AFTER overcoming some teething problems during the first decade of its evolution, the Islamic banking sector has now entered a phase full of big opportunities, but also of bigger challenges.
The central bank has floated a five-year strategic plan to help Islamic banking institutions (IBIs) exploit the opportunities and efficiently address the challenges.
“Two key challenges for IBIs are to develop suitably qualified and trained human resource, and penetrate deeper into the promising but least-exploited sectors of the economy,” says a State Bank of Pakistan (SBP) official.
The SBP’s strategic plan 2014-18 for Islamic banking calls upon IBIs to increase their lending to agriculture and small and medium enterprises (SMEs) in a way that each sector gets at least 5pc of their total deposits, or 10pc of total financing, whichever is higher, by the end of 2015.
“If we use the 5pc of deposit yardstick, IBIs’ financing to the farming sector should be over Rs40 billion,” says the CFO of a local Islamic bank.
To meet this target, IBIs will have to come out of their ‘lend to the corporate sector comfort zone,’ and work hard for developing agri-finance products and reach out to rural Pakistan. As of last December, 71.8pc of their total financing was in the corporate sector, and only 0.1pc in agriculture.
As for higher lending to SMEs, the gap between the current and the desired level is not so wide. Still, IBIs must double their pace of lending, because SMEs currently get just 5.1pc of their total financing.
“Higher lending to agriculture, SMEs, low-cost housing and Islamic microfinance will help attain greater financial inclusion, which remains grossly neglected,” says a central banker, while lamenting that Islamic banks are operating largely in urban and semi-urban areas.
However, the SBP has not set any benchmarks for financing in low-cost housing and microfinance.
“It has assured us of its support for initiating consultations with stakeholders, building capacity, undertaking research and launching pilot projects by 2018,” says the head of an Islamic bank.
Executives of Islamic banks admit that developing specific products to boost financing to agriculture and SMEs is not that difficult, particularly in the presence of elaborate guidelines from the SBP.
“The real problem is two-fold,” says a Shariah advisor to a leading Islamic bank. “IBIs don’t want to sacrifice short-term gains [coming via the corporate sector] for long-term gains [waiting for gradual exploitation in agriculture and SMEs]. Besides, they haven’t made enough investment in developing human resource required for the job.”
Despite the challenges, opportunities also abound for Islamic banking. One big opportunity for banks is to capitalise on enhanced awareness about Shariah-compliant banking over the last 10 years of its successful operation.
“Whereas capitalising on deposit mobilisation is a bit easier, it’s really hard in terms of product diversification and asset management,” says a senior executive of Dubai Islamic Bank. “Banking products in general and Islamic banking products in particular are quite complex. People want simple, easy-to-understand things.”
That, in turn, boils down to two things. “We will have to set aside larger sums of money for research and human resource development. And we will also have to ensure sustainably high rate of profits,” sums up a senior executive of Meezan Bank.
A conventional banker who oversees the cluster of Islamic banking branches of his bank points out that Islamic banking tends to focus more on producing qualified Shariah advisors than grooming people working in treasury or product development departments.
“Two key training sessions are currently in progress, including one online, but both are for Shariah advisors only. For heavens’ sake, these people would only certify what’s Islamic and what’s not. But where are we going to find people who can develop tailor-made products and procedures for financing in specific areas,” he challenges.
With a modest recovery underway, consumer financing is likely to grow faster in coming years. The auto industry is coming out of the woods; housing is doing better than before; people are seeking more consumer loans; and companies are joining hands with banks to sell more of their daily-use electronic gadgetry.
“To make use of these healthy developments, IBIs have been asked to develop more diminishing Musharaka products, in line with market prices and rentals. The SBP wants us to do it by 2017,” reveals a local Islamic bank’s executive.
To seize financing opportunities emerging after the recent recovery in industrial output and exports, “the SBP also wants IBIs to accelerate, from next year, Musharaka and Modaraba-based financing”.
“In this regard, the central bank has promised to incentivise those who come up with products with improved features, besides providing an enabling policy environment. We have also been asked to revamp long-term Islamic financing facility and existing Islamic export finance by next year as well.”
In addition, the Islamic banking department of the central bank will develop comprehensive guidelines for project-specific or infrastructure-specific Sukuks. This will help private and public sector companies obtain Shariah-compliant project financing, deepen the Islamic bond market, and facilitate the government in its drive to gradually shift from short-term to long-term borrowings. SBP officials say these guidelines will be ready by 2015.