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Educating Islamic banking


Former Member of Task Force on Islamic Money Market IFSB, Former Head of FSCD SBP, Former Head of Research ArifHabib Investments, Member visiting Faculty KASBIT/BIZTEK/Sheikh Zayed Institute University of Karachi/PAF KIET/MAJU

Islamic banking has emerged as a market phenomenon in 70’s era and then started spreading. It got pace in 21st century but still it is less than 1% of overall banking assets in the world. The main question arising is lack of its awareness amongst the general masses.

State Bank of Pakistan Deputy Governor Saeed Ahmad assigned to handle this sensitive area in Pakistan has stated this at the launch of the second phase of media campaign held at SBP on Dec30 last year that campaign is basically aimed at promoting Islamic banking in the country.On this question we are with Mr. Saeed if he delivers. The main theme of the second phase focuses on preparation of documentaries on Islamic finance explaining the basic concepts, practices and general misconceptions, intensive use of print media, engaging electronic media for initiating talks on Islamic banking and finance by renowned Islamic finance professionals, highlighting value proposition and Shariah compliance of Islamic banking and dissemination of brochures and pamphlets. But in outcome it came with one theme that “for my  heart satisfactionI go to Islamic Banking”. This approach is absolutely shallow as it misses that Islamic Banking can bring social justice by directly connecting Monetary side with Real sector. It also misses that through this we can create a non-criminal society as it prohibits to invest in Haram kind of businesses. Secondly State Bank in this campaign by siding with one segment of banking and one blue eyed advertisement company also reflect that how Mr. Saeed has been misguided by the Management of Islamic Banking Department of SBP.

Going forward The Deputy Governor said that in the third round Financial Innovation Challenge Fund would be launched soonwith the theme to invite business schools and universities for the establishment of a “Centre of Excellence for Islamic Banking and Finance”. Chairman Committee for Media Campaign IrfanSiddiqui of Meezan Bank said that with coordinated efforts the Islamic banking industry will achieve its 20 per cent market share target by 2020. But this is not enough. By this pace we would reach to full fledge Islamic Banking in 22nd Century.

We must understand that for developing Islamic Banking one needs to develop qualified and trained human resource, and penetrate deeper into the promising but least-exploited sectors of the economy.In this context all persons including minorities and particularly the females should be encouraged and given all the facilities for training in Islamic Banking.A special Islamic Institute of Banking as part of NIBAF or IBP should be established.The other one is that Islamic banking institutions must work hard for developing agri-finance products and reach out to rural Pakistan. Whether we are serious in doing this is a question for all.

One big opportunity for banks is to take an advantage of enhanced awareness about Shariah-compliant banking.Banking products in general and Islamic banking products in particular are quite complicated.People want simple, easy-to-understand thingslarger sums of money for research and human resource development.

State Bank assertion that Islamic banking tends to focus more on producing qualified Shariah advisors than grooming people working in treasury or product development departments is absolutely wrong. Every area has its special features. Hence for developing Islamic BankingSharia Scholars, Bankers, Market Practitioner and Legal Experts all are needed. State Bank should understand that most credible Islamic Banking experts in the world are non-Muslim as they work to develop the market products by considering all aspects pertaining to market requirements. However It would be better that State Bank should have a Head of Shariaadvisor monitoring thefunctions of Shariah advisors of commercial banks with a limit to advise on their particular area. Eventually the State Bank Head Sharia advisor with its IslamicSharia advisors should certify what’s Islamic and what’s not in some events.

It is seen that different tailor-made products and procedures for financing in particular areas are made by commercial conventional banks. For healthy developments, Islamic Banking Institutions have been asked to develop more diminishing Musharaka products, in line with market prices and rentals.Islamic banking industry has been trying for the last over twenty years to extend it’soutpace to bring it at least to the level of conventional banking. But the absence of Shariah-compliant legal framework which needed to make interest-free banking acceptable and create sound financial institutions is the major hurdle behind its low infiltrationin the financial market.Attempts should be made to modify the existing structure to provide better products and quality service within the ambit of Islamic laws.

