RESEARCH ON

Impact of Islamic banking on economic growth: A comparative study of

Pakistan

Supervised by

MR. SAJJAD

Submitted by

SEHRISH RAJA

ABDUL KARIM KHAN

MUHAMMAD OWAIS

State bank of Pakistan BSC

Peshawar

Session 2015-2016

1

TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION.........................................................6Background of the study..........................................................................................................................6

History and Evolution of Islamic Banking:.............................................................................................6

What is Islamic banking?........................................................................................................................7

Three main pillars of Islamic banking system.........................................................................................7

Shari’s supervision.......................................................................................................................7

Screening.....................................................................................................................................8

Community based investments....................................................................................................8

SOME OF THE BASIC MODES OF FINANCING OF ISLAMIC BANKS 8

MUSHARAKAH.......................................................................................................................................9

MUDARABAH.........................................................................................................................................9

MURABAHA..........................................................................................................................................10

IJARAH.................................................................................................................................................10

SALAM..................................................................................................................................................11

ISTISNA.................................................................................................................................................11

ECONOMIC DEVELOPMENT............................................................................................................11

Objectives of the study:.........................................................................................................................12

Significance of the study:.......................................................................................................................13

limitations of the study:.........................................................................................................................13

CHAPTER 2: LITERATURE REVIEW...........................................14

CHAPTER: 3 ANALYSES..................................................................19GROWTH ANALYSIS OF ISLAMIC BANKING IN PAKISTAN IN PAST 10 YEARS..........................................19

TABLE: 1.................................................................................................................................................19

DATA ANALYSIS:....................................................................................................................................19

TABLE: 2.................................................................................................................................................20

DATA ANALYSIS:....................................................................................................................................20

TABLE: 3.................................................................................................................................................21

DATA ANALYSIS:....................................................................................................................................21

2

TABLE: 4.................................................................................................................................................22

DATA ANALYSIS:....................................................................................................................................22

FINANCING PORTFOLIO OF ISLAMIC BANK............................................................................................23

DATA ANALYSIS:....................................................................................................................................23

CHAPTER 4..........................................................................................25POLICY RECOMMANDATIONS FROM THE LITERATURE:........................................................................25

RECOMMENDATIONS TO CONTROL POVERTY.......................................................................................25

MUSHARAKAH:..................................................................................................................................25

MUDARABAH:....................................................................................................................................25

SALAM:..............................................................................................................................................25

ISTISNA:.............................................................................................................................................26

Murabaha:.........................................................................................................................................26

IJARAH:..............................................................................................................................................26

MUSAWAMMAH:..............................................................................................................................26

RECOMMENDATIONS TO CONTROL UNEMPLOYEMENT...................................................................26

MUSHARAKAH:..................................................................................................................................26

MUDARABA:......................................................................................................................................26

SALAM:..............................................................................................................................................26

ISTISNA:.............................................................................................................................................26

RECOMMENDATIONS TO CONTROL ILLETARCY RATE............................................................................27

MUSHARAKAH:..................................................................................................................................27

SALAM:..............................................................................................................................................27

Recommendations to control inflation..................................................................................................27

MUSHARAKAH:..................................................................................................................................27

SALAM:..............................................................................................................................................27

ISTISNA:.............................................................................................................................................27

MURABAHA.......................................................................................................................................27

IJARAH:..............................................................................................................................................28

MUSAWAMMAH:..............................................................................................................................28

CHAPTER5: CONCLUSION.............................................................29

REFRENCES........................................................................................30

3

DECLARATION

We hereby declare that we are the author of this thesis; that the work of which this thesis is a record

has been done by us , and that it has not previously been accepted for a higher degree.

Signed:_________ Date: ________Mohammad Sajjad

4

CERTIFICATE

I certify that Ms. Sehrish Raja, Mr. Abdul Kareem, and Mr. Muhammad Owais have worked

upon the assigned topic “ Impact of Islamic Banking on Economic Growth of Pakistan”.

Signed:___________________ Date: ________________Mr. Mohammad Sajjad

5

CHAPTER 1: INTRODUCTION

Background of the studyIslamic banking has established itself as an emerging alternative to interest based banking and

has grown rapidly over the last two decades both in Muslim and non-Muslim countries. Islamic

banks have recorded high growth rates in both size and number and operate in over 60 countries

worldwide and bankers predict that Islamic banking could have control over 50% of savings in

the Islamic countries within the next decade. The practices and activities of Islamic banks reflect

the environment in which they are based. There are strong retail operations in Iran and Saudi

Arabia. In the secular societies of northern Africa, Islamic banks compete on the quality of

products rather than on religious grounds. In Kuwait, financing has focused on the petroleum

sector and real estate investment and in the United Arab Emirates; the emphasis is on trade and

finance.

