Islamic finance on the fast growth trajectory in Pakistan: Islamic banking in Pakistan has shown robust performance since 2003, when State Bank of Pakistan (SBP) issued policies for the promotion of Islamic banking in the country.
Over the last three years, the Islamic banking industry has captured an estimated 2% or Rs 79 billion (US $1.32 billion) of banking assets reflecting strong demand of Sharia' compliant financial products. Furthermore, Islamic banking deposits reached Rs 54 billion (US $900 million) in March 2006, representing 2% of total banking deposits in the country.
This progress is commendable compared to other countries. According to Mr Pervez Said, Director Islamic Banking SBP, Islamic banking currently accounts for 12% of the market in Malaysia where it started in 1983 while in Indonesia it has been able to capture only 1% of the market since inception in mid-1990s.
Future outlook is positive. According JS Capital Markets, "Islamic banking is where the real growth charm for banks lies". Our analysis suggests that total Islamic banking deposits in Pakistan are set to reach Rs 780 billion by 2014, seeking 10% share of the market.
The opportunity is significant and has attracted both new stand-alone Islamic banks and conventional financial institutions. Presently there are 4 full fledged Islamic banks operating in Pakistan, while 2 more banks have also been licensed. Further, 11 conventional banks are offering Islamic banking products as compared to only 3 in 2003. The market is currently being serviced through a network of 110 Islamic banking branches that are expected to double in the next 12-18 months.
REGULATORY SUPPORT: SBP is championing the cause of promoting Islamic banking in the country through a measured, comprehensive approach. The Islamic Banking Department at SBP has formed a broad regulatory framework aimed at the establishment and promotion of an Islamic banking system in line with best international practices. Further, SBP has issued "Essentials and Model Agreements for Islamic Financing" that serve as the benchmark for developing Sharia' compliant products. The Central Bank has also formed a Task Force to map out a plan for introducing short term and medium term liquidity management products based on innovative Islamic structures. These measures are primarily demand-driven and provide an option to the customers to choose between the two banking systems in accordance with their preference.
A FAVORED INVESTMENT AVENUE: Pakistan has emerged as an attractive investment destination for GCC investors and Islamic banking is the favoured asset class both in the GCC and Pakistan. Over the last 12 months, several institutions have invested, or are in the process of investing in Pakistan via Islamic banking channel. These include Dubai Islamic Bank, Dubai Bank, Unicorn Investment Bank, Bank Islam Malaysia and Abu Dhabi Islamic Bank.
The trend is reflective of the market sentiment in the GCC that has seen a number of conventional banks transform into Sharia' compliant institutions over the recent years. A prime example is the National Commercial Bank in Saudi Arabia that has transformed its entire retail banking operation to be Sharia' compliant. The investor response to new Islamic banks has been particularly rewarding for the shareholders. One example is the Islamic Bank of Britain (IBB) that was set up in the UK by Arab investors. The market value on IPO of IBB was 415% of its original investment (6p shares priced at 25p).
CHALLENGES: Islamic finance industry in Pakistan is still in its infancy. Infrastructure support, through institution building, human resource development, product innovation and a favourable operating environment, will determine future growth of Islamic finance industry. All stakeholders including industry players, regulators, infrastructure institutions and academia will have to work jointly to meet these challenges.
GLOBAL ISLAMIC INFRASTRUCTURE INSTITUTIONS: Seven think tanks supporting global Islamic finance industry include Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), Islamic Research and Training Institute (IRTI), International Financial Services Board (IFSB), International Islamic Financial Market (IIFM), Liquidity Management Center (LMC), International Islamic Rating Agency (IIRA) and General Council for Islamic Banks and Islamic Financial Institutions (GCIBFI).
AAOIFI, based in Bahrain, is involved in setting accounting, auditing, governance and Sharia' standards for the Islamic finance industry. To date, AAOIFI has issued 56 standards which have been successfully implemented in Bahrain, Malaysia, Sudan, Jordan, Qatar and Saudi Arabia. The Institute of Chartered Accountant (ICAP) is developing Islamic accounting standards in Pakistan.
IRTI, a member of the Islamic Development Bank (IDB) Group, has undertaken numerous theoretical and applied research studies and also sponsors training facilities for professionals in member countries. In current scenario, the potential global Islamic banking training industry is conservatively estimated at US $50 - 75 million per annum. The key impetus is provided by the GCC markets where a number of well capitalised, new Sharia' compliant financial institutions are being launched, and several existing institutions are either fully transforming to Sharia' compliant banking or are adding Islamic windows to their current offerings.
IFSB has been established in Malaysia to develop regulatory and supervisory standards for the Islamic banking and finance industry. Since its inception in 2002, IFSB has gained support of 94 members including World Bank, IMF, Bank of International Settlements, Asian Development Bank and SBP.
Bahrain based IIFM is responsible for the development of the global primary Islamic capital and short term financial market and, subsequently, for the creation of a secondary market for Islamic financial instruments. Dearth of Islamic financial instruments and absence of a secondary market are the most serious issues being faced by Islamic banks globally. Consequently, liquidity management is far more challenging for Islamic banks compared to their conventional counterparts. Islamic banks are not able to optimise returns through effective liquidity management.
LMC, brainchild of Bahrain Monetary Agency (BMA), is an active player in the development of short term treasury products. It is currently focusing on asset securitization business.
"Sustained growth of Islamic capital markets and Sharia' compliant financing is dependent on the independent evaluation of issuers", according to Mr Jamal Zaidi, Chief Executive Officer of IIRA. Based in Bahrain, IIRA has recently started operations and will offer sovereign ratings, credit ratings, Sharia' quality ratings and corporate governance ratings. Institutions from Pakistan are amongst the founding members of IIRA, a factor that should facilitate knowledge transfer.
IDB and many other Islamic Financial Institutions have jointly formed the GCIBFI that performs the important task of raising awareness and enhancing visibility of Islamic finance. The objective of this entity is to help integration of Islamic banking in the global financial markets.
NEXT STEPS: Islamic finance in Pakistan can reach its full potential if a holistic approach is adopted by all stakeholders in the industry. In addition to establishing Islamic commercial banks, efforts should also be made to encourage other Islamic finance institutions ie Takaful companies, investment banks, asset management companies and Islamic bond houses.
Islamic financial institutions should focus on product development to provide complete business solutions to their clients. Experiences from the Gulf region and Malaysia should be reviewed to ensure that the best practices from these markets are introduced in Pakistan. Serious initiatives are required in the area of Islamic banking and finance training to develop local expertise. In Pakistan, the projected growth of Islamic banking according to our research suggests a training market of approximately US $2 million per annum by 2014. Clearly, there is strong potential for focused knowledge institutions with a national and regional mandate.
A number of Pakistani bankers have been involved in developing pan industry institutions abroad. Further, SBP is an active member of a number of such institutions. Islamic finance industry in Pakistan can leverage this expertise to establish on ground think tanks in association with global infrastructure institutions.