Growth of Islamic Banking in Pakistan

GROWTH OF ISLAMIC BANKING IN PAKISTAN
Supervised by:
DR.NAILA NAZIR
Submitted by:
AMJAD ULLAH (DAWAR)
M.Sc Final Year
DEPARTMENT OF ECONOMICS
UNIVERSITY OF PESHAWAR
Session 2010-2011
The thesis is submitted to the Department of Economics

University of Peshawar in the partial fulfillment of the
requirement for the Award of
Master Degree in Economics
Submitted by:
AMJAD ULLAH (DAWAR)
M.Sc Final Year
Department of Economics
Session 2010-2011
============================
It is Recommended That the Thesis Prepared by

AMJAD
Be accepted as fulfilling this part of the requirement for the degree of

Master of Science in Economics.
Supervised By: _________________________

DR.Naila Nazir
Deportment of Economics
University of Peshawar
Approved By: ________________________

DR. NAEEM UR REHMAN
Chairman,
University of Peshawar
External Examiner: ________________________
Session 2010-2011
IN THE NAME OF ALLAH THE MOST GRECIOUS AND MERCIFUL
We are thankful to Allah who has given us the courage to complete the thesis. After
ALLAH we thank our Parents who have supported us in the ups and downs of Life by
Saying, “When the going gets tough, the tough one gets going”
Finally we are thankful to our supervisor DR. NAILA NAZIR whose tremendous support
has made us able to fulfill the requirements of our thesis.
AMJAD ULLAH
ABSTRACT
The Banking system in economy works like the blood circulation system of a
body. The basic concepts and objectives are common to any banking system
whether it be Islamic or conventional banking. The difference lies in methodology
adopted to achieve these objectives.
In this research study ,growth of Islamic banking ,efforts in the implementation of

riba free Banking in Pakistan, performance of Islamic Banking, expansion ,
sectoral concentration, investment in Islamic banking, problems and issues
regarding Islamic banking and different factors that influence the growth of
Islamic banking has been thoroughly analyzed.
All the data is arranged according to the data collected using different sources. The
data was collected from articles and journals, In-depth Interviews from general
public, depositors, and account holders as well as from the officials of different
Islamic and conventional banks. In this regard a questionnaire was also distributed,
the total population size for questionnaire is 600 persons, i.e. 300 persons about
Islamic banks and 300 persons about conventional banks in Peshawar, Dera Ismail
Khan, and Bannu were asked to express their views during this study.
The replies of the above questionnaire show that peoples in Pakistan expect that
Islamic banks are more helpful for economic development, social balance and
human prosperity.
The main finding of the research is that there is a strong need for a riba-free
banking system. People perceive a number of emotional benefits from a product
that is based on the tenets of Islam. The objective is to alleviate the feeling of guilt
by following the tenets of Islam. There is also a belief that Islamic banking will
help fight the ills of the economy of the country.
Table of contents
S. NO TITLE PAGE#
i. Acknowledgement i
ii. Abstract ii
Chapte#1 INTRODUCTION 1
1.1 Introduction 1
1.2 Purpose of Study 6
1.3 Research Objectives 7
1.4 Limitation of the Study 7
1.5 Organization of the Study 8
Chapter#2 LITERATURE REVIEW 9
Chapter#3 RESEARCH METHODOLOGY 16
3.1 Research Methodology 16
3.2 Mode of Observations 16
3.3 Field Data Collection 17
3.4 Sampleling Design 17
3.4.1 Target Population Size 17
3.4.2 Sample Size 17
3.5 Data Collection Methods 17
3.5.1 Data collected sources 17
Chapter#4 GROWTH AND PROBLEM OF ISLAMIC BANKING 18

4.1 Growth of Islamic Banking 18
4.1.1 Growth 18
4.1.2 Shariah Compliance Development 20
4.1.3 Shariah Standards 22
4.1.4 Current Industry Review 22
4.1.5 Industry Progress and Market Share 23
4.1.6 Operating Performance 26
4.1.7 Outreach Expansion 28
4.1.8 Asset Quality 33
4.1.9 Financing Products 34
4.1.10 Sectoral Concentration of Financing 36
4.1.11 Investments 37
4.1.12 Deposits Mobilization 38
4.1.13 Maturity Profile 40
4.1.14 Prospects 41
4.1.15 Agriculture 46
4.2 Problems and Issues 47
4.2.1 Taxation Issues 47
4.2.2 Financial Reporting and Accounting Standards 48
4.2.3 Islamic Export Refinancing Scheme 49
4.2.4 Lack of Expertise 50
4.2.5 Other Initiatives 50
4.2.6 Network Issues 51
4.2.7 Lack of Awareness 52
Chapter#5 RESULT AND DISCUSSION 54
5.1 Customer Preferences 54
5.2 Customer Understands 56
Chapter#5 MAIN FINDINGS AND CONCLUSIONS 60
6.1 Main Findings And Conclusions 60
6.2 Recommendation 63
QUESTIONNAIRE
REFERENCES
CHAPTER# 1
1. INTRODUCTION
1.1 INTRODUCTION:
In any economy banks play very important role. A bank is a reliable financial
institution, which has core business of mobilizing the savings of people for
investment purposes. It receives the money from one group and lends to other
group of people. So bank performs the duty of financial intermediary.
Usually there are two types of banks, conventional banks and Islamic banks. In
simple words Islamic banks operate in interest free system. Prohibition of interest
is ordained in Islam in all forms and intent. This Prohibition is strict, absolute and
unambiguous.
The Holy Qur'an in verse 278 of Surah Al-Baqarah states:

"O ye who believe! Fear Allah and give up what remains of your demand for riba,
if ye are indeed believers."
Verse 2: 279 says:

"If you do it not, take notice of war from Allah and His Messenger. But if ye turn
back; ye shall have your capital sums. Deal not unjustly and you shall not be dealt
with unjustly."
It therefore, follows that interest is prohibited as it leads to injustices and Islam is

against all forms of injustices and exploitations and pleads an economic system,
which aims at securing extensive socio-economic justice1. The Islamic law of
prohibition of riba, which includes interest, was originally not based on economic
Theory but on Divine Authority which considers the charging of interest as an act
of1 (Source:
injustice.
Siddiqui, H. Asrar (1975) Practice and Law of Banking in Pakistan. International Institute of Islamic Economics (1999
Islamic banks appeared on the world scene as active players two decades ago. But
many of the principles on which Islamic banking is based have been commonly
acceptable all over the world for centuries rather than decades, as it is evident that
Islamic finance was practiced predominantly in the Muslim world throughout the
middle Ages, promoting trade and business activities. In Spain and the
Mediterranean and Baltic States, Islamic merchants became indispensable
middlemen for trading activities. It is claimed that many concepts, techniques, and
instruments of Islamic finance were later adopted by European financiers and
business persons. "Although the western media frequently suggest that Islamic
banking in its present form is a recent phenomenon, in fact, the basic practices and
principles date back to the early part of the seventh century"
The main issue here is to know about the differences between operations of a
conventional bank and an Islamic bank by focusing on the principles and
instruments of Islamic banking.
It is difficult to say with accuracy which was the first such company or bank that
pioneered this concept of Islamic banking in practice. Some analysts and experts
in the field are of the opinion that, Islamic banking and finance, in the modern
context, first emerged in 1963, when Mit Ghamr Saving Bank began an
experimental project offering interest free banking in Egypt. The project was a
success and lead to the bank opening four new branches by 1967. In the same
year, eight new banks mushroomed offering interest free banking. Due to the
political climate prevailing in Egypt during that period, the success of these
Islamic banks was seen as a threat, and they were forced to close down in 1971. 2
2. (Source: Islamic Banking Conceptual Framework and practical operation P.7 by Abdur Rahim Hamdi)
As measure of the success of Islamic banks some traditional riba banks have
started imitating these banks by opening Islamic windows or offering Islamic
investment funds, unit trusts and or manage Islamic accounts for individuals.
Among these banks are kilentwort boston ( unit trust ) credit swisse and first
boston ( personal investment account ) UBS ( unit trust fund ) and the Austrian
leader’s bank ( unit trust ). Misr bank has Islamic branch. 3
Some observers are of the opinion that the concept of an "Islamic bank" was born
at the Islamic Summit of Lahore, Pakistan in 1974 which recommended the
creation of an Islamic Development Bank. Since then Islamic banking and
financial institutions have grown rapidly. A 1993 report from the International
Association of Islamic Banks estimated the then industry to be valued at $80
billion. A more recent article appearing in the Wall Street Journal estimates the
potential market for Islamic investments to be up to $150 billion.4
Malaysia in 1983 passed an Islamic Banking Act to facilitate the growth

Of indigenous Islamic banks and finance companies thus became the first Muslim
economy to issue bonds on an Islamic basis. Since then, some 50-60 institutions
have been established, and are now in the process of forming an Islamic inter-bank
market (i.e. in which banks borrow or lend to each other). Within 10 years of
introducing the Islamic Banking Act, the Malaysian government has taken further
steps to popularize Islamic banking and finance, by allowing conventional banks
to offer Shariah-compliant instruments. The most distinctive feature of Islamic
banking in Malaysia is that it is being embraced by its Chinese and non-Muslim
Population who are opting to deposit their savings or borrow money on an Islamic
basis.
3 Source: http://www .Islamic- finance.net

4. (Source: www. Islamic - banking.com).
The momentous decision of the Pakistani Supreme Court, in Ramadan 1420, to

strike down all laws that condone interest and their orders to the Federal
government to bring all existing financial organizations in line with Islamic
principles is truly path breaking. The world is watching with bated breath to see
how the whole economy faces this challenge.5
These trends in Malaysia and elsewhere are having a profound effect on the
banking and financial world as a whole. For example, America's Citibank was the
first major conventional bank to establish an Islamic bank in Bahrain, with an
operating capital of $20 million It may be a puny sum, but, it does suggest to some
degree that conventional banks have begun to embrace Islamic banking on a
moderate scale. Here again the point arises, that, there is some difference between
the operations of two banking systems and also there is something which is
attracting conventional banks towards Islamic banking system.6
A significant proportion of the banking system has been Islamized in Pakistan.

Recently the state bank of Pakistan has allowed commercial banks to set up
Islamic banking subsidiaries or provide full Islamic banking facilities through
dedicated branches.7
5. Source: www .alrajhibank.com.sa/Islamicebanks.htm

6. Source: (The Economist, 1996).
7. Source: Article on Islamic Banking, Finance & Economics” by Maryam Ayaz Manager Business Development,
Apvision (Private) Limited.
Meezan Bank of Pakistan had conducted a research last year to ascertain, is

7
Islamic banking really a need of the people The main findings of the research
were that there is a strong need for a riba-free banking system. People perceive a
number of emotional benefits from a product that is based on the tenets of Islam.
The objective is to alleviate the feeling of guilt by following the tenets of Islam.
There is also a belief that Islamic banking will help fight the ills of the economy of
the country.8
A number of other Western financial institutions have followed suit by Offering
Islamic mutual funds and other investment products. For example, ANZ Grind
lays is now offering financial products that meet Islamic criteria. Germany's fourth
largest bank, Commerz bank, started offering Islamic mutual funds from
December 1999. In February 1999, Dow Jones introduced the Dow Jones Islamic
Market index (DJIM) of 600 companies worldwide that comply with the Shariah
laws.
Many Western Academic Institutions are introducing Islamic Economy and