History and Evolution of Islamic Banking:

The origin of Islamic banking system can be traced back to the advent of Islam when the Prophet

himself carried out trading operations for his wife. The “Mudarbah” or Islamic partnerships has

been widely appreciated by the Muslim business community for centuries but the concept of

“Riba” or interest has gained very little diligence in regular or day-to-day transactions.

The first model of Islamic banking system came into picture in 1963 in Egypt. Ahmad Al Najjar

was the chief founder of this bank and the key features are profit sharing on the non interest

based philosophy of the Islamic Shariah. These banks were actually more than financial

institutions rather than commercial banks as they pay or charge interest on transactions. In 1974,

the Organization of Islamic Countries (OIC) had established the first Islamic bank called the

Islamic Development Bank or IDB. The basic business model of this bank was to provide

financial assistance and support on profit sharing.

6

By the end of 1970, several Islamic banking systems have been established throughout the

Muslim world, including the first private commercial bank in Dubai(1975), the Bahrain Islamic

bank(1979) and the Faisal Islamic bank of Sudan (1977).

What is Islamic banking?Islamic banking is a financial system whose key aim is to fulfill the teachings of the Holy Quran.

The theory of Islamic banking is based on the concept that interest is strictly forbidden in Islam,

and that Islamic teachings provide the required guidance on which to base the working of banks.

The basic principle that has guided all theoretical work on Islamic banking is that although

interest is forbidden in Islam, trade and profit is encouraged.

Conventional banking uses the interest rate mechanism to carry out its financial operations.

Muslim scholars have developed a completely different model of banking that does not use

interest but rather relies on profit-loss sharing for purposes of financial intermediation. The basic

principle in Islamic law is that exploitative contracts or unfair contracts that involve risk or

speculation are impermissible. Under Islamic banking, all partners involved in financial

transactions share the risk and profit or loss of a venture and no one gets a predetermined return.

Three main pillars of Islamic banking system

Various pillars exist that allow Islamic banks to deliver competitive performance and promote

socially and ethically responsible business practices. Of these, the three main pillars that

contribute to improvements in quality of life throughout society include Shari’a supervision,

screening and community based investment.

Shari’s supervision

Shari’a supervision by a qualified Shari’a advisory board is an essential component of the

Islamic financial structure. The board consists of prominent scholars who are well versed in

Islamic law that relates to transactions and business dealings. The board is supposed to be

independent and screens investment strategies, implementation, monitoring and reporting.

7

Screening

The second main pillar known as screening, involves the activities of including or excluding

publicly traded securities from investment portfolios or mutual funds based on the religious and

ethical conditions of the Islamic law. Some businesses are not in keeping with Islamic laws and

the stocks from such companies are therefore excluded.

Community based investments

Community based investment programs provide capital to those who are unable to access it via

conventional channels. These community-based investments allow people to improve standards

of living and assist them to develop small businesses and create jobs.

SOME OF THE BASIC MODES OF FINANCING OF ISLAMIC BANKS

Islamic banks are mainly involved in trade activities through different modes of financing or

products which are given below;

Musharakah

Mudarabah

Murabaha

Musawammah

Ijara

Istisna

Salam

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MUSHARAKAHMusharakah means a relationship established under a contract by the mutual consent of the

parties for sharing of profits and losses in the joint business. Under Islamic banking, it is an

agreement under which the Islamic bank provides funds which are mixed with the funds of the

business enterprise and others. All providers of capital are entitled to participate in management

but not necessarily required to do so. The profit is distributed among the partners in pre-agreed

ratios, while the loss is borne by each partner strictly in proportion to respective capital

contributions.

MUDARABAH

A form of partnership where one party provides the funds while the other party provides

expertise. The people who bring in money are called "Rab-ul-Maal" while the management and

work is an exclusive responsibility of the "Mudarib". The profit sharing ratio is determined at

the time of entering into the Mudarabah agreement whereas in case of loss it is borne by the Rab-

ul-Maal only. In case of Islamic banks, the depositors are called Rabb-ul-Maal and the bank is

called Mudarib.

There are two types of mudarabah transactions that are stated below;

Al-Mudarabah Al-Muqayyada:

Rab-ul-maal who, in case of Islamic bank, is depositor specifies a particular business or a

particular place for the mudarib (bank), in which case he shall invest the money. This is called

Al-Mudarabah Al-Muqayyadah (restricted Mudarabah).

