Therefore, for further successful development of the industry this critique must be

overcome through proposing a genuine alternative on the basis of moral values and social

benefits orientation.

22

In regard to Kazakhstan market we found that there was a clear interest for Islamic finance

products. We conducted a survey in forms of the web questionnaire and the e-mail poll for a

control. The available market share was assessed 21% - 45% of the total banking market.

Other factors, such as the banking sector penetration, religious matters and consumer

behavior as well as a case-study of Al Hilal in Kazakhstan corroborate our findings in the

survey and promise a good opportunity for new Islamic finance ventures.

Further we prepared a business plan of a new Islamic bank in Kazakhstan to see if we can

put all the ingredients together to make the project commercially viable and interesting for

potential investors. Also through analysis of external and internal factors we derived a

business strategy for the bank with focus on small and medium enterprises (SME) and retail

market segments.

On the basis of our discussion and analysis we came up with a value proposition of the new

bank: the Sharia-based banking products with clear evidence of socio-economic

improvement for a client and the country. A prerequisite for successful delivery of this value

will be comprehensive education and marketing communication programs in order to

increase awareness and understanding of Islamic finance in the market. Extensive branch

network, strong 'Know Your Customer' (KYC) and risk management systems must be also

put in place.

Through our financial projections we concluded that the project can attract potential

investors promising the Internal Rate of Return (IRR) of 25.1%.

We proposed a list of recommendations for investors, regulators and for further market

researches. The most important are the following:

1. The business strategy with the formulated value proposition should be considered

seriously by potential shareholders to minimize a reputational risk of Islamic finance

overall and the new bank in particular. Thus a ‘Socio-Economic Better-Off Test’ for each

and every transaction needs to be introduced along with existing in practice Sharia

compliance control and risk reports.

23

2. The bank to a larger extent should use genuine and unique Islamic finance partnership

mechanisms, where both risk and profit are shared.

3. Not only Islamic banks, but also the regulators should take actions in informing and

educating the market on Islamic finance goals and mission, principles and mechanisms.

4. The bank and the regulators must ensure that the Islamic finance legislation framework

is being improved as it is planned in the Road-map of the Government of the RK and the

recent draft law.

5. The infrastructure of the market should be set-up for effective assets and liabilities

management.

These recommendations obviously require some efforts and costs. But the benefits will

overweight them as soon as an effective market place with well-informed potential

customers, harmonized regulation in banking, tax and civil law and appropriate

infrastructure in interbank and capital markets is created. Islamic banks will benefit from

correct value perception and increasing the potential market by higher awareness level. In

turn, the Government will benefit from higher financial inclusion and more sukuk

investments through developing the local component of Islamic finance.

We are confident that our findings and proposals will be considered seriously by potential

investors and regulators. The collected data may be applied for subsequent researches on

different marketing and product strategies.

A potential of the banking sector, a macroeconomic outlook of RK, the Government and the

National Bank programmes on Islamic finance are critically discussed throughout the

dissertation.

Finally the business plan provides the main guidelines and checklist of all the necessary

components for a successful start-up in Islamic banking in Kazakhstan.

24

2. INTRODUCTION

Nowadays Islamic banking and finance is recognized as a fast growing industry and

increasingly important part of the global financial system. Emerged in early 1960s the

industry has grown into US$ 1.1 trillion of Sharia-compliant assets (Hall, 2012). Countries

across the world adopt special legislation to allow Islamic banks and financial institutions

operate as alternative to conventional finance. While this growth primarily comes from

Muslim countries, Islamic banks can also be seen in countries with majority of Non-Muslim

population. UK, France, Australia, China and Singapore have their financial centers’ doors

open for the Islamic finance.

Kazakhstan adopted the legislative foundation for Islamic banking in 2008, being one of the

first among Commonwealth of Independent States. Some initiatives are taking place also in

Kyrgyzstan, Azerbaijan and Russia.

The main motivation for Kazakhstan government is to attract more foreign investments,

especially from the oil-rich Middle East. At the second Conference on Islamic Finance in

Kazakhstan the Prime-Minister Karim Massimov emphasizes an important role of Islamic

finance in implementation of the country’s new industrial programme and calls upon Islamic

countries businessmen to participate in the prioritized projects (as cited by Zhanibekov,

2011). Furthermore, ‘over the next 5-10 years the government is aiming to attract up to US$

10 billion by issuing Islamic securities’ (Zhanibekov, 2011).

A religious aspect also exists. Kazakhstan is historically a Muslim nation. Despite suppression

of the religion during the Soviet era, a growing number of people recover their national and

religious values now.

On the other hand, since the legal frame had been put in place Kazakhstan has welcomed

one Islamic bank only. In spite of several investment forums and conferences, where Kazakh

market was actively promoted, other new players are yet to be seen.

25

The objective of this dissertation is to answer the question "How attractive is setting up an

Islamic bank in Kazakhstan?". This question implies two other sub-questions such as "Is

there a demand for Islamic banking in Kazakhstan?" and "Is it a commercially viable

project?".

To deal with these questions we review the Islamic banking industry and Kazakhstan

banking sector in the following chapter. Next we present a demand study for Islamic

banking in Kazakhstan, where both primary and secondary data is used. The business plan

chapter provides the strategic analysis, business development plan and financial projections

of a new Islamic bank.

Finally we conclude that a new Islamic bank in Kazakhstan is a viable business idea and can

be interesting for potential investors.

This paper can be helpful for additional discussion, analysis and decision-making by

investors interested in Islamic banking in Kazakhstan. Also the derived conclusion and

recommendations can be useful for further development and improvement of the

regulatory framework in the country.

26

3. LITERATURE REVIEW

3.1. ISLAMIC BANKING RATIONALE

A good point to start is an emphasis that Islamic banks are profit-oriented enterprises just

like their conventional counterparts. The key difference is that Islamic banks must operate

within the boundaries, clearly established by Sharia or Islamic law (Ayub, 2007).

The main rules of Sharia forming the boundaries and distinguishing Islamic banks from

conventional are the following (e.g. Asaria, 2012; Ayub, 2007):

Prohibition of riba that means usury and includes all forms of interest.

Prohibition of gharar, maisir and qimar that means uncertainty, gambling and game of

chance. In this sense financial speculation is not permitted and all financial transactions

must be backed by a tangible asset.

Prohibition of risk transferring and risk selling. Instead, risk must be shared amongst

business partners.

Restrictions on sale of debt and financial assets and their pledge as collateral.

Prohibition of finance for haram businesses. This means businesses that are repugnant

to Sharia Law including, but not limited, alcohol, tobacco and pork production,

entertainment related to gambling and vulgarity, as well as interest-bearing financial

services.

At first glance the Sharia guidance may seem rather technical instruction what is allowed

and what is not. However, Sharia is a code of laws based on the Divine book Al-Qur’an and

Sunna, which are the Prophet Muhammad’s (PBUH) words and acts. Therefore, the Sharia

guidance for Islamic finance is not only a letter of the law, but also a direct reflection of

spiritual and moral values of the religion.

Being an integral part of Islamic economics, Islamic finance through its principles and

mechanisms aims for distributional equity and social justice (e.g. Asaria, 2012; Ayub, 2007).

27

3.2. ISLAMIC BANKING PRODUCTS

Islamic banks offer their clients a wide range of banking services just like conventional

banks: deposit products, debit and credit cards, personal finance as well as business, trade

and project finance. Insurance (Takaful), investments and asset management are also

among Islamic finance products. However the latter is out of scope of this paper as we focus

on a commercial Islamic bank’s business project.

Figure 1: Core Islamic Banking Products

Source: Author’s work based on Vicary Abdullah & Chee (2010) and Dar Al Sharia Consulting (2012).

Figure 1 shows the main types of Islamic banking contracts both for deposit and finance

products. The description of all these products is given in the Appendix A. In practice these

provide a base for certain sub-types and hybrids (structured products).

3.3. ISLAMIC BANKING: SITUATION – COMPLICATION -PERSPECTIVE

3.3.1. SITUATION

3.3.1.1. Situation: Growth and Significant Milestones

Since its inception in 1963 Islamic banking and finance has achieved many significant

milestones.

28

Figure 2: Islamic Finance Developments

Source: IFSB et al, 2010.

The mode of banking has attracted attention of many policy-makers and practitioners

around the globe. It is not only local banks in Muslim countries, but also well-known

financial institutions of the Europe and America, including HSBC, Deutsche Bank, Credit

Suisse and Citigroup, who offer the Sharia services.

The Banker magazine (2012, web-page) stated a firm growth of the sector:

‘Since the publication of the first Top 500 Islamic Financial Institutions by The Banker in 2007, Islamic finance has continued to demonstrate upward growth despite growing pains and a loss of confidence in global financial systems. The 2011 survey of financial institutions practising Islamic finance reveals that sharia-compliant assets rose by 21.45% from US$895billion in 2010 to US$1,087billion in 2011.’.

The number of financial institutions offering Islamic finance products grew from 525 in 2007

to 675 in 2011 operating across 55 countries (The Banker, 2011).

3.3.1.2. Situation: Supportive Infrastructure

The industry is supported by well-established institutions:

IDB, IFSB, ISRA, IRTI,

29

General Council for Islamic Banks and Financial Institutions (CIBAFI),

Accounting and Auditing Organization for Islamic Financial Institutions (AAOFI),

International Islamic Financial Market (IIFM),

Islamic Liquidity Management Centre (ILMC),

International Islamic Rating Agency (IIRA),

International Arbitration and Reconciliation Centre for Islamic Financial Institutions.

The standard-setting, regulation development and industry facilitation are among the key

functions of these authorities. They play a vital role for Islamic finance momentum. (e.g.

Auyb, 2007).

In order to facilitate the capital market for Islamic finance a number of indexes such as Dow

Jones Islamic Index, Al-Meezan Islamic Investment Index and the Malaysian Islamic index

have been introduced (e.g. Auyb, 2007).

Another important milestone is the Islamic interbank benchmark rate launched by Thomson

Reuters on November 22, 2011 (Hancock, 2012).

3.3.1.3. Situation: Outperformance and Resilience

The IMF analysts (Hasan & Dridi, 2010) conducted a comparative research on 120

conventional and Islamic banks that comprised about 80% of the global Islamic banking

(except Iran). The study showed that Islamic banks had better profitability on cumulative

basis (pre- and post-crisis 2008-2009) than conventional banks. The authors also mentioned

that it is Sharia that protected Islamic banks from investing in the instruments that seriously

damaged its conventional counterparts and triggered the global crisis.

The IDB analysis on the MENA region echoed to the IMF findings (Ali, 2011, p.40):

‘The Islamic banking sector has demonstrated more resilience against the financial crisis mainly due to avoidance of interest. The requirement to abstain from interest made their financing activities more tied to real economy and also required them to avoid exposure to toxic financial derivatives.’.

30

On the asset management side Sandwick and Polson (2012, p.10) concluded after

performance test of both Islamic and conventional portfolios:

‘We can observe Islamic portfolios appearing to consistently outperform conventional portfolios during highly stressed downward market conditions. Equally, the same Islamic portfolios seem to enjoy performance equal to similar conventional portfolios during upward-moving markets.’.

The following chart drawn from Google-Finance shows: from 2005 to date the Dow Jones

Islamic Market World Index (DJIM) gained 34.07%, whereas Dow Jones Industrial (DJI) and

S&P 500 (INX) up only 24.55% and 18.51% respectively.

Figure 3: DJIMin Comparison with DJI and S&P 500

Source: Author’s chart from Google-Finance (2012).

Furthermore, Islamic banks were found better prepared for new Basel III capital

requirements due to stronger capital structure, higher than average capital ratios and

31

limited use of derivatives as compared to conventional banks (Kara, 2011).

3.3.2. Complication

3.3.2.1. Complication: Overcoming Challenges

Having many inspired opinions and very promising trends on one hand, there is some

criticism of the industry on the other. Also, there are some natural obstacles due to the

sector’s infancy and the environment. These issues cannot be ignored by the market

participants and have to be tackled to ensure a new impetus for the sector.

Hasan and Dridi (2010, p.33) suggested that ‘while the global crisis gave Islamic banks an

opportunity to prove their resilience, it also highlighted the need to address important

challenges.’. As these key challenges they discussed a need for improvement of liquidity risk

management, bank resolution legal framework and human capital development.

3.3.2.2. Complication: ‘Reverse Engineering’

One of the major criticisms of Islamic banking is about so called ‘reverse engineering’ based

on conventional products and reluctance of Islamic banks to develop the risk-sharing

instruments (Asaria, 2012; El-Gamal, 2006).

Figure 4 depicts that the most preferable instrument of Islamic banks is debt-creating

Murabaha and deferred sales, with average proportion of 77% of total financing portfolio

across the selected countries. In some countries like Kuwait, Yemen and UAE this type of

financing is above 95%, whereas it is below 50% only in Bahrain.

32

Figure 4: Composition of Financing Modes in Islamic Banking Sectors, 2008

Source: Adapted from Ali (2011, p.18).

In turn, the share of the risk-sharing products based on Musharaka and Mudaraba contracts

is marginal. The maximum proportion of 30% is observed in Saudi Arabia.

However, there are certain reasons of the current situation:

Firstly, the partnership requires from clients a full transparency to banks, which is

not always achievable.

Secondly, the partnership implies risks-sharing along with profit-sharing condition,

which is also not always welcomed by clients in upward markets.

Thirdly, it is more risky and expensive for Islamic banks.

Besides, it is about ‘the dearth of secondary markets and lack of deep capital

markets’ (Asaria, 2012, p. 6).

‘Equity based methods are not easy for banks to implement because they have to perform an enhanced level of due diligence and put in place stringent risk-management controls while joint projects are ongoing. It is also difficult at the start of a project to determine who would be a good business partner and who is unsuitable. In the end, the bank has to utilize more resources, not only to perform due diligence but also to be more actively involved in the running of the joint-venture businesses.’ (Vicary Abdullah & Chee, 2010, pp. 190-191).

33

Overall, the competition from conventional banks and the market environment to a large

extent force Islamic banks to replicate conventional products and make them Sharia-

compliant.

‘The drive towards similarity with conventional banks is less by volition than a result of the current operating and regulatory environment which does not provide all the necessary support and infrastructure institutions that are needed for a well-functioning Islamic banking industry.’ (Ali, 2011, p. 34).

3.3.2.3. Complication: Sharia-Compliant Versus Sharia-Based

Sharia governance efficiency along with shortage of Sharia scholars are another critical, if

not the most important, area for the sector.

Each of the top six Sharia scholars hold positions in the large number of Boards ranging from

38 to 78 (Travers, 2010). Accordingly this gives them availability to spend in one Board from

6 to 3days per year maximum, which is obviously not enough for the effective governance.

A research on corporate governance of Islamic banks in the MENA region (Habib et al, 2009)

casted doubt on Sharia Supervisory Boards (SSB) working integrity and long term viability of

the existing practices. The research discovered large discrepancies among banks in status of

SSB, namely their role, span and authority. Lack of independent supervision over SSB in

banks is another point of consideration.

A case-study analysis on Islamic banks in Saudi Arabia (Mustafa, 2009) found that while

Islamic banks in the country are more profitable than conventional competitors, they

significantly underpay their depositors. The profitability advantage was resulted from higher

proportion of demand deposits that are unremunerative. In turn, this is due to religious

clients’ behavior, who bring deposits to an Islamic bank to avoid riba, while getting no or

less income comparing to those who open accounts with conventional banks. This led the

author to a question on Sharia governance role since the study indicated a contradiction to

Sharia goals on just and fair income distribution.

34

It is important to note a distinction between the Sharia-compliant and Sharia-based activity.

As we discussed in the previous section, Murabaha prevails on balance sheets of Islamic

banks by approbation of the scholars. Although there is no riba in Murabaha contract, it

creates debt that is not encouraged in Islamic economics. What might be permitted by

Sharia is not always good and does not always meet the final goals of Sharia (Maqasid al-

Sharia). Here is a Life Example: a fast food made from allowed ingredients will have Halal

label, however, it would be barely healthy for consumers to have it every day.

As a result, some critics (e.g. El-Gamal, 2006, location 2760-62) blamed existing Sharia

governance system on the ground of ‘the form-above-substance’ approach in compromising

with Islamic legal restriction and copying conventional banks. El-Gamal (2006) also raised an

issue that Islamic finance should be re-branded. The idea was that having very noble aims of

Islamic economics, namely social justice and distributional equity, today’s Islamic financial

institutions are far from bringing benefits to society and economical value to their

customers. He suggested being truly an Islamic bank there is no need to name itself ‘Islamic’

rather it needs to be really socially oriented.

Mustafa (2009) also expressed a concern on future reputation of Islamic banking if existing

Sharia approach continues. He critically cited quite tough statements: ‘In two of the most

populous Islamic countries Pakistan and Egypt Islamic banking is already under suspicion of

being nothing more than ‘marketing ploy’ (Tripp, 2006, p. 146) and ‘not less than a fraud’

(Dawn, 2007).’. Some scholars even argued that the modern Islamic banking products, such

as Qard-Hassan, Wadiah, Murabaha were not free of riba (Nyazee, 2009).

As suggested by Asutay (ND) the power of ‘homoeconomicus’ prevailed over behavioral

norms of ‘homoIslamicus’, because profit maximization goals of Islamic banks overwhelm

social justice goals of Islamic economics (Asutay, ND, p. 16).

If we put Hyman Minsky’s ‘The Financial Instability Hypothesis’ (Minsky, 1992) at all of the

above, we would find Islamic banks being in potential danger as the growth of the industry

was resulted mainly from the debt-based financing. According to the hypothesis ‘the

accumulation of debt is the initial trigger for financial crisis. Economic stability in the short-

35

run breeds instability in the long-run as debt accumulates to unsustainable levels’ (Haneef &

Smolo, 2010, p. 1).

3.3.3. PERSPECTIVE

3.3.3.1. Perspective: Reshaping

Many agree that the Islamic finance industry is in urgent need of a specially designed and

globally unified ‘regulatory-prudential-supervisory framework’ (Mirakhor & Krichene, 2009,

p.71).

The Task Force on Islamic finance and Global Financial Stability under auspices of IFSB, IDB

and IRTI (IFSB et al, 2010) based on the latest global financial crisis lesson recognized all the

current issues and derived strategies for improvement, including areas of liquidity

management, macro-prudential regulation, infrastructure, accounting and auditing

standards, crisis management, rating process and talent development.

