"I shall watch with keenness the work of your organisation...compatible with Islamic ideas of social and economic life. We must work...and present to the world an economic system based on true Islamic concept of equality of manhood and social justice," so addressed Mohammad Ali Jinnah at the inauguration of the State Bank of Pakistan in 1948.
Yet, despite the fact that Islamic banking was inevitable in an Islamic republic, Pakistan was a late entrant to the practical model of Islamic banking. However, the past few years have seen Islamic banking getting due recognition, although the journey has just begun and there is a long way to go before it becomes huge in terms of size and impact on the overall financial industry.
During Zia's era, the regulator brought about sweeping changes in the financial system in the quest of 'Islamisation of the economy', which resulted in a countrywide roll out of Islamic banking. However, critics argue that the change was sudden and without adequate preparation, which led to confusion and, therefore, Islamic banking could not really kick off in its true spirit.
The lessons learnt from the unsuccessful attempt in the 1980s led to a more realistic approach in re-launching of Islamic banking in the 1990s. The SBP issued licenses, formulated Shariah compliant guidelines, and introduced various investing and financing tools for the Islamic banks, gradually, by virtue of which, Pakistan today has five full fledged Islamic banks along with more than a dozen conventional banks that run Islamic operations on the sidelines.
The growth of Islamic banks in Pakistan was massive during CY07-CY09 despite the global recession and unfavourable financial environment. The massive 34 percent and 33 percent growth in Islamic banks' asset size during CY07 and CY08 respectively speaks volumes of the relative immunity that the system enjoys over conventional banks. This is because the very nature of Islamic banks' deposits and advances does not hamper growth a great deal.
Conventional banking during the same period grew at a much slower pace, understandably though, as the financial system faced the impact of a weakening economy. The base effect and the developed stage at which the conventional banking system stands also explained the slower growth rate in relation to the relatively infant stage of the Islamic banking industry.
The Islamic banks' asset growth, however, considerably slowed down during the first six months of CY10, which many industry watchers say is not a good sign. Experts argue that the industry should instead continue to grow for another 5-6 years in ideal circumstances. It seems that Islamic banks have reached the consolidation phase a bit too early which reflects the hurdles that the Islamic banking system faces in Pakistan.
Islamic banks have shown steady progress in deposit growth at a much better pace than conventional banks, managing to increase the deposit market share from nearly 4 percent in CY07 to nearly 7 percent by June 2010. These numbers have made the experts believe that the market is very much there to be tapped; it is just a matter of effectiveness and being competitive.
Advances growth, on the other hand, has been lacklustre, which is reflective of the fact that Islamic banks lack ample avenues for financing. The advance-to-deposit ratio, resultantly, shows a dismal picture when compared to that of the conventional banks. The ADR has worsened gradually from CY07, from the high of 73 percent in CY07, it has touched the lows of 48 percent as on June 2010.
"Islamic banks' ADR generally are comparable with that of conventional banks across the world, therefore, the poor ADR in Pakistan's case is a reflection of the cautious approach that the Islamic banks adopt and also the lack of enough financing tools and opportunities available in the Shariah system in Pakistan," said a seasoned Islamic banker associated with Meezan Bank.
Another hindrance to Islamic banks' profitability is the lack of Shariah compliant investment avenues which causes short-term liquidity issues. That is why Islamic banks usually carry higher cash balances than conventional banks and, in turn, yield lower returns on their investments.
There have been efforts to develop the derivates market for Islamic banks and other investment tools, but progress has been painfully slow and has yielded little fruit. The Sukuk market does exist, but is not liquid enough as it is not frequently traded in the secondary markets due to demand-supply issues.
Islamic banks eagerly await the State Bank to finally approve the Islamic T-bills, which could help a great deal in addressing the industry's problems of lack of investment tools. That said, enough still needs to be done towards the development of Shariah compliant investment tools, where a good lead can be taken from Malaysia which has plenty of Islamic investment instruments including swaps, T-bills etc.
Islamic banks rely on asset based financing to generate return for depositors. The fixed rate based products face heavy criticism due to their apparent resemblance with conventional tools. Entrepreneurs are also reluctant to share profits with the financiers in low risk ventures. Lack of documentation makes it difficult to work with real business ventures.
Malaysia and other regional countries have relaxed regulatory tools and taxation parameters for Shariah banks. Islamic bankers are of the view that since Islamic banking is new in the country, it demands relaxation in taxation because in Islamic banks the depositors are partners and share the actual profit and loss unlike traditional banks where depositors are creditors and their principal is protected.
Moreover, because of the differing nature of depositors, the percentage of SLR and CRR should be relaxed keeping in view the risk profile to create a level playing field and to reflect the risk-sharing nature of shariah banking deposits. The industry demands the central bank to treat Islamic banks from a different yardstick than the one used for commercial banks.
Availability of quality human capital is also a big issue - business schools, banks and other bodies have to work hard to produce more scholars on the subject, because the opportunity on offer is huge and the human resources required to tap that are few and far between.
Last, but not the least, there is a trust deficit amongst the consumers, both potential and the existing ones. A large majority still believes the current Islamic banking not to be in compliance with Shariah and perceives it as just a change in nomenclature.
