Apr 9 - 15, 20

Islamic finance has achieved a substantial growth in the last few years, annualizing a growth rate of about 18 percent.

The Islamic finance industry that was currently estimated to be worth about US$1 trillion had made further headway in the Islamic traditional markets such as Malaysia, the Gulf Cooperation Council countries, Pakistan, Indonesia, apart from penetrating new markets such as Europe and Africa. While Islamic banking assets account for a large part of this value, the segment that has enjoyed especially strong growth in the more recent years is Sukuk.

Despite growth, Islamic banking is facing challenges like any other new industry, which despite being new is actually a very competitive market. Islamic banking is based on the principles of Islamic finance and people have very little knowledge about these concepts. This in itself gives rise to a number of challenges, for instance, establishing credibility and spreading awareness. Capacity building is another major challenge posed to the Islamic banking.

Conventional banking is being taught in numerous universities whereas very few institutions are offering formalized education in Islamic banking, thus production of quality human capital is another challenge for our growing sector. The lack of effective marketing remains as one of the key reasons why the sector has not been able to serve its massive potential. However, with growth of Islamic banking, more educational institutions are emerging to prepare skilled human resource.

According to a recent IMF study, Islamic banks performed better than conventional ones in terms of profitability, credit, and asset growth. The Islamic banking system has great potential for further market share expansion and a possible contribution to market stability given the available credit. Assets also reflected a similar trend, which were less affected and grew on twice the pace of conventional banks during the period of economic crisis.

The growth in the market share of Islamic banking in Pakistan has also been impressive. This can be seen by looking at the market share achieved by other countries over time. The Islamic banking sector in Pakistan has around 10 per cent share of the total banking industry.

In Pakistan, Islamic banking emerged as a response to both religious and economic needs. Efforts for economy-wide elimination of Riba started during 1970s and most of the significant and practical steps were taken in 1980s. The mid-80s attempt was a significant step in the evolution of Islamic banking system in the country.

In a technical sense, it was the most advanced model compared to any other model being practiced anywhere in the world at that time. However, that system fell apart as it did not adequately address issues such as putting in place an effective Shariah compliant mechanism, giving emphasis to capacity building, and opting for a flexible and evolutionary approach. In any case, this effort provided a valuable experience that has been taken into account while formulation of SBP's current strategy to re-launch Islamic banking in Pakistan.

The banking system in an economy works like the blood circulation system of a body. As only an efficient blood circulation system can ensure a healthy body, similarly an efficient and equitable banking system can dispense economic efficiency and justice. These basic concepts and objectives are common to any banking system, be it conventional or Islamic. The difference lies in the methodology adopted to achieve these objectives.

Conventional banking aims to meet these objectives through use of interest-based contracts while Islamic banking achieves these objectives through trade-based contracts. In Pakistan, Islamic banking emerged as a response to both religious and economic needs. The initiative to re-introduce Islamic banking in Pakistan was launched back in 2001 when the government decided to promote Islamic banking in a gradual manner and as a parallel and compatible system that is in line with the best international practices. Following the decision of the government to shift to interest free economy in a phased manner without causing any disruptions, the effort was envisaged to be based on a market driven and flexible approach. Furthermore, it aims at building a broad based financial system in the country to enable all segments of the population to access finance. While the number and operations of Islamic banks are fast expanding, this segment of the market is still small relative to the appetite for Islamic finance. Pakistan, in light of its experience, is launching a gradual and steady approach to Islamic banking. Moreover, it only caters for around 32,000 borrowers through around 300 branches relative to the country-wide five million borrowers (or 4.8 million excluding microfinance borrowers) tapped through 7,700 branches by conventional banks. Financing and investment levels of Islamic banks barely range around Rs77 billion, which is below three per cent of the total banking system's advances. On the product side, Islamic banks so far offer about 75 per cent of products currently available in conventional banking while clean lending for consumer financing products, like personal loans and credit cards, still pose a challenge.

Islamic banks operate exclusively in large cities with some now venturing into secondary cities but they are absent from rural areas where there is great potential for business growth. Global interest in Islamic finance industry and Pakistan's success in laying foundation and core infrastructure of Islamic financial system lends confidence that the country has good potential and prospects to further exploit this industry.

Going forward, however, it is important that Pakistan adopts a more calibrated and coordinated approach and strategy for the development of Islamic finance industry.

It is forecasted that in year 2012 Islamic banking deposits will reach in the range of Rs900-1000 billion and financing in the range of Rs700-800 billion. In Pakistan, conventional banking has got a new lease of life with the advent of consumerism. Riba-free banking is running parallel to interest-based banking under the same roof and this approach is accepted by many religious scholars as a "transitional phase" to achieve some evolution of Islamic banking through famous brands.

Foreign and local commercial banks have formed Shariah boards, offering Islamic products to Muslim customers. But, criticism is voiced especially over mixed institutions with questions how they are financing their Islamic banking windows - whether through lending from conventional banking channel.

Branchless banking is gaining ground where electronic channels such as phones, internet, short messages, or mobile phones are used heavily for banking, making it simply impossible to segregate Islamic or non-Islamic customers reaching the call centre of the bank having both modes of operations. So, banks running conventional operation and having an Islamic window too, are servicing two opposite customers through a single source.

Although, Islamic banking is progressing in Pakistan, but the need of the hour is to capitalize on opportunities by offering pro-people products. Islamic banking has huge potential and with more aggressive approach, this industry could get its due share and status.