Moody’s Investors Service, a reputable think tank, commented in its latest report that the Islamic banking industry in Pakistan has, on average, grown annually by 24 per cent over the last decade — expanding by 30.6pc in 2021 alone. It is expected to grow beyond 50pc in the next few years in sync with the financial markets of major Islamic countries that have already crossed this target.

To understand this aggressive switch to Islamic banking, let’s begin with a simple insight. Islamic Banking, as the name denotes, is a Sharia-compliant option for handling financial instruments in a rapidly diverse market that is constantly evolving to address new challenges.

According to Islamic Sharia, Islamic banking cannot deal in transactions involving interest/riba (an increase stipulated or sought over the principal of a loan or debt). Further, they cannot deal in the transactions having the element of Gharar or Maiser. Moreover, they cannot deal in any transaction, the subject matter of which is invalid (haram in the eyes of Islam). Hence reducing the risk at all levels.

Perhaps keeping that in mind, the Islamic banking sector feels more empowered to take the bull by the horns. It is this trust in the financing and Sharia compliance (Riba-free) which is the major magnet that is now gravitating the public toward this form of banking.

As the finance sector grows, Sharia-compliant banking is growing steadily more popular with the increase in confidence in Islamic instruments

According to the KAP study (Knowledge, Attitudes and Practices) survey conducted over 10,000 households in Pakistan by the State Bank of Pakistan (SBP) in 2014, 74pc of respondents showed a willingness to switch to Islamic Banking while 17pc were still considering the option.

This shows that a clear majority is not just receptive but also supportive of the Riba-free banking system. So, while we see tremendous growth in the overall banking sector, we also see a substantial increase in confidence in Islamic instruments.

The Islamic Banking industry has gradually introduced various products which can be an alternative to the products offered by conventional banks. The induction of these products was done keeping in mind the demand of the local masses and the compliance with Sharia standards which are established by the global authority, Accounting and Auditing Organisation for Islamic Financial Institutions.

Products like Roshan Digital Accounts, housing and auto finance, Hajj scheme, financing schemes for businesses etc picked up pace including Islamic Refinance Export and Islamic Long-Term Financing in the last few years. Roshan Digital, in fact, has become one of the most consistent supports for the finance sector in Pakistan.

The government now prefers to raise funds through Sukuks, an alternative Sharia-compliant instrument of the government’s bonds. And the reason is very valid, the amount of financing is less than the lending cost of interest-based bonds. The savings are substantial, in the billions, and this attracted the government to avoid borrowing from Medium-Term Treasury Bills (T-Bills) and Pakistan Investment Bonds (PIBs).

Last year, the SBP also introduced Sharia-compliant Open Market Operation (OMO) facility for Islamic banks to manage their liquidity issues effectively. This facility has extended the room for the growth of Islamic banks in the future. Sukuks raised by the government surged to over Rs2 trillion, according to the data released by the SBP.

One important advantage that the Islamic banking industry retains over conventional banking is its non-performing financing which stood at 2.7pc against 7.9pc.

Speaking of the market status presently, out of 25 mainstream commercial banks, five are full-fledged Islamic banks, and 17 conventional banks are offering the services of Islamic banking through separate divisions and windows. Two out of ten microfinance banks also commenced Islamic banking services. A few of the banks are planning to go ahead with Akhuwat, the Islamic microfinance institution, due to its potential to grow big in terms of quick rolling and turnover.

There are presently almost 4,000 branches and 1,500 windows operated across the country by these banks. Nearly 500 new branches were added across the country in 2021 and more branches will be added as we move forward.

These branches not only enhance the penetration of Islamic banking instruments but convert an otherwise non-banking section of the population (people who avoid using commercial banking due to some reason or the other including faith concerns) into a productive part of the growing economy.

Islamic banking institutions in Pakistan are more profitable than their conventional counterparts and their loan performance is better. For 2021, they reported a return on assets of 1.3pc and a return on equity of 21.4pc, compared to 1.0pc and 14.1pc for conventional banks. The difference in profitability was due to lower loan-loss provisioning needs at the Islamic banks, given their better loan quality and their lower funding costs, Moody’s report said.

While given the industry’s growth potential and strong financial performance, we expect more banks to apply for Islamic banking licenses and for conventional banks to convert to fully Islamic systems. We have the example of Faysal Bank Limited, with around 3pc market share, already in the process of converting from conventional banking to Islamic, the report further mentioned.

The share of Islamic banking in overall deposits and assets has increased to nearly 20pc at present. It is set to increase to 30pc by 2025 as per the strategic plan by the SBP. It also plans to enhance the branch network of the Islamic banking industry to 35pc of the overall banking industry and 10pc and 8pc share of small and medium enterprise Financing and Agriculture Financing respectively in private sector financing.

As stated earlier, if we look at the next five-year projections, with the industry growth at a conservative 10pc, Pakistan could convert half of the banking and financial sector into using Islamic instruments in the next 15 years.

The signs are that Islamic banking will be leading (significantly) to further on-board the banked population of the country which has surged to over 20pc already. The use of banking services in Pakistan will increase, the use of cash will slow down gradually and the money will circulate in the financial sector. More importantly, the GDP-to-saving ratio is likely to improve by double-digits.

At least ten Islamic countries have already achieved a significant market share of the domestic banking and financial sector including Iran, Saudi Arabia, the United Arab Emirates and Bahrain. Keeping in view, the demand pattern and growth curve of Islamic banking and the financial sector in the country, Pakistan should be rapidly moving to shift a substantial part of its financial systems and economy towards Sharia guidelines through the Islamic Banking initiative in near future.

The writer is the founder of the Corporate Pakistan Group and former minister of state and chairman, Board of Investment

Published in Dawn, The Business and Finance Weekly, August 1st, 2022