Al-Mudarabah Al-Mutlaqah:

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In case where Rab-ul-maal (depositor) gives full freedom to the Mudarib (bank) to undertake

whatever business he deems fit, this is called Al-Mudarabah Al-Mutlaqah (unrestricted

Mudarabah).

MURABAHAMurabaha is one of the most common modes used by Islamic Banks. It refers to a sale where the

seller discloses the cost of the commodity and amount of profit charged. Therefore, Murabaha is

not a loan given on interest rather it is a sale of a commodity at profit.

The mechanism of Murabaha is that the bank purchases the commodity as per requisition of the

client and sells him on cost-plus-profit basis. Under this arrangement, the bank is bound to

disclose cost and profit margin to the client. Therefore, the bank, rather than advancing money to

a borrower, buys the goods from a third party and sell those goods to the customer on profit. A

question may be raised that selling goods on profit (under Murabaha) and charging interest on

the loan (as per the practice of conventional banks) appears to be one of the same things and also

produces the same results. The answer to this query is that there is a clear difference between the

mechanism/structure of the product. The basic difference lies in the contract being used.

Murabaha is a sale contract whereas the conventional finance overdraft facility is an interest

based lending agreement and transaction. In case of Murabaha, the bank sells an asset and

charges profit which is a trade activity declared halal (valid) in the Islamic Shariah. Whereas

giving loan and charging interest thereupon is pure interest-based transaction declared haram

(prohibited) by Islamic Shariah.

IJARAHIjarah refers to transferring the usufruct of an asset but not its ownership.

Under Islamic banking, the bank transfers the usufruct to another person for an agreed period at

an agreed consideration. The asset under Ijarah should be valuable, non-perishable, non-

consumable identified and quantified. All those things which do not maintain their corpus during

their use cannot become the subject matter of Ijarah, for instance money, wheet etc.

10

SALAMSalam is a sale transaction in which full payment for the naturally made products are made fully

in advance while the delivery is made in future. Parallel salam is done here as a risk mitigation

tool to sell out the commodity obtained through salam contract. It’s mostly done for the

facilitation of small formers to fulfill their need of funds.

ISTISNAIstisna is same like a salam agreement done in the human made products here full payment in

advance is not necessary funds are made available with the progress of work and delivery is

made in future. Here parallel istisna can be done for the sake of risk mitigation.

ECONOMIC DEVELOPMENTAccording to the American economic development council (1984),

“Economic development is the process of creating wealth through the mobilization of human,

financial, capital, physical and natural resources to generate marketable goods and services”.

Economists today argue that “development is about outcomes, that is, development occurs with

the reduction and elimination of poverty, inequality, and unemployment within a growing

economy” (Dudley Seers: 1969)

The three main objectives of development are;

Producing more ‘life sustaining’ necessities such as food, shelter, and health care and

broadening their distribution

Raising standards of living and individual self esteem

Expanding economic and social choice and reducing fear. (Todaro & Smith)

The concept of the Islamic economic system as described in all its aspects focuses on the

worship of the creator, which includes man’s duty to develop life on earth, thus securing a decent

11

standard of living for the individual. Islam stresses that man is the principle agent for developing

life on earth and hence the development of man is a required condition for the development of

society.

The large number of economic ills, including poverty, social and economic injustice, inequalities

of income and wealth, economic instability and inflation of monetary assets are all in conflict

with the value system of Islam.

Therefore it is the responsibility of the money and banking system to contribute to the

achievement of socio-economic development and hence eliminate such economic ills. The

principle goals and functions of the Islamic banking system include economic well-being with

full employment and maximum rate of economic growth, equal distributions of income and

wealth and as a result socio-economic justice, and the generation of sufficient savings and their

productive mobilization and stability in the value of money.

This study is therefore conducted to see whether Islamic financial system has resulted in some

sort of economic growth, welfare and improvement in the living standard of individuals who

were not easily accessible to the conventional loans offered by conventional banks.

Objectives of the study:

To investigate the impact of Islamic banking on the economic growth of Pakistan through

a descriptive and inductive approach.

To suggest the policy recommendations

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Significance of the study:

The main purpose of this study is to specify the impact on Islamic banking on the economic

growth of Pakistan in the last 13 years from 2003 to 2015. This study is different from other

studies conducted in the past in a way that no study has analyzed the entire data of past 13 years.

The study has given certain recommendations regarding the role of Islamic banking in

controlling unemployment rate, poverty and inflation. The study has also proved the significance

of Islamic banks in improving the literacy rate.

limitations of the study:Among a number of limitations of the study the main limitation of this study is the non

availability of data on different variables.

