growth prospects of islamic banking in pakistan

Lubna Mueen Arbi (M.Com)The Islamia University of Bahawalpur

Growth prospects of Islamic Banking in Pakistan

SBP Internship Project 2

Freedom of Muslim world from colonial powers was almost accomplished in the second half of 20th century and

widespread revitalization of Islamic ideology took its path in Muslim societies. Whereby the people started looking at the

existing social systems through Islamic perspective and recommended modifications and improvements. The

Muslim scholars and philosophers challenged the world’s ruling economic and social systems and revealed their weaknesses. Capitalism system was scrutinized and criticized in depth due to its magnitude and general

acceptability in majority of leading societies of the world.

Evolution of Islamic Banking


QISMUT — Qatar, Indonesia, Saudi Arabia, Malaysia, UAE and Turkey —six regional global markets along with Bahrain, which

are important to the forthcoming internationalization of the Islamic banking industry. They grip a large pool of financial and intellectual capital of the industry that will drive the next wave

of development across existing and new markets. Islamic banks are already serving 38 million customers globally, two-thirds of whom are located in QISMUT. QISMUT Islamic banking assets have reached US$662b in 2013.And expect a CAGR of 19.7% through 2013–18, with total assets reaching US$1.6t

across these six important markets. Globally, Islamic banking assets are expected to grow to US$3.4t by 2018.

Evolution of Islamic Banking (continued)


• 1970s Some efforts started with no conspicuous results.

• 1980s Bold and comprehensive initiatives were undertaken. Pakistan was ranked amongst the three countries of the world for

commencing non-interest based banking. Various legislations (Companies Ordinance, 1984, Negotiable Instruments Act, 1882, State Bank Act and Recovery of Loans Laws etc. were reviewed to bring these in line with the tenants of Islam. A new interest free Instrument namely; PTC (Participation Term Certificate) for Corporate Financing was introduced and was later replaced with TFC(Term Finance Certificate). Non-Interest Based Instruments (NIB) were announced. In the Conventional Banks separate interest free counters were opened on January 01, 1981. For meeting working capital needs of trade and industry, Musharakah was introduced on July 01, 1982. Profit and loss sharing basis was introduced in Conventional Banks on April 01, 1985.

Islamic Banking History in Pakistan


• 1990s In November 1991, Federal Shariah Court was established. An announcement was made on December 23, 1991 that transactions involving interest in banks would cease to have effect finally by June 30, 2001.

• 21st Century Commission for Transformation of Financial System Bank of Pakistan. Task Force was set up in SBP to suggest ways and means to eliminate interest from Government financial transactions. However, parallel banking system namely; Conventional and Islamic Banking has continued till today.

Islamic Banking History in Pakistan (continued..)


Current status (In Pakistan)

Figure 1: Table 1 is taken from IBB March 2014 report presented by BBP


Money is not a commodity though it is used as a medium of exchange and store of value.

Profit on trade of goods or charging on providing service is the basis for earning profit.

Islamic bank operates on the basis of profit and loss sharing. In case, the businessman has suffered losses, the bank will share these losses based on the mode of finance used (Mudarabah, Musharakah).

The execution of agreements for the exchange of goods & services is a must, while disbursing funds under Murabaha, Salam & Istisna contracts.

Difference between Islamic and conventional banking


Islamic banking tends to create link with the real sectors of the economic system by using trade related activities.

The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller

Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed repayment of their funds,

The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation is being charged and these proceeds are given to charity.

Difference between Islamic and conventional banking (continued)


Islamic mode of financing • Sharia Based

financing• Sharia Compliance

Modes of financing

Range of Islamic products


•Mudarabah is a renowned type of Islamic partnership form whereby skill and money are brought together to conduct business. Profit is distributed according to agreement while loss is borne by capital provider (Rab ul maaL) only.

Mudarabah

• Musharakah is a joint enterprise formed conducting some business in which all partners share the profit according to pre decided ratio while loss is shared according to the ratio of contribution.

Musharakah

Sharia Based financing


1. Murabaha •Murabaha is used as successful substitute product for short term loans and overdraft under conventional banking.

2. Ijara •Ijara has substituted successfully the facility of leasing under conventional financial system.

3. Diminishing Musharakah

•Diminishing Musharakah is used for house financing by IFIs and has supplanted successfully conventional mortgages.

4. Bai Salam •Essentially Bai e Salam is used to fulfill financing of agricultural needs of farmers. Farmers in this contract sell their crops prior to harvesting to IFIs in order to get money for acquiring seeds and fertilizers.

5. Bai Muajjal •Literal meaning of Bai Muajjal is deferred / credit sales. Islamic financial Institutions (IFIs) are using this approach to finance the customers’ needs by supply of anticipated commodities. The modification between Murabaha and Bai Muajjal lies in cost disclosure.

