The rise of Islamic house finance

Islamic house financing is gaining strength. If anyone has any doubt, they should look no further than the graphs. After crossing over in September 2015, the share of Islamic house financing has kept its pace. That share stood at 33 percent in September 2015, and now stands at 38 percent, where the increasing share of Islamic banks as against the Islamic windows of conventional banks is also noticeable.

According to SBPs quarterly house financing reports, gross outstanding housing loans by public banks fell 18 percent year-on-year whereas that of private banks and HBFC grew by 17 percent and 7 percent respectively. In contrast, gross outstanding house loans by Islamic financing grew 25 percent year-on-year in CY16.

This growth comes largely in line with the trends spotted since the days of 2007-08 global financial crisis and its rippled affects in Pakistan. Back then many a banks had burned their fingers and were shying away from consumer loans; borrowers too were hesitant taking loans in the high interest rate scenario. However, while the conventional bankers stayed from consumer finance for housing purpose, the gap was filled by Islamic lenders.

This was largely on two accounts. One, while liabilities of Islamic banks have grown considerably over the last many years, they have little avenues to park their monies; the demand for long term Islamic structured government papers has not been adequately filled. Second, is the growing consumer preference for Islamic finance.

The growing preference for Islamic finance is not only because of consumers religious preferences, as surveys by the IFC and the SBP have repeatedly brought to light. It is also because of the structure of the transaction. In an Islamic house finance transaction, the principle component remains the same across the tenure of the loan, whereas in conventional house finance transaction, the principle component is small in the early years of the tenure, and grows as the tenure grows. The latter model leaves the borrowers high and dry if they want to restructure the transaction in the early years of the tenure.

Its a healthy sign that mortgage finance is growing; yet the levels are not at desired levels. In other developing economies the share of mortgage finance is much higher than in Pakistan, and in developed economy its a norm. With real estate prices rising faster than the average middle class income, the affordability of housing is getting dearer. It is therefore imperative to build yield curve for long term papers, especially in Islamic domain and peg those with mortgage.