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CHAPTER 2: LITERATURE REVIEW

There is much more inequality in the distribution of income and wealth today than there has ever

been in the past, both within and between nations. Inequality is growing and this is regarded as a

threat to the social and economic stability. A large part of the blame is laid on the monetary and

financial system.

This practice has its origins in the fact that western banking institutions have profitability rather

than social imperatives as their primary concern. The result of such practices is unequal income

distribution, highly skewed towards the wealthier portion of society, and unjustly deprives non-

property holders of gaining access to finance.

According to the World Bank research observer (1996), commercial banks prefer to lend to low-

risk activities and are reluctant to finance high risk projects, even if such projects, even if such

projects present better investments opportunities. They are also less willing to finance small

firms that don’t have adequate collateral.

In contrast, fostering serious economic development is a key objective of Islamic banks as they

seek to maximize social benefit. Islamic banks therefore work hard to overcome shortages and

difficulties to progress to a higher stage of self-sustained development, resulting in a favorable

effect on socio economic harmony due to equal distribution of income.

It has been widely claimed by development economists that policy and resource allocation is

strongly focused on large firms and that existing banking institutions prefer to grant credit

facilities to clients who are able to offer sufficient collateral security.

According to Abdouli (1991), Kahf Ahmad and Homud (1998), Siddiqi (2002), and Iqbal (1997),

maximizing of profitability is not only concern of Islamic banking institutes and the principles

that Islamic banks are based on are deeply integrated with ethical and moral values. They also

state that Islamic banks do not depend on tangible collaterals and lead to a better distribution of

14

income, allowing access to finance for those in poorer classes of society, and resulting in greater

benefits for social justice and long term growth.

In contrast with the conventional methods, Islamic financing is not centered only around credit

worthiness but rather on the worthiness and profitability of a project, and therefore recovering

the principle becomes a result of profitability and worthiness of the actual project.

Entrepreneurship and risk sharing are therefore promoted by Islamic finance and its expansion to

the non wealthy members of the society is an effective development tool. The social benefits are

clear, as currently the poor are often exploited by financial institutions charging usurious rates.

(Iqbal, 1997)

The nature of Islamic banking operations are directly affected by the success or failure of client

enterprises as a result of the profit-loss-sharing process (Abdouli, 1991). The relationship is

based on a partnership, with cash being entrusted to bankers for investement, and returns shared

between depositors and bankers. Losses are carried by fund owners. This sharing principle is

very different to traditional banking practices. It introduces the concept of sharing to financing

and creates a performance incentive within the mind of bankers that relates deposits to their

performance in the use of funds. This increases the deposit market and gives it more stability

(Kahf, 2002).

Iqbal (1997), Abdul-Fattah, Jabarti, and Sofrata (1984), and Ziauddin (1994) are the opinion that

Islamic bankers encourage people to invest as investment depositors receive a share in the banks

profits.

Investors are motivated by the human desire towards ownership, high rewards and the

satisfaction of being part of a success project ( martan et al, 1984). Issuers of the islmic finance

have wider latitude in financing services and negotiate a profit share between zero and 100 when

dealing with the savers and investors. This allows them to better mobilize resources and attract

investors as a higher profit share results in lower finance costs. (Ziauddin, 1994)

15

According to Iqbal (1997), the economic development of Islamic countries can be greatly

enhanced by the Islamic financial system due to the mobilization of savings that are being kept

awaya from interse based banks and the development of the capital markest. This motivation to

invest in Islamic banks may also stem from the fact that research shows that the share in the

banks profits may at tume be higher than the fixed rates of intersest given by conventional banks.

Some of the literature on islmic banks states that the replacement of interest by profit loss

sharing may result in high instability of the entire economic system a sprobelms originating in

one part of the economy will rapidly spread to other parts of the economy. However the general

consensus is that interest free banking tends to enhance stability and it is in fact the interste based

debt financing that contributes to economiv instability.

Islamic finance allows a closer link between real economic activity that creates value and

financial activity to be forced. Accoerding to iqbal (1997), the Islamic financial system can be

expected to be stable due to the elimination of debt financing and enhanced allocation efficiency.

Analytical models show that the Islamic banking system is stable as the term and the structure of

liabilities and assets are symmetrically matched through profit-sharing, lack of fixed interst costs

and the impossibility of refinancing through debt. (Yusri, 2005)

Chapra (1992), Kahf (1982), Siddiqi (1983) and Zarqa (1983) all support the idea that profit

sharing is more stable than the interest based system resulting in prevention of fluctuations in

rates of return. It has been pointed out that interest based debt financing is a major factor in

causing economic instability in capitalist economies. As soon as the bankers find that business

concerns are beginning to incur losses they reduce assistance and call back loans (Yusri, 2005).

