ISLAMIC BANKING HAVING IMMENSE GROWTH POTENTIAL

SHAMSUL GHANI (shams_ghani@hotmail.com)
June 23 - 29, 2008

From Pakistan's perspective, the history of Islamic Banking is somewhat chequered. The absence of a proper legal framework, the lack of an overall consensus of all Fiqhas, the Shariat Appellate Bench's setting aside of all previous decisions including its own decision of December 1999 whereby it asked the government to remove all laws involving interest by June 30, 2001 (subsequently extended by one year) and various governments' failure to get the issue resolved in earnest are the few turnarounds that have imparted an air of uncertainty to the future of Islamic Banking in Pakistan. The State Bank has played a positive role in boosting this promising industry yet a final verdict by the supreme religious bodies as to the tenability of the in-use financial models from Shariah point of view remains a distant possibility.

The potential of the industry is immense. What is needed is the designing of a sound legal framework with no ambiguities from religious point of view that could be made subject of any subsequent litigation. Having achieved this, we could concentrate on enlarging the base of this emergent sector of finance holding a global appeal both for Muslims and non Muslims. The State Bank governor, in one of her speeches last year said, "The Islamic Finance now seems to be a reality and is on its way to be institutionalized, albeit at different levels in different countries, and the western world is now selectively and cautiously positioning to invest in this system. Spread across 70 countries, Islamic Finance has grown to almost a $ trillion industry. Despite its growth, given its current size and composition it is still a niche market in the overall global financial industry".

THE SUCCESS STORY

The success story dates back to early eighties when under geo political 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 which in fact is interest sans compounding. The oil boom of 2003 saw a shift in Arabs' attitude that diverted the dollar surplus to Muslim countries having Islamic channels of financial services. This change, besides giving Muslim countries an opportunity to develop and strengthen their Islamic banking and finance systems gave an option to the US and European countries to enter this new yet lucrative market by opening of Islamic windows in their existing banking systems. That was the beginning of a new era for the Islamic Finance. Non Muslims, hardly interested in the Shariah compliance, were attracted by the generous rates of profit offered in this developing market. In Pakistan, banks like Standard Chartered, ABN Amro and Citi are offering products conforming to the principles of Shariah. The growth of this burgeoning industry may receive a setback unless protected by strong Shariah-based legal framework duly supported by equally strong and effective policy and regulatory frameworks. The concerns about this emerging market's capability to withstand the challenge of competition from the conventional global banking market found on time-tested strong policies are still voiced by many quarters.

THE WORKING OF THE SYSTEM

Besides few full-fledged Islamic Banks licensed to operate, almost all major domestic banks have opened stand-alone branches to exclusively offer Islamic banking services. The well-known foreign banks have opened Islamic Finance windows in branches basically operating on conventional banking lines. State Bank of Pakistan, having been assigned the role of regulatory authority, has a separate Islamic Banking Department to oversee the functioning of Islamic banks / branches besides providing advisory and allied services. The Department is divided into the following four Divisions with specific objectives:

Policy Division Objectives: Devise a vision and strategy paper, study the best international practices, deal with legal, regulatory, taxation and accounting issues, steer the task force on R & D and deal with issues relating to Islamic economics.

Shariah Compliance Division Objectives: To strengthen the supervisory aspect of Islamic Banking, to analyze the banks' financial data, to develop new products for liquidity management and inter bank market, and to liaise with international institutions involved in Islamic Finance.

Business Support Division Objectives: To provide administrative support to the Department, to make arrangement for various meetings and to arrange for training and video conferences.

Shariah Board Secretariat Objectives: To arrange Shariah Board meetings, and conduct due diligence of Shariah advisors of International Banking Institutions.

THE PRODUCTS

The commonly used Islamic banking products are Morabaha, Musharika, Ijara, TFC etc. While Morabaha is used by financial institutions for lending to business and industry, Musharika is used to raise business funds from individuals, AOPs and business entities. Ijara or Leasing is used to finance business and industrial assets. Only operating lease that does not transfer the ownership of the asset to the lessee at the termination of lease is considered Islamic. In this form of lease, the leased asset appears on the balance sheet of the financial institution. Finance lease that transfers the ownership of the asset to the lessee at the termination of lease is not recognized as Islamic. TFCs or Term Finance Certificates are used by the corporate sector and financial institutions to raise funds for business purpose. These certificates carry a maturity date for redemption purpose and are usually tradable.

Functions of Banks, Modarabas and Leasing companies are often overlapping.