The State Bank has allowed commercial banks to set up Islamic banking subsidiaries or provide full Islamic banking facilities through dedicated branches.
Many local and foreign banks say they are making in-house preparations to start Islamic banking through dedicated branches but none of them is ready to set up an Islamic banking subsidiary.
“It is far easier to start with a dedicated branch rather than with a subsidiary,” says a top banker whose bank has submitted to the SBP a plan for starting Islamic banking through a dedicated branch. Under the rules, an Islamic banking subsidiary has to be a public limited company and must be listed on the stock exchange with a paid-up capital of Rs 1 billion. More importantly at least 51 per cent of the paid-up capital is to be subscribed by the bank which is going to set up this subsidiary. In addition to that an Islamic banking subsidiary must follow almost all mandatory requirements applicable to banking companies like that of capital adequacy ratio—and also ensure full compliance with the rules of Shariah. “The expected gain is not worth all this—not at least at this moment,” says head of a large local bank. He says Islamic banking is still more of a concept in Pakistan rather than a reality. “But of course this concept is worth exploring and with the passage of time it might work.” That is why banks want to do Islamic banking initially through dedicated branches to have a more practical idea of what Islamic banking is all about and if they should do this on a larger scale.
Commercial banks are reluctant in starting Islamic banking on a wide scale mainly because they are not sure if the government really wants to Islamize the financial system—and if so how and when? Another reason is that the banks themselves do not believe that interest-free banking is possible: many even doubt if at all the present interest-based banking is really violative of Islamic law.
But one thing is very encouraging: Meezan Bank Ltd.—the first Islamic commercial bank—has not only managed to stay afloat but is set to grow. (MBL earned a pre-tax profit of Rs 213 million in a year ending on September 30 2002 up from Rs 154 million in the comparable period of 2001). The bank that after securing the status of a scheduled Islamic commercial bank on January 31 2002 started full fledged commercial banking from May 1, 2002 after it had acquired Pakistan operations of Societe Generale. Since then it has been functioning smoothly despite that a general enabling environment has not been in place. The bank officials say they owe much to the State Bank for their smooth functioning as the central bank has offered tailor-made solutions to the problems facing the new bank. Two examples would clarify this statement.
The SBP has allowed the Meezan Bank to maintain only six per cent (non-earning) statutory liquid reserves instead of 15 per cent required for other banks. The SBP has done this realising that the MBL being an Islamic bank cannot keep SLR in treasury bills and other interest-based securities—and that asking it to maintain 15 per cent non-earning SLR is unfair.
Similarly the SBP has helped the bank in developing an Islamic system to claim export refinance from the SBP against the export loans it offers to its customers under the SBP export finance scheme.
“We have created a pool of assets for this purpose based on the concept of Ijarah and Murabahah and our bank and the State Bank do share it on pre-fixed ratios,” explains an official of the MBL.
Islamic T-bills: Liquidity management conforming to the rules of Shariah is a big challenge. In the absence of an Islamic instrument for liquidity management not only the Meezan Bank has been in problem but it also scares those commercial banks that plan to start Islamic banking through dedicated branches. The answer lies in developing sort of Islamic T-bills.
The Meezan Bank has already developed the module of Ijarah Sukook or Islamic T-bills and it is currently under review at the State Bank.
The SBP sources say what delays the approval of the design for the proposed Islamic T-bills is that the government has to identify the assets that could be securitized to back up this instrument.
The bills are proposed to be created through securitization of fixed assets of the government that would be first purchased by the investors and would then be leased out to the government. The government would pay rental on these leased assets and that very rental would be the yield of the bills.
Bankers well versed with Islamic banking say government assets in organisations like Pakistan Steel and Wah-based industries can be securitized under such Islamic modes like Salam or Istisna. But they admit that it may take the government months to work out their nitty-gritty. The State Bank is at a fairly advanced stage of setting up an Islamic banking department and SBP officials say that once the department starts working issues like development of Shariah-based liquidity management instruments would receive immediate attention. Currently two small divisions on Islamic economics and Islamic banking are working under two different departments of SBP—the Research Department and Banking Policy Department. “With the creation of a full-fledged Islamic banking department all issues of Islamic banking and finance relating to policy making or otherwise would be handled under one roof,” says an official. “That would help SBP find timely solutions for the problems facing an Islamic bank or Islamic banking branches etc.”
Malaysian help: In late January this year a team of Islamic banking experts from Bank Negara Malaysia (central bank of Malaysia) and other financial institutions of that country conducted a five-day orientation course on Islamic banking in Karachi. SBP officials as well as commercial bankers attended the course. Some of them told Dawn that the issue of setting up an Islamic inter-bank money market was discussed at length. They said the Malaysian experts informed the participants that Islamic inter-bank money market has been functioning smoothly in Malaysia since 1994. They said that eligible banking institutions are allowed to trade in designated Islamic financial instruments and also explained in details the structure of these instruments.
The Malaysian experts were of the view that there is an urgent need for introducing such instruments in Pakistan after the SBP has allowed the commercial banks to start Islamic banking and one full-fledged Islamic bank has already been in operation. Under an agreement between the State Bank of Pakistan and the Bank Negara Malaysia, the two central banks offer technical assistance to each other. Islamic inter-bank money market: Some participants of the course told Dawn that one of the major instruments used in the Islamic inter-bank market in Malaysia is mudarabah inter-bank investment (MII) that can also be introduced in Pakistan. MII refers to a mechanism whereby a deficit Islamic banking institution can obtain investment from a surplus Islamic banking institution based on mudarabah or profit sharing.
The period of investment is from overnight to 12 months while the rate of return is based on the rate of gross profit before distribution for investment of one year of the bank that obtains investment. The profit-sharing ratio is negotiable among both parties.
The investor bank, at the time of negotiation, would not know what the return would be, as the actual return would be crystallised towards the end of the investment period. That fits well into the Islamic concept of banking that prohibits pre- fixing the rates of return. Sources in SBP say SBP high-ups do realise that with some dedicated Islamic banking branches of major local banks coming into operation there would be a genuine need for putting in place an Islamic inter-bank money market.
Lack of competent advisors: So far only a limited number of banks have come up with concrete plans for starting Islamic banking through dedicated branches. Prominent among them are (i) the Khyber Bank (ii)the Habib Bank AG Zurich and (iii)the Muslim Commercial Bank.The National Bank and the United Bank are also at an advanced stage of in-house planning for this purpose but it is not known if they have submitted their plans to the State Bank. Officials of the Habib Bank claim their bank is also keen on starting Islamic banking through dedicated branches but the specifics of their plan is not known.
Senior bankers say many other banks also want to start Islamic banking branches—and they are making some in-house preparations as well—but there are not many Shariah advisors available. Under the rules banks need to have Shariah advisors well versed in both Islamic financial system as well as conventional banking to supervise Islamic banking to be undertaken by them—even if it is done through one dedicated branch.
Bankers say if they fail to find Shariah advisors from amongst the graduates of Deeni madaris they will turn to the departments of Islamic learning of reputed universities including the Islamabad university that has international institute of Islamic economics attached with it. Sources in the SBP say if the Shariah advisors fulfil the criteria laid down for them under the set of rules for Islamic banking it is irrelevant whether they come from Deeni madaris or conventional universities.