Expanding Reach of Islamic Banks

With a futuristic approach, Islamic banks are now trying to find Shariah-compliant mode for overnight borrowings from the State Bank discount window. The Islamic banking committee of Pakistan Banks Association is fine-tuning a proposal for this purpose to present it to the State Bank.

On its part, the SBP is seeking membership of the International Islamic Liquidity Management of Malaysia formed to develop liquidity management solutions for Islamic banking industry in collaboration with governments and central banks.

“As a class, Islamic banks do not face the kind of liquidity crunch that forces traditional banks to use the SBP discount window,” says president of an Islamic bank. “But going forward we may need such a facility if borrowings and cash withdrawals outpace growth of deposits.

This cannot be ruled out as business keeps expanding. Besides, development of an Islamic version of the SBP discount window would be another milestone in growth of Islamic banking.”

Islamic banking in Pakistan has already covered many milestonesthe most important being its outreach, development of Islamic treasury bills or Ijara Sukuk that the government uses to raise funds from Islamic banks and emergence of an inter-bank Islamic money market. Islamic banks are now also ambitious about developing Islamic banks offered rate or IBOR which they can use in place of KIBOR and provide ease of business to their customers.

But technical hitches remain stronger barriers. The fact that the share of Islamic Banking Institutions (IBIs) in our banking industry has widened from just 0.3 in 2003 to 6.7 per cent in 2010 speaks about their success stories.

What has added to their charm is that IBIs remained almost immune to the perils of the 2008-09 global financial crises and the Great Recession.

“People believe that Islamic banking is a real hedge against such crises and this continues to fuel even faster growth in Islamic banking,” according to a senior executive of Meezan Bankthe premier Islamic bank in Pakistan.

“The financial crisis followed by the August 5 downgrading of (top-tier long-term) US credit rating (for the first time since 1941) would further reinforce public confidence in Islamic banking which has a better in-built system of mitigating market risks. And this should accelerate progress of Islamic banking in Pakistan even further.”

During the financial crisis of 2008-2009 and immediately afterwards in 2010 key pointers of growth of the IBIs showed over a hundred per cent increase. Their total assets mounted up from Rs206 billion in 2007 to Rs477 billion in 2010; deposits swelled from Rs147 billion to Rs390 billion and net financing and investment surged from Rs138 billion to Rs338 billion. Total number of branches of five Islamic banks plus Islamic branches of about a dozen conventional banks also shot up from 289 to 751 during the last three years.

The re-branding of Dawood Islamic Bank as Burj Bank after acquisition of the bank’s majority stakes by two Middle Eastern financial groups last month is expected to improve key indicators of the IBIs further.

Burj Bank officials say they have ambitious plans to expand branch network and develop innovative products for clients in addition to using the brand name of Burj for seeking the business of handling home remittances of Pakistanis settled in Middle Eastern countries. Currently, conventional banks and foreign exchange companies cater to this business.

One recent accomplishment of the IBIs is that the share of agribusiness in their overall mix of financing went up to about 2.6 per cent in the last year from just 0.8 per cent a year earlier. But it still fell short of the overall banking industry’s average of about six per cent. Islamic bankers say issues in pricing of farm loans, developing tailor-made products for deposit raising and financing for different classes of rural clients and typical problems in farm loan recovery are big challenges for them.

However, they insist that higher income levels in rural areas and growing inclination of rural people towards Islamic banking continue to drive them to develop more customer-friendly products for farmers.

Over the years, Islamic banks and dedicated Islamic branches of conventional banks had struggled to diversify their financing mix with a view to reaching out to key sectors of economy. And 2010 statistics showed that their struggle bore fruits. For example, in such industries like automobile and transport equipment, cement, sugar, textiles, chemicals and pharmaceuticals, electronic/electrical appliances, and shoes/leather garments, the percentage of share of Islamic banking finance was higher than that of the overall banking industry average.

According to 2010 SBP report on Islamic banking, loans to individuals also constituted 16.5 per cent of Islamic banking financefar higher than the industry average of 12 per cent.

Islamic bankers say a couple of factors have led them to expand financing portfolios in the above-mentioned areas. These include increasing demand for riba-free banking, customer-friendly products, higher quality of services and focus on those clients who were ignored or maltreated by conventional banks. These bankers also attribute similar reasons for growth in deposits. They say that after overcoming some thorny issues related to the application of Shariah laws, Islamic banking institutions now also offer fixed deposit facility which is expanding their deposit base. By the end of last year more than one third of total deposits of the IBIs fell into the category of fixed deposits.

One important thing that Islamic banking institutions have not been able to address so far is that their banking spread is still higher than that of the banking industry’s average.

“Against the industry’s average of 6.8 percentage points in December 2010, the IBIs spread was slightly higher at 7.1 percentage points,” said one senior Islamic banker pointing out that in the initial years of IBIs operation the difference was a bit wider.