Islamic banking now has a 13pc share in our overall banking industry. But its ability to serve agriculture, small and medium enterprises, poor households and low-cost housing sectors remains low for want of a more diversified range of Shariah complaint products.

And, even in corporate financing, Islamic banking institutions (IBIs) are unable to tap unmet requirements because of a lack of needed diversification of financial products.

As of March 2016, IBIs’ outstanding financing of the corporate sector was as high as 74.3pc—higher than the entire banking industry’s exposure of 68.4pc of the financing mix.Compared to this, their financing of SMEs and agriculture stood at 2.6pc and 0.7pc respectively—far lower than the banking industry’s average of 5.8pc in each case.

Few Shariah-compliant financing products not enough to meet diverse business needs

“Two things keep IBIs from reaching out to the reservoirs of potential clientele,” says a former senior central banker. “First, their branch networks are still concentrated in large urban centres (56pc of all IBIs branches are located in five big cities i.e. Karachi, Lahore, Rawalpindi, Islamabad and Faisalabad). Secondly, the product range of IBIs is a bit narrow and their reliance is too heavy on just two Islamic modes of financing.”

As of March 2016, Murabaha and Diminishing Musharaka had a combined 54.5pc share in the financing mix of Islamic banking.

“Both Murabaha and Diminishing Musharaka cover a wide range of Shariah-compliant contracts, with a variety of corporate and non-corporate clients,” says a senior executive of Dubai Islamic Bank. Other modes of financing (like Ijarah, Musharaka (plain), Salam and Istisna) are also used frequently for contracting deals with borrowers.

Bank executives agree that “not enough work has been done with a view to enhancing the scope of these modes of Islamic finance to the extent that a variety of banking products based on them can be developed.”

Central bankers say that the five-year (2014-18) strategic plan for Islamic banking does recognise the need for further development and diversification of Shariah-compliant banking products. Since its initiation IBIs’ reliance on Murabaha and Diminishing Musharaka has gradually shrunk from 66.2pc in March 2014, to the current 54.5pc of total Shariah compliant financing.

“One must understand that the modes of Islamic financing (that we discuss in terms of product development) are the foundations on which buildings of Islamic banking products are built.’ says an official of SBP well-versed with Islamic banking.

“When businesses and individuals deal with IBIs they are introduced to banking products that look, and the names of which sound similar to conventional banking products. So, from a clients’ point of view it’s less important what modes of Islamic financing are being used most often and what modes are being used with lesser frequency or on a limited scale.”

What is important for individuals and businesses, though, is whether IBIs are meeting all their financial needs. That is where the numbers don’t tell us a very good story; except for in the corporate sector, IBIs penetration remains quite low in such key sectors like agriculture, SMEs, microfinance and housing etc.

Even commodity, an area tied closely to both the corporate and agriculture sectors, claims only 9pc share in IBIs’ total financing pie against the banking industry’s average of 11.3pc. IBIs have, however, been catering well to the needs of those consumers whose share in their financing mix is as high as 10.9pc against the banking industry’s average of 6.6pc, thanks to rapid development of Ijarah-based products. The share of Ijarah mode of financing, in the financing mix of IBIs, is 7.2pc.

What keeps IBIs from entering agricultural and SME financing in a big way or from tapping the potential of Islamic microfinance and housing finance is not just a lack of well-suited Islamic banking products. “Of late, they have lined up so many products with fancy names for agriculture, SMEs and housing finance,” says a former head of agricultural credit at one of the top five commercial banks. “Like commercial banks, IBIs too are extremely risk averse and frequent launch of government Sukuk (Islamic bonds) provides them with a cool way of earning big profits.”

By March 2016, the investment to deposit ratio of IBIs soared to 43.9pc, only slightly lower than their financing to deposit ratio of 46.9pc—thanks largely to the launching of Rs80.4bn Ijarah Sukuk.

If IBIs have to be pushed toward more generous lending in priority sectors identified in the current five-year strategic plan, then the government must also reduce its appetite for bank borrowing. The strategic plan does not only admit the need for product diversification on part of IBIs, and a requirement on their part to penetrate into priority areas of agriculture, SMEs, microfinance and low-cost housing; but has also set indicative targets for the industry to achieve by 2018, central bankers say. It is in this backdrop that from the last fiscal year IBIs have been involved in SBP-supervised agriculture lending by banks and microfinance banks.

For example, it is expected that new housing finance products would be developed based on market prices and rentals against the current practice of fixed property prices and KIBOR-linked rentals.

Published in Dawn, Business & Finance weekly, July 11th, 2016