Is­lamic bank

The Pak Banker - - FRONT PAGE -

The Is­lamic bank­ing in­dus­try is grow­ing but it also faces struc­tural prob­lems. The in­dus­try holds ap­prox­i­mately 15 per cent of to­tal bank­ing de­posits. But when it comes to in­vest­ments, Is­lamic banks have a share of only 5pc in the form of liq­uid­ity in­stru­ments. Cur­rently, con­ven­tional banks have two kinds of liq­uid­ity in­stru­ments: trea­sury bills and Pak­istan In­vest­ment Bonds ( PIBs). The tenors of trea­sury bills are three, six and 12- months while those of PIBs range from three to 30 years. Is­lamic banks, how­ever, have only one liq­uid­ity in­stru­ment to in­vest in: gov­ern­ment Ijara Sukuk ( GIS), the last auc­tion of which was held in June 2017.

The dif­fer­ence be­tween con­ven­tional in­stru­ments and GIS is that the for­mer are pure debt se­cu­ri­ties while the lat­ter has an un­der­ly­ing as­set to back it. As of June, the to­tal amount of PIBs and trea­sury bills held by con­ven­tional banks was Rs2.2 tril­lion and Rs4.8tr, re­spec­tively. Is­lamic banks held GIS worth only Rs368 bil­lion. Banks keep these liq­uid­ity in­stru­ments to meet their Statu­tory Liq­uid­ity Re­quire­ment ( SLR), which is aimed at pro­tect­ing the in­sti­tu­tion in the case of a panic run on the bank. Pre­vi­ously, both con­ven­tional and Is­lamic banks were sup­posed to keep 19pc of their de­mand and time li­a­bil­i­ties in the form of SLR- el­i­gi­ble in­stru­ments. But the in­ven­tory of Is­lamic liq­uid­ity in­stru­ments was de­plet­ing. So in­stead of is­su­ing new in­stru­ments, the State Bank of Pak­istan ( SBP) re­vised the SLR re­quire­ment down­ward to 14pc for Is­lamic banks in Novem­ber 2016. This has ac­tu­ally sent the wrong sig­nals about the in­dus­try. Tech­ni­cally, Is­lamic banks are now riskier than con­ven­tional banks as the for­mer keep a smaller per­cent­age of their de­posits in SLR- el­i­gi­ble in­stru­ments.

In­stead of al­lo­cat­ing new as­sets for the Is­lamic bank­ing in­dus­try, the PML- N took the largest mo­tor­way as­set out of the do­mes­tic mar­ket and floated in­ter­na­tional sukuk against it. Its pri­or­i­ties were clear: for­eign ex­change re­serves were the coun­try's main need while do­mes­tic fund­ing could be raised through trea­sury bills and PIBs. Hence, con­sid­er­a­tion for the Is­lamic bank­ing cap­i­tal mar­ket went on the back­burner. How­ever, to avert a liq­uid­ity de­ploy­ment cri­sis at that time, the SBP is­sued a cir­cu­lar in Oc­to­ber 2015 that al­lowed the Min­istry of Fi­nance to buy the sukuk that were ma­tur­ing in a month's time on de­ferred pay­ment for one year. This de­ferred pay­ment pur­chase by the gov­ern­ment - also known as bai mua­j­jal - took out the trad­abil­ity com­po­nent from the in­stru­ment. Nev­er­the­less, it was SLR- el­i­gi­ble.

In Is­lamic bank­ing, as­sets have to be cre­ated be­fore li­a­bil­i­ties un­like the con­ven­tional model. Due to a lack of gov­ern­ment-guar­an­teed SLR-el­i­gi­ble pa­pers, Is­lamic banks have been forced to fi­nance PSEs at fine rates, rais­ing the risk of non-per­form­ing loans. Due to smaller re­turns on their as­sets, Is­lamic banks are find­ing it dif­fi­cult to raise de­posits at higher rates, re­sult­ing in de­posit at­tri­tion. Also, these in­sti­tu­tions don't have the lux­ury of an in­ter­est rate cor­ri­dor (avail­able to con­ven­tional banks) where banks can place funds at a min­i­mum rate or bor­row at a max­i­mum rate from the SBP in dire need. Hence, the ax­iom that the cen­tral bank is the lender of last re­sort to all banks doesn't ex­ist for Is­lamic banks.

Fol­low­ing mea­sures should be taken to ad­dress these prob­lems: the fi­nance min­istry should buy sukuk on de­ferred pay­ment from Is­lamic banks be­fore ma­tu­rity and sell them back in the mar­ket and then repeat the whole process. Through mul­ti­ple it­er­a­tions, Is­lamic banks will be able to get rid of their ex­cess liq­uid­ity. The min­istry should also al­lo­cate more as­sets for sukuk. The gov­ern­ment should come up with a short- term al­ter­na­tive to trea­sury bills for Is­lamic banks. A pos­si­ble so­lu­tion can be a prod­uct that al­lows the gov­ern­ment to fund its quar­terly pur­chases of crude oil/ fur­nace oil through the Is­lamic bank­ing in­dus­try by is­su­ing SLR- el­i­gi­ble short- term pa­per.

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