Banking as Subjects, like Harvard University Center for Middle Eastern Studies
(CMES), Durham University, UK, Dow Jones University….etc.
These indicators reflect the rising trend of Islamic banking and finance throughout
the world. This encourages one to know in detail what Islamic banking is all
about, what are its principles and how it is different from conventional banking
system.
8. Source: Meazan Bank annual report 2008-2009
The Amana Fund, the LARIBA bank, in USA and the Halal investment Company
in London is another indicator of the growing salience of Islamic banking
institutions not just in Muslim countries, but in the West as well. These efforts in
different countries for Islamic banking present not only an excellent working
examples for those who did not believe in the practicality of the interest free
banking but also provide a spade work over which the infrastructure of interest
free banking for a country could be built up.
1.2 Purpose of Study:
It is true that external financing is utmost important almost for every kind of
business in an economy and banking industry is the main facilitator in this regard.
Islamic banking system plays its role in the banking industry as its minor part.
Even though it’s a minor part it can’t be left behind because banks are the citadels
of the economic growth. So, studying Islamic banking system in detail will not
only benefit the researcher but also will be a source of effective information for
many classes of bank customers. It will help better understanding Islamic banking
system and its salient features.
The main purpose of the study of this topic is to focus on the growth of Islamic
Banking sector in Pakistan, Due to slow economic activities Islamic banking
sector grow more than the conventional banking sector in Pakistan, the study
highlights the growth in all aspects i.e. growth in Market Share, Investment,
Branch network, and Depositors.
1.3 Research Objectives:
As such, the objective of this study is to review the various aspects of Islamic
Banking and to identify the factor of growth of Islamic banking in Pakistan and
also assess their viability and applicability with respect to individual and corporate
consumers.
 To review the History and growth of Islamic Banking in Pakistan.
 To find out the different factors, how it affect the growth of Islamic
banking.
 To review the problem of Islamic Banking in Pakistan.
1.4 Limitation of the Study:
The research is conducted within the following limitations:

 To keep the study manageable research is conducted on limited grounds.
 The study is conducted on small level and only the important aspects are
considered.
 The researcher has tried to collect sufficient data to make an effective
analysis.
Therefore, in this study the results about Islamic banking should be taken only as
indicative and perceptive rather than conclusive.
1.5 Organization of the study:
The whole study is classified into the following chapters
Chapter 1st is about introduction, 2nd Chapter is about literature review,

Chapter 3rd is about research methodology, chapter 4th is about growth and
problems of Islamic Banking in Pakistan, Chapter 5th is about results and
discussions and Chapter 6th contains main findings and conclusions.
CHAPTER# 2
LITERATURE REVIEW
Kahf (2002) in his paper, interest free banking disagrees with the interest based
banking yet interest free banks have the similar credit risk as by the conventional
banks. Therefore Base I, II have suggested that the calculation of the minimum
capital requirement should be the same as required by the conventional banks. The
Islamic Banking is different in nature from traditional banking. This article first
discusses the Islamic financial operations then analyzes the Islamic procedure
which has been introduced in Pakistan since 1985. This article revealed that
islamization has moderate effect on this sector because the banks adopted the
system that is closely resembles to traditional system. Another reason is that they
are state owned The Islamic banking has not been applied the fully procedures as
described by the pillar II of the new Basel Accord. The application of the said
proposals does not create barriers for the Islamic banking and finance.
Ahmad & Hassan (2007) explained in their study in Bangladesh regarding

regulations and performance Islamic banking. The most important finding of this
research article is that there is lack of regulatory framework for its proper
functioning according to Shariah. There is also lack of interbank money market
which also affects the performance of the Islamic banking. The discrimination has
also been observed regarding legal reserve requirements. The researcher suggested
that in Bangladesh the independent banking act should be constituted to control,
guide and supervise the operations and practices of the Islamic banking. So that
the legal support to the stake holders may be provided.
Naser & Shahin (2004) have also studied about problems, challenges and
opportunities facing by the Islamic banking in United Kingdom. The data was
collected from the senior officials of the banks. The main problem faced in the
United Kingdom that is heterogeneous and potential clients. Furthermore the lack
of expert staff and competition from the conventional banks also faced in United
Kingdom. It has been concluded that the e-banking can play pivotal role for the
success of Islamic banking. There is need to sit together to the UK officials and
Islamic banking representatives to discuss the challenges of the Islamic Banking.
There is need to recruit professional individuals who have the know how about the
Islamic banking. It is contended that the perceptions of senior. So that such
problems may be resolved by using such strategy.
Abdullah (2007) found that Malaysia is the first country who played the vital roll
in Islamic banking. It also introduced the dual banking as well as pure Islamic
banking. In this article an innovation has been brought out that is hire purchase
and also known as alijara WA iqtana. The Islamic banking is going very
successful but there is still need to bring changes by the policy makers. To make
strengthen the Islamic banking transactions there is need to develop strong legal
framework. There is also needed to make strong both the operational regularity
and substantive laws to resolve problems relating to Islamic banking.
The shariah should be analyzed to make new innovations instead to impose

restrictions. There is need to explore the potential and wisdom of Shariah. There is
immense need of cooperation is required to make collaboration among Shariah
scholars, researchers, academicians and researchers to conduct the study in depth
to make strong Islamic products. The government and other agencies should also
make efforts for the new avenue of Islamic banking and hire purchase. The most
important is that the government should remove the uncertainty regarding Islamic
hire purchase.
Garas (2007) explained in his book that Globalization has affected our life
politically, economically and financially. There are both aspects in this
globalization. The positive aspect is that there is the movement of human capital
and new technology among countries. On the other side of the coin the
government is unable to control the flow of capital. The oil prices flourished the
investment in GCC countries and also encouraged the Islamic finance .There is no
doubt that Islamic financial institutions having potential for growth but still there
are certain challenges. There are two types of these challenges internal and
external. Internal challenges include that the customers still rely on the
conventional banking system and the numbers of the current IFIs are not enough
to meet the requirements to international transactions. Furthermore the transaction
system is still premature to attract new clients. There is also lack of unified
regulatory system for the products and transactions.
Iqbal and Khan (1998) said in their book that the global growth of Islamic
banking is taking advantages of its uniqueness to meet the challenges of growth
though the status of the Islamic banking is growing rapidly. But still the
institutional arrangement is necessary to take part in the global economy. The
Shariah compatibility should be judged by qualified Shariah scholar because for
any medical problem the person will consult with the medical specialist to get best
solution. That’s why the solution of the problem in Shariah, it can be taken from
the qualified Sharia scholar to get the exact decision. This way a good institutional
structure may be developed. I believe it may be the right time to start simply with
an international association of shariah scholars for the finance industry.
Hameed and Basheer (2003) have conducted an analysis about the financial
record of seven banks in Malaysia and Bahrain. The purpose of this article was to
analyze the Islamic financial products viability to interest based contracts. It
analyzes that Islamic banks pay Zakat and finance economic activities according
to Shari’ah. However it concludes that there is need to make legal frame work so
that the Islamic financial products may regulate in the Islamic financial market
Samad, A. Gardner, D. & Cook, J.B. Another article has been written in which the
author determine the determinants of the Islamic Bank Profitability. This article
demonstrates that all sources of funds are correlated with the profitability. It has
also been observed that inflation and interest rate also affect the Islamic financial
products. This study found that there was no significant variation in earning
between Islamic banks in competitive and monopolistic market. However there
was strong evidence that benefit of the investors has been observed in
monopolistic market. The study demonstrated that banks performed well in
competitive market then their counterpart. Therefore protectionism policy adopted
by the Muslim governments is inappropriate and could distort future progress of
Islamic Banking. In the end it has been recommended that establishment of more
banks will make it more viable and efficient.
Stefflar and Cornilisse (1995) said in their book that, the process of privatization
of banks has not been connected with the Islamization. Islamic banks have brought
no change regarding stability of the banks. The performance of the Islamic banks
is not up to the mark. Then theoretical comparison has been given of Islamic banks
and conventional banks. In the end of the article the author concludes that the
effect of Islamization is greater but less effective.
Amad and Kahf said that the Islamic banking have discovered Islamic
economics. Islamic banking is a system which really follows the Shariah rules and
regulations and Islamic economic system also abide by the Shariah. In 1950 to
1960 a study was conducted in Egypt and Malaysia regarding interest free
banking. But this study did not put any face value for Islamic banking. The first
Islamic bank was established in 1994 in Dubai and international Islamic Banks
was established in 1976 and now it has 53 member countries. Now a day’s Islamic
bank has been established almost in all the countries around the globe. Some
institutes have been established in America even small in numbers bit they are
using Islamic financing. The purpose is to create strategic alliance between Ulama
and Bankers. Further to develop Banking techniques by this Alliance.
Today Islamic banking is really in immense need of rethinking to compete in this

rapidly growing world. There is also need to redefine the structure for success in
future. The Islamic banking has really been appreciated by the conventional
banking and it also finding ways to become main stream banking. The Islamic
banks should enhance their efficiency to cope up new projects. Merger of the
Islamic banks is compulsory for the survival in this era. There is need to increase
the size, capital and should create ability to create assets.
Haron (2004) Identified the determinants of the profitability are more important
for the researches. In past decades the researchers has been found determinants for
the profitability. But all previous study has been conducted for the conventional
banks. The Islamic banks are still waiting for such kind of study. The Kahf has
been conducted study about the determinants of profitability of Islamic banking.
The researcher has been identified the internal and external determinants of the
profitability of the Islamic Banking. The money supply also plays an important
role for the profitability of the Islamic banks.
Zubair and Hassan (2007) defined that the rapid growth with the Islamic
financial institutions especially banks, assessment of their performance have also
flourished. The performance should be evaluated with reference to social
responsibility and legal frame work. This article tells us that Islamic banking is not
out of fault. Some ratio analysis has been conducted two views the performance of
the Islamic banks. Traditional banking has also been compared with the ratios of
current Islamic banking.
Iqbal (1998) used empirical data for empirical study which has been conducted in
1990-1998 on Islamic Banking. The analysis in this article revealed that the
growth of this banking is slow but it is not matter of worry because at the initial
stage the growth of the institutions is seen slow and when the industry matures
then it starts goes to up. This study revealed that there was no mobilization of
funds because the Muslim community does not involve in interest based system.
Consequently they keep their savings in personal lockers rather than in a bank.
After that in coming days the Islamic financial institutions attracted these savings
and deposit growth of these institutions increased. After that some conventional
banks started to officer the Islamic products. In nineties the Islamic mutual funds
were also developed and some deposits also converted to that side. The
performance of the Islamic banks considered quite good and Islamic banks found
good capitalize, stable and profitable.
The profitability ratio of these banks is considered reasonable according to

international standard. But the current rates on assets of these banks do not
considered good. However some variations have been observed in Islamic banks
in terms of growth and performance. Another paper concludes that there is no any
sort of difference in Islamic & conventional banks with respect to profitability and
liquidity. However the study finds significant difference in credit performance.
The conventional banking is existed in the whole world. But innovation is the core
key to survive for the long run. Islamic banking has introduced by following this
notion. Interest free banking is in the initial stage therefore facing some
challenges. The regulatory frame work of interest free banking is poor and proper
interbank money market is not available. The Basal II suggested that Islamic
banking has the same risk like interest based banking therefore it is suggested that
calculation of capital is required as desired by interest based banking. In this
growing world there is need to rethink that how can efficiency of this banking be
improved. The growth of this banking is bit slowly but there is no need to get
worry because growth is found slow at infancy stage. In this paper the attempt has
been made that how the Islamic banking working in Pakistan.
CHAPTER#3
RESEARCH METHODOLOGY
3.1 Research Methodologies:

This study would explore & review the research done on Islamic banking by
different researchers and scholars. This research work used data collection direct
from the financial Statements of the banks, both Islamic and conventional and also
from the reports of State Bank of Pakistan; another source is direct from the
customer of the both kinds of banks, documents researches and interviews of the
relevant authorities. Fieldwork was conducted during the months of December and
January of year 2010-2011. Although all replies were collected in personnel at the
allocated areas, the primary data collection applied obtaining the information from
peoples through filling of questionnaires, observation, and interview methods.
3.2 Mode of Observations
In-depth structured interviews have been selected for banking officials and
questionnaire for observational tools to gather primary data in the form of
feedback from general public or account holders. Secondary data has been
collected from State Bank of Pakistan (SBP) and different sources that are
manipulated later. The logic for using this questionnaire is to insight into the
growth potential and future prospects of Islamic banking through identifying the
perception of general public regarding Islamic banking.
3.3 Field Data Collection
The data was collected from general public of different Islamic and conventional
banks and from different Islamic baking officials. The questionnaire was
distributed, was filled out and was received on same day. During the process when
they were filling the questionnaire I stay there in order to over come any difficulty
faced by the respondent in filling out questionnaire.
3.4 SAMPLELING DESIGN
3.4.1 TARGET POPULATION SIZE:
The total population sizes for questionnaire 300 persons at Islamic banks and at
300 conventional banks in Peshawar, Dera Ismail Khan, and Bannu were asked to
express their views during this study.
3.4.2 SAMPLE SIZE:
The sample size for this study would be 600.
3.5 Data Collection Methods
3.5.1 Data collected sources:

from articles and journals
from “Economics Books”
by “Questionnaires”
by “In-depth Interviews”
by “Internet”
CHAPTER#4
GROWTH AND PROBLEM OF ISLAMIC BANKING

4.1 GROWTH OF ISLAMIC BANKING:
4.1.1 Growth:
Islam was the basis of creation of an independent state within the undivided Indo-
Pak Sub- Continent. All Constitutions of Pakistan have incorporated, within the
Principles of policy, the elimination of Riba as an important objective of the State
Policy. Quaid-e-Azam, the father of the nation, in his speech at the occasion of the
Inauguration of State Bank of Pakistan, had expressed the desire for evolving an
Islamic system of banking. In Pakistan Islamic banking emerged as a response to
both religious and economic needs. Efforts for economy wide elimination of Riba
started during 1970s and most of the significant and practical steps were taken in
early 1980s. It was a very bold and comprehensive exercise. Pakistan was among
the three countries in the world that had been trying to implement interest free
banking at comprehensive / national level.
Numerous measures were taken to introduce interest free banking in Pakistan.

