ISLAMIC FINANCE IN PAKISTAN

AROOJ ASGHAR
(feedback@pgeconomist.com)

Apr 9 - 15, 20
12

Islamic finance is developing at a remarkable pace in Pakistan. State bank of Pakistan (SBP) launched its Islamic banking policy in December 2001 and established Islamic banking department in September 2003. With concentrated efforts, Pakistan now has six full-fledged Islamic banks while thirteen existing conventional banks are operating Islamic windows. In addition, 200 branches of various banks now offer Islamic banking. As per an estimate, Islamic financial services industry is growing at an impressive rate of around 30 per cent.

According to SBP, total assets size of Islamic banking is Rs560 billion which is around 7.3 per cent of conventional size as on 30th June, 2011; total number of Islamic banking branches has increased to around 800 which is 8.3 per cent of overall conventional branches. Moreover, around Rs200 billion credit facilities have been disbursed by the Islamic banks through different Islamic mode of financing mostly comprises of Morabaha financing of around 45 per cent followed by Diminishing Mushraka of around 30 per cent.

Islamic finance dates back to 1975 with the establishment of Bank Al-Faisal in Egypt. The number of Islamic financial institutions has risen to over 400 in more than 75 countries since then. Mostly concentrated in the Middle East and Southeast Asia (with Bahrain and Malaysia the biggest hubs), they are also appearing in Europe and the United States. It is estimated that the industry will grow at a rate of 15 to 20 per cent annually of existing assets of US$350 billion.

The importance and potential of Islamic banking prompted the International Monetary Fund (IMF) to facilitate the establishment of the Islamic Financial Services Board (IFSB) in 2002.

Leading international conventional banks like Citibank, Standard Chartered, and Deutsche Bank have also started Islamic banking which is 100 per cent based on Islamic Sharia. Coverage and extent of Islamic banking varies from country to country. For example, only Islamic banking is available in Iran and Sudan whereas conventional and Islamic systems coexist in various other countries including Indonesia, Malaysia, Pakistan, the United Arab Emirates, etc.

Pakistan has a mixed system of Islamic financial services where both Islamic and conventional banks having Islamic windows are operating side by side. As a matter of fact, Islamic bankers are targeting those who are already the target of conventional banking. Therefore, there is a need to target those who are not accessed by the banking industry.

Islamic banking industry in Pakistan should grow annually at the rate of 20 per cent to raise its share from the existing 3.5 per cent to around 15 per cent over the next few years. The target may appear ambitious, but Islamic banking in some of the countries has already achieved these results.

The liquidity position of Islamic banks is also strong as government auctioned two Sukuk in 2011 of Rs89 billion against which Islamic banks offered Rs122.5 billion.

As per last available economic survey of Pakistan, the Islamic banking assets, deposits and financing continued showing strong growth with total assets increasing to Rs477 billion in 2010 from Rs366.3 billion during the same period last year. The year-on year (YOY) growth in the assets was 30 per cent. Assets of Islamic banks rose from Rs44.1 billion in CY 04 to Rs477 billion in CY10.

SBP acknowledges the need of an Islamic Money Market and that is why it is focusing on the development of a comprehensive solution that would provide Islamic inter-bank money market, Islamic Inter-bank Offered Rate (IIBOR) as a benchmark for pricing of various Islamic banking products. In addition, development of Shariah compliant portfolio at SBP offers a placement facility to Islamic banks.

The Islamic banking system of Pakistan is constantly offering opportunities for financial innovation and flexibility in order to structure different types of financial products.

There is also an encouraging shift from a debt based financial system to an equity-based partnership system. There is huge appetite for Islamic financial services but the growth is constrained by the lack of infrastructure support and dearth of professional Islamic bankers.

While the operations of Islamic banks are fast expanding, this segment of the market is still small relative to the appetite for Islamic finance.

Islamic banking system is based on the principle of profit and loss sharing. First of all, profit-sharing channels invest funds into the projects with highest expected profitability as opposed to the interest-based system, where funds go to the most creditworthy borrowers and whose projects may not necessarily be the most profitable ones.

As a matter of fact, Islamic finance is for practicing Muslims rather than so called Muslims like me. As we all know, Shariah mode of finance emphasizes profit and loss sharing and prohibits fixed-returns. In a layman's term, by fulfilling commitments towards banks on profit or loss basis means sharing profit if there is a profit and if there is loss share the loss. This in other words means honesty, integrity, and transparency. Honestly speaking how many of us follow these simple and essential principles of life.

As per a conservative estimate, around 70 per cent Pakistanis prefer Islamic products if all things are equal. It is said that if an Islamic product has the same world standard, same return and the same facility just like a competitive conventional banking product has, people will get Islamic product instead of the conventional product. Sector experts in Pakistan are of the view that Islamic finance can grow phenomenally like telecom and mineral water industries in coming days.

Islamic finance industry needs to spend money to create awareness and introduce their products among masses. The two big segments that need to be tapped for Islamic banking are the masses and the rural clients. The rural population needs credit for seeds, fertilizers, land, tractors, and other farm inputs.

Islamic banks should provide finance for all such requirements. Approximately, 50 per cent rural population, which is engaged in non-form activities, like cottage industry, also needs small advances.

Further, there is also a need of Takaful, an Islamic Insurance. Takaful is relatively new in Pakistan but has a good potential, if it targets farmers by providing insurance cover for the crops, cattle and other requirements. Though Takaful is getting popular, yet there are a number of issues, which need to be addressed.

The bankers need to chart out a strategy on devising attractive and alternative options and products. The products and options should be competitive enough to attract the people who are accustomed with the conventional banking. There is also a need to improve coordination between the State bank and Islamic banks.

In short, ability of the banks to give comfort to the people on the Islamic products is the driving force behind the effective development, growth, and sustainability of Islamic finance industry. In order to promote the Islamic finance, it is important to take the following steps: enhance and revamp the regulatory framework for Islamic finance; develop quality human resource; enhance understanding and capacities of Islamic banking risk management; promote international standards, best practices and good corporate governance in the Islamic banking system; and create awareness that Islamic finance offers an opportunity to diversify financial system, which will release pressure on the conventional banking system and develop and diversify the overall financial system of the country.