Commercial banking and company laws appropriate for implementation of Islamic banking and financial contracts do not exist. Islamic banking contracts are treated as buying and selling properties and hence are taxed twice.  No doubt the commercial, banking and company laws contain provisions that are narrowly defined and prohibit the scope of Islamic banking activities within conventional limits. It is necessary that special laws for the introduction and practice of Islamic banking be put in place. For supporting Islamic legal system Islamic banking courts mustbe established within Banking Mohtasib area. The courts would require extra efforts and costs. In such a case banking and companies’ laws in several countries require suitable modifications to provide a level-playing field for Islamic banks.

Deposits in Islamic banks are usually based on principle of profit and loss (Musharaka or Murabaha). If something happens and the bank suffers loss it has to be transferred to the depositor directly.This fear of loss is the biggest barrier to deposit mobilization in Islamic banks.  The depositors should be provided with some kind of protection.

Supervision of Islamic banks is equally important. At present, lack of effective prudential regulation is one of the weaknesses of the Islamic banking industry. For instance, leasing prudential regulations are applied to Ijara where the nature of both is different, such as taking advances. The bank is the owner in Ijara; so taking advances will render the contract of Ijara for conversion into Musharakah whereas the rules of Ijara are applied to it, which is illegal.

All Islamic financial institutions offer the same basic products, (90 per cent Murabaha and Ijarah) but the problem is that each institution has its own group of Islamic scholars on the Shariah board to approve the product. Consequently, the very same product may have different features and will be subject to different kind of rules in these institutions.

Islamic banks are reluctant to enter into long-term transactions due the lack of availability of liquidation through secondary market. There should be liquidity support in the form of lender of last resort facility from SBP.There is no proper mechanism of transparency and disclosure to the public in order to ensure consumer protection as provided by Shariah.

Intensive use of print media, engaging electronic media was tried before also but it was not successful.This time the State Bank should try this in cooperation with some media persons who know some ABCD of Islamic Banking.

Four examples are often quoted in growth of Islamic Banking viz: Sudan, Iran,Malaysia and Pakistan. All are trying to have complete Islamic Banking but they are still standing at the brink of parallel Banking. So in all these countries and others a transitional phase exist with more to come. But primary question remains that how far introduction of Islamic Banking in these countries have succeeded in getting success in macro indicators effecting the lives of theirpeople. In Sudan inflation has remained at 32.1% with unemployment at 10%, GDP growth rate at 3.2% Public Debt above 100% of GDP. In Iran inflation has remained at 18.2% with unemployment at 10.4%, GDP growth rate at -2.2 %, Public Debt above 18.7 % of GDP. In Malaysia inflation has remained at 3.1 % with unemployment at 3.1 %, GDP growth rate at 6.4 % Public Debt at 53 % of GDP. In Pakistan inflation has remained at 5.2 % with unemployment at 6.4 %, GDP growth rate at 4.2 %, Public Debt above 67 % of GDP ( the weakest point in case of Pakistan is that its 30% of population lives below poverty linei.e. Rs 200 per day. Unofficially this figure is above 60%). Except Malaysia we see that Islamic Banking has played almost no role in correcting macro indicators. SBP is Pakistan needs to look towards this area.

As for first example after independence Sudan, established the Sudan Currency Board to replace Egyptian and British money. It was not a central bank because it did not accept deposits, lend money, or provide commercial banks with cash and liquidity. In 1959 the Bank of Sudan was established to succeed the Sudan Currency Board and to take over the Sudanese assets of the National Bank of Egypt. In February 1960, the Bank of Sudan began acting as the central bank of Sudan, issuing currency, assisting the development of banks, providing loans, maintaining financial equilibrium, and advising the government. Since the Nimeiri government decreed the 1970 Nationalization of Banks Act, all domestic banks have been controlled by the Bank of Sudan.

