Salman Ahmed Shaikh
Islamic banking in Pakistan is an established industry with 12% market share achieved in just over a decade. There are 5 full fledged Islamic banks and more than 15 other commercial banks that operate Islamic banking windows alongside conventional banking in Pakistan.
One of the challenges faced by Islamic banking industry in Pakistan is that deposit mobilization had been much easier as compared to using the deposits to provide finance. Islamic banks with asset-backed financial products rely much more on formal documented manufacturing based industries where finance is required for plant and machinery, raw material and industrial equipment.
On the other hand, the financing operations that are overly dependent on asset backed debt based modes of financing create several issues.
First, in times of recession, Islamic banks in Pakistan have limited product range for firms that require finance in already ongoing projects in which big investments had already been made, but financing is required to meet rising costs of energy and utilities.
Secondly, in recession, purchasing new assets for expansion is not the first things most firms would do or can afford to do. Hence, if Islamic banks remain stuck in debt based modes of financing, they will have to start offering buyback or sale and leaseback type of products which are not preferable or ideal from the Maqasid-e-Shari’ah perspective.
Third, over-reliance on debt based modes of financing requires firms to take initiative and increase their demand for such products from Islamic banking. Hence, the supply side response by Islamic banks is hindered and they may remain ineffective in bringing an economy out of recession by providing less restricted and flexible modes of financing like Mudarabah and Musharakah.
But, Islamic banks in Pakistan seem to be content with surplus liquidity. Instead of using the deposits to provide finance to private sector, they had increased investments. This has resulted in a finance to deposit ratio of as low as 34% in recent months. This undermines their function of financial intermediation between firms and households.
It is surprising that we do not look at development towards Islamic economics ideals by looking at the size of equity markets, number of new IPOs and self-employed professionals. They are all avoiding payment and receipt of interest directly. We need to get out of this mentality of only assessing progress towards Islamic economics ideals in the commercial practice of Islamic banks.
The path dependency is followed more rigorously in product design for commercial viability, but not when another institutional structure appears to conform to basic Quranic injunctions, but not to the directly Fiqh defined parameters. For instance, the modern day venture capital funds, private equity, public and private corporations are time tested structures which avoid direct involvement of interest and for which sufficient covenants had been developed by way of experience and legislation which render these structures highly usable in current times.
Banking penetration is 11% in Pakistan, then, 89% of the population is already interest free by not being directly involved in interest based banking. The number of firms using their own equity, family funds, partnership or capital markets for finance maybe much more in number than those opting for bank finance alone.
If commercial viability is a valid excuse when 89% of Pakistanis not use banking services in the first place, then, Islamic banking penetration in future will become an obstacle against itself when there will be an academic call to change the structure for Maqasid-e-Shari’ah compatibility.
Banks usually serve risk averse clientele. The equity investors are also in financial markets and are willing to take part in equity investments with no guarantee of either capital gains or dividends. In fact, they participate despite there being capital value tax and capital gains tax in Pakistan’s stock trade.
Banks hide behind the depositors who in the first place, are only placing funds with banks as a secure way to park liquidity rather than as a means of investment. It is confirmed by the very low deposit rates in Pakistan which do not even makeup half of Pakistan’s inflation rate during the last 10 years.
Karachi Stock Exchange, the premier equity market of Pakistan has market capitalization of about $70 billion which is roughly one-third of Pakistan’s GDP. While corporate bonds have very little penetration and banking services are utilized by only 11% of population. Most savers with adequate risk apatite look to invest in secondary market for equities. Karachi Stock Exchange had provided return of 48% and 49% in 2012 and 2013 respectively. Hence, the less risk averse investors favor equity investments in liquid stocks for parking their surplus money.
Still, no Islamic bank has seriously ventured in micro finance sector in Pakistan and not even in investment banking. Helping IPOs by investment banking operations is closer to fulfilling Maqasid-e-Shari’ah than getting trapped in path dependency and debt based product structures in commercial and retail banking.
Islamic banks are in search of a distinct identity for themselves and to showcase their significant and unique impact on the economy that can legitimize their economic merit over and above the conventional banks. Facilitating IPOs through investment banking can make them play an effective role and also pave the way towards increased use of equity based financing over debt based financing in Pakistan.