That can only be done when all the scholars sit together and define what exactly is Islamic banking and the regulator should facilitate them by providing sufficient tools to operate in the current environment, like a different benchmark rate than Kibor for the Islamic banks because it makes the Islamic banks look every bit like conventional banks.
In the final analysis, there is indeed great potential in Islamic banking; it is just that the banks and the regulator need to align the concept more strictly with the Islamic teachings.
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Key Balance Sheet Items
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Rs(bn) CY05 CY06 CY07 CY08 CY09 9MCY10
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Assets Investments (net) 800 833 1,276 1,087 1,737 1,803
Advances 1,991 2,428 2,688 3,173 3,240 3,739
Lending to Fis 212 210 191 188 240 *NA
Funding Equity 292 402 544 563 660 585
Deposits 2,832 3,255 3,854 4,218 4,786 4,818
Borrowing from FIs 351 438 452 459 659 *NA
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Profit and Loss
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Rs(bn) CY05 CY06 CY07 CY08 CY09 9MCY10
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Interest Income 170.4 272.6 361.7 477.1 566.3 372.1
Interest Expense 14.5 23.0 171.5 244.7 304.6 200.6
Net interest Income 155.9 249.6 190.2 232.3 261.8 171.5
Provisions 2.9 3.1 53.2 102.2 94.0 38.8
Other Income 11.1 15.5 84.8 85.1 94.1 51.8
Operating Income 12.5 179.4 275.0 317.5 355.9 184.5
Profit after Tax 15.4 21.2 23.6 41.7 57.1 38.9
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Segment-wise Advances
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Rs(bn) Dec-07 Dec-08 Jun-09 Dec-09 Mar-10 Jun-10
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Commodity 148 235 399 419 364 484
Consumer 371 332 300 269 262 246
Agriculture 151 155 151 156 160 164
SMEs 437 375 335 348 326 318
Corporate 1,520 2,016 1,953 2,065 2,090 2,046
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Asset Quality Indicators
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As at Jun-10 (%) Top 5 Top 6 to 10 Top 11to20 Top 21to29 All 29 Banks* FBs
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Infection Ratio 11.2 13.1 16.1 14.4 12.6 8.6
Net Infection Ratio 2.3 4.9 5.9 6.7 3.7 2.0
Provision Coverage 81 .6 65.8 67.3 57.4 73.6 78.7
Net NPLs to Capital 10.6 30.7 26.3 19.4 17.7 4.5
Fixed Investment 12.7 13.9 13 14 14.8 14.6
Working Capital 8.7 11.5 13 12 13 12.8
Trade Finance 7.2 10.6 12 10 11.5 10.7
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* All commercial banks
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Revenue
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Rs (bn) Net-interest Income Non-interest Income
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CY08 CY09 9MCY10 CY08 CY09 9MCY10
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NBP 37.1 38.5 31.7 16.4 19 11.4
HBL 35.6 41.7 33.6 10.3 9.9 7.9
UBL 27.9 32.7 25.1 10.7 11.7 7.3
MCB 28.5 35.8 27.0 5.8 5.6 4.6
ABL 13.3 18.7 16.6 4.9 6 3.7
BAFL 10.5 10.9 9.9 4.8 5.2 3.4
SCB 16.4 16.3 12.7 6.6 6.9 4.4
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Costs*
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% Cost of Funds Intermediation Cost
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CY08 CY09 9MCY10 CY08 CY09 9MCY10
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NBP 3.80 5.50 5.70 2.90 3.10 3.17
HBL 4.30 5.00 4.68 3.40 3.30 3.17
UBL 4.90 5.30 4.62 3.10 3.10 4.23
MCB 3.40 4.10 3.93 2.20 2.60 2.77
ABL 5.60 6.50 6.35 2.70 2.70 2.79
BAFL 6.70 7.50 7.30 3.20 3.30 3.30
SCB 3.80 5.10 4.44 6.80 6.00 5.42
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*9M numbers annualised
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Returns*
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% Return on Equity Return on Asset
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CY08 CY09 9MCY10 CY08 CY09 9MCY10
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NBP 20.5 20.7 14.8 2 2.1 1.5
HBL 17.9 18.6 19.8 1.5 1.6 1.8
UBL 21.9 19.5 18.4 1.5 1.5 1.6
MCB 31.5 27.3 24.4 3.6 3.3 3.0
ABL 21.2 30.5 26.7 1.2 1.8 1.8
BAFL 9.2 5.2 9.4 0.4 0.2 0.5
SCB 1.6 1.5 5.1 0.3 0.2 0.7
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*9M numbers annualised
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Profits
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% Net Profit Margin Rs(bn) Profit after Tax
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CY08 CY09 9MCY10 CY08 CY09 9MCY10
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NBP 28.9 31.7 26.4 15.5 18.2 11.4
HBL 21.8 23.8 31.3 10.0 12.3 11.3
UBL 21.6 20.7 39.2 8.3 9.2 8.1
MCB 44.9 37.4 39.6 15.4 15.5 12.5
ABL 22.8 28.9 28.9 4.2 7.1 5.8
BAFL 8.5 5.6 11.3 1.3 0.9 1.5
SCB 2.9 2.9 11.2 0.7 0.7 1.9
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Sources: SBP, NBP Bulletin Company Accounts, BR Research
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The writer can be reached at [email protected]
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