The Faisal Islamic Bank, whose principal patron was the Saudi prince, Muhammad ibn Faisal Al Saud, was officially established in Sudan in 1977 by the Faisal Islamic Bank Act. The “open door” policy enabled Saudi Arabia, which had a huge surplus after the 1973 Organization of Petroleum Exporting Countries (OPEC) increases in the price of petroleum, to invest in Sudan. Members of the Muslim Brotherhood and its political arm, the National Islamic Front, played a prominent role on the board of directors of the Faisal Islamic Bank, thus strengthening the bank’s position in Sudan. Other Islamic banks followed. As a consequence, both the Ansar and Khatmiyyah religious groups and their political parties, the Umma and the Democratic Unionist Party, formed their own Islamic banks.

The Faisal Islamic Bank enjoyed privileges denied to other commercial banks (full tax exemption on assets, profits, wages, and pensions), as well as guarantees against confiscation or nationalization.

The appeal of the Islamic banks, as well as government support and patronage, enabled these institutions to acquire an estimated 20 percent of Sudanese deposits. Politically, the popularity and wealth of Islamic banks have provided a financial basis for funding and promoting Islamic policies in government.In 1999, Sudan began exporting crude oil and in the last quarter of 1999, recorded its first trade surplus.

However the Corruptions Perception Index indicates Sudan as one of the most corrupt nations in the world. Sudan still has one of the lowest human development in the world. Almost one-fifth of Sudan’s population lives below the international poverty line which means living on less than US$1.25 per day.

Iran’s economy is a mixture of central planning, state ownership of oil and other large enterprises, village agriculture, and small-scale private trading and service ventures. Iran is ranked as an upper-middle income economy by the World Bank. The government doesn’t recognize trade unions other than the Islamic Labor Councils, which are subject to the approval of employers and the security services. The minimum wage is 487 million rials a month ($134). Unemployment has remained above 10% since 1997, and the unemployment rate for women is almost double that of the men.

Economic sanctions against Iran, such as the embargo against Iranian crude oil, have affected the economy. Sanctions have led to a steep fall in the value of the rial, and one US dollar is worth 27,347 Rial, compared with 16,000 in early 2012.

Malaysia is a relatively open state-oriented and newly industrializedmarket economy. The State plays a significant but declining role in guiding economic activity through macroeconomic plans. Malaysia has had one of the best economic records in Asia, with GDP growing an average 6.5 per cent annually from 1957 to 2005. In 2014, the GDP (PPP) was about $746.821  billion, the third largest economy in ASEAN and the 28th largest in the world. In 1991, former Prime Minister of Malaysia, Mahathir bin Mohamad outlined his ideal in Vision 2020, in which Malaysia would become a self-sufficient industrialized nation by 2020.In the 1970s, the predominantly mining and agricultural-based economy began a transition towards a more multi-sector economy. Since the 1980s, the industrial sector, with a high level of investment, has led the country’s growth. The economy recovered from the 1997 Asian financial crisis earlier than neighboring countries did, and has since recovered to the levels of the pre-crisis era with a GDP per capita of $14,800. Economic inequalities exist between different ethnic groups. The Chinese make up about one-third of the population, but accounts for 70 per cent of the country’s market capitalization. Chinese businesses in Malaysia are part of the larger bamboo network, a network of overseas Chinese businesses in the Southeast Asian market sharing common family and cultural ties.

Islamic banking in Malaysia began in September 1963 when Perbadanan Wang SimpananBakal-Bakal Haji (PWSBH) was established. PWSBH was set up as an institution for Muslims to save for their Hajj (pilgrimage to Mecca) expenses. In 1969, PWSBH merged with PejabatUrusan Haji to form LembagaUrusandanTabung Haji (now known as LembagaTabung Haji).

