ACCORDING to the latest available data, Islamic banks account for around 10pc of total bank deposits, and the average annual growth of the sector exceeds 10pc.

Despite this achievement, the most frequently asked question is about the difference between Islamic and conventional banking, because apparently there is no difference in rates of interest and profits offered by the two types. Furthermore, there is no basic difference in the working styles of incumbents employed in Islamic and interest-based banks, as both are equally hungry for low-cost current and savings accounts (Casa).

Religious scholars argue that real Islamic banking lies in Shariah-based financial instruments and not in making an interest based product ‘Shariah-compliant’. When an interest-based financial product is made ‘Shariah-compliant,’ it adds to the cost and the speed-time process, which is borne by the users and clients of Islamic banks.

For example, Islamic banks mobilise accounts from the public under Modaraba — a liability side management — but they do not provide funds to their clients under Modaraba — asset side deployment. A liability side Modaraba is a Shariah-compliant product, whereas an asset side Modaraba is ideally Shariah-based because this type of Modaraba was done by the Holy Prophet (PBUH) himself.

The development of an Islamic Inter-Bank Offered Rate — a profit-based benchmark for pricing financial products — is urgently required by Islamic banks

Critics argue that Islamic banks use the Karachi Inter-Bank Offered Rate (Kibor) for pricing their products because their cost of funds rise and fall in line with the increase/decrease of Kibor, which is essentially an interest-based benchmark.

There is a limited area of work for Islamic banks as they do not have any product for meeting the financial needs of farmers, nor can they invest in T-bills. They also do not have an inter-bank market for Islamic banks to ‘lend and borrow’ from each other. They provide the bulk of finance under Murabahah — a trade-related mode — which is least desirable in Islamic finance, according to some religious scholars.

There is a free movement of bank personnel from interest-based banks to Islamic banks and vice versa. In Islamic banks, they provide Islamic rationale to their clients for mobilisation of deposits, but when they switch over to an interest-based bank, they get a different mindset and a skill set for attracting accounts by offering higher interest rates. Conceptual clarity and commitment to the cause of Islamic finance or otherwise is seen very little.

We are working simply on the modalities of Islamic banking, which is only one part of the overall Islamic economic thought. The efforts of the State Bank of Pakistan for making a comprehensive model of Islamic banking is not supplemented by research and development work from academia in a desired manner.

For example, the development of an Islamic Inter-Bank Offered Rate (Iibor) — a profit-based benchmark for pricing financial products — is urgently needed by Islamic banks. This requires strenuous research and analysis from universities, religious scholars and Madrassas (religious schools).

Although Islamic banking is being taught as a subject in some colleges and universities, the desired quality research work on real-time issues faced by Shahriah-compliant banks is not forthcoming. Similar is the case with religious scholars and Madarassas. Finally, and most importantly, there is dominance of the interest rate mechanism in the financial and real sectors of the economy.

More than 90pc of financial intermediation — mobilisation of deposits from surplus units for onward lending to deficit units — is interest-based. Informal loan markets are working in almost every business cluster, where people borrow at rates much higher than that offered by banks. Before the announcement of every monetary policy statement, the likely increase/decrease in the SBP’s discount/repo rate (interest rate) remains the most speculated indicator in the market.

The central bank — the main source of guidance for Islamic banking in the country — is itself interest-based. Bulk of the SBP’s income comes from interest charged on government and bank borrowings. Certainly, in a full-fledged Islamic economic system, the central bank would also be free from interest. This area of work is yet to be taken.

Despite these odds at home, positive developments are taking place globally in favour of Islamic banking, particularly after the sub-prime crisis of 2008. Currently, there is a great deal of thinking and debate in Western banking and financial circles to redefine the rules of the banking business so as to make the financial sector more disciplined and supportive of the real sector, instead of destroying it.

It is time for us to work for a comprehensive model of an Islamic economic system at home by involving all stakeholders. In order to win the confidence of the general public, Islamic banks should offer a few Shariah-based financial products like Modaraba and Salam. Modaraba fully suits the fund requirement of youth and start-up ventures because banks do not finance such enterprises that have a track record of less than three years. The annual credit requirement of farmers is more than Rs1trn, whereas the contribution of Islamic banks is almost nil.

In the shape of arthis (middleman), a distorted type of Salam is already in place in the country, under which farmers get advance from arthis/shopkeepers sitting and selling their produce to them later on. Instead of banks, there is a need to involve private business entities in Salam financing.

The writer is the President of the Institute of Banking and Business Learning Lahore munir1951@hotmail.com

Published in Dawn, Economic & Business, September 1st, 2014