Islamic Banking – The Way Forward
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.