Ask an average person if Pakistan is getting more Islamic, and the answer will vary greatly. To the right(eous), the country couldn’t be more distant from religion, as evidenced by co-ed schools or girls being able to breathe. For others, it’s hard to miss the overdose of religiosity.

While one can still debate about the country at large, the Islamisation project is hard to miss when it comes to our finance industry. According to the State Bank of Pakistan, deposits of Islamic banking reached Rs5.16 trillion as of December 2022, representing 23 per cent of the industry-wide total. Just for context, this share stood at 14.4pc back in 2017. During the same period, the share of Islamic branches in overall banking has gone from 17.9pc to 25.15pc.

By the proponents, Islamic banking is considered an equaliser of sorts, which allows the predominantly Muslim population access to financial services while still being true to their beliefs.

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There’s merit to that claim since the proliferation of Shariah-compliant banking, large amounts of deposits have been mobilised from people who might otherwise have avoided the formal net. In fact, both Islamic banking (IB) and window operations (IBB) have seen deposits grow by 143.5pc and 219.4pc over the last five years, far outpacing the 81.8pc of the conventional industry.

Islamic banking’s investments-to-deposits ratio grew to 63.39pc in 2022 from just 20.39pc in 2017

Plus, Islamic banking had one restriction, which turned out to be an advantage. Given the lack of Shariah-compliant sovereign securities, they had to actually do financing, which was their job to begin with. This is why both IB and IBB have traditionally had advances to deposits (ADR) ratios much higher than their conventional counterparts.

In Q4-2022, the ADR of IB was 58.83pc and IBB at 62.03pc. This was fairly higher compared to the overall industry’s 53.02pc, which in turn was more of a window dressing operation. In order to avoid the penalty levied by the SBP, banks in December last year extended advances to their buddies at non-banking financial institutions, who in turn invested that money into government securities. As a result, ADR spiked by 423 basis points compared to November.

Anyway, let’s not digress. The point is that the historical gap between the ADR of Islamic and the overall industry is now closing fast. In the last five years, the ratio for IB has fallen from 67.17pc to 58.83pc. More importantly, its investments-to-deposits ratio (IDR) has grown to 63.39pc by 2022 from just 20.39pc in 2017.

Between FY18 and FY23, the federal budget deficit has increased from Rs2.26tr to Rs6.52tr, with domestic banks the biggest beneficiary of the sovereign’s failure

While this may still be significantly better than the overall industry IDR of 79.68pc, that’s honestly a very low yardstick to compare against. At least for anyone with a shred of self-respect and ambition. But obviously, it signifies a much deeper problem where you have an increasingly cash-constrained government that needs to borrow to meet its expenses.

Between FY18 and FY23, the federal budget deficit has increased from Rs2.26 trillion to Rs6.52tr, with domestic banks the biggest beneficiary of the sovereign’s failure.

Undoubtedly, it has worked incredibly well for the banks who have posted phenomenal profits for the last two years, growing even in triple digits off a high base. And who’d say no to easy money? But the problem is that contrary to what economic textbooks say about sovereign being risk-free, it’s no longer the case in Pakistan. Not in the recent past and short-term future, at least.

For the industry, this should be a point of reflection as they deliberately moved away from their core job to serve as the sugar daddy of the government as it was all too easy.

But now, the sovereign risk is just not the same, and their ability to manage that is questionable too as last year showed us. Especially the Islamic banks, who so eagerly got into the same mess after continuous lobbying for Shariah-compliant securities.

In fact, the Islamic finance industry for years has relied on governmental support of various sorts. But now that it has grown to a significant size, the benefits aren’t showing as they should have. Who’d have guessed that Pakistani businesses with state support would turn out to be rent-seeking? That has surely never happened before.

The writer is the co-founder of Data Darbar

Published in Dawn, The Business and Finance Weekly, October 16th, 2023