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Supervised by: DR.NAILA NAZIR Submitted by: AMJAD ULLAH (DAWAR) M.Sc Final Year
DEPARTMENT OF ECONOMICS
UNIVERSITY OF PESHAWAR
GROWTH OF ISLAMIC BANKING IN PAKISTAN
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
UNIVERSITY OF PESHAWAR
It is Recommended That the Thesis Prepared by
GROWTH OF ISLAMIC BANKING IN PAKISTAN
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, Department of Economics University of Peshawar External Examiner:
Department of Economics
UNIVERSITY OF PESHAWAR
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.
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
i. Acknowledgement ii. Abstract Chapte#1 INTRODUCTION
1.1 1.2 1.3 1.4 1.5 Introduction Purpose of Study Research Objectives Limitation of the Study Organization of the Study
i ii 1
1 6 7 7 8
Chapter#2 LITERATURE REVIEW Chapter#3 RESEARCH METHODOLOGY
3.1 3.2 3.3 3.4 3.4.1 3.4.2 3.5 3.5.1
16 16 17 17 17 17 17 17
Research Methodology Mode of Observations Field Data Collection Sampleling Design Target Population Size Sample Size Data Collection Methods Data collected sources
GROWTH AND PROBLEM OF ISLAMIC BANKING
4.1 4.1.1 4.1.2 4.1.3 4.1.4 4.1.5 4.1.6 4.1.7 4.1.8 4.1.9 4.1.10 4.1.11 4.1.12 4.1.13 4.1.14 4.1.15 4.2 4.2.1 4.2.2
Growth of Islamic Banking Growth Shariah Compliance Development Shariah Standards Current Industry Review Industry Progress and Market Share Operating Performance Outreach Expansion Asset Quality Financing Products Sectoral Concentration of Financing Investments Deposits Mobilization Maturity Profile Prospects Agriculture Problems and Issues Taxation Issues Financial Reporting and Accounting Standards
18 18 20 22 22 23 26 28 33 34 36 37 38 40 41 46 47 47 48
4.2.3 4.2.4 4.2.5 4.2.6 4.2.7 5.1 5.2 6.1 6.2
Islamic Export Refinancing Scheme Lack of Expertise Other Initiatives Network Issues Lack of Awareness Customer Preferences Customer Understands Main Findings And Conclusions Recommendation
49 50 50 51 52
Chapter#5 RESULT AND DISCUSSION Chapter#5 MAIN FINDINGS AND CONCLUSIONS QUESTIONNAIRE REFERENCES
CHAPTER# 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
1 (Source: 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
(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 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 IndoPak 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 countrywide. 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 8 Total Assets Share in industry Growth (YoY) Deposits Share in industry Growth (YoY) Net Financing & Investment Share in industry Growth (YoY) Total Islamic Banking Institutions Total No. 0f Branches 411 6.1 31.3 330 6.4 38.6 23.5 4.6 21.2 19 667 366 5.6 32.7 283 5.9 39.9 226 4.5 21.3 19 651 276 4.9 34 202 4.8 37.4 235 4.6 21.2 18 515 206 4 73.1 147 3.8 75 138 3.5 89 18 289 June. 07 Dec.0 6 119 2.8 65.3 84 2.6 68 73 2.3 52.1 16 150 71 2 63.6 50 1.8 66.7 48 1.7 60 11 70 44 1.5 238.5 30 1.3 275 30 1.3 200 11 48 13 0.5 8 0.4 10 0.5 4 17 Dec.05 June.04 Dec.03
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
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 (Capital- Net NPAs) to Total Assets Assets Quality Ratio NPFs to Financing Net NPFs to Net Financing Provisions to NPFs Net NPAs to Total Capital Real estate financing to Total Financing FCY Denominated Financing to Capital Earnings and Profitability Net Income to Total Assets (ROA) Return on Equity (ROE) Net Interest Income to Gross Income Non- Interest Income to Gross Income Trading & Fx Gains (Losses) to Gross Income Operating Expense to Operating Expense Spread Between Financing & Deposit Rate Liquidity Liquid Asset to Total Assets Liquid Asset to Deposits Avg. Matunity of Liabilities (Days) Avg. Matunity of Assets (Days) 24.8% 32.6% 308.25% 708.43% 26.8% 34.5% 387.6%1 638.72% 25.8 32.2 383.55 595.73 34.2 45.3 417 594 0.8% 6.0% 82.0% 18.0% 6.1% 65.1% 29.7% 7.1% 0.8% 7.0% 81.1% 18.9% 7.0% 70.2% 32.2% 7.7% 0.8 6.9 80.7 19.3 8.0 71.8 32.1 7.7 1.1 10.8 74.7 25.3 7.8 52.6 36.7 6.9 7.0% 12.4% 5.0% 2.4% 54.4% 11.6% 10.8% 11.1% 11.4% 9.6% 7.3% 3.8% 50.0% 15.8% 11.3% 5.8% 10.4 9.2 6.5 2.8 58.8 11.5 10.8 9.6 9.9 8.2 12.9 3.8 73.2 17.2 2.3 16.1
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
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 suboptimal 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 BankIslami Pakistan Limited
Dawood Islamic Bank Limited Dubi Islamic Bank Pakistan Limited Emirates Global Islamic Bank Limited Meezan Bank Limited
42 36 58 181
Islamic Branches of Conventional Banks
Askari Bank Limited Bank Alfalah Ltd Bank Al Habib Faysal Bank Limited Habib Bank Limited Habib Metropolitan bank MCB Bank Limited National Bank of Pakistan Soneri Bank Limited Standard Chartered Bank The Bank of Khyber The royal Bank of Scotland United Bank Limited
29 06 60 10 11 04 11 08 06 11 19 03 05
Askari Bank Limited Banklslami Pakistan Limited Dawood Islamic Bank Limited Emirates Global Islamic Bank Limited Meez Bank Limited
The bank of Khyber Sub Total Grand Total Table 4.4
02 32 08 02 21
03 68 667
Source: Banking Policy & Regulations Department, State Bank of Pakistan.
