The State Bank of Pakistan (SBP) is known throughout the global Islamic financial industry as an innovator and advocate of Islamic banking.

Having been among the first few central banks to issue Islamic banking guidelines and regulations in 2008, SBP is exploring new frontiers such as Shariah compliant tools for agriculture financing in hopes of further promoting the industry and making it continue to be relevant to the Pakistani economy.

Here are excerpts of SHABBIR H. KAZMI’s interview with Saleem Ullah, director of SBP’s Islamic banking department.

Progress to date
Pakistan can rightly take pride in achieving many milestones in the successful introduction of Shariah compliant commercial banking. Although we can be considered a late starter, I believe the achievements we’ve made in the past decade surpass those of some countries. We introduced Islamic banking parallel with conventional banking, thus giving consumers a choice between the Islamic and conventional modes of banking.

Pakistan, being a predominantly Muslim country, has huge potential for the large-scale expansion of Islamic banking and its emergence as a strong competitor of conventional banking. In the past year itself we witnessed the addition of 100 Islamic banking branches throughout the country.

As it is, Islamic banks in Pakistan currently offer a wide range of Shariah compliant products and services including Murabahah, Ijarah, Musharakah, Diminishing Musharakah, Mudarabah, Salam and Istisnah. These products cater to the demand for Shariah compliant banking services from various sectors/sub-sectors of the economy including corporates, SMEs, consumers and commodity financing. Efforts to introduce Shariah compliant products for agriculture are also at an advanced stage, and we anticipate this to open up new vistas for the Islamic banking industry in the country.

Policy being pursued
The Strategic Plan for the Islamic Banking Industry (2007-12), chalked out by the central bank, aims at achieving a 12% share of the total market. However, as Islamic banking assets currently account for only 6% of the market, to see this double by 2012 will be quite a feat.

Despite this, the future prospects for the growth and development of the Islamic banking industry in Pakistan are very bright. The recent financial crisis in the western financial markets has also substantially improved the acceptability of Islamic banking both locally and internationally, which will help boost the industry’s prospects.

The major areas of focus in the immediate term and near future include:

• Diversifying the investment avenues for Islamic banking institutions, particularly short-term liquidity management.
• Improving the legal, regulatory and supervisory framework.
• Improving the Shariah compliance levels within the industry.
• Improving Islamic banking literacy through awareness campaigns and programs.
• Capacity building.
• Gradual movement of Islamic banking institutions towards participatory modes.

Product development
The central bank and Islamic banking players in Pakistan are well aware of the fact that the process of development of new Shariah compliant products is a little slow — the overall slowdown in economic growth during the last two years also contributed in impeding the growth in new product development.

The industry however has arrived at a consensus on the critical importance of new product development to help maintain the industry’s growth.

Pakistan is also an active member of the Islamic Financial Services Board, the Accounting and Auditing Organization for Islamic Financial Institutions and the International Islamic Financial Market, which is also likely to help in improving product mix and market practices.

Shariah compliance
Pakistan has an elaborate Shariah compliance mechanism — the central bank has its own Shariah board and all the Islamic banks and conventional banks with designated Islamic banking branches have their own Shariah advisors.

All the products and services offered by Islamic banking institutions are required to be approved by their Shariah advisors; in case of difference of opinion between the Shariah advisors and the banks’ management, the issue is referred to SBP’s Shariah board whose decision/opinion is final and binding on the Islamic banking institutions.The SBP Shariah board also reviews the broad Shariah issues of the industry and delivers its opinions to promote standardization in the industry. Further, we have a mechanism for Shariah inspections/audits along with the financial audit to assess Shariah compliance levels in the industry; Pakistan is probably the only country having this mechanism, which increases consumer confidence in the Shariah permissibility of Islamic banking products.

Key issues
Despite impressive growth during over the past five to six years, the industry is still facing a number of challenges, which we will have to tackle effectively in order to maintain the growth momentum. These include:

• Extremely low literacy (understanding) on Islamic banking.
• Limited capacity of Islamic bankers.
• Lack of liquidity management instruments.
• Low pace of product innovation.
• Over-conservatism of Islamic banking institutions in tapping new avenues and developing participatory financing models/products.
• Blurring the distinction between Islamic and conventional banking.

Sector outlook
The growing confidence of the public in Islamic banking has encouraged other players to introduce Islamic financial products. A number of Islamic mutual funds are already operating in the country and with about half a dozen Takaful operators in the pipeline, this will help drive the momentum in the use of the Islamic concept of risk sharing.

The flotation of Sukuk by entities like Pakistan International Airlines, Water and Power Development Authority and many other corporate entities has also opened access to Shariah compliant project financing.

Having said this, there is no room for complacency — Islamic banking institutions in Pakistan will have to come up with better and more efficient solutions to meet the financing needs of the business community, and the central bank will have to make its policy and regulatory framework more responsive to the industry dynamics.