The Islamic financial services industry has become an important component of the financial system in an increasing number of jurisdictions. The industry is performing at a remarkable rate and becoming a competitive alternative to conventional banking around the world. The segment has witnessed considerable developments and is now regarded as one of the fastest-growing industries of the global financial system particularly in the unbanked Muslim population.
The excellent performance is due to strong demand, quality research and product innovation. The progress is also supported by a strong financial infrastructure which includes an effective supervisory structure, credible standards and an effective risk management system. At present, total global financial assets of the Islamic financial industry is estimated to be around US$2 trillion and is expected to double in the next five to seven years.
Likewise in Pakistan, on the backdrop of excellent growth globally, Islamic finance is expanding sensibly across the country in an impressive manner. Pakistan, with a large Muslim population, remains at the forefront in promoting Islamic finance. The country has an important strategic geographical location which, along with a rich source of minerals and a large and highly productive agricultural region, makes it a marketplace with ample business opportunities for trade and finance.
At present, the Islamic financial services industry of Pakistan consists of Islamic banks, microfinance banks, Islamic mutual funds, Modaraba entities, Takaful companies and Islamic REITs. Commercial and microfinance banks operate under the State Bank of Pakistan (SBP) while the rest of the sector is supervised by the Securities and Exchange Commission of Pakistan (SECP).
Review of 2015
The Islamic banking industry in Pakistan has progressed considerably and its share has increased from scratch in 2002 to nearly 12% of the overall banking industry in terms of its asset size. The branch network of Islamic banking is continuously expanding throughout the country at a fast pace and catering to the demand for Shariah compliant banking products. The stability and resilience of the Islamic financial industry had attracted wider acceptability of this system as a viable alternative to the conventional financial system. No doubt, under the dynamic leadership of Saeed Ahmed, the deputy governor, the SBP has played a leading role in further promoting and developing Islamic banking within the country on sound footings.
SBP is continuously improving and strengthening its legal, regulatory, and supervisory framework and also remains active in creating awareness within the masses for Islamic finance. The SBP is also engaged in refining and improving the legal and regulatory framework to ensure its responsiveness to the evolving industry dynamics and its effectiveness in identifying, measuring and mitigating the risks associated with this industry.
During the year, the SBP issued the Shariah Governance Framework for Islamic Banking. The primary objective of this framework is to strengthen the overall Shariah compliance environment of Islamic banking institutions and explicitly define the roles and responsibilities of various organs of Islamic banking institutions including the board of directors, the executive management, the Shariah Board, the Shariah Compliance Department, etc.
The SBP had also announced the establishment of a center of excellence for the development of high-quality human resources required for the Islamic finance industry. The center will further strengthen the foundations of Islamic finance within the country through rigorous research and effectively address the challenge of a shortage of human resources. The five-year strategic plan which was launched last year is gradually being implemented in phases. The key focus areas/objectives of the strategic plan are:
- enabling a policy environment
- Shariah governance and compliance
- awareness and capacity-building, and
- market development.
The SECP has also provided various incentives for the promotion of Islamic finance at the country level. Under the progressive leadership of Zafar Hijazi, the chairman of the SECP, the commission has become very active in promoting Islamic finance. The major breakthrough was the establishment of a separate Islamic Finance Department (IFD). According to the mandate, the IFD will carry out the functions of Shariah regulation and compliance, product development and market awareness. The head of department of the IFD is Bilal Rasul who has vast experience in Islamic finance.
The IFD has also envisaged a roadmap for restructuring and reorganizing the Islamic capital market. The roadmap entails the introduction of uniform Shariah regulation for Takaful, Modaraba entities, Islamic mutual funds, Islamic pension funds, Islamic REITs, Islamic financial institutions other than banking, Shariah compliant (non-financial) companies, Islamic products and instruments. Within the SECP’s jurisdiction, Islamic mutual funds, Modaraba and Takaful companies are growing very well particularly the Modaraba sector which is performing very well and contributing to the promotion of Islamic finance in the country. Modaraba entities have the unique nature of a Shariah compliant corporate entity and have completed almost three decades of business operation within Pakistan’s financial market as Islamic financial institutions.
During the year, Takaful windows with conventional insurance companies were also allowed to start their Takaful operations. The first Shariah compliant REIT fund also started its business in 2015. The Islamic REIT fund was a good development for the promotion of the Shariah compliant property market in Pakistan. The SECP has also formed a new Shariah Advisory Board within the IFD in order to harmonize the Shariah-related business, operations and structure of the instruments of Islamic finance and to adopt a standardized approach for the practical application of various modes.
Preview of 2016
Keeping in view the growth potential of the Islamic finance market, the government seems quite determined to push ahead with this industry in Pakistan. The present government has showed their commitment in facilitating the development of the Islamic finance industry by creating an enabling environment. Last year, the government constituted a high-level steering committee for the promotion of Islamic banking and finance in the country under the chairmanship of Saeed. Significant progress has been made by the committee in key areas including a review of the legal, regulatory and taxation frameworks as well as the development of liquidity management solutions and the Islamic capital market which will greatly support further development of this industry.
The establishment of a separate Islamic division within the SECP is also an excellent step in the promotion of Islamic finance. The development of capital markets, mutual funds, Modaraba and Takaful companies complements the growth of the Islamic banking industry. Realizing the crucial need for close collaboration in the overall financial system, a joint forum of regulators from the SBP and the SECP has been established. This forum will help in creating a conducive environment and developing the necessary regulatory standards for the Islamic financial industry. It is a very positive move from both regulators and will greatly support the overall expansion of Islamic finance in the country.
Recently, the SBP has issued the first license to a microfinance bank for Islamic banking. This will definitely provide support in addressing issues of financial inclusion and the development of Islamic finance as an alternative and compatible system at the micro level. This will not only provide investment avenues to Islamic financial institutions but will also enable these institutions to make significant contributions toward poverty alleviation as well. Another landmark move was made by the central bank with the issuance of the first Islamic subsidiary bank license to a conventional bank. This initiative will further encourage major conventional banks to have a fully-fledged Islamic bank as a subsidiary under their conventional banking arm.
The future outlook of the Islamic finance industry in Pakistan is very promising with bright prospects. Both the regulators, the SBP and the SECP, are playing vital roles for the growth and promotion of the Islamic finance industry in the country. Pakistan is the world’s second-most populous Muslim nation and has great potential for the expansion of Islamic finance which is largely an untapped industry. The major challenges are to educate the masses and widen the outreach to improve the visibility and accessibility of Islamic products so as to encompass the financially excluded segment as well. Although the industry has shown rapid growth, concerted and proactive efforts are still required for areas that need further developing in order to nurture this industry.