Islamic Banking & Finance Page 11-01-2019

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Liquidity Issues of Islamic Banks in Pakistan

Muhammad Arif

Shariah-compliant banks in Pakistan, the world’s second most populous Muslim nation, hold only 13.6 % of total banking assets in Sept 2018. That is well below levels of around 29.1 % seen in Gulf Arab states.

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 In Sept 2018, Islamic banks show a decline in liquid assets to total assets from 28.8% in June 2017 to 22.8% in June 2018 as compared to conventional banking liquid assets to total assets as 47.7% in June 2018. Likewise In Sept 2018 Islamic banks show a decline in liquid assets to total deposits from 34.7 % in June 2017 to 27.9% in June 2018 as compared to conventional banking liquid assets to total deposits as 63.6 % in June 2018.

The reason for this fall is very simple. The Islamic banking industry holds approximately 14.7 per cent of total banking deposits. But when it comes to investments, Islamic banks have a share of only 5.92 pc in the form of liquidity instruments. The conventional Banks have Rs 6,500 billion government securities against their deposit of approx Rs 11,000 billion whereas Islamic Banks have just Rs 385 billion of Sukuk apart from Bai Muajjal against their deposits of Rs 2,000 billion.

SBP helped earlier Islamic banks’ by lowering their statutory liquidity requirement to 14% of total demand liabilities from 19% against maintaining 19% for conventional Banks thus reducing the amount of liquid assets which banks must maintain as reserves.

In Islamic banking, assets have to be created before liabilities unlike the conventional model. Due to a lack of government-guaranteed SLR-eligible papers, Islamic banks have been forced to finance PSEs at fine rates, raising the risk of non-performing loans. Due to smaller returns on their assets, Islamic banks are finding it difficult to raise deposits at higher rates, resulting in deposit attrition. Also, these institutions don’t have the luxury of an interest rate corridor (available to conventional banks) where banks can place funds at a minimum rate or borrow at a maximum rate from the SBP in dire need. Hence, the axiom that the central bank is the lender of last resort to all banks doesn’t exist for Islamic banks.

Further sukuk are a lifeline not just for Islamic banks. Asset management companies also need them for their Islamic mutual funds. Takaful operators also require sukuk for their fund management.

Hence to resolve the finance ministry should buy sukuk on deferred payment from Islamic banks before maturity and sell them back in the market and then repeat the whole process. Through multiple iterations, Islamic banks will be able to get rid of their excess liquidity.

Further ministry should allocate more assets for sukuk. If motorways and airports can’t be allocated, there should be some other unencumbered assets elsewhere parked in different ministries that can be used for sukuk issuance. There is a misconception that the underlying asset has to be an earning one. Assets against which sukuk were issued in the past — motorway or the airport — have all been earning assets. That doesn’t need to be the case. An asset of the Public Development Sector Program (PDSP) can also be financed through sukuk. For example, post offices have to be established in every corner of the country. They don’t necessarily earn profit, but the government can issue sukuk against such buildings. The government can also fund the construction of dams through Islamic banks by issuing SLR-eligible sukuk.

In addition to this the government should also come up with a short-term alternative to treasury bills for Islamic banks. A possible solution can be a product that allows the government to fund its quarterly purchases of crude oil/furnace oil through the Islamic banking industry by issuing SLR-eligible short-term paper by using Salam mode of financing. Bahrain example can be followed in this regard.

Further an Islamic Banking department should be set up in the Ministry of Finance to look after the affairs of the Islamic banking industry. There is a director general for the Debt Management Division, but his job is limited to the issuance of treasury bills and PIBs.

In the absence of these measures, there is a risk that Islamic financial institutions will fail to meet their statutory liquidity requirement and be forced to supplement it with cash, further eroding their profitability and becoming less competitive to the conventional side.

Scenario of Islamic Banking and Finance in 2019

Manzar Naqvi

After passing 2018, not proved much beneficial for Global Islamic Banking and Finance Industry due to Middle East political situation, fall in oil prices and international trade wars between two powers I.e. USA and China, 2019 has arrived.  It is hoped that in 2019 Islamic banking and finance industry and its volume would go above $2.5 trillion. According to the Thomson Reuter study, the global Islamic finance industry grew by 11% in 2017 compared to the previous year to $2.4 trillion 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 would be 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.

