Islamic Banking & Finance Page 22-02-2019

Whether SBP deserves award for best Central Bank in promoting Islamic Finance?

Muhammad Arif

State Bank of Pakistan (SBP) has won the global award as the best Central Bank in promoting Islamic finance for the year 2018. The coveted award is conferred by Islamic Finance News (IFN), an arm of RED money Group, Malaysia.

The IFN Award is the global endorsement of SBP initiatives for the promotion of Islamic banking in Pakistan. Previously, SBP was bestowed with this coveted award earlier in 2015 and 2017. Islamic banking industry in Pakistan has witnessed an impressive growth in 2018 with its assets reaching 12.9% of banking sector and deposits accounting for 14.8% of the total banking industry deposits wherein industry footprints kept on enlarging with two new institutions getting license to offer Islamic banking products and services. SBP also introduced Shariah compliant version of Long Term Financing Facility (LTFF) enabling Islamic banking customers to avail subsidized financing from Islamic banks for setting up export oriented projects.

It is pertinent to mention that Shariah-compliant banks in Pakistan, the world’s second most populous Muslim nation, hold only 13.6 % of total banking assets in Pakistan in Sept 2018 and below 2% of world Islamic Financial assets. That is well below levels of Gulf Co-operation Council (GCC) maintaining its status as largest domicile for Islamic finance assets in global market share to 42%. The share of countries in the Middle East and North Africa (ex-GCC) is 29.1%. Asia had the market share of is 24.4%.

Pakistan’s government believes it can pull more people into the formal banking sector – especially in rural areas – by expanding the Islamic finance sector, and this could boost economic growth. However Capital to Total Assets of Islamic banking side is 6.4% as compared to 7.6% of the conventional side. Islamic banks are still contributing 0.3% of its total financing on agriculture as compared to 4% of conventional side. Liquid Asset to Total Assets of Islamic banking side is 22.8% as compared to 44.7% of the conventional side. Liquid Assets to Total Deposits of Islamic banks is 27.9% as compared to 63.3% of conventional side. From SBP side the industry was expected to allocate at least 5% of the deposits or 10% of financing whichever is higher to the Agriculture financing.

This situation has prompted some Islamic banks to issue capital-boosting sukuk; earlier Meezan raised 7bn rupees ($66.9mn) via a private placement of subordinated sukuk. Others have opted for consolidation: Al Baraka Bank Pakistan completed a merger with Islamic lender Burj Bank. In 2015 Habib Bank  and  Meezan Bank jointly issued Rs 22 billion K-Electric sukuk-2022 using Musharkah mode of Financing. SBP has also helped earlier by lowering Islamic banks’ statutory liquidity requirement to 14% of total demand liabilities from 19%, reducing the amount of liquid assets which banks must maintain as reserves.

Hence Islamic banks face an acute shortage of Shariah-compliant liquid assets, aggravated by limited supply of local currency sovereign sukuk. Further Islamic banks have not produced ample products, rather they have produced mostly based on Murhabah and Diminishing Musharakh showing that they highly rely on consumer financing.

According to SBP Strategic Plan for Islamic Banking Industry of Pakistan 2014 – 2018 target was set to double the number of Islamic banking branches from 1,200 and to increase its market share to 15%. However given the huge potential of the country SBP would have set 20% share of the market by 2018. Along with these two challenges Islamic banking is also facing legal and regulatory framework challenges that are beyond its immediate access.

The banking sector in Pakistan should be caring enough to respond to any challenge without all norms of finance industry like capacity building and educating Islamic finance. Currently SBP is running Islamic banking courses in collaboration with NIBAF that lacks skill to design Islamic Banking courses with staff not competent to handle such courses. But if you ask them frankly than they would say that they are the best in the world. It is like our governance at government level that whatever you say they will not agree. Nobody wants to break prevailing status quo.

So with these situations we all and particularly SBP have to struggle hard to show that it deserve real appreciation from abroad and within the country.


Issues in growth of Islamic finance

Manzar Naqvi

The Islamic Finance Development Report 2018, compiled by Thomson Reuters and the Islamic Corp for the Development of the Private Sector, shows figures for the Islamic finance industry and its further growth in the near future.

According to the study, the global Islamic finance industry grew by 11% in 2017 compared to the previous year to $2.4tn in assets and showed compounded annual growth of 6% since 2012. These figures are based on data collected from 56 countries with Islamic finance industries, mostly in the Middle East and South and Southeast Asia, and there from a total of 1,389 fully-fledged Shariah-compliant financial institutions and windows.

Of the entire assets, Islamic banking accounted for 71%, or $ 1.7tn, of the industry’s total assets in 2017. Based on the report’s findings, the global Islamic finance industry will reach a total global asset volume of at least $3.8tn by 2023, which translates into further double-digit annual growth from 2018 onwards and represents an annual growth rate of 9.5% over the past decade.
The growth is mainly driven by expansion of Islamic finance into new territories, as well as by new and innovative capital market products and the development and adoption of sector-specific financial technology. However, while the growth is seen to be sustainable, the number of Islamic financial institutions is expected to drop owing to a continuing consolidation within the Islamic banking sector, with some large mergers and acquisitions to take place in the dominant markets such as Malaysia and the GCC.