6. Istasna •This tool of financing is useful for infrastructure projects. Parallel Istasna contract is allowed however performance of second Istasna contract must not be conditional on the fulfillment of first contract.

Range of Islamic products


• Meezan Bank

• Al Baraka Pakistan

• Bank Islami

• Burj Bank

• Dubai Islamic Bank Pakistan

Pakistan Islamic banking financial institutions


• "And whatever riba you give so that it may increase in the wealth of the people, it does not increase with Allah." [Surah Ar-Rum 30:39]

• "And because of their charging riba while they were prohibited from it." [Surah An-Nisaa 4-161]

• "O those who believe do not eat up riba doubled and redoubled." [Surah Al-e-Imran 3- 130]

Concept of Riba in Islam


• "Those who take interest will not stand but as stands whom the demon has driven crazy by his touch. That is because they have said: 'Trading is but like riba'. And Allah has permitted trading and prohibited riba. So, whoever receives an advice from his Lord and stops, he is allowed what has passed, and his matter is up to Allah. And the ones who revert back, those are the people of Fire. There they remain forever. Allah destroys riba and nourishes charities. And Allah does not like any sinful disbeliever. Surely those who believe and do good deeds, establish Salah and pay Zakah, have their reward with their Lord, and there is no fear for them, nor shall they grieve. O those who believe, fear Allah and give up what still remains of the riba if you are believers. But if you do not, then listen to the declaration of war from Allah and His Messenger. And if you repent, yours is your principal. Neither you wrong, nor be wronged. And if there be one in misery, then deferment till ease. And that you leave it as alms is far better for you, if you really know. And be fearful of a day when you shall be returned to Allah, then everybody shall be paid, in full, what he has earned. And they shall not be wronged." [Surah Al-Baqarah 2:275-281]

Concept of Riba (continued)


• From Hazrat Jabir (May Allah be pleased with him): The Prophet, cursed the receiver and the payer of interest, the one who records it and the two witnesses to the transaction and said: "They are all alike [in guilt]

• Jabir ibn Abdallah (May Allah be pleased with him), giving a report on the Prophets Farewell Pilgrimage, said: The Prophet addressed the people and said "All of the riba of Jahiliyyah is annulled. The first riba that I annul is our riba, that accruing to Abbas ibn Abd al-Muttalib (the Prophet’s uncle); it is being cancelled completely.

Hadith on riba and its exclusion from Holy Prophet (peace be upon him)


• Bayhaqi has also reported the above hadith in Shuab al-iman with the addition that "Hell befits him whose flesh has been nourished by the unlawful."

• From Hazrat Abu Hurayrah (May Allah be pleased with him): The Prophet said: "God would be justified in not allowing four persons to enter paradise or to taste its blessings: he who drinks habitually, he who takes riba, he who usurps an orphans property without right, and he who is undutiful to his parents."

Hadith Holy Prophet (peace be upon him) continued


2009 2010 2011 2012 20130

50

100

150

200

250

300

100 107

132

186199

100

125

162

225

266

HBL MBL

Financial Analysis(Growth in assets)


2009 2010 2011 2012 20130

50

100

150

200

250

300

350

100 109

137

178

205

100

131

169

230

289

HBL MBL

Deposit Accounts Growth


2009 2010 2011 2012 201372.00%

74.00%

76.00%

78.00%

80.00%

82.00%

84.00%

86.00%

88.00%

90.00%

78.30%

80.50% 80.51%

82.08%83.07%

84.73%

81.25%

86.22%

88.24%

86.94%

Chart Title

HBL MBL

Earning asset ratio


2009 2010 2011 2012 20130.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

8.69%

9.39%8.78%

7.39% 7.61%7.32%

6.94%6.64%

5.55% 5.43%

HBL MBL

Equity Capital to Total Assets


2009 2012 2011 2012 20130

2

4

6

8

10

12

14

16

18

9.0878.606

9.32310.208

10.72611.03812.204

12.762

14.872

16.183

HBL MBL

Deposits Times Capital


2009 2010 2011 2012 20130.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

67.40% 65.60%

53.40%

43.20% 42.70%

81%

54%

44%41%

47%

HBL MBL

Loans to Deposits


2009 2010 2011 2012 20130

0.5

1

1.5

2

2.5

3

3.5

2.475

2.924 3.012

2.208 2.107

1.401 1.374

2.322

1.8751.713

HBL MBL

Basic earning power


2009 2010 2011 2012 201387.00%

88.00%

89.00%

90.00%

91.00%

92.00%

93.00%

94.00%

95.00%

90.20%

89.60%

90.40%

91.70% 91.80%

92.80% 92.80%93.10%

92.40%

94.30%

HBL MBL

Debt ratio


2009 2010 2011 2012 20130.00%

0.50%

1.00%

1.50%

2.00%

2.50%

1.55%

1.84%1.96%

1.42%1.34%

0.83%

1.07%

1.69%

1.26% 1.20%

HBL MBL

Return on assets (ROA)


2009 2010 2011 2012 20130.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

17.80%19.60%

22.30%

19.10%

17.10%

11.20%

15.30%

25.40%

22.60%

18.90%

HBL MBL

Return on Common Equity


Vision Statement

To evolve a stable and distinct Islamic Banking System based on Shariah principles that creates value for all stakeholders particularly the users and providers of

Islamic financial services.