Africa is seen as a particular area of potential growth for Islamic banking in 2019, as a growing number of governments there is laying out roadmaps for the industry’s development and providing respective regulatory frameworks.  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 that 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.

The average growth of the industry will remain the same in Middle East. Tanzania and Kenya are expected to introduce and enhance regulatory framework for Islamic financial industry and it will have direct positive effect for the growth of the industry. Moreover, Uganda and Ethiopia would also be claiming the same growth. Whereas, in West Africa, Nigeria and Senegal will record the growth of the industry by enhancing the market base of Islamic microfinance and Islamic bonds (Sukuks). In North Africa, the Moroccan Islamic financial industry will emerge.

In another report, In India the Reserve Bank of India (RBI) is expected to allow for Islamic banking after coming election, so that 200 million people would be able to avail the financial system coherent with their beliefs.

In 2019, the Takaful industry is not expected promising due to certain reasons and the same was observed in 2018. The Sukuk industry is expected to grow and it is projected that new Sukuks would be issued. Islamic microfinance is also emerging tremendously for poverty alleviation and most of the countries are including in their policy part. It is expected that the volume of Islamic microfinance industry will shift from 1% to 2% in 2019 due to its importance.

Issues in devising Islamic financial products

Mubesher Mir

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. But Islamic finance has become sophisticated enough to appeal on both counts.

Though the principles underlying Islamic finance are as old as the religion itself, modern banks did not start offering sharia-compliant products until the mid-1970s. Since then it has grown into a global industry, with total assets of around $2.4 trillion now in 2019. Most of that (nearly 81%, according to Malaysia’s central bank) is entrusted either to Islamic banks or to the Islamic units of conventional banks. The rest takes the form of sukuk, Islam’s answer to bonds (11%); Islamic investment funds and Islamic Microfinance (6%) and takaful, the Islamic version of insurance to 2%.

The demand created by this rapidly growing pool of Islamic capital has spurred the growth of sharia-compliant products. These take many forms, but none may pay or charge interest, nor can they invest in things that Islam forbids (so no alcohol, pork, gambling or pornography). In an Islamic mortgage, for instance, a bank does not lend money to an individual who buys a property; instead, it buys the property itself. The customer can then either buy it back from the bank at a higher price paid in installments (murabahah) or make monthly payments to the bank comprising both a repayment of the purchase price and rent until he owns the property outright (ijara).

By the same token, a holder of sukuk has not technically lent the issuer money; instead, he owns a nominal share of whatever the money was spent on and derives income not from interest but either from the profit generated by that asset or from rental payments made by the issuer. At the end of the sukuk’s term the issuer returns the principal to the investor by buying his share of the asset.

Cynics may point out that the difference between these structures and a conventional bond or mortgage is, in practice, rather slight: both provide predictable income to those who make their capital available. But that does not seem to have dampened their appeal.

Recently Al Rayan Bank PLC has become the first UK bank to issue a Sukuk. The £250 million sterling denominated issuance is backed by UK mortgages with a maturity of 2052. The transaction was priced at Sterling 3 months’ LIBOR plus 80bps. Al Rayan bundled 1,672 home purchase plans to act as security for its sukuk, The last Sukuk originating out of the UK was the UK Sovereign Sukuk issued in 2014, though an issuance by Emirates Airlines in 2015 for $913 million was guaranteed by the UK Government. Chinese state-owned bank the Industrial and Commercial Bank of China (ICBC) has also become the first Chinese bank to help arrange an international dollar based sukuk. ICBC is helping to arrange for Pakistan’s $1 billion 5 year Sukuk. Overall it is maintained for volume of Sukuk issuance internationally at $70 billion-$80 billion in 2018.

Malaysia would continue to support overall market growth, owning to its strong market foundations and government support for Islamic finance.

However Despite strong recent growth for Islamic financial products, there still is room for further expansion, both in relatively unbanked Muslim countries in the developing world and in the West. As the orders for Britain’s issue show, demand for sovereign sukuk is strong. Hong Kong and South Africa are also scheduled to issue dollar-denominated sukuk. Luxembourg, Russia, Australia, the Philippines and South Korea have also shown interest.

But there are potential pitfalls as well. 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.

Hence such rows have led to calls for greater international standardization. This ask for creation by national regulators of such entities as the Islamic Financial Services Board is asking for compliance with both religious and prudential guidance, thus 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 Islam has 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 and SECP.

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