ISLAMIC BANKS SHOW HIGH GROWTH POTENTIAL
SAAD ANWAR HASHMI
Apr 9 - 15, 2012
Islamic banks were set up in Pakistan and globally with an aim to provide an alternative to conventional banking offering Sharia compliant products. Islamic banks work on the premise of earning through profits not categorized under the ambit of Riba which is prohibited in Islam. Riba has been forbidden in Surah Al Baqra in clear terms and was further advocated in the Historical Judgment on Riba by the Supreme Court of Pakistan.
State Bank of Pakistan (SBP) with a separate function to look after Islamic financing further encourages the promotion of Sharia compliant banking practices through establishment of Islamic banks of conventional banks offering Islamic banking windows.
The Islamic Banking Department at SBP was established at SBP in 2003 to promote Islamic banking in the country. Currently, there are six licensed full-fledged Islamic banks and twelve conventional banks with standalone Islamic banking branches. Islamic banks are expected to show double digit growth through CY12, to have reached a branch network of 800 branches nationwide by June 2011.
Islamic banks not only target those who want to avoid Riba but are also open to those who may be non-Muslims and wish to operate bank accounts and apply for asset based products.
The success of Islamic Banking is based on the mindset of those who believe why Riba is forbidden and wish to continue banking through Islamic principles. With an increase in Islamic teachings and trainings, there has been increased inclination to move from conventional to Islamic banks not only in Pakistan but also in western markets particularly UK adding to the banking growth. The phenomenon of structural shift in asset mix of Islamic banking industry from financing to investment continued through CY11.
Islamic banks operate alongside conventional banks in a highly competitive environment for attracting deposits. Islamic banking assets stand at Rs560 billion constituting more than seven percent share of overall banking industry assets. In terms of deposits, the industry share of Islamic banks is 7.3 percent estimated to grow up to 10 percent in CY12.
Conventional banks in order to support an alternate mode of banking are opening Islamic bank branches. About 63 percent of the branch expansion during FY12 has come from Islamic branches of conventional banks with 89 percent of all branches in Punjab and Sindh.
Islamic banks have shown success and are able to grow their business in line with conventional banks which show the inclination towards Islamic financing. Based on current performance, the total lending against these products increased from Rs164 billion in FY10 to Rs199 billion in FY11 of which Muarabaha having a share of 72.4 percent whereas Diminishing Musharaka with a share of 31.8 percent as of June 2011 based on the Financial Stability Review released by SBP.
With respect to corporate lending, textile sector lending was recorded at 17.7 percent in FY11 followed by Agri business at 6.10 percent and high net worth individuals at 11.30 percent.
Based on prudence in its lending practices through agreements based on equity injection and partnership between the bank and the borrower, there is an increased vigilance from the bank to ensure the non performing loans are at their minimum. Comparing infected ratio, Islamic banks have performed better than conventional banks. Based on asset quality, non-performing loans to total financing increased from 6.5 percent in FY10 to 7.5 percent in FY11 compared to industry average of conventional banks at 15 percent as of June 2011. Deposit base grew from Rs329 billion in FY10 to Rs452 billion in FY11 with an YoY growth of 37.1 percent.
Islamic banks with respect to the product line offer products, which are at par with what conventional banks offer. The challenge is the understanding of these products with end to end transactions; how these products are compliant with Sharia. It is a common belief that Islamic banks products are simply change of name of regular banking products, which is not the case if reviewed how these transactions were carried out during the time of Holy Prophet (S.A.W).
Islamic banks in Pakistan generally offer specialized products, which include Murabaha, Ijara, Musharaka, Mudaraba, Diminishing Musharka, Salam, Istisna and Qarz-e-Hasna.
Islamic banks due to the mode of lending and way of transaction structured under the ambit of Sharia have shown high degree of resilience. One of the major differences is that depositors unlike conventional banks are considered partners sharing of profit and losses.
Islamic banks enjoy a built-in stabilizer to help them cope with the economic downturns for payment of profit. If profitability of an Islamic bank declines in an economic downturn, depositors receive lower returns, but if profits rise, they enjoy higher returns. This profit sharing reduces risk for the banks, which means they are less likely to become insolvent.
Depositors rather than being considered as liability are considered more as partners in business injecting not deposits to be used as advances but equity, which is another reason why Islamic banks are considered safe.
Islamic banks are gaining popularity globally where international banks are establishing Islamic banking windows to cater to the increased demand. Citibank, Standard Chartered, and HSBC globally have already established divisions for Islamic banking. Equal success is witnessed in Africa and Europe. It is estimated that another 250 branches will be established for Islamic banking in CY12 in Pakistan creating further employment in the industry. Since depositors are considered as partners with lending products through creation and management of an Islamic pool, banks stake in investment returns is as important as stake of a depositor.
Islamic banks have a larger liability to manage in case of a loss, resulting in prudence in lending keeping the infection ratio below that of conventional banks.
The success of Islamic banks largely depends on Islamization of the economy since Islamic banks compete with commercial banks for deposit. With conventional banks establishing Islamic banking windows, full-fledged Islamic banks in the country face a tougher challenge to grow the business in terms of volume and competitive pricing at par with conventional banks.
Government needs to promote the bond and money market for Islamic banks through floating of Sukuks where banks can earn through investment of residual funds. Islamic banks in Pakistan are in early stages of growth and so far have shown high potential to compete with conventional banks and promote Islamic financing. Since conventional banks compete with Islamic banks, the growth of the business depends on the increased knowledge of Islam with practice and the drive to promote such alternate mode of banking at par with principles of Islam.