The Islamic banking and finance system offers more ethical and efficient alternative to the interest-based conventional financial system. Islamic banking and finance institutions emerged in the Middle Eastern financial markets in early 1970s, based on models developed by Islamic economists over the past decades. Many Muslim countries, including Pakistan, adopted these models and launched Islamic banking institutions. Some Western banks also launched Islamic banking and finance products to serve their Muslim customers.
Islamic banking is defined as banking system which is in consonance with the spirit, ethos and value system of Islam and governed by the principles laid down by Shariah. Interest free banking is a narrow concept denoting a number of banking instruments or operations, which avoid interest. Islamic banking, the more general term, is based not only to avoid interest-based transactions prohibited in Shariah but also to avoid unethical and un-social practices. In practical sense, Islamic Banking is the transformation of conventional money lending into transactions based on tangible assets and real services. The model of Islamic banking system leads towards the achievement of a system which helps achieve economic prosperity. Islamic banks focus on generating returns through investment tools which are Shariah compliant as well. Islamic Shariah links the gain on capital with its performance. Operating within the ambit of Shariah, the operations of Islamic banking are based on sharing the risk which may arise through trading and investment activities using contracts of various Islamic modes of finance.
Over the recent years, however, it has registered unprecedented growth due to core factors that include consistent high oil prices worldwide, booming economies of the Middle East, increasing diversification of Islamic banking products, clients and markets, and other changes in the world of politics.
The success of Islamic banking and finance in the Middle East and Asian regions bears profound impacts on global financial markets. The increasing numbers of Western financial institutions are using Islamic banking and finance as an opportunity to add innovation and diversity to their operations and attract oil-wealth and local Muslim clientele to their doors. Islamic financial institutions are becoming partners with Western market players to promote Islamic banking and finance products and services in European and Western markets. The Western market environments have turned up more conducive for Islamic banking and finance practice. These developments are very encouraging and have given the Islamic banking and finance industry a window of opportunity to become truly competitive and integrated part of international financial markets.
World over support
The global Islamic banking market covers different aspects, like Islamic Banking, Takaful (the Islamic Insurance), Sukuk (the Islamic Bonds) and Shariah Capital Market (Islamic funds).
Islamic banking is the largest sector in the Islamic finance industry, contributing to 71%, or USD 1.72 trillion, of the industry’s assets. The sector is supported by an array of commercial, wholesale, and other types of banks. Yet commercial banking remains the main contributor to the sector’s growth. There were 505 Islamic banks in 2017, including 207 Islamic Banking windows. However, the number of players is not necessarily indicative of the size of the industry, in terms of assets. Islamic finance’s second-largest market, Saudi Arabia, has 16 Islamic banks, including windows, which is less than the smaller markets of Malaysia and the United Arab Emirates.
According to Price Waterhouse & Coopers 2018 Digital Banking Consumer Survey the growing number of digital-only, or ‘disruptor banks’ with no physical branches, have emerged. Islamic banks are also catching up on this trend, with the launch of digital-only subsidiaries, such as Gulf International Bank’s Meem in Bahrain and Saudi Arabia, and Albaraka Türk‘s Insha in Germany and other European countries with large Muslim communities.
Islamic banking is commonly seen to have two advantages over conventional banking. The first is a perception that Islamic banks are bound to a higher moral standard. They will not take on irresponsible amounts of risk or pay outsize bonuses to their top bankers. The second is that earnings come from identifiable assets, not opaque combinations of derivatives and securities. Because Islamic banks cannot make money through interest, they rely on ties to tangible assets, such as real estate and equity, charging ‘rent’ instead of interest.
The strong investments in the Halal Sectors, infrastructure, and Sukuk bonds, especially through electronic modes in all products and services are becoming a catalyst factor in the growth of global Islamic Finance.
In all the three main sectors i.e. Banking, Capital Markets and Takaful , the total estimated industry’s worth was more than USD 2 trillion in 2017 which having a steady growth at the rate of around 8% and reversing the preceding two years of assets’ growth stagnation (2017: USD 1.89 trillion vs. 2016: USD 1.88 trillion).
The entries by Saudi Arabia and Nigeria into Sukuk market as well as the pan-African multilateral development finance institution has created gushed of record 25.6% to close at USD 399.9 billion as at end 2017 [2016: USD 318.5 billion].
The global Islamic finance market is fragmented with a large number of players trying to grab a significant chunk of the developing market. In some regions, like Asia and Africa, it is moderately growing with the presence of a large number of local players and some major players. However, GCC is a highly competitive market, with the presence of large number of international players. Bank Al-Rajhi, Dubai Islamic Bank, and Kuwait House Finance, are among the major players present in the region. Shariah-compliant assets represent a significant portion of total banking assets of the GCC. While in the Middle East & North African (MENA) region, Islamic Banking assets represent 14% of total banking assets. In the GCC, the market share of Islamic banking crossed the 25% threshold, which suggests that Islamic banks have become systemically important in these countries.
Growth in the GCC region
GCC Islamic banking assets reached USD 490 billion by the end of June 2013, with Saudi Arabia dominating the region with a 49% share, followed by the United Arab Emirates (19%), Kuwait (16%), Qatar (11%), and Bahrain (5%). This segment is still nascent in Oman (Islamic Financial Services Board (IFSB), (2015)). Islamic banking has acquired systemic proportions in Kuwait, Saudi Arabia, and the United Arab Emirates, in line with IFSB’s definition of systemic, at least 15% of banking system assets. Retail Islamic banking in Bahrain has reached systemic proportions with a 27% asset share in retail banking, and a 13% asset share in total retail and wholesale banking. Oman’s entry in Islamic Banking was in late 2012.
