In spite of huge scope for growth in the country’s nascent Islamic banking industry, most specialised Islamic banks are either losing money or barely making profits in their struggle for survival in a highly competitive market and a low-interest rate environment.

Despite a handsome growth of 7.4pc during the second quarter of the present calendar year to June, that saw the industry’s assets jumping to Rs1.745tn not-withstanding, majority of the Islamic banks are accumulating losses and finding it hard to meet the central bank’s minimum capital requirement (MCR) of Rs10bn.

The country’s Islamic banking industry has made significant progress since its re-launch in 2002. At present, the industry has acquired an 11.4pc share in assets and 13.2pc share in deposits of the overall banking sector, according the State Bank of Pakistan.

The MCR should be different for small and large banks according to the size of their risky assets

In 2015, the Islamic banking industry continued its double digit growth reflected by the year-on-year growth of its assets by 27.9pc and deposits by 28.5pc; the growth was also higher than the growth of 16.8pc for assets and 12.6pc for deposits in the overall banking industry.

Bankers say Islamic banks are growing 2-2.5 times faster than conventional banks in Pakistan and have already expanded significantly in the consumer finance sector, capturing half of the market share in car lease and mortgage finance. The (consumer finance) market share of the Islamic banks is increasing by 1pc annually and has gone up to 14pc in 2016 from 9pc 5 years ago, according to a Meezan Bank executive.

Still, the field remains uneven for most of the full-fledged Islamic banks, as well as conventional banks operating standalone Islamic branches. At least three full-fledged Islamic banks — Dubai Islamic Bank Pakistan, Burj Bank and Albaraka Bank Pakistan — have been unable to meet the MCR despite repeated extensions allowed by the central bank.

Although Dubai Bank made a small profit during the first half of the ongoing year, the remaining two lost substantial money. The losses accumulated over the years have already forced Burj Bank to merge with Albaraka Bank Pakistan to allow the latter to meet the MCR by the deadline of Dec 31, 2016. Barring Meezan Bank, none of the full-fledged Islamic banks’ is making sustainable profits.

The results of the majority conventional banks operating standalone Islamic banking branches are also not very encouraging.

“There are several factors responsible for the difficult situation most full-fledged Islamic banks are finding themselves in today,” the Meezan Bank executive said on condition of anonymity. “The banks that were given licences to operate in Pakistan in the mid 2000s found themselves in a tight corner soon after the central bank raised the MCR limit from Rs6bn to Rs23bn (since cut down to Rs10bn). That came as a shock to the sponsors of these banks and their focus shifted away from growth to managing their capital.”

Later in 2008, the global financial meltdown saw some of the Gulf sponsors of these banks lose huge sums of money that left them with little room to support their Islamic banking ventures in Pakistan. “The economic slowdown in the country also affected the Islamic banking industry and a couple banks found themselves in a difficult situation,” he argued.

Recently, the Meezan Bank executive said, the low-interest rate regime has hit the income of these banks quite hard while their cost of operating branches remains rigid, eating into their profits and making them suffer losses.

“Pakistan’s entire banking industry is structured on a high interest rate regime. When the rates started to plunge, the cost of funds also went down. But the branch administration costs still remain high as consumers are getting most banking services, if not all, free of any charge. If you look at the financial results, you’ll see that even smaller conventional banks are in a crisis and profits of the large banks have decreased because of low interest rates (and high administration costs).”

Mubashar Bashir, a Finca Microfinance Bank executive, is of the view that banking, in Pakistan in general, and Islamic banks in particular, will remain under stress for the next couple of years. “With a small base of depositors and just 2pc of borrowers accounting for four-fifth of the entire banking sector loan portfolio, you cannot expect smaller banks to stay profitable in the highly competitive market in Pakistan.”

Yet he says the chances of Islamic banks merging with each other remain dim even though the deal between Burj Bank and Albaraka Bank Pakistan does point to further consolidation of this sector.

He said the struggling full-fledged Islamic banks could easily turn their losses into profits provided they started charging for their services. But, he argued, none of these banks are in a position to risk this because in the given conditions the competition from large conventional banks, like Habib Bank operating standalone Islamic branches, will wipe them out of the market.

“The managers of the large banks know they can make billions just by starting to charge the free services they are offering their customers. But they are not doing so because this gives them leverage over the smaller full-fledged Islamic banks.”

The Meezan Bank executive insists that the central bank will continue to help the Islamic banks facing difficulty in meeting its MCR limit if they kept their capital adequacy ratio (CAR) at a higher level to avert any risks, but added that the MCR should be different for small and large banks, according to the size of their risky assets.

“I believe that the struggling specialised Islamic banks will survive this difficult time. However, if this low interest regime gets extended to 4-5 years, then I don’t see any future for them (barring a couple of them) or even for smaller conventional commercial banks.”

Published in Dawn, Business & Finance weekly, October 17th, 2016