Secular government, religious finance: Turkey's growth in Islamic finance and banking.

• Author: Ali, Dahlia

1. INTRODUCTION

   A decade ago, the idea of Turkish, shari 'a-compliant instruments issued by the government would have been inconceivable. (1) Turkey's movement from assertive secularism, to the Justice and Development Party's (AKP) passive secularism has allowed the country to slowly delve into the estimated USD1.6 trillion industry of Islamic Finance. (2) With the Turkey Capital Markets Board's new regulations on five types of sukuk, the Turkish Treasury's commitment to biannual sukuk issuances, and expected use of Islamic finance for USD350 billion in infrastructure spending within the Turkish borders, local and foreign interest in interest-free products and low cost borrowing will be triggered. (3) What will distinguish Turkey's Islamic instruments from those elsewhere in the Middle East and Far East Asia, attracting foreign participation, is the fundamental division of mosque and state and development of a private market for shari 'a-compliant instruments.

   This Note explores the development of the Turkish passive secular ideal, and its incorporation of Islamic finance principles. Part II of this Note will discuss the history of Islamic finance and Turkey's political development after the dissolution of the Ottoman Empire, focusing on the incorporation and limitation of the Muslim religion and Islamic principles. (4) Part III of this Note will explore the rise of Turkey's current ruling political party and financial picture of Turkey today, exploring developments in both the Turkish public and private sector. (5) Part IV of this Note will explore the key steps Turkey has taken to develop its Islamic finance and banking (IFB) industry and analyze potential riches to be reaped, both locally and internationally. (6) Finally, Part V of this Note will conclude by highlighting the huge advantage Turkey has taken in developing its IFB industry, and showcase the disadvantage Western nations will be in if they do not follow in Turkish footsteps. (7)

2. HISTORY

   1. Development of Islamic Finance

      Offering a unique investment avenue, IFB seeks to avoid interest, Riba, and uncertain risk, Gharar. (8) The core of IFB, "trade in physical, productive assets and the sharing of risks in the development of projects," provides investors with non-illusory profit and cost expectations. (9) IFB is governed, like all prongs of life in the Muslim religion, by shari'a law. (10)

      The primary sources of shari 'a law are the Holy Quran, the Muslim sacred text, and the Sunnah: the actions, teachings, and practices of the Prophet Mohammad. (11) Both the Quran and the Sunnah are considered the revealed sources of knowledge. (12) Secondary to the Quran and Sunnah in the development of shari 'a law is ijtihad, or independent reasoning, considered the derived source of knowledge. (13) The goal of shari'a law is to promote human welfare, ensuring growth and justice while protecting religion, life, reason, family, and property. (14)

      Classic shari'a law, fully developed around the year 900 A.D., was not a code of law, but rather a compilation of religious and legal scholarship for judges to use in their decision making. (15) By the mid-19th century most Muslim countries adopted Western laws and legal systems because of colonization, and continued their use after gaining independence. (16) After decolonization, there was a reemergence of Islamic thought, specifically in the world of banking and finance, resulting in the establishment of the first Islamic banks in the 1970s. (17)

      Beginning its most rapid growth in the 1990s, IFB grew 25% annually and today holds assets in excess of USD1.6 trillion and continues to experience a 15% growth rate. (18) This recent expansion has helped develop a framework for handling trust funds, venture capital and financial papers based on leasing, forwards, and mark ups; ijara, salam, and murabaha respectively. (19)

      IFB frowns upon the Western idea of making money with money, based solely on the creditworthiness of the borrower who owns the project. (20) In IFB, the Western ideal is thought to be the cause of rippled losses and losses based on inflation. (21) This is not to say, however, that IFB doesn't have a positive attitude toward individual wealth and economic activity. (22)

      1. Islamic Financial Products

         IFB products are structured in such a way to ensure the bank and the customer share the risk and profits of the investment, based on negotiated terms. (23) This structure reinforces the importance Islamic law places on fairness and good measure over the freedom to contract. (24)