Province wise Break-up of Islamic Banking Branch Network Type Islamic Banking Type Islamic Branches of Conventional Banks
Bank Name Askari Bank Limited Bank AL Habib Ltd Bank Alfalah Ltd Bank Albaraka Islamic Habib Bank Ltd Banklsiami PakistanBank Ltd Habib Metropolitan Ltd MCB Bank Limited Dawood Islamic Bank Ltd National Bank of Pakistan Soneri Bank Ltd Dubai Islamic bank Pakistan Ltd Standard Chartered Bank Pak Emirates Goble Islamic Bank Ltd
Bolochistan 2 1 1 1 8
Federal 1 Capital
Punjab 14 2 39 15 4 30 1 5 18 3 1 16 3 27
Sindh 7 2 14 8 3 23 3 3 20 2 2 11 3 20
Grand Total 29 6 60 29 11 70 4 11 42 8 6 36 11 58
1 1 2
3 2 1 2 1 2 1 2 1 2 9 19
5KP 1 33 2 5 1 1 1 14 3 6 17 36 12 1 2
1 1 1 3 1 3
Meezan Bank Limited IB.Total The Bank of Khyber The Royal Bank of Scotland United Bank Limited Faysal Bank Limited SAIBBs Total
4 19 2
84 1 190 3 1 3 4 83
65 147 2 2 1 3 47
181 416 19 3 5 10 183
1 2 8
Type Sub Branches
Askari Bank Limited BankIslami Pakistan Ltd Dawood Islamic Bank Ltd Emirates Global Islamic Bank Meezan Bank Limited The Bank of Khyber Sub Branches Total Grand Total 1 3 1 3 1 1 1 7 5 32 2 1 5 73 11 1 24 297 2 9 3 1 14 5 1 7 1 29 223 2 32 8 2 21 3 68 667
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
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 Arifwala Attock Bahawalpur Chahwal Daska Dera Ghazi Khan Faisalabad Gojra Gujar Khan Gujranwala Gujrat Hafizabad Jaranwala Jhang Jhelum Kamoki Kasur Khanewal Khushab Lahore Mandi Bahauddin Main Channu Mainwali Multan Okara Pakpattan Pindi Ghaib Rahim Yar Khan Rawalpindi Sadiqabad Sahiwal Sargodhe Sheikhupura Sialkot Texila Taba Tex Singh Vehari Wah Cantt 1 4 3 2 1 2 27 1 1 10 9 2 2 3 4 1 2 1 4 113 1 2 1 24 2 1 1 6 31 2 3 6 3 13 1 1 4 2 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67
Abottadad Bannu Batkhela Charsadda Chitral Dera Ismail Khan Hanged Haripur Koht Manshra Mardan Mingora Nowshera Peshawar Swabi Tank Timergara 11 1 1 1 1 3 1 3 2 6 5 1 3 29 2 1 1
68 69 70 71 72 73 74 75 76 77 Chaman Gawadar Hub Chowki Kuchlack Loralai Muslim Bagh Pishin Qilla Saifullah Quetta Zhob 1 1 1 1 3 1 1 1 22 1
78 Islambad 32
79 80 81 Giligit 1 4 3
39 40 41 42 43 44 45 46 47 48 49 50 Badin Hyderabad Karachi Larkana Matiari Mirpur Khas Nawabashah Sakarand Sanghar Sukkur Tando Adam Tando Allahyar 1 17 185 1 1 3 4 1 2 5 1 2
Mirpur AJK Muzaffarabad
Pujab Total Sindh Total KP Total Balochistan Total Federal Capital Total Northern Areas Total Azad Kashmir Total