Mirakhor (2011) suggested that the lack of risk-sharing instruments within the today’s

Islamic finance market is comparable to a market failure and calls for government

intervention, specifically in development of and participating in a well-functioning stock

market. The stock market with long-term higher-return and higher-risk equity instruments

can be supportive for Islamic banking industry providing liquidity and promoting risk-sharing

culture.

36

3.3.3.2. Perspective: Bright Future If Only…

The milestones and trends so far achieved by the Islamic finance provide a solid ground for a

promising future of the industry.

By recent estimation the global industry will be growing at rate of 25 percent annually with

leading to the total assets value at US$5 trillion in 2016 (Emerald Insight, 2012 as cited by

Businessislamica, 2012).

‘Growth rates should be strong in near future’ (Vicary Abdullah & Chee, 2010, p. 273).

In favor of these projections we can claim the following:

1. Simple comparison of proportion of the total Sharia-compliant asset under

management, which is about 1% of global financial asset size, and proportion of

Muslim population in the world, which is about 20%, gives us a strong argument that

there is a huge room for the industry to grow. It is estimated that nowadays only

12% of Muslim population use Islamic Finance (Hancock, 2011).

2. The Middle–East cash flow from oil is a strong support for expansion of Islamic

finance in the region and beyond. The region has more than half of the world’s

proven oil reserves (53%1).

3. Economic growth in Asia will also be supportive due to significant Muslim population

in the region, especially in countries like India, Malaysia and Indonesia.

4. Ethical and social responsible investments are on increasing demand in the West in

the light of economic crisis and social unrests, banking corporate scandals and

environmental issues.

5. Governments and financial centers are aiming for growth and diversification of

investments in their countries and therefore have to open doors for Islamic finance.

In the wake of the ongoing financial and economic turmoil across the globe, many scholars,

regulators and policy-makers consider Islamic finance as a viable alternative to the

1Source: OPEC website - http://www.opec.org/opec_web/en/data_graphs/330.htm

37

conventional financial system. Furthermore, some of them see Islamic banking as a recipe

from the key problems existing in the modern financial system such as uncontrolled money

issue, lack of ethical limits and reliance on the market efficiency, focus on growth without

consideration of wealth distribution, weak role of the state in allowing greed and excessive

profits (eg. Ayub, 2007).

In fact, some warnings for conventional finance were even before the crisis, especially

regarding derivatives called as ‘financial weapons of mass destruction’ (Buffett, 2003 as

cited by Caba-Maria, 2011, p.5). The recent financial crisis unveiled a whole range of

imperfections of the conventional banking and financial system, such as ‘too-big-to-fail

dilemma’, ‘moral hazard’ and weak ‘market discipline’ attached to it, ‘money-multiplying

capacity of the banks’ and ‘unsustainable leverage’, ‘issuers of toxic assets’ and cost of

‘taxpayers’, who pay for bankers’ losses (Carmassi et al, 2010, p.1-13; Schwarcz, 2010;

Monks & Minow, 2011).

Indeed the new phenomenon was created by the modern banking system, whereby profits

are privatized and losses are socialized. The discussion on conventional banking and recent

crisis in details is beyond of this paper. However, it is worth to quote the Governor of the

Bank of England Mervyn King:

‘Of all the many ways of organising banking, the worst is the one we have today.’

(King, 2010, p.16).

Overall, the Islamic banking and finance industry is on the rise and has a great potential. It

has essential internal as well as external prerequisites for future growth.

Nevertheless, it requires a significant course of corrections, primarily, regarding the revision

of its initial objectives of social justice and distributional equity. Then implementation and

all technical issues as governance, legal framework and product development must be

subordinated to those objectives. We need a transformation of the industry ‘from the mere

halal stage to the halalan-tayyiban stage’ – from Sharia-compliant to Sharia-based (Haneef

& Smolo, 2010, p. 19).

38

Sharia governance system should be revised as well. Not only capacity of Sharia scholars for

effective participation in SSB, but also all disputable issues regarding products and

regulations of Islamic banks must be resolved teamwise.

39

3.3.3.3. Perspective: Summary Using SWOT

Table 1: SWOT-Analysis for Islamic Banking Industry

Inte

rnal

Strengths Weaknesses High and continuous growth over the last four

decades: assets up 21.5% in 2011 International recognition and opening doors

even in countries with majority of Non-Muslim population

Spread of geographical scope Institutional infrastructure in place (IDB, IFSB,

AAOFI etc.) Strong demand for riba free and ethical

finance Outperformance over conventional banks and

asset management Higher resilience to shocks and crisis Ethical and moral values, increasingly

demanded around the globe, already ingrained to Sharia principles

Problems recognition and the industry road-map in place

Human capital deficit Sharia scholars deficit Reverse-engineering of conventional

products Focus more on debt-based products than

equity-based instruments Liquidity management due to lack of short

term investments, sovereign papers and illiquid secondary market of Sukuk

Additional cost involved due to Sharia supervision

Lack of absolute standardization across the board (among countries, schools of thought)

Inactive role of Governments in some countries

Exte

rnal

Threats Opportunities Reputation risk due to conventional products

imitation Reputation risk due to yet invisible social

benefits Path-dependency on conventional model Cannibalism if authenticity lost

Support from economic growth and oil reserves in Muslim countries

Spread across the globe and grow to cater for needs of growing Muslim population of 1.6 billion2

Increase in efficiency by regulation and governance, product development standardization, economy of scale and market infrastructure development (liquidity framework and capital markets)

Revival with very unique and authentic value proposition based on strong ethics and social justice goals

Delivery a viable alternative to conventional system as more resilient to crisis and ethical mode of finance

2 Pew Research Center (2012)

40

3.4. KAZAKHSTAN BANKING SECTOR BACKGROUND

Since Kazakhstan declared its independence in 1991 it has been carrying out a lot of reforms

towards a market-oriented economy. The Soviet era Kazakhstan Republic’s Gosbank was

transformed to the National Bank of the Republic of Kazakhstan in 1993 and Russian ruble

was replaced by Kazakh tenge (KZT), the national currency. The two-tier banking system was

introduced with the National Bank as its first tier and all other commercial banks as the

second one. The National Bank was empowered to fulfill traditional central bank’s functions

including money issue, currency control, monetary policy and banking regulation and

supervision (NBK, 2012a).

The latter function was transferred to the FMSA in 2004. Prior to it all segments of the

financial market, including banking, insurance, pension funds and securities firms, were

unified under auspices of NBK. This agency had operated until 2011 and then was rejoined

back to NBK (FMSA, 2012a).

Currently, NBK oversees 38 commercial banks, including one Islamic bank opened in 2010

(FMSA, 2012b).

Figure 5: Kazakhstan Banking Sector Development, 2002-2011

Source: Author's work based on banking statistics (NBK, 2012b; FMSA, 2012b).

41

Over the last decade Kazakhstan banking sector has experienced a rapid growth until 2008,

when the total assets reached 91% of GDP. Before then the banking sector had been one of

the most dynamic industries of the economy. NBK facilitated growth by strategies aimed

towards international banking and finance standards in terms of accounting and reporting,

information technologies and risk management, infrastructure and regulation. Specifically,

in 1999 NBK established the Kazakhstan Deposit Insurance Fund to facilitate savings in the

banking system. To facilitate and support the mortgage and house financing the Kazakh

Mortgage Company and Kazakh Mortgage Guarantee Fund were introduced in 2000 and

2003 respectively. In 2004 the First Credit Bureau was established to provide a stronger

credit discipline among borrowers.

The global financial crisis has affected the sector heavily. Several systematically important

banks such as BTA, Alliance, Halykbank, KKB and Temirbank were bailed-out by the

Government. Some of them like KKB and Halykbank bought their shares back after a critical

period of credit crunch. Others like BTA and Alliance are still under the Government

management and underwent through a tough process of their foreign debt restructuring.

Unprecedented 70% haircut of the US$16.65 billion debt in 2010 by BTA deeply damaged

the banking industry reputation and credibility. In 2012 the bank defaulted again on its

external liabilities offering another 80% haircut to the investors (Azimkanov, 2012).

Since 2008 the role of the banking sector in the economy decreased significantly. The total

Assets-to-GDP ratio fell down as much as twice to 47% at the end of 2011. This can be

explained by three main factors:

1. Due to mineral resources export-oriented economy the GDP has rebounded

relatively quickly and continued to grow in 2010-2011 at 7.3-7.5% rate in constant

prices (NBK, 2012b; IMF, 2012a). At the same time the major companies of oil and

mining industries do not rely on the local banks preferring to finance their

operations by internal sources, equity and bond issuance.

2. The growth of the banking assets has stopped due to the impeded access to

international capital market that was a significant driver of the growth before the

crisis. Kazakh banks easily borrowed abroad around US$ 45 billion or 53% of total

42

liabilities as of 01 January 2008 (NBK, 2011). Now, the banks have switched to local

deposits as more stable funding base.

3. Dramatically deteriorated loan portfolio, especially to construction and real estate

industry, has forced banks to create provisions against bad loans. The non-

performing loans3 (NPL) grew from 2.4% of the total loans in 2006 up to 37.8% in

2009 (See Figure 6). Tough work on the recovery constrains a new credit expansion.

Figure 6:Affected Loan Portfolio of Kazakh Banks, 2004-2012

Source: Author's work based on banking statistics (NBK, 2012b; FMSA, 2012b).

Overall, despite economic recovery of the country and structural changes in the banks’

balance sheet during last few years, the banking sector is still fragile. Already high NPL ratio

may be even higher than official number, as indicated by IMF report (See Appendix B). At

the same time the decreased Assets-to-GDP ratio designates a low penetration of the

banking sector, promising a high potential for growth.

3 For the purpose of this paper NPL includes doubtful loans of the 5th category and bad loans according to FMSA classification

43

3.5. OUTSET OF ISLAMIC FINANCE IN KAZAKHSTAN

Islamic finance in Kazakhstan commenced in 1996 when IDB opened its Representative

office in Almaty, then capital of the RK. The regional office in Almaty covers the whole

Central Asia, Azerbaijan and Albania. So far in Kazakhstan the bank has executed 19 projects

for the amount of US$ 90.8 million, including US$ 22.7 million of trade finance facilities for

Kazakh banks in 2000-2002 (IDB, 2012). However, this exposure is quite marginal (0.1%) to

the total banking assets (US$ 86.4 billion as of 2011).

The second step into Islamic finance was taken through external borrowings by few Kazakh

banks. Specifically, BankTuranAlem, then the second largest bank borrowed US$ 50 million

in 2005 and US$ 250 million in 2007 on commodity Murabaha agreement. In the same 2007

Alliance bank received US$150 million Sharia-compliant syndicated loan facility from 19

Middle-East banks (Tashimov & Kalabin, 2007).However, due to the crisis these initiatives

were suspended. Moreover, these two banks were taken over by the Government.

The crisis, on the other hand, became a trigger for another more important step in Islamic

finance development in Kazakhstan. The Government, pursuing a new type of investments

that demonstrated its relative stability during the credit crunch, suggested a special

legislation for Islamic finance. The law was signed by the President Nazarbayev on 12

February 2009 (Islamic Finance Law, 2009). The banking law, tax code and civil code were

amended introducing the new mode of financial intermediation. Not only Islamic banks, but

also Islamic investment funds and Islamic securities were instituted to operate in the

Kazakhstan market.

The decision was in line with a long-distance programme of development of Almaty city as a

Central Asia financial hub. The dedicated Agency on Development of the Regional Financial

Centre of Almaty City (RFCA) started promoting new opportunities for potential Islamic

finance investors through a number of conferences, forums and investors meetings. At the

same time RFCA, FMSA and other vested interest organizations engaged in propaganda

among the population and market participants for the sake of awareness of Islamic Finance

principles.

44

In 2010, a year after the law was passed, the first Islamic bank in Kazakhstan was opened

thanking to an intergovernmental agreement between the RK and UAE. That was JSC ‘Al

Hilal Islamic bank’, a subsidiary of Abu Dhabi state-owned Al Hilal Bank.

Besides, the market has gained two more participants–the Mutual Insurance Society ‘Halal

insurance’ Takaful’ in Islamic insurance and the ‘Fattah Finance’ in investment banking. The

Islamic Finance Development Association has been established to coordinate and follow-up

any issues related to the law and regulations. Consultancies and law firms such as ‘Akyl-

Kenes consulting’, ‘Kausar consulting’ and ‘Grata Law Firm’ have been actively involved in

the business and legal advisory.

The Government and NBK continue to demonstrate a political will to support the new

industry. This year the Road-map of Islamic finance development until 2020 was approved

(The Government, 2012). The Road-map includes main actions to be taken, responsible

parties and time-frame for the following directions4:

1. Legislation Improvement;

2. Educating market;

3. Islamic Finance Infrastructure Development;

4. International Cooperation;

5. Public Sector Development;

6. Islamic Financial Services Development;

7. Science and Education;

8. Investors Relations.

Three years after adopting the law and applying significant efforts to attract foreign

investors we have still been seeing only one Islamic bank. Some other banks announced

their plans to enter the Kazakhstan market, including Malaysian Amana Raya and Qatar

4 For detailed breakdown see Appendix C

45

Islamic Bank (Goud, 2011). But they are yet to be appeared. Partially it might be because of

general investment activity decay in the light of ongoing economic uncertainty all over the

world. Also, despite the law was signed, it seems there are certain legal barriers on the way

of smooth growth of the industry.

Currently NBK and the Government have prepared a draft law proposing improvements to

the existing legislation (NBK, 2012c). Specifically, the draft is suggesting a number of

amendments regarding clarification of the list of Islamic banks’ activities, including the

commodity Murabaha and equity participation (Musharaka). This would sync the banking

with the Tax code, which allows avoiding value-added tax (VAT) for all financial services in

Kazakhstan. Also currently unavailable for retail market the partnership and the agency

based products need to be clarified in the law. The Wakala product needs clear definition

since the regulator interprets the law differently from common understanding.

Furthermore, the draft provides a legal base for a voluntary Islamic deposits guarantee fund

since conventional deposit insurance scheme is repugnant to Sharia.

Another step forward has been taken recently when the state-owned Development Bank of

Kazakhstan (DBK) successfully issued the first Kazakhstani Sukuk bonds. The Malaysian

ringgit-denominated securities issued in July 2012 were based for the equivalent of US$ 76.7

million. The five-year notes were priced to yield of 5.5 percent (Bloomberg, 2012). This was

the first issuance within the bank’s 1.5 billion ringgit (US$ 480 million) programme. The deal

definitely opens doors for other Kazakh emitters on Sukuk market.

46

Figure 7:Readiness Chart: Market vs. Industry

Source: Adapted from Miller (2012).

Overall, Islamic banking and finance in Kazakhstan has been evolving from its infancy in

terms of regulation, infrastructure and number of market participants. Despite some

progress, the overview shows that Kazakhstan is quite far from a full readiness of the

market and the industry as indicated on the chart above. The Government’s and NBK’s

active role is crucial for further development.

3.6.APPLYINGSTRATEGIC AND MARKETING MANAGEMENT

3.6.1. KEY SUCCESS FACTORS

To succeed in business a company must meet two conditions. First, it must supply what the

customers want to purchase, and, second, it must survive in competition (Grant, 2010). The

Key Success Factors framework helps to analyze demand and competition in the market.

47

Figure 8: Identifying Key Success Factors

Source: Author’s replication from Grant (2010, p.88).

Kotler and Keller (2009, p.53) added that providing customers with what they want is not

enough: ‘to gain an edge companies must help customers learn what they want’. It means

companies must identify demand for specific product not only as a clear stated need of

customers, but also as their other implicit needs such as ‘real, unstated, delight and secret

needs’. Putting all together, companies must form and deliver a value proposition to satisfy

customer needs. This can be applied to Islamic banks as well.

3.6.2. SEEKING A NEW VALUE PROPOSITION

Kotler and Keller (2009, p.163) defined the value proposition as ‘a statement about the

experience customers will gain from the company’s market offering and from their

relationship with the supplier’.

Prerequisites for success

What do customers want? How does the firm survive competition?

Analysis of demand

• Who are our customers? • What do they want?

Analysis of competition

• What drives competition? • What are the main dimensions of competition? • How intense is competition? • How can we obtain a superior competitive position?

KEY SUCCESS FACTORS

48

Islamic banks have been growing rapidly so far, but to continue successful growth they have

to look carefully at the customer needs. In order to address those needs Islamic banks have

to formulate and communicate to the market a clear value proposition. As was discussed

many factors may affect the value proposition. High competition from conventional finance,

valid criticism on deviation from Sharia goals and weak understanding of the products by

clients endanger the industry. The customers may become unsatisfied when realized that

the products they have purchased were mimicked from conventional market. Yet so called

‘penalty for faith’, when Islamic banking products turn to be more expensive than

conventional, also raised questions on social mission of the industry that has to be

embedded in the business according to Maqasid al-Sharia.

DiVanna (2011) reported that a simple value proposition as no-riba and no-haram activity is

not sufficient any more. The new value proposition of Islamic banks must be far beyond

simple Sharia-compliance. He argued that educating customers on product offerings,

transparency of Sharia board activity and ‘greater array of customized products’ are needed.

After all Muslims as well as non-Muslim customers are looking for ‘the best value for money’

(DiVanna, 2011, p.27).

In the next Chapter we attempt to identify a demand for Islamic banking through a survey

conducted among a sample of potential customers in Kazakhstan. This helps us to formulate

a value proposition for our business project.

49

4. DEMAND STUDY

In order to conduct a demand study we collected and used both primary and secondary

data.

4.1. MARKET PENETRATION

As a starting point of demand study for Islamic banking it is worth to assess a country

banking penetration. In order to analyze the market penetration we looked at the total

credit of the banking sector in relation to GDP. We compared the ratio with other emerging

and developing economies.

Figure 9:Banking Credit-to-GDP Ratio in Selected Countries,2011, (%)

Source: Authors work based on the World Bank’s database (The World Bank, 2012)

Against the background of the comparable countries the economy of Kazakhstan is

significantly underbanked. This diagram shows that Kazakhstan banks have a high potential

market in the long-run.

50

4.2. RELIGIOUS FACTOR

Kazakhstan population of 16.7 million is represented by more than 100 nations (KazStat,

2012). According to the General census in 2009 the original Kazakh nation is majority with

64% of the population (KazStat, 2011). The Russians is the second largest with 23% of total.

As reported, Muslims are 70% of the country’s population, while Christians are 26%.

At first glance Islamic finance potential in Kazakhstan seems overwhelming to traditional

banking, owing to the majority of Muslim population. However, it is worth saying that due

to some historical reasons, including Soviet era restrictions, the religious commitment of the

population is quite low comparing to other countries.