         Mudaraba is one form of partnership contract in IFB, where one partner provides the capital and the other partner provides the skills and experience to run a shari'a-compliant project. (25) Profits within the mudaraba contract are shared between the two parties at a pre-negotiated ratio; losses are directly born by the investor and indirectly by the partner (requestee of the capital) who is unrewarded for his work. (26) The second form of partnership contract in IFB is musharika, where two or more parties provide capital for a shari 'a-compliant project. (27) In a musharika contract both profits and losses are shared based on the parties' participation or at a pre-negotiated ratio. (28) The essential difference between mudaraba and musharika contracts rests on the parties' capital investment participation ratio. (29)

         The IFB equivalent to conventional bank lending is murabaha. (30) Murabaha is a contract for the sale of goods, with a deferred payment. (31) In a murabaha contract, the bank purchases the asset and sells it to the requesting client at a fixed price, which includes the bank's profit. (32) The key distinction between murabaha and conventional lending is seen in instances of default. (33) Under IFB principles the client will still only be responsible for the original, fixed price, whereas in conventional lending interest continues to accrue. (34) Murabaha, or cost-plus financing as it is sometimes called, represents the majority of IFB transactions totaling over 70%. (35)

         Ijara contracts, with some key distinctions, are comparable to conventional leasing mechanisms, where a bank agrees to purchase equipment and lease it to the client for a rental fee. (36) The key distinctions between ijara contracts and conventional leases are the effective start dates, the liability upon destruction of the asset, and the right of purchase at the end of the lease. (37) In an ijara contract the lease begins upon delivery of the asset, unlike conventional leases that begin upon the date the contract is signed. (38) While conventional leases hold the lessee liable for the full rent if the asset is destroyed, ijara contracts dictate that the bank factor the cost of insuring the asset into the rent charged to the client. (39) Finally, in ijara contracts the purchase option cannot be mandated as binding on the client. (40)

         Sukuk, plural of saak, are the IFB equivalent to bonds, but give holders ownership in a "proportional part of the underlying asset." (41) The most dominant sukuk seen today are lease-based sukuk, or sukuk al-ijara. (42) This form of sukuk requires the "client" (entity wishing to purchase asset) to set up a special purpose company (SPC) to which the seller of the asset sells. (43) Once the asset is owned by the SPC, it leases the asset for a set period of time to the lessee (the client, who in most cases was also the seller). (44) The SPC establishes a trust for the asset and issues sukuk to cover the purchase price of the asset. (45) These sukuk have a maturity date equivalent to the term of the lease, and holders receive distributions upon collection of rents by the SPC. (46) At the end of the lease term, the asset is sold to the lessee for the purchase price paid, and the sukuk holders' interest in the asset are bought out. (47)

      2. Islamic Finance in Today's Economy

         Expanding into nations with both a majority Muslim and minority Muslim population, the number of IFB institutions has exceeded 600, operating in over seventy-five countries. (48) As of 2013, global IFB assets reached USD1.6 trillion, of which only USD434 billion comes from the Gulf Cooperation Council (GCC). (49) But, IFB remains minute when compared to its conventional counterpart. (50)

   2. Evolution of the Mosque and State Relationship in Turkey

      After the fall of Ottoman Empire, Mustafa Kemal Ataturk, leader of the Republican People's Party, took over the government and enacted radical changes to move Turkey from its traditionally Islamic culture to--in his view--the superior Western culture. (51) The Ottomans had "fused religion with the state," and the most significant of Ataturk's reform was the departure of politics and law from religion. (52) To truly secularize Turkey, Ataturk sought to truly neutralize Islam politically. (53)

      After 27 years under the Republican People's Party, the Democrat Party took control in 1950. (54) The Democrat Party "rejected interpretations of secularism that led to a hostile attitude toward religion and advocated a separation between religion and state that prevented government from interfering in religious affairs." (55) Amongst new religious freedoms, the Democratic Party's economic policies led to inflation and high debt. (56) The worsening economy led to a military takeover on May 27, 1960, after which the Committee of National Unity came into power. (57) The new majority, while upholding religious freedoms, converted the legislature into a multi-branch system and established a Constitutional Court through the 1961 ratification of the Constitution of the Second Turkish Republic. (58)

      In 1965, the Justice Party gained the majority. (59) At the time, Turkey's political state lent itself to balance its extreme secularist and spiritual theories on religion's role within the state, allowing both parties to adopt moderate stances on religion. (60) In 1969, a former member of the Justice Party left to establish his own...