297 223 73 34 32 1 7
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
NPF Provision Net NPF NPA Net NPAs Jun-09 1,803.2 788.7 1,014.4 1,953.2 1,030.9 Mar-10 11,871.3 5,935.7 5,935.6 13.628.6 6,659.8 jun-10 10,649.9 6,261.8 4,388.1 12,454.4 4,921.1 YoY 490.6 693.9 332.6 537.7 377.4 QoQ -10.3 5.5 -26.1 -8.6 -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 Nonperforming 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 endJune 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
Murabaha Ijarah Musharaka Mudaraba Diminishing Musharaka (DM) Salam Istisna Others Total Murabaha Ijarah Musharaka Mudaraba Diminishing Musharaka (DM) Salam Istisna Others Total
Jun-09 58.0 26.2 3.7 0.9 45.3 2.9 4.8 2.3 144.3 40.2 18.2 2.6 0.7 31.4 2.0 3.3 1.6 100.0
Mar-10 60.8 22.7 2.8 0.4 51.3 6.5 10.6 7.0 162.1 37.5 14.0 1.7 0.2 31.7 4.0 6.6 4.3 100.0
Jun-10 72.4 23.8 6.0 0.4 46.4 3.2 6.4 5.4 164.0 44.1 14.5 3.7 0.2 28.3 2.0 3.9 3.3 100.0
Source: Annual Accounts except for June 2010, data for which is based on Unedited Quarterly Accounts
The financing through 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
Chemical and Pharmaceuticals Agribusiness Textile Cement Sugar Shoes and Leather garments Automobile and transportation equipment Financial Insurance Electronics and electrical appliances Production and transmission of energy Individuals Others Total Jun-09 7.1% 1.0% 20.5% 2.2% 2.8% 1.6% 2.6% 1.1% 0.0% 1.1% 4.5% 22.8% 36.4% 100.0% Mar-10 10.5% 0.6% 20.6% 2.8% 6.0% 1.2% 2.0% 1.0% 0.0% 1.0% 4.5% 20.1% 31.6% 100.0% Jun-10 9.1% 1.1% 18.3% 3.5% 3.6% 1.1% 1.9% 1.3% 0.0% 0.9% 4.8% 19.1% 36.4% 100.0% Industry 4.1% 5.8% 16.9% 2.5% 2.3% 0.6% 1.6% 1.2% 0.0% 1.6% 9.4% 12.8% 41.1% 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.
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
Federal Government Securities Fully paid up ordinary Shares TFCs, Debentures, Bonds, & PTCs Other investment Investment by type Held for trading Available for sale Held to Maturity Surplus/ (deficit) on revaluation Net investments Jun-09 17,073.6 1,678.5 19,408.3 15,891.9 -------127.6 39,904.9 11,211.4 (31.8) 53,539.8 Mar-10 27,081.1 1,997.9 24,866.2 19,564.4 ---------------59,147.0 11,465.8 254.3 72,892.7 Jun-10 27,032.7 1,757.6 26,173.8 23,841.6 --------------64.717.5 11,697.2 110.7 77,999.7 YoY 58.3 4.7 34.9 50.0 ---------------62.2 4.3 (447.9) 45.7 QoQ (0.2) (12.0) 5.3 21.9 --------------9.4 2.0 (56.4) 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.
