LOW ACCOUNT BASE RESTRICTING THE PENETRATION OF ISLAMIC BANKING

SYED M. ASLAM
Mar 12 - 18, 2007

The Governor State Bank of Pakistan Dr. Shamshad Akhar speaking as the chief guest at a conference on Islamic financial markets in Karachi late last month said that "there are customers who have shied away because of faith, or due to inaccessibility to Islamic banking... by end 2006 out of one thousand persons only 171 had deposit accounts. And only 30 per cent of the adult population of the country has a bank account." She had also asked the Islamic banks, and for that matter dedicated Islamic branches, that all major commercial banks now have, to enhance their market share. She also said that capturing 10-15 per cent share of the total banking assets of the country should be 'a piece of cake' for the Islamic banks because a huge untapped customer base still remains unexploited in Pakistan. Islamic banks, she added, presently manage a negligible three per cent or Rs 100 billion assets of the banking system in the country.

Advising the Islamic banks to focus on finding new customers in the under-served areas to ensure easy growth she presented graphical details of the immense untapped potential in the country. The revelation highlights the importance of bringing the vast untapped majority into the banking system for a number of other reasons. First, it is crucial because without it all attempts, no matter how sincere, to document the economy would and secondly, and as important, it would help raise substantial amounts of money in deposits that could be better invested for the benefit of the people as well as the development of the country.

Looking at the socio-economic and political ground realities the huge marginalized majority should be brought in to the banking system without being bothered about Islamic or traditional banking. What does it matter to these people if a bank that approaches them to open accounts is Islamic or traditional? Socio-economic realities also show that the cost of maintaining and operating savings accounts in the country has already become too high even for what we usually refer to as middle-class. There are all kinds of charges and penalties that banks now charge for failure to maintain lowest minimum balance that differ from bank to bank.

The Governor's advice, good as it is, may not achieve the desired results in an era when commercialism succeeds everything else and where there is a severe competition among banks for "high value clients". Who would be interested to 'exploit the huge untapped potential' in the 'underserved areas' when the banks are chasing high value clients in the urban centres?

The Scenario Despite the bottlenecks the fact remains that Islamic banking has started to make its presence felt in Pakistan like elsewhere in the world. Early this month, another Islamic Bank, Emirates Global Islamic Bank (EGIBL) was launched in the country with six branches nationwide. The bank has been sponsored by the Emirates Investment Group of UAE and Al-Rajhi Group of Saudi Arabia

Islamic banking has registered an impressive growth since 2003 when there was it comprised just one full-fledged Islamic bank and two conventional banks in the country. With the addition of EGIBL the number of fully dedicated Islamic banks in the country has increased to 6 fully dedicated while 13 conventional banks, both domestic and foreign, are also licensed to operate dedicated Islamic banking branches. These Islamic and conventional banks together have a branch network of 157 branches across 24 cities across the country.

The total assets of the Islamic banking sector in the country recorded a fabulous growth of 24 per cent to Rs 118.183 billion December 2006 from Rs 95.020 billion in September 2006 which accounts for market share of just about 3 per cent. The deposits of the Islamic banking sector also grew by over 25 per cent from Rs 66.011 billion to Rs 83.742 billion during the same period. The collective financing and investment of Islamic banks touched Rs 65.137 billion, which was 55 per cent of their collective assets. However, in term of percentage the share of Islamic banking sector in total banking sector's deposits and financing and investments remained low at just 2.7 per cent and 2.4 per cent respectively.

Though the share of Islamic banking in the overall banking industry still remains quite small it is nevertheless encouraging that it is steadily growing substantially in term of percentage the primary example of which is the 24 per cent increase in the asset. However, the central bank is targeting to increase the total assets of the Islamic banking sector from 3 per cent at present to at least 15 per cent by the year 2012.

Shortage of professionally qualified human resources seems to be one of the major reason impeding the growth of Islamic banking in the country because the existing educational infrastructure is not geared to produce qualified and efficient professionals to meet the rising demand of top, middle and entry level management positions.

