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  • Key factors shaping the future of Islamic Banking in Pakistan

Islamic banking has emerged as a significant player in the global financial landscape, offering unique financial products and services that adhere to Shariah principles. Through an examination of current trends, challenges and opportunities, this paper aims to elucidate the potential trajectory of Islamic banking in the years to come, while also highlighting the unique characteristics and developments within Pakistan’s banking sector. Islamic banking has witnessed remarkable growth and expansion in recent decades, propelled by increasing demand for ethical and Sharia-compliant financial services. With a global Muslim population exceeding 20 billion i.e. 25% of the world population, Islamic banking has emerged as a dynamic and rapidly evolving sector within the broader financial industry.

The global Islamic banking industry has experienced steady growth, driven by factors such as increasing awareness of Islamic finance principles, favourable regulatory environments, and growing demand from Muslim consumers. Islamic banking assets have expanded significantly over the past decade, with major Islamic financial hubs emerging in countries such as Malaysia, Saudi Arabia, and the United Arab Emirates. Moreover, the integration of Islamic finance into mainstream financial markets, through initiatives such as Sukuk issuance and Shariah-compliant investment funds, has further bolstered the industry’s prominence on the global stage.

Despite its rapid growth, Islamic banking faces several challenges, including regulatory complexities, lack of standardisation, and limited product innovation. Furthermore, the global economic landscape, marked by geopolitical tensions and market volatility, presents additional challenges for Islamic banks. However, these challenges also present opportunities for innovation and adaptation, particularly in areas such as fintech integration, sustainable finance, and cross-border collaboration. By leveraging technological advancements and embracing a customer-centric approach, Islamic banks can position themselves for sustained growth and resilience in an increasingly competitive environment.

In Pakistan, Islamic banking has witnessed remarkable growth and acceptance in recent years. Pakistan, reflecting the country’s commitment to fostering an Islamic financial system aligned with Shariah principles, with Islamic banks and Islamic windows of conventional banks collectively commanding a substantial market share. The State Bank of Pakistan (SBP), the country’s central bank, has played a pivotal role in promoting Islamic finance through regulatory reforms and initiatives aimed at fostering the development of the industry. It serves as the regulatory authority and primary driver of Islamic finance initiatives. Despite notable achievements, challenges such as low financial literacy, limited product diversification, and regulatory compliance remain areas of concern for Pakistan’s Islamic banking sector.

Islamic banking has witnessed remarkable growth and acceptance in Pakistan, reflecting the country’s commitment to fostering an Islamic financial system aligned with Shariah principles. Central to the development of Islamic banking in Pakistan is the State Bank of Pakistan (SBP), the country’s central bank. Since the establishment of Islamic banking in Pakistan in the late 1970s, the SBP has implemented various regulatory frameworks, policy measures, and strategic interventions to promote the growth and stability of the Islamic banking sector.

The SBP has played a crucial role in establishing and refining the regulatory framework governing Islamic banking operations in Pakistan. Key regulatory measures include the issuance of Shariah-compliant banking licenses, prudential regulations for Islamic banks, and guidelines for Shariah compliance and governance. The SBP’s regulatory oversight ensures that Islamic banks adhere to Shariah principles while maintaining financial stability, consumer protection, and market integrity.

The honourable Federal Shariat Court (FSC) in its judgement on Riba dated April 28, 2022 has declared that Riba is prohibited in all its forms and manifestations, and directed to convert Pakistan into an interest-free economy by end of CY27. The verdict has directed to delete the word “interest” from all relevant clauses under different laws and to amend all laws with respect to the judgment. Eliminating Riba is a comprehensive task that requires concerted efforts from various stakeholders and involves a number of challenges and milestones.

