ISLAMIC BANKING: SBP'S FORECAST AND ACTUAL PERFORMANCE AT ODDS
THE PREVIOUS STATE BANK GOVERNOR, WHILE ADDRESSING THE FLOOR OF HARVARD LAW SCHOOL IN APRIL 2008, SAID:
SHAMSUL GHANI (email@example.com)
Dec 21 - 27, 2009
"Impetus to Islamic Finance (IF) comes from not only its strong appeal and demand both from Muslims and now from Western world but from recognition and reality that IF is indeed an alternate and viable financing mechanism. If appropriately nurtured, it has potential to broaden and deepen financial markets. This is critical for financial markets that suffer from (a) low level of financial penetration - level of financial exclusion in developing markets is as high as level of financial inclusion in developed markets; (b) high dependence on bank and debt based systems; (c) small and liquid capital markets IF's authenticity lies in its inherent characteristics to enrich and supplement conventional finance by offering options and solutions to address these gaps in financial system, while effectively and efficiently allocating capital and allowing opportunities to optimize firm's capital structure."
At work in around 70 different countries, Islamic finance has grown to a one trillion dollar plus industry. Pakistan's Islamic banking growth story dates back to early eighties when under geopolitical compulsion the United States decided to use Islam against the then USSR in Afghanistan. Islamic forces in Pakistan were mobilized and a demand for Islamic financial system was created. Under this system, interest was replaced by mark up, a concept based on the idea of simple interest.
With the conclusion of Afghan war that culminated in the disintegration of USSR, the Islamic euphoria generated by the vested western interests started to subside and with that the pace of Islamization of economy also retarded. The mark-up-based banking continued to exist alongside the conventional interest-based banking. It was after 9/11 that the urge to promote Islamic banking got a new impetus throughout the Islamic world.
Under obligation to respect the clout of oil producing Muslim nations, the west also followed suit by participating in the development of Islamic banking and finance.
The Islamic banking sector in Pakistan is developing at its own pace. If appropriate efforts to attain a high level of financial inclusion are made, this sector has huge potential to grow. The major Islamic banking products are Murabaha, Ijara (leasing), Musharika, and Diminishing Musharaka.
Murabaha is mark-up-based asset-acquisition finance. Since the mark up rate is determined by conventional benchmark (usually KIBOR), the recognition of Musharaka as an interest-free product is debatable. Ijara or leasing is quite popular in Pakistan. However, only operating lease - and not finance lease ñ is recognized as Islamic. Musharaka could not gain currency at the outset as the configuration of an instrument based on profit and loss sharing could not be spelled out to the satisfaction of all and sundry.
To begin with, PTCs (Participation Term Certificates) based on profit and loss sharing were introduced to finance corporate sector needs. The arrangement did not work properly and with certain modifications PTCs were replaced by TFCs (Term Finance Certificates). This arrangement continues till date. Musharaka made a strong comeback in the shape of Diminishing Musharika which is being used to finance house purchases. Under this arrangement, the customer and the bank share the house financing cost in an agreed ratio. The ownership of the house remains with the bank and is transferred to the customer only after the financing cost shared by the bank is paid back in agreed installments, called units.
This payback does not carry any interest charges. Instead, during the intervening period, the customer keeps on paying rent to the banker. Now, is that rent related to the ongoing house rent rates or to the market lending rates? This question needs to be answered by the Shariah committees of the respective Islamic banks. The leading Islamic banking products Murabaha, Diminishing Musharaka and Ijara have shares of 41 percent, 29 percent and 22 percent, respectively, in the total Islamic banking finance business. Table 1 shows the size of Islamic banking sector as well as its share in the overall banking sector of Pakistan.
TABLE 1: ISLAMIC BANKING INDICATORS (RS. IN MILLION)
. FY04 FY05 FY06 FY07 FY08 FY09* Assets of Islamic Banks 44,143 71,493 119,294 205,212 200,415 271,084 Deposits of Islamic Banks 30,185 49,932 83,740 146,945 141,933 198,049 % Share in Banks Assets 1.40 2.10 2.90 4.20 4.10 5.30 % Share in Bank Deposits 1.25 1.90 2.80 4.10 3.90 5.20 * December figures
While the Islamic banking sector growth in Pakistan is not commensurate with its actual potential, it has passed the test of systemic strength and functional buoyancy during the recent global financial crisis when Islamic banking sector emerged almost unscathed. During these times of Islamic resurgence, the idea of Islamic banking should not be difficult to sell, especially to the non-urban sector of economy where people are not much aware of the intricacies of conventional financial systems and who are more interested in the purity rather than the size of their banking profits.
The theory of financial inclusion with an extended outreach needs to be put to practice. There is every reason to believe that the conventional banking sector will create hurdles in the way to high growth of Islamic banking sector. This is the point where the role of SBP will come into limelight. While the setting up of a separate Islamic banking department at SBP is welcome, one expects it to afford a level playing field to the nascent but hugely potential sector. The SBP forecast for the Islamic banking sector's growth, briefly summarized in table 2, and the level of its variance with the actual performance is a big question mark on SBP's support to the Islamic banking.
TABLE-2: SBP FORECAST AND ACTUAL PERFORMANCE OF ISLAMIC
|Islamic Banks Deposits as per SBP Forecast||215,938||340,128||499,036||722,109||907,064|
|Actual Islamic Banks Deposits||141,933||198,049||-||-||-|