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ISLAMABAD: Pakistan’s Islamic Banking Industry is growing rapidly with a combination of a predominantly Muslim population, still modest financial inclusion, and the commitment of the government and regulators as the key driving forces, says Moody’s Investors Services (Moody’s).

The rating agency in its report on Pakistan stated that huge growth over the past decade shows no signs of slowing. Islamic banking assets in Pakistan have grown by an average of 24 per cent per annum over the past decade to Rs5,577 billion ($31.2 billion), accounting for around 19 per cent of total banking assets, up from 8 per cent in 2011.

“We expect growth in Islamic banking to continue to materially outpace conventional banking, reaching a market share of total assets and deposits of around 30 per cent by end-2026, with net financings market share at around 33 per cent. We estimate average growth over 2021-26 to range between 25 per cent-28 per cent for total assets and deposits, and over 20 per cent for net financings,” it added.

The report noted that financial inclusion in the country is still modest, despite recent progress; according to the State Bank of Pakistan (SBP) approximately 62per cent of the country’s adult population have an account with a formal financial institution, against an average of 95per cent in high-income countries. The combination of these factors provides the bedrock for the industry’s development.

The SBP’s five-year Strategic Plan for the Islamic banking industry set out targets and identifies six areas of focus that will enable the industry to achieve them. The regulator is also supporting the gradual adoption of AAOIFI Shariah accounting standards, enhancing liquidity management tools, undertaking numerous awareness and capacity building programmes and has issued instructions to improve Shariah non-compliance risk management, it added.

The Islamic banking industry in Pakistan has grown by 24 per cent a year on average over the last decade - expanding by 30.6per cent in 2021 alone. Total Islamic banking assets accounted for 18.6 per cent of total banking assets at the end of 2021, standing at Rs5,577 billion, up from Rs 641 billion in 2011. Deposits stood at Rs4,211 billion, holding a 19.4per cent market share, with an average annual growth of 23 per cent over the period.

Net financings amount to Rs2,597 billion, or a 25.7per cent market share and have grown even faster than deposits, reaching an average expansion of 29 per cent over the past decade. The outperformance of financings is likely driven by the more limited availability of Shariah-compliant liquidity products as well as strong demand for financing products.

The rating agency noted that Islamic banking institutions in Pakistan are more profitable than their conventional counterparts and their loan performance is better. For 2021, they reported a return on assets of 1.3per cent and a return on equity of 21.4per cent, compared to 1.0per cent and 14.1per cent for conventional banks. The difference in profitability was due to lower loan-loss provisioning needs at the Islamic banks, given their better loan quality and to their lower funding costs.

The nonperforming finances (NPFs), the equivalent to nonperforming loans in conventional banking, stand around 2.7per cent of gross financings, well below the market average of 7.9per cent. Superior loan performance reflects both a lack of legacy problem loans/financings and the banks’ recent aggressive growth, which has increased the denominator of the ratio and indicates their financings have still to be tested in a downturn.

Islamic banking institutions do, however, maintain slightly lower capital and liquidity buffers. Lower liquidity reflects Islamic banks’ higher proportion of financing-to-deposits (at 62per cent, against 47per cent for conventional banks), but also the historically more limited availability of Shariah-compliant liquidity products, although this has been gradually improving.

According to the World Bank and its Global Findex Database, only around 21per cent of Pakistan’s adult population had a bank account with a formal financial institution in 2017. Although significant progress has been made over the past few years, with the SBP now estimating financial inclusion at 62per cent, this remains well below the 95per cent financial inclusion in high-income countries or that of regional peers, such as India, whose inclusion rate of over 80per cent.

The government and the SBP have been instrumental in strengthening the regulatory and legal framework, improving awareness of the industry and broadening its capacity. SBP Governor Dr. Reza Baqir was appointed chairman of the council of the Islamic Finance Services Board (IFSB), an international standard-setting body of regulatory and supervisory agencies, for 2022. The key policy document that sets out Pakistan’s vision for the Islamic industry is the SBP’s third five-year Strategic Plan for Islamic Banking Industry, which was unveiled in April 2021.

The targets it sets out for achievement by 2025 include; 30 per cent share of total banking assets and deposits, 35per cent share of the branch network and catering for underserved sectors, and setting a 10per cent and 8per cent share of SME and agriculture financing, respectively.

The plan envisages achieving the targets by focusing on six pillars; strengthening the legal framework and resolving tax-related issues, in order to provide a level playing field to the Islamic banking industry, enhancing the regulatory framework, updating the risk management guidelines, adopting Islamic financial accounting and prudential standards issued by the Islamic Financial Services Board, and developing a resolution regime, reinforcing Shariah governance as the growing size and complexity of the industry requires fast-track adoption of Shariah standards issued by AAOIFI, and enhancing guidelines for conducting external Shariah audits in consultation with external audit firms, improving liquidity management, including the development of Sukuk structures for issuance of regular Sukuk programmes, and the development of Shariah-compliant structures for liquidity management, expanding outreach and market development to underserved sectors and regions and bolstering human capital and raising awareness. Specifically, the focus will be on supplying high-quality talent to match the needs of the industry and performing annual awareness programmes of Islamic banking institutions.

Copyright Business Recorder, 2022

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