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ISLAMIC BANKING IN PARALLEL WITH THE CONVENTIONAL SYSTEM
Pakistan is benefiting from the experiences of other leading centres of Islamic finance in the region
By SHABBIR H. KAZMI
Nov 17 - 23, 2003
The initial efforts were to eliminate Riba from Pakistan's economy in one go. However, later on it was understood that it was a mammoth job. Therefore, the new strategy is to develop a parallel banking system based on Islamic injunctions and allow the people to make their own choice. More than a year ago the first Islamic commercial bank commenced its operations in Pakistan. More and more banks are in the process of Islamic banking operations. In an exclusive interview PAGE discussed with Pervez Said, Director of the newly established Islamic Banking Department of State Bank of Pakistan the overall process of Islamization of financial system in the country.
PAGE: In the financial system there are two major stakeholders, financial institutions and clients. What has been the response of each of them?
PERVEZ SAID: Response has been very encouraging from both stakeholders. About half dozen institutions have approached State Bank of Pakistan (SBP) for issuing licenses for Islamic banking branch operation. In addition to Meezan Bank (MB), Muslim Commercial Bank has started Islamic banking branch operations from September 2003. Bank of Khyber is starting one branch operation from November 22, 2003. Bank Alfalah, Habib Bank AG Zurich and Habib Bank have been given in principle approval for opening branches and now they are busy in preparing manuals for operations. Clients' response is also very encouraging as MB is receiving abundant funds from the public. Business community is also getting insight of Riba-free modes of financing. Creation of public awareness about philosophy of Islamic Banking is a main challenge before us.
PAGE: How do you review the performance of Pakistan's first bank offering commercial banking services?
PERVEZ: Meezan Bank started its operations in March 2002, has been functioning smoothly and has also registered sizeable growth. Now it has a network of 8 branches located in Karachi, Lahore, Faisalabad, and Islamabad. MB's Islamic products include Riba-free Rupee Saving Account, Riba-free Dollar Saving Account and Certificates of Islamic Investment. On assets side, MB is mainly using the mode of Murabaha and Ijarah. The Bank started its Car Ijarah scheme in July 2002 and SME operations as an independent business unit in October 2002. The total financing portfolio of MB at end June 2003 was Rs. 5.3 billion as compared to Rs 3.5 billion as of June 30, 2002, showing an increase of 51% over the last year. The income from capital operations amounted to Rs 69 million, with an average return of 14%. Net assets increased to Rs 1.7 billion as at June 30, 2003 from Rs 1.6 billion as at end-December, 2002.
PAGE: How efficient and effective the central bank has been as the regulator of Islamic banking in the country?
PERVEZ: The SBP is in the process for evolving an environment conducive for working of Islamic banks according to true spirit of the Shariah. Islamic Banking Department has been created in the central bank by bunching the two divisions on Islamic Economics and Islamic Banking in the Research and Banking Policy Departments respectively. A director of the new department has been inducted who would also serve as Advisor to the Governor on Islamic banking. This would help SBP in tackling the issues of introducing and regulating Islamic banking operations and in finding solutions for the problems facing Islamic banks, Islamic banking subsidiaries or branches. The Central Board of Directors of the SBP has also approved establishment of Shariah Board in the Bank.
State Bank is trying to take care of a number of factors relating to institutional arrangements and supervisory/regulatory and legal framework. It would require an innovative approach keeping in view the Shariah essentials of Islamic modes, standards recommended by Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) and the international best practices and standards designed/adapted by Malaysian-based Islamic Financial Services Board (IFSB) of which the State Bank is also a member. The State Bank is represented on the committee for development/review and adaptation of accounting standards for Islamic modes of financing that was constituted in the Institute of Chartered Accountants Pakistan (ICAP). The Committee has finalized the standard on Murabaha and is in the process of finalizing standard on Ijarah. The Committee has also prepared a draft standard on Musharaka. The SBP is also reviewing its forms of financial statements for Islamic banks/branches in the light of AAOIFI standards.
Efforts are underway to develop Islamic products for SLR and to invest excess liquidity by Islamic financial institutions. The products may include Islamic commercial papers of short-term maturity and Islamic Sukuk-based on financing of commodity trade and leasing of fixed assets. These products will offer quasi-fixed and varying returns to the investors depending on the underlying risk of the product. In this context, recourse is being made to the experience of Bahrain Monetary Agency (BMA) that in addition to the application of rigorous regulatory and transparency standards, has pioneered a range of innovations designed to broaden the depth of Islamic financial markets and to provide Islamic institutions with wider opportunities to manage their liquidity and risk spectrum.