Implementation of monetary policy and public policy objective of price stability is a key public policy consideration of every state to ensure sustainable economic growth. For this purpose, SBP has been specifically entrusted with the statutory objective of maintaining price stability. To this end, SBP uses policy rates and several other monetary policy management tools, like other central banks. For fuller conversion of the economic and financial system to Shariah-compliant mode, there will be a need to develop and implement Shariah-compliant tools for the operation of monetary policy. Like other central banks, SBP uses short-term policy rate to affect aggregate demand in the economy to achieve the goal of price stability; the rate is managed through various monetary policy management tools e.g., OMOs and the interest rate corridor. While the SBP has already instituted Shariah-compliant OMOs injection and Shariah-compliant standing facility, there is a need to build a Shariah-consistent mechanism to mop up surplus liquidity as well as a suitable alternate to policy rate for anchoring the price expectations. However, the development and implementation of a suitable mechanism will, inter alia, require adequate capacity on the part of market participants as well as a sufficiently large size of the Islamic banking sector and Shariah-compliant securities and assets.

The financial deepening and outreach of the financial sector is limited in Pakistan. However, the strong growth in Islamic banking since the early 2000s indicates that it can play a significant role in improving financial depth and inclusion in the country. According to a recent study conducted by SBP in collaboration with the Department for International Development (DFID), religious beliefs contribute 23% to the demand for Islamic banking and the overall demand for Islamic banking is higher amongst households (retail) than businesses. Though Islamic banking has recorded a consistent increase, its assets to GDP ratio stood at around 8%, which is quite low when compared to some other jurisdictions. In the context of this low level of deepening, the exceptional growth posted by the Islamic banking industry over the last two decades indicates that there is huge potential for growth. Further, there is also great potential for financing in agriculture, SMEs, housing, and microfinance sectors. These sectors hold promising prospects to generate lucrative returns, productivity and employment, provided the necessary financing is available. These sectors largely remained under-served due to multiple reasons, including the religious considerations of proprietors and entrepreneurs.

With adequate business strategies and focus, Islamic banks can explore the potential of underserved segments and create value for both their investors as well as society by meeting the banking needs of these high-potential segments. Thus, the uphill task of converting to Islamic banking brings with it not only challenges but also enormous opportunities. Capable managerial skills and trained human resources will be a key element in exploring the fuller potential of Islamic banking. Besides, innovation and efficient use of technology can play a crucial role in reaching out to the whole spectrum of the population and addressing their financial services needs through convenient and cost-effective products. Besides furthering financial inclusion, balanced economic growth, and growth potential for market players, Islamic banking can also contribute to the key policy objectives of price and financial stability. The very nature of Islamic banking business – that it is based on partnership in ethical business activities and real assets – makes it less prone to financial fragilities and price bubbles.

The current landscape of Islamic banking seems to be in a mature stage from the perspective of knowledge and skills in Islamic banking, footprint and regulatory and supervisory guidelines and frameworks. The already enabling environment presents vast opportunities for conventional banks to explore the huge potential of Islamic banking. As far as the strategy to implement FSC’s Judgment is concerned; over the last two decades, SBP has provided an enabling legal and regulatory framework along with necessary market infrastructure that has facilitated increasing the share of Islamic banking to around one-fifth of the banking sector. While these arrangements and experience gained in enhancing the Islamic banking footprint will continue to facilitate growth in Islamic banking, a time-bound full-scale conversion requires coordinated and sustained efforts from multiple stakeholders. In this context, SBP has initiated a consultation process with the relevant stakeholders with a view to ensure fast-track adoption of Islamic banking in line with the judgment of the FSC. The government has demonstrated a firm commitment towards the promotion of Islamic banking and finance in the country and has constituted a high-level steering committee for providing strategic guidance in the implementation of FSC’s judgment on Riba under the patronage of the Minister for Finance and Revenue. The committee is being chaired by Governor-SBP and comprises key stakeholders such as the Ministry of Finance, SBP, SECP, Institute of Chartered Accountants of Pakistan (ICAP), Shariah scholars, bankers, legal experts and representatives of the business community.

In order to steer the process of conversion of conventional banking into Islamic banking, SBP has constituted a high-level committee for the transformation of conventional banking into Islamic. The committee comprises senior officials of SBP and Presidents/CEOs of some commercial banks. Additionally, SBP has formed different working groups, in diverse areas like legal reforms; regulatory & supervisory reforms; awareness creation & capacity building; review of conversion plans of banks; fast-track adoption of international standards; and coordination with government and other stakeholders.

