UNDER THE SHADOW OF CONVENTIONAL FINANCIAL SYSTEM
TARIQ AHMED SAEEDI
Apr 9 - 15, 2012
For years, auto financing remained a profitable portfolio of conventional banks and even after the full-fledged introduction of car Ijarah from Islamic banking institutions in a direct competition to the leading conventional system, profitability was hardly affected due to the rising appetite of auto loans in the market. It was only after upward trend in interest rate and rising non-performing loans that banking industry in general got cautious in expanding its consumer finance portfolio.
Islamic financing industry has not been the exception and it is moving very cautiously in building up assets in consumer financing sector. In fact, Islamic consumer financing has been declining consecutively for the last four years. Referring to four-year statistics shows that share of Islamic financing to automobile and transportation equipments stands at one to two per cent.
DECLINE IN CONSUMER FINANCING
From 22.3 per cent in December 2008, the share of consumer financing in its total portfolios fell to 20 per cent in December 2009, 15.9 per cent in the following year, and 13.9 per cent by December 2011, according to the state bank of Pakistan (SBP).
Clearly, this shows the priority of Islamic banking institutions in making of assets. Corporate sector accounted for 73 per cent of total financing portfolio of Islamic banks. Notably, asset base of Islamic banks grew impressively 34 per cent to Rs641 billion year on year with its profitability to have reached Rs10.6 billion. The industry had enjoyed annual growth rate of 30 per cent in the previous years. Murabaha had the highest share in total financing while diminishing musharaka and ijarah accounted for small shares.
As of last yearend, branch network of Islamic banking industry reached to 886 branches, which also include sub-branches and Islamic branches of conventional banks with five Islamic banks including Al Baraka Islamic Bank, BankIslami Pakistan Ltd., Dawood Islamic Bank Ltd., Dubai Islamic Bank Pakistan Ltd., and Meezan Bank Ltd. operating in the country. Meezan bank led the all the Islamic banks with 275 branches as of December 2011.
Being the pioneer of Islamic banking in the country, Meezan bank has carved out its distinct position in the flourishing Islamic finance industry. The bank offers leased cars for three and five years. It also makes contracts of leasing used cars.
UNDER THE ASSET-BASED FINANCING
It is generally believed that Islamic finance industry is operating under the shadow of conventional financial system. Authorities on Islamic finance industry are also suspicious of its conducts and imitation of conventional system's products.
How the conventional financing is different from the Islamic financing is perhaps still a question looking for a practical answer in the interest-based dominated societies like Pakistan. Especially when it comes to auto financing, majority of people find the question rather more probing.
What is called interest on principal amount charged to a borrower over the credit cycle of his/her conventional auto loan is named rent in Ijara car financing, so the people ask. To put it simple, Islamic bank buys a car and then rents it out to the customer at a markup instead of loaning amount to him/her to purchase a car that happens in the conventional way of auto financing. Markup is a difference between cost of buy and price of sale. One can call it service facilitation charge or simply service charge. Then, how does it differ from interest accrued on the conventional loan, which can also be defined as service charge?
Islamic finance does not charge interest. "We don't recognise the concept of interest... to look for some profit from trading money," Dr Bambang Brodjonegoro at the Islamic Development Bank told BBC. An obvious question arises if Islamic finance does not charge interest, then how does an institution offering asset-based financing or noninterest loans earn profits?
COMPLEMENTARY OR SUBSTITUTE
Advocates of Islamic finance say Shariah-compliance is more an egalitarian type of financial inclusion distinguishable noticeably from the system that has little consideration of principle of equality and is fed on motivation to rack up profits. They argue it is an absolute substitute of what reigns supreme in the international financial landscape. Nonetheless, there are people who do not subscribe to this viewpoint.
"I don't think that this Islamic banking system is the alternative, that we have one or the other. I think this is a complementary service, a way of doing service," said Prof Ekmeleddin Ihsanoglu, Secretary General of the Organization of Islamic Countries.
"It needs to be an option there where people can find different ways of doing the same thing," he added. Islamic finance experts say risk-sharing forms the core of Islamic economic system that shares profit and loss with the stakeholders/investors.
Islamic bulletin has highlighted quite an understandable comparison of Shariah-compliant Ijara and conventional lease contract to draw a fine line between the two modes of financing. It says Ijara contract requires first payment only after handing over of asset to lessee whereas conventional lease entails payment on financing. Late payment penalty is donated to charitable organization in the former. In contrast, it is an earning for the latter. Lessor sustains losses to asset if not caused by negligence in Ijara. Conventional lessor transfers it to lessee.
The well-wishers of Islamic economics fear that Islamic finance industry is assimilating with the global economic system by imitating its products. The turning point appeared at the time of global financial crisis and statements in favour of power of Islamic financial system made it one of the leading beneficiaries of diversion of investments from conventional financial institutions. Global assets of Islamic financial institutions are expected to reach $1.6 trillion in 2012 since lenders are looking at the substitutes in view of reduction in lending from European and US banks. "It is time for Islamic finance to pause and think of the direction it is taking," advised Prof. Habib Ahmed, a veteran Islamic finance specialist.