Finding the will to succeed
Pakistan shares the honour of being among the pioneers of Islamic banking in the world. Efforts for its introduction began in the mid-60s, with serious progress being made in the late 70s and 80s.
In 1979, specialised financial institutions such as HBFC, ICP and NIT took the first step towards eliminating interest from financial transactions. After the Banking Companies Ordinance (BCO) 1962 was amended in January 1981, interest-free counters opened up in nationalised bank branches as well as in a local branch of the Bank of Oman. Deposits mobilised against PLS were invested in government commodity transactions. By July 1985, all commercial banking, except for foreign currency accounts, had come under the purview of PLS.
In November 1991, the Federal Shari’ah Court (FSC) declared most financial practices and laws that had been adopted earlier to be un-Islamic. The government and some DFIs appealed against the FSC ruling to the Shari’ah Appellate Bench (SAB) of the Supreme Court, but they were turned down and June 30, 2001 was set as the date to scrap ‘interest-based’ banking.
The State Bank of Pakistan (SBP) was also directed to set-up a Commission for Transformation of the Financial System to plan and implement the transformation. In June 2002, a reconstituted SAB set aside the Riba Judgments of 1991 and 1999 and the FSC was asked to resume hearings. Hence, a dual system of banking, i.e. Islamic and conventional remained operational.
Although due credit must be given to those illustrious bankers and Islamic scholars, whose efforts during the 70s and the 80s led the way to the introduction of interest-free banking in Pakistan, a lack of continuity, foresight and perhaps conviction in policy making impeded progress. However, in the wake of the global financial crisis of 2007, a strong realisation has emerged among international experts in banking and finance that while the crisis had forced some icons of the western financial system to go down on their knees, most Islamic banks remained unscathed. A World Bank policy research working paper published in October 2010, made light of the issue by stating that “… Islamic banks increased their liquidity holdings in the run-up to and during the crisis relative to conventional banks.”
However, the paper admitted that “there is also consistent evidence of higher capitalisation of Islamic banks and this capital cushion plus higher liquidity reserves explain the relatively better performance of Islamic banks during the current crisis.”
####As one of the pioneers of Islamic banking, Pakistan needs to do more to make the concept a model for success, argues Ejaz Wasay.
Earlier in 2008, the Asian Banker had reported that assets of the 100 largest Islamic banks in the world grew by a whopping 66% at the height of the crisis. Seven out of the top 10 position holders were Iranian banks. Bank Melli Iran (BMI) was number one and Saudi Arabia’s Al Rajhi Bank was in second place. Another publication, The Banker, later revealed in 2011 that total assets of shari’ah-compliant financial institutions, had crossed the one trillion dollar mark.
At this point, it would be worth reviewing the performance of some of the bastions of Islamic banking, such as Bahrain, Iran and Malaysia to look for some insights.
Bahrain
Bahrain is widely recognised as the nursery of Islamic finance in the world. Presently 29 Islamic banks operate there with total assets worth $16.4 billion.
In addition, there are 15 Takaful (Islamic insurance) companies and one re-insurance (re-Takaful) company. Many conventional banks also operate Islamic windows. The Bahrain Monetary Agency (BMA) regulates the operation of both Islamic and conventional banks. Bahrain was ready for a pioneering role in 1978, when the Organization of the Islamic Conference (OIC) espoused the need for Muslim countries to adopt their religious beliefs and principles in financial dealings. Over the years, Bahrain has made significant progress and takes credit for introducing many firsts: the Islamic banking regulations CBB Rulebook, Sukuk Islamic Bonds, a regulatory framework for Takaful and re-Takaful companies and an Islamic Sukuk Liquidity Instrument (ISLI), a much needed liquidity management tool.
Iran
Interest-free banking was adopted in Iran as a consequence of the Islamic Revolution in 1979. As a first step the government nationalised most banks and merged them into six commercial and three specialised banks. It then took nearly four years for the Islamic Banking Law to be passed by the Consultative Assembly. During this time a Money and Credit Council administered interest rates. Iran went through serious trials and tribulations in implementing the system, oscillating between the standard IMF-World Bank structural adjustment programme and their own homegrown policies. Critics assert that the Iranian interest-free banking law was simply “a mirage created to legitimise interest”, as hardly any loss-sharing has occurred in commercial transactions. Banks charge preset rates, approved by the Central Bank. High value collateral such as real estate, commercial paper and bank guarantees eliminate any risk of loss to banks.