Role of state bank of Pakistan in Islamisation of banks


• Focal point for all Islamic banking functions, initiatives at SBP

• Strengthen the legal, regulatory and Shariah compliance framework for

Islamic banking Institution (IBIs)

• Adopt/adapt prudential standards issued by international organizations

such as IFSB, AAOIFI to harmonize the Shariah practices in Pakistan

• Steer/facilitate the SBP Shariah Board meetings, and Shariah Advisors’

Forum

• Shariah review of IBIs products

• Coordination with other departments for IBIs’ licensing and branch

licensing

Departmental Objectives


• Collaborate with ICAP for adoption of AAOIFI accounting

standards

• Industry capacity building initiatives, Awareness and promotion

program

• Focused research initiatives-both empirical and theoretical

• To leverage support from international infrastructure

institutions dealing with Islamic finance i.e. IFSB, IDB,

AAOIFI and IIFM for promotion of Islamic banking in

Pakistan.

• Issuance of Periodic Islamic banking bulletin and News Watch

Departmental Objectives contd..


IBD OrganogramDirector

Policy Division

Regulations Unit

Prudential Standard

Adoption Unit

Licensing and Coordination

Unit

Product Dev. and Review Unit

Shariah Division

Shariah Board Secretariat Unit

Shariah Standard Unit

Shariah Compliance Unit

Promotion & Dev. Division

Awareness Creation Unit

International Affairs Unit

Capacity Building Unit

Market Analysis and Research Division

Research Unit

Market Analysis Unit

Data Unit

Business Support Unit

Shariah Board Director's Staff


• Issuance of Shariah Governance Framework

• Issuance of Five year Strategic Plan for Islamic Banking Industry of Pakistan (2014-18)

• Completion of Knowledge, Attitude and Practices Study

• Awareness Creation

• Constitution of Steering Committee for Promotion of Islamic Banking

• Profit Distribution and Pool Management Framework

• Liquidity Management Framework

Recent Initiatives for Promoting Islamic Banking


• Justice and Objectivity: (equitable distribution of income and wealth)

• Liquidity Ease: (because Islamic banks don’t ensure fixed return to be paid even if bank itself suffered loss)

• Improved Customer Relations: (The banks are prospective to know their fund users better in order to ensure that the funds are used for productive commitments)

• No Fixed Commitments: (any prearranged fixed obligations such as interest payments on deposits)

• Transparency: (profit is distributed in the pre-agreed ratio)

• Ethical and Moral Scopes: (strong ethical and moral magnitudes of doing business and choosing business activities to be financed)

• Destabilizing Speculation:

• Banking for All:

Advantages of Islamic banking over conventional banks


• Shariah Elucidations (difference of opinions given by different shariah committee which create doubt in the mind of people.)

• Shariah Experts and Specialists: (availability to Islamic banking customers.)

• Product development and execution: . (Till now Islamic banks have altered products from conventional banking which creates doubts in the mind of a common user)

• Competition from conventional banking: (History and volume of conventional banks is much more then Islamic banks so it’s not easy to compare both in same scenario.)

Problems faced by Islamic institutions


• The major problem what I feel in Islamic banking is difference in international Islamic standard. And they must be synchronized throughout the globe.

• Difference of opinion in religious groups should also be dissolved by having common research platforms.

• Government should promote Islamic banking and give Islamic banks the relief for further promotion.

• Awareness among general public about the differences between Islamic and Conventional Banking.

Suggestions


• Research and development in the field of Islamic Finance for the development of new Islamic Banking Products.

• Training facilities for HR in Islamic Banking is needed because only Islamic system cannot be implemented if the employees are not equipped with the required Islamic banking training.

• University level courses in Islamic Banking and Finance should be introduced because there no specialized degree is yet been offered by any educational institution in Pakistan.

• Islamic banking research system.

Suggestions

growth prospects of islamic banking in pakistan

Economy & Finance

islamic banks

islamic banking industry

islamic banking history

islamic perspective

qismut islamic banking

status of islamic bank

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bbp sbp internship project