Banking and other relevant laws viz. State Bank of Pakistan (SBP) Act,
Companies Ordinance, recovery laws, negotiable instruments act, etc. were
amended to Facilitate interest free banking system and the industry was given a
specific Timeline to convert to the Islamic banking system.
State Bank Pakistan also gave the industry the products which it was allowed to
use without any change or exception. Islamic banking was rolled out country-
wide. New regulations were prepared prescribing the modes of financing, profit
distribution mechanism for deposits, financing facilities by State Bank of Pakistan,
(SBP) etc. which constituted ground work for Islamization of financial system.
The mid-80s attempt was a significant step in the evolution of Islamic banking
system in the country. In a technical sense it was the most advanced model
compared to any other model being practiced anywhere in the world at that time.
The efforts and practical steps undertaken in the 1980’s to Islamize the economy at
national level are considered As pioneering work in the Muslim world as this
became important reference Material for other countries which undertook the path
towards introduction and establishment of an Islamic banking system. In early 90s
the whole exercise was challenged in the Federal Shariat Court and the procedure
adopted by banks in Pakistan since July 1, 1985 was declared un-Islamic by the
Federal Shariat Court (FSC) in November 1991. The system was based largely on
‘mark-up’ technique with or without ‘buy-back arrangement’. The Federal Shariat
Court (FSC) declared that various provisions of the laws held repugnant to the
injunctions of Islam in its Judgment dated November 14, 1991 would cease to
have effect as from July 1, 1992.
In a meeting held on September 4, 2001 under the Chairmanship of the President

of Pakistan, attended by officials of the Ministries of Finance and Law, Governor
State Bank of Pakistan, Chairman and some members of the Council of Islamic
Ideology and the Chairmen, and the two Task Forces it was decided that the shift
to interest free economy would be made in a gradual and phased manner and
without causing any disruptions. It was also agreed that State Bank of Pakistan
would offer three institutional options.
1) Setting up subsidiaries by the commercial banks for the purpose of Conducting

Shariah compliant transactions;
2) Specifying branches by the commercial banks exclusively dealing in Islamic
Products with all safeguards to ensure integrity and purity of Islamic banking
operations,
3) Setting up a new full-fledged commercial bank to carry out exclusively
banking business based on proposed Islamic products.
As a result of these efforts, in 2001, an Islamic Banking Division was established
in the Banking Policy Department at Sate Bank of Pakistan (SBP). This time
around, concerted efforts were made by Sate Bank of Pakistan (SBP) to undertake
Islamic Banking in its true spirit and also keeping in view the lessons learnt from
the experience of Bahrain, Malaysia and Saudi Arabia etc. in this area.
Accordingly, steps have been taken to set up a parallel banking system, so that an
enabling environment is ensured for the sector, avoiding any serious repercussions
of entire transformation of financial sector.
4.1.2 Shariah Compliance Developments:
The present re-launch of Islamic Banking in Pakistan by the State Bank of

Pakistan has been based not only on the lessons learnt from the history of Islamic
Banking efforts in Pakistan but also on the experiences of other countries in the
world that are currently known for their leadership role in this banking sector. The
basic difference, in Sate Bank of Pakistan (SBP’S) current policies regarding
Islamic banking and the previous efforts, is the approach adopted Islamic Bank of
Pakistan (SBP’S) by wherein the introduction of Islamic Banking is being viewed
more as a change management issue rather than as a religious or a legal issue.
This basic difference in approach defines the policies on Islamic Banking and is
primarily responsible for the success achieved so far. It was decided to promote
Islamic banking in a gradual manner and as a parallel and compatible system that
is in line with best international practices. Following the pronouncement of the
government to shift to interest free economy in a phased manner without causing
any disruptions the effort was envisaged to be based on a market driven and
flexible approach. Furthermore this approach is also helping build a broad based
financial system in the country to enable all segments of the population to access
financial services.
Shariah compliance is the most important aspect of Islamic finance. The

Credibility of Islamic Banking Institutions (IBIs) not only depends on the financial
health of the institution but also on its adherence to the Shariah.
Under the current strategy for promotion and development of Islamic Banking as a
parallel, viable and compatible system, State Bank of Pakistan has put in place a
comprehensive Shariah Compliance Structure.
The Shariah Compliance Framework established by State Bank of Pakistan

consists of:
1. Shariah Board at Sate Bank of Pakistan
2. Shariah Advisor
3. Essentials & Model Agreements of Islamic Modes of Financing
Instructions and Guidelines for Shariah Compliance in Islamic
Banking Institutions
4. Shariah Advisors Forum
5. Shariah Compliance Inspection
6. Standardization of Shariah Practices- Adoption of AAOIFI
(Accounting and Auditing Organization for Islamic Financial Institutions)
4.1.3 Shariah Standards:
Each Islamic Banking Institution (IBI) is required to work under the guidance of a
Shariah advisor. To keep this process more objective, broad based and responsive
to the market conditions Sate Bank of Pakistan (SBP). Shariah Board has
approved Fit & Proper Criteria for Shariah advisors of Islamic Banking
Institutions (IBIs). According to these Criteria, minimum required Shariah and
contemporary educational qualification as well as experience and Exposure for
becoming a Shariah Advisor has been defined. Moreover, to minimize conflict of
interest, it has been specified that a person cannot work as Shariah Advisor for
more than one Islamic Banking Institution (IBI) in Pakistan. Further, it has been
specified that a Shariah Advisor shall not hold any executive/non-executive
position in any other financial institution, except working as Shariah Advisor of
Islamic mutual funds of the same Islamic Banking Institution (IBI). In addition to
that, Shariah Advisors of Islamic Banking Institution (IBIs) have been barred from
having any substantial interest in or becoming employee of some types of
organizations like exchange Companies, corporate brokerage houses or stock
exchange.
These provisions in Fit and Proper Criteria for Shariah Advisors has ensured
Objectivity in evaluation criteria, minimization in conflict of interest and Induction
of new lot of Shariah advisors in the market.
4.1.4 Current Industry Review:
This time there has been a shift in the approach from the legal & regulatory
perspective to that of dealing with the whole affair of introducing Islamic banking
in Pakistan as a change management issue. As compared to our past experience
our new approach provides flexibility to the Islamic Banking Institution (IBIs) as
regard to products, instruments and Shariah compliance methodology. This new
initiative has witnessed a very encouraging response. As at end of the year 2003
only one bank operated as a full-fledged Islamic bank and three conventional
banks were operating Islamic banking branches. Currently there are 6 full fledged
licensed Islamic banks (IBs) and 12 conventional banks have licenses to operate
dedicated Islamic banking branches (IBBs). All of the five big banks in Pakistan
are providing Islamic banking services.
4.1.5 Industry Progress and Market Share:
Islamic banking maintained its high growth trajectory during quarter Apr-Jun
2010. The total assets of Islamic banking institutions (IBIs) increased to Rs 411
billion in June 2010 from Rs 313 billion in June 2009, showing an impressive
growth of 31%. The deposits spearheaded the growth with 39% increase during
the year. The investment and financing however did not show the same pace of
momentum and have shown comparatively tenuous growth at 21% which is
indicative of the difficulties being faced by Islamic Banking Institution (IBI’s) in
assets acquisition.1
1 Source: SBP Data
Figure 4.1 Shares and Growth of Islamic Banking

Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
The assets, deposits and net investment & financing have posted growth rates of
31, 39 and 21 percent, respectively. The high growth in various components of
Islamic banks balance sheet has enabled the Islamic Banks to make further inroads
in the overall banking industry in Pakistan; the shares of assets, deposits and
investment & financing increased to 6.1, 6.4 and 4.6 percent respectively during
the quarter ended June 2010. The branch network increased to 667 branches from
651 in December 2009.
Table 4.1: Industry Progress and market share

Rupees in billion and shares and growth in Percent
June.10 Dec.09 Dec.0 June. 07 Dec.0 Dec.05 June.04 Dec.03
8 6
Total Assets 411 366 276 206 119 71 44

Share in industry 6.1 5.6 4.9 4 2.8 2 1.5 13
Growth (YoY) 31.3 32.7 34 73.1 65.3 63.6 238.5 0.5
Deposits 330 283 202 147 84 50 30
Share in industry 6.4 5.9 4.8 3.8 2.6 1.8 1.3 8
Growth (YoY) 38.6 39.9 37.4 75 68 66.7 275 0.4
Net Financing & Investment 23.5 226 235 138 73 48 30
Share in industry 4.6 4.5 4.6 3.5 2.3 1.7 1.3 10
Growth (YoY) 21.2 21.3 21.2 89 52.1 60 200 0.5
Total Islamic Banking
Institutions 19 19 18 18 16 11 11 4
Total No. 0f Branches 667 651 515 289 150 70 48 17
Growth ratio may slow down marginally largely due to continuously rising base.
The Islamic Banking Institution (IBIs) are flush with liquidity since last couple of
years due to continued growth in deposits coupled with the dearth of liquidity
management instruments. The excessive liquidity in Islamic Banking Institution
(IBIs) could also be partly attributed to the cautious approach of Islamic Banking
Institution (IBIs) in assets acquisition. The prime target market of Islamic Banking
Institution (IBI’s) has usually been the big conglomerates and Multinational
Corporation (MNC’s). This in turn enables them to maintain a sound quality of
their financial and investment portfolio. However this squeezes the profit margins
of Islamic Banking Institution (IBI’s) as due to the peculiar nature of their
clientele, clients are able to solicit credit on their own terms. Moreover this also
leaves the Small and medium enterprises (SMEs) and startup business ventures
devoid of Islamic financial services. the Islamic Banking Institution (IBIs) have
fared relatively well during and post 2008 global financial markets crises; however
the recent floods—worst in the history of Pakistan—are likely to adversely affect
asset quality of banks including Islamic Banking Institution (IBIs.) Consequently,
the performance of the banking system including Islamic Banking Institution
(IBIs) during the coming few quarters may remain under stress.
4.1.6 Operating Performance:
The operating performance of Islamic Banking Institution (IBIs) remained weaker

than the banking system. The based on Return on Assets (ROA) and Return on
Equity (ROE) of Islamic Banking Institution (IBIs) at 0.8% & 6.9% was relatively
lower than the industry average of 1.1% and 10.6%, the Return on Assets (ROE)
though improved to 6.9 % in June 2010 compared to 6.0 % in June 2009. The
major source of Islamic Banking Institution (IBI) income, at around 80 %, is
mark-up income compared to around 70 percent for the conventional banks, which
is indicative of low diversification of Islamic Banking Institution (IBIs) sources of
Income compared to the conventional banks.
Table 4.2 Performance Indicators

June.10 Mar. 09 Jan.08
Industry
Capital
Capital to Total Assets 7.0% 11.4% 10.4 9.9
(Capital- Net NPAs) to Total Assets 12.4% 9.6% 9.2 8.2
Assets Quality Ratio
NPFs to Financing 5.0% 7.3% 6.5 12.9
Net NPFs to Net Financing 2.4% 3.8% 2.8 3.8
Provisions to NPFs 54.4% 50.0% 58.8 73.2
Net NPAs to Total Capital 11.6% 15.8% 11.5 17.2
Real estate financing to Total Financing 10.8% 11.3% 10.8 2.3
FCY Denominated Financing to Capital 11.1% 5.8% 9.6 16.1
Earnings and Profitability

