Jan 23 - 29, 20

Islamic banks 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.

SBP encourages sharia compliant banking practices through establishment of Islamic banks of conventional banks offering Islamic banking windows.

The Islamic Banking Department 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 grow at a rate between 15 to 17 percent through CY12 reaching a branch network of 800 branches nationwide by June 2011. 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 estimated to grow up to 10 per cent in CY12.

Conventional banks in order to support an alternate mode of banking, is pushing for opening of Islamic bank branches. About 63 percent of the branch expansion during FY12 has come from Islamic branches of conventional banks with 89 per cent of all branches in Punjab and Sindh.

Those who bank with Islamic Banks do so to avoid Riba taking advantage of banking permissible in Islam. Islamic Banking Resilience primarily depends on the mindset of consumers believing in an alternate mode of banking to avoid Riba.

With increased knowledge of Islam and teaching of Islamic Banking and Finance, there has been increased inclination to move from conventional to Islamic Banks adding to the banking growth.

The phenomenon of structural shift in asset mix of Islamic banking industry from financing to investment continued through CY11.

During this period, the share of financing in total assets dropped to almost 33 percent from 36 percent while share of investment increased to 42 percent from 39 percent. This shift is not due to decline in financing but because of unprecedented growth in investment, which is attributable to issuance of GOP Ijarah Sukuk of about Rs190 billion during Oct 10 to June 11.

Islamic banks offer specialized products which include Murahaba, Ijara, Musharka, Mudharba, Diminishing Musharka, Salam, Istisna and Qarz-e-Hasna being major asset based products.

Total lending against these products increased from Rs164 billion in FY10 to 199 billion in FY11 of which Murabaha having a share of 72.4 per cent whereas Diminishing Musharka with a share of 31.8 per cent as of June 2011.

With respect to corporate lending, textile sector lending was recorded at 17.7 per cent in FY11 followed by Agri business at 6.10 per cent and high net worth individuals at 11.30 per cent.

Comparing infected ratio, Islamic Banks have performed better than conventional banks. Based on asset quality, nonperforming loans to total financing increased from 6.5 per cent in FY10 to 7.5 per cent in FY11 compared to industry average of conventional banks at 15 per cent as of June 2011. Deposit base grew from Rs329 billion in FY10 to Rs452 billion in FY11 with YoY growth of 37.1 per cent.

Islamic banks due to their lending practice are considered safe since they do not participate in investment avenues, which have uncertainties in returns e.g. derivatives and were not effected with the global financial crisis.

According to a latest report by CNBC International on the world's safe banks for 2011, eleven of the top 20 classified were Islamic banks. The assessment was done based on asset quality and capital base to withstand shocks.

Depositors unlike conventional banks are considered as partners sharing profit and losses. Islamic banks enjoy a built-in stabilizer to help them cope with economic downturns for payment of profit. If profitability of an Islamic Bank declines in an economic downturn, depositors receive lower returns, but if profits increase they enjoy higher returns. This profit sharing reduces risk for the banks, which means they are less likely to become insolvent. However, as the banks build up a profit equalization reserve, which can be used to finance payouts during difficult years, depositors benefit from some protection of their returns during economic downturns. Investors seeking sharia compliance have portfolios which are more heavily weighted in sectors which are less likely to be affected with economic downturn and have long term sustainable growth.

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.

Stability for Islamic Banks is through profit and loss sharing where unlike conventional banks 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.

One of the unique and salient characteristics of Islamic banks is the integration of ethical and moral values with its banking operation. Financing of Islamic banks are restricted to useful goods and services and development projects.

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 bring prices at par with conventional banks.

A competitive advantage for Islamic banks is providing banking services similar to that of commercial banks, which are sharia compliant and under the premise of Islam which will encourage consistent business growth and increase in deposits.

Government needs to make an effect to promote the bond and money market for Islamic banks through floating of Sukuks where banks can earn through investment of residual funds.