In an Islamic banking system more stability is experienced as in times of crisis investment

depositors automatically share the risk due to profit-and-loss sharing, meaning that individual

banks as well as the entire banking system is less likely to break down (Zaher and Hassan, 2001).

16

The focus of Islamic finance on profitability and rate of return of investments due to equity and

profit sharing has the potential of directing financial resources to the most productive

investments and hence increases the efficiency of the financing process and in the real sectors

(Kahf et al, 1998).

Economic development requires mobilization of financial resources both internally and

externally and any resources left hoarded indicate unrealized potential for economic

development.

Qureshi (1984) and Nagvi (1981 and 1982) claim that Islamic bankers are increasingly exposed

to risk due to equity-based financing, however Islamic scholars believe that the elimination of

interest increases stability. In financial theory a linear relationship exists between risk and return,

meaning that low risk is associated with low return and high risk brings about high return.

(Chapra, 1992)

Risk is a key component of making investment and investors share the risk involved with those

carrying out investment activities. Islamic finance provides depositors with some influence on

investment decisions and gives banks and financial institutions a share in the decision making

process. This allows both risk and decision making to be spread over a much larger number and

variety of people, allowing wider involvement in economic activities (Ziauddin, 1994).

In a study by Turen (1996) on the risk analysis of Islamic banks, he states that as interest is

abolished for deposit holders and replaced by profit-sharing, the fixed interest payment is

minimized or eliminated and therefore Islamic banks experience higher coverage of interest

charge ratios and therefore lower financial risks.

A further study by Samad and Hassan (1997) that compares an Islamic bank with a group of

conventional banks shows that Islamic banks are less risky than conventional banks. Sarker

(1997), however, found that the risk involved in profit sharing is very high, but states that many

external factors and obstacles interfered with the proper implementation of the Islamic banking

system.

17

Sarker (1997), Samad and Hassan (1997), concluded that if Islamic banks are supported with

appropriate banking laws and regulation, they can provide efficient banking services which

encourage economic development.

From the literature it is evident that both theoretically and empirically, economists find Islamic

banking viable, acceptable and also efficient and significantly effective in developing the

economy.

18

CHAPTER: 3 ANALYSES

GROWTH ANALYSIS OF ISLAMIC BANKING IN PAKISTAN IN PAST 10 YEARS

TABLE: 1 DESCRIPTION Dec-

2003

Dec-

2004

Dec-

2005

Dec-

2006

Dec-

2007

Dec-

2008

Mar-

2009

Mar-

2010

Mar-

2011

Mar-

2012

Mar-

2013

Mar-

2014

Mar-

2015

ASSETS 13 44 72 119 206 276 278 371 497 644 847 1016 1302

% OF

BANKING

INDUSTRY

0.5% 1.5% 2.1% 2.9% 4% 4.9% 5.6% 6.7% 6.9% 7.7% 8.7% 9.4% 10.4%

Source: State Bank of Pakistan, Bulletin December 2003-2015.

Amount in billions

DATA ANALYSIS:If we talk about last ten years i.e. from 2003 to 2015, we will find sustained growth in all

respects and this fact is shown in the tabulation as well. In 2003 total assets owned by Islamic

banks were Rs. 13 billion which are now increased to Rs. 1302 billion and the share of Islamic

banking in the industry with respect to amount of asset was 0.5%, which now increased to 10.4%

in 2010.

As golden principles of Islam has suggested that real trade activity bring real increase in the

assets of a business which is clearly reflected in above mentioned statistics where the value of

assets has been increased from 2003 over the period of time up to 2015. Such increase occurs

due to the bank investment in different products. As the asset portfolio of Islamic banks increase

it encourage further trade activity and trade volume which would create many employment

opportunities and investment opportunities which will ultimately leads to the circulation of

wealth in several hands and economic activities will boost up. At the early stage of Islamic

banking in Pakistan a minor portion of Islamic banks business activities were contributing to the

economic development while with the passage of time awareness as well capital of Islamic banks

has been increased and effectively designed different products to utilize their funds in more

19

profitable opportunities that ultimately leads their contribution into the economic development of

Pakistan today upto 12%.

TABLE: 2

DESCRIPTI

ON

Dec-

2003

Dec-

2004

Dec-

2005

Dec-

2006

Dec-

2007

Dec-

2008

Mar-

2009

Mar-

2010

Mar-

2011

Mar-

2012

Mar-

2013

Mar-

2014

Mar-

2015

TOTAL

DEPOSITS

8 30 50 84 147 152 206 289 398 530 704 872 1122

% of

banking

industry

0.4

%

1.3% 1.8% 2.6% 3.8% 4.8% 5.9

%

7.2

%

7.3

%

8.4% 9.7

%

10.7

%

12.2

%

Source: State Bank of Pakistan, Bulletin December 2003-2015.

