Muhammad Arif
Muhammad Arif : Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), Former Head of FSCD SBP, Former Head of Research ArifHabib Investments and Member IFSB Task Force for development of Islamic Money Market, Former Member of Access to Justice Fund Supreme Court of Pakistan.

The industry has been grown to about $2 trillion in size for attracting banking users whose religious objections have kept them away from conventional banking services drawing non-Muslim bankers into the field, and (according to other supporters) introducing a more stable, less risky form of finance.

However, the industry has also been questioned for ignoring its “basic philosophy” and moving in the wrong direction over the decades.

 This has happened first by the sidelining the original finance method advocated by promoters — risk-sharing finance — in favor of fixed-markup finance of purchases (particularly murabaha), and then by distorting the rules of that fixed-markup murabaha, effectively delivering conventional cash interest loans following conventional interest rates, but disguised with “ruses and subterfuges” and burdened with “higher costs, bigger risks.

Other issues/complaints raised include a lack of effort by the industry to help small traders and the poor;  the question of how to deal with inflation late payments, the lack of hedging of currencies and rates or sharia-compliant places to park short term funds for liquidity; the non-Muslim ownership of much of Islamic banking and the concentration of what ownership is in Muslim hands.

A study on the size and market share of Shariah-compliant Islamic banking in Muslim countries found “strong and consistent empirical evidence” that the development of Islamic banking leads to “higher banking sector development” rather than attracting money and existing customers away from conventional banking as measured by “the amount of private credit or bank deposits scaled to GDP.”

Proponents have argued that Islamic financial institutions are more stable than conventional banks because they forbid speculation and their two main types banking accounts — “current account” and mudarabah accounts — carry less risk to the bank. This is because in a current account the customer (in theory) earns no return and (in theory) the bank is not supposed to invest the account funds. The alleged stability in a mudarabah account comes from the smaller risk of loan defaults because that risk is shared with the depositor. If the borrower cannot pay back part or all of the money lent to them by the bank, the amount going to the depositor is cut by an equivalent amount, whereas in a conventional bank the depositor is given fixed interest payments whether or not the bank’s earnings decline from loan defaults.

 The majority of Islamic banking clients are found in the Gulf states and in developed countries. Studies of Islamic banking customer in Malaysia and Pakistan found customer satisfaction was connected to service quality. A study of Islamic banking customers in Bangladesh found “most customers” between 25–35 years, “highly educated” and having a “durable relationship” with the bank, more knowledgeable about account than financing products.

In series of interviews conducted in 2008 and 2010 with Pakistani banking professionals (conventional and Islamic bankers, Shariah banking advisors, finance-using businessmen, and management consultants), it was noted that many Islamic bankers expressed “cynicism” over the difference or lack thereof between conventional and Islamic bank products.

The lack of requirements for external Shariah-compliance audits of Islamic banks in Pakistan, shariah boards lack of awareness of their banks’ failure to follow shariah compliant practices in or their power to stop these practices. However this did not deter patronage of the banks by the pious (one of whom explained that if his Islamic bank was not truly shariah compliant, ‘The sin is on their head now, not on mine! What I could do, I’ve done.’)

One estimate of customer preference (given by a Pakistani banker) in the Pakistani banking industry, was that about 10% of customers were “strictly conventional banking clients”, 20% were strictly Shariah-compliant banking clients, and 70% would prefer Shariah-compliant banking but would use conventional banking if “there was a significant pricing difference”. A survey of Islamic and conventional banking customers found (unsurprisingly) Islamic banking customers were more observant (having attended hajj, observing salat, growing a beard, etc.), but also had higher savings account balances than conventional bank customers, were older, better educated, had traveled more overseas, and tended to have a second account at a conventional bank. Another study, using “official data” reported to State Bank of Pakistan, found that for lenders who had taken out both Islamic (Murabaha) financing and conventional loans, the default rate was more than twice as high on the conventional loans. Borrowers were “less likely to default during Ramadan and in big cities if the share of votes to religious-political parties’ increases, suggesting that religion – either through individual piousness or network effects – may play a role in determining loan default.”

The main challenges to Islamic Banking are as follows

  1. “Low levels” of awareness and understanding of Islamic finance products and services among the public, leading them to not patronize these products and services;
  • A need for “increased regulatory clarity and harmonization, better cooperation between Islamic and conventional financial standard-setters, and further improvement of supervisory tools”, to deal with the “complex financial products and corporate structures” in some countries/jurisdictions brought about by “regulatory and supervisory frameworks” that do not “address the unique risks of the industry”;
  • A “scarcity of Shariah-compliant monetary policyinstruments” and a lack of understanding of “the monetary transmission mechanism”;
  • “Underdeveloped” safety nets and resolution frameworks. A lack of complete Islamic deposit insurance systems where premiums are invested in Shariah-compliant assets, or Shariah-compliant “lenders-of-last-resort”;
  • Regulators who “do not always have the capacity (or willingness) to ensure Shariah compliance.”

