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Strengthening Islamic Banking

The general perception is that Islamic banking in Pakistan is making progress in leaps and bounds. The supporting arguments are number of branches offering this facility, percentage of deposits held by Islamic financial institutions (Islamic banks and designated Islamic banking branches of conventional banks and Islamic banking attaining the status of first choice. However, some of the critics and even diehard followers of Islamic banking believe the pace of growth is not as robust as it should have been; keeping in view the fact that overwhelming majority of the population is Muslim in Pakistan.

It may be very easy to raise fingers towards the regulators, players, academia and even the general public and hold them responsible for the slow pace of progress. However, making a realistic evaluation of the prevailing situation is not as easy or as simple as being portrayed by certain quarters. One has no reason to doubt the sincerity of even any individual. Let everyone keep one point in mind that conventional banking is more than two years old and its structure have been constructed after trial and error and a lot of research is still being made to remove whatever weaknesses still persist. Followers of both the Islamic and conventional banks have unanimous faith that they are the custodian of depositors’ money, lending/investment has to be made with extreme care to safeguard the interest of depositor and also ensure modest return for them. Similarly they have to ensure that money is lent to those only, who have credible and dependable track record.

Money is lent after thorough examination be it an individual or a corporate borrower and also economic viability of every project is evaluated. Appropriate disclosures are also made mandatory to protect the interest of all the stakeholders i.e. shareholders, depositors, borrowers, employees and all those who are the beneficiaries of the financial system.

Let another point also be made very clear that Pakistan carries a huge load of external debt and multilateral institutions are hesitant in becoming part of Islamic banking system. This argument has lost a lot of weight after the financial crisis of 2008, which proved that Islamic baking is more resilient in terms of risk evaluation as well as risk mitigation. Now it is the responsibility of the Government of Pakistan (GoP) to structure borrowing in such a way that it meets the stringent lending criteria of multilateral lending institutions.

Another point that proves active participation of multilateral financial institutions in Islamic mode of financing is ever growing size of Sukuk, both corporate and sovereign. In the past Pakistan has floated dollar denominated Sukuk, which generated enormous response. This leads to only one inference that some of quarters within the GoP are not serious in making Islamic banking the first choice.

I am sure, many of the critics and the regulators would be certainly annoyed by my inference. However,the point would become crystal clear if one goes through the financing documents of Neelum-Jehlum Hydel project. According to the experts who have access to the documents and share of the participating banks, Islamic banks were given far little share as compared to their offer. One of the possible rationalizations is that the conventional banks are the biggest lenders to the GoP therefore, those have to be given the lion’s share. This once again supports the perception that GoP is not serious is making Islamic banking the first choice.

It is not a secret that the overwhelming majority of Pakistani population suffers from financial exclusion. Therefore, Islamic banks have an enormous unbanked market. However, to serve this enormous segment they have to bid farewell to the current policy of giving preference to the corporate clients. In one of my previous articles I have suggested Islamic banks to focus on lending to farmers. The indicative target of lending to agriculture sector fixed by the central bank is around one trillion rupees, which is too paltry keeping in view the demand of the agriculture sector of the country. At present lending to farmers is done under two heads: 1) input loans and 2) developmental loans.

Another harsh reality if that in Pakistan postharvest losses of agriculture commodities are around 15 percent and for fruits up to 40 percent. If these losses are contained, income of the farmers will be increased and the country will have extra exportable surplus. The added advantage will be that agricultural commodities produced in the country would become competitive in the global markets. However to achieve this target modern warehouses and logistic facilities have to created.

Reportedly, the size of just one crop, wheat is estimated around Rs750 billion. If one adds to this the value of rice, sugarcane, maizeand cotton crops and fruits, the amount may exceed ten trillion rupees.

To achieve the target an ‘out of box plan’ has to be developed, which should look at some basic impediments and recommend workable solutions. Bankers often hide their face behind non-availability of the collateral (the most common collateral used by banks in land ownership document). If I am not accused of being novice, Islamic banks can extend input loans without land ownership document. The collateral will be the crop and risk of its destruction can be mitigated through Takaful. It is on record that State Bank of Pakistan has decided to pay the insurance premium of subsistence level farmers. Therefore, neither the Islamic banks nor the farmers will have to pay the risk mitigation charges.

It is also said that there is need for creating awareness among the masses about Islamic banking. The propagators ignore a few basic facts that attract the borrower include: 1) cost of fund, type of collateral, repayment schedule and above all availability of loans at the door of farmers. It is on record that the banks having strong field force and have not only the largest agriculture portfolio, but also the highest recoveries.

With the deployment of technology the presence of brick and mortar branches is becoming less important. Now availability fund, cost of fund and cost of transaction have attained more importance. Clients are even willing to pay extra cost if a product of guaranteed quality is delivered at their doorstep.

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