KARACHI: Pakistan's central bank has published a detailed five-year plan to promote Islamic finance through an array of proposed legislative changes, product incentives and instructions to market participants.

The plan aims to double the branch network of Islamic banks, which now have about 1,200 branches, and increase the industry's market share to 15 per cent of the banking system by 2018 from roughly 10 per cent now.

The document says it would create a level playing field for Islamic banks in the world’s second most populous Muslim nation; their financing-to-deposit ratio would reach a level that was at least on a par with their conventional peers.

The central bank said the plan would focus on improving the public's perception of the industry, and it included a detailed timetable for the gradual roll-out of initiatives.

“Despite strong growth momentum, the industry perception is still not very positive, largely due to limited awareness and similarities between conventional and Islamic banking products,” said Saleem Ullah, director of the central bank’s Islamic banking department.

The regulator aims to encourage Islamic banks to not only obey industry rules but also follow the spirit of Islamic principles, such as an emphasis on transactions based on real economic activity rather than monetary speculation.

“Product offerings are overwhelmingly debt-based, which though they meet the minimum sharia requirements don’t meet the sharia objectives of risk- and reward-sharing, and equitable and broad-based distribution of economic gains,” Ullah said.

As of September, Pakistan had five full-fledged Islamic banks and 14 others offering Islamic banking products; they held a combined 926 billion rupees ($8.8 billion) of assets or 9.5 per cent of the total, central bank data showed. That compares with around 25 per cent in the Gulf Arab region.

Legal framework

The central bank intends to develop a distinct legal framework for Pakistan’s Islamic banks by 2018, and to propose changes to its own charter and review other legislation to eliminate any confusion and inconsistencies.

It will work with federal and state governments to provide tax neutrality for Islamic banks to limit extra product costs.

The regulator will also step up adoption of guidelines from the Malaysia-based Islamic Financial Services Board and the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions, the global industry's two main standard-setting bodies.

A sharia governance framework is scheduled to be released in Pakistan this year which will specify roles and responsibilities of management, scholars approving Islamic finance activities, and sharia compliance and audit officers.

Guidelines for development finance institutions to start offering Islamic banking are to be issued by 2015. An alternate resolution mechanism for resolving Islamic banking disputes is planned for 2016.

An Islamic pricing benchmark for money market transactions and short-term lending would be devised by 2015, as well as guidelines for treasury products. By 2016, the central bank is to have rationalised minimum capital requirements for full-fledged banks, Islamic windows and Islamic banking subsidiaries of conventional banks.

This would be complemented by a media campaign to promote the industry which was launched last year and is to be strengthened.

Complex

The central bank's complex plan would be challenging to implement for any regulator, even in more developed economies than Pakistan. Success in all of the initiatives is not entirely under the central bank's control; it will need the cooperation of other institutions such as parliament and the finance ministry, which may be distracted by other issues.

Nevertheless, the central bank appears willing to invest considerable effort in the scheme. Last month it named a new deputy governor to focus on Islamic banking and enlisted renowned scholar Muhammad Taqi Usmani to its sharia board.

Its plan addresses some challenges, such as the need to develop a short-term Islamic money market, which have dogged Islamic finance globally for years and have not been resolved by regulators in many other countries.

To harmonise industry practices, Pakistan's central bank plans to review major products and issue instructions by 2016 on products' essential requirements. It will restrict certain mechanisms in Islamic banking transactions such as agency agreements, hiba (gifts) and waad (unilateral promises) which it believes can be criticised by scholars.

Incentives would be introduced by 2015 to stimulate profit-sharing transactions such as musharaka and mudaraba, which are widely known but relatively rarely used Islamic contracts.

By 2017, housing finance products would be designed based on market prices and rentals, rather than the current practice which uses interest-based pricing benchmarks. Guidelines would also be developed by next year for project and infrastructure sukuk (Islamic bonds).

The regulator will encourage Islamic banks to increase financing to the agriculture sector and to small enterprises. By 2015, the banks are expected to allocate at least 5 per cent of deposits or 10 per cent of financing to each sector.

Similar efforts will encourage financing of low-income housing, where there is unfilled demand of 7.5 million housing units that is accumulating by 350,000 units every year, the central bank said.

It plans to revamp an existing sharia-compliant export refinance scheme and develop a long-term financing facility by 2015.