Net Income to Total Assets (ROA) 0.8% 0.8% 0.8 1.1
Return on Equity (ROE) 6.0% 7.0% 6.9 10.8
Net Interest Income to Gross Income 82.0% 81.1% 80.7 74.7
Non- Interest Income to Gross Income 18.0% 18.9% 19.3 25.3
Trading & Fx Gains (Losses) to Gross 6.1% 7.0% 8.0 7.8
Income 65.1% 70.2% 71.8 52.6
Operating Expense to Operating Expense 29.7% 32.2% 32.1 36.7
Spread Between Financing & Deposit Rate 7.1% 7.7% 7.7 6.9
Liquidity
Liquid Asset to Total Assets 24.8% 26.8% 25.8 34.2
Liquid Asset to Deposits 32.6% 34.5% 32.2 45.3
Avg. Matunity of Liabilities (Days) 308.25% 387.6%1 383.55 417
Avg. Matunity of Assets (Days) 708.43% 638.72% 595.73 594
The operating expense to gross income ratio of Islamic Banking Institution (IBIs)
is also much higher than the industry. Specifically, expense to gross income ratio
of Islamic Banking Institution (IBIs) is 71.8 % compared to 52.8 % of the
industry. The high level of operating expenses are however advisable to their
expansion drive rather than inefficiency. The Islamic Banking Institution (IBIs)
branch network more than doubled during last two years; the branches opened
particularly during last one years would be achieving break evens during next 2-3
quarters, thus enabling the Islamic Banking Institution (IBIs) to improve their
expense to income ratios. Interestingly personnel expenses of Islamic Banking
Institution (IBIs) are lower than the industry median (though 7 it has gradually
increased in last few quarters), which may be indicative of relatively weaker
quality of human resource of Islamic Banking Institution (IBI).
The spread (based on actual yield on the financing less deposits) is relatively
higher for Islamic Banking Institution (IBIs) at 7.7 percent compared to the
industry average of 6.9 percent as at end-June 2010. The higher spread of Islamic
Banking Institution (IBIs) is largely coming from a lower level of (NPFs)
compared with their conventional counterparts. The relative better assets quality
enabled them to earn better yield on their financing portfolio than the industry as a
whole. Nonetheless, higher spread remains an area of concern as it reflects sub-
optimal returns to the deposits, both for Islamic Banking Institution (IBIs) and
conventional banks.
4.1.7 Outreach Expansion:
The branch network of Islamic Banking Institution (IBIs) has increased to 667
branches by end-June 2010. With addition of 210 and 143 branches in 2008 and
2009, an increase of 29 branches in during Jan-Jun 2010 does not seem very
impressive. The slowdown in branch expansion is reflected in both the full-fledged
Islamic banks (IBs) and Islamic banking branches of conventional banks (IBBs).
The slowdown is attributable to fast pace expansion of branch network during last
two years with current focus on making the branches fully operational. Further, the
growth in branch network during next 1-2 years would largely be emanating from
conventional banks having Islamic banking branches (IBBs) both through
conversion of existing conventional branches into Islamic Banking Branches
(IBBs) and new Islamic Banking Branches (IBBs).
The Islamic Banking (IBs) accounts for 416 branches and Islamic banking
branches (IBBs) accounts for 183 branches while the rest 68 are sub branches of
both Islamic Banking (IBs) and Islamic banking branches (IBBs). The
geographical coverage of Islamic banking extends across the four provinces, Azad
Kashmir, Northern areas and Federal capital covering 84 cities. The province-wise
data reveals that Sindh, Punjab, Balochistan, Khyber-Pakhtunkhwa and Azad
Kashmir accounts for 223, 297, 73, 34, and 7 branches respectively, while the rest
32 branches are in the Federal Capital. 653 branches are in the banked areas while
only 14 branches which represent a minuscule 2.3 percent are in the unbanked
areas.
The Islamic Banking Institutions (IBIs’) branch network is however largely

concentrated in big cities and banked areas. The need is for Islamic Banking
Institution (IBIs) to focus more on the unbaked and rural areas so that a larger
populace can access Islamic banking at their doorsteps. The conventional banks
having Islamic banking branches are in an advantageous position to convert their
existing conventional branches in these areas into Islamic banking branches.
Table 4.3 Islamic Banking Branch Network

Type
Islamic Banking
Name of Bank No of Branches
Al Baraka Islamic Bank 29

BankIslami Pakistan Limited 70
Dawood Islamic Bank Limited 42
Dubi Islamic Bank Pakistan Limited 36
Emirates Global Islamic Bank Limited 58
Meezan Bank Limited 181
Sub Total 416
Islamic Branches of Conventional Banks
Askari Bank Limited 29

Bank Alfalah Ltd 06
Bank Al Habib 60
Faysal Bank Limited 10
Habib Bank Limited 11
Habib Metropolitan bank 04
MCB Bank Limited 11
National Bank of Pakistan 08
Soneri Bank Limited 06
Standard Chartered Bank 11
The Bank of Khyber 19
The royal Bank of Scotland 03
United Bank Limited 05
Sub Total 183
Sub Branches
Askari Bank Limited 02
Banklslami Pakistan Limited 32
Dawood Islamic Bank Limited 08
Emirates Global Islamic Bank Limited 02
Meez Bank Limited 21
The bank of Khyber 03
Sub Total 68
Grand Total 667
Source: Banking Policy & Regulations Department, State Bank of Pakistan.
Table 4.4 Province wise Break-up of Islamic Banking Branch Network

Type Islamic Banking
Type Islamic Branches of Conventional Banks
Bank Name Azad Bolochistan Federal KP Northern Punjab Sindh Grand Total
Kashmir Capital Areas
Albaraka Islamic Bank 1 2 3 15 8 29

Banklsiami Pakistan Ltd 1 8 2 5 1 30 23 70
Dawood Islamic Bank Ltd 1 2 1 18 20 42
Dubai Islamic bank Pakistan Ltd 3 2 4 16 11 36

Emirates Goble Islamic Bank Ltd 3 2 6 27 20 58
Meezan Bank Limited 2 4 9 17 84 65 181
IB.Total 4 19 19 36 1 190 147 416

Bank Name Azad Bolochistn Federal KP Northern Punjab Sindh Grand
Kashmir Capital Areas Total
Askari Bank Limited 2 1 5 14 7 29

Bank AL Habib Ltd 1 1 2 2 6
Bank Alfalah Ltd 1 3 3 39 14 60
Habib Bank Ltd 1 1 2 4 3 11
Habib Metropolitan Bank Ltd 1 3 4
MCB Bank Limited 1 1 1 5 3 11
National Bank of Pakistan 2 1 3 2 8
Soneri Bank Ltd 1 1 1 1 2 6
Standard Chartered Bank Pak 1 1 3 3 3 11
The Bank of Khyber 2 12 3 2 19

The Royal Bank of Scotland 1 2 3
United Bank Limited 1 3 1 5
Faysal Bank Limited 1 2 4 3 10
SAIBBs Total 2 8 32 83 47 183
Type Sub Branches

Askari Bank Limited 1 1 2
BankIslami Pakistan Ltd 1 3 3 2 9 14 32
Dawood Islamic Bank Ltd 3 5 8
Emirates Global Islamic Bank 1 1 2
Meezan Bank Limited 1 2 11 7 21
The Bank of Khyber 1 1 1 3
Sub Branches Total 1 5 5 24 29 68
Grand Total 7 34 32 73 1 297 223 667
Source: Banking Policy & Regulations Department, State Bank of Pakistan
Table 4.5 City wise Break-up of Islamic Banking Branch Network

S.No Cities No of Branches S.No Cities No of Branches
Punjab Khyber Pakhtunkhwa
1 Arifwala 1 51 Abottadad 11
2 Attock 4 52 Bannu 1
3 Bahawalpur 3 53 Batkhela 1
4 Chahwal 2 54 Charsadda 1
5 Daska 1 55 Chitral 1
6 Dera Ghazi Khan 2 56 Dera Ismail Khan 3
7 Faisalabad 27 57 Hanged 1
8 Gojra 1 58 Haripur 3
9 Gujar Khan 1 59 Koht 2
10 Gujranwala 10 60 Manshra 6
11 Gujrat 9 61 Mardan 5
12 Hafizabad 2 62 Mingora 1
13 Jaranwala 2 63 Nowshera 3
14 Jhang 3 64 Peshawar 29
15 Jhelum 4 65 Swabi 2
16 Kamoki 1 66 Tank 1
17 Kasur 2 67 Timergara 1
18 Khanewal 1
19 Khushab 4
20 Lahore 113
Balochistan
21 Mandi Bahauddin 1 68 Chaman 1
22 Main Channu 2 69 Gawadar 1
23 Mainwali 1 70 Hub Chowki 1
24 Multan 24 71 Kuchlack 1
25 Okara 2 72 Loralai 3
26 Pakpattan 1 73 Muslim Bagh 1
27 Pindi Ghaib 1 74 Pishin 1
28 Rahim Yar Khan 6 75 Qilla Saifullah 1
29 Rawalpindi 31 76 Quetta 22
30 Sadiqabad 2 77 Zhob 1
31 Sahiwal 3
Sargodhe
32
Sheikhupura
6 Federal Capital
33 3
Sialkot Islambad
34 13 78 32
35 Texila 1
36 Taba Tex Singh 1 Northern Areas
37 Vehari 4 Giligit
38 Wah Cantt 2 79 1
Sindh Azad Kashmir

80 Mirpur AJK 4
39 Badin 1 81 3
Muzaffarabad
40 Hyderabad 17
41 Karachi 185 Pujab Total 297
42 Larkana 1 Sindh Total 223
43 Matiari 1
44 Mirpur Khas 3
KP Total 73
45 Nawabashah 4 Balochistan Total 34
46 Sakarand 1
47 Sanghar 2
Federal Capital Total 32
48 Sukkur 5 Northern Areas Total 1
Tando Adam
49
Tando Allahyar
1 Azad Kashmir Total 7
50 2
Grand Total 667
Source: Banking Policy & Regulations Department, State Bank of Pakistan
4.1.8 Asset Quality:

During the quarter Apr-Jun 2010 the non-performing financing has increased
substantially Year over Year (YoY) basis, however there is a decrease of around
10 percent on Quarter on Quarter (QoQ) basis. The net non-performing financing
shows similar Year over Year (YoY) and Quarter on Quarter (QoQ) trends.
Table 4.6 Non- performing Financing & Assets

Rupees in million
Growth
Jun-09 Mar-10 jun-10 YoY QoQ
NPF 1,803.2 11,871.3 10,649.9 490.6 -10.3
Provision 788.7 5,935.7 6,261.8 693.9 5.5
Net NPF 1,014.4 5,935.6 4,388.1 332.6 -26.1
NPA 1,953.2 13.628.6 12,454.4 537.7 -8.6
Net NPAs 1,030.9 6,659.8 4,921.1 377.4 -26.1
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts
The Non-performing asset (NPAs) and net Non-performing asset (NPAs) also
have similar inclining trends. However, on a positive note the recovery has
improved substantially both on Year over Year (YoY) and Quarter on Quarter
(QoQ) basis. The slowdown in (NPF) and Non-performing asset (NPA) coupled
with better recovery derive reflects positively on asset management of the IBIs.
The infection ratio, net infection ratio, and Non-performing asset (NPA) to capital
ratio, of Islamic Banking Institution (IBI) are better than the industry at end-June
2010. The assets infection as depicted by (NPFs) to financing ratio at 6.5% is
almost the half of the industry average which stood at 12.9%. The net Non-
performing asset (NPFs) to net financing ratio at 2.8% is also much better than the
industry average of 3.8%. Similarly the net Non-performing asset (NPAs) to
Capital ratio of Islamic Banking Institutions (IBIs) at 11.5% is also better than the
industry average of 17.2%. The improved asset quality of Islamic Banking
Institutions (IBIs) can be evidenced from rapid fall in infection ratio both on gross
and net basis while there is an increase in provisions against (NPFs). The only
concern seems to be an increase of 4.7 percentages in foreign currency exposures
as percent of capital. The foreign currency exposure in financing for Islamic
Banking Institutions (IBIs) at 9.6% is also much lower than the industry median of
16.1% at the quarter end and has shown a declining trend for the Islamic Banking
Institutions (IBIs). The exposure of Islamic Banking Institutions (IBIs) on the real
estate sector is much higher at 10.8% than the industry average of 2.3% at end-
June 2010. Nevertheless, the recent economic slowdown due to massive flooding
in the country can potentially reverse these encouraging trends.
4.1.9 Financing Products:
The financing mix remained concentrated in Murabaha financing. In fact, the

