May 11 - 17, 2009

Over a span of about seven years assets of Islamic banks in Pakistan have got close to 5%, which itself is a remarkable achievement. Keeping in view a population of around 200 million with more than 97% Muslims growth potential is enormous but yet to be tapped prudently and efficiently. Growing interest of corporates, variety of asset and liability products being made available and enhanced outreach is likely to further accelerate the growth rate.

The first full-fledged Islamic commercial bank commenced its operation in the country in 2002. Now six Islamic banks and more than a dozen conventional banks with designated branches are offering 'ethical banking' equally attractive for non-Muslims. Keen interest of players, enormous interest of the clients and proactive approach of regulators is laying down the foundation of an elaborate infrastructure. Until end 2008, around 500 branches offering Islamic banking were operating but during 2009 another 200 branches will be established.

The efforts of State Bank of Pakistan have been recognized globally. It is evident from the results of the 2008 Islamic Finance news poll that the more focused and specialized Islamic financial institutions are favored to those of the larger global historically conventional institutions with Islamic operations. As more of the world's financial centers announce their interest in attracting Islamic finance to their shores one would assume the Best Central Bank in Promoting Islamic Finance category would be more competitive. For the fourth consecutive year, Bank Negara Malaysia was voted number one with more than double the votes of their nearest rival, the State Bank of Pakistan, which itself leapfrogged the Central Bank of Bahrain into second place in year 2008.

Islamic Banking Bulletin July-September 2008 quarterly data of Islamic banking institutions (IBIs) reveal the continuation of the upsurge in assets, deposits, and financing. The Islamic banking industry remained resilient despite recent liquidity pressures on the global level; the financial crises deepened and resulted in heavy losses to financial sector giants of the developed world. Nonetheless, anecdotal evidence suggests that Islamic finance industry showed tremendous resilience and the investors' interest remained largely intact. The share of Islamic banking institutions' assets, deposits, and financing & investment increased to 4.6%, 4.2% and 4.4% respectively at the end of quarter.

Deposits of IBIs rose despite the problems in the conventional banking sector. The deposits as on September 30, 2008 stood at Rs171.3 billion reflecting Quarter on Quarter (QoQ) increase of one per cent. The shares of Savings, Fixed and Current Accounts of customers' deposits were 31%, 39% and 22% respectively. Due to combined efforts of the State Bank as well as the industry, the demand for Islamic banking services in the country is increasing.

Investments of IBIs as on September 30, 2008 stood at Rs40.3 billion which showed a QoQ increase of 15%. The increase in investments reflected the new investment especially in Ijarah Sukuk worth Rs6.5 billion issued by the Government in September 2008, which was a remarkable achievement for Islamic banking industry of Pakistan. This step has helped in minimizing the liquidity management issues of IBIs, as these Sukuk are Statutory Liquidity Requirement eligible.

Islamic Banking Industry in Pakistan depicts financing (net of provisions) of Rs142.2 billion at end September 2008, reflecting a QoQ increase of 8%. There is hardly any change in the mode wise financing mix during the quarter. In specific terms, share of Murabaha, Ijarah, and Diminishing Musharaka remained largely unchanged at 41%, 21%, and 30% respectively.

Total Assets of IBIs stood at Rs251 billion showing an impressive QoQ increase of 7%. Within assets, investments, operating fixed assets and financing were the major contributors to total assets growth. The growth of investments, operating fixed assets and financing was 15%, 10%, and 8%. The other assets also grew at a rapid rate of 25%. The increase in fixed assets may reflect the increasing number of branches of Islamic banking institutions-showing extension in outreach.

State Bank of Pakistan raised Rs6.522 billion through sale of three-year Ijarah Sukuk, setting cutoff margin over benchmark at 45 basis points. This was the first ever auction of an Islamic paper in the domestic market. The central bank received bids worth Rs9.522 billion. The margins over benchmark that the primary dealers demanded ranged from minus 10bps to 100bps. The cutoff margin set by SBP will be applicable to all accepted bids. According to head of treasury of a leading Islamic bank, roughly up to one billion rupees was invested by Islamic banking windows of conventional banks while the rest was invested by full-fledged Islamic banks.

Banks were quite satisfied with the margins offered by the central bank. This was the first ever auction of an Islamic paper in the market. Earlier, Islamic banks had bought Sukuk issued by WAPDA and Karachi Shipyard and Engineering Works, but those were not sold through an auction.

Reportedly foreign investors also showed interest in investing in the government's Sukuk. However, the offer could not be accepted in the absence of government's instructions on if and how the foreign investors could participate in the auction. The government had not issued any notification about foreign investors' participation in these papers.

With the Sukuk issue, the IBIs would be in a better position to manage their liquidity. Earlier, they had to place cash with the central bank to meet their SLR because of shortage of securities. Moreover, they did not get any profit on that cash. Now they will be able to invest their excess liquidity in these papers and earn profits.

Islamic banks have to place 9 percent of their deposits with the central bank as SLR. This requirement is 19 per cent for the conventional banks. It is likely that the central bank may raise the SLR for Islamic banks after sometime when auctions of government Sukuk become a routine. In the past the shortage of securities was so acute that a leading Islamic bank failed to buy KS&EW Sukuk from the market because those holding the paper did not want to sell. The IBIs may be content but they still need to have short-term Shariah-compliant instruments. The three-year Sukuk is not an alternative to treasury bills.