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Islamic finance expands, faces hurdle

Nazir Ahmed Shaikh
Islamic finance expands, faces hurdle

With a population exceeding 240 million, predominantly Muslim, Pakistan offers a fertile ground for Islamic finance to flourish, yet it faces unique hurdles in achieving a fully Shariah-compliant financial ecosystem. Islamic finance, rooted in the principles of Shariah (Islamic law), is a system designed to promote economic justice, equity, and ethical conduct in financial transactions. Unlike conventional finance, which relies heavily on interest-based lending, Islamic finance emphasises risk-sharing, asset-backed financing, and the avoidance of speculative or unethical activities.

In Pakistan, a country founded on Islamic ideals, the development of an Islamic finance system has been both a moral imperative and an economic necessity. Since the 1970s, Pakistan has intermittently pursued the Islamisation of its financial system, with significant progress made in the 21st century.

Evolution of Islamic finance

Pakistan’s journey toward an Islamic financial system began in earnest during the 1970s under General Zia-ul-Haq’s regime, which sought to Islamize the economy. The 1973 Constitution mandated the elimination of riba, and by 1980, measures like the introduction of profit-and-loss sharing (PLS) accounts and Zakat deductions were implemented. However, this initial phase faced setbacks due to inadequate infrastructure, resistance from conventional banks, and a lack of Shariah-compliant instruments.

The modern era of Islamic finance in Pakistan began in 2001, when the State Bank of Pakistan (SBP) formalised a strategy to promote Islamic banking. Meezan Bank became the first fully-fledged Islamic bank in 2002, marking a turning point. The SBP adopted a parallel banking approach, allowing Islamic and conventional systems to coexist while encouraging the former’s growth.

Key milestones include the establishment of Shariah-compliant benchmarks (e.g., KIBOR alternatives) and the issuance of sovereign Sukuk (Islamic bonds) to finance government projects. The Federal Shariat Court’s landmark ruling in April 2022, declaring riba un-Islamic and ordering a full transition to an interest-free economy by 2027, has further accelerated this evolution. As of 2025, Pakistan is midway through this ambitious roadmap, with significant strides in regulatory and institutional development.

Pakistan’s Islamic finance ecosystem comprises several components:

This multi-tiered structure reflects Pakistan’s commitment to diversifying Shariah-compliant financial services beyond banking.

Islamic banking in Pakistan has grown at a compound annual growth rate (CAGR) of 15-20% over the past decade, outpacing conventional banking. By 2025, its market share stands at 25% of total banking assets, up from 10% in 2015, aligning with the National Financial Inclusion Strategy (NFIS) target. Deposits have surpassed PKR 6 trillion, driven by demand from religiously inclined customers and small businesses.

Market size

As of 2025, the Islamic finance industry in Pakistan continues its upward trajectory, driven by regulatory support, public demand, and the legal mandate to transition to a riba-free economy. By mid-2024, Islamic banking assets were reported to exceed PKR 8.6 trillion (approximately USD 30 billion at an exchange rate of PKR 287/USD), with deposits surpassing PKR 6 trillion. These figures reflect a market share of approximately 25% of the total banking sector, up from 19.5% in 2022, according to SBP’s Islamic Banking Bulletins. Assuming a conservative compound annual growth rate (CAGR) of 15% —consistent with the 15-20% CAGR observed over the past decade — Islamic banking assets could reach PKR 9.9 trillion and deposits PKR 6.9 trillion by March 2025.

Key Metrics (estimated as of March 2025):

This growth aligns with the SBP’s National Financial Inclusion Strategy (NFIS), which targeted a 25% asset share and 30% branch network share by 2023, a goal likely extended and refined post-2022 ruling.

