Islamic Banking has had more to do with the world of high finance than with village economies. But things are changing. Professor Volker Nienhaus profiles a developing bank in Kibris.

The performance of the Faisal Islamic Bank of Kibris should be eval­uated against the background of the particular political and economic situ­ation, of Cyprus. Therefore, a few notes on Northern Cyprus are given first.

The island of Cyprus has seen an eventful history. It was part of the Byzantine empire, conquered by Richard 1 of England, passed on to the Knights Templar, ruled by the Lusignans from France, controlled by the Republic of Venice, taken over by the Ottoman Sultans and ceded to Britain before it gained its independ­ence in 1960. The ancestors of the majority of the island people were Greek, but the constitution embodied a number of provisions for the protection of the rights of the Turkish Cypriots. But in November 1963, President Makarios submitted proposals for an amendment of the constitution which would have substantially reduced the rights of the Turkish minority. The former tensions escalated into bloody intercommunal hostilities by the end of the year. This caused the United Nations to send a peace keeping force in March 1964. The situation erased somewhat when negotiations on a new constitution started after the presidential elections of 1968. But this was only a temporary relief; it was not possible to terminate the bloody conflict between Greek-Cypriot National Guard, and the union of Cyprus with the state of Greece (Enosis) was close to become a reality.

This threat of the independence of Cyprus caused Turkey on July 20, 1974, to make a military intervention. As a result, the island became factually divided and separated into the Turkish North and the Greek South. The justification for the Turkish intervention resulted from a Treaty of Guarantee concluded in Zurich and London in 1959 by which the three states of Greece, Turkey and Great Britain took the obligation to guarantee the independence and the constitution order of Cyprus.

                                                                                                                                              Table 3:

After 1974, negotiations on a re­unification of Cyprus over and again came to no result. To emphasize their status as equal partners for nego­tiations, the Turkish Cypriots declared their part of the island to be the “Turkish Federated State of Cyprus" in 1975. This was still seen as a part of one Greek-Turkish state of Cyprus. But by the end of 1983, the "Turkish Republic of Northern Cyprus" (TRNC) was proclaimed as an inde­pendent and sovereign state. Inter­nationally, this state is recognized only by the Republic of Turkey so far. The Turkish Republic of Northern Cyprus economically depends upon mainland Turkey. About half of the TRNC budget is financed by aid trans­fers and credits from Turkey. About 1/2 to 2/3 of the chronic trade balance deficit results from foreign trade with Turkey. The same currency is in circu­lation and the legal tender in TRNC and Turkey, namely the Turkish Lira (TL). The figures in table 3 give an idea of the structure and the past performance of the Northern Cyprus economy. An "Economy Co-operation Protocol" was signed by the end of 1986 between Turkey and TRNC. It sets out a framework for the future development of the economic relations between the two parties. The prime aim of the protocol is to render the economy of TRNC more self-reliant and to reduce the dependence on Turkey in general and on Turkey's aid in particular.

The government of Northern Cyprus will promote the development_: of the tourism and services sectors in general; in particular, it will take measure to liberalize the banking business and allow offshore banking in TRNC. In spite of dependencies, the government of Northern Cyprus pursued an autonomous economic policy already in the past. There are, for example, remarkable differences be­tween the economic, tax and banking laws of Cyprus and Turkey. Otherwise it would not have been possible to set up an Islamic bank in Northern Cyprus as early as 1982. In the Re­public of Turkey a special law had to be enacted as the basis for the es­tablishment of financial, institutions which do their business in accordance with the prescriptions and injunctions of the Islamic law (Sharia), and these institutions still are not allowed to include "Islamic" in their names.