Figure 10: Islam Religion in Kazakhstan and Other Countries

Source: Pew Research Center, 2012

51

The Pew Forum research found that the religion is really important for only 18% of total

population. This indicator should become a starting point for estimation of Islamic banking

available market share.

On the other hand, we know from practice that Islamic finance is in demand by non-

Muslims as well. Specifically, in Malaysia the share of non-Muslim clients in Islamic banks is

about 40% (e.g. Ayub, 2007).

4.3. MARKET SURVEY

4.3.1. METHODOLOGY OVERVIEW

In order to analyze demand we have conducted a survey (See Appendix D). The survey

included eight questions, 4 of them were dichotomous, 2 were multiple-choice and 1 was

mixed (dichotomous on first level and multiple-choice for sub-questions). The questions

were prepared to test:

1. General knowledge on Islamic banking and its existence in Kazakhstan;

2. Attitude to Islamic banking in Kazakhstan;

3. Willingness to be a client of an Islamic bank in Kazakhstan;

4. Price-sensitivity;

5. Preferences on institutional form and on types of services demanded.

The questionnaire was prepared carefully to mitigate risks of misunderstanding by

respondents on the one hand and to avoid forcing respondents towards any particular

answer on the other. To check the bias risk the questionnaire was shown to friends and

colleagues, then was corrected. The questionnaire was placed on the web-site

http://119.82.251.235 controlled by the author.

First, the web link to the questionnaire was distributed amongst 1,180 people in the

‘Bolashak Group’ on Facebook. This is the group of Kazakhstani alumni who studied abroad

on the Government education program ‘Bolashak’ (The Future). Currently these people

52

work on various positions in public and private organizations. Under this request the

answers were getting from 01 to 22 August 2012.

The core survey campaign was arranged on the most popular5 Kazakhstan news website

www.nur.kz. The banner was placed on the website with frequency of 53,000 shows per day

in average during one week from 22 to 29 August 2012.

Before that we also placed the banner on another news portal - www.zakon.kz. However,

due to ineffective advertising plan this campaign contributed to the survey marginally.

In order to enhance attractiveness of the banner and minimize hesitation of potential

respondents the banner and the survey invitation were launched under the name of

consultancy ‘Akyl Kenes consulting’ (See Appendix E). This company is directly involved in

the industry development, particularly by organizing already two international forums on

Islamic banking in Kazakhstan. The company by courtesy agreed to assist in this survey.

However, all technical issues, including advertising and hosting of the questionnaire, were

under the author’s control.

The website’s audience is quite diverse6 in terms of age, social background, profession,

family status, income and geographic location across the country. This gave us an

assumption that the respondents were randomly sampled.

To confirm or disprove the diversity of the respondents we asked the personal information

of the people such as age, profession, income and gender. We intentionally did not ask

about nationality and religion to avoid any separatist hint and thereby not answering.

However, the web-surveys, although are increasingly popular, suffer from problems of

misunderstanding, low response rate and over-representing ‘people with strong (usually

5 Rank 1st in the category ‘Internet’ by Count Zero Rating with 202,287 users per day as of 29

August 2012 (www.zero.kz )

6 The portrait of audience is available on http://corp.nur.kz/content/?node_id=12

53

negative) opinion’ as being based on ‘voluntary response samples’ (Bowerman et al, 2010, p.

9).

Therefore we conducted a control survey by email interview among people we know

(relatives, friends, present and former colleagues, student fellows). In turn, these people

asked their network to participate in the survey. These respondents could ask clarifications

on questionnaire, so risk of misunderstanding was mitigated. The control survey was

conducted during the month of August 2012.

4.3.2. RESPONSE RATE

The web-survey collected totally 225 responses, out of which 32 from Facebook campaign

and 193 responses received from the advertising on the news websites.

As far as response rate is concerned, the Facebook response rate was 2.7%. The web-site

advertising campaign provided us with 0.21% of the click-through ratio (CTR), the main web

response measure. These indicate quite adequate response rate comparing to average CTR

of social-media-share links (0.5%7) and Facebook’s social ads for UK (0.04%8).

However, out of 728 clicks on the advertising banner on www.nur.kzwe received only 161

completed questionnaires or 22.1%. This might be due to different reasons, specifically the

low speed of Internet connection and/or transition from page-to-page in the questionnaire,

difficulties with understanding and/or reluctance in answering the particular question or

providing personal information.

For the control-survey the response rate was 59%, where 59 responses received out of 100

people approached by email. The summer holidays season affected the rate as some people

were abroad in annual leave.

7 Marketingprofs (2012)

8 EmailStatCenter (2012)

54

4.3.3. SAMPLE DISTRIBUTION

Using the Central Limit Theorem (Bowerman et al, 2010), as sample size (n) is larger than 30

for both the web-based and the control-survey, we can assume that our sample mean is

normally distributed.

The sample represented quite diverse groups of population in terms of gender, age,

occupation and income size. Although there are some variations between the web-based

and the control-survey audience, overall both are diversified similarly.

Figure 11: Respondents’ Distribution by Gender

55

Figure 12: Respondents’ Distribution by Age

Figure13: Respondents’ Distribution by Occupation

56

Figure 14: Respondents’ Distribution by Income Size

For the gender the control-survey is more balanced than the web-survey. The more

significant variation is about the occupation where the control-survey represented mainly

by employees (83%). The majority of the web-survey’s responses came from employees too,

but only 55% of total answers, thus having more other groups such as business owners,

public servants and students. Also the web-survey was represented most (36% of total

respondents) by people with minimum annual income (less than US$ 5,000), whereas the

control-survey had only 14% under this category. The control-survey had more people with

income between US$ 30,000 to 100,000.

57

4.3.4. SURVEY RESULTS ANALYSIS

Figure 15: Responses Distribution on Question 1

‘Are you aware of the existence of Islamic banking in the financial market of Kazakhstan?’:

The majority of respondents in both polls said they knew about Islamic banking in

Kazakhstan. However, the awareness of the industry still has not been created fully among

the population. The significant proportion of people in the web-survey (28.4%) did not know

about the new industry in the financial market.

Figure 16: Responses Distribution on Question 2

‘Do you support the policy of the Government of Kazakhstan to introduce Islamic banking as alternative financial services and attract new foreign investments into the economy?’:

Before we asked the second question we informed those who were not aware of the

industry, putting the notice:

‘In 2008 the Republic of Kazakhstan adopted a package of legislation on the implementation of Islamic banking as an alternative to traditional banks. In 2010 the first Islamic bank in Kazakhstan obtained a license and opened.’.

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As we found the majority (94-95%) supports the government policy and appearance of

Islamic banks in Kazakhstan. This would imply a positive attitude to the new industry among

the society.

Figure 17: Responses Distribution on Question 3

‘Do you think that Islamic banks due to their specifics need to be more socially oriented than traditional banks?’:

This and subsequent questions were asked to test understanding and expectations about

Islamic banking mission and goals.

The results demonstrate that the majority of people fairly enough expects higher social

orientation of Islamic banks than this expected from traditional banks. However, more than

a quarter of the sample in the control-survey believes that there is no difference between

the two. This might be due to lack of clear understanding of Islamic banking principles

and/or also high expectations to traditional banks in terms of social responsibility.

Figure 18: Responses Distribution on Question 4

‘Do you think that Islamic banks are the same commercial and for-profit organizations as traditional banks?’:

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This diagram shows that, as it was assumed above, there is not a public consensus about

Islamic banking principles, its mission and goals. About one third in the both polls (32-36%)

believes that Islamic banks are not for-profit organizations.

Figure 19: Responses Distribution on Question 5

‘At which main condition you would prefer to use the services of an Islamic bank as an alternative to conventional one?’:

The results of this question seem quite controversial. The majority of the web respondents

(52.4%) chose ‘specifics of Islamic banks…’ as a main argument in favor of the services from

Islamic banks. While the email-survey vast majority (76.3%) chose ‘the better price’ as a

main reason of their willingness to use Islamic banking products. This might be explained by

a drawback of the voluntary response samples, which we discussed earlier. Although

Bowerman et al (2010) were talking about over-representing usually negative opinion we

can suspect over-representing positive opinions in the web-survey.

Other factors, such as strong brand and reliable reputation, quality service, convenient

location and professional marketing or willingness to experiment with a new product

offering, were not very significant in both cases (3.1% - 6.8%).

The small proportion of people online (3.6%) expressed their negative attitude by denying

even a possibility to ever use Islamic banks. By contrast, this type of responses was not

found in the control poll.

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Figure 20: Responses Distribution on Question 6

‘Would you agree to use the products and services of Islamic banking on less profitable

conditions than conventional banking?’:

In addition to question 5 this was a testing of the price sensitivity of the potential clients.

The vast majority of both polls’ respondents (67-78%) said they were not ready to pay a

premium price on Islamic banking products. Just one third in the web-survey and one fifth

(22%) in the control one would agree for a premium (lower rate on deposits and higher cost

on credit products than in traditional banks). We gave several sub-questions to this category

of people to test how much extra they can tolerate.

Figure 21: Tolerance to Premium Price on Islamic Banking Products

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This graph represents the conditional probability for the price tolerance as the sample space

was reduced to the groups of respondents who are ready to tolerate to some extra price.

Overall the chart is skewed more to the right that means the price tolerance tends to be

minimal. The highest classes belong to ‘up to 5%’, where are 28.4% and 23.1% of the

respondents respectively for the both methods. The tolerable premium size is concentrated

within the first two classes ‘up to 5%’ and ‘between 5% and 10%’, where are more than half

of the respondents (55.4%) within this range. The concentration for the control-survey is

much wider, including the first four classes up to 20% premium, which cover 69.3% of the

respondents.

On the other hand, these results are not normally distributed. The web-survey shows

another extreme concentration at the maximum range of the premium ‘up to 50%’ with

23% of the respondents. By contrast, it is only 7.7% for the control questionnaire.

Applying the conditional probability for the whole sample:

The highest two classes ‘up to 5%’ and ‘up to 10%’ premium comprise of only 18.2%

of all the web-survey voters;

The four classes ‘up to 20%’ premium are made up of just 15.3% of the whole

control-survey sample size;

Only 7.6% of potential customers are likely to agree with the maximum range of the

premium ‘up to 50%’ in the web-survey and just 1.7% in the control one.

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Figure 22: Responses Distribution on Question 7

‘What are your preferences on the organizational form of the Islamic Bank?’

The most popular opinion is ‘Islamic bank as a standalone financial institution’ in both

surveys (64.4% and 45.8%), whereas ‘Islamic window’ received only 7.6% and 11.9% votes

respectively. The second place went to the indifferent opinion either for a standalone bank

or Islamic window in a well-known traditional bank. Surprisingly the third opinion in the

web-survey was for ‘None of the above’ (8.9%), which probably means a lack of interest of

Islamic banking products within this group. In the control-survey it is just 5.1%. These

negative opinions do not strongly correspond to Question 5 where only 3.6% respondents

claimed they would never have an interest for Islamic banking.

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Figure 23: Responses Distribution on Question 8

‘What kind of financial services do you need most?’:

The most demanded products are personal and business financing with 62% and 41.6%

votes respectively. Saving, current and deposit accounts are required by 52.6% of the

respondents. Investments with higher risk profile collected 19.6% of votes. Almost 3% needs

nothing. The control-survey generally reflects the same demand pattern.

This question was aimed to test a general demand on the certain types of financial services,

without emphasizing whether it is Islamic banking products or not. However, the results

display a risk-aversion of the voters by choosing less risky and less profitable deposit

products rather than more risky investments with higher expected return (27.5% for

deposits versus 19.6% for investments). The difference is even larger in the control-survey:

42.4% versus 18.6%.

4.3.5. STATISTICAL INFERENCE

The most critical finding for an Islamic bank in Kazakhstan is given in Figure 20 for Question

6 of the survey.

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Figure 24: Islamic Banking Premium Price Tolerance in Kazakhstan

Agree to pay an extra for Islamic

banking products

Frequency Percentage (%)

Web-survey Email-survey Web-survey Email-survey

YES 74 13 33 22

No 151 46 67 78

Total 225 59 100 100

The sample proportion of potential customers who are ready to pay extra can be used to

estimate an available market for the Islamic banking industry in Kazakhstan. For the purpose

of this analysis we name this category ‘loyal customers’. From the table above the

proportion of loyal customers seems substantially different between the two polls: 33% in

the web-survey versus 22% in the email one.

Therefore, we conducted a comparison between the two population proportions. We used

the formula of ‘A large sample confidence interval for the difference between two

population proportions’ (Bowerman et al, 2010, p.418):

100 (1-⍺) percent confidence interval for p1 - p2 is

.

First, we assume that we have two randomly selected samples of size n1=225 and n2=59.The

proportion of the loyal customers in the first sample is =0.33 and in the second is

=0.22.

We checked that the samples are large enough to use the formula:

n1 =225*0.33=74, n1(1 - )=225*0.67=150.75 and

n2 =59*0.22=12.98, n2(1 - )=59*0.78=46.02.

Since all the products are at least 5, both samples n1and n2can be considered as large.

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Using the normal distribution table (Bowerman et al, 2010, p.251-252), we found - value

for the confidence interval of 95% equals to 1.96.

Then, the 95% confidence interval for the difference was calculated as follows:

.

This means that we are 95% confident than , the proportion of the loyal customers out of

all potential customers reflected by the web-survey is between over

the , the proportion of the loyal customers out of all potential customers reflected by the

email-survey. Hence, the 95% confidence interval for the proportion was found as:

[ -E, +E] =[0.22-0.0123, 0.22+0.2323]=[0.2077, 0.4523].

This implies that the loyal customers’ proportion based on the web-survey is approximately

between 21% and 45% out of all potential customers. The margin of error is quite significant

due to the substantial difference of the survey results and minor sample size, although

statistically large.

Although the range is large it provides us with good grounds for prediction. We can forecast

that the available market share of the Islamic banking in Kazakhstan can span between 21%

and 45% of the total banking market.

4.4. CASE STUDY: FIRST ISLAMIC BANK IN KAZAKHSTAN

A subsidiary of Al Hilal Bank was established in Kazakhstan in 2010.The bank has opened so

far three outlets including head-office in Almaty, the commercial capital, and two branches

in the capital city of Astana and Shymkent, most populated center on the South of the

country.

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Figure 25: ‘Al Hilal Bank Kazakhstan’ Performance Indicators, 2010-2012

Particular, US$ million FY 2010 FY 2011 Growth 2011 1H 2012 Growth 1H 2012

Total Assets 62.5 85.3 36.4% 78.7 -7.8%

Loan portfolio 21.2 39.4 85.6% 53.3 35.4%

Total Liabilities 21 16 -21.5% 9 -42.3%

Clients deposits 3.3 3.9 16.3% 3.8 -1.4%

Borrowings 13.7 11.9 -13.0% 0.0 -100.0%

Capital 41.6 68.9 65.5% 69.2 0.4%

Net Income -2.5 -1.3 47.9% 0.7 157.7%

Source: FMSA, 2012b.

The assets of the bank grew by 36% in 2011, but went down by 8% for six month of this

year. The main reason of decrease was in the settlement of US$ 12 million borrowings from

other financial institutions. However, the clients’ funds are not growing this year in contrast

with 16% growth in 2011.

Among positive trends the loan portfolio grows continuously. The shareholders capital

increased significantly in 2011 due to the new capital requirements.

As usual for start-up projects the first two years of the operations were in losses, while in

2012 the bank has achieved breakeven and turned to profit.

The bank’s market share is quite marginal, 0.09% in terms of assets. As announced the bank

is aiming for 1% of the market share during the next 2 years.

The main strategy of the bank is focused on corporate clients especially national companies

where the bank tries to leverage on the Kazakhstan government support thanking the

intergovernmental agreement between Kazakhstan and UAE. In the retail segment the bank

is targeting only wealthy people with minimum deposit amount of US$5,000.

According to the bank’s annual report (Al Hilal bank, 2012) the main products offered to the

corporate clients are commodity Murabaha (58%) and Ijara (42%). The retail banking

presents a current account based on Qard-Hassan and a deposit based on Mudaraba

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contracts. As we can see the biggest proportion of the bank’s financing portfolio falls under

Murabaha, which is the most criticized and disputable product.

As a pioneer in the market the bank has faced some practical obstacles in regard to the

banking and tax legislation that was discussed in Section 3.5 of Chapter 3. The bank is

actively working with regulators suggesting improvements in the law.

Being a part of ‘Al-Hilal Group’, the bank receives support from the head-office in Abu-Dhabi

in terms of Sharia supervision, risk management and funding base.

4.5. CUSTOMER BEHAVIOR

While conducting a demand study it is worth looking at customers’ behavior, their

preferences and intentions.

The customer purchase process usually consists of the following five stages (e.g. Balabanis,

2010):

1. Problem recognition and understanding of needs;

2. Information search on the value required;

3. Search of alternative values;

4. Purchase decision;

5. Post-purchase behavior.

Islamic banking can be a good alternative within this buying process for both Muslims and

non-Muslim customers.

The recent global financial crisis has a certain impact on the mind-set of banks’ customers in

regard to the financial system. Ernst & Young conducted the Global Consumer Banking

Survey in 2012 among 28,560 banking customers in 35 countries (Ernst & Young, 2012). The

following findings were highlighted:

12% of people are most likely to change their banks (it was only 7% in 2011);

22% of customers want their banks to improve pricing structures;

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40% of customers globally are losing confidence in the banking industry;

44% of respondents use social networking sites to find out more on banking services;

47% of customers prefer to use internet banking for simple transactions like money

transferring and account statements;

50% of respondents were dissatisfied with high banking fees;

70% of people globally are ready to provide their banks with more information if this

can result in better service;

71% of customers seek advice on banking products from their friends, family and

colleagues.

These findings are also important to take into consideration for an Islamic bank project in

Kazakhstan. Specifically, we can see that less confidence and dissatisfaction with their

current banks make customers open to alternatives, including other conventional and

Islamic banks. Price sensitivity and quality of service are still the most critical moments for

banking customers. Readiness for higher transparency is necessary for risk-sharing products

of Islamic banking.

It is crucial for a bank to form correct customer’s expectations and meet these expectations

in full. Benefits on the word-of-mouth, Internet-banking and social networking technologies

are important to know for planning a marketing communication mix. We can see that these

channels of communication can be effective to gain a market share by spreading a unique

value proposition and reputation of the bank. But this also can work in the other way

around when in the post-purchase stage the customer, if left not satisfied, spreads negative

information about the banking experience.

