Dec 22 - 28, 2008

While Islamic banking services are fast penetrating in Pakistan composed of 97 percent Muslim population-second only to Indonesia-that has been a real charm for bankers and financial institutions and slightly denting the conventional financial system global share-thereby least affected with the loud global banking industry crisis-its operational base over the foundation of conventional regulatory framework is restricting it in optimizing market share; in Pakistan which is little over 4 percent. The regulator of banking industry in Pakistan is facilitating the operation of Islamic banking through policy blends meanwhile it is working on plan to realign regulations in line with religious guided tenets as well as market dynamics to extend outreach of Islamic banking services.

With successful re-launch of Islamic banking in 2002 based on market driven economic principles instead of just legal or religious enunciations State Bank of Pakistan has designed a strategy paper recently especially keeping prospects of Islamic banking under considerations within local and international contexts and envisaged 12 percent market share of Islamic banking industry for 2012. Supporting two main objectives: to design flexible and locally as well as internationally acceptable regulatory framework; and to establish Shariah compliance mechanism in conformity with global best financial practices extension of outreach, Shariah compliance mechanism, strengthening of regulatory framework, and capacity building and internal and external relations were strategies formulated by the central bank.

It says unlike past the re-launch gets further reinforcement to role out Shariah-compliance system from the market demands without disturbing the present time tested and effective regulatory framework until new system withstands recurrent trial and error exercises and following system be entirely meritorious and 'market-led rather than solely through legal means or religious dictates'. Islamic finance explicitly prohibiting riba (interest) based transactions, permitting only trade based contracts requires certain changes in current institutional framework that has its inclination towards conventional financial system that follows contrast methodology to execute banking contracts.

There is similarity of objective and distinction of methodology in conventional and Shariah compliance banking according to the regulator. 'To dispense economic efficiency and justice through efficient and equitable banking system is a shared objective.' However, it safely consents with the prohibitive method of conventional financing. Catering to needs of particular segments of the society, the new approach has assimilated previous experiences of Islamic banking and imitated role models Malaysia and Bahrain which are leading Islamic finance economies. This will also aim at to attract investments from the world over in Islamic financial sector.

At present, although Islamic banking industry is providing financial solutions competitive to conventional system to a set of customers it has not achieved the position to complement the structure as presently it has in stock only 75 percent of total products being offered in conventional banking and despite potential not or limitedly reached in agriculture (0.0% borrowers), SME (1.5%), consumer sectors (especially housing loan 1.2%), and commodity financing (1.2%). Therefore, SBP is trying to broaden the horizon in which full potential of Islamic banking or financing is realized. Islamic finance seeks conversion to more risk sharing financial and equity based instruments and subscribes to variety of liability and asset management approaches. Changes it seeks in financial structure would not only lead wide range of diversification in solutions but also apparently bring into financial sector network underserved and inaccessible market.

A strategy concentrates on to extend reach of Shariah compliance financial products in urban areas as well rural and underserved regions through nurturing Islamic micro, agriculture, and SME finances. It is expected that these modes of financing will acquire 23.3 percent share of overall Islamic financing by 2012. Since all past attempts to remove interest banking were rigid and nonflexible to dynamic needs of the market, they failed to record considerable growth in Islamic financial sector despite that Pakistan was among three countries in the world which introduced non-interest banking transactions at national level in 60s. The Banking Companies Ordinance 1962 was amended to accommodate such transactions.

Proponents of need-based IBIs believe that it is an element of flexibility in terms of products, instruments, and Shariah compliance methodology that has enabled Islamic finance sector to get hold of substantial space within a short span of time. From end 2003 when first full fledged Islamic banking license was granted and three conventional banks were running Islamic window operations from branches to closure of FY08, a significant growth was recorded in deposit and asset base. Till end of FY08 six banks completely involved in Islamic banking with entire industry network of 330 branches spreading across 50 various cities and towns nationwide and total assets of Islamic banking industry was over Rs. 255 billion, equivalent to 4.5 percent of total banking assets.

The performance of deposits, assets, and investment in IBIs of Pakistan has been remarkable and rapid as compared to other nations. For instance, Malaysia Islamic banking captured 13 percent market share in 25 years. First Islamic bank started operation in Malaysia in 1983. Similarly, IBIs in Indonesia has 1.7 percent share in banking industry even though Islamic banking was embarked on in earlier 90s. The deposits in IBIs of Pakistan constitute highest portion in maintaining capital adequacy and seldom fall below 60 to 70 percent. Besides, over a period of time increasing level of saving and fixed deposits shows rising trust of clientele.

Among other essential line of actions the SBP strategy would strengthen coordination with other policy making institutions to underpin foundation of consolidated regulatory framework across the broad spectrum of all sectors of Islamic financial industry. Capacity building of Shariah Board issuing rulings about business by inclusion of Islamic economics experts will help formulation of regulations and its implementation. Importantly, this may be instrumental in establishment of Islamic benchmarks for pricing liquidity instruments.