The first Islamic bank in Malaysia was established in 1983. In 1993, commercial banks, merchant banks and finance companies were allowed to offer Islamic banking products and services under the Islamic Banking Scheme (IBS). These institutions however, are required to separate the funds and activities of Islamic banking transactions from that of the conventional banking business to ensure that there would not be any co-mingling of funds.

In Malaysia, the National Sharia Advisory Council additionally set up at Bank Negara Malaysia (BNM) advises BNM on the Sharia aspects of the operations of these institutions, as well as on their products and services. In 2006, Bank Negara Malaysia setup International Centre for Education in Islamic Finance (INCEIF) a dedicated University to provide skilled and certified personnel for Islamic Finance in Malaysia. The university was established as part of the Malaysian Government’s initiative to further strengthen the country’s position as an international Islamic finance center. It is the only university in the world that is wholly dedicated to postgraduate study in Islamic Finance.

Astonishingly Global Islamic Finance Report 2014reveals that Pakistan ranks number nine in the world in terms of development of the Islamic financial services industry in the country whereas we claim our position at number 2.

A London-based Islamic financial advisory company, Edbiz Consulting, has formulated the Islamic Finance Country Index (IFCI), which ranks about 50 countries of the world in terms of their role in developing, promoting and advocating Islamic banking and finance. Pakistan comes after eight countries, namely Iran, Malaysia, Saudi Arabia, Bahrain, Kuwait, United Arab Emirates (UAE), Indonesia and Sudan.

The Global Islamic Finance Report 2014 estimates the size of the global Islamic financial services industry at $1.813 trillion. This represents 12.3% annual growth, an increase of $182 billion in absolute terms.

Many Islamic financial institutions appear among top five banks in their respective countries. In Pakistan, the largest Islamic bank is Meezan Bank, which is fast assuming mainstream prominence.

According to report the newly unveiled Islamic banking strategy by the State Bank of Pakistan attempts to double the number of Islamic banking branches from 1,300 in the next four years, and to increase its market share from 12% to 20%.

Given the huge potential the country has in terms of Islamic banking, increasing the share to 20 % is a modest aim. Indeed, if Islamic banking fails to achieve 20% share in the market by 2018, by all indicators, it fails to reach its potential.

Given that a number of banks showing renewed interest in Islamic banking, the industry targets an increase of 2% in market share every year through Brownfield growth, i.e.cannibalization of conventional banking and through conversion of conventional into Islamic banks.

As an example once Summit Bank is converted into a full-fledged Islamic bank, it will become the second largest Islamic bank in the country, taking the number two position from BankIslami (assuming that BankIslami does not grow further). Only this will give 8% additional market share to Islamic banking over the next four years.

If Islamic banks exhibit Greenfield growth, more than the growth in conventional banking, it should be able to double its market share. Greenfield growth is not only possible but is in fact needed in Pakistan where there is widespread financial exclusion.

If that happens, the country will stand next to a number of Gulf countries and Malaysia where Islamic banking represents between 20% and 30% of the market share. Pakistan, however, will become the most important player in Islamic banking and finance, if it attains 20% market share. This is so because the country is the second largest Islamic market (population-wise) after Indonesia.

Now State Bank has got new Director of Islamic Banking with new ideas. But he must be careful. We are living in a world especially in Pakistan where Taqlidi Islam is in vogue with Taliban like groups to operate. In spite of Zarbe Azb going on against Taliban we have to fight againstmany discarded ideas based on mercantile and tribal era that have infiltrated in our minds. So to change them very cautious moves are required, remaining independent from the Islamic Banks as they are profit oriented organizations. To make the whole system equity based as per its basic requirement, is bit difficult. We have to find some correlation between debt based and non-based products. Further we have to link Islamic Banking with country’s macro indicators. Islamic Banking from A to Z should be based on social justice and to eliminate poverty in Pakistan not thorough rhetoric but with practical steps and products. Still Islamic Banking stands as a specialized area. Hence State bank has to act independently in all specializedareas and that is the crux of all answers to move forward.



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