Share of Islamic banking is still hovering around 3% of the total banking sector of the country which showed the Islamic banking has little chance to emerge as the parallel banking system in the country.
The growth of Islamic banking as 'rapid pace of growth', but the details showed that neither the pace of growth matched with the growth in conventional banking, nor its share was improving to capture a bigger piece of cake. The total banking assets of the Islamic banking increased from Rs 118 billion in December 2006 to Rs 136 billion in March 2007. However, its shares in terms of asset percentage of banking industry were just 3.2% while comparing conventional banking assets.
The size of the conventional banking has been increasing rapidly for the last four years which left the Islamic banking far behind in the race for banking market. In terms of deposits, Islamic banking share was 3% of total banking deposits, though the size of deposits increased substantially during the last 15 months. The deposit rose to Rs 83 billion in December 2006 from Rs 50 billion in December 2005. It further rose to Rs 93 billion in the first quarter of 2007 till end of March 2007.
Murabaha financing is almost 40% of the total financing by the Islamic banking institutions as of the quarter ending March 2007. Second most widely used mode of finance is Ijarah financing accounting for about 30% of the total financing. Growing interest in diminishing Musharakah is depicted representing 17% of the total financing. This was not encouraging for the growth of the Islamic banking. However, financial position of the Islamic banking industry is strong and earning and profitability ratios have improved.
Recently State Bank of Pakistan (SBP) has allowed Islamic banks to make investment in shares in the ready, cash and future markets. Now Islamic banks may invest their surplus funds in shares of such companies whose primary business is not prohibited under Shariah.
On the other hand State Bank will also help to establish Islamic microfinance banks to service the low income segments. In this connection SBP has formulated guidelines for provision of Islamic microfinance services and products by financial institutions. These guidelines will allow the establishment of full fledged Islamic microfinance banks, microfinance services by Islamic banks, Islamic microfinance services by conventional banks and Islamic microfinance services by conventional microfinance banks. A number of microfinance banks are presently operational but no Islamic microfinance bank is there to offer financial products based on Islamic teachings.
In participatory modes four categories are of permissible of financing Modaraba, Musharaka, Diminishing Musharaka, Equity participation in forms of Shares. With regard to trade related modes, Ijara (Leasing), Murabaha, Musawama, Istijrar, Salam, Istinsa but Tawarruq would be allowed by the Central Bank in exceptional case.
Islamic banking in Pakistan is growing at an excellent pace. The Shariah-based lending in the country was introduced in 2002, when the State Bank of Pakistan issued the first Islamic banking license to Meezan Bank Limited. Since then the Islamic Banking sector in the country had been growing fast. On of the one hand a chain of new full-fledged Islamic banks is being developed gradually but steadily in Pakistan while on the other the existing commercial banks had been given license to undertake Islamic-mode of financing.
Number of full-fledged Islamic banks reached five from two at the end of 2005. At least 13 conventional banks have opened branches for Islamic banking while the total number of braches reached 170 from just 70 at the end of 2005. However, the growth of banking braches was significant while more full-fledged Islamic banks were coming to operate in the country. This indicates that there was potential of growth in this sector.
According to the State Bank of Pakistan, total assets of Islamic commercial banks of Pakistani origin had now increased from Rs 79 billion in 2004-05 to Rs 136 billion in March 2007. The deposit base of these banks had recorded growth and now these stood at Rs 93 billion.
Banking, being the most important sector of any financial system, it is importance remains the same in the Islamic financial operation also. Right from the time Pakistan came into being as an independent Muslim State, efforts were made to create an interest-free economy. The constitutions of 1956, 1962 and 1973 provided for various time spans to ensure total elimination of interest.
In September 1977, the then President of Pakistan entrusted the Council of Islamic Ideology with the task of preparing a blueprint for an interest-free economic system. In November 1977, the Council appointed a Panel of Economists and Bankers. The banker-members of the Panel were assigned the job of drafting a framework for interest-free commercial banking.
This sub-committee completed its report in January 1978. The Panel presented its full report in February 1980 and adopted it with certain modifications. This was presented to the Federal Government in June 1980. Effective from January 1, 1981, all domestic commercial banks were permitted to accept deposits on the basis of profit and loss sharing (PLS). Over the past few years, steps have been taken to develop new non-interest-bearing financial instruments with a view to facilitating investment by PLS deposits.
