The Chairman of National Commission for Government Reforms, Dr Ishrat Husain, has said that Islamic finance can be a powerful tool for growth of economy and amelioration of the condition of the poor in the Muslim countries.
He was speaking at the inaugural session of third annual international conference on Islamic banking here on Wednesday. He said that most of the attention on Islamic finance had so far been focused on regulatory characteristic, Shariah-compliance and expansion and penetration issues. Very little work has been done to explore the unique features of Islamic finance for the larger good of the society, particularly in the context of economic growth and poverty alleviation, he added.
He observed that in Islamic economic model the market mechanism makes the allocation and distribution of resources subject to a double layer of filters. Unlike the Western model, the Muslim is not expected to behave in a way that is exclusively concerned with his immediate self-gratification. The resource that initial resource endowments are able to exercise in the allocation and distribution of resources may be reduced substantially. This may induce individuals to voluntarily hold their claims on resources within the limits of general wellbeing and thus create harmony between self-interest and social interest even when the two are in conflict.
He said that the distortions in the capitalist system, created by excesses of individual greed through profiteering, black-marketing, hoarding, collusion, adulteration and cheating are non-existent among the true followers of Islam. This makes the Pareto optimal solution of the market economy under the Islamic system superior to that prevailing under pure capitalist system. The promotion of simple living and the reduction of wasteful and conspicuous consumption helps reduce excessive claims on resources and thereby release a greater volume of resources for need-fulfilment by others who are not so well off. It may also help promote higher savings and investment and thereby raise employment and growth which will have positive impact on the economic conditions of the poor.
At the macro level, Islamic economic model in its ideal form tends to combine the positive aspects of the capitalist economy and socialist economy while minimising their negative consequences. The capitalist economy based on private property and market mechanism allocates resources efficiently but as it takes initial resource endowment as given, equity considerations do not figure in this system. Islamic system overcomes the deficiencies of both systems as it is solidly based on private property and market mechanism but has also explicitly built-in equity and distribution through compulsory deduction of Zakat ie transfer payments from the asset holders to the poor segments of the population. Islamic economic model addresses the distribution issues explicitly after growth takes place and market has allocated the gains. It does so by a compulsory deduction of 2.5 percent of tangible wealth and net asset holdings from the incomes generated by the market mechanism for transfer among the vulnerable, sick, handicapped, indigenes and poor segments of the society.
He said that only really deserving persons and families or 'mustahaqeen' receive these payments and, in Pakistan it is estimated that private transfers made voluntarily to the poor account for two percent of GDP annually. These welfare payments are a potent force in reducing poverty, helping the vulnerable to earn their own livelihood and lower income disparities.
At the sectoral level, the introduction of Islamic banking has promoted financial inclusion by bringing those who have so far remained outside the conventional banking system, thus deepening the financial sector. There are believers in Islamic Faith who do not use the conventional banking system because of their strongly held views that this system is based on Riba. They are, however, willing to deposit their savings into Islamic banks and eager to borrow from these banks for expansion of their businesses or new investment. Thus, a significant segment of population, particularly in the rural areas, shanty towns in urban centres, comprising of small and medium entrepreneurs, small farmers and self-employed persons that is currently outside the organised financial sector will be brought into its fold.
During last eight years the number of borrowers from the banking system in Pakistan has risen from one million to 5.5 million - an impressive rise. But this number can easily double if Islamic banks take measures to penetrate the above geographical areas and serve those who are currently outside the banking system. Access to agriculture credit, including livestock, fisheries, dairy, SMEs finance including small mining and transport enterprises, low-cost housing finance, etc, provided by Islamic banks would relax the credit constraint these individuals and businesses face today in expanding their businesses or investing in productivity or building assets.
He said that the conventional banks' presence is limited to metropolitan areas and big cities, and large rural areas are not served by them. Islamic banks can spread their geographical presence by locating their branches or other delivery channels in these potentially attractive but under-served areas and use IT tools and alliances with post offices and other distribution outlets to develop cost-effective business model. Rural areas in Pakistan are a reliable and sustainable pool for mobilising low-cost deposits which can provide a stable source of funding for Islamic banks that would not only cover their extra costs but also give them a competitive edge.
He said that microfinance is catching on quite rapidly in Pakistan. The recovery record of the poor, who are the main beneficiaries of microcredit, has proved to be quite robust even under adverse circumstances. But the penetration rates are still quite low while the scope for expansion is quite wide. He said that there is a huge demand for Islamic microfinance, and the mosques can be used as low-cost launching pad for reaching out the segment of the population that is quite hard to penetrate.
In order to win the confidence of future clients Islamic banks have to take extra precautions and safeguards to ensure that they meet the exhaustive requirements to be Shariah-compliant. The role of Islamic banks is not limited t passive financier concerned only with timely payments and loan recovery. The bank is in fact a partner in business and has to concern itself with the nature of business and profitability position of its clients.
He said that Islamic banks and Islamic financial institutions can accelerate their pace of expansion and this expansion would not only help in poverty alleviation but would also reduce income inequalities and foster inclusive growth.
The truth of the matter is that most of the poor possess only one asset ie their unskilled labour; but to produce income and take care of their consumption as well as investment needs they require some capital to add to their labour. This credit constraint can be eased by Islamic banks by locating their branches in under-served areas, catering to neglected economic activities, he concluded.