Amount in billions

DATA ANALYSIS:Total deposits with Islamic banks in this year i-e 2015 are Rs. 1122 billion while in 2003 they

were just Rs. 8 billion and the share with respect to amount of deposits in the industry was 12.2%

which was 0.4% in 2003

Total deposits of Islamic banks have shown continuous increasing trend past 10-12 years. This

shows the consumer interest and trust worthiness upon Islamic banks. It is an indication towards

the use of idle resources in the economy which were previously not utilized for further progress

of the economy, hence indicating an economic growth due to the multiplier effect of each rupee

invested in financial transactions.

TABLE: 3

20

Description

Dec-2003

Dec-2004

Dec-2005

Dec-2006

Dec-2007

Dec-2008

Mar-2009

Mar-2010

Mar-2011

Mar-2012

Mar-2013

Mar-2014

Mar-2015

Financing and investement

10 30 48 73 138 186 185 229 374 487 669 662 768

% of industry share

0.5% 1.3% 1.7% 2.3% 3.5% 4.3% 4.5% 6.2% 6.7% 7.4% 8.4% 7.6% 7.5%

Source: State Bank of Pakistan, Bulletin December 2003-2015

Amount in billions

DATA ANALYSIS:In 2003, Net Financing and Investment was Rs. 10 billion, while in 2015 it is Rs. 768 Billion.

The share in industry with respect to Net Financing & Investment is 7.5% now while in 2003 it

was just 0.5 %.

Financing and investments plays a key role in mobilizing the funds from one portion of the

society to another portion of the society. If the banks get deposits form depositors but do not

invest these deposits, there would be no transactions in the economy and hence reflect zero

economic growth. Islamic banks accept deposits on profit loss sharing basis. Islamic banks invest

client’s monies in common stocks and use them to earn profits both for their clients and share

holders. Mostly the funds generated or Islamic bank deposits are invested in infrastructure

building. Infrastructure is the main contributor in the economic development of a country. It

provide excessive job and employment opportunities to the public hence reflecting economic

wellbeing of the country and results in an increased living standard of people. The table above

shows that Islamic banks have been continuously investing the deposits in various products

offered by Islamic banks such as musharakah, mudarabah, salam, istisna, ijara etc to generate

greater multiplier effects.

21

TABLE: 4

DESCRIPTION Dec-2003

Dec-2004

Dec-2005

Dec-2006

Dec-2007

Dec-2008

Mar-2009

Mar-2010

Mar-2011

Mar-2012

Mar-2013

Mar-2014

Mar-2015

No of full fleged Islamic banks

3 11 11 16 18 18 19 17 17 17 19 20 22

Total no of branches

17 48 70 150 289 515 524 654 759 905 1100 1314 1597

Source: State Bank of Pakistan, Bulletin December 2003-2015.

Amount in billions

DATA ANALYSIS:Growth of Islamic banks with respect to number of Islamic banking institutions can be seen from

the table no 3. In 2003 there were just 3 institutions which became 11 in 2004 and remain 11 in

2005 too. In 2006 these institutions increased to 16 and later on in 2007 they further increased to

18 and remained 18 in 2008. In 2009 the number of Islamic banking institutions was 19 but in

2010 they decreased to 17 and remained 17 in 2011 and 2012. In 2013, Islamic banks again

showed increase in the number of Islamic banking institutions. It increased to 19, 20 and 22

institutes in 2013, 2014 and 2015 respectively. This increase shows that Islamic banks have

played a vital role in providing employment opportunities in the past years and it’s still on way

towards progress opening new doors to the fresh graduates and Islamic bankers..

FINANCING PORTFOLIO OF ISLAMIC BANKSept Dec Mar Dec Mar Mar Mar Mar Mar Mar Mar

22

YEARS 2006 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Murabaha 20,627M

26,506 M

28,961M

53,375M

52,466 M

60.8 M

86.1M

83.3B 90.4B 106.7B

113.7B

Musharakah

351 M 533M 583M 3,135M 1,320 M

2.8 M

5.7M 1.6B

3.6B 27.9B 47.6B

Mudarabah - - 308M

1,650M

0.4 M

0.3M 0.2B

0.5B 0.6B 0.2B

Diminishing musharakah

6549M

10,600M

12,313M

42,327M

43,987M

51.3M

55.7M

73B

89.7B 107.2B

147.9B

Salam 2365M

465M

583M

2,649M 3,070M

6.5 M

4.8M 8.2B

13B 18.6B 22.3B

Istisna 642M 900M

400M

4,274M 4,523M

10.6 M

7.6M 11.1B 16.4B 19.5B 31B

Qarz-e-hasana

6M 7M 8 17 M - - - -

Others 5000M

7000M

6,867M

7,876M

2614M

7 M

5.8M 8.2B

14.1B 15.5B 21.9B

TOTAL 53162M

65,742M

70,671M

146,314M

139400M

162.1M

189.5 207.9 251.1B

323.2B

417.8B

DATA ANALYSIS:

The diversification of IBI ‟s portfolio reveal that diminishing musharakah constitutes the major

portion of the portfolio and it further reinforced its supremacy with almost 35.4% shares in the

overall financing. Mode wise financing of Islamic banking industry remained concentrated in

Murabaha and Diminishing Musharaka as these modes collectively contributed nearly 63 % of

overall financing. However, Murabaha declined from December 2014 to march 2015 from 127

billion to 113 billion. While Diminishing Musharaka has increased from 107 billion in march

2014 to 147 billion in march 2015. It has shown increase both in absolute amount as well as its

share in overall financing. Among other modes of financing, Ijara, Musharaka and Salam

witnessed increase in their share in overall financing as well as in amount of financing. Ijarah

financing has inceased from 27 billion in march 2014 to 33 billion in march 2015. Musharakah

financing has also witnessed growth of 47 billion in 2015 from 27 billion in 2014. Salam

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financing has increased from 18 billion in march 2014 to 22 billlion in march 2015. Murabaha

contributes 27.2% share to the total financing according to the state bank bulliten 2015.

CHAPTER 4

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POLICY RECOMMANDATIONS FROM THE LITERATURE:From the literature it is evident that the Islamic banking is growing at a much faster pace during the last few years and the statistics shows that Islamic banking sector has made tremendous growth in its assets, total market share, deposits, financing and investments. Also all the modes of transactions including Musharakah, Mudarabah, Murabaha, istisna, Salam, Ijarah have also shown a drastic positive increase which is a sign of growth and prosperity of Islamic banking in Pakistan. With an increasing growth rate of Islamic banks it is clear and evident that if Islamic laws and regulations are truly and fully implemented in all the Islamic banks we can very soon get rid of economic problems such as poverty, inflation and unemployment rate prevailing in Pakistan.

RECOMMENDATIONS TO CONTROL POVERTY

MUSHARAKAH:Encourages partnerships with a recognized party (i.e., bank and so financial bottlenecks are less problematic for small entrepreneurs)

Most of unknown profit of business will be determined accurately, and major share of profit will go to bank and finally to its depositors unlike interest based banking when only determined interest rate goes to bank and its creditors, i.e., the bank depositors.

All this activity will help in removing the black economy and idle resources to use and shared with small savers of economy, reducing level of population below poverty line.

MUDARABAH:Mudarabah is a very potent tool for removing interest from society by providing an interest free tool for skill utilization and especially can help in mobilizing resources of society by employing them as mudarib while bank will provide the finance and also bear the chances of profit and loss, which is absent in interest based financing for venture capital. Small traders and skill men of Pakistani villages especially agricultural and craftsmen can generate mass exports through it,

reducing poverty.

SALAM:Salam is very useful in reducing agricultural sector poverty easily, by enabling the banks and farmers to contract with each other of the crops and to get finance at appropriate time, instead of

usurious loans, which ultimately deteriorate through compounding of interest and farmer, will

not pay it easily.

ISTISNA:Istisna is useful in housing sector especially, boosting the construction demand, creating

employment of factors of production and wealth to society without harmful effects of interest.

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Murabaha:Murabaha has no direct effect upon poverty reduction, but indirectly it provides a good tool for an efficient deferred sale, providing business men asset of its choice and bank of its profit for effort and risk taking.

IJARAH:Ijarah has no direct effect upon poverty reduction.

MUSAWAMMAH:Same as murabaha but perhaps musawama is the mode of finance which has least effect on poverty reduction as it helps in trading better without interest.

RECOMMENDATIONS TO CONTROL UNEMPLOYEMENT

MUSHARAKAH:Musharkah also creates jobs for many people in society, being finance based mode, promotes enterprise and partnership ventures, creating jobs in the country.

MUDARABA:Mudaraba has an effect on reducing the business sector unemployment, as it encourages business management by skilled people and promotes commercial activity, unemployment is reduced with it in short and long run both.