Regionally, Africa is seen as a particular area of potential growth for Islamic banking, as a growing number of governments there is laying out roadmaps for the industry’s development and providing respective regulatory frameworks.

For example, Northern African countries such as Morocco and Algeria have seen the launch of several Islamic banking subsidiaries and windows in the recent past, while sub-Saharan countries such as Nigeria, Senegal and Kenya have also implemented banking, legal and regulatory frameworks to spur growth in the Islamic banking sector. Because only Sudan and Djibouti have so far reached meaningful levels of Islamic banking assets as a proportion of total banking assets in Africa, growth potential is huge in all other countries where the continent’s estimated 250mn Muslims live.

As per asset size, Iran, Saudi Arabia and Malaysia remain the largest Islamic finance markets worldwide according to the study, while Cyprus, Nigeria and Australia saw the most rapid growth. As per another important valuation, Thomson Reuter’s specially developed Islamic Finance Development Indicator score, or IFDI, which aggregates indicator scores for quantitative development, knowledge, governance, corporate social, responsibility and awareness, shows that Malaysia, Bahrain and the UAE led the 131 countries assessed.
The emerging Islamic finance markets which had most improvements in their financial and supporting ecosystems include Iraq, Suriname, Nigeria and Ethiopia.

The study also points out that the digital revolution is beginning to transform the Islamic banking sector. There have been launches of several Islamic online banks, and a fast-growing number of startups are focusing on a broad range of fintech solutions for Islamic banking and are also innovating with new technologies such as block chain. New digital banking channels mean for traditional banks that they can increase their outreach to more under banked regions, and with the rapidly growing popularity of mobile banking, particularly among younger people, a growing number of disruptive digital-only banks with no physical branches have emerged that are attracting a sizeable number of clients and are becoming serious competition for established Islamic banks.

The advent of robo-advisers and digital wealth management services give the industry another innovative momentum, while the supporting ecosystem sees innovations such as digitized learning or new methods to digitize complex Islamic finance contracts by facilitating block chain. Such new developments are particularly encouraged by countries such as the UAE and Bahrain, while Shariah scholars across the industry are now busy with reviewing Shariah compliance of fintech innovations, the study finds.

However still most of the world’s Muslims are not so devout that they completely abjure conventional finance: even in Saudi Arabia, the assets of Islamic banks account for barely half of all banking assets. Muslim account-holders tend to be more concerned with the products and service on offer than with the strictures of sharia. Despite growth for Islamic financial products, there still is room for further expansion. There are potential pitfalls. Goldman’s previous attempt to enter the market foundered amid claims its proposed sukuk did not comply with sharia. Indonesia has scaled back its issuance of one type of sukuk due to similar complaints. Malaysian scholars approved an Islamic credit card based on a transaction known as baya al-ina, which Arab scholars have rejected as being too close to interest-based lending.

Such rows have led to calls for greater international standardization—hence the creation by national regulators of such entities as the Islamic Financial Services Board, which issues both religious and prudential guidance, playing the same role as the Basel Committee does for conventional banks. Zeti Akhtar Aziz, previous governor of Malaysia’s central bank, believes it will foster “harmonization in how institutions are regulated”. But since there is no overarching authority that can approve its rulings, there will always be disputes. Pakistan is also engulfed with such disputes. For this proper Islamic Banking laws covering all documentations are required for Islamic banks’ with strict monitoring of SBP.

Investment in Islamic Mutual Funds

Mubesher Mir

A Mutual Fund is a single portfolio of investments where investors put their money to be managed by an asset management company on behalf of its many investors. This allows each investor access to a professional managed pool of funds.

Fund Manager invests the fund’s capital in profitable avenues and attempt to earn a return for the fund’s investors. The income earned through these investments and the capital appreciation realized is shared by its unit holders in proportion to the number of units owned by them.

Islamic mutual fund works in a similar manner as a conventional fund except that the Islamic mutual fund only deploys funds in Shariah-compliant investments. The key players in Islamic mutual fund are: Asset Management Company, Trustee, Shariah Advisor & Registrar. It is basically Shariah-compliant Avenue of investment for individuals, corporate clients and retirement schemes with features as follows-

  • Riba-free returns.
  • Online access to individual accounts.
  • Professional fund management expertise.
  • Required minimum investment as low as possible.
  • Easy withdrawal of money.
  • No minimum holding period.
  • Risk diversification.

The fund’s primary objective is to provide unit holders with a good and stable rate of current income consistent with long-term preservation of capital in a Shariah compliant manner. A secondary objective is to take advantage of opportunities to realize capital appreciation. The fund seeks to provide the investors with a rate of return consistent with a broadly diversified portfolio of long, medium and short term, high quality Islamic income instruments. Islamic Income Mutual Funds invests only in Shariah-compliant income instruments to provide regular Halal income to investors and aims to provide a superior risk-adjusted return to the investors.

