October 8, 2024

Islamic finance in Uzbekistan

1. Legislative framework;
2. Subjects of Islamic finances;
3. Principles of Islamic finances;
4. Types of Islamic finance services;
5. Penalties in Islamic finance contracts.

Islamic finance is a system of financial transactions that complies with Shariah principles. It prohibits the payment of interest and incorporates the principles of fair distribution of risk and profit between the bank and the customer. The introduction of Islamic finance services in Uzbekistan has been under heated discussion since 2018. Since then, legislative acts have been adopted that promote the idea of Islamic finance and facilitate the expansion of the market for lending services.

1. Legislative acts

Law of the Republic of Uzbekistan “On Non-Bank Credit Organisations and Microfinance Activity” dated 20.04.2022 No. ZRU-765;

Decree of the President of the Republic of Uzbekistan “On additional measures to increase the role and share of microfinance services in the development of entrepreneurial activity”.

Decree of the President of the Republic of Uzbekistan “On measures on further development of the capital market” dated 13.04.2021 No. UP-6207 (Presidential Decree);

Resolution of the Central Bank on approval of the regulation on the procedure for the provision of Islamic financing services by microfinance organizations dated 19.07.2024 No. 23/4.

2. Subjects of Islamic finances

Islamic financing is provided by microfinance organizations in the amount exceeding the amount of microcredit. These services may be provided to individuals and legal entities.

The procedure for providing Islamic finance services is developed by the Central Bank of the Republic of Uzbekistan. On July 19, 2024, the Central Bank adopted a resolution establishing the procedure for the provision of services by microfinance organizations on Islamic financing.

According to the resolution, microfinance organizations may provide the following Islamic finance services:

1.	Ijara muntahiyya bittamlik	leasing the premises with the condition of its subsequent purchase;
2.	Islomiy ijara	transfer to the client for temporary possession and (or) use of things (property) that were purchased by a microfinance organization at the client’s request or that are not in use on the balance sheet of this organization for an agreed period;
3.	Murobaja	financing a client by selling goods in installments with a pre-determined price for the goods and a markup;
4.	Muzoraba	financing a client by directing funds to the client’s commercial activities with the aim of generating profit;
5.	Mushoraka	a partnership based on the distribution of profits and losses, in the form of financing a client through the implementation of commercial activities (partnerships) by a microfinance organization together with one or more participants (clients) or participation in the authorized capital of legal entities.
6.	Salam	financing a client through prepayment by a microfinance organization of the price of a product to be delivered in the future to the supplier (client) of this product.

Special Council for Coordination of Islamic Finance Issues (hereinafter referred to as the Special Council) a special council responsible for the provision of services by a microfinance organization related to Islamic financing, based on the requirements of the legislation and this Regulation. 

A mandatory condition for the provision of Islamic financing services is the creation of a special council by participants (shareholders) at a general meeting, consisting of at least five people. By decision of the general meeting of participants (shareholders) of a microfinance organization, a special council may be attracted on the basis of an agreement (outsourcing), which is organized in the presence of associations or unions specializing in this area and consists of a composition that meets the requirements established by these Rules.

At least one member of the special council must have a higher education in Islamic law, one must have a higher education in law, and the remaining members must have an international certificate in Islamic finance.

3. Principles of Islamic finance

One of the features of Islamic finance is “Riba” – no interest charges. A microfinance institution (MFI) is not allowed to charge interest for late payments, but can, however, charge a penalty for delay. 

4. Types of Islamic finance 

Murobaha (Providing a financing service on a deferred sale basis).  Murobaha is a financial instrument in which the customer receives the goods or assets immediately but pays for them afterward, usually with a markup. The markup must be clearly defined in the contract. The customer has the right to pay in installments over a predetermined period.

Islomiy ijarah (purchase of premises and leasing). The terms of the Islamic leasing contract and payments must be clearly defined. In order to provide the facility on an Islamic lease, the MFI must own the title to the facility.

The MFI is responsible for any defects in the provided property. The cost of major repairs to the leased property is at the expense of the MFI, while maintenance and current repairs are at the expense of the client. Also, the MFI, in order to minimize risks associated with possible unfair actions (inactions) of the client, has the right to require collateral from the client (pledge, guarantee, deposit). For example, if the client refuses to accept Islamic leasing, the deposit may be used to cover the actual losses of the MFI.

Ijara muntahiyya bittamlik (leasing the premises with the condition of its subsequent purchase). The object of Islamic leasing may be acquired by the client with the MFI in joint shared ownership. In this case, the lease payments are determined based on the MFI’s share of the common property.

Salam (Provision of prepayment financing service). Salam is a type of Islamic finance that allows an MFI to advance funds to a client against the prepayment of goods. The goods must be easily identifiable. It should be possible to weigh, count, or measure those goods. Money, crypto-assets, gold, and silver cannot be subject to prepayment.

Muzoraba (Providing a profit-sharing financing service). Muzoraba is a form of partnership in which one party provides the capital (Rabul Mal) and the other party manages the business (Mudarib). The profits from the business are shared as per the terms of the agreement. Losses are borne solely by the capitalist, except in cases where these losses are due to negligence or misuse of capital by the manager.

Mushoraka (Provision of financing service based on profit and loss sharing). When entering into this contract, the parties (MFI and client(s)) must clearly define the profit shares. In a partnership, the parties have the right to delegate the partnership management rights to several partners or to one partner. Profits are allocated according to capital shares unless otherwise stated in the contract. Losses are also allocated according to capital shares and the parties are not entitled to assign losses to a party in excess of its capital share. Clients may voluntarily assume losses without prior agreement.

Any party to the contract may withdraw from the contract by giving prior notice to the parties to the contract. The withdrawal of one or more parties from a contract does not mean the termination of the partnership between the remaining parties.

5. Penalties (liquidated damages) in Islamic finance contracts

The draft allows microfinance organizations to collect penalties (liquidated damages) when a client breaches its obligations. However, all funds received at interest must be kept separate from the microfinance organization’s profits and allocated to charity.