ISLAMIC BANKING INDUSTRY
FOZIA AROOJ (Fozia.firstname.lastname@example.org)
June 29 - July 5, 2009
The growth and progress of Islamic banking in Pakistan has been remarkable during the last five years. Currently there are six licensed full-fledged Islamic banks and 12 conventional banks with standalone Islamic banking branches with the total branch network of over 336 branches operating in more than 50 cities of all the provinces and Azad Kashmir.
Islamic banking has emerged as a recognised global industry. Dubai Islamic Bank was the first Islamic bank established in 1975. Today the total asset base of Islamic banking industry is exceeding $900 billion and is expected to cross $4 trillion mark in next 5 years. Albeit the share of Islamic banking in global banking industry is very small, it is exhibiting impressive growth i.e. 15-20% per annum.
Presently more than 250 Islamic financial institutions are operating worldwide from China to US. Western banks through their Islamic units in UK Germany, Switzerland, and Luxembourg are also practicing Islamic banking.
In Pakistan, Islamic banking can be made a viable option and alternative to conventional banking. But, market mechanism is the deciding factor whether it is robust enough to offer an exclusively Islamic banking system in the country. Owing to prohibition of undertaking risky business, Islamic banking has largely escaped the fallout from the global financial crisis in an era where mainstream institutions are devastating badly. As a matter of fact, Islamic banks have avoided complex debt-based structures and have relied more on retail deposits and financed real estate, private equity, and equities.
Unlike conventional financial institutions, Islamic financial institutions are not prone to risks. Even now, western governments and banks are considering possible regulation instead of giving up interest based and speculative transactions. However, just surviving the financial crisis does not mean that Islamic banking will influence conventional banking. Need of the hour is to develop a progressive and sound system that is in line and compatible with the global financial sector, providing innovative Shariah compliant products and services to achieve equitable economic growth.
ISLAMIC FINANCE PRODUCTS
Presently, there are a variety of Islamic banking instruments and transactions in vogue. Islamic financing products such as Murabaha, Ijara, Musharaka and Islamic Export Refinance are catering to a diverse cross-section of the economy, including the corporate, SMEs, and consumer sectors. Some important terms are elaborated as follows:
1. Musharaka is a business structure in which the bank not only makes a financial contribution to the enterprise, but may also participate in managing the venture.
2. In Mudaraba, the institution provides the requisite financial resources, but does not participate in managing the enterprise.
3. Murabaha is an arrangement in which the bank, instead of advancing a loan to the client wishing to purchase certain goods or equipment, purchases the items and sells them to the client at cost plus a declared profit.
4. In Tawarruq, the bank buys an asset and immediately sells it to the client on a deferred payment basis. The client then sells the same to a third party for immediate delivery and payment. Consequently, the client receives a cash amount and has a deferred payment obligation for the mark-up price to the bank. The asset is typically a metal, like copper or platinum.
5. Ijarah is the leasing or hiring of a physical asset and it is one of the fastest growing activities of Islamic banks.
ISLAMIC EQUITY FUNDS
Investment banking activities have also been introduced in Islamic financial institutions. The launching of Islamic investment equity funds in 1990s and subsequently their robust growth has broadened the realm of Shariah based money market instruments. Currently, there are approximately 100 Islamic equity funds worldwide. The total assets managed through these funds currently exceed US$5 billion and is growing by 12ñ15% per annum. This high rate of growth is likely to attract more investors to this side and there are positive signs that more funds will be launched. Some Western financial tycoons are also figuring out the opportunities to enter the market and launching similar Islamic equity products. Dow Jones has established credible equity benchmarks since 1990s named as Dow Jones Islamic market index.
In spite of being a thriving industry, Islamic banking faces many challenges and inherent problems, which are prohibiting many sects of Muslims to accept it as truly Islamic. Some of the issues are given as follows:
1. Not all the Muslim scholars agree that the existing structure of transactions is in line with the Islamic ideology and the commandments of Sharia. Most of them have different interpretations of Islamic law. They refer to the hidden and concealed elements of Riba and gharar in these transactions.
2. There is a dearth of qualified professionals in Islamic banking institutions. Personnel in banks are not skilled in Islamic banking techniques and laws. Therefore, they are unable and poorly equipped with logic and concrete grounds to market the products and persuade target market. They are hardly able to respond to the queries raised by religious sections of the society.
3. There is no binding set of universal Islamic rules because there is no consensus amongst religious experts. There are bodies and organisations - Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is one of them - that are trying to address this lack of Islamic standardisation. The setting up of a supreme Shariah board can serve the purpose well. In Indonesia, a national Shariah board issues rulings that are mandatory for all Shariah boards in the country.
4. Islamic equity funds have seen phenomenal growth. However, the marketing strategy in Pakistan is equally pathetic as markets are emphasizing on products and not on addressing the needs of investors. Consequently, over the last few years, quite a number of funds have closed down. In fact, most of the funds tend to target high net worth individuals and corporate institutions, with minimum investments ranging from US$50,000 to as high as US$1 million. Target markets for Islamic funds vary; some cater to local markets, e.g. Malaysia and Gulf-based investment funds. Others clearly target the Middle East and Gulf regions, neglecting local markets and have been accused of failing to serve Muslim communities.
According to State Bank of Pakistan, licenses for more Islamic banks are being issued and Gulf investors are launching a new $10 billion Islamic bank and plan a $3 billion initial public offering in the fourth quarter 2009 to tap interest in sharia-compliant institutions.
This industry has a promising future as the increasing number of conventional banks such as Citibank, HSBC, RBS, Standard Chartered, and UBS are engaging in Shariah compliant operations. The most important thing is that Islamic bankers should not mix up the concepts and distinguished features between Islamic and conventional banking in their eagerness and keenness to draw more funds from wealthy non-Muslim clients or Muslim clients that are not bothered about the true spirit of this industry.