Islamic Refinance Scheme introduced by the State Bank of Pakistan for Working Capital Financing of Small Enterprises and Low-End 
Medium Enterprises

The Islamic Refinance Scheme for Working Capital financing of Small Enterprises and Low-End Medium Enterprises (IWCF) has been offered to Islamic Banking Institutions (IBIs) and Islamic Development Financial Institutions (Islamic DFI); SBP will act as Rab-ul-Maal by providing mudarabah investment facility to the PIFIs, in the form of investment in a PIFI’s general pool, and the PIFI shall act as the Mudarib of general pool. The exposure of SBP under the scheme shall be on all assets of a PIFI’s general pool to the extent of SBP’s investment in general pool, and therefore shall not be limited to the assets financed under the scheme.

Financing shall be initially available to meet the working capital requirements of below mentioned SME sectors.

2.      Information Technology (IT)

3.      Furniture

4.      Surgical goods Surgical goods

5.      Dates processing Dates processing

6.      Gems and jewelry

7.      Leather industry Leather industry

8.      Fruits, vegetables and food processing & packaging

9.      Printing & packaging Printing & packaging

Small Enterprises (SEs) as defined in SBP’s Prudential Regulations (PRs) for SME financing are eligible under the scheme. Maximum financing limit for SEs is the same as defined in SBP’s relevant PRs.

Medium enterprises (MEs) with annual sales turnover of upto Rs 300 million are eligible under the scheme. Maximum financing limit for MEs is Rs 50 million.

The maximum period for which the investment under the scheme may be made shall not be more than one (1) year.  The retirement of financial obligations/ redemption under the scheme shall be made by the customers within one year from the date depending upon the tenure for which the facility is availed and underlying mode of Islamic finance used by PIFIs. The mudarabah investment made with the PIFIs shall mature on the due date agreed with SBP, and SBP is authorized to deduct outstanding balance of its investment in the general pool as per “Instructions for Profit & Loss Distribution and Pool Management for Islamic Banking Institutions” issued vide IBD Circular No. 3 dated November 19, 2012, as amended from time to time. In case a customer pays the financing amount or its installment, in part or in full, on or before the due date(s), SBP’s share in the general pool will be redeemed equal to the payments received from customer. PIFIs shall adjust the financing amount so received from the customer by purchasing the SBP’s proportionate share in the general pool immediately, but not later than two (02) working days, from the concerned office of SBP BSC, failing which the SBP shall also be given the profit, as per the actual profit of the general pool, for the number of days this proportionate share is not purchased by a PIFI. However, no penalty shall be charged either from a PIFI or its customer in case of payment of financing amount or installment, in part or in full, before due date.

Shariah Structure of the Facility-Disbursement of Funds from SBP to PIFIs under Mudarabah i. After making disbursement(s) on account of the facility to the customer, the PIFI shall approach the concerned office of SBP BSC for obtaining mudarabah investment to the extent of the amount disbursed/ financed to the customer. ii. The Mudarabah investment by SBP shall be made on the basis of certification by the Internal Audit of PIFI with regard to confirmation that the financing is within the terms and conditions laid down in respective category of the facility. A copy of the said Internal Audit Certificate shall also be submitted to the concerned office of SBP BSC at the time of obtaining Mudarabah investment. iii. The SBP BSC office shall provide mudarabah investment within two (02) working days from the date of receipt of request on submission of duly filled in prescribed documents a. IWCF:2-Mudarabah Investment Request Form (IWCF–2) b. IWCF:3-Debit Authority (IWCF–3) c. IWCF:4-Copy of Demand Promissory Note by PIFI’s customer (IWCF–4) d. IWCF:5-Undertaking of the customer on the format e. Financing Agreement between PIFI and customer (inclusive of redemption schedule) f. A copy of Internal Audit Certificate as per Para 1.7.1 (ii) above. g. Any other document(s), advised by SBP, from time to time.

The expected rate of return on financing provided by the PIFI to its customer under the scheme may not exceed rates announced by SBP on similar refinance facilities. Further, SBP expects profit rates/return on its investment close to its return on such type of refinance facilities

Allocation and Distribution of Profit / Loss:- i. The SBP’s investment in the general pool will be assigned profit sharing ratio and weight age keeping in view SBP’s expected rate of return as well as PIFI’s policy and practice for such type of depositors in the general pool. Such weight ages shall be used to calculate profits on SBP investments. ii. At the end of every month, but not later than the 7th working day of the following month, after calculation of the actual profit of the general pool by the PIFI, SBP’s share of profit will be appropriated for credit into a separate non-remunerative account held with the PIFI. The profit accumulated in this account shall be transferred to SBP within 7 working days from the close of a quarter. No profit shall accrue or be applicable on the amount standing to the credit of reserve account. iii. The determination of profit will be made in line with section 2 of “Instructions for Profit & Loss Distribution and Pool Management for Islamic Banking Institutions (IBIs)” issued vide IBD Circular No. 3 dated November 19, 2012, as amended from time to time.

If at any time the general pool of a PIFI suffers a loss, it shall be borne by all the depositors of the general pool, including SBP, to the extent of their respective ratios of investments in the general pool. ii. The PIFI will be responsible for any loss incurred to SBP under this facility, if the said loss is subsequently proven to have been caused on account of negligence/mis- statement and/or misrepresentation, on the part of PIFI, as determined by internal auditor, external auditor and/or SBP inspection team.


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