####After floundering for almost a decade, Pakistan’s drive towards establishing Islamic banking found its champion in the SBP in the new millennium.
Malaysia
The evolution of Islamic banking in Malaysia followed a three-stage process. In the first phase ending in 1992, the focus was on creating a regulatory framework. Over the next decade work was done on institution building. A second Islamic bank, Bank Muamalat, was launched in 1999. In the third phase, extending until 2010, the system was further consolidated, thereby attracting international Islamic banks to the country. Kuwait Finance House (Malaysia) Berhad was established in 2005, followed by the arrival of several other players in Islamic banking: Deutsche Bank AG (2010), BNP Paribas, National Bank of Abu Dhabi and Sumitomo-Mitsui Banking Corporation. Although there is merit in the manner Malaysia pursued its objectives, some scholars feel that Islamic banking in the country is not sufficiently insulated from conventional banking.
Pakistan – way forward
After floundering for almost a decade, Pakistan’s drive towards establishing Islamic banking found its champion in the SBP in the new millennium. The Commission for Transformation of Financial System (CTFS) submitted its report in August 2001. Two task forces set up in the Ministry of Law proposed a set of laws and Finance Ministry officials and experts visited several countries to experience their systems at first hand.
Meezan Bank, the first full-fledged Islamic bank, commenced operations in 2002. The SBP also allowed commercial banks to set up separate subsidiaries or open up Islamic banking windows. By December 2011, the structural and operational framework of the SBP was fairly well set.
A centralised Shari’ah Board became the apex shari’ah body and banks appointed shari’ah advisors as per SBP guidelines. Internal audit became compulsory in Islamic banks, while the SBP also carried out periodic inspections.
Between 2009 and 2011, the government raised more than three billion dollars equivalent against Sukuk (Islamic bonds). The Sukuk Ijara issued in 2012 raised Rs 38 billion. The assets of Islamic banks crossed Rs 640 billion in December 2011, 34% above 2010. Deposits crossed Rs 521 billion. Financing and investments contributed strongly towards asset growth. Banks earned a combined profit of Rs 10 billion. Full-fledged Islamic bank branches and Islamic banking windows added up to 886, with two-thirds concentrated in seven cities. The corporate sector accounted for 73% of the business, consumer finance for 14%, commodities for six percent and SMEs for 5.2%.
A significant portion of the increase in the investment portfolio was on account of government borrowings.
It must be pointed out here that Islamic banks in Pakistan still have a long way to go. What will make this happen is a question on everybody’s mind. Starting with the basics, profit or rate of return is a major factor for mobilising Islamic bank deposits, although the idea of attaching a definitive return on deposits negates the principles of shari’ah. Religious motivation plays a role in drawing people towards Islamic banking, but if that were the overriding factor, non-Muslims would not put their money in the system. Banks like HSBC are currently promoting Islamic finance quite successfully to non-Muslim customers.
To grow Islamic banking in Pakistan at a faster clip, a few areas need to be explored further:
1 Separating Islamic banking from conventional banking: A two-pronged strategy allowing Islamic banking windows in conventional banks dilutes the confidence of customers and reinforces the belief that the two systems do not really stand apart. Limiting Islamic banking to full-fledged Islamic banks, in my opinion, would speed up conversion.
2 Focusing on smaller cities and towns: The fact that Islamic banks in Pakistan are concentrated in seven major cities is like a self-fulfilling prophecy and counterproductive from a strategic perspective. If this practice continues, shari’ah-based banks will never be able to test the full potential of smaller cities and towns, where life is simpler and religious sentiments perhaps stronger.
3 Offering Islamic micro-finance: Any banker would know that the business of micro-finance is quite different from large scale conventional banking. It is a grassroots approach based more on trust. To me it is a no-brainer that Islamic micro-finance will flourish, given a chance.
4 Developing human resources: Most people in Islamic banks today either come from conventional banking backgrounds, with education acquired under a western, capitalistic economic system. This has to change. Islamic finance is being seriously taught in countries like Bahrain and Malaysia and even in colleges in the US and Canada. It is about time every reputable university offering business education here did that too.
In summary, Pakistan is verdant territory for Islamic banking, which is a system that is better than conventional banking. It should only take the will to succeed… to succeed.
Ejaz Wasay is Senior Fellow Marketing, Institute of Business Management.