The working groups would provide policy and operational recommendations in their respective areas to ensure the transformation of the conventional banking system into Shariah-compliant banking. These working groups have representation from all relevant stakeholders like SBP, the banking industry, Shariah scholars, etc.

Under the guidance of the Steering Committee and in consultation with the relevant stakeholders, SBP is working on the development of a transformation plan for the conversion of the conventional banking system into an Islamic one. In addition, a working group comprising officials from the Ministry of Finance, SBP, SECP, representatives from the Islamic banking industry, and centers of excellence in Islamic finance education is working to explore and recommend the possibility of using a variety of underlying assets for issuance of assets-light Sukuk structures of different tenors by the government, so as to convert public debt to Shariah-compliant mode and ensure regular availability of Sukuk in the market.

Keeping in view the extensiveness of the transformation task, SBP has also modified its institutional arrangement for better prioritisation of objectives and enhanced focus. For this purpose, a dedicated Islamic Finance Group has been established in SBP which comprises two departments i.e. Islamic Finance Policy Department and the Islamic Finance Development Department.

Islamic Finance Policy Department will especially work on policy formulation for the transformation of conventional banking into Islamic banking and ensure its timely implementation while the Islamic Finance Development Department will focus on the promotion of Islamic finance through awareness and capacity-building initiatives, market research, and international collaboration. With the further strengthening of SBP’s institutional capacity and concerted efforts of various stakeholders, the drive for conversion to a Riba-free financial system and economy is expected to gain traction going forward and hopefully meet the timeline as advised by the FSC.

In addition to regulatory oversight, the SBP has implemented various policy initiatives to promote the expansion and diversification of Islamic banking services in Pakistan. These initiatives encompass areas such as product development, financial inclusion, and capacity building. The SBP has encouraged innovation in Islamic banking products and services, fostering greater consumer choice and competitiveness within the industry. Moreover, the SBP has spearheaded initiatives to enhance financial literacy and promote awareness of Islamic finance principles among the public, contributing to the broader adoption of Islamic banking in Pakistan.

The SBP has undertaken strategic interventions to address emerging challenges and capitalise on growth opportunities within the Islamic banking sector. These interventions include measures to enhance regulatory compliance, strengthen risk management practices, and foster collaboration between Islamic banks and other stakeholders. The SBP’s strategic interventions have played a crucial role in ensuring the resilience and sustainability of Islamic banking operations in Pakistan, particularly in the face of evolving market dynamics and regulatory requirements.

The SBP’s efforts to promote Islamic banking in Pakistan have yielded significant results, with Islamic banks capturing a substantial market share and expanding their presence across the country. The SBP’s regulatory framework and policy initiatives have contributed to the growth and stability of the Islamic banking sector, fostering investor confidence and financial inclusion. Looking ahead, the SBP remains committed to further advancing Islamic finance principles and promoting the development of a robust and dynamic Islamic banking industry in Pakistan.

Islamic banking is poised to play an increasingly prominent role in the global financial landscape, offering ethical and Shariha-compliant alternatives to conventional banking. With its strong foundation and growing momentum, Islamic banking is well-positioned to navigate challenges and capitalise on emerging opportunities in the years to come. In Pakistan, the continued growth of Islamic banking presents significant potential for financial inclusion, economic development, and the advancement of Shariah-compliant finance principles. By embracing innovation, fostering collaboration, and promoting financial literacy, Islamic banks can pave the way for a prosperous and sustainable future in the evolving world of finance.

Looking ahead, the future of Islamic banking both globally and in Pakistan hinges on several key factors, including regulatory reforms, technological innovation, and market dynamics. To capitalise on growth opportunities and address existing challenges, stakeholders in the Islamic banking industry must prioritise collaboration, innovation, and sustainable practices. Moreover, enhancing financial literacy and promoting awareness of Islamic finance principles among consumers will be crucial for driving adoption and expanding the reach of Islamic banking services.

The author, Nazir Ahmed Shaikh, is a freelance writer, columnist, blogger and motivational speaker. He writes articles on diversified topics. He can be contacted at