Oct 24 - 30, 2011

None of the Islamic banks, either full-fledged or those with Islamic banking branches, have ventured into Islamic micro finance in Pakistan despite that the industry is enjoying double-digit growth.

There are five full-fledged Islamic banks and 15 conventional banks with Islamic banking branches in the country. The share of the industry in the banking system has risen to over seven percent from just 0.5 percent in 2002.

This is not due to the fact that the target market is not sufficient to venture into microfinance business. Approximately, 40 percent of the labor force is employed in agriculture and this sector can be the main target market for microfinance. Poverty rate has risen to 43 percent. The country has plenty of young labors aged between 15 and 40.

Informal credit markets already exist and recovery rates are higher i.e. 95 percent offering a great opportunity for sustainable growth. Density of population is high and therefore, transaction costs would be lower. Since interest rate charged in conventional credit markets is usurious (as high as 50 percent or even more), the affordability of the products is also not a problem since formal institutions would target a much lesser required rate of return. In contrast to this, there have been several conventional financial institutions and even conventional banks, which have informally contributed to promote microfinance.

Part of the reason behind negligence of microfinance by Islamic financial institutions (IFIs) is to do with their management. The management of the banks in IFIs is and has never been interested in it until the principal institutional investors in the bank agree to it.

This is the case with almost every IFI over here and almost everywhere. The principal investors behind such institutions have limited inclination and vision for having an Islamic economy and mostly Islamic banking and finance for them is a new niche market to enter and diversify.

In Pakistan, conventional banks with Islamic banking branches are twice more in number than the full fledged Islamic banks. With dual operations, egalitarian initiatives cannot be expected from them. Islamic banks can also not be expected to come to the rescue due to lack of both intention and will which is signified by the fact that despite huge liquidity at their disposal, they have extremely low advance to deposit ratio and due to which their spreads are higher than conventional banks.

Islamic banking spread is 8.80 percent as compared with 6.90 percent for the overall industry, as per the Islamic banking bulletin, SBP Apr-Jul, 2011. Since 6.90 percent is for the overall industry, which includes Islamic banks as well, the banking spread for conventional will be even lower and the gap between the banking spreads of two institutions will be even higher. This makes idealistic promises of Islamic finance all the more meaningless.

Not only Islamic banking spreads are higher than conventional banks in Pakistan, but the average loan size and average firm size they finance is much bigger than conventional banks signifying that they are currently only financing blue chip companies. Another point of concern is that Islamic banks provide much less financing to small and medium enterprises than conventional banks.

The so called asset backed nature of financing in Islamic finance deprives one to finance education, health, autonomous and necessary consumption. What it ensures is the rent seeking by Islamic institutions that insure the asset and add this insurance cost in the rentals and Murabaha price to make the receivable as secure as interest received on loan by mitigating price, market and asset risk, which is the basic distinguishing feature between trade and Riba.

Furthermore, after completing one decade since establishment of the first Islamic bank in Pakistan, Islamic banks still use the same benchmark which conventional banks use for pricing products, with the only difference that Islamic banks' profit margin (banking spreads) are at least two percentage points higher than conventional banks.

The writer has authored "Proposal for a New Economic Framework Based on Islamic Principles".