Murabaha financing has rebounded during the quarter under review from 37.1% to
44.1% of the financing. There is a slight decline in Discount Margin (DM)
financing, Salam and Istisna modes. Nonetheless, Murabaha, Ijarah and Discount
Margin (DM) constitute around 87 % of the financing.
Table 4.7 Financing Mix Rupees in billion

Jun-09 Mar-10 Jun-10
Murabaha 58.0 60.8 72.4
Sou rce: Annual
Ijarah 26.2 22.7 23.8
Accounts
except Musharaka 3.7 2.8 6.0 for June 2010,
data for Mudaraba 0.9 0.4 0.4 which is
based on Unedited
Diminishing Musharaka (DM) 45.3 51.3 46.4 Quarterly
Salam 2.9 6.5 3.2 Accounts
Istisna 4.8 10.6 6.4

The Others 2.3 7.0 5.4 financing
Total 144.3 162.1 164.0 through
Murabaha 40.2 37.5 44.1
Ijarah 18.2 14.0 14.5
Musharaka 2.6 1.7 3.7
Mudaraba 0.7 0.2 0.2
Diminishing Musharaka (DM) 31.4 31.7 28.3

Salam 2.0 4.0 2.0
Istisna 3.3 6.6 3.9
Others 1.6 4.3 3.3
Total 100.0 100.0 100.0
participatory modes remained at extremely low levels both due to low demand and
Islamic Banking Institutions (IBIs) reluctance to increase their risk appetite.
Similarly, use of financing modes like Salam and Istisna, which can be used to
finance nontraditional sectors like agriculture and Small and medium enterprises
(SME), remained lack luster.
4.1.10 Sectoral Concentration of Financing:

The Islamic Banking Institutions (IBIs) financing concentration does not show
much sign of improvement and is concentrated in a few sectors. Though the trend
is in line with the overall banking industry’s financing the same cannot be deemed
desirable. The Islamic Banking Institution (IBI) financing is confined to sectors
like Textile, Chemical & pharmaceutical and Individuals, where Islamic Banking
Institutions (IBIs) have around 18.3, 9.1 & 19 % concentration compared to 16.9
& 4.1 and 12.8 % respectively for the rest of the banking industry.
Table 4.8: Financing Concentration-percent share

Jun-09 Mar-10 Jun-10 Industry
Chemical and Pharmaceuticals 7.1% 10.5% 9.1% 4.1%
Agribusiness 1.0% 0.6% 1.1% 5.8%
Textile 20.5% 20.6% 18.3% 16.9%
Cement 2.2% 2.8% 3.5% 2.5%
Sugar 2.8% 6.0% 3.6% 2.3%
Shoes and Leather garments 1.6% 1.2% 1.1% 0.6%
Automobile and transportation equipment 2.6% 2.0% 1.9% 1.6%
Financial 1.1% 1.0% 1.3% 1.2%
Insurance 0.0% 0.0% 0.0% 0.0%
Electronics and electrical appliances 1.1% 1.0% 0.9% 1.6%
Production and transmission of energy 4.5% 4.5% 4.8% 9.4%
Individuals 22.8% 20.1% 19.1% 12.8%
Others 36.4% 31.6% 36.4% 41.1%
Total 100.0% 100.0% 100.0% 100.0%
The concentration in a few sectors implies concentration of risk as well. For

instance, the likely distress to Textile sector due to expected higher cotton prices
(resulting from losses in floods) may adversely affect the textile sector and its
financiers. Moreover, the financing to the individuals is very sensitive to the
overall economic activity and in times of distress there are higher chances of
defaults.
4.1.11 Investments:
The investments of Islamic Banking Institutions (IBIs) have shown substantial

growth of Year over Year (YoY) 46% and Quarter on Quarter (QoQ) 7.0% in June
2010. The Year Over Year (YoY) growth primarily represent the Rs 14.4 billion
(GoP) Ijarah Sukuk and Rs 6.8 billion PIA Sukuk issued in September and
October 2009, respectively. There is a substantial decline of 12 percent in
investment in shares during the quarter, though investments in shares remained
marginally positive on Year over Year (YoY) basis.
Table4.9 Investments
Rupees in million
Growth
Jun-09 Mar-10 Jun-10 YoY QoQ
Federal Government Securities 17,073.6 27,081.1 27,032.7 58.3 (0.2)
Fully paid up ordinary Shares 1,678.5 1,997.9 1,757.6 4.7 (12.0)
TFCs, Debentures, Bonds, & PTCs 19,408.3 24,866.2 26,173.8 34.9 5.3
Other investment 15,891.9 19,564.4 23,841.6 50.0 21.9
Investment by type -------- -------- -------- -------- ---------
Held for trading 127.6 --------- -------- --------- -------
Available for sale 39,904.9 59,147.0 64.717.5 62.2 9.4
Held to Maturity 11,211.4 11,465.8 11,697.2 4.3 2.0
Surplus/ (deficit) on revaluation (31.8) 254.3 110.7 (447.9) (56.4)
Net investments 53,539.8 72,892.7 77,999.7 45.7 7.0
In terms of investment types, investments are largely concentrated in Held for sale
and Held to maturity categories, while there are negligible securities in Held for
trading category—largely a result of lack of Shariah compliant tradable securities.
The constraint on availability of proper investment avenues is a major constrain on
profitability of Islamic Banking Institutions (IBIs). The constraint is more
disturbing in wake of rapid growth in deposits.
The State Bank of Pakistan (SBP) and the domestic and international Islamic
banking community are striving to evolve effective and efficient Shariah
compliant liquidity management tools.
4.1.12 Deposits mobilization:
The deposit mobilization remained strong during Apr-Jun 2010. The Year over
Year (YoY) and Quarter on Quarter (QoQ) growth in deposits remained robust at
38.5% and 14.1 % respectively. The YoY growth in deposits is largely coming
from the customer deposits at 40.6 percent. All the customer deposit types—fixed,
saving and current—have shown close to 40 percent YoY growth. Similar trends
have continued during the quarter ended June 2010.
Figure 4.02
The comparative analysis of composition of deposits of Islamic Banking

Institutions (IBIs) and industry reveals that the behavior of Islamic Banking
Institution IBI depositors and conventional banks depositors is almost similar.
Table 4.10 Breaks of Deposits
Rupees in million & growth in percent
Growth
Jun-09 Mar-10 Jun-10 YoY QoQ
Deposits 238,168.5 289,090.3 329,778.3 38.5 14.1
Customers 219,079.4 274,106.4 308,067.0 40.6 12.4
Fixed Deposits 88,871.8 113,179.6 123,484.7 38.9 9.1
Saving Deposits 75,176.1 94,321.1 105,162.7 39.9 11.5
Current Accounts- Remunerative --------- ---------- ----------- ------ ------
Current Accounts- Non Remunerative 53,165.4 64,086.7 76,676.9 44.2 19.6
Others 1,866.1 2,518.9 2,742.7 47.0 8.9
Financial Institutions 19.089.2 14,983.8 21,711.3 13.7 44.9

Remunerative Deposits 19.039.8 14,813.4 21,340.1 12.1 44.1
Non-remunerative Deposits 49.4 170.5 471.2 651.3 117.7
Currency Wise
Local Currency Deposits 255,474.1 272,091.3 312,488.5 38.6 14.8
Foreign Currency Deposits 12,694.5 16,999.0 17,289.8 36.2 1.7
Source: Annual Accounts except for June 2010, data for which is based on Unedited Quarterly Accounts.
The similar depositors’ preferences in Islamic Banking Institutions (IBIs) and

overall banking industry may reflect that Islamic Banking Institutions (IBIs) need
to do better with reference to the vast potential of the market. A stronger evidence
of this assertion came from high level of non-remunerative current accounts in
Islamic Banking Institutions (IBIs). This implies that the Islamic Banking
Institutions (IBIs) have to focus more aggressively on their awareness campaign
together with effective marketing of Islamic banking as offering Shariah compliant
returns to the depositors. Possibly, a combined marketing campaign by Islamic
Banking Institutions (IBIs) under a single banner.
4.1.13 Maturity Profile:
The maturity profile of assets and liabilities of Islamic Banking Institutions (IBIs)
closely resembles that of the banking industry at end-June 2010. The average asset
maturity of Islamic Banking Institution (IBI) as of June 2010 is concentrated in 3-
month maturity. On the liability side, the average maturity is also concentrated in
shorter tenor.
The maturity gaps as of June 2010 depict higher gaps in shorter tenors as
compared to longer tenors. This trend is also consistent with the industry behavior.
Table 4.11 Maturities of Assets and Liabilities
Jun-09 Mar-10 Jun-10 Industry
Assets
Maturing upto 3 months 37.7 40.1 42.9 43.4
Maturing from 3 months to 1 yr 22.5 22.8 22.6 27.0
Maturing from 1 yr to 5 yrs 26.4 26.7 25.1 17.8
Maturing after 5 yrs 13.3 10.4 9.4 11.9
Liabilities
Maturing upto 3 months 58.6 51.7 54.3 55.8
Maturing from 3 months to 1 yr 25.2 28.2 25.5 21.3
Gap- asset share minus liabilities share
Maturing upto 3 months (20.9) (11.7) (11.4) (12.4)
Maturing from 3 months to 1 yr (2.7) (5.3) (3.0) 5.7
4.1.14 Prospects:
While the number and operations of Islamic banks are fast expanding, this
segment of the market is still small relative to the appetite for Islamic finance.
Pakistan, in light of its past experience, is launching a gradual and steady approach
to Islamic banking. Despite rapid expansion in industry, the share of Islamic
banking in the total banking system is a modest 4.0%. Moreover, it only caters for
around 32,000 borrowers through around 300 branches relative to the country-
wide 5 million borrowers (or 4.8 million excluding microfinance borrowers)
tapped through 7,700 branches by conventional banks. Financing and investment
levels of Islamic banks barely range around Rs77 billion, which is below 3% of
the total banking system’s advances. On the product side, Islamic banks so far
offer about 75% of products.
currently available in conventional banking while clean lending for consumer

financing products, like personal loans and credit cards, still pose a challenge.
Islamic banks operate exclusively in large cities with some now venturing into
secondary cities but they are absent from rural areas where there is great potential
for business growth. Global interest in Islamic finance industry and Pakistan’s
success in laying basic foundation and core infrastructure of Islamic financial
system lends confidence that the country has good potential and prospects to
further exploit this industry. Going forward, however, it is important that Pakistan
adopts a more calibrated and coordinated approach and strategy for the
development of Islamic finance industry.
Islamic banking can serve as a key vehicle to improve and strength the access to
development finance by bringing in financial innovation that can cater adequately
to diverse demands of the population as well as corporate sector’s and country’s
infrastructure financing requirements, while ensuring that it nurtures faith based
system of financing consistent with the Shariah principles. Major elements of this
strategy would require both industry and SBP to closely work together on multiple
fronts. Some of the key areas of focus include: ‘Aggressive deposit mobilization to
augment domestic financial savings of the country’. Although late starter, Islamic
banks have phenomenal potential to exploit resource mobilization. Substantial
savings have still not been channeled into the financial system because of
reservations relating to interest based system or return deficiencies of the
conventional system. Islamic banks, besides catering to the needs of small
depositors through profit and loss sharing basic accounts with no Charges need to
tap high net worth investors and companies which are increasingly being driven to
the attractive options and returns being offered by more innovative players
worldwide. Fast adaptation of these practices by the Islamic finance industry will
be helpful in competing more effectively with conventional banks in raising
deposits. Resource mobilization is critical for Islamic finance industry to grow
effectively and meet the alternative requirements of economy and society.
Despite these issues, it is believed that Islamic banking can grow at a much faster
pace than conventional banking. This paper outlines and discusses in detail the
specific steps to be taken. State Bank of Pakistan (SBP’s) policies towards Islamic
Banking will be:
1. Liberal for branch licensing of Islamic Banking Institutions (IBIs)
2. Encouraging and supportive of Islamic Banking Institutions (IBIs) in using
alternate delivery channels in order to extend their outreach
3. Encouraging foreign Islamic banks to establish Islamic Banks in Pakistan
4. Encouraging the establishment of Islamic microfinance banks
5. Providing enabling environment for Islamic Banking Institutions (IBBs) of
conventional banks to convert into Islamic banking subsidiaries.
To achieve the target market share of 12%, an increase in coverage of the existing
banking segments and entry into new segments of microfinance, agriculture,
infrastructure and Small and medium enterprises (SME) finance will be targeted.
Based on the above direction of State Bank of Pakistan SBP’s policy and feedback
from the industry, following forecast for the industry has been developed:
Table 4.12 Annual Growths (In Million)

