Scope for Islamic banking seen

Scope for Islamic banking seen
Financial soundness, solvency of Islamic banks remained strong despite global financial crisis

Azhar Bukhari
The promotion of Islamic banking and finance is the need of the hour.
Islamic finance is a system based on strong economic and social considerations, envisaging equitable distribution of rewards and risks among the stakeholders.
However, it is very encouraging that the Islamic finance is being practised by Muslims as well as a few non-Muslim countries. The United Kingdom had taken significant initiatives in the development of Islamic finance by adopting an open door policy.
The investors from Middle East, Far East and UK have shown keen interest in the establishment of Islamic banks in Pakistan. The total assets of Islamic banks in Pakistan are increased to Rs340 billion. There are 170 branches of six licenced Islamic banks and more than 13 commercial banks are also offering Islamic banking services.
Moreover, the financial soundness and solvency of the domestic Islamic banks remained strong despite constraints and global financial crisis as the total assets of the industry increased to Rs 340 billion during the third quarter of FY 2008-09.
From 01 January to June 2009, the deposits of the Islamic banks surged to Rs 140 billion, financing and investments mounted to Rs 176.4 respectively while the number of full-fledged Islamic bank branches including stand-alone branches of conventional banks extended to 341 as of end-FY 08-09.
A detailed performance review on Islamic banking revealed that Islamic banking in Pakistan has grown rapidly in the last few years. Keeping in view the small size of the industry and its evolutionary nature, the growth achieved so far has been impressive and has persistently outpaced its conventional counterparts.
The consistently high average growth rate is attributed to the entry of four new players in the market in FY07 and FY08. At present there are six Islamic Banks (IBs) operating in Pakistan with 238 branches.
Though the performance in terms of growth of assets is impressive, it has not translated into a proportionate increase in profitability as reflected in the ROA and ROE for Islamic banks. At 0.6 and 3.3 percent for CY07 respectively, these ratios for Islamic banks are below the overall banking sector average.
Notably, these indicators do not portray the actual picture due to the entry of four new banks in the market which started operations as recently as CY06 and 156 CY07, and are still in the process of establishing their business, expanding their deposit base and enhancing the scope of their operations.
It would normally take a new bank 3-4 years to become profitable and start operating efficiently, i.e. once the start-up costs and the expenditure on the development of management systems and related infrastructure, start to yield results.
This shows a higher ROA (2.6 percent) and ROE (16.3 percent) in CY05, when there were only 2 dedicated Islamic banks operating in the industry. Both indicators declined sharply in the subsequent year (with a marginal improvement in CY07) simply due to the enhanced capital and asset base effect: the new banks contributed a significant amount to the total capital and asset base of the Islamic banking industry, but the earnings are still largely concentrated in the two previously established banks in the sector. Both ROA and ROE for the industry are expected to increase in coming years, as the new banks establish themselves on a sound footing. That said the current strains on the macroeconomic environment might exacerbate this process.

A Brief History
Modern banking system was introduced into the Muslim countries at a time when they were politically and economically at a low ebb, in the late 19th century. The main banks in the home countries of the imperial powers established local branches in the capitals of the subject countries and they catered mainly to the import export requirements of the foreign businesses. The local trading community avoided the “foreign” banks both for nationalistic as well as religious reasons. However, as time went on it became difficult to engage in trade and other activities without making use of commercial banks.
With the passage of time, however, and other socio-economic forces demanding more involvement in national economic and financial activities, avoiding the interaction with the banks became impossible. As countries became independent the need to engage in banking activities became unavoidable and urgent. Governments, businesses and individuals began to transact business with the banks, with or without liking it. This state of affairs drew the attention and concern of Muslim intellectuals. The story of interest-free or Islamic banking begins here. Interest-free banking seems to be of very recent origin.