The Evolution of Participation Banking in Turkey Liam Hardy Islamic

Winter 2012 The Evolution of Participation Banking in Turkey Liam Hardy INTRODUCTION religiously Participation banking, a moniker for financial conservative Islamic finance in practices structured in accordance with Islamic segments of Turkey is a more law, has not traditionally made up a large Turkey became recent phenomenon. segment of Turkey’s finance sector due to the marginalized in Changes in country’s secular tradition since the start of the both modern Republic in 1923. However, participation policymaking government priorities banking has grown in recent years because of and business, and public more permissible public attitudes, decreased trust which were sensibilities have in the conventional banking sector after financial highly allowed participation crises in 2001 and 2008, and the desire to attract interconnected. banking to gradually capital from the Gulf region. As a result, the The country’s current government, led by the Justice and constitution and acquire legitimacy, Development Party (AKP), has sought to shape a government particularly within the regulatory framework for participation banking in were modeled past decade. line with the country’s changing sensibilities after France’s towards the role of religion in public life. This has “laicité” system, developed in conjunction with an expansion of which mandated a separation of religious and Islamic finance in the global economy more political affairs. The Caliphate and Sultanate were generally. disestablished, the veil was banned from public Given its secular identity, Turkey would at venues, religious convents and dervish lodges first appear incompatible for Islamic finance in its were closed, and the Directorate of Religious economy. The modern nation‐state of Turkey, Affairs was entrusted with writing the Friday founded after the breakup of the Ottoman sermons and monitoring religious activity. Empire, was deeply influenced by the reforms of The state bureaucracy and military routinely its founder and first president, Mustafa Kemal resisted Islamic influence in business and finance Ataturk. While Ataturk set about implementing throughout the Republican period following these the country’s reforms in the 1920s and 1930s, reforms. During much of this time, Turkey had a highly centralized economy and followed a policy Liam Hardy, Master of International Business 2012, of “etatism,” whereby state institutions owned is concentrating in International Finance & Banking and managed most important industries. The and Southwest Asia & Islamic Civilization. He issue of Islamic finance was not a consideration, graduated with a B.A. from Georgetown University. as conventional financial intermediation was He previously worked for a Turkish newspaper and practiced in line with European norms, as it had business association and spent summer 2011 as a been since the Ottoman period. graduate intern for the Black Sea Energy and Islamic finance in Turkey is a more recent Economic Forum of the Atlantic Council. phenomenon. Changes in government priorities © The Fletcher School – al Nakhlah – Tufts University 160 Packard Avenue – Medford, MA 02155-7082 USA – Tel: +1.617.627.3700 2 al Nakhlah and public sensibilities have allowed participation development as part of the global economy has banking to gradually acquire legitimacy, been a relatively recent phenomenon. While the particularly within the past decade. The idea of modern Islamic finance has been traced to expanding magnitude of associated clientele and Indian Muslims in the 1940s, and precursors took deposits has allowed participation banks to reach place in Egypt in the 1960s, the first Islamic over 4.5 percent of market share in total assets, up financial institutions took shape during the 1970s.1 from nearly 1 percent in 2001. Turkey has gone Under the auspices of the Organization of the through a fundamental shift since the rise to Islamic Conference (OIC), and with backing from power of the AKP, which has sought to promote Saudi leaders such as King Faisal, Muslim leaders greater religious influence in the country despite sought to create an Islamic banking system that the historically secular identity of its ruling could help manage the “political and economic bureaucracy and military. The country recently destiny” of the Islamic world.2 The challenge passed new legislation to encourage Islamic would be creating a system that would be banking in the private sector, and government “consistent with religious precepts” and “viable officials have indicated interest in issuing in the modern global economy” through a process sovereign sukuk, comparable to bonds, for funding of itjihad, loosely defined as the careful reflection federal budget requirements. and effort used for interpreting Islamic texts.3 These changes represent a shifting paradigm Under these conditions, the Islamic Development in the level of acceptance for participation Bank was founded in 1974 at an OIC summit in banking in Turkey. They have also unfolded in Lahore, and a number of Islamic banks began to the context of two periods of economic turmoil: operate in the following years.4 the domestic financial crisis of 2001 and the global While conventional finance facilitates the financial crisis of 2008. Participation banking flow of capital to investment opportunities that emerged stronger after each of these periods of provide the highest return in the marketplace, instability. The shift in tolerance fits a trend of Islamic finance governs investments with an moving away from a highly state‐controlled underlying altruistic rationale of producing the economy towards greater economic liberalization. most optimal socioeconomic outcome in line with However, participation banking’s role in the Islamic norms.5 Some notable characteristics economy will likely grow as Turkey considers include its avoidance of riba, interest‐based options for attracting investors from the Arab lending or usury, and gharar, speculation or Gulf region who are currently highly liquid in uncertainty. It also has a special focus on halal, or terms of capital and also religiously conservative. religiously permissible activity – such as Despite its growing popularity, Islamic observing dietary restrictions on alcohol, tobacco, banking remains a small part of the total financial and pork – as well as other ethical and religious sector and will likely remain so due to lack of goals.6 The reason for these distinctions involves penetration in the market and strong competition Islam’s preoccupation with creating a “moral from the conventional banking system. Turkey economy,” where profits from commerce are also has much deeper conventional capital generally seen as more favorable in comparison markets than other Muslim majority countries with profits from money‐lending or speculation, that did not pursue similar policies of which are considered sinful or undesirable modernization during the last century. because of potential negative social consequences. Meanwhile, the compatibility between the The underlying contracts of Islamic products country’s secular legal identity and state forms of differ from their conventional counterparts in participation finance, such as sovereign sukuk structure. For example, murabaha, a sale‐based issuances, remains contentious. instrument similar to a conventional loan, involves the purchase of an asset by a bank and its ISLAMIC FINANCE IN THE GLOBAL ECONOMY sale to the client at a cost plus a declared profit.7 Islamic finance is a source of funding that The structuring as a sale has important legal adheres to Islamic fiqh, or jurisprudence, and its implications according to fiqh, which has an © The Fletcher School – al Nakhlah – Tufts University Winter 2012 3 elaborate set of rules governing sales that dictate extent that globalization has affected capital the terms of risk and mutual consent.8 These rules markets in the past several decades, Islamic seek to ensure the security of the investment and finance has become transnational in scope and avoid social conflict among the relevant parties importance. through framing the transaction as a commercial one involving an agreed‐upon cost and profit. ORIGINS OF ISLAMIC FINANCE IN TURKEY Other sale‐based products can include the Conflict between Islamic banking and financing of commissioned manufacturing or Turkey’s secular identity seemed inevitable from construction, istinaa, or a forward sale, salam, the start. Islamic finance faced strong competition which require structures different from their from both public and private conventional banks conventional equivalents as well. Lease‐based and a skeptical public. Since Ataturk’s reforms, instruments, ijara, are similar to traditional leasing Turkey had a highly centralized economy and with certain distinctions, and equity‐based followed a policy of “etatism,” whereby state financial intermediation can take place through institutions owned and managed most important profit and loss arrangements known as industries. However, the 1980s saw a period of mudaraba.9 liberalization of Turkey’s tightly controlled These products can be disputed and can economy under the Prime Ministry of Turgut differ among geographic regions because local Özal. This followed the global trend away from religious scholars often have different centrally‐planned economies and also resulted interpretations of the Islamic law underlying the from poor economic performance under the financial transactions. The rising use of Islamic etatist system. As part of a plan to attract more

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