2008 2009 2010 2011 2012
Expected Deposit Size 215,938 340,128 499,036 722,109 907,064
Annual Growth Rate -------- 58% 47% 45% 26%
Expected Financing Size 184,641 277,153 413,594 600,014 731,591
Annual Growth Rate -------- 50% 49% 45% 22%
It is forecasted that by 2012 Islamic banking deposits will reach in the range of
Rs. 900-1000 billion and financing in the range of Rs. 700-800 billion. The
growth rates of these deposits are expected to be in the range of 45-60% in next
three years. Thereafter the growth is expected to be around 25% as the market
would mature having a larger base and greater competition with the conventional
counterparts. The Islamic Banking Institutions (IBIs) are expected to achieve this
target on the basis of canalizing funds from huge untapped markets and supportive
role of State Bank of Pakistan (SBP) in regulations and allowing opening of
branches in new business places. State Bank of Pakistan (SBP) will follow
relatively liberal branch expansion policies for Islamic banking or at least at par
with conventional banking. Based on State Bank of Pakistan (SBP’s) projections
and the feedback from the industry, following are projections for expansion in the
branch network:
The IBIs in the next three years will expand their branch network at a faster pace.
However, after the year 2011, the growth in branch network is expected to settle
down. Although this is an ambitious plan however the industry is comfortable with
it and it is also in line with the inspirational market share.
To increase the outreach of Islamic banking offerings, the industry will be
encouraged to enter the Microfinance and Agriculture sectors, in addition to the
Small and medium enterprises (SME) sector. Some Islamic banks are already
focusing on the Small and medium enterprises (SME) sector and getting a good
response from customers. The basic approach to entering these segments would be
to maximize the leveraging of the existing conventional banking infrastructure and
introducing Islamic banking products through these. State Bank of Pakistan (SBP)
will introduce the Shariah compliance mechanism and segregation of Islamic
banking business on the balance sheet and income statements. The specific steps
planned for each of these sectors will be as follows:
The central bank will use the conventional Microfinance strategy and focus more
on adding the aspects peculiar to Islamic banking. As a first step, State Bank of
Pakistan (SBP) has already issued guidelines for offering Islamic Microfinance
Services. According to these guidelines various types of institutional arrangements
have been suggested for provision of Islamic microfinance services which include.
1. Establishing full-fledged Islamic Microfinance Bank (MFB)

2. Islamic microfinance services by full-fledged Islamic Banks
3. Islamic microfinance services by Conventional banks
4. Islamic microfinance services by Conventional Microfinance Banks
For each type of arrangement, a detailed framework has been provided outlining
the systems and controls to be adopted and application procedure as well as
different options available to Microfinance banks bank (MFBs) by which Islamic
microfinance services can be offered. Going forward help will be provided to the
banks offering Islamic microfinance for developing products through joint forums
of experts from State Bank of Pakistan (SBP) as well as the participating banks.
Incremental volumes for Microfinance will therefore be ensured. At the same time
some conversion is also expected to take place.
Recently announced Microfinance strategy envisions 3 million borrowers by year

2010. It is expected that around 4-5 percent of the borrowers will be using Islamic
microfinance facilities. SBP expects that growth in Islamic microfinance will pick
up gradually as Islamic banks will expand to new areas after consolidating their
position in core sectors like corporate and consumer finance. Moreover,
establishment of dedicated Islamic microfinance bank(s) and introduction of
Islamic microfinance services by conventional Islamic Microfinance Bank’s
(MFBs) will give a boost to the sector. The estimated market size has been
forecasted as follows:
Table 4.13 Microfinance

Microfinance 2008 2009 2010 2011 2012
Expected Volume 10 100 500 1000 2000
% of Islamic Banking 0.01% 0.04% 0.1% 0.2% 0.3%
Financing ------ ------- -------- --------- ---------
Annual Growth Rate ------ 900% 400% 100% 100%
4.1.15 Agriculture:
State Bank of Pakistan (SBP’s) approach would remain the same as that for other
development finance sectors. A task force has been constituted that consists of
experts from participating banks and State Bank of Pakistan (SBP). This
committee is in the process of developing products that can be offered by banks
undertaking Agriculture credit. These products are expected to be operationally
ready by the end of the year. Meanwhile State Bank of Pakistan (SBP) will be
issuing guidelines and then regulations for this sector. Keeping in view the
inclination of end users for getting finance through Shariah-compliant products,
scope of this market is huge; State Bank of Pakistan (SBP) expects the following
volumes from this sector:
Table 4.14 Expected Agricultural Growths

Microfinance 2008 2009 2010 2011 2012
Expected Volume 370 1400 4100 12000 21000
% of Islamic Banking 0.2% 0.5% 1% 2% 3%
Financing ------ ------- -------- --------- ---------
Annual Growth Rate ------ 278.4% 193% 193% 75%
4.2 PROBLEMS AND ISSUES:
4.2.1 Taxation Issues:
State Bank of Pakistan (SBP) has put in place a process that is comprehensive and
provides the necessary groundwork to all the government departments concerned
to enable them executing their part of the change in rules. This process consists of
forming a committee at Institute of Charted Accounting of Pakistan (ICAP) that
determines the accounting treatment of Islamic transaction modes.
Based on the accounting treatment, changes needed in the tax rules to provide
same effective taxation treatment to Islamic transactions as that provided to
conventional transactions are made State of Pakistan (SBP) initially took up the
issue of double taxation on Murabaha transactions with the Central Board of
Revenue (CBR) and proposed amendments in the taxation laws in Consultation
with market players so as to provide a level playing field to the Islamic Bank
Institutions (IBIs). Consequently, in the budget for the year 2004-2005, an
amendment was made (Statutory Regulatory Order 445(1) / 2004) in the Sales Tax
Act, in terms of which goods delivered under a Murabaha financing arrangement
to or by a bank or a financial institution approved by the State of Pakistan (SBP)
or the Securities and Exchange Commission of Pakistan (SECP), as the case may
be, were not to be treated as Supply.1
1 Source: Dr.Noor Ahmed Memon (2007) Islamic Banking: Present and Future Challenges, Journal of Management and Social
Sciences Vol. 3, No. 1, (Spring 2007) 01-10.
Also amendments in Income Tax Ordinance in areas like minimum turnover

taxes etc. have been introduced. However lately in the Finance Bill 2007 it has
now been ensured that taxation of Shariah compliant Islamic banking would
be treated as par with conventional banking.
4.2.2 Financial Reporting and Accounting Standards:
In Pakistan, the regulatory financial reporting framework for the Islamic Banks
(IBs) and the Islamic Banking Divisions of Conventional Banks consist of:
• The International Financial Reporting Standards (IFRS);

• The Banking Companies Ordinance (BCO), 1962;
• The Companies Ordinance (CO), 1984; and
• Various rules and regulations devised by the State Bank of Pakistan (SBP) and
the Securities and Exchange Commission of Pakistan (SECP) particularly
including the State Bank of Pakistan (SBP) Prudential Regulations and Banking
Supervision Department-Circular-4 of 2006.
According to the SBP’s recently issued Guidelines for Shariah Compliance in

Islamic Banking Institutions following are the Financial Reporting and General
Disclosure requirements: Islamic Bank Institutions (IBIs).shall follow financial
reporting standards for Islamic modes of financing issued by the Securities and
Exchange Commission of Pakistan (SECP) under the Companies Ordinance, 1984.
For modes/areas not covered by these standards, Islamic Bank Institutions (IBIs)
are encouraged to use Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI) Accounting Standards Moreover in the annual report,
Islamic Bank Institutions (IBIs) are encouraged to disclose.
Ijarah has been notified through SRO 431 (I) / 2007 dated May 22, 2007 by the
Securities and Exchange Commission of Pakistan (SECP). It was made applicable
on the financial statements for the periods beginning on or after July 01, 2007.It is
applicable on companies, i.e. the lessees, also. In addition, work is in progress on
standards for Profit Distribution to PLS depositors, Diminishing Musharaka
followed by Musharaka.
4.2.3 Islamic Export Refinancing Scheme:
Similar to the export refinance facility available to conventional banks, in 2002

State Bank of Pakistan (SBP) started a Musharaka based Islamic export refinance
scheme (IERS) for Islamic banks and stand-alone Islamic branches operating in
the country. Islamic Banking Institutions (IBIs) are availing this facility under
both parts of SBP’s Export Finance Scheme (EFS). The framework of the Islamic
export refinance scheme (IERS) is based on the concept of Profit & Loss Sharing.
The State Bank shares the actual profit of the Musharakah pool of the Islamic
Bank. However, in case the actual profit of the pool is more than ongoing rates
under conventional Export Finance Scheme (EFS), the excess profit so received by
State Bank of Pakistan (SBP) is credited to the Takaful fund, (a reserve fund to be
maintained by State Bank of Pakistan (SBP) under Islamic modes) for risk
mitigation that would be used to meet future losses arising during implementation
of Islamic export refinance scheme (IERS). It is interesting to observe that up till
2005 only Meezan Bank Limited was availing this facility for their clients,
whereas in the FY 2009-2010 four Six (6) fledged Islamic banks and Twelve (12)
conventional banks having Islamic Bank of Institution (IBBs) have availed the
said facility.
4.2.4 Lack of Expertise:
Capacity Building is another major challenge being faced by Islamic financial

Industry. Proper understanding of Islamic banking services and their equal
treatment vis-à-vis conventional products is vital for the practitioners in Islamic
Finance Industry for product innovation and differentiation. It is, therefore,
extremely important to have the people with the right kind of skills and
commitment to run Islamic financial institutions. In the wake of high growth rate
experienced by Islamic Bank Institution (IBI), State Bank of Pakistan (SBP) is
putting special emphasis on ensuring that adequately trained human resource is
employed by the Islamic Banking Institutions. Banks are asked to provide
appropriate training to the staff before getting a license from State Bank of
Pakistan (SBP).
In order to give the relevant local and international exposure to employees of