4.6. SUMMARY

The demand study, including the market penetration analysis, the market survey and the

case-study of the first Islamic bank as well as religious and customer behavior has provided

us with valuable findings.

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The market penetration of the banking sector in Kazakhstan (41%) looks very low as

compared to other developing countries. The great potential market implies a strong

demand on banking services in the long-run.

The majority of Muslim population of the country is a real prerequisite to high demand on

Islamic banking. However, the share of people committed to religion is only 18%.

On the basis of the survey we have found a positive attitude to the new industry among the

society in general.Only 5-6% of the voters do not support the government policy on

developing the Islamic banking in Kazakhstan. A very few people (3.6%) denied a possibility

to ever use Islamic banks.

It was found that despite the majority of respondents knows about the existence of Islamic

banking in Kazakhstan the industry awareness must be created at a better level among the

population of the country. This will increase the potential market for Islamic products.

We observed a certain degree of confusion about Islamic banking profit and social goals.

Understanding Islamic banking principles, its mission and goals is paramount for the

industry success. Otherwise, a wrong market expectation from Islamic banking might lead to

a negative experience, thereby damage the industry reputation.

Another very important finding is about the key success factors for Islamic banks. The

majority of the web respondents (52.4%) said they would use Islamic banking mainly due to

‘the specifics of Islamic banks’ that stand for moral and ethical values and Sharia-compliance

of the business. On the contrary the control-survey’s vast majority (76.3%) do matter ‘the

better price’ as a main reason of their willingness to use Islamic banking products. But this

controversy was almost negated by the next question of the questionnaire that directly

tested the price sensitivity.

The vast majority of both polls (67-78%) are not ready to pay a premium price on Islamic

banking products comparing to conventional banking. The price premium tolerance tends to

be minimal with concentration of respondents in the range below 10% extra.

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Based on the survey we forecast the available market of Islamic banking in Kazakhstan 21%–

45% of the total banking market. The lower limit somewhat corresponds to the proportion

of devout Muslims in the country. At the same time, as we discussed, Islamic finance around

the world serves non-Muslim customers as well.

In terms of organizational form the most preferable one would be ‘Islamic bank as a

standalone financial institution’. This might be partially due to the decreased trust in large

conventional banks during the crisis.

The most demanded products in the banking market are personal and business financing.

Saving, current and deposit accounts are also important for potential clients. We also

observed a risk-aversion among respondents that might restrain Islamic banking deposit

products based on risk-sharing mechanism. The riskier investment instruments would be

required for only one out of five people in the market. Only 3% said they do not need

banking at all.

The case of ‘Al Hilal’ in Kazakhstan shows that during two years the bank has established its

customer base, opened two branches apart from the head-office and achieved the

breakeven point. Overall, the case demonstrates that Islamic banking in Kazakhstan is in

demand. At the same time the bank’s target is limited by corporate and national companies,

ignoring SME and retail segment. Furthermore, the bank’s product offering is concentrated

on the controversial Murabaha, while the risk-sharing instruments have not been practiced

yet.

The customer purchase process and the Global Consumer Survey 2012 by Ernst & Young

show us that Islamic banks can be a real alternative for both Muslims and non-Muslim

clients. Nowadays the chances for Islamic banks are higher when overall trust to banking

system is in decline due to the global financial and debt crisis. But success will depend on a

particular value proposition and customer satisfaction.

All these findings are important to know for the strategy and business planning that will be

covered in the next Chapter.

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5. BUSINESS PLAN

In this Chapter, first, we will formulate a business strategy for an Islamic bank based on

analysis of current external environment and desirable internal factors. Then we will look at

the required ingredients for business development such as corporate governance, products

and services, infrastructure and human resources. Finally we will prepare financial

projections to see if the bank can achieve sustainable profitability and, thus can interest

investors.

5.1. BUSINESS STRATEGY ANALYSIS

5.1.1 EXTERNAL FACTORS

5.1.1.1. PEST

Political:

Twenty years of the President's power provided Kazakhstan with stability needed for

economic and structural reforms after the USSR collapse. However, the current political

situation does not seem as stable as recently.

In 2011 there was a labor strike in the oil industry where workers required a higher salary.

That resulted in unprecedented bloodshed and arrests of many participants. This only

increased an underlying social discontent. In 2012 also several unprecedented mass crimes

happened that raised questions on adequate security in the society.

In May 2011 the Government established the new Authority on Religious Affairs in the wake

of so called ‘religious extremism’ danger. A new law was adopted later in October 2011

restricting prayer rooms in governmental offices, educational organizations, army and penal

colonies. At the same time the President Nazarbayev himself promotes inter-confessional

and inter-ethnic peace and spiritual values in the society. Under his personal supervision a

new ‘Hazret Sultan’ mosque in Astana, the biggest mosque in Kazakhstan, was constructed

and opened in 2012.

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The changing socio-political environment is one of main sources of country’s vulnerability

(IMF, 2012b).

Economical:

Kazakhstan along with Russia and Belarus has formed a Customs Union that unified the

export-import duties and opened borders of the countries for free goods flow. It is planned

to develop it into the Economic Union and, probably, the Currency Union in future. Although

benefits for Kazakhstan are currently disputable the Union provides the countries a chance

to compete in the bigger domestic market. It requires the Governments to develop the

country’s economic competitiveness.

In general the economic environment in the country is favorable for a start-up (See Table 2

below). The easy rebound from the crisis was achieved mainly due to recovery in oil prices

in 2010. The stable economic growth is projected over the next 5 years (IMF, 2012b). The

surplus of the current account will continue to accumulate reserves of the Central bank and

National oil fund, making the exchange rate relatively stable and gradually depreciating in

nominal value. In contrast, in 2009 when the current account had negative balance and

accumulated deficit for previous years NBK conducted a once-off devaluation of tenge to

increase competitiveness of the export-oriented industries. The budget surplus will keep the

public external debt at manageable level. Monetary and exchange rate policies are expected

to support economic activity, mainly export-oriented, while targeting low inflation rate.

The GDP structure is quite diversified and the main industries are following: Mining - 18.2%,

Construction - 8.5%, Agriculture – 5.5%, Manufacturing - 11.6%, Real estate -13.9%, Trade –

12.7%, Transportation and Communication – 8.7% (IMF, 2012b). As we can observe from

the table below rate of growth of non-oil production in GDP is higher since last year than oil-

production. This might partly be a result of the Government’s Industrial and Innovative

Development Programme, aiming to diversify the economy and increase competitiveness of

the country.

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Table 2: Kazakhstan Macroeconomics, Selected Indicators, 2007-2017

Indicators Actual Projections

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Real GDP growth per

annum (p.a.), %

2.9 3.2 1.2 7.3 7.5 5.9 6.0 6.2 6.3 6.3 6.4

- incl. oil n/a n/a 7.1 7.3 1.0 1.6 1.3 1.9 5.6 5.9 5.6

- Non-oil n/a n/a 0.5 7.2 8.3 6.4 6.5 6.7 6.4 6.3 6.5

GDP, US$ billion 106.8 132.9 114.6 147.9 184.2 206.4 227.5 252.5 282.5 316.2 355.2

GDP per capita, current

prices, US$ 6.6 8.6 7.1 9.0 10.7 11.9 13.2 14.6 16.2 18.4 20.9

Unemployment, % 7.3 6.6 6.6 5.8 5.4 5.3 - - - - -

Consumer Price Index

p.a., %

10.8 17.0 7.3 7.1 8.3 5.6 7.2 6.6 6.3 6.0 6.0

NBK refinancing rate, %

average (avg.) p.a.

9.5 10.8 8.6 7.0 7.4 6.0 - - - - -

Current account, % of GDP -7.9 4.7 -3.6 1.6 7.6 7.1 5.3 4.0 3.3 2.9 3.0

Fiscal Balance, % of GDP -1.7 -2.1 -1.4 1.4 5.5 4.9 4.5 4.1 3.9 3.7 3.6

Public external debt, % of

GDP

2.0 1.62 3.2 3.5 3.0 2.8 3.0 3.0 2.9 2.8 2.8

Total External debt, % of

GDP

92.4 80.9 97.9 79.9 66.6 65.2 62.3 56.4 51.1 46.9 43.6

National Fund, US$ billion 21.0 27.5 24.4 31.0 43.7 54.9 64.6 73.0 82.5 91.4 101.2

NBK gross international

reserves, US$ billion

17.6 19.9 23.1 28.3 29.3 35.3 38.4 42.8 44.8 48.5 54.2

Nominal exchange rate,

KZT/US$

120.3 120.79 148.46 147.5 148.4 149.7 - - - - -

Memorandum items:

Crude oil and gas

condensate production

(million tons)

n/a n/a 75 80 81 82 83 85 90 95 100

Oil price, US$ per barrel ~60.0 ~120.0 61.8 79.0 104.0 114.7 110.0 102.8 97.2 93.3 91.0

Source: NBK, 2012b; IMF, 2012a

On the other hand, there are several serious challenges as well. The most critical one is an

economic dependency on volatility of energy prices and global demand slowdown. Also the

total external debt seems high with 67% to GDP in 2011, although it has a 96% non-

government share.

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The weakness of the banking sector after the crisis is another important economical

challenge as we discussed in Section 3.4 of Chapter 3. In 2010 Kazakhstan adopted the

Conception of the financial sector development in the post-crisis period (The President,

2010). This document identified the main directions of the financial sector of Kazakhstan in

order to improve its quality after the crisis, strengthen resilience for future shocks and

increase financial inclusion of the country to achieve the pre-crisis level of the banking

sector to GDP ratio. One of the directions arising from the Conception is a further

stimulation of Islamic finance development as additional source of external capital and

domestic savings.

An empirical analysis by IMF suggested that 'the probability for Islamic banking to develop in

a given country rises with the share of the Muslim population, income per capita, and

whether the country is a net exporter of oil' (Imam & Kpodar, 2010, p. 20). From this

perspective Kazakhstan has quite favorable conditions for Islamic banking penetration.

Social:

The country population is expected to grow from 16.5 million in 2011 to 18.5 million in 2020

(KazStat, 2012).

Country in general and regions with high rural population in particular, which is 45%, require

significant public spending in terms of infrastructure development, machineries and

equipment, education and medical care.

In the wake of the recent social unrests the Government announced increase in pensions

and social benefits, new investment projects and facilitation of employment (IMF, 2012b).

The next graph demonstrates Kazakhstan’s position among other developing and developed

countries in terms of life expectancy and national income per capita. Despite similar head

income the life expectancy in Kazakhstan is well below the one in countries like Thailand,

Turkey, Malaysia and Mexico. Even the countries with lower national income per capita

have higher life expectancy (Indonesia, Vietnam and Albania). It challenges the Government

to spend more on health and education.

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Figure 26: Life Expectancy vs. Income per capita among Rich and Poor Countries

Source: Wilkinson & Picket, 2009

Technological:

The country’s infrastructure needs to be upgraded. It supposes generating of public

spending as well as private investment projects in road construction, electricity,

telecommunications and manufacturing.

It is positive to note that the country has progressed in terms of mobile and Internet

penetration as well as application of modern technologies like 3G, LTE, CDMA-450/800 and

fiber-to-the-building.

Banks introduce all the available technologies such as I-banking, mobile-banking and plastic

cards. The Government and NBK stimulated the population, including pensioners, to open a

banking card account. Number of the cardholders almost doubled from 5.3 million in 2007

to 10 million as of 01 July 2012 (NBK, 2012b).

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Table3: PEST for Kazakhstan

Political Economic Social Technological 20 years of the stable

Presidency have become a key of economic and structural reforms;

Current political situation is alarmed with 2011 labor strike in oil-industry and several mass crimes in 2012;

The changing socio-political environment is a source of risk

Easy economic rebound;

Favorable domestic macroeconomic environment;

Robust forecast over next 5 years;

Strategy of diversification from oil & gas;

S&P sovereign credit rating: investment grade BBB+

Still high dependency on oil prices and global demand

Health and education are among the main challenges remaining;

More social safety net is expected;

Growing population, although with high rate of ageing;

Significant rural population

More infrastructure investment projects are expected;

Progress in mobile and Internet penetration as well as application of modern technologies;

Banks introduce new technologies

Overall, Kazakhstan looks attractive for an investment, owing to its macroeconomic

conditions, mineral resources and financial reserves. The examination of social and

technological aspects revealed needs for significant investments in infrastructure. However,

the main risks for the mid-term perspective are:

1. Viability of the ruling party to sustain the political stability and improve social

safety net;

2. Recovery of the banking sector;

3. Stability of oil prices and global demand.

The Global Competitiveness Report for 2012-2013 ranked Kazakhstan up to 51st from 72nd

two years earlier (The World Economic Forum, 2012). The report marked some

improvements in macroeconomic stability and technological readiness. The report also

emphasizes important challenges related to health and education, business sophistication

and innovation.

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5.1.1.2. PORTER’S FIVE FORCES

Figure 27: Porter’s Five Forces for Kazakhstan Banking Sector

Source: Author’s work based on financial market statistics(FMSA, 2012b).

The banking sector’s concentration has been gradually decreasing over the last several

years, but still out of 38 banks Top 5 captures more than 60% of the assets. The high NPL

78

ratio and provisioning resulted in dramatic losses in the banking sector in general and for

the major banks particularly. The best profit mainly belongs to several mid-sized banks and

subsidiaries of foreign banks. They were more conservative before the crisis and escaped

from significant exposure to construction and real estate sector. Also they did not depend

on the external borrowings. These banks are currently capturing market share from the

large banks that are having problems with loans quality.

The competition requires extensive branch network across the country and sales force as

well as costly advertising. Speed and quality of service are also a critical success factor for

banks.

The deposit insurance system is important for growth of deposits. The system protects not

only small depositors, but also large amounts up to approximately US$ 33 thousand (KZT 5

million) while the estimated average deposit is between US$15 to 20 thousand. From

Islamic banks perspective, lack of insurance mechanism for depositors is a competitive

disadvantage.

Institutional investors such as pension funds and insurance companies are other stable

sources of funding in local market. Assets of these two sectors are more than 10% of GDP as

of 01 July 2012. However, allocation of these assets is a restricted subject to credit rating.

Pension assets, for instance, require banks to have at least ‘BB-‘ rating from S&P or another

international rating agency. Therefore the credit rating is a key success factor in terms of

funding from institutional investors.

Commercial banks compete with other financial institutions such as state-owned DBK,

Housing and Construction Bank (HCB) and Agro-Credit Corporation. On certain niche of the

markets the substitution for banking service is also provided by leasing and mortgage

companies as well as microfinance organizations. Their role is quite perceptible comparing

to the banking sector. The loan portfolio of DBK to the total loan of banking sector is 2.7%,

while shares of HCB and mortgage companies in the banks’ mortgages and housing

construction loans are 14.7% and 6.6% respectively (NBK, 2012b).

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During the last three years a few new licenses were issued, including one for the first Islamic

bank ‘Al Hilal’. Malaysian ‘Amana Raya’ and ‘Qatar Islamic Bank’ have postponed their

decision to enter the market. The minimum capital requirements were raised by the

regulator increasing the financial entrance barriers.

5.1.1.3. COMPETITORS ANALYSIS

Table 4: Competitors Analysis: Top 10 Banks in 2011

Selected Indicators, 2011 KKB HBK BTA BCC ATF ALB SBR TSB KAS EUA

Capital, US$ billion 2.9 1.9 -1.6 0.6 0.4 0.06 0.3 0.2 0.3 0.2

Assets, US$ billion 16.7 14.9 10.9 7.2 6.6 3.6 3.3 2.9 2.8 2.5

Growth in Loan, % p.a. -3 12 27 12 2 -2 103 123 25 19

Growth in Deposits, % p.a. -5 9 10 -12 9 41 100 94 25 -3

Retail deposits in total deposits, % 40 37 41 54 30 39 18 29 70 28

Change in Market Share, % of total assets -0.8 0.5 -4.0 -1.8 -0.5 0.1 1.5 1.5 0.4 -0.1

Return on Equity (ROE), % 0.3 12.6 -9.7 3.8 -59 141 15.2 11.8 25.6 20.4

Net Interest Margin (NIM), % 5.57 4.5 -1.0 2.3 3.2 3.0 5.8 4.8 9.9 6.0

Provision to Loan, % 35 24 62 16 20 45 5 4 16 10

No of Branches and Outlets 157 549 247 197 109 126 98 119 235 76

Source: FMSA, 2012b. For purpose of this table: KKB – Kazkommertsbank, HBK –Halyk Bank of Kazakhstan, BTA

– BankTuranAlem, BCC – BankCenterCredit, ATF – ATF Bank, ALB – Alliance Bank, SBR – Sberbank, TSB –

Tsesnabank, KAS – Kaspi Bank, EUA – Euarsian Bank.

As a result of the crisis the majority of large banks (like KKB, BTA, Alliance and ATF) were

experiencing bad loans burden and losing their market share in 2011 as they restricted

lending and focused on recovery. In contrast, the mid-sized banks Tsesnabank and

Sberbank, having fewer problems, demonstrated remarkable growth in deposits and loans.

It resulted in the gained market share and good profit.

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We can predict that this situation will continue in the next couple of years. Big banks will try

to solve their issues with bad loans and clean the balance sheets while mid-sized banks will

try to capture the market leveraging on higher flexibility.

And again we see that the extensive branch network across the country is required to

penetrate the market and support the bank growth.

On the other hand, Islamic banks were found to be rather a complement than a substitute

to conventional banks (Imam & Kpodar, 2010). This corresponds with our survey findings

about price tolerance. Thus Islamic banks have a unique opportunity to capture a certain

niche in the market without a direct competition with conventional banks. However, the

potential market can grow even higher as Islamic banks are competitive.

5.1.2. INTERNAL FACTORS

We used the ‘Vision, Mission and Values’ and ‘Who, What and How’ tools to propose a

business strategy based on our literature review and analysis of external environment in

Kazakhstan.

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5.1.2.1. VISION, MISSION AND VALUES Table5:‘Vision, Mission and Values’Analysis

VISI

ON

:

Analysis: A new Islamic bank needs to focus on effective social benefits it delivers without

compromising on its financial sustainability. This will be in accordance with

Sharia rules and values and also will position the bank at its unique place in the

market.

Proposition: To be the country’s number one supplier of most dependable and most socially

effective banking services. To be the bank that while doing banking business is

committed to society.

MIS

SIO

N:

Analysis: To be truly an Islamic bank and avoid a reputational risk the bank must see its

mission in helping businesses and individuals to support their financial needs and

thereby stimulate an economic activity for the benefit of society. A fruitful long-

term relationship with customers will be achieved through a sense of

partnership.

