Is­lamic Bank­ing – The Way For­ward

Enterprise - - Editor’s desk -

The Global Is­lamic Fi­nance Re­port 2014 es­ti­mated the size of the global Is­lamic fi­nan­cial ser­vices in­dus­try at $1.813 tril­lion at the end of 2013. This rep­re­sented 12.3% an­nual growth over 2012, an in­crease of $182 bil­lion in ab­so­lute terms. Many Is­lamic fi­nan­cial in­sti­tu­tions ap­pear among top five banks in their re­spec­tive coun­tries. In Pak­istan, the largest Is­lamic bank is Meezan Bank, which is fast as­sum­ing main­stream promi­nence. Growth of Is­lamic bank­ing in the coun­try has been over 30%, which is cer­tainly above the av­er­age global growth rate of Is­lamic bank­ing and fi­nance. If this trend con­tin­ues, Is­lamic bank­ing as­sets could in­crease ex­po­nen­tially from their cur­rent size.

The Is­lamic bank­ing strat­egy of the State Bank of Pak­istan has at­tempted to greatly in­crease the num­ber of Is­lamic bank­ing branches and also to in­crease their mar­ket share. Given the huge po­ten­tial the coun­try has in terms of Is­lamic bank­ing, such in­crease is pos­si­ble. In­deed, it is sur­mised that if Is­lamic bank­ing fails to achieve 20% share in the mar­ket by 2018, by all in­di­ca­tors, it would be con­sid­ered to have failed in reach­ing its true po­ten­tial. Many banks have dis­played re­newed in­ter­est in Is­lamic bank­ing. Thaw in­dus­try should tar­get an in­crease of 2% in mar­ket share ev­ery year through Brown­field growth, i.e. can­ni­bal­i­sa­tion of con­ven­tional bank­ing and through con­ver­sion of con­ven­tional into Is­lamic banks. If Is­lamic banks ex­hibit Green­field growth, more than the growth in con­ven­tional bank­ing, it should be able to dou­ble its mar­ket share. Green­field growth is not only pos­si­ble but is in fact needed in Pak­istan where there is wide­spread fi­nan­cial ex­clu­sion. If Is­lamic bank­ing is used as a tool for pro­mot­ing fi­nan­cial in­clu­sion, there is no rea­son that Is­lamic bank­ing should not be able to achieve the im­por­tant mile­stone of 20% mar­ket share. If that hap­pens, Pak­istan will stand next to a num­ber of Gulf coun­tries and Malaysia where Is­lamic bank­ing rep­re­sents be­tween 20% and 30% of the mar­ket share. Pak­istan, how­ever, will be­come the most im­por­tant player in Is­lamic bank­ing and fi­nance, if it at­tains 20% mar­ket share. This is so be­cause the coun­try is the se­cond largest Is­lamic mar­ket (pop­u­la­tion-wise) af­ter In­done­sia.

The Gov­er­nor of the State Bank of Pak­istan has urged the coun­try’s Is­lamic banks to de­velop ways to re­ward their cus­tomers in line with a surge in the sec­tor’s prof­itabil­ity, or face reg­u­la­tory ac­tion. Is­lamic fi­nance is ex­pe­ri­enc­ing a re­vival in Pak­istan, aided by an am­bi­tious five-year plan that reg­u­la­tors hope will dou­ble the in­dus­try’s share of the bank­ing sec­tor to 20 per cent by 2020. A grow­ing client base and im­prov­ing as­set qual­ity helped Is­lamic banks post prof­its be­fore tax of 12 bil­lion ru­pees in the third quar­ter of last year, al­most dou­ble the year-ear­lier amount ac­cord­ing to cen­tral bank data. But reg­u­la­tors want to tackle con­sumer per­cep­tions that Is­lamic banks fal­ter when it comes to so­cial re­spon­si­bil­ity and eth­i­cal bank­ing prac­tices. The av­er­age fi­nanc­ing-to-de­posit spread – the dif­fer­ence be­tween what banks charge for fi­nanc­ing and what they pay their de­pos­i­tors – for all lenders, Is­lamic and con­ven­tional, re­mains high and should be “rea­son­ably ra­tio­nal­ized,” ac­cord­ing to the State Bank gov­er­nor Ashraf Wathra. He stated this in a re­cent speech made to a gath­er­ing of in­dus­try ex­ec­u­tives. He did not spec­ify a sat­is­fac­tory level, but sin­gled out Is­lamic banks as the ones need­ing to re­ward cus­tomers in line with a rise in prof­its.

“Banks were ad­vised to come up with their own so­lu­tions or the SBP will ap­ply shari­a­com­pli­ant mea­sures to ad­dress the is­sue,” said Wathra. He did not elab­o­rate, but in the past the State Bank has pre­scribed min­i­mum tar­gets for banks to lend to spe­cific sec­tors of the econ­omy such as agri­cul­ture and small busi­ness. Is­lamic banks fol­low religious prin­ci­ples which ban the charg­ing of in­ter­est and gam­bling, and stress the shar­ing of risk and prof­its. The in­dus­try has de­vel­oped a range of sharia-com­pli­ant fi­nan­cial tools, some with greater profit-shar­ing qual­i­ties than oth­ers. Is­lamic banks fall short when it comes to us­ing strongly profit-shar­ing in­stru­ments such as musharaka, whose share of over­all Is­lamic fi­nanc­ing in Pak­istan was only 10.1 per cent as of Septem­ber 2015, com­pared to 4.2 per cent a year ear­lier. Musharaka is a part­ner­ship in which two or more par­ties agree to pro­vide cap­i­tal, shar­ing both prof­its and losses ac­cord­ing to a stip­u­lated ra­tio. By con­trast, murabaha – a cost-plus-profit ar­range­ment where one party agrees to buy mer­chan­dise for an­other –com­mands the lion’s share of fi­nanc­ing by the coun­try’s Is­lamic banks, at 30.3 per cent. Murabaha is of­ten crit­i­cized for lack­ing eco­nomic sub­stance and its re­sem­blance to a con­ven­tional loan.

Hope has also been ex­pressed by the Pak­istan govern­ment that it would work closely with Is­lamic banks to achieve the fun­da­men­tal ob­jec­tive of pro­mot­ing Is­lamic bank­ing, be­sides in­creas­ing co­op­er­a­tion to fa­cil­i­tate trade and in­vest­ment.

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