Pakistan is currently reeling from extremely high inflation, brought on by an ambitious spending programme and subsidised financing in the wake of Covid-19 to spur growth. As a result, credit to the private sector expanded by Rs2.28 trillion between Q1-2020 and Q2-2022. But that’s a familiar story.

What has yet to be discussed is how, as of the end of FY22, it was the first time when Islamic banking branches (IBB) of conventional banks surpassed full-fledged Islamic banks (IB) in terms of their credit offtake. The former’s outstanding portfolio stood at Rs1.31 trillion as against the latter’s Rs1.269tr, according to Broad Money data published by the State Bank of Pakistan (SBP).

As a result of this increase, the share of IBB in overall private sector credit reached 14.23 per cent versus IB’s 13.74pc. This is despite the latter having a much bigger deposit base of Rs2.36tr, as against the former’s Rs1.85tr by 2021.

In fact, over the last eight years, IBB’s credit to the private sector has increased at a compound annual growth rate of 32.75pc, as against IB’s 19.74pc and conventional banks’ 8.99pc. Even more impressively, it has managed to grow in every single quarter since Q2-2014. So the question is obvious: what explains this rise?

There is a growing tendency among Islamic banks to join their conventional banking brethren in a rich tradition of rent-seeking

According to Sana Tawfik, Vice President of Research at Arif Habib Ltd, this could partly be because of conventional banks pushing their lending through their Islamic windows due to the lower cost of funds. “As the liquidity avenues of Islamic banks have improved with the issuance of riskless Sukuks, there has been a tendency to switch towards that as long as the advances-to-deposits ratio is above the SBP-mandated 50pc,” she says.

It seems like the Islamic banks, which were borne out of the idea to lend, also prefer being a money market fund management company. According to SBP’s Quarterly Compendium on Banking Statistics, Islamic Banking branches did net financing of Rs1.47tr against full-fledged Islamic banks’ Rs1.49tr by FY22. Again, that’s despite having a much bigger balance sheet.

To better drive the point home, the absolute value of financing may not be as important so let’s look at the ratio. At the end of 2021, the IBBs had an asset deposit ratio (ADR) of 66.9pc whereas IBs stood at 57.6pc. Sure, it was still better than the overall banking’s 46.7pc, but that should never be the benchmark for anyone.

This trend is clear even at the bank level. For example, a major Islamic bank had gross financing and related assets of Rs777 billion and deposits of Rs1.46tr during the year ended 2021. This translated into an ADR of 53pc — which is lower than both industry-wide IB and IBB levels.

“With a total deposit size of approximately 1.6 trillion rupees, Meezan Bank has a relatively large deposit base compared to other full-fledged Islamic Banks. This means that advances need to increase by a larger absolute amount in order for us to improve the advances-to-deposit ratio compared to other Islamic banks with smaller deposit bases. In their case, even a modest increase in the absolute amount of advances can have a much bigger impact on ADR due to low base effect,” Meezan Bank replied in a statement to Dawn’s questions.

Compare that with the book of the largest Islamic window operations of a conventional bank. With financing of Rs226bn and deposits closing at Rs347bn by 2021, its ADR was 65pc. That’s 12 percentage points higher than its counterpart during the comparable period.

According to the annual report, the said bank took “an extensive project to convert Islamic windows to branches”, which saw the Islamic branches increase from 62 to 259, even as the overall number of branches declined from 1,697 to 1,685.

Faysal Bank’s CFO, Majid Ali Syed, also reiterates this view, saying that the high ADR is that advances are the first thing to be converted into Islamic, while deposits only follow later on. According to him, there is also a tendency to increase lending due to potential tax savings.

But can IBBs sustain this momentum? As per Sana Tawfik, there might be a return to normalcy in this quarter and the next. “Conventional banks have to meet the minimum ADR on an unconsolidated basis, so they will have to increase their non-Sharia-compliant lending as well,” she says. IBs’ relatively lower ADR could also be explained by faster growth in the deposit base.

The weekly M2 data published by the SBP has so far supported her view though the picture will be much clearer when quarterly numbers are published. But that still leaves a growing tendency among Islamic banks to join their conventional banking brethren in a rich tradition of rent-seeking where good-for-nothing treasuries park most of the customer money into government securities.

Published in Dawn, The Business and Finance Weekly, October 31st, 2022