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

It is not surprising that a bank which paid competitive rates of return for depositors in past years and which is expected to continue with this in the future can attract more customers and deposits. What is surprising, however, is that the number of depositors who do not receive any return for their deposits was also increasing substanti­ally. Saving deposits do not share the profits (or losses) of the bank or rece­ive any other remuneration. Neverthe­less, the number of savers increased from 2,000 by the end of the first business year to more than 6,000 by the end of the third year (1986) (table 7). This number of savers is equiva­lent to approx, 4% of the total popu­lation of northern Cyprus. But the cities of Lefkosa and Girne were the only places where the bank had branches but at the end of 1986; the population of these two cities is only about 45,000 people. Thus FIBK could win approximately 14% of the relevant population. This may be equivalent to 1/4 or 1/3 of all house­holds in the catchments area. The fig­ures for the average size of the dep­osits (in cable 7) clearly indicate, that the vast majority of the depositors must be very small savers. This is that sector of the population which FIBK as a private development bank' should reach. These are the poorer income groups whose economic be­haviour should be transformed by the savings and investment education of an Islamic bank that accepts for itself a kind of social and developmental obligation and responsibility. As it seems, FIBK was quite successful in reaching its target group, and (not only but also and especially) the poorer people started to accept the new type of financial institution repre­sented by FIBK.

                                                                                                                                                                Table 6:

There are numerous examples in the files of the bank that its efforts towards an education of the small savers has been successful. Many people started to deposit small amounts in irregular intervals in their savings accounts, and they also often withdrew these deposits after a short period of time. But after a while, when they realised that indeed they could get their money whenever they wanted it, the withdrawals became less frequent, the deposits became more regular and often also the amounts increased. Under the guid­ance and with the assistance of the bank, many poorer people came to realise that they and the ability for a modest capital formation from their own very limited resources. This is a very important experience for these people that may encourage them to take the initiative for an improvement of their economic situation and make efforts, for example, to start a self-employed business.

In a considerable number of cases the FIBK then provided additional funds to those people whom the bank knew as regular and reliable savers. Social loans of modest amounts were given at preferential terms for the purchase (or rent) of productivity and income improving devices (like sewing machines, tools for craftsmen, spare parts for agricultural machines). The people who had received these social loans made all efforts to meet their obligations to the bank, and no cases of serious defaults were reported. That the poorer people make all ef­forts to meet their debt obligations is not so surprising for most if not all of these poorer people, the FIBK was and is the only bank that takes care of them and provides the funding for their small projects. If they want to continue their new business and need further financing in the future, they simply cannot afford to default or to become irregular debtors in any other respect.

The capital owners of FIBK and FIIC did not receive a dividend in the last years. In 1986 the profits of the bank and investment company impro­ved substantially as compared to 1985. If the management will be able to find more profitable outlets for the dep­osits, the payment of dividends may become possible in the future. The management should consider a more international approach for its business. There seem to be numerous good investment opportunities with the ex­pansion of the tourism industry and the service sector (i.e. health care) in Northern Cyprus, but the resources of FIBK are limited compared to the capital required by some of these in­vestment projects. It may be a viable and profitable strategy for FIBK to act (with a small funding contribution from own resources) as the lead man­ager of a consortium of (Islamic) fin­ancial institutions which provide together and from outside Cyprus the capital for larger tourism or service projects.

                                                                                  Table 7:

The cooperation with other Islamic banks for the consortium financing of large projects in TRNC is only one of the several options for the future business strategy of FIBK. It should be possible to design a strategy that allows to combine the developmental efforts of FIBK (education of small savers, social loans) with a sufficient overall profitability of the total funds under management. If the latter can be achieved, FIBK could be taken as a good example for the reconciliation of developmental and commercial aims and objectives; it would be a proof that development banking is vi­able even without governmental sup­port.