For this investment managers first keep in view macro situation of the country and of the world. For instance he or she has to take care in 2019 that the current economic situation of Pakistan seems like a long evening full of storm and stress. Long dragged political turbulence in first seven months and then economic instability in later months led to a great deal of volatility in stock market; whereby the KSE100 index reached to its first low at 39,666 in July’18 and then to 36,663 on October’18. Although the market displayed some recovery during April’ 18, however due to lack of clarity on macroeconomic front particularly on the IMF program, the market has been moving sideways these days. With the economy classified as a USD300 bn plus economy continuously expanding along with the results of CPEC’s investments and Saudi’s investments to bear fruits in the future. Things in CY18 did not fit well to mark the year as a wonderful journey as we thought it would have been. Policy makers are facing great challenges to manage the day by day widening current account deficit.

The State Bank used economic deflationary measures like i) increasing interest rates to attract foreign investments and ii) depreciating currency exchange rate to boost exports, but these measures were not sufficient enough to manage the bleeding foreign reserves which stood at USD 8.048bn as at Dec 18, 2018 covering less than two months of import cover. Increased global oil prices were also adding the burden to the swollen import bill. With the end of political turbulence after Imran Khan’s government came into power, investors breathed a sigh of relief in the second half of the year. Saudi grant of USD 3 bn with deferred payment of oil purchases worth USD 3bn and UAE loan of USD3bn also enhanced investors’ confidence. However, disagreement on the IMF bailout package upon some structural and fiscal reforms required by Government of Pakistan is restricting investors to regain confidence. Now after visit of Saudi Crown Prince some positivity in the scene has again entered. Now looking at different rate of returns in ist Q of Cy 2019- 6-Months T-Bills is at 10.55%, 10-Year Pakistan Investment Bonds (PIBs) is at 13.06%, Ijarah Sukuks is at 6.65%, SBP Policy Rate is at 10.25%, TFCs (AA rated and above) is at 11.04%, Corporate Sukuks is at 10.87% and Bank Placement (AA Rated and above) is at 10.75%.

Now for Islamic mutual Funds it has to bear in mind that the issue of lack of Shariah compliant investment avenues has continued to persist over the years. Despite a significantly strong growth in Islamic deposits over the last few years, which have recently clocked in at Rs. 2.0 trillion (forming around 15% of the total banking deposits), regular Ijarah Sukuk auctions are still not witnessed like PIBs (auctioned once a month) and T-bills (auctioned twice a month). The last Ijarah Sukuk auction was carried out in June 2017 after a gap of one year and 3 months and recently, Ijarah XVI with the issue size of Rs. 117 bn was matured, further squeezing the investment avenues available to investors. However, in order to facilitate Islamic Banks and Islamic windows of Commercial Banks SBP conducted a Bai Muajjal auction whereby in total bids were received for the total amount of Rs. 76.5 bn out of which the state bank accepted Rs. 72.5 bn at a cut-off yield of 11.47%. For the auction, the participants placed their bids in the range of 7.86% to 12.99%.

During the month of November, due to no announcement of Ijarah Sukuk auction, built up a huge demand/supply gap due to which the resultant yields in Ijarah Sukuk auctions are considerably low in comparison to the conventional market. Some of the blue chip corporate has already started to understand the excess liquidity situation of the Islamic Financial sector and have started issuing corporate Sukuks to raise debt at relatively lower spreads than they would have had to bear in case of TFCs or bank loans; in line with this observation, increased Issuance of corporate Sukuks was witnessed during the CY18. Hopefully, a consistent increase in the issuance of new Sukuks (both government and corporate) will be seen going forward which will aid the Islamic market in tackling its long outstanding excess liquidity problem. 2018 has also seen geopolitical tensions, steadily increasing interest rates and a strong US dollar, leaving many investors to believe that the gold price has reached its bottom. So what will happen to the investment in yellow metal in 2019 is a question for every investor?

In this regards Meezan Gold Fund (MGF) which is the only Shariah compliant commodity funds of the country has provided over 19% return in CY18TD. The fund provides a convenient means of taking exposure to this asset class.

Some of the other top Islamic funds (based on NAV) according to Mutual Funds Association of Pakistan are:

  • Meezan Investment Funds
  • ABL Islamic Financial Planning Fund
  • JS Islamic Fund (Shariah Compliant equity — Absolute return)
  • UBL Al Ameen Funds (Shariah Compliant Money Market — Annualized return)
  • NAFA Islamic Principal Protected/Preservation Fund (Shariah Compliant Fund of funds – Absolute return)
  • Dawood Islamic Fund (Shariah Compliant Asset Allocation – Absolute return).
  • Alfalah GHP Balanced Allocation Fund.
  • Alfalah GHP Islamic Prosperity Planning Fund (AGIPPF) is an Open-ended Fund.
  • Atlas Islamic Income Fund (Shariah Compliant Income — Annualized return.