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Future looks bright for Islamic banking in Pakistan

Islamic banking, like any other banking system, is an evolving system worldwide. Since the inception of conventional banking system; work on the concept of Shariah compliant Islamic banking system was also started. A number of financial instruments are available in the market now while work is still going on inventing new solutions. We see exceptional progress in Islamic finance industry, exhibiting annual average growth of about 20 percent in recent years. The growth is not only because of rising demand but also because of increased number of banks offering Shariah-complaint products not only in the Muslim countries but even European countries are also working on the Islamic mode of financing. In an estimate; there is currently more than 2 trillion dollar worth of deposits and investments lodged in Islamic banks, mutual funds, insurance schemes (known as Takaful), and Islamic branches of conventional banks. It is expected that the value of Islamic banking assets and assets under management will reach USD 5 trillion by 2030 while Islamic banks growing more rapidly than the average banking sector in most of the countries.

Fundamental principle of Islamic finance is to promote economic activities in a way that would enhance the social welfare. The key feature of Shariah financing is asset-based contracts therefore, it prohibits trading of debt contracts to earn a profit (Riba), profit-taking without an underlying economic activity, and activities that are not considered halal (i.e. Shariah-compliant). The contractual relationship between lenders and borrowers is governed by the shared business risk and returns from investment i.e. profit and loss sharing.

State Bank of Pakistan (SBP) has been encouraging the initiatives of banks for proposing Shariah based financing solutions. SBP is voted as the ‘Best Central Bank in promoting Islamic finance’ for the fourth time by a poll conducted by Islamic Finance News (IFN), REDmoney Group Malaysia. This is the second international award bestowed upon SBP for Islamic banking during FY2021. Earlier, the Global Islamic Finance Awards (GIFA) had also declared SBP as the ‘Best Central Bank’ of the year in September 2020.

There is a view that the Islamic banking is still relatively in its infancy stage as compared to the more established commercial banking sector in Pakistan. A number of conventional banks have now set up their Islamic banking windows in parallel to the commercial banking system after fulfilling regulatory requirements of the State Bank, while some have established a completely new set up for Islamic Banking purposes for example, MCB, Bank Alfalah etc. Islamic banking in Pakistan started in 2001 and by the end of 2020, the infrastructure of the Islamic banking industry remained the same with 22 Islamic banking institutions; 5 full-fledged Islamic banks; and 17 conventional banks having standalone Islamic banking branches. However, the branch network of Islamic banking institutions increased from 2,913 branches to 3,274 branches during FY20. The major share of branches is concentrated in Punjab, followed by Sindh and Khyber-Pakhtunkhwa. The number of Islamic banking windows (dedicated counters at conventional branches) operated by conventional banks having Islamic banking branches stood at 1,394.

Pakistan’s Islamic banking system is evolving and has generated new dimension and prospects in the banking sector. Pakistan being a Muslim majority country and has a huge potential to attract new customers. However, it is not fully tapped because of less knowledge and awareness about the governing issues of Islamic products and services and their possible solutions. Globally, Murabaha and Mudarabah products are among the fastest growing Islamic finance instruments, but in Pakistan, recently there was a big fraud on the name of Mudarabah, which has shaken the confidence of the people on this particular instrument.

As per a study, religion is the main factor for growth of Islamic banking in Pakistan as Islamic banking is based on the Islamic laws and principles,however, most of the Islamic banking customers in Pakistan have adopted both the banking systems, whereas about 66 percent of the customers have accounts in conventional banking system only. This shows that Islamic banks are lacking many of the feature and the requirements that customer wants. Customers of Islamic banks want their money security (like other banking system) along with growth without Riba. Due to stiff competition among products of Islamic banking, the Islamic banking therefore needs to consider several procedures and methods such as bank’s image and performance, speed of transaction, channel of delivery system, banking convenience and product diversity to attract all sorts of customers.

One of the biggest challenges, Pakistan’s Islamic banks are facing is the liquidity problem,which is greatly impacting the performance of Islamic banks in two ways; some banks enjoy surplus in liquidity while others are marred by the liquidity crunch and, in either of the situation, banks’ profitability suffers negatively. There is no fixed and permanent solution to the problem and great deal of effort needs to be put in for the development of products for liquidity management in Islamic banks. However, to handle the problem, at the moment, Islamic banks generate interbank arrangement through opening of their accounts with each other under Mudarabah arrangements. As far as SBP’s support to Islamic banks is concerned, though SBP is positive in supporting Islamic banks but its support level cannot be equated to that with the conventional banks till the availability of Shariah-compliant money-market products.

However, with a security backed instrument, Islamic bank can be equipped with Islamic money market instruments by the issuance of tradable Sukuk bonds. Fundamental requirement of a Shariah-compliant products is to get an approval by the Shariah board of any Islamic bank and a certificate of its compliance with the Islamic rules and principles. Since the board members belong to different school of thoughts, therefore, the process of product innovation becomes sometimes slow due to difference of opinion.

Moreover, there is a high cost of innovation while most of the banks are not doing enough research work thus hindering the growth of offering new products. While, a large segment of the account holders are not fully aware of the concept and products of Islamic banks. Product based material (easy to understand) needs to be distributed among the account holders so as to promote the concept of Islamic banking in Pakistan. Despite a number of challenges, the future looks bright for Islamic finance in Pakistan. Financial institutions in countries such as Bahrain, the UAE, and Malaysia have been gearing up for more Shariah compliant financial instruments and structured finance. At the same time, the leading financial centers, e.g. Hong Kong, London, New York and Singapore, are also making significant progress in establishing the legal and prudential foundations to accommodate Islamic finance side-by-side with the conventional financial system. Pakistan Islamic banking system should work with the established markets on offering new products in Pakistani market. That would be more efficient, and cost effective.

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