For the time being, MB has been allowed to maintain Statutory Liquidity in the form of current account with SBP to the extent of 40% of SLR for commercial banks (which works out to 6% of their Time and Demand Liabilities) till the issuance of Islamic certificates by the Government or other similar non-interest bearing GoP securities. Similarly, MB has also been allowed to maintain Special Cash Reserve (SCR) on FE-25 deposits in current account with SBP in local currency to the extent of 40% of SCR for other banks in order to avoid interest payments on SCR. A Musharaka-based Export Refinance Scheme has been designed by SBP in order to provide export finance, under both parts of the scheme to eligible exporters on the basis of Islamic modes of financing.
PAGE: It has been observed that as a make shift arrangement MB has invested bulk of the resources in equities market, which has also been allowed under Prudential Regulations. Why other options i.e. Musharaka and Murahaba, have not got popular?
PERVEZ: In principle, investment in shares of joint stock companies conducting Halal business is Shariah compliant. Therefore, whenever there is liquidity they invest in the stock market. However, proper regulatory framework is needed for introduction of Islamic securities products through stock exchanges.
PAGE: Is the SBP following any model in use in any other country or is it evolving its own model with the help of local and international scholars?
PERVEZ: Previously, Pakistan had been making efforts to transform the whole economy from interest-based to interest free system. Keeping in view the difficulties involved and the level of work needed the Government and the SBP decided in 2001 to promote Islamic Banking in the country in parallel with the conventional system. Accordingly, in order to promote Islamic Banking in Pakistan, SBP is following a three-pronged strategy:
(a) Establishment of full-fledged Islamic bank(s) in the private sector;
(b) Setting up of subsidiaries for Islamic Banking by existing commercial banks; and
(c) Allowing Stand-alone branches for Islamic banking in the existing commercial banks.
In formulating this strategy, the SBP is examining the experiences of other countries like Malaysia, Bahrain, Indonesia, etc. Bahrain is the leading centre for Islamic finance in the Middle East region. The establishment of the Prudential Information and Regulatory Framework for Islamic Banks (PIRI) by the BMA in conjunction with AAOIFI has gone a long way towards establishing a legal and regulatory framework to meet the specific risks inherent in Islamic financing structures.
The BMA has quite recently signed MoU with the London Metal Exchange (LME) to pool assets to develop and promote Shariah compliant tradable instruments for Islamic banking. The arrangement is seen as a major boost for industry's integration in the global financial system and should set the pace for commodity trading environment in Bahrain. BMA has also finalized draft guidelines for issuance of Islamic bonds and securities from Bahrain. In May 2003, the Liquidity Management Centre (LMC) launched its debut US$ 250 million Sukuk on behalf of the Government of Bahrain. Total Bahrain Sukuk is expected to cross the US$ 1 billion mark later this year.
Pervez Said has been appointed as Director of the newly established Islamic Banking Department of State Bank of Pakistan w.e.f. September 15, 2003. He will also carry the title of Advisor to the Governor, SBP on Islamic Banking. Mr. Said is probably one of the few Pakistanis who have hands on experience of actually developing Islamic products and practically marketing those products in a commercial banking environment. Born in 1956, Mr. Said did his MBA from Ohio University, USA in 1980. He brings with him a vast and varied experience of over 22 years. He worked both with the banks and multinationals. He has had extensive experience in the field of Islamic Banking. Outside Pakistan, he has worked on Islamic Banking with Citibank, Standard Chartered Bank (SCB) in the UAE and Mashreq Bank. He was responsible for putting together SCB's Global Islamic Banking propositions including retail as well as wholesale banking. Prior to that, he has worked for Citibank in the UAE as Head of Global Islamic Banking Team and was responsible for development of a comprehensive range of Islamic Financial Products along with underlying contracts, business model, marketing strategy, business requirement documents etc. He also handled issues related to the Central Bank and Shariah Board. In Pakistan, he has worked as Head of Marketing and Business Development, Meezan Bank for about 2 years. Earlier, he remained attached with the Citibank in Pakistan as Marketing Director for over seven years and was responsible for introducing various branded financial products like "Citi Sarmaya". He has also a rich marketing experience of about 13 years with multinationals such as Johnson & Johnson, where he was the Managing Director for Pakistan, Reckitt & Colman, W. Woodwards, Lever Brothers and Exxon Chemical Pakistan.