Proposition: The bank stands to help Kazakh businesses and people build a greater and

brighter future for themselves and their country by providing highly professional,

modern and Sharia-based banking services for all.

As a truly Islamic bank it sees itself as a partner of private businesses, individuals

and the Kazakhstan community as a whole.

VALU

ES:

Analysis: The bank needs to be closer to the society as a real partner. Quality of service is

a success factor for any bank. Sharia fundament will provide the bank with

exceptional ethics and moral standard, which will be valued by customers over

time. The same level of commitment to staff, customers and future generations

will provide a sustainable growth of the bank.

Proposition:

Honesty and Respect – the bank makes it a responsibility to treat each and every

customer with honesty and respect.

Trust and Partnership – the bank is a partner that customers can always trust.

Quality of Service – the bank intends to provide the most reliable banking

services and find solutions to every banking need.

Contribution – the bank aims to make a positive contribution to Kazakhstan

through a beneficial Islamic banking mechanism.

Sustainability and Growth – the bank thinks about the future of the bank, the

Kazakhstan people and the country.

Ethics and Morals – the bank is based on highest ethical and moral standards of

Sharia that makes the bank socially responsible in every relationship - with the

customers and communities as well as the staff.

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5.1.2.2. WHO – WHAT – HOW

Table 6: ‘Who – What – How’ Analysis

Analysis Proposition:

Who …Not

Although the bank is positioned to

serve as many clients as possible,

targeting profitability and social

benefits, the main target segment

should be SME and Retail. Very small

business will be left as area of

microfinance institutions. Too large

clients are already banked by big local

and foreign banks and also will be

limited by the single borrower limit

that is 20% of bank’s net worth.

Retail clients

Small business (assets size

from US$ 0.2 million and 5

employees minimum)

Medium Business (up to US$

3.5 million assets and 250

employees)

Corporate business (more

than US$ 3.5 mil assets and

250 employees)

In main 16 cities of the

country

Activities repugnant to

Sharia

Micro-Business

Too small business (less

than US$0.2 mil assets

and 5 employees)

Too large corporate

clients

In rural area

Analysis Proposition:

What …Not

The Islamic bank will provide full range

of banking products and services

within the Sharia requirements.

As discussed, the key success factor

for Islamic banking will be in truly

social orientation of the business.

Hence, all transactions must be

subject not only to Sharia-compliance

approval, but also to a ‘Socio-

Economic Better-Off Test’.

In future it might be considered to set

up subsidiaries in other financial

segments such as Takaful, investment

Sharia based banking

products with evidence of

socio-economic betterment

for a client, the bank and the

country:

Deposits and Cards

Financing (Lease &

Investment products)

Cash management and

Remittance

E-service (email and

Internet-banking)

Financial consultancy on

projects financed by the

bank

Conventional riba-based

products

Insurance

Securities

Investment banking

Murabaha should be

used in limited supply

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banking and leasing as majority of

competitors established their financial

groups and cross-sell their products.

Analysis Proposition:

How …Not

Creating brand equity of the bank as

well as Islamic finance in whole will

require significant efforts in terms of

educating both staff and society on

Islamic finance principles, mission and

goals.

Advertising and other marketing mix

tools will be used to communicate the

value proposition to potential

customers.

High quality service and Personal

Client Relationship is a key to attract

mid-sized and large clients.

Strong KYC and Risk policies need to

be applied to mitigate financial and

business risks, fraud and moral hazard.

Personal client relationship

Approaching new customers

(direct marketing)

Marketing communication

mix, including advertising

Internet, email and mobile

phone

Cross-selling

Strict KYC and Risk policies

Educating and training staff

Educating society on Islamic

finance, public relations

‘Better-off’ test on socio-

economic benefits

Waiting for a walking

customer

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5.1.3 FINDINGS USING SWOT Table 7: SWOT-Analysis for a New Islamic Bank

Inte

rnal

Strengths Weaknesses

New Islamic bank with the new value proposition – socio-economic benefits for customers and the country

Clean balance sheet, lack of problematic assets that have hugely affected large banks in the market

Tested demand for Islamic banking with certain share of extra price tolerable clients

Ethical and moral values inevitably ingrained to Sharia principles will differentiate the bank from majority of the market players

Target segment: SME and Retail

Potential resources and capabilities to execute the bank’s strategy

Human capital deficit, comprehensive training required

Sharia scholars deficit

Risk-sharing instruments require extensive resources for due-diligence with customers

Liquidity management due to virtually lack of Sharia short-term investment in the domestic market

Additional cost involved due to Sharia supervision

Lack of branch network

Misunderstanding Islamic finance principles by clients → wrong customer expectations

Lack of Deposit Insurance system for Islamic banks → disadvantage to conventional competitors

Legislation adaptation needed: Tax issues (VAT for commodity Murabaha), Banking law definitions (Wakala, partnerships for retail etc.)

Risk-aversion of potential clients

Need minimum credit rating ‘BB-‘ for institutional investors

Exte

rnal

Threats Opportunities

Reputation risk if conventional products are imitated

Reputation risk if social benefits are invisible

Regulatory risk if the Government plans (Road-Map) are not implemented properly

Possible entry of big players would increase competition

Political stereotype risks ‘associated’ with Islam

Exploit the potential of the banking sector and macroeconomic environment to grow in the long-run

Educating potential customers and increase awareness of Islamic finance products, hence boosting future demand and increasing potential market

Grow in momentum to capture a market share while only one Islamic bank is in the market and large conventional banks are in hangover from the crisis

Meeting current demand and satisfying loyal customers, boost future demand and spread across the country and beyond Muslim audience

Financial inclusion strategies of the Government include Islamic finance alternative

Significantly increase in efficiency over time upon the Government Road-Map implementation, including improvement of regulation, tax issues, liquidity framework and deposit guarantee scheme

Diversify in Islamic finance with Takaful and Investment bank subsidiaries forming an Islamic financial holding

Expand to neighbor countries (Russia, Uzbekistan, Kyrgyzstan, Tajikistan and Turkmenistan)

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5.1.4 STRATEGY FORMULATION

Putting together our findings in literature review, demand study and the external and

internal factors summed up in SWOT (Table 7), we have derived the business strategy of the

bank as follows.

Target segments: SME and Retail across the country. The corporate clients also will be

within the focus, although in less priority.

Value proposition: The Sharia-based banking products with clear evidence of socio-

economic betterment for a client and the country.

Delivering Value:

Educating the market;

Marketing communication mix;

KYC and Risk screening;

High ethics and moral standards;

‘Socio-Economic Better-Off Test;

High quality standards;

Modern technologies;

Branch network.

Figure 28 depicts the desired strategic position of the bank in the market in terms of ROE

and market segments. However, the value proposition will significantly differentiate the

bank from the majority of players, providing the bank with a source of competitive

advantage.

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Figure 28: Strategic Groups and Market Segments

Source: Author’s work based on banking statistics as of 01 July 2012 (FMSA, 2012b).

An important area of concern is time to enter market. Since there is a legislation

imperfection it is better to have the law fully adapted and the market informed for Islamic

banking. The pioneers of the market have to take disproportionate costs on lobbying the

legislation improvement and educating the market. At the same time it will give the bank a

chance to skim and penetrate the market building strong brand equity before new entries

occur. From this perspective, internal resources and capabilities providing effective

operational and risk management are crucial for the successful entry.

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5.2. Business Development Plan

5.2.1. Corporate Governance

5.2.1.1. Shareholding

Regarding Corporate Governance, the bank will follow the local legislation and best

international practices.

According to Article 15 of the Banking Law of the RK commercial banks including Islamic

banks can be established only in form of a joint-stock company (Banking Law, 2012).

Foreign organizations or banks can perform as major shareholders of banks in Kazakhstan

(more than 10% of total shares) if only they have credit rating equal or above the sovereign

rating of Kazakhstan. The current rating of Kazakhstan is BBB+ by Standard and Poor’s.

Common law on joint-stock companies shall be applied to the banks activity, shareholders

and corporate governance. Public companies listed on the Stock exchange must approve

and publish Corporate Governance Code.

Shareholders of the bank conduct the general meeting at least once a year to assess the

bank’s performance, approve its annual report and consider the dividend distribution.

The governance system in Kazakhstan supposes the dual board structure with the Board of

directors as senior supervision board and the Management board as executive body.

Shareholders appoint the Board of Directors as a senior management of the bank who

represents shareholders’ interests and is accountable to shareholders. The Board of

Directors, in turn, appoints the Management board as executive body.

5.2.1.2. Board of Directors

The Board of Directors (BOD) will be elected and approved by the shareholders. The BOD

must include 3 members minimum. At least 30 percent of total number of the BOD

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members must be independent directors (Joint-Stock Law, 2012, article 54). The Chairman

of the BOD is elected and appointed by the BOD from its members.

The main objective of the BOD is to ensure that the bank is managed properly in accordance

with the law and regulations and in interest of the shareholders and all other stakeholders.

The BOD reviews and approves strategic and business plans of the bank, oversee and advise

the management board.

For carrying out its functions the BOD will set up sub-committees, such as the Audit

committee, the Risk committee and the Nomination and Remuneration committee.

The BOD and its committees will conduct meetings at least once every quarter.

5.2.1.3. Council on Principles of Islamic Finance

In accordance with Article 52-2 of the Banking Law an Islamic bank must establish a Council

on principles of Islamic finance (Banking Law, 2012).

The Council is an independent body appointed by shareholders of an Islamic bank upon

recommendations of the BOD. The law does not stipulate the size of the Council and

qualification requirements to its members, leaving these at discretion of shareholders.

The role of the Council is supervision over the bank’s policies and transactions to ensure the

banking activity is in compliance with the Banking law and Sharia.

The bank’s internal regulations (the General Rules on banking transactions and the Credit

Policy) are subject to approve by BOD only upon the Council’s prior approval.

Daily banking transactions and the Credit committee decisions conducted in accordance

with the General Rules and the Credit Policy are not subject to approve separately by the

Council. However, the Council has an authority to examine any transactions conducted by

the bank making sure it is in compliance with the Law and Sharia.

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The bank will set up the Council according to these requirements of the Banking Law in

Kazakhstan and international practice of Islamic banks.

5.2.1.4. Management Board

The Management board (MB) is elected and appointed by the BOD as executive body of the

bank. The Chairman of the MB is appointed by the BOD and cannot be the Chairman of the

BOD. Other members of the MB will be Deputies of the Chairman and other selected top

managers. There will be at least 3 members of the MB.

The MB will meet at least once a month. The MB will cooperate with the BOD on all

strategic issues. The MB is accountable to the BOD on monthly basis.

The MB is responsible for overall and operational management of the bank and execution of

its strategy and business plan agreed with the BOD.

To carry out its functions the MB will establish committees such as the Credit Committee,

the Assets and Liabilities Committee (ALCO), the Compliance Committee and the Business

Development Committee.

5.2.1.5. Internal Control, Risk Management and Audit

Based on Article 40-5 of the Banking Law (Banking Law, 2012) the bank must set up the

internal control and risk management system, including:

1. Authorities, functions and responsibilities of the BOD, the MB and the bank

departments regarding the internal control and risk management;

2. Internal regulations such as policies and procedures on internal control and risk

management;

3. Limits on acceptable size of risks for every type of banking transactions, different

industries exposure, separate products and financial instruments;

4. Internal procedures regarding management reporting system, including reports on

internal control and risk management;

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5. Internal criteria of effectiveness of the risk management system (self-assessment).

The internal control system must ensure security of the bank’s assets and effectiveness of

operations through the ‘Plan-Do-Check-Act’ cycle. The system should include the following

elements:

1. Preventive control mechanisms such as physical security of assets (cash, buildings),

information security, segregation of duties, dual control, transaction authorizations,

limits on single transaction, staff, client and product;

2. Directive control mechanisms such as regulations, manuals, policies, procedures and

product descriptions;

3. Detective control mechanisms such as monitoring and reporting, reconciliation of

data and audit trails;

4. Corrective control mechanisms such as back-up, database rollback and graceful exit

in information system.

The main types of risks are the following:

1. Financial risks: Credit risk, Market risk, Liquidity risk;

2. Business risks: Operational risk, Legal risk, Regulatory risk, Reputational risk.

The bank will follow the NBK requirements for the internal control and risk management

system(Risk Regulation, 2005) The Risk department will be set up to assess all main risks

attributable to the bank’s operations and report to the BOD on a monthly basis.

The ALCO will monitor and manage all financial risks related to the assets and liabilities

management. Treasury transactions will be problematic for the time being due to lack of

Sharia-compliant instruments on the local money market and the capital market.

Opportunity to seek instruments abroad will be limited by the currency position prudential

standards. On the other hand, we see a little progress in this area. In July this year DBK

issued sukuk for about US$ 77 million with 38 percent purchased in Kazakhstan. ‘AlHilal

Kazakhstan’ signed an agreement with ‘Citi bank Kazakhstan’ based on commodity

Murabaha for interbank deposit transactions.

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The Credit committee will design a credit process separately for corporate, SME and retail

products. To standardize the process and effectively assess the credit risk the Credit

Committee will develop a rating system for corporate and SME clients and a scoring system

for retail products. A data from the Credit Bureau and the State Pension Center will be used

for credit appraisal. The former provides credit history of a client and the latter is a source

of salary statement for all citizens in Kazakhstan.

Islamic banks must comply with the following prudential standards (Prudential Regulation,

2009):

1. Capital adequacy ratios;

2. Single borrower limits;

3. Liquidity ratios;

4. Currency open position limits and net position limit;

5. Maximum investments in fixed and non-financial assets;

6. Capitalization in regard to liabilities to non-residents (foreign debt leverage).

The Compliance control department and Compliance Committee will be established as a

part of the integral system of internal control and risk management. The compliance control

must ensure that the bank’s operations and employees’ behavior are in compliance with

business ethics, regulations and laws. The anti-money laundering law is one of the main

areas where the Compliance department will focus on.

The Internal audit and External audit are important parts of the Bank’s overall control

system. The Internal audit department must conduct internal audit on a regular basis with

focus on effectiveness and efficiency of business process and internal control system. The

External audit of the financial statement as well as audit of internal control and risk

management systems must be conducted on an annual basis minimum. According to the

Banking Law the bank must conduct external audit by one of the ‘big four’ international

audit organizations.

The BOD is ultimately responsible for putting the internal control and risk management

systems in place. The Heads of Risk, Internal Audit and Compliance while working with the

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MB on a daily basis will report to the BOD directly on a monthly basis and/or in case of

emergency.

5.2.1.6. Business Ethics

Being a part of corporate values and underlying principles of Islamic finance, business ethics

are a cornerstone of the bank’s corporate governance. They also underpin the bank’s value

proposition for customers.

Business ethics norms must be declared and promoted among the bank’s staff by the

business ethics code or within the corporate governance code.

The main areas of the business ethics will include:

1. Compliance with Sharia principles and standards;

2. Compliance with corporate values;

3. Compliance with laws and regulations;

4. Rights of employee;

5. Rights of customer;

6. Moral hazard and conflict of interests;

7. Professionalism;

8. Corporate social responsibility;

9. Environment and sustainability;

10. Transparency and confidentiality;

11. Anti-Corruption and anti-money laundering.

The BOD and the MB must ensure that the business ethics are not only declared, but also

followed.

5.2.1.7. Organizational Chart

The organizational chart is outlined in Appendix F. The structure suggests that there will be

separated business lines for corporate, SME and retail segments. It will let the business arms

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focus on the particular market segment, identify customer needs carefully and standardize

business processes and procedures, hence achieve higher effectiveness and efficiency of the

operations. Other departments such as IT, Accounting, Marketing and Sales will be universal

and supportive to all the business arms.

5.2.2. Products and Services

5.2.2.1. Deposit Products

The bank will offer its clients, legal entities and individuals, the following deposit products:

1. Current account based on Qard-Hassan contract. This will provide customers with

money saving, payment and cash management mechanism.

2. Investment account based on Mudaraba contract. This will provide customers with

opportunity to invest their money and earn some income. This product will vary for

different terms and currencies, mainly KZT, US$and Euro. Also the bank will develop

restricted and unrestricted Mudaraba variations of the deposit investments

depending on risk appetite of potential customers.

3. Card account. The debit and credit cards will be designed in compliance with Sharia.

5.2.2.2. Financing Products

The bank will offer its clients, legal entities and individuals, the following financing products:

Mudaraba – the bank will invest into business projects, expecting pre-agreed proportion of

profit.

Musharaka - the bank will invest into business projects and retail transactions based on the

partnership. For retail products a diminishing Musharaka will be used.

Murabaha – the bank will finance purchase of fixed and movable assets for customer

purpose. However, this type of products must be limited as it creates debt and is most

disputable on hidden riba issue.

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Ijara – the bank will provide lease of assets required by customers. Variations of operating

and financial lease contracts will be available.

Istisna – the bank will finance manufacturing or construction of future assets.

Salam – the bank will finance immediate cash needs of customers. This type of products also

must be limited as it is a debt-based instrument.

Wakala –agency contract will be used for trade finance and in hybrid with other products

for the process of assets purchase and sale.

All these types of financing will be designed for both legal entities (business) and individuals

(retail) except Mudaraba that will be used for the business financing purpose only.

Collateral against negligence of customers will be applied for all as a general rule.

Mudaraba and Musharaka as risk-sharing mechanisms will be in priority of the bank’s

product development and sales target. However, currently according to the Banking Law the

products based on partnership are assumed only for business purpose and limited to the

retail clients. The draft law we reviewed in Section 3.5 of Chapter 3 is supposed to improve

this legal drawback.

5.2.2.3. Sukuk

Sukuk will be an important and additional source of funding for the bank’s expansion. The

pension funds and insurance industry as institutional investors by their assets size represent

more than 10% of GDP as of 01 July 2012. As their assets grow they are continuously

interested for new financial instruments in the market. However, allocation of the assets is

restricted subject to credit rating and listing requirements of Kazakh stock exchange. The

bank can be listed for sukuk only in 2 years of business9.

9http://www.kase.kz/ru/listing-how-to

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5.2.2.4. E-banking

Electronic banking will be in priority of the bank as a modern and technology-based way of

customer service. The bank will provide the following services:

1. Internet banking (with options of account statement, money transfer within the

bank as well as to other banks and abroad);

2. Email-banking with account statement and customer care;

3. SMS-banking providing customers with information about transactions on their

account;

4. Plastic cards with debit and credit card as well as virtual cards based on current

account.