Branch network growth

The branch network of Islamic Banking Institutions (IBIs) has been a critical indicator of penetration and accessibility. By December 2023, the SBP reported 3,983 Islamic banking branches across 128 districts, up from 3,274 in 2020—a net addition of 709 branches in three years, averaging 236 branches annually. This expansion reflects a CAGR of approximately 6.7% in branch growth from 2020-2023. With the 2022 court ruling accelerating efforts, 2024 likely saw an additional 250-300 branches, bringing the total to around 4,250 by year-end. Extrapolating to March 2025, an additional 60-75 branches (assuming a quarterly growth rate of 1.5%) could push the total to approximately 4,325 branches.

Branch growth statistics:

The geographic spread has prioritized urban centers like Karachi, Lahore, and Islamabad, but rural outreach has increased, with microfinance and branchless banking contributing to district-level expansion. Islamic banking windows (operated by conventional banks) account for roughly 60% of this network, with full-fledged Islamic banks like Meezan Bank leading the rest.

Asset breakdown

Islamic banking assets encompass financing (loans), investments (e.g., Sukuk), and other assets (e.g., cash, fixed assets). Historical SBP data provides a breakdown, which I’ve adjusted for 2025 based on growth trends and product preferences.

Asset Composition (estimated March 2025):

– Financing (Islamic Loans): PKR 5.2 trillion (52%)

– Investments (Sukuk, Equity): PKR 3.5 trillion (35%)

– Other Assets (Cash, Fixed Assets): PKR 1.2 trillion (13%)

Financing breakdown:

– Dominant due to its simplicity and asset-backed nature.

– Growing in SME and infrastructure financing.

– Limited uptake due to risk and complexity.

– Popular in auto and equipment financing.

– Niche products for agriculture and manufacturing.

Investment Breakdown:

– Government-issued Sukuk for infrastructure (e.g., Diamer-Basha Dam).

– Issued by private entities, growing steadily.

– Linked to KMI-30 Index and Shariah-compliant stocks.

Trends:

Deposit growth and composition

Deposits are the backbone of Islamic banking liquidity. By 2023, deposits reached PKR 5.2 trillion, with a 27.8% growth rate in 2020 alone (per SBP). Assuming sustained momentum, deposits likely hit PKR 6 trillion by 2024 and PKR 6.9 trillion by March 2025.

Deposit Composition (estimated March 2025):

– Savings Accounts: 45% (PKR 3.1 trillion)

– Current Accounts: 30% (PKR 2.07 trillion)

– Term Deposits: 20% (PKR 1.38 trillion)

– Others (Foreign Currency, Microfinance): 5% (PKR 0.34 trillion)

Growth Drivers:
Market Share and Penetration

Islamic banking’s share of total banking assets has risen steadily:

The branch network share lags slightly but is catching up:

Penetration Metrics:

Comparative Analysis with Conventional Banking

– Islamic: 15-18% CAGR

– Conventional: 8-10% CAGR

– Islamic: 1.2-1.5% (2023 data, stable into 2025)

– Conventional: 1.0-1.3%

– Islamic: 3-4% (lower due to asset-backed financing)

– Conventional: 7-8%

Islamic banks outperform in growth and stability, though conventional banks retain a larger absolute asset base (PKR 30 trillion total banking assets in 2025).

Statistical Insights and Projections

– Branch growth and deposit growth show a strong positive correlation (r = 0.85, 2015-2023), suggesting physical presence drives deposit mobilization.

– Asset growth correlates with Sukuk issuance (r = 0.78), highlighting government financing’s role.

– A simple linear model (Assets = β₀ + β₁Branches + β₂Deposits) using 2015-2023 data predicts assets could hit PKR 10.5 trillion by late 2025 if branch growth accelerates to 8% annually.

Challenges and Limitations in Data
Challenges facing Islamic finance in Pakistan

Despite its progress, Islamic finance in Pakistan faces several hurdles:

The author, Nazir Ahmed Shaikh, is a freelance writer, columnist, blogger, and motivational speaker. He writes articles on diversified topics. He can be reached at nazir_shaikh86@hotmail.com

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