ISLAMIC BANKS FACING OPERATIONAL AND INSTITUTIONAL PROBLEMS
Nov 19 - 25, 2012
Islamic Banking has been growing at a swift speed in Pakistan as well as all over the world. Pakistan and many Muslim countries are experiencing dual banking system. The Islamic Banking industry has generated considerable interest in the financial world in recent years. It is considered as Faith-based banking with considerable growth potential.
The interest-free Islamic banking has recorded a vigorous growth in the last few years and would further expand vastly with the help of effective legislation and introduction of more products.
Total assets of Islamic banking in Pakistan have grown by 34 percent to Rs641 billion at the end of last calendar year. In the same degree deposits base has also increased by 34 percent to Rs521 billion during 2011.
Market share of Islamic banking has grown exceptionally in the overall banking industry. Total assets of Islamic banking are 7.8 percent of the total banking industry while deposits have 8.4 percent share in the total banking sector in the country.
In 2002, Meezan bank limited started operations as the first local Islamic bank in Pakistan. In a decade this Islamic Bank has shown a phenomenal growth.
Islamic banking industry has witnessed an attractive growth during the global financial crisis. In Pakistan, many full-fledge Islamic Banks are operating with over 600 branch across the country. Many conventional banks have also opened their Islamic windows to cater the needs of Muslims.
It is also relevant to mention that Islamic Banking industry has been facing many bottlenecks both operational and institutional.
Some of the hitches being faced by Islamic banking in Pakistan are examined below:
Islamic Banks have not yet been successful in creating an interest-free structure to place their funds on a short-term basis. They face the same problem in financing consumer loans and government deficits.
The risk involved in profit-sharing is so high that most of the Islamic banks have taken recourse to those instruments of financing which bring them a fixed sure return.
The problem with the Islamic banking is the lack of expert Islamic bankers who have clear or deep perception knowledge of Islamic banking and finance. Currently, our Universities have degree, certificate and diploma programs on Islamic Banking and Finance. But unfortunately these programs are not up to the mark and do not provide practical knowledge and expertise in the field of Islamic Finance. It is advisable that both Shariah Scholars and industry experts provide training in schools, colleges, Universities and Madrasahas.
Islamic banks need to improve their management capabilities by training their personnel in project appraisal, monitoring, evaluation and performance auditing.
The biggest problem for Islamic Banking is the lack of short term Investment Avenue. Islamic Banks cannot invest in interest based instruments such as T-Bills and Pakistan investment bonds.
To overcome the problem the Government of Pakistan issues Ijarah Sukuk to provides some relief as an alternative to Pakistan Investment Bonds. The demand for short term investment is stronger than of supply of limited Ijarah Sukuk.
Many Muslim countries are offering relaxed rules and regulations for Islamic Banking industry. Pakistan should also offer such rules and regulations for Islamic banking industry which would help this industry to grow swiftly.
Government patronage and regulatory/tax reforms play a vital role for any industry to grow an accelerating speed. Governments like United Kingdom and Malaysia are offering relaxed rules and taxation for exploiting the great demand for Shariah-compliant investment by Muslim investors, especially from the Middle East.
Pakistan can also become a regional hub for Islamic finance if proper regulatory reforms are introduced. To achieve this goal, the Government needs to revamp the existing structure of taxes and duties to make them conducive to Islamic finance.
To encourage people to invest in Shariah compliant products, government should introduce incentives in the form of tax credits.
For example, the Malaysian government has given certain incentives for investors in Islamic Finance industry till the year 2016 to make Malaysia a regional hub for investment.
Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has introduced various Sharia'h standards to bring some consistency into the Sharia'h based legal framework of the Islamic finance and banking industry. But these standards needed to bring these agreements in assent with the local taxation and law makers.
It is not possible to achieve the up to the mark level of allocative efficiency when executives change over from Islamic banks to conventional banks to escape high cost borrowing.
Profitability of projects the best device of efficient resource allocation, at this situation, does not apply to Islamic banking system as it, considering the rational behavior of the borrower, takes recourse to modes other than profit-loss-sharing. This situation continues as long as Islamic banks operate side by side with the conventional banks.
It has been evidenced that distributive efficiency of Islamic banking is lost when an Islamic bank starts operation under conventional banking framework. Any shift from profit-loss-sharing modes leads the system break the direct relationship between the incomes of the entrepreneurs, the bank and the depositors.
In the absence of Islamic money market in Pakistan, the Islamic banks cannot invest their surplus fund i.e., temporary excess liquidity to earn any income rather than keeping it idle.
All the Government Treasury Bills, approved securities and Pakistan Bank Bills in Pakistan are interest bearing. So, the Islamic banks cannot invest the permissible part of their Security Liquidity Reserve and liquid surplus in those securities, consequently they deposit their whole reserve in cash with state Bank. Alike the liquid surplus also remains not invested.
Substantial problem facing Islamic banks in Pakistan is how to organize their relationships with foreign banks, and more generally, how to conduct international operations. This is, of course, an issue closely related to the creation of financial instruments, which would be accordingly consistent with Islamic principles and acceptable to interest-based banks, including foreign banks.
Islamic Banks go very closely to the pricing policies of the government. They cannot benefit from hidden costs and inputs, which heighten the level of prices by certain entrepreneurs without any justification.
It is keenly observed when Islamic banks start operation within the conventional banking structure their efficiency goes on diminishing.
The setback is not because of Islamic bank's own fault but it is the capability - undermine operation of the conventional banking system that puts a disadvantageous impact on the efficient operation of Islamic banks.
Even under the conventional banking framework Islamic banks can operate with certain level of efficiency by applying in a reasonable percentage the PLS modes - the distinguishing features of Islamic banking.
Islamic principles specify certain conditions that need to be bound to while developing Islamic banking products. Having left with no choice due to the absence of attractive investment avenues, Islamic banking products mainly rely on asset based financing to generate returns for their depositors.
Due to lack of documentation in the economy, Islamic banks are finding it difficult to enter into profit and loss sharing based real business ventures with their customers instead of fixed return products. Moreover, businessmen and industrialists are also reluctant to share profits with the financiers in low risk ventures.
Some Pakistani customers are doubtful about the genuineness of Islamic banking practices. Most customers have opinions that are based on information that is not correct and represent lack of understanding of Fiqh issues.
To succeed as a viable banking option, Islamic banks need whole hearted supporters but also a number of patronizing institutions to perform functions which are being carried out by various financial institutions in the conventional model.
Attempts should be made to change the existing structure to provide better products and quality service within the ambit of Islamic laws.
Banking and insurance have to go hand in hand in matters of trade and business in order to protect investments of banks against unanticipated hazards and disasters. Unfortunately, Islamic banks have to depend on interest-based insurance companies in the absence of Islamic insurance companies.
Islamic banks can satisfy most of the conditions if they can operate as only one system in an economy examined above.