The Islamic Banking Department of the central bank, the State Bank of Pakistan, is playing a proactive role to encourage Islamic banks introduce new products to enhance their share of the market. It is also assisting them to benefit from the technical know how and expertise that it has as well as from the Shariah Board. Beyond Arabic terminologies Islamic banking in Pakistan rely heavily on Murahaba and Ijarah modes of loans that raises many questions because it is only technically different than the interest in the conventional banking. Murahaba literally means sale on profit; cost plus profit, sale at stated cost price and mark-up, sale at a specified profit margin. The term is, however, now used to refer to a sale agreement whereby the seller purchases the goods desired by the buyer and sells them at an agreed marked-up price, the payment being settled within an agreed time frame, either in installments or lump sum. The seller undertakes all the management needed for the purchase and also bears the risk for the goods until they have been delivered to the buyer. This has been adopted as a mode of financing by a number of Islamic banks. As a financing technique, it involves a request by the client to the bank to purchase a certain item the bank does that for a definite profit over the cost, which is settled in advance.

On the other hand Ijarah literally means letting something on lease or technically, sale of a definite use of services in exchange for a definite reward. Commonly used for wages, it also refers to a contract of land lease at a fixed rent payable in cash. It also refers to a mode of financing adopted by Islamic banks. It is an arrangement under which an Islamic bank leases equipment, a building or other facility to a client against an agreed rental. The rent is so fixed that the bank gets back its original investment plus a profit on it.

The share of other Islamic modes of financing musharikah, diminishing musharikah and Islam is much lower than Murabaha and Ijarah. Musharikah is an agreement under which the Islamic bank provides funds which are mingled with the funds of the business enterprise and others. All providers of capital are entitled to participate in the management but not necessarily required to do so. The profit is distributed among the partners in pre-determined ratios, while the loss is borne by each partner in proportion to his contribution. Bai al-salam, refers to advance payment for goods which are to be delivered later. Normally, no sale can be effected unless the goods are in existence at the time of the bargain. But this type of sale forms an exception to the general rule provided the goods are defined and the date of delivery is fixed. The objects of this type of sale are mainly tangible things but exclude gold or silver as these are regarded as monetary values. Barring these, bai salam covers almost all things which are capable of being definitely described as to quantity, quality and workmanship. One of the conditions of this type of contract is advance payment; the parties cannot reserve their option of rescinding it but the option of revoking it on account of a defect in the subject matter is allowed. It is usually applied in the agricultural sector where the bank advances money for various inputs to receive a share in the crop, which the bank sells in the market. The concentration on Murabaha and Ijara is limiting the growth of Islamic banking on the one hand and depriving the people of benefits that it truly offers.

SHARIAH COMPLIANCE FRAMEWORK –COUNTRY WISE

COUNTRY

ISLAMIC BANKING LAW

SHARIAH COMMITTEE

FIT & PROPER CRITERIA FOR SHARIAH ADVISOR/ COMMITTEE

SHARIAH COMPLIANCE INSPECTION

SHARIAH STANDARDS

ACCOUNTING STANDARD

Malaysia

Islamic Banking Law 1983

Shariah Advisory Council

Shariah Committee

Approval by BNM*

Governance through Shariah Committee

All Products approved by SAC, Role of Shariah Committee defined by BNM

Accounting Standards developed by MASB*

Bahrain

Regulations for Islamic Banks

Shariah Supervisory Committee

Shariah Supervisory Board

N.A

Internal and External Shariah Audit as per AAOIFI* standards

AAOIFI

AAOIFI

Indonesia

Laws for Islamic Banking Introduced in 1992 & Amended in 1999

National Shariah Board

Shariah Supervisory Board

NSB approves appointment of SSB members

Internal and External Shariah Audit

Fatwa on products issued by NSB

AAOIFI

Iran

Usury free Banking Act 1983

Council of Guardian

N.A

N.A

No

Guidelines provided by Council of Guardians

Not Known

Brunei

Islamic Banking Act Cap.168

Shariah financial supervisory Board (SFSB)

Shariah Advisory Board

SFSB approves appointment of Shariah Advisory Board members

No

SFSB Approves Islamic products introduced by Financial Institutions

Not Known

Pakistan

Banking Companies Ordinance, 1962 and Policies for Islamic Banking in 2001 & 2003

Shariah Board

Shariah Advisor

Fit & Proper Criteria by SBP

Manual developed in 2004, now being implemented

Essentials for Islamic modes

AAOIFI standards are being adapted by a committee of ICAP*

*MASB= MALAYSIAN ACCOUNTING STANDARDS BOARD
*BNM= BANK NEGARA MALAYSIA
*AAOIFI= ACCONUTING AND AUDITING ORGANIZATION for ISLAMIC FINANCIAL INSTITUTIONS
*ICAP= INSTITUTE of CHARTERED ACCOUNTANTS of PAKISTAN
SOURCES: State Bank of Pakistan