SALAM:Salam has also a great potential in reducing rural sector unemployment and reduces trends towards urbanization as well, by enabling farmers and agriculturists, salam engages them at villages and towns, decreases unemployment burden at civic offices and factories

ISTISNA:It has also good effects upon reducing unemployment by boosting construction and house building activities in society and generally any manufacturing activity using Islamic modes of finance.

RECOMMENDATIONS TO CONTROL ILLETARCY RATE

MUSHARAKAH:No direct effect but promotes business enterprise culture in society, growth of skilled people is needed so may be helpful in growth of literacy. Moreover, financing a school or university via musharakah may be helpful for its management extending its facilities.

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SALAM:Generates agricultural and rural sector development and eventually more income for these poor people, where 70% people of Pakistan resides, enabling more of children parents to afford their education.

Mudarabah istisna murabaha ijara and istina have no direct effect on control of illetarcy rate.

Recommendations to control inflation

MUSHARAKAH:Musaharakah has a potent effect on controlling inflation and spread of baseless credit, promoting joint ventures without potent investigations and research ensures business successes, not speculations in its success and thus speculative trading of its stocks and securities.

Musharakah deposits are also on PLS basis, sharing the risk of loss in addition to profit.

SALAM:Salam has a great effect on reducing inflation in Pakistan like country, where food stuff has reached its peak prices, the main way it cuts inflation is through ensuring increased aggregate supply and reduced food products deterioration by use of pesticide and fertilizers at appropriate times, boosting the yield of land and farms to much extent.

ISTISNA:Istisna has a little effect on inflation control

MURABAHAMurabaha has also good effect on reducing inflation, as it involves use of agency contract with proposed borrower who can buy goods of its demnd, at discounted or lowest possible price for its proposed lender as agent, it ensures that lowest prices are used in contract, no need of borrowed interest based loans for borrower, and so inflation will reduce.

IJARAH:Ijarah has also great potential for protecting against inflationary harms to middle class people and entrepreneurs as well, by allowing the use of asset without sudden cash outflows, it enables them to modify, or replace even after some months or years, their equipment or machinery without much cash flow swings. But ijarah like ordinary lease, can sometimes leads to inflation itself if economy is working at full employment level, then boosting demand of goods further increases its prices in market.

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MUSAWAMMAH:Muswamah ensures a good method for inflation reduction as it is a interest free tool, but to hamper inflation murabaha is better, because the buyer would know cost as well in murabaha.

CHAPTER5: CONCLUSION

It is evident from the above discussion that the efficiency and growth of Islamic banks is on an ever increasing trend. Due to strong commitment of the SBP toward the promotion of Islamic banking sector in Pakistan it is on fast growing track. Where substitutes are available, there originates competition in financial sector. Yet increase in the deposits, branch networks, financing facilities as well as increased number of customers in the Pakistan, as being witnessed in the last decade, is a proof that the Islamic banking sector have the potential to grow and expand and diversify further. To cope with the increasing Islamic banking need of the clients the

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conventional banks are also opening Islamic banking branches or departments within their conventional banking system. This study was mainly conducted for finding the relation between the growth of Islamic banking industry and its impact on development of Pakistan. the following conclusions can be drawn from the study;

The Islamic profit sharing concept helps to foster economic development by encouraging equal income distribution and which results in greater benefits for social justice and long term growth.

The profit sharing scheme encourages investment because investment depositors receive a share in the bank’s profits. This increase in investors will implicitly result in the increase in employment.

The Islamic financial system is more stable than the conventional banking system due to the elimination of debt financing. It also reduces inflation in the economy as the supply of money is not permitted to go above the supply of goods.

Islamic banks are less risky than conventional banks as both investors and entrepreneurs share any risks that are involved in the business.

Islamic banks should develop its current products in addition to innovate new financial products to avoid the problem of narrowing the investments just in real estate.

REFRENCES

Abdouli. (1991). access to finance and colletrals: islamic versus western. KAU: islamic Economics , 55-62.

Ahmad. (2004). economic developement in islamic perspective revisited. Journal of KAU , 53-83.

khan, a. a. (1998). challanges facing islamic banking. IRTI .

mohammad, A. a. (2008-2009). The state of Arabic nation.

Rafique, A. (2011). prospects of islamic banking: Reflection from Pakistan. Australian Journal of business and Management research , 125-134.

rehman, A. (2010). creatinga nd effective and efficient regulatory framework for the islamic capital market, global islamic finance forum.

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turen, S. (1996). Economic Performance and risk analysis of the Islamic banks: The. Journal of KAU: Islamic Economies , 3-14.

ziauddin. (1994). islamic banking state of the Art.

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