The "Faisal Islamic Bank of Kibris" (FIBK) was established, in late 1982, (under the name of "Islamic Bank of Kibris" which was changed to the present one in December 1982). The init­ially very modest capital of 350,000 US$, was mainly paid in by Arab subscribers. Operations started in the head office in Lefkosa (Nicosia) in March 1983. Branches were opened in Girne (Kyrenia) in February 1986 and in Gazi Magusa (Famagusta) in April 1987. Because banks in Northern Cyprus are not allowed to deal in commodities, FIBK set up a sub­sidiary especially for its Morabaha (mark-up trading) transactions: the Faisal Islamic Investment Company (FIIC). FIIC became operational in 1984. The paid in capital of the bank and the investment company together was raised to 1 million USS in 1984 and to 2 million USS in 1985.

The share of FIBK and FIIC in the total capital and reserves of all (1986: 12) banks in Northern Cyprus (exclud­ing the Central Bank) is 7-8 %, this is close to the average. With regard to deposits and total assets, FIBK and FIIC are still below the average. This is partially explained by the fact that some Northern Cyprus banks have large foreign branches (esp, in Lon­don) whose deposits are included in the statistics, resulting in a bias against banks without large foreign branches. FIBK and FIIC follow a distinct philosophy in their business which is different from the approach of the conventional banks. Some figures can demonstrate that in fact the business of FIBK/FIIC is different from the activities of the conventional banks in Northern Cyprus.

Two-third of all credits advanced by the Northern Cyprus banks are con­centrated on the public sector. This means that they finance mainly the budget deficit and some larger public enterprises. The large number of smaller and medium sized private en­terprises received only just 1/3 of total bank credits. In contrast to this, FIBK and FIIC do not finance the public sector at all but employ all their funds in financing the activities of smaller and medium sized private enterprises (table 4.)

                                                                                                                                                                Table 4                                

To finance medium and long term projects banks need deposits of a sim­ilar, i.e. of medium and long term, maturity. The share of deposits with a maturity of one year (or longer) was 35% of the total deposits of all North­ern Cyprus banks in 1986 while 60% were sight deposits, i.e. deposits that could be withdrawn at any time. This relation is just the reverse for FIBK and FIIC. The share of funds with a maturity of one year (or longer) was lore than 70% while sight deposits accounted to less than 50% (table 5.) The high share of sight deposits in total bank deposits can be explained to a large extend with the fact that in past years it was for most depositors not attractive to hold deposits in con­ventional banks (for other than trans­action payment purposes). At a lime when inflation was as high as 40% and more, the government had limited the interest rates for deposits to 22% in Northern Cyprus. At the lame time the interest rates for dep­osits in Turkey were at least twice the rates in Cyprus. Since the same cur­rency is in circulation in Cyprus and in Turkey, illegal capital export to Turkey (capital flight) was very easy, and it was also never a real problem to deposit money in foreign currency accounts outside Cyprus. If nevertheless big customers wanted to deposit larger amounts in their accounts in Cyprus, they received in addition to the official maximum interest rate some special premiums' so that the interest rate differences were equalized and the returns for large deposits re-gained attractiveness in Cyprus.

These practices were not very legal but very common and more or less tolerated by the authorities. For the smaller   savers, however, the con­ventional banks did not offer any pre­mium. These people had to look for other employments for their funds in order to protect them against the high inflation.

Under these circumstances the Faisal Islamic Bank of Kibris could offer an attractive alternative to those savers who, on the one hand, did not consider ‘capital export' to be an acceptable strategy, and whose dep­osits, on the other hand, were not big enough for a ‘preferential treatment' by the conventional banks. The rates of return which FIBK paid for PLS time deposits were clearly higher than the maximum interest rates, and these rates further showed and upward trend (table6.). If this trend continues can be expected that by the end of year 1987 the rates of return paid for PLS deposits will equate or even exceed the market rate of interest. In this case, FIBK could attract an in­creasing number of those savers who are looking for a maximum return and who are willing to shift their deposits from conventional banks to FIBK. Total deposits may increase again after a stagnation in 1986 as compared to 1985. It would be a big challenge for the management of FIBK to find suitable employments for these additional funds so that the profit expectations of the depositors could be fulfilled by the end of the year.

                                                                                                                                                                Table 5