Shariah-compliant assets represent a significant portion of total banking assets of the GCC. While in the Middle East & North African (MENA) region, Islamic Banking assets represent 14% of total banking assets. In the GCC, the market share of Islamic banking crossed the 25% threshold, which suggests that Islamic banks have become systemically important in these countries. The global Islamic finance market is fragmented with a large number of players trying to grab a significant chunk of the developing market. In some regions, like Asia and Africa, it is moderately growing with the presence of a large number of local players and some major players. However, GCC is a highly competitive market, with the presence of large number of international players. Bank Al-Rajhi, Dubai Islamic Bank, and Kuwait House Finance, are among the major players present in the region.
Growth and future in Pakistan
In Pakistan, the Islamic Banking was commenced in early 80’s. The pace of development was very slow in next 22 years. In 2002,the Islamic banking activities was revived under the duel banking system.
Islamic banking industry continued its double digit growth during 2015 as depicted by year-on-year (YoY) growth of the industry’s assets by 27.9 percent and deposits by 28.5 percent respectively; Asset base of Islamic banking industry stood at Rs 1.6 trillion while the deposits base reached to Rs 1.3 trillion. In terms of share Islamic banking constitutes 11.4 percent in assets and 13.4 percent in deposits of overall banking industry.
The YoY growth of assets and deposits of Islamic banking industry is higher than the YoY growth of overall banking industry which was 16.8 percent for assets and 12.6 percent for deposits during 2015.
Currently, in Pakistan, Assets of Islamic banking industry increased by around Rs. 3 billion during the quarter July to September, 2019 and stood at Rs. 2,995 billion by September 30, 2019. Deposits of Islamic banking industry were recorded at Rs. 2,407 billion by end September, 2019.
Market share of Islamic banking assets and deposits in the overall banking industry was recorded at 13.8 percent and 16.1 percent, respectively by end September, 2019. Profit before tax of Islamic banking industry was recorded at Rs. 46 billion by end September, 2019. The network of Islamic banking industry consisted of 22 Islamic banking institutions; 5 full-fledged Islamic banks (IBs) and 17 conventional banks having standalone Islamic banking branches (IBBs) with 2,979 branches spread across 115 districts by end September, 2019. The number of Islamic banking windows operated by conventional banks having IBBs stood at 1,353.
Assets of Islamic banking industry increased by Rs. 3 billion during the quarter July to September, 2019 and were recorded at Rs. 2,995 billion, compared to Rs. 2,992 billion in the previous quarter. Market share of Islamic banking industry’s assets in overall banking industry’s assets was recorded at 13.8 percent by end September, 2019. The share of financing and investments (net) in total assets of Islamic banking industry stood at 51.6 percent and 19.9 percent, respectively by end September, 2019
Deposits of Islamic banking industry were recorded at Rs. 2,407 billion by end September, 2019. Market share of Islamic banking industry’s deposits in overall banking industry’s deposits increased to 16.1 percent by end September, 2019 compared to 15.9 percent in the previous quarter.
The category wise breakup of deposits reveals that fixed deposits increased by 11.3 percent (Rs. 55 billion) while current (non-remunerative), saving and current (remunerative) deposits declined by 5.7 percent, 2.9 percent and 22.2 percent, respectively by end September, 2019.
Breakup of deposits among IBs and IBBs reveals that deposits of full-fledged Islamic banks declined by Rs. 4 billion during the period under review and were recorded at Rs. 1,451 billion by end September, 2019. Similarly, deposits of IBBs declined by Rs. 3 billion and were recorded at Rs. 956 billion by end September, 2019. The share of IBs and IBBs in overall deposits of Islamic banking industry stood at 60.3 percent and 39.7 percent, respectively during the period under review.
Liquid assets to total assets and liquid assets to total deposits of Islamic banking industry decreased as compared to previous quarter and stood at 19.5 percent and 24.3 percent, respectively by end September, 2019. Financing to deposits ratio (net) of Islamic banking industry was recorded at 64.2 percent by the end of September, 2019 compared to 53.6 percent of overall banking industry. The ratios of Capital to total assets and capital minus net non-performing assets to total assets of Islamic banking industry were recorded at 6.6 percent and 6.1 percent, respectively by end September, 2019. Both the ratios remained lower than those of overall banking industry averages.
Profit before tax of Islamic banking industry was recorded at Rs. 46 billion by end September, 2019. Profitability ratios like return on assets (ROA) and return on equity (ROE) before tax were recorded at 2.1 percent and 33.2 percent, respectively by end September, 2019. During the period under review, operating expense to gross income ratio was recorded at 52.5 percent, compared to 52.6 percent in the previous quarter It is also important noting that this ratio was lower than that of overall banking industry ratio.
In Pakistan, Islamic banking industry has now grown to more than 16% of the overall banking sector, and it is expected to grow to 20%-25% by the year 2023. It is expected that by the correct enforcement of initiatives taken by the Government will not only enable the Islamic banking industry to grow at a faster pace but will also strengthen the foundations of a true Riba-free, Islamic economic system.
[box type=”note” align=”” class=”” width=””]The author, Mr. Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes articles on diversified topics. Currently he is associated with SZABIST as Registrar and could be reached at [email protected][/box]