Islamic Banking Department and also other departments of State Bank of Pakistan
(SBP) (that are dealing with Islamic banking industry) it is ensured that
appropriate training opportunities are utilized. Moreover occasionally the Islamic
Banking Department of State Bank of Pakistan (SBP) conducts an internal
Awareness/Training Program on Islamic Banking which helps in educating the
State Bank of Pakistan (SBP) staff on Islamic Banking and Finance concepts and
issues.
4.2.5 Other Initiatives:
Institute of Bankers Pakistan conducts seminars, training courses etc. for creating
wider awareness among bankers about the conceptual and operational framework
of Islamic banking. The subject of Islamic Banking and Finance has also been
included in its Banking Diploma courses. The curriculum of (IBP’s) Banking
Diploma Examination has been revised and updated. They have also revised the
syllabus on the subject of Islamic Banking and Finance.
A number of other educational institutions like International Institute of Islamic
Economics, International Islamic University Islamabad, and Centre for Islamic
Economics, Karachi, etc are also offering academic and training courses on
Islamic banking and finance. SBP has developed a standardized curriculum for
certification, post-graduate and master level programs in Islamic Banking. The
curriculum has been sent to the Higher Education Commission (HEC). HEC’s
Curriculum Review/Revision Committee would in due course consider the
curriculum for possible adoption in Pakistani educational institutions. This attempt
will hopefully ensure up to a certain extent the quality of the offerings by
education, training and research institutions offering Islamic Banking courses.
4.2.6 Network Issues:
Distribution Network: As at end of June 2010 there were only around 667 licensed
branches in the Islamic Banking sector in comparison with around 7800 branches
on conventional side. The availability of financing through Islamic Banking is still
very much limited. In this scenario State Bank of Pakistan (SBP) apart from
considering liberal branch licensing policy is also encouraging the Islamic banking
institutions to utilize alternate delivery channels for improving the accessibility of
the Islamic banking services across the length and breadth of the country. These
include the options of Islamic Banking Windows and Branchless Banking.
Islamic Banking due to its appeal among the masses because of its ethical and
religious dimensions has a strong growth potential in fields like micro financing,
agriculture financing, infrastructure finance, Small & Medium Enterprises etc.
Moreover as the demand for launching of diversified and Integrated Islamic
financial System in the country is on the rise there is a great potential for Islamic
Banking products in these areas. Till now only one or two Islamic banking
branches are engaged in Islamic Microfinance services and there is a strong need
for development of. this segment. However the major issue in this regard at this
point of time is awareness about Islamic microfinance. Islamic banks were till
recently in developmental phase and high infrastructure cost deterred them from
moving into new sectors & rural areas. However now that they have passed the
break even stage they can afford to explore such avenues. In this regard SBP has
already issued the Guidelines for provision of Islamic microfinance services and
products by financial institutions, Product Development: On the consumer banking
side clean lending products like Personal Loans and Credit Cards still pose a
challenge.
4.2.7 Lack of Awareness:
Like any other “new” concept, Islamic banking and finance is also going to take
some time to be fully comprehended by the people at large. Any new product
when introduced in a market will go through the natural dynamics of initially
being understood by a few and with the passage of time as its need and
practicability is felt and appreciated by more and more people greater efforts are
employed to make it recognizable for everyone. In Pakistan the failure of
implementing the Islamic banking system in its true spirit in the 1980’s is another
major factor that contributes to the high level of skepticism expressed by many
commentators. These two factors along with many others make task of creating
awareness about Islamic banking among the masses a daunting one. To address
this issue, State Bank had initially conducted a successful awareness program for
providers and users of Islamic banking services.
Islamic Banking Department’s page on SBP’s website gives ample information

about the policies, regulatory framework and other important areas. A quarterly
Islamic Banking Bulletin providing update on local as well international
developments in the field of Islamic banking and finance is being published by
Islamic Banking Department. Seminars on Islamic Financial Accounting
Standards on Murabaha and Ijarah and the Risk Management Guidelines for IBIs
have been conducted which were attended by senior executives/representatives
from SECP, Islamic banking industry and SBP. Professional bankers and
accountants delivered lectures on the subjects from various perspectives and these
events provided an excellent opportunity to the participants to discuss the practical
problems faced by them in the implementation of these standards/ guidelines.
CHAPTER# 5
RESULT AND DISCUSSION

The data collected is summarized according to the numerical order of the
Questionnaire and analyzed according to the importance and need of the study.
Some of the questions are analyzed in details and some of are not due to the
requirement of the study.
5.1 Customer Preferences:
Table 5.1 Age distribution of the respondents. (300 responses from each bank)
Age Group I.B. responses % C.B. responses %
18-30 28 9.3 18 6
31-40 yr 72 24 52 17.33
41-50 yrs 126 42 66 22
51-60 yrs 59 19.7 60 20
61 above 15 5 104 34.67
Source: Primary Data 2010-2011
The table above contains the different age group in both Islamic Bank (I. B) and
Conventional Bank (C. B). The table shows this clearly that Islamic Baking is
more popular in young and middle age peoples of the society, while the
conventional banks are popular in old or senior citizens of the country.
Table 5.2 Genders. (300 responses from each bank).

IB Responses % CB Responses %
Male 300 100 300 100

Female 0 0 0 0
This set of distribution shows that respondents in both kinds of banks were Male.
During our whole stay, at different place, we could not meet any female
respondent or account holder at Islamic Bank.
Table 5.3 Educational Qualifications. (300 responses from each bank)

A. High School 16 5.3 116 38.7
B. Intermediate 91 30.34 82 27.33
C. Graduate 193 64.3 102 34.0
D. Ph.D 0 0 0 0
The analysis of the table 5.3 shows that Islamic banking is more popular in highly
educated class of the society as compared to conventional banks. University
graduates respondents of Islamic banks represent 64.3 percent as compare to the
34 percent of conventional banks respondents. While, high school graduate
respondents at conventional banks are 38.67% as compare to 5.33% in Islamic
Bank.
Private employees and businessmen are more in numbers in Islamic banks as

compare to conventional banks. While the numbers of students and government
employees are more in the conventional banks.
Table 5.4 Monthly Incomes. (300 responses from both banks)
A.5000-8000 10 3.0 190 62.33
B.8001-12000 17 5.67 67 22.33
C.10001-12000 29 9.67 24 8.0
D.12001-15000 93 31.0 11 3.67
E. More than 15000 151 50.3 8 2.67
The result of table 5.4 is negative to one of the dedication of the Islamic banks
i. e., to participate more in human prosperity and elimination of poverty. This
result shows that Islamic banks are more popular in high-level income groups of
the society, while conventional banks are more popular in low-level income
groups.
5.2 Customer Understands:

For what purposes do you use this Bank?
Table 5.5 (300 responses from each bank)
Investment/Saving 191 63.67 178 59.33
Borrowings 38 12.66 43 14.34
Others 71 23.67 79 26.33
Table 5.5 shows that the distribution of account holders in both types of banks is
symmetric. Although the purposes distribution is not very clear, yet Conventional
bank have more numbers of respondents at their services section.
Do you understand the key concepts of Islamic banking?
Table 5.6 (300 responses each bank)
Yes 289 96.33 263 87.67
No 11 3.67 37 12.33
Tabulation of above question illustrates a very interesting result. There was

unexpectedly high percentage of the conventional bank account holders or visitors
who were well aware of the Islamic banking concepts. On the other hand, as
oppose to our expectations 11 of the Islamic bank respondents were not aware of
the concepts of the Islamic banking.
This result shows that Islamic banks did not explained well the concepts of Islamic
banking to their customers. And this result was of opposite to expectations, that
Islamic banks enhance the awareness and education both in economic as well as
religious matters and support the religious resurgence for the community.
If you have an opportunity to open an account with Islamic bank,

would you transfer your account to Islamic bank?
Table 5.7 (300 responses from conventional bank)
IB Responses CB Responses %
Yes N/A 211 70.33
No N/A 10 3.33
No reply N/A 79 25.33
The table 5.7 indicates very supportive response for transfer of their financial
activities from conventional bank to Islamic bank.
Would you please tell us the reason for the transfer of your account?
Table 5.8 (300 responses from conventional bank)
I.B Responses C.B Responses %
RIBA N/A 213 71
Higher Profit N/A 52 17.33
Other N/A 35 11.66
Peoples want to transfer their bank dealings from conventional banks to Islamic
banks because of religious background as well as higher profits as shown by the
annual financial reports of both kinds of banks.
Would you continue to deal with Islamic bank even if its
Services charges are higher than the conventional banks?
I.B Responses % C.B Responses %
Yes 231 77.0 194 64.7
No 13 4.3 17 5.7
No Reply 56 18.7 89 29.6
This question also shows an affectionate attachment of the people for Islamic
baking. Even in the case of higher bank charges peoples are willing to continue
their dealings with Islamic bank.
Do you agree? Islamic Banks can contribute more to the societal
balance, human prosperity and welfare.

I.B Responses % C.B Responses %
Agree 226 75.3 234 89
Disagree 13 34.33 6 2.3
Don’t Know 61 20.33 23 8.7
The replies of above question show that peoples in Pakistan expect that Islamic
banks are more helpful for economic development, societal balance and human
prosperity. It is also verdict from the injunction of Shariah rules that Islamic
financial institutions are obliged to participate in the equal distribution of wealth,
human prosperity and equal economic development this research study is result of
a pioneer fieldwork conducted so far on Islamic Banking in Pakistan. Therefore,
the results should be taken only as indicative and perceptive rather than
conclusive. It is hoped that further Empirical or theoretical studies will be done to
draw more definitive realities.
CHAPTER# 6
MAIN FINDINGS AND CONCLUSIONS
6.1 Main Findings and Conclusion:
Theoretically speaking, there is no concept of loans and credits in Islam for

financing trade, industry and agriculture except Qard Hasan and where profit and
loss sharing is not feasible like interest-free loans by the federal government to
provincial governments for their developmental needs. Islamic banks, therefore,
involve themselves in financing (short, medium and long term) for the working
capital requirements, and also contribute to the capital of an enterprise by
participating in its equity. These financings are on profit and loss sharing basis.
Islamic banks also mobilize resources on profit and loss sharing basis as distinct
from interest payments to depositors on predetermined rates.
Islamic banking is a part of over-all value system of Islam. It is, therefore,

imperative that simultaneously genuine efforts are made to ensure that the people
are imbued with honesty of purpose and their actions conform to Islamic values.
The basic values that Islam seeks to establish are:
(a) Freedom
(b) Brotherhood
(c) Equality
(d) Justice
(e) Trust i.e. treating the God – given capabilities and resources as trust.
(f) Honest Consciousness i.e. sense of responsibility and care for one’s
obligations.
In a system based on profit and loss sharing, it is to the advantage of banks and
financial institutions to invest in those projects where higher rates of profits are
anticipated. The financing by Islamic banks under this system is done within the
framework and keeping in view the social considerations, the Requirements of
priority sector and the safety of funds. The Islamic banking system, therefore,
induces savings and capital formation and lead to optimum allocation of resources.
Islamic banks operating on profit and loss sharing basis are definitely in a stronger
position to absorb the shocks to their assets position (bank’s financing), as the
losses are simultaneously absorbed by the changes in the value of deposits placed
with the banks. The nominal value of deposits of Islamic banks is not guaranteed
like investment in shares of a bank or for that matter of a joint stock company. The
real value of “Assets and Liabilities” (Uses of Funds and Sources of Funds) of
Islamic banks is, therefore, equal at any point of time. It is, however, to be ensured
through prudent and professional banking practices, procedures and systems that
the losses in the financing portfolio are as low as possible and that highest possible
returns are paid to the depositors and investors.
Theoretically and empirically, it is not difficult for specialists in economics And

finance to find Islamic banking in not only viable and acceptable, but also efficient
and significantly effective. It is not therefore surprising to see large multinational
banks and institutions are providing Islamic financial services to their customers in
significant amounts. As an innovation, Islamic banking has been practiced for
more than a quarter of a century.
Although, Islamic banking system is more viable than conventional Banking

system it has some challenges also, like: The well-known fiscal prejudice against
profit and in favor of interest is just an example, where interest payments are
partially or fully tax exempt, and profit gets no such advantage. Similarly New
instruments are needed; a uniform regulatory environment and legal framework
have yet to be developed. The total implementation and success of Islamic banking
in a country needs re-shaping the society, re-structuring of the economic system
and reframing of the laws according to the dictates of Islam. Islamic banks also
face a challenge of developing innovative services and products for mobilizing
deposits And utilizing them effectively and efficiently for financing under profit
and loss sharing system. Islamic banks like all other modern conventional banks
under interest-based system have to remain competitive and tailor their services
and products according to the needs and requirements of their clients, ensuring that
the products designed by them remain within the framework of Shariah.
International operations would have to be continued on interest basis till such time
that a suitable and mutually acceptable alternate is found. This will, however,
depend upon the success of Islamic banking on the domestic fronts in a large
majority of Muslim countries of the world. While taking steps to enforce Islamic
banking, it will have to be seen that interest is eliminated in such a way that it does
not abruptly disturb the basic structure of the economy. It has also to be ensured
that initially the Confidence of the people is developed and strengthened in the
new system. This approach would also provide an opportunity to refine the newly
formed laws to support the Islamic system of banking in the light of experiences
gained during the process. The development of an inter bank market is another
challenge. With the establishment of the Islamic Fiqh Academy (IFA) in Jeddah
and wide spread growth of specialized training centers dedicated to train people in
Islamic Finance and banking practices, and a series of International conferences,
the challenges are being addressed with vigor. With the forced opening up of the
economy and gradual removal of barriers, Governments and regulatory bodies,
too, is co- operating in making Islamic banking a part of mainstream banking. In
the years to come, as Islamic banking breaks new ground and expands into new
areas, there is sure to be an increased effort in broadening its principles and scope.
6.2 Recommendations:
It, however, appears that although tremendous efforts for Islamization of banking
system and for streamlining and enhancing the scope of the activities of Islamic
banks are being made in many Muslim countries, but effective steps for
reformation of the societies in the respective countries are not being taken up with
the same zeal and enthusiasm. This is an essential prerequisite for the success of
Islamic banking and deserves serious considerations by all those who are involved
in the process of Islamic banking.
The following are the suggestions for future growth and success of Islamic Banks.
Which be successful and produce full dividends, if the society in which it operates,
is geared on Islamic principles. It is, therefore, of utmost importance that sincere
and effective efforts are simultaneously made to transform the Existing societies,
in the Muslim countries, into truly Islamic societies.
1. A basic tenet of commercial banking is capital guarantee. The capital entrusted