5.2.2.5. Pricing Policy

The objective of the Bank’s pricing policy will be based on the business goals such as

bringing a new value proposition in the market with strong ethical and socio-economic

benefit for all– the bank, the customer and the country. The bank will aim for a sustainable

return that would be attractive enough for shareholders and supportive for the bank’s

expansion plans. At the same time the profit rate on the financing products should be high

enough to pay a competitive return to depositors.

The next table demonstrates the net interest margin and interest spread distribution among

banks in Kazakhstan. The indicators are based on all interest-bearing asset and liabilities

nevertheless the overall picture reflects a difference in pricing and interest rates policies.

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Table 8: NIM and Interest Spread Distribution among Kazakh Banks (01 July 2012)

# Name of the bank Yield of assets Cost of funds Net Interest

Margin Interest Spread

1 Kazkommertsbank 8.5% 5.7% 5.61% 2.80% 2 Halykbank 6.7% 3.8% 4.06% 2.96% 3 BTA 4.3% 7.5% -1.58% -3.25% 4 BankCenterCredit 7.5% 5.9% 2.50% 1.64% 5 ATF (Unicredit) 6.8% 4.6% 3.25% 2.15% 6 Alliance bank 7.2% 7.7% 3.16% -0.47% 7 Sberbank 8.8% 3.8% 5.50% 5.00% 8 Tsesnabank 11.4% 6.2% 5.57% 5.26% 9 Kaspi 14.8% 9.0% 8.22% 5.82%

10 Eurasian bank 12.2% 6.4% 6.64% 5.71% 11 Citi bank 1.5% 0.2% 1.37% 1.36% 12 Nurbank 6.5% 6.0% 2.81% 0.49% 13 Temirbank 7.3% 8.3% 2.63% -1.03% 14 Housing and construction bank 4.5% 2.6% 3.10% 1.91% 15 HSBC Kazakhstan 5.3% 0.7% 4.77% 4.61% 16 RBS Kazakhstan 1.2% 0.4% 0.84% 0.79% 17 Alfa bank 7.3% 3.4% 4.53% 3.90% 18 Delta bank 13.7% 6.1% 9.50% 7.63% 19 Exim bank 10.9% 6.7% 6.03% 4.24% 20 Kazinvest bank 7.5% 5.0% 3.57% 2.54% 21 VTB 9.6% 4.9% 6.06% 4.70% 22 Bank of China 1.0% 0.1% 0.90% 0.88% 23 Astana finance bank 8.2% 2.7% 6.42% 5.48% 24 Home credit 32.0% 6.3% 29.48% 25.70% 25 RBK 8.8% 4.5% 4.86% 4.33% 26 Forte bank 6.4% 2.9% 4.59% 3.54% 27 Industrial bank of China 1.5% 0.4% 1.28% 1.15% 28 AsiaCredit Bank 10.7% 4.0% 8.33% 6.64% 29 Shinhan Kazakhstan 5.6% 1.7% 4.98% 3.94% 30 Bank Positive 5.4% 0.6% 5.54% 4.78% 31 Kazakhstan Ziraat bank 5.0% 0.0% 5.25% 5.02% 32 Kassa Nova 14.5% 5.3% 11.36% 9.16% 33 Punjab National Bank Kazakhstan 3.6% 3.6% 2.89% -0.02% 34 Islamic bank Al Hilal 4.3% 0.1% 4.13% 4.16% 35 Senim bank 9.6% 7.7% 4.77% 1.90% 36 Taib bank 4.5% 4.6% 2.72% -0.11% 37 National bank of Pakistan 9.0% 4.1% 8.47% 4.85% 38 Zaman bank 7.0% 2.2% 6.28% 4.79% Total 7.1% 5.4% 3.83% 1.67%

Minimum 1.0% 0.0% -1.6% -3.2%

Maximum 32.0% 9.0% 29.5% 25.7%

Mean 7.9% 4.1% 5.2% 3.8%

Median 7.2% 4.5% 4.8% 3.9%

Standard Deviation 5.2% 2.6% 4.7% 4.4%

Source: FMSA, 2012b

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The analysis of the assets yield and cost of fund shows that there is a significant difference

between the loan and deposit rates of commercial banks in Kazakhstan. The extreme values

are far from average. The standard deviation is comparable with average rates of return on

assets and liabilities. This reflects strong differentiation of the banks in terms of market

segment, product offering and value proposition.

We would like to test if we can apply the 10% premium that was found tolerable in our

demand survey. If we apply 10% extra over the average yield of assets (7.9%) would be only

0.79% that is far below the standard deviation (5.2%). The same thing is with the liabilities.

Another test of price differentiation in the market is presented in the table below where we

compare three banks, competing in the same market segments, SME and retail.

Table 9: Variation of Loan and Deposit Rates for Selected Banks (September 2012)

Deposits effective rates, % Tsesnabank Sberbank Eurasianbank Standard Deviation

KZT US$ KZT US$ KZT US$ KZT US$

6 month 5.10 3.10 3.60 2.80 1.30 3.00 1.91 0.15

12-13 month 7.50 3.90 6.40 3.80 8.30 3.00 0.95 0.49

10% discount test 6 month 0.51 0.31 0.36 0.28 0.13 0.30 12-13 month 0.75 0.39 0.64 0.38 0.83 0.30

Loan to Small business, % Tsesnabank Sberbank Eurasian Standard Deviation Minimum annual effective rate 11.30 12.00 14.00 1.4

processing fee 0.50 - - 10% premium test 1.13 1.20 1.40 Source: Published banks rates10 as of 13 September, 2012.

As we can see the 10% supposed premium of the Islamic bank is well below the standard

deviation of the banks’ rates, except the US$ deposits with the minimal variance.

10Websites: www.tsb.kz; www.sberbank.kz; www.eubank.kz

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Overall, we can conclude 10% premium price for Islamic banking products we derived from

the demand survey analysis seems acceptable in the market and will be hardly considered

as a marked difference.

However, our analysis of the industry has shown quite high competition in the market,

especially in the SME and retail segments.

Therefore, the bank should accept a competitive pricing policy. Thanking to its

differentiation advantage and unique selling points of the value proposition the bank will

not use a market penetration pricing rather it will follow the market at the first stage. This

means the ‘going-rate pricing’ method (Kotler and Keller, 2009, p.433). Under this method

the bank will price its products similarly (more or less) to the main competitors.

Later, upon the marketing efforts, educating the market and increase of awareness of

Islamic banking principles and the bank’s particular value proposition, the bank can

gradually transfer to the customers’ ‘perceived-value pricing’ (Kotler and Keller, 2009,

p.432). Under this method the bank would differentiate itself from majority of the players

and thereby charge tolerable premium 5-10% over the main competitors. However, socio-

economic benefits should be weighted carefully before the bank uses premium pricing.

5.2.3. IT INFRASTRUCTURE

The bank will require a robust Information Technologies (IT) architecture to record,

integrate and keep transactions data. The system should provide a flexible toolkit for

analysing, reporting and timely management intelligence.

In the table below we plan the bank’s IT structure and budget, based on research through

potential vendors and advice from IT-specialists.

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Table 10: IT Structure and Budget

Item Specifications Indicative price, US$

1. Core system Flex Cube (FC), Oracle 400,000 Software FC license – 150 concurrent users 20,000

Data base Oracle DBASF – 10 licenses 240,000 Hardware 16-core 3.7 GHz POWER7 IBM Power 750 Express server

64 GB of memory, two 146 GB 2.5" hot-swappable disk drives, AIX Standard Edition license Operating System included

65,000

Standby server and Test server, 3 Application servers IBM x3650 M4

124,000

Data storage IBM DS3524 DC Model (8Gb FC 4 Port Daughter Card, 5 discs 300GB 15,000 rpm 6Gb SAS 2.5” HDD for RAID 10, 2GB Cache )

30,000

Card system integration server x3650M4; DWH Server (reports)

60,000

Implementation Team: 1 project manager, Database admin and experts for parameterization, 27 week plus 4 week post live support

396,000

2. Card system Software

Compass Plus, TranzWare, 200K trnx., 50 ATM, 200 POS, 50K card holders

300,000

Membership Principal Membership to MC &VISA 250,000 Data Base Oracle - ASF for TWO, 24000; Oracle - ASF for TWS,

15000 310,000

Hardware TWCMS servers, 2 Main 8-core 3.7 GHz POWER7 IBM Power 730 Express server, 32 GB; Stand by 8-core 3.7 GHz POWER7 IBM Power 730 Express server, 32 GB; Test IBM x3630 M4 and Application Server; Main IBM x3650 M4 and Stand By IBM x3650 M4

136,000

Equipment for card issuance 100,000 Implementation 500$ man-day* 4 weeks, 1 project manager plus 1 expert 125,000

Total 2,556,000

Source: Vendors’ web-sites www.ibm.com, www.oracle.com and consultations with IT professionals.

These IT characteristics are indicative and based on the desired capacity of the system and

equipment, specifically number of licenses, processors, servers and users. The proposed IT

profile will be sufficient for potential growth of the bank during the projected period if

required maintenance is provided. A cost-saving can be achieved if the parent-bank

software is used.

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5.2.4. BRANCH NETWORK PLAN

Kazakhstan is number 9 in the world in terms of territory that spans to 2,727,300 square

kilometers. In terms of administrative units the country is comprised of 14 regions, 84 cities,

159 districts, 241 settlements and 2,042 rural counties.

Figure 29: Map of Kazakhstan

Source: Google, 2012

This land size and administrative-territorial structure of Kazakhstan require banks to develop

an extensive branch network not only in the capital, but also across the country. Below is

the branch number distribution of the banks, which have more than 10 branches.

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Figure 30: Branch Numbers Comparison (September 2012)

Source: FMSA, 2012b

These numbers include full scale branches and small outlets, usually retail and SME

oriented.

We see that banks with large branch network focus on SME and retail. Specifically

Halykbank, BTA, Kaspi, BCC, Tsesnabank. As we discussed in the Porter’s Forces analysis the

Top 5 banks in terms of assets hold 55% of the total branch number in the country (2,282).

As we realized in our previous analysis the bank needs to develop a branch network large

enough to cover at least main cities, and 14 region centers. Based on the main branch in

each region center smaller branches will be opened around.

In order to prioritize the locations we should have a look at the banking loan distribution

between the regions.

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Figure 31: Geographical Distribution of Total Banking Loans (September 2012)

Source: NBK, 2012b

Figure 32: Geographical Distribution of Small Business Banking Loans (September 2012)

Source: NBK, 2012b

The two charts above show that the geographical distribution of both total loan and small

business loan is identical. More than half of the loans were issued in Almaty, former capital

and now a commercial center of the country. Astana, present capital, won the second place.

Karaganda, East and Pavlodar regions are the next, completing the Top 5 largest economical

regions.

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Taking into consideration these data as well as the resources required for opening branches

we propose the following indicative plan:

Table11: Branches Opening Indicative Plan

# Region/City Number of branches Time frame Full scale Service center

1 Almaty city, incl. head office 2 3 2013 2 Astana 1 2 2014 3 Karaganda 1 1 2014 4 East (Ust-Kamenogorsk) 1 1 2015 5 Pavlodar 1 1 2015 6 South (Shymkent) 1 1 2015 7 Kostanai 1 1 2016 8 Aktubinsk 1 1 2016 9 Atyrau 1 1 2016 10 Mangystau-Aktau 1 1 2016 11 North (Petropavlovsk) 1 1 2017 12 Zhambyl - Taraz 1 1 2017 13 West (Uralsk) 1 1 2017 14 Almaty region 1 1 2017 15 Akmolinsk - Kokshetau 1 1 2018 16 Kyzylorda 1 1 2018 17 Other 1 5 2019 18 Other 1 5 2020 19 Other 1 5 2021 20 Other 1 5 2022 Total 21 39 60

By the end of 2018 the bank will cover all the main cities in the country. Until 2022the bank

will have 60 outlets. However, it is still below the top 10 banks in terms of number of

branches while the 10th bank has 98 outlets. Therefore, the bank will continue to analyze

needs in branches depending on effectiveness of the existing branch network and capacity

and potential markets in a particular city.

5.2.5. MARKETING COMMUNICATION MIX

The marketing communication mix will play a vital role in communicating the value

proposition of the bank and promotion of unique selling points of its products and services

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in the market. It will help to build long-term customer relationship and create strong brand

equity.

Furthermore, Islamic banking in whole is a new concept for Kazakhstan and as we have seen

in the survey results there is a certain part of population(9-28%), who know nothing about

Islamic banking in the country. Islamic banking principles and goals are confused by a third

of the respondents (32-36%). All these require a comprehensive education of people about

Islamic finance. This is also in line with the Road-map of Islamic finance in Kazakhstan.

However, the pioneers in the market have to take a leading role in educating the society.

Therefore, the bank will use a whole range of tools of the marketing communication mix, as

presented in the figure below:

Figure 33: Marketing Communication Mix

Source: Kotler and Keller (2009, p.513).

Advertising will cover TV, radio, newspapers and outdoors. Also some corporate and

product materials such as brochures and leaflets will be used by sales force. Sales force will

be involved in direct sales process, meeting clients and making presentations. Sales

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promotion comprises participation in fairs and exhibitions of financial organizations. Events

and public relations will form an educating program about Islamic finance in general and the

bank’s value proposition in particular. Seminars and publications will be actively put into

practice. Direct and interactive marketing will be employed using E-banking instruments.

Also, social networking and word-of-mouth ways of spreading of information should be

taken into account as we know that these are in preference of respectively 44% and 71% of

banking customers globally (Ernst & Young, 2012).

In turn, it will increase awareness of Islamic banking not only among Muslims, but also non-

Muslim customers, hence extending potential market and boosting future demand.

Table 12 portrays marketing and advertisement expenses in 2010-2011 for 6 selected banks:

KKB, the largest bank, four mid-sized SME and retail banks, which demonstrated good

growth in 2011, and the first Islamic bank.

Table 12: Marketing Expenses for Selected banks in 2010-2011 (US$, million)

Banks, 2011 % of total Opex % of total Assets 2010 % of total Opex % of total

Assets KKB 11.2 4% 0.07% 8.0 5% 0.05%

Tsesnabank 2.5 4% 0.08% 2.2 2% 0.14% Eurasian 4.7 5% 0.19% 1.4 2% 0.06% Sberbank 2.6 3% 0.08% 2.6 5% 0.14%

Kaspi 8.1 7% 0.29% 6.8 7% 0.28% Al Hilal 0.01 0.1% 0.01% 0.03 0.8% 0.07%

Average 4.8 4% 0.12% 349% 4% 0.12%

Source: Annual reports of the banks for 2011 (KKB, 2012a; Tsesnabank, 2012a; Eurasianbank, 2012; Sberbank,

2012; Kaspi bank, 2012; Al Hilal bank, 2012).

These banks, except Al Hilal, are well-established financial organizations in the market, thus

they benefit from scale economies. We see that Al Hilal, being a pioneer in the market, does

not spend enough to promote Islamic finance in the society. This again reflects its strategy,

focusing mainly on large corporate clients, which are targeted by the direct sale.

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Obviously for a start-up, focusing on SME and retail, the cost in relation to total assets and

operational expenses will be higher than in the established and matured banks. Based on

these indicators the bank will plan the marketing and advertisement cost as follows:

Table 13: Marketing Indicative Budget for 2013

# Marketing budget US$ % of Budget 1 Advertisement 850,000 57%

1.1. TV 600,000 40% 1.2. Radio 50,000 3% 1.3. Outdoors 150,000 10% 1.4. Other 50,000 3% 2. Public Relations & Publicity 200,000 13% 2.1. Seminars 150,000 10% 2.2. Other 50,000 3% 3. Direct & Interactive Marketing 200,000 13% 3.1. Web-site 150,000 10% 3.2. Other 50,000 3% 4. Promotion & Events 150,000 10% 5. Direct Sale 100,000 7% Total 1,500,000 100%

It corresponds to 13-60% of the leaders’ budget, but dramatically higher than AlHilal’s. Every

year onward the budget will increase gradually depending on the branch network and sales

effectiveness.

5.2.6. HUMAN CAPITAL MANAGEMENT

As far as the shareholders of the future bank have got all the necessary ingredients for a

start-up it will all depend on quality of project implementation and execution. Human

resources become the highest priority. The bank needs to build a professional, committed

and inspired team.

Within the Strategic Human Resource Management a combination of the ‘best-fit’ and the

‘resource-based’ approaches will be implemented (McKenna & Beech, 2008, pp. 31-36). The

former will help to create a corporate culture through selection, appraisal, rewarding and

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development processes. The latter will consider the human resources as an asset and source

of competitive advantage of the bank rather than costs to be minimized.

The bank will develop a Balanced Scorecard System and Performance Appraisal. They will

allow the management to align staff activities to the vision and strategy of the bank,

improve internal and external communications and monitor organizational performance

against strategic goals. The appraisal results will influence the decisions on pay and reward,

career promotions as well as training and development.

The bank will follow the Labor Code of Kazakhstan that regulates rights and obligations of

employee and employer, relationship between the two.

In recruitment and selection process the bank will cooperate with headhunters, sufficiently

operating in Kazakhstan. Due to the relatively high level of the banking sector development,

especially before the crisis, it seems easy to find professionals in banking in the market.

However, a special training program on Islamic finance should be provided for the

employees on a regular basis.

5.3. FINANCIAL PLAN

5.3.1. MAIN ASSUMPTIONS

1. It is assumed that the team, the banking IT core system and the main products are ready

to launch operations prior to beginning of the projected period.

2. The financial projections are computed over the period of 10 years. This is longer than

normally practiced in business with average projected period of 3-5 years. First reason for

longer time horizon is social underlying orientation of Islamic finance and this should

manifest itself in longer-term business plan. Secondly the entry barrier (capital

requirements) that was lifted up by NBK requires a longer payback period.

3. The minimum paid-up capital according to NBK requirements is about US$ 70 million.

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4. Deposit and financing portfolios growth is based on average of seven selected banks for

the first half of 2012 and equal to US$ 367 thousand and US$ 680 thousand per month per

branch respectively (FMSA, 2012b).

5. Cash reserves for liquidity position is based on selected banks’ benchmark and equal to 5

% of the total liabilities (Tsesnabank, 2012a; KKB, 2012a).

6. The interbank deposits, sukuk and borrowings are used as plugs of the projection model,

depending on funds excess or needs to support the loan portfolio growth and the liquidity

position.