These include commodity operations of government and its agencies, export bills, investment in shares, purchase of participation term certificates (PTCs), provision of loans to specialised credit institutions, (which had already moved to non-interest-bearing operations), Musharakah (Partnership) lending, hire purchase, and Mudarabah certificates.
New steps were initiated on January 1, 1985, to formally transform the banking system in next six months, thus completing the first phase of bringing the entire financial system under Islamic principles. From that date, all finance was provided by banks to government, public sector corporations or private joint stock companies under the specified Islamic (non-interest-bearing) modes of financing. Nevertheless transactions with the government continued to be based on modern commercial interest. The state also obtained financing through the sale of bonds whose purchase by the private sector was facilitated by bank credit at fixed rates.
Effective from April 1, 1985, all finance provided to private sector entities, including individuals, become limited to the specified modes. Accordingly since July 1, 1985, banks have not been accepting any interest-bearing deposits, all existing deposits having become subject to PLS rules.
Deposits in current account continue to be accepted as in the past (no share in profits or losses of banks, equivalent to no interest). Foreign currency deposits and loans initiated from abroad, however, continue to remain exempted from the purview of new regulations. These practices naturally served as a façade for the Shariah based banking because the conventional interest-based system also continued side by side.
Three countries- Pakistan, Iran and Sudan-backed by experiences of the last few years, claimed that success in replacement of interest rate mechanism with non-interest-based modes and ensured financial stability of the system or effectiveness of their monetary policy. They simultaneously emphasised the need for developing global standards for Islamic banking.
State Bank of Pakistan has established Islamic Banking Department to give focussed attention to the area. The Central Bank is pursuing three-pronged strategy to promote Islamic Banking in Pakistan _ to establish full-fledged Islamic banks in the private sector; setting up of subsidiaries by the existing commercial banks; and separate branches for Islamic banking by the existing commercial banks. A Shariah Board is also in place at the State Bank of Pakistan, having experts to guide the Islamic banking industry.
The SBP has kept minimum capital requirement for interest-free banks at Rs 2 billion for a full-fledged bank/subsidiary and Rs 50 million for a branch. It has set cash reserve ratio with the Central Bank for Islamic banks at 11 per cent all in cash, while that for conventional banks it is 20 per cent, 15 per cent being the statutory liquidity requirement and 5 per cent in cash due to lack of Shariah-compliant government securities.
Islamic banks cannot maintain their liquidity requirement by securing government bonds as they are being offered to them at a fixed interest rate, and these rates do not conform to Shariah principles. Thus, Islamic banks can invest the difference between these two at four per cent in lucrative assets to compensate for the foregone return on government securities. Recently State Bank of Pakistan (SBP) has allowed Islamic banks to make investment in shares in the ready, cash and future markets.
Islamic banking industry has shown tremendous growth and its advances have increased six fold, which clearly sends a message that the Islamic banking is right on the growth path. Those who refused to acknowledge the phenomenon in the early days now are active participants and mobilising their efforts to tap into this fast-growing Islamic financial market. The West has also recognised the potential of this industry and a large number of Western banks have either established subsidiaries and/or opened Islamic banking window operations.
Now Japan is looking to become the first major industrialised nation to issue Islamic bonds in hopes of attracting money from oil-rich Muslim countries. Japan would be the first Group of Seven nation to issue the Islamic bond, called "sukuk" bond on a national basis, although companies in the developed world have already done likewise.
Demand for Islamic financing is growing in countries with significant Muslim populations, particularly in the Middle East. Largely Muslim Malaysia is the current Asian leader in Islamic banking after introducing services in 1983.
According to the International Monetary Fund, total world-wide assets of Islamic financial institutions exceed $400 billion and are growing 15 per cent annually.
Islamic banking and finance is likely to continue growing in the Asia Pacific region. The industry is set to develop its own identity separate from conventional banking as new Islamic financial products are rolled out, said the report by Financial Insights, a company under market research and analysis firm International Data Corp (IDC).The future for Islamic banking and finance in Asia looks bright and continued support by government authorities should ensure this future is grounded in strong, sensible regulation.
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