to the bank by a depositor must be returned to him in full. Conventional Banking
system fully complies with this requirement. While Islamic banking as practiced
today does not provide capital guarantee in all its deposit Accounts. In many
countries, this is one of the two main objections to Permitting the establishment of
Islamic banks. There is no objection to paying Zero interest on deposits. Thus, by
paying zero interest and guaranteeing Capital, the proposed system satisfies both
the riba-prohibition rule of Islam and the capital guarantee requirement of
conventional Banking Acts. This enables it to obtain permission to set up and
operate as a deposit Bank in all countries of the world, while obeying the riba-
prohibition rule and qualifying to be an “Islamic” bank.
2. All relevant laws in Muslim countries who have established or are in the
Process of establishing Islamic banks should be reviewed so as to bring them in
conformity with the Shariah. Necessary laws also need to be framed for providing
legal cover to the transactions; services and products developed Under the Islamic
banking system.
3. The research and training centers for Islamic banking established in Various
Muslim countries should pass on their findings to their Muslim Countries to assist
them in establishing new Islamic banks and enhancing their existing capabilities.
4. Muslim scholars, bankers and economists should explain, to their counterparts
in Western / American countries as also to various international financial and
monetary agencies like the World Bank and International Monetary Fund, the
salient features of Islamic banking. It should also be a good idea to invite their
suggestions for achieving the objective of socio-economic Justice, in the context
of Islamic baking.
5. There is an urgent need for more extensive cooperation among Islamic Banks
throughout the world. There should, therefore, be more organized and Systematic
meetings, seminars, conferences and workshops to exchange Experiences and
expertise and to foster closer cooperation in all spheres of operations.
6. Muslim countries, who have established Islamic banks, should transact the
imports and exports business between them on Islamic principles. This would lead
to handling more and more international transactions under Interest-free system
and would provide a model for other conventional banks to deal with Islamic
banks on interest-free basis. This will also help in developing the much needed
International Islamic Financial Markets.
7. The central banks of Muslim countries should prepare themselves more

vigorously for fulfilling their new and enhanced responsibilities under Islamic
banking system. In addition to their normal functions of supervising the operations
of banks and the quality of their financing portfolio, central banks should also
regulate the ratios of profit sharing, by prescribing a range within which, the banks
would be free to deal with their clients under the Islamic system.
8. Islamic Development Bank has to adopt a very innovative approach to Gear

them for assuming a global role on the footprints of The World Bank. It has
accordingly to establish a number of affiliates and subsidiaries for Carrying out the
multi dimensional functions and responsibilities, under The Islamic banking
system.
9. A Monitoring commission for Islamic banks should be constituted by all

Muslim countries. Prominent Muslim scholars of all schools of thought,
economists, Jurists and bankers should be the members of this commission. The
commission should have a number of committees to deal with various issues of
Islamic Banking and should be entrusted with responsibilities mainly the
following:
a) Developing by Ijma (a secondary source of Islamic jurisprudence through the

process of consensus of opinion) a uniform banking code with in the prescribed
regulatory framework of Shariah. This banking code would provide legal certainty
had would also develop uniform banking practices to be adopted by Islamic banks.
b) Ensuring that all the existing modes of financing are appropriately amended,
wherever necessary, so that they are bought within the purview of Shariah.
c) Developing of uniform accounting systems and standards for providing

consistency in accounting treatment of various operations and products of Islamic
banks.
d) Designing new and innovation services and products for financing On profit
and loss sharing basis.
e) Standardization of the systems, procedures, charge forms and other documents

for handling various banking transactions under Islamic banking system.
f) Providing solution to any problem or guidance on any matter referred to it, by
any bank.
10. Finally, conclusion is that, being a Muslim we should discontinued the interest
based Financial and banking system. So that we may be saved from the
punishment of “Riba" described in Quran and Hadith. E.g. the Prophet peace be
upon him said as follows “on the night of ascendance to The Heavens, I passed by
a group of people who had tummies as big as houses, filled with snakes that could
be seen from outside. I asked The Arch- Angel Jibrael as to who they were. He
said that they were the people who ate “Riba.” And the earlier it is realized better
it would be for all.
References
Siddiqi, Muhammad Najatullah (1983) Banking without Interest. Leiscester: the

Islamic founded on, UK.
Siddiqui, H. Asrar (1975) Practice and Law of Banking in Pakistan. International

Institute of Islamic Economics IIUI (1999) Islamabad. Siddiqui, Shahid Hasan.
Islamic Banking Karachi: Royal Book Company. Khan, Mohammad Ikram.
(1992) Islamic Banking in Pakistan. Lahore:
Islamic Banking Conceptual Framework and practical operation P.7 by (Abdur

Rahim Hamdi)
bdus, S. 2 (2004), “Performance of Interest free Islamic Banks Vis-à-vis Interest

Based Conventional Banks of Bahrain”. IIUM Journal of Economic &
Management 12, by the International Islamic University Malysia
Haron, S (2004), “Determinants of Islamic Bank Profitability”. Global Journal of

Finance and Economics. Vol 1, No 1
Iqbal, Ahmed & Khan (1998), “Challenges Facing by Islamic Banking”.
95 pages – 17x24 Cm. Islamic Economy Legal Deposit No. 2282/19 ISBN:
9960-32-065-0 Islamic research and training institute Islamic development
Zubair & Hassan (2007), “Measuring Efficiency of Islamic Banks: Criteria,

Methods and Social Priorities”. Paper No. 2977, posted 07. November
Muhammad Taqi Usmani, (2008), “An Introduction to Islamic Finance”. Quranic

Studies Publishers Maktaba Ma’ariful Qur’an Karachi
Dr.Noor Ahmed Memon (2007) Islamic Banking: Present and Future Challenges,
Journal of Management and Social Sciences Vol. 3, No. 1, (Spring 2007) 01-10.
Article on Islamic Banking, Finance & Economics” by Maryam Ayaz Manager

Business Development, Apvision (Private) Limited.
State Bank of Pakistan (2010). Strategic Plan for Islamic Banking Industry of
Pakistan 2005- 2010. State bank of Pakistan.
Federal Bureau of Statistics
Banking Policy & Regulations Department, State Bank of Pakistan.
State Bank of Pakistan (2010) Quarterly Report on Islamic Banking
State Bank of Pakistan (2007) Islamic Banking Review 2003 – 2007
(The Economist, 1996)
What is Islamic Banking?
(http://www .Islamic- banking.com / banking.
http: // www .Islamic banking.
http://www .Islamic- financing.
www.sbp.org.pk/ibd/Bulletin/Bulletin.asp
QUESTIONNAIRE
Name: -------------------------------------------------
Male Female
Bank:
A: Islamic banking B: Conventional Banking
Age group: A. 18-30 B. 31-40 C. 41-50
D. 51-60 E. 61 above
Qualification: A. High School B Intermediate
C. Graduate D.Ph.D
Monthly Incomes: A.5000-8000 B.8001-12000 C.10001-12000

D.12001-15000 E. More than 15000
Q.No 1 For what purposes do you use this Bank?
Investment/Saving Borrowi1ngs Others
Q.No 2 Do you understand the key concepts of Islamic banking?
Yes No
Q.No 3 If you have an opportunity to open an account with Islamic

bank, would you transfer your account to Islamic bank?
Yes No No reply
Q.No 4 would you please tell us the reason for the transfer of your
Account?
RIBA Higher Profit Other
Q.No 5 Would you continue to deal with Islamic bank even if its
services charges are higher than the conventional banks?
Yes No No Reply
Q.No 6 Do you agree? Islamic Banks can contribute more to the

societal balance, human prosperity and welfare.
Agree Disagree Don’t Know
AMJAD ULLAH
MSc Economics Final
Peshawar University.
Cell phone: 0308-8080101

Growth of Islamic Banking in Pakistan

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Growth of Islamic Banking in Pakistan

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GROWTH OF ISLAMIC BANKING IN PAKISTAN

The thesis is submitted to the Department of Economics

It is Recommended That the Thesis Prepared by

Be accepted as fulfilling this part of the requirement for the degree of

Supervised By: _________________________

Approved By: ________________________

External Examiner: ________________________

In this research study ,growth of Islamic banking ,efforts in the implementation of

3.5.1 Data collected sources 17

Chapter#4 GROWTH AND PROBLEM OF ISLAMIC BANKING 18

The Holy Qur'an in verse 278 of Surah Al-Baqarah states:

Verse 2: 279 says:

It therefore, follows that interest is prohibited as it leads to injustices and Islam is

Malaysia in 1983 passed an Islamic Banking Act to facilitate the growth

3 Source: http://www .Islamic- finance.net

The momentous decision of the Pakistani Supreme Court, in Ramadan 1420, to

A significant proportion of the banking system has been Islamized in Pakistan.

5. Source: www .alrajhibank.com.sa/Islamicebanks.htm

Meezan Bank of Pakistan had conducted a research last year to ascertain, is

Many Western Academic Institutions are introducing Islamic Economy and

8. Source: Meazan Bank annual report 2008-2009

1.3 Research Objectives:

1.4 Limitation of the Study:

The research is conducted within the following limitations:

1.5 Organization of the study:

The whole study is classified into the following chapters

Chapter 1st is about introduction, 2nd Chapter is about literature review,

Ahmad & Hassan (2007) explained in their study in Bangladesh regarding

The shariah should be analyzed to make new innovations instead to impose

Today Islamic banking is really in immense need of rethinking to compete in this

The profitability ratio of these banks is considered reasonable according to

3.1 Research Methodologies:

3.2 Mode of Observations

3.3 Field Data Collection

3.4 SAMPLELING DESIGN

3.4.1 TARGET POPULATION SIZE:

3.4.2 SAMPLE SIZE:

The sample size for this study would be 600.

3.5 Data Collection Methods

3.5.1 Data collected sources:

GROWTH AND PROBLEM OF ISLAMIC BANKING

Numerous measures were taken to introduce interest free banking in Pakistan.

In a meeting held on September 4, 2001 under the Chairmanship of the President

1) Setting up subsidiaries by the commercial banks for the purpose of Conducting

4.1.2 Shariah Compliance Developments:

The present re-launch of Islamic Banking in Pakistan by the State Bank of

Shariah compliance is the most important aspect of Islamic finance. The

The Shariah Compliance Framework established by State Bank of Pakistan

4.1.4 Current Industry Review:

1 Source: SBP Data

Figure 4.1 Shares and Growth of Islamic Banking

Table 4.1: Industry Progress and market share

Total Assets 411 366 276 206 119 71 44

4.1.6 Operating Performance:

The operating performance of Islamic Banking Institution (IBIs) remained weaker

Table 4.2 Performance Indicators

Earnings and Profitability

4.1.7 Outreach Expansion:

The Islamic Banking Institutions (IBIs’) branch network is however largely

Table 4.3 Islamic Banking Branch Network

Al Baraka Islamic Bank 29

Askari Bank Limited 29

Table 4.4 Province wise Break-up of Islamic Banking Branch Network