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
Deposits Customers Fixed Deposits Saving Deposits Current Accounts- Remunerative Current Accounts- Non Remunerative Others Financial Institutions Remunerative Deposits Non-remunerative Deposits Currency Wise Local Currency Deposits Foreign Currency Deposits 255,474.1 12,694.5 238,168.5 219,079.4 88,871.8 75,176.1 --------53,165.4 1,866.1 19.089.2 19.039.8 49.4
289,090.3 274,106.4 113,179.6 94,321.1 ---------64,086.7 2,518.9 14,983.8 14,813.4 170.5
329,778.3 308,067.0 123,484.7 105,162.7 ----------76,676.9 2,742.7 21,711.3 21,340.1 471.2
38.5 40.6 38.9 39.9 -----44.2 47.0 13.7 12.1 651.3
14.1 12.4 9.1 11.5 -----19.6 8.9 44.9 44.1 117.7
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 3month 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 Maturing upto 3 months Maturing from 3 months to 1 yr Maturing from 1 yr to 5 yrs Maturing after 5 yrs Maturing upto 3 months Maturing from 3 months to 1 yr Maturing from 1 yr to 5 yrs Maturing after 5 yrs Maturing upto 3 months Maturing from 3 months to 1 yr Maturing from 1 yr to 5 yrs Maturing after 5 yrs 37.7 22.5 26.4 13.3 58.6 25.2 11.0 5.2 (20.9) (2.7) 15.4 8.0 Mar-10 40.1 22.8 26.7 10.4 51.7 28.2 14.9 Jun-10 Assets 42.9 22.6 25.1 9.4 Liabilities 54.3 25.5 15.0 43.4 27.0 17.8 11.9 55.8 21.3 16.9 Industry
5.2 5.2 6.0 Gap- asset share minus liabilities share (11.7) (5.3) 11.8 5.2 (11.4) (3.0) 10.1 4.3 (12.4) 5.7 0.8 6.0
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 countrywide 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)
Expected Deposit Size Annual Growth Rate Expected Financing Size Annual Growth Rate 2008 215,938 -------184,641 -------2009 340,128 58% 277,153 50% 2010 499,036 47% 413,594 49% 2011 722,109 45% 600,014 45% 2012 907,064 26% 731,591 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 Expected Volume % of Islamic Banking Financing Annual Growth Rate 2008 10 0.01% ----------2009 100 0.04% ------900% 2010 500 0.1% -------400% 2011 1000 0.2% --------100% 2012 2000 0.3% --------100%
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 Expected Volume % of Islamic Banking Financing Annual Growth Rate 2008 370 0.2% ----------2009 1400 0.5% ------278.4% 2010 4100 1% -------193% 2011 12000 2% --------193% 2012 21000 3% --------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 18-30 31-40 yr 41-50 yrs 51-60 yrs 61 above I.B. responses 28 72 126 59 15 % 9.3 24 42 19.7 5 C.B. responses 18 52 66 60 104 % 6 17.33 22 20 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 Male Female 300 0 100 0 % CB Responses 300 0 % 100 0
Source: Primary Data 2010-2011
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 B. Intermediate C. Graduate D. Ph.D
IB Responses 16 91 193 0
% 5.3 30.34 64.3 0
CB Responses 116 82 102 0
% 38.7 27.33 34.0 0
Source: Primary Data 2010-2011
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 B.8001-12000 C.10001-12000 D.12001-15000 E. More than 15000 IB Responses 10 17 29 93 151 % 3.0 5.67 9.67 31.0 50.3 CB Responses 190 67 24 11 8 % 62.33 22.33 8.0 3.67 2.67
Source: Primary Data 2010-2011
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 Borrowings Others IB Responses 191 38 71 % 63.67 12.66 23.67 CB Responses 178 43 79 % 59.33 14.34 26.33
Source: Primary Data 2010-2011
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 No IB Responses 289 11 % 96.33 3.67 CB Responses 263 37 % 87.67 12.33
Source: Primary Data 2010-2011
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)
Yes No No reply IB Responses N/A N/A N/A CB Responses 211 10 79 % 70.33 3.33 25.33
Source: Primary Data 2010-2011
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)
RIBA Higher Profit Other I.B Responses N/A N/A N/A C.B Responses 213 52 35 % 71 17.33 11.66
Source: Primary Data 2010-2011
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?
Table 5.9 (300 responses from each bank)
Yes No No Reply I.B Responses 231 13 56 % 77.0 4.3 18.7 C.B Responses 194 17 89 % 64.7 5.7 29.6
Source: Primary Data 2010-2011
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.
Table 5.10 (300 responses from each bank)
I.B Responses Agree Disagree Don’t Know 226 13 61 % 75.3 34.33 20.33 C.B Responses 234 6 23 % 89 2.3 8.7
Source: Primary Data 2010-2011
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.
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 ribaprohibition 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.
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
Name: Bank: ------------------------------------------------Male Female
A: Islamic banking B: Conventional Banking Age group:
A. 18-30 D. 51-60 B. 31-40 E. 61 above C. 41-50
A. High School C. Graduate
B Intermediate D.Ph.D
B.8001-12000 C.10001-12000 E. More than 15000
For what purposes do you use this Bank? Investment/Saving Borrowi1ngs Others
Do you understand the key concepts of Islamic banking?
If you have an opportunity to open an account with Islamic bank, would you transfer your account to Islamic bank?
Q.No 4 would you please tell us the reason for the transfer of your
Q.No 5 Would you continue to deal with Islamic bank even if its services charges are higher than the conventional banks?
Do you agree? Islamic Banks can contribute more to the societal balance, human prosperity and welfare.
AMJAD ULLAH MSc Economics Final Peshawar University. Cell phone: 0308-8080101
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