7. Expected profit rates on financing and deposits are based on average interest rates in

foreign currencies in the market according to NBK Statistical Bulletin #6, June 2012 (NBK,

2012b). These rates were verified with actual average rates in US$ of one of the mid-sized

banks (Tsesnabank, 2012b). We did not apply any price premium over the average rates

though it was found applicable and tolerable in our previous analysis (See Section 4.3.4. of

Chapter 4 and Section 5.2.2.5 of Chapter 5). Therefore, we were conservative in our

projections.

8. The branch network plan, IT investments, and marketing budget are taken into account as

discussed in sections 5.2.3 -5.2.5 of Chapter 5.

9. Administrative expenses are computed in the following way:

Cost benchmark was derived based on the actual branch budget for 2012 of one of

the mid-sized banks (Tsesnabank, 2012b);

The head office expenses were computed including the operational part, back office

staff and depreciation. The growth rate of 2% was applied every year for inflation (in

US$) and expansion.

Head office and branches budget was multiplied by 25% as additional costs

attributed to specifics of Islamic banking. Particularly additional cost may occur due

to higher needs of human resources for due-diligence procedure in partnership

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instruments. Also Sharia control is an additional cost over conventional banks’

expenses.

Another margin of safety rate was applied for contingency as 5% over the head

office and branches budget.

10. Provisioning allowances are benchmarked against 3 selected banks and equal to 1.3% of

gross loan every year. This allows us to accumulate provisions against the 6.8% NPL level

(Tsesnabank, 2012a; Sberbank, 2012; Eurasianbank, 2012).

11. The income tax in Kazakhstan is 20%. In case of losses the tax benefit is carried forward

over 10 years.

12. No dividends are assumed during the planned period.

Details on assumptions are indicated in Appendix G.

5.3.2. BALANCE SHEET AND INCOME STATEMENT

The Balance sheet and Income statement are indicated in Appendix H.

Overall, the total assets of the bank will grow to US$ 2,629million over the projection

period. The equity of the bank will go up to US$ 250 million with initial capital injection just

US$ 70 million. The break-even will be achieved in the fourth year and in the fifth year the

bank will turn to profit, growing continuously year-on-year because of economies of scale.

The net profit for the last projected year is expected to reach US$ 64 million.

5.3.3. KEY PERFORMANCE INDICATORS

As it will take time to achieve economies of scale the profitability ratios will continuously

improve over the projected period. The return on average equity (ROAE) and on average

assets (ROAA) in 2022 will reach 29.4% and 2.7% respectively. The net interest margin will

grow at the beginning of projections to 6.5% and then decline to 5.5% as more borrowings

planned to support the growth of the bank. The cost-to-income ratio due to the scale effect

will gradually decline from 116% to 25%. This seems feasible comparing to other Kazakh

banks, for example KKB’s ratio was 20% as of 01 July 2012 (KKB, 2012b). Another feasibility

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test of the bank’s operations capacity is the amount of loans served by one employee. We

have got US$ 2.3 million that is similar to KKB’s indicator - US$2.4 million (KKB, 2012b).

The liquidity, capital adequacy and asset quality ratios are taken into account considering

the average indicators in the market and the regulation standards.

The growth rate of the assets reflects the different stages of the bank’s life-cycle. The start-

up, expansion and high growth stages will be started to transfer to the mature growth at the

end of the projected period. The maximum growth rate of 95% in 2015 will continuously

decrease to 25% in 2022.See Appendix I for details.

5.3.4. MEASURING RETURN ON INVESTMENT

As a result of the financial projections we have measured the return on investment

attributed to shareholders, who invested US$ 70 million as a paid-up capital. The free cash

flow was computed based on the financial modeling formulas (Benninga, 2008, pp. 177-

201). The Terminal Value is assumed as 1.5 multiple to Book Value (Shareholders capital at

the end of 2022). Using MS Excel we found the following (See Appendix J):

The payback period is 8 years.

The Accounting rate of return (ARR) is 16.4%.

The Net Present Value (NPV) is USD 128.0 million with required rate of 12.5%.

IRR is 25.1% for the projected period.

The pay-back period seems to be quite long; however ,the Islamic finance itself as a social-

oriented business needs longer than usual time horizon. Also quite high paid-up capital

requirements in Kazakhstan make the business project viable in the longer term. Overall,

the ARR, NPV and IRR look attractive over the projected period. The NPV is positive and

promises to increase the value of the bank’s shareholders significantly. The IRR 25.1% is

twice higher than the current discount rate used in the market for Kazakhstan banks

(12.5%11).

11 Investment banks practice in Kazakhstan (e.g. BCC-Invest, 2012, p.18)

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6. CONCLUSION The overview of Islamic finance industry in the world and the steps taken by the authorities

in Kazakhstan, including the legislation framework, the Road-map, the debut sukuk issuance

and opening of the first Islamic financial institutions, promise a good opportunity for Islamic

banking in the country.

The demand study, including the web and email surveys, banking penetration analysis,

religious factors, customer behavior and case-study of the first Islamic bank in Kazakhstan

allows us to forecast the available market share of Islamic banking in the country 21%-45%

of the total banking market.

At the moment decrease in trust to the banking sector globally and in Kazakhstan

particularly provides firm grounds for Islamic finance to become a viable alternative to

conventional banking.

However, this requires the former to distinguish itself from the latter. The strong criticism

overwhelms Islamic finance for its mimicry of conventional products and losing its

uniqueness and authenticity. Therefore, every new ventures as well as existing institutions

must revise Islamic finance underlying principles, its mission and goals. Specifically, Islamic

finance, being an integrated part of Islamic economics, is supposed to promote social justice

and distributional equity as its high level goals. On micro-level a bank must increase financial

services’ accessibility to all the population and stimulate economic activity in a just and fair

way that is primarily sharing risks and profit.

Keeping this idea in mind and after the external and internal factors analysis we derived a

business strategy of an Islamic bank with focusing on SME and retail segments. The value

proposition should include the Sharia-based banking products with clear evidence of socio-

economic betterment for a client and the country. A prerequisite to the successful delivery

of this value will be in comprehensive education and marketing communication programs in

order to increase awareness and understanding of Islamic finance principles in the market.

Branch network, strong KYC and risk management systems must be put in place also.

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The business development plan and the financial projections show us that the project is

supposed to be commercially viable and can be interesting for potential investors. Although

the payback period will take 8 years, the longer than usual time horizon of the project is

justified by large initial investments according to the minimum capital requirements and, on

the other hand, by social orientation of the business that should not expect some fast

money. It is expected to reach IRR 25.1% over 10 years. This is two times higher than the

current cost of capital of the Kazakh banks.

This research has suggested that the specific mission of Islamic finance could successfully fit

with the common business goals, whereby following Maqasid al-Sharia will equally lead to

the socio-economic improvement and decent return on investment.

The main risks, nevertheless, underlie in effective execution of the business plan, adoption

of the draft law on regulation improvements and further support and development of the

industry by the Government. Therefore we suggest some recommendations in Chapter 7.

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7. Recommendations

A. On the basis of the research has been done we recommend potential

investors the following:

1. The business plan with its strategic analysis, value proposition and financial projections

can be considered as fundamentals for a new Islamic banking venture in Kazakhstan.

2. The new bank should focus on SME and retail segments.

3. The bank should use more genuine and unique Islamic finance partnership mechanisms

where both risk and profit are shared. The use of the debt-based instrument should be

limited.

4. In order to ensure that the value proposition is being delivered the bank should introduce

a ‘Socio-Economic Better-Off Test’. This can be in addition to Sharia compliance control and

Risk management process, being already in banking practice. Thereby, the bank should

assess betterment for its customers and overall contribution to the country prosperity from

socio-economic perspective.

5. To increase awareness of Islamic finance principles, its mission and goals, and to

communicate the bank’s value proposition to the market the bank will need to conduct a

comprehensive marketing and educational programs.

6. At the first stage the new Islamic bank should accept a competitive pricing policy and

follow the market with the ‘going-rate pricing’. Upon the marketing efforts and increase in

awareness of Islamic banking principles the bank can gradually transfer to the customer

‘perceived-value pricing’, where a premium price of 5-10% is considered acceptable by

potential customers and found being within the range of price standard deviation among

the banks in Kazakhstan. However, a premium pricing should be carefully weighted from an

angle of social mission of Islamic finance.

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7. To prevent an adverse selection and a moral hazard, where some customers can expect

easing from the bank in terms of collateral, payment discipline and pricing, the bank should

introduce a top notch KYC and risk management policies.

8. A new venture in Islamic banking in Kazakhstan should be established as a standalone

Islamic bank. It is not only the Law requirements, but also a preference of the majority of

the survey respondents.

9. Current situation in the market is favorable for a new Islamic banking entrance owing to

recent financial crisis and decline in trust to large conventional banks. Only few mid-sized

banks are competing currently and gaining the market share.

10. The Banking Law amendments drafted by NBK should be adopted before the bank starts

operations.

11. The business plan execution will require effective asset and liabilities management. It

will depend on smooth development of interbank and capital markets locally and abroad.

This should be tested prior to starting of the business.

12. The branch network deployment will be critical for a successful business plan execution.

The bank should organize required resources for smooth and timely opening of outlets. It

should minimize a time lag between expenses for opening and start of generating income by

a branch. Therefore, the branches for the next year should start preparing in the current

year.

13. The lack of deposit guarantee scheme for Islamic banks might put the business plan at

risk. Our survey found a risk aversion among potential customers. However, education of

the market and a strong reputation of the bank (its shareholders) may mitigate this risk.

Also, the Law amendments suppose introducing an option of a voluntary deposit guarantee

fund for Islamic banks.

14. It would be a competitive advantage if the bank is established by existing Islamic

financial institution from abroad. This will provide a new venture with support in product

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development, Sharia compliance control and cost of funds. It may also benefit through

economies of scale in terms of IT and back-office expenses.

15. The required investment grade credit rating (at least BBB+) of a parent bank will be an

additional competitive advantage in the capital market both in Kazakhstan and abroad.

Specifically, in Kazakhstan this will allow attracting funding from the pension funds and

insurance companies, which are large institutional investors.

B. The government authorities are advised as follows:

1. Since the Government pursues new investments into the country, particularly through the

sukuk issuance, the local Islamic finance component has become important for this. More

Islamic investments can be attracted if there are local Sharia-compliant financial

institutions, investors and projects. Hence the Government should continue to improve the

regulation environment and develop the local Islamic finance component.

2. The Government and financial market regulators have certain strategies for financial

inclusion, particularly outlined in the Conception of the financial sector development in the

post-crisis period from 01 February 2010.And Islamic banking needs to be seriously

considered from this perspective. Thus, the Government’s Road-map on Islamic finance

must be implemented effectively and in time.

3. As the pioneers of the market will bear disproportionately higher cost for educating the

market on Islamic finance comparing to the next entrants the regulators should play also a

key role in the information programs. This is in line with the Road-map and must be realized

together with the financial institutions.

4. The stock market development in Kazakhstan should be a priority for the regulators.

Effectively operating capital market with long-term higher-return and higher-risk equity

instruments can be supportive for Islamic banking industry, providing liquidity and

promoting risk-sharing culture.

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C. In addition to our findings, there is a room for further researches:

1. A marketing research can be conducted in terms of decision making process in families,

age and genders of decision makers and especially those, who are price tolerated.

2. Income size breakdown of the different groups of potential customers needs to be

analyzed.

3. Geographical specifics should also be analyzed, as the main nationalities are distributed

differently across regions, cities and rural areas.

Thereby, more specific marketing and product strategies can be derived with focus on

particular gender, age groups and income size of potential customers, as well as with

geographical prioritization.

D. Final recommendation

A good point to end this paper is a quote from the recent book ‘Islamic finance: Why It

Makes Sense’ on moral imperative of Islamic finance:

‘It is not about finding billion-dollar petroleum projects or becoming the next Islamic finance multi-millionaire. Rather, it is to do with alleviating poverty and wealth gaps around the world.’(Vicary Abdullah and Chee, 2010, p.2).

We estimate the returns on investment in a new Islamic bank in Kazakhstan to be attractive

for potential investors, though it should not be a paramount goal. Attractiveness of Islamic

investments must be weighted first of all from the viewpoint of socio-economic betterment

of people and the country. When this is achieved, an investor will be rewarded inevitably

since Islamic bank supposes a real, trustworthy partnership and participation in mutual

sharing the benefits.

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Appendix A:Core Islamic Banking Products Description

1. Deposit Accounts:

Wadiah – in this type of deposit the bank safe keeps the depositor’s money and pays it back to him on demand. There is not a fixed return on this deposit, however, the bank can offer some return in a form of gift (hibah).

Mudaraba - in this type of deposit the bank accepts depositor’s money and invests them into agreed (restricted or unrestricted) projects as a fund manager. Then profit is shared as per the pre-agreed ratio, whereas loss is born by the depositor as an investor.

Qard-Hassan - in this type of deposit the bank borrows money from depositors and offers no profit on it. The bank is obliged to return money back in full amount.

2. Investment based financing contracts:

Mudaraba is a partnership, whereby the bank (as investor) provides the client (as entrepreneur) with a capital needed for his projects. The profit from the project is shared as per the pre-agreed ratio, whereas loss is born by the bank as an investor.

Musharaka is a partnership, whereby the bank and the client participate by their equities to finance a project. Profit is shared based on pre-agreed ratio that may not be linked to the equity distribution. In case of loss it is shared by both partners on a pro-rata basis.

Wakala is an investment agency contract, whereby the principal appoints an agent to conduct a transaction or make an investment on his behalf. The agent bears no risk and shares no profit; however, he is entitled to an agency fee. Islamic banks can operate on both ends being an agent for a client or appoint a client as its agent for business transactions, such as trade finance and/or purchase and selling assets.

3. Sale-based financing contracts:

Murabaha is a fixed-price sale contract, whereby the bank purchases certain goods on the client’s request and resells them to the client at a marked-up price, consisted of cost and profit. While the title is transferred from the bank to the client immediately, the purchase price is paid on a deferred basis. The important condition is that the profit of the bank must be disclosed to the client before signing the contract and cannot be changed over time.

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Salam is a sale contract, whereby the buyer (bank) purchases goods with up-front price, while the delivery of goods is on a deferred basis in future. Such goods may include any fungible commodities and must be described in the contract. As a result the seller (client) receives cash for the term until the goods delivery. The bank earns profit from reselling the commodity at higher price in the market.

Ijara is a leasing contract, whereby the bank (lessor) purchases and leases an asset to the client (lessee). The lease can be operating or financial, where the asset is returned to lessor in the former and is purchased by lessee in the latter upon the lease term completion.

Istisna is a contract, whereby the bank finances a construction of building or manufacturing of goods for the client (a buyer of these future assets). Once the contract is signed the bank (seller) starts to finance the production and the client (buyer) is obliged to take delivery in future and pay the purchase price to the bank on a deferred basis or in installments.

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Appendix B: IMF on Kazakhstan Banking Sector12

12 Extract from IMF Country Reporton Kazakhstan (IMF, 2012b, p.7)

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Appendix C13: Kazakhstan Islamic Finance Road-Map

The Road-map of Islamic finance development until 2020 approved by the Resolution of the Government of the Republic of Kazakhstan from March 29, 2012 # 371 stipulates the following core directions.

1. Legislation Improvement:

a) Conduct an analysis of main problems of Islamic finance development – on a regular semi-annual basis until 2020;

b) Develop recommendations on legislation improvement – annually until 2020; c) Prepare a draft law on Islamic finance and Islamic insurance – 2012; d) Consider possibility to grant special conditions for ownership registration of

Murabaha, Ijara and Istisna contracts – 2013; e) Sign a convention on double taxation with South-East Asia and Midle-East countries

– 2020; f) Taxation synchronization with the banking and insurance law amendments - 2012-

2013; g) Consider necessity of separate legal framework for Islamic microfinance and other

financial institutions (leasing and mortgage companies, investment funds, securities companies, etc.) – 2013;

2. Educating market:

a) Prepare and execute media-plan – annually until 2020 ; b) Consider creation of a special Internet resource on Islamic finance – 2013; c) Publish in mass-media information on Islamic financial institutions registered in

Kazakhstan – annually until 2020; d) Informative distribution on Islamic finance in Kazakhstan among the diplomatic

representatives of Kazakhstan abroad - 2013-2014;

3. Islamic Finance Infrastructure Development:

a) Consider possibility to establish a central Council on Islamic finance - 2012-2013; b) Support market of short-term liquidity for Islamic financial organizations -2014-2015; c) Introduce Islamic indexes similar to Dow Jones Islamic Index – 2016;

13 Author’s summary on the Government Resolution

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d) Consider opportunity to develop Almaty city as the regional Islamic finance hub- 2012;

4. International Cooperation:

a) Establish cooperation with international Islamic finance organizations, including the IFSB, ILMC, IIFM, AAOIFI, IIRA, CIBAFI – annually until 2020;

b) Cooperation with the rating agency of Malaysia (RAM Holding) - 2012-2013; c) Establish cooperation with other international Islamic finance organizations and

leading universities, providing Islamic finance education (World Bank, Asian Development Bank, USA and UK universities) - 2013-2014;

d) Participate in the main annual events on Islamic finance (IDB annual meeting, IFSB summit in Malaysia, WIBC in Bahrain, WIFC in London and WIEF in Malaysia) - until 2020;

5. Public Sector Development:

a) Consider establishment of a committee on Islamic finance development within NBK – 2014;

b) Consider necessity of special budget programme – 2013; c) Organize an intergovernmental twinning programme to study and exchange of

experience from successful countries in Islamic finance (Malaysia, Bahrain, UAE, UK, USA, Luxembourg) - 2012-2013;

d) Issue sovereign Islamic securities - 2012-2014;

6. Islamic Financial Services Development:

a) Select appropriate industrial projects and organize Islamic securities for their financing– 2012;

b) Facilitate to opening new Islamic banks - 2013-2014; c) Facilitate to Islamic insurance development - 2012-2013;

7. Science and Education;

a) Introduce ‘Islamic finance’ module in curricula of economic universities -2012; b) Study experience of Islamic finance by Kazakhstan universities – 2013; c) Organize round-tables and discussions on Islamic Finance with participation of

scientists, scholars and practitioners - 2012-2014; d) Conduct seminars for state authorities employees on a regular basis – annually until

2020;

122

e) Establish an educational and analytical centre on Islamic finance study – 2013; f) Consider opportunities of organizing education abroad for Kazakhstan specialists in

the field of Islamic finance – 2013;

8. Investors Relations:

a) Conduct negotiations and meetings with banks, funds and investors from South–East Asia and Middle-East countries to attract investments in Kazakhstan- annually until 2020;

b) Organize events in Kazakhstan – annually until 2020; c) Activate cooperation with IDB Group (Country Strategy) - 2012-2014; d) Consider possibility to increase Kazakhstan share in the international Islamic financial

organizations - 2012-2014; e) Prepare information on losses of Islamic financial institutions occurred due to

Kazakhstan counterparties; consider further solutions for these investors – annually until 2020;

f) Activate role of the Kazakhstan Chamber of Commerce and Industry within its membership in the Islamic Chamber of Commerce and Industry: cooperation on the business and investment opportunities and Islamic finance development in Kazakhstan - 2012-2014;

g) Regular update of the list of investment projects for distribution among Organization of Islamic Cooperation members – quarterly until 2020.

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Appendix D: Survey Form and Questionnaire

[Translated from Russian]

Islamic Banking in Kazakhstan: Is there any demand?

Dear Sir/Madam,

Kazakh consulting company "Akyl-Kenes Consulting" would like to ask you to take part in the survey: Islamic banking in Kazakhstan: Is there any demand?

This survey is a part of research about demand among the locals and the business community for the services of Islamic banking in Kazakhstan.

The results will be used in the scientific and educational process and can also be provided to interested investors, financial market regulators and the Government of the Republic of Kazakhstan.

The following survey consists of eight questions and will take an average up to 5 minutes.

Thank you for your assistance in conducting the research.

Akyl-Kenes Consulting

www.akylkenes.com

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Survey Questionnaire

Personal Data

Before you answer the questions please provide the following information about yourself to summarize the data about the audience, participating in the survey.

Age:

16-20 21-30 31-40 41-50 50+

Gender: M, F

Occupation:

Business owner Employee Public servant Priest Student Retiree Unemployed

Average annual income (in US$):

up to 5000 5 000 – 10 000 10 000 – 30 000 30 000 – 50 000 50 000 – 100 000 100 000 – 200 000 200 00 and above

Question 1:

Are you aware of the existence of Islamic banking in the financial market of Kazakhstan?

Yes No

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For information:

In 2008 the Republic of Kazakhstan adopted a package of legislation on the implementation of Islamic banking as an alternative to traditional banks. In 2010 the first Islamic bank in Kazakhstan obtained a license and opened.

Question 2:

Do you support the policy of the Government of Kazakhstan to introduce Islamic banking as alternative financial services and attract new foreign investments into the economy?

Yes No

Question 3:

Do you think Islamic banks due to their specifics need to be more socially oriented than traditional banks?

Yes No

Question 4:

Do you think Islamic banks are the same commercial and for-profit organizations as traditional banks?

Yes No

Question 5:

At which main condition you would prefer to use the services of an Islamic bank as an alternative to a conventional one?

If the price terms (rates) offered by the Islamic bank for deposit and loan products are more profitable than in the traditional banks in Kazakhstan

The specifics of the bank, because I believe that Islamic banking is a distinctive, more ethical and more equitable way of financial services rather than traditional banking

Other conditions, such as a well-known brand and reliable reputation, professional marketing and quality service, convenient location and parking, comfortable office, a desire to try new products, etc.

Under any circumstances I would not be a client of the Islamic bank Question 6:

Would you agree to use the products and services of Islamic banking on less profitable conditions than conventional banking?

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(That is when the rate of return of an Islamic bank deposit products lower and / or cost of credit products is higher than in a traditional bank).

No Yes

Yes, agree but on condition that the rates will not differ by more than (the percentage refers to the difference between the rate of Islamic bank and a conventional bank):

50%

45%

40%

35%

30%

25%

20%

15%

10%

5%

0%

Question 7:

What are your preferences on the organizational form of the Islamic Bank?

Islamic bank as a standalone financial institution Islamic window in a well-known traditional bank Any of the above None of the above

Question 8:

What kind of financial services do you need most?

(You may choose more than one answer)

Personal financing (mortgage, auto loans, consumer loans, etc.) Business financing (working capital, project finance, leasing, etc.) Savings and cash management services (current and saving accounts with no

interest) Deposit products (relatively low risk and low income in the form of interest) Investment (relatively high risk and high expected return) None of the above

The End!

Thank you very much for participating in our survey!

127

Appendix E: Screenshot of the Survey Banner

The screenshot from the website www.nur.kz with the survey banner as of 23 August 2012

(the banner is circled in red):

128

Appendix F: Organization Chart

Risk Management Committee

Head of Audit

Deputy Chairman of Management Board

IT Department

Administrative Department

Human Resources Department

Marketing Department

Call Center

Branch 1, Branch 2, etc.

Card Center Clearing & Remittance Department

Accounting Department

Treasury Department

International Relations Department

Sales Department

Legal Department

Planning Department

Branch coordination Department

Managing Director

Managing Director

ALCO

Credit Committee

Business Development Committee

Corporate Business

Head of Compliance

Compliance Committee

Deputy Chairman of Management Board

SME Business

Retail Business

Chairman of Management

Board

Audit Committee

Head of Risk

Nomination & Remuneration Committee

Board of Directors

Council on Islamic principles (Sharia Board)

Shareholders

129

Appendix G: Financial Projections: Main Assumptions

Balance Sheet Currency Unit: US$, thousands (ths) 2013 - 2022 Comments

Assets Cash reserves, % of total liabilities 5 Benchmark is based on selected banks (KKB, Tsesnabank)

Accounts receivable from banks balance This is the model's plug using the Excel 'Solver' solution to adjust the balance. It means placing excess liquidity in interbank market

Securities, % of funds available 70 - 50 Placing funds available after financing disbursement. The securities portfolio is a second line of liquidity Financing portfolio (gross), US$ ths per month per branch 680 Benchmark is derived from average growth of 7 selected banks based on performance for the first six

months 2012

Non-performing loans, % of total financing 3.4 – 6.8 Average for 3 selected banks (Tsesnabank, Eurasian, Sberbank) as of end 2011. For the first two years we applied only 50% of the indicator as the portfolio will be new

Fixed and Intangible Assets, US$ ths 2,910 See separate budget. The assets value remains constant meaning additional investments every year will be equal to amount of depreciation. Depreciation applied to expenses

Other assets, % of total financing 1.7 Average for 6 selected banks Liabilities

Liabilities to customers, US$ ths per month per branch 367 Benchmark is derived from average growth of 7 selected banks based on performance for the first six months 2012

Demand deposits from individuals, % of total individual deposits 15

Structure of deposits is based on conventional banks indicators and Islamic banks specifics in terms of interest free accounts

Demand deposits from legal entities, % of total corporate deposits 50

Investment deposits from individuals, % of total individual deposits 85

Investment deposits from legal entities, % of total corporate deposits 50

Sukuk (Bonds) balance Sukuk and borrowings are other two plugs of the projection model. Sukuk can be used only after 2 years of profitable performance and assumed as long-term debt

Borrowings balance Sukuk and borrowings used when deposits and capital are not enough to support growth and keep liquidity ratios at proper level

Other liabilities, % of total deposits 1.5 Average for 6 selected banks Shareholders Equity Ordinary shares, US$ ths 70,000 Capital injection is to comply with minimum capital requirement of NBK Off-Balance Sheet Items, % of total financing 30 Indicative, 30% of total financing

130

Income statement Currency Unit: US$, ths 2013 - 2022 Comments

Income from finance activities: financing to legal entities 8.2 Average rates in the market: Statistic bulletin, NBK (2012b)

financing to individuals 13.8 Average rates in the market: Statistic bulletin, NBK (2012b)

interbank 3.83 Average rates in the market: Statistic bulletin, NBK (2012b)

securities 4.45 Al Hilal bank (2012), DBK 2012 sukuk issuance benchmark Expenses from finance activities: deposits to legal entities 1.3 Average rates in the market: Statistic bulletin, NBK (2012b)

deposits to individuals 5.5 Average rates in the market: Statistic bulletin, NBK (2012b)

sukuk 4.45 Al Hilal bank (2012), DBK 2012 sukuk issuance benchmark

borrowings 3.83 Average rates in the market: Statistic bulletin, NBK (2012b)

Other operating income (net), % of total deposits 2.1 Average for 6 selected banks as percent of total liabilities. Conservatively we took the same proportion but out of customer deposits

General and administrative expenses

Head office, US$, ths benchmark +25%+2%

Admin costs budgeted based on real budget of one of the mid-sized bank (Tsesnabank). Due to specifics of Islamic banks operations the additional cost applied as 25% over conventional bank's cost. Then 2% growth rate on yearly basis applied for US$ prices and expansion

Branches, US$, ths benchmark +25%*No. of branhces

Standard branch budget is US$ 577 ths, small branch - US$ 313 ths. The additional cost 25% applied as margin of safety

Contingency reserve , % of head office and branches budget 5 5% of head office and branches budget applied as margin of safety for branch expansion (inflation,

project management issues etc.)

Marketing, US$, ths 1,500 – 3,537 See initial Marketing budget for 2013. In subsequent years annual growth of 10% applied.

Loss provisions, % of total financing portfolio 0.67- 1.33 Average for 3 selected banks (Tsesnabank, Eurasian, Sberbank) as of end 2011. For the first two years we applied only 50% of the indicator as the portfolio will be new

Income before tax Income Tax, % of profit before tax 20 The corporate income tax in Kazakhstan is 20%

Income Tax benefit, % of losses before benefit 20 Losses give a tax benefit (offset in future tax) carried forward for 10 years

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Appendix H: Financial Projections: Balance Sheet and Income Statement

Balance Sheet (US$, ths) 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Assets Cash reserves 559 2,237 7,645 17,119 29,383 42,989 58,713 76,279 96,188 118,939 Accounts receivable from banks 13,458 7,677 2,084 7,421 12,499 15,519 30,097 52,766 90,852 151,578 Securities 42,545 16,557 17,582 30,696 39,056 36,351 34,424 26,432 17,374 12,250 Financing portfolio (gross) 20,406 81,626 187,739 350,990 579,542 857,069 1,175,409 1,542,724 1,959,015 2,424,281 Provisions 136 680 3,183 7,863 15,590 27,018 42,690 63,260 89,380 121,704 Financing portfolio (net) 20,270 80,945 184,555 343,127 563,951 830,051 1,132,719 1,479,464 1,869,635 2,302,577 Fixed and Intangible assets 2,910 2,910 2,910 2,910 2,910 2,910 2,910 2,910 2,910 2,910 Other assets 342 1,367 3,143 5,877 9,704 14,351 19,681 25,831 32,801 40,592 Total assets 80,084 111,693 217,919 407,150 657,503 942,170 1,278,543 1,663,682 2,109,760 2,628,845

Liabilities Liabilities to customers 11,019 44,076 101,375 189,527 312,941 462,800 634,697 833,039 1,057,828 1,309,062 Demand deposits from individuals 708 2,834 6,518 12,186 20,121 29,756 40,808 53,561 68,013 84,167 Demand deposits from legal entities 3,148 12,592 28,961 54,145 89,402 132,214 181,321 237,984 302,202 373,975 Investment deposits from individuals 4,015 16,059 36,935 69,053 114,017 168,617 231,246 303,510 385,410 476,944 Investment deposits from legal entities 3,148 12,592 28,961 54,145 89,402 132,214 181,321 237,984 302,202 373,975 Sukuk (Bonds) 0 0 0 0 0 200,000 280,000 380,000 500,000 700,000 Borrowings 0 0 50,000 150,000 270,000 190,000 250,000 300,000 350,000 350,000 Other liabilities 166 664 1,527 2,855 4,714 6,971 9,561 12,549 15,935 19,719 Total liabilities 11,185 44,740 152,902 342,382 587,655 859,771 1,174,257 1,525,588 1,923,762 2,378,781

Shareholders Equity 68,899 66,953 65,017 64,767 69,848 82,399 104,286 138,094 185,997 250,064 Ordinary shares 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 70,000 Retained Profits/Accumulated Losses (1,101) (3,047) (4,983) (5,233) (152) 12,399 34,286 68,094 115,997 180,064 Total equity and liabilities 80,084 111,693 217,919 407,150 657,503 942,170 1,278,543 1,663,682 2,109,760 2,628,845

Off-Balance Sheet Items 6,122 24,488 56,322 105,297 173,863 257,121 352,623 462,817 587,704 727,284

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Income statement (US$, ths) 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Income from finance activities: 3,404 6,210 12,724 24,664 42,171 64,052 89,517 118,817 152,291 190,381 financing to legal entities 810 3,652 9,579 19,039 32,727 50,296 70,817 94,248 120,835 150,533 financing to individuals 186 838 2,198 4,369 7,511 11,542 16,252 21,629 27,731 34,546 interbank 515 405 187 182 381 537 874 1,587 2,750 4,643 securities 1,893 1,315 760 1,074 1,552 1,678 1,575 1,354 975 659 Expenses from finance activities: 144 654 2,685 7,285 14,010 22,472 32,140 42,649 54,484 68,215 deposits from legal entities 23 102 270 540 933 1,440 2,038 2,725 3,511 4,395 deposits from individuals 121 552 1,457 2,915 5,034 7,772 10,996 14,706 18,945 23,715 sukuk 0 0 0 0 0 4,450 10,680 14,685 19,580 26,700 borrowings 0 0 958 3,830 8,043 8,809 8,426 10,533 12,448 13,405 Net financial income 3,260 5,555 10,039 17,379 28,161 41,580 57,377 76,169 97,807 122,166 Other operating income (net) 229 916 2,107 3,939 6,504 9,619 13,192 17,314 21,986 27,208 Total Operatin income 3,490 6,471 12,146 21,319 34,665 51,199 70,568 93,483 119,793 149,374 General and administrative expenses 4,730 8,360 12,063 16,951 21,857 24,448 27,538 30,652 33,794 36,966 Head office 1,518 1,549 1,580 1,611 1,643 1,676 1,710 1,744 1,779 1,814 Branches 1,558 4,842 8,180 12,631 17,082 19,307 21,986 24,665 27,344 30,023 Contingency reserve 154 320 488 712 936 1,049 1,185 1,320 1,456 1,592 Marketing 1,500 1,650 1,815 1,997 2,196 2,416 2,657 2,923 3,215 3,537 Operating profit before loss provisions (1,240) (1,889) 83 4,368 12,808 26,751 43,031 62,830 85,999 112,408 Loss provisions 136 544 2,503 4,680 7,727 11,428 15,672 20,570 26,120 32,324 Income before tax (1,376) (2,433) (2,420) (312) 5,081 15,324 27,358 42,261 59,879 80,084 Income Tax (20%) 0 0 0 0 1,016 3,065 5,472 8,452 11,976 16,017 Income Tax benefit (carried forward) (275) (487) (484) (62) (1,016) (292) 0 0 0 0 Net income/net loss for the year (1,101) (1,946) (1,936) (250) 5,081 12,551 21,887 33,809 47,903 64,067

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Appendix I: Financial Projections: Key Performance Indicators

Key Performance Indicators 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Profitability & Efficiency ROAE (%) -1.6% -2.9% -2.9% -0.4% 7.5% 16.5% 23.4% 27.9% 29.6% 29.4%

ROAA (%) -1.4% -2.0% -1.2% -0.1% 1.0% 1.6% 2.0% 2.3% 2.5% 2.7%

NIM (%) 4.3% 6.1% 6.5% 5.9% 5.7% 5.6% 5.5% 5.5% 5.5% 5.5%

Cost / Income (%) 135.5% 129.2% 99.3% 79.5% 63.1% 47.8% 39.0% 32.8% 28.2% 24.7%

Funding and Liquidity Credit / Deposit (%) 185.2% 185.2% 185.2% 185.2% 185.2% 185.2% 185.2% 185.2% 185.2% 185.2%

Cash / Total Liabilities (%) 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%

Liquid Assets / Total Assets (%) 70.6% 23.7% 12.5% 13.6% 12.3% 10.1% 9.6% 9.3% 9.7% 10.8%

Highly Liquid Assets / Demand deposits (%) 363.5% 64.3% 27.4% 37.0% 38.2% 36.1% 40.0% 44.3% 50.5% 59.0%

Long-term Debt in Total Liabilities (%) 0.0% 0.0% 0.0% 0.0% 0.0% 23.3% 23.8% 24.9% 26.0% 29.4%

Capitalization Tier 1 Capital/ Total Assets (%) - 6% min 86.0% 59.9% 29.8% 15.9% 10.6% 8.7% 8.2% 8.3% 8.8% 9.5%

Total Capital/ Risk-weighted Assets (%) -12% min 118.1% 95.1% 47.6% 25.7% 17.4% 14.5% 13.7% 14.2% 15.3% 16.7%

Asset Quality NPL/Total Financing portfolio (%) 3.4% 3.4% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8%

Accumulated Provision/Total Financing portfolio (%) 0.7% 0.8% 1.7% 2.2% 2.7% 3.2% 3.6% 4.1% 4.6% 5.0%

General Information Asset growth p.a. (%) - 39% 95% 87% 61% 43% 36% 30% 27% 25%

No. of outlets: Head Office & Branches 5 10 16 24 32 36 42 48 54 60

No. of Staff 121 210 326 481 636 714 798 881 965 1,049

Loan per staff, ths US$ 168 389 575 729 911 1,201 1,474 1,751 2,030 2,312

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Appendix J: Financial Projections: Measuring Return on Investment

Measuring Return on Investment 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Free Cash Flow Calculation (US$, ths) Profit after tax (1,101) (1,946) (1,936) (250) 5,081 12,551 21,887 33,809 47,903 64,067

Add back depreciation 326 326 326 326 326 326 326 326 326 326 Add back after-tax interest on long-term debt - - - - - 3,560 8,544 11,748 15,664 21,360

Add back loss provisions 136 544 2,503 4,680 7,727 11,428 15,672 20,570 26,120 32,324

Changes in operating Net Working Capital

Subtract increases in Cash 559 1,678 5,408 9,474 12,264 13,606 15,724 17,567 19,909 22,751

Subtract increases in fixed assets at cost 326 326 326 326 326 326 326 326 326 326

Free Cash Flow (1,524) (3,080) (4,841) (5,044) 544 13,933 30,379 48,560 69,778 95,000

Terminal Value (1.5x Book Value)

375,097

Period in years:0 1 2 3 4 5 6 7 8 9 10

Initial investments:(70,000) (1,524) (3,080) (4,841) (5,044) 544 13,933 30,379 48,560 69,778 470,097

NPV (r=12.5%) 128,022 IRR 25.1%

ARR 16.4%

AVG profit 18,006

AVG book value 109,632

Payback period (years) 8

Initial investments 70,000

Still to recover (71,524) (74,604) (79,445) (84,489) (83,944) (70,012) (39,633) 8,927

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© Madi Akmambet, 2012