Islamic Banking & Finance 19-05-2017

Islamic banking and  socio-economic justice

Regarding the objective of promoting social justice, all practices of the IBIs- taking deposits and financing and investments, may lead to the contrary, even worse than in the conventional banks. Islamic banks' return on equity and earnings per share (EPS) have increased visibly over past some years but the profit rates for depositors, particularly the general (savings) depositors have decreased drastically. While the conventional banks have to pay presently a minimum historically lowest profit of about 4 % per annum on savings deposits at the time when the benchmark interest rate in Pakistan is at 5.75 percent, IBIs are paying as low as 2 percent in many cases, simply because the SBP has not obliged them to pay a minimum due to the features of murhabah contract.

We shall give only one example each for deposits and financing sides to explain ineffective implementation of the regulatory instructions. SBP did a good job by prohibiting hibah to individual depositors (Nov. 19, 2012) and phased out the individuals hibah by July, 2015. But the IBIs circumvented the regulation and offered higher weightage based products to their 'priority' deposits at the cost of common depositors. Some banks have been giving over 5 % annual profit to priority Savings Account holders by offering special PLS deposits against 2-2.5 % annual profit to common PLS savings depositors. On financing side, accounting / financial reporting by banks in case of ij?rah financing needs regulatory over watch. Only 3 Islamic Financial Accounting Standards (IFAS-I, 2, and 3) could be notified by the SECP over the last 12 / 13 years.  IFAS 2 requires ij?rah income to be recognized on accrual basis - as and when the rental becomes due (clause 10.4) meaning that full amount of due rent has to be included in the installments for payment of rent and the principal. But, IBIs normally charge in the initial stage a much higher part as rent and smaller part from the principal that results in loss to the lessee in case of pre-mature termination due to theft, major accident or non-payment due to any problem with the lessee. As per IFAS-2, IBIs may be advised to recover the principal commensurate with the depreciation charge.

As regards the objective of facilitating the real sector through supply of sufficient purchasing power, the IBIs continue to be ignoring it having even better avenues to get risk free returns by using grey area products.  Replacing genuine murh?bah, ij?rah, salam, istisn?', etc with Running Mush?rakah, secured or unsecured lending to conventional banks by tawarruq simply means that IBIs are interested in maximizing their risk free earnings only without care for social contribution or even Shari’ah compliance in letter and spirit. 

Required role of the  jurists / Shari'ah advisors

According to the instructions of SBP, the burden whether a product passes Shari’ah compliance test, rests on the shoulders of IBIs' Shari’ah Boards. Shari’ah scholars have been assigned the Divine responsibility of ensuring a Shari’ah compliant, trustworthy and robust system that could be helpful in enhancing financial and social inclusion and provide necessary support for sustainable growth and development of the economies and the societies. They need to perform this duty as a trust and without any conflict of interests while ensuring that each and every transaction conforms to the principles of Shari’ah, and that justice is done with all stakeholders particularly the general account holders. [Q: 4:58 and 33:39]. 

Measures for Regulatory Improvements include-

The prime factors behind the problems as indicated above are non-availability of any single basis for products' approval and decision making, and SBP's inability to properly govern the skills and role of RSBMs and Shari’ah Boards. Below, we recommend some steps to be taken instantly:

a)Basis for Shari’ah Decision Making and Products Approval: There has to be one basis for products approval and decision making. AAOIFI's Shari’ah Standards may be made mandatory; Further, SBP may enforce an SOP and a "Code of Conduct - Ethics and Principles for approval of Structured Products";

b)Products Approval Process: Products suggested by IBIs Shari’ah Departments may be analyzed thoroughly by the Shari’ah Research Unit of the IBD (SBP) to ensure that nothing is against AAOIFI's Standards; and then submit to the SBP's Shari’ah Boards for approval keeping in view implications of products for stakeholders and objectives of Islamic banking; IBIs may then be advised not to use any structured product unless approved expressly by the SBP's Shari’ah Board .

c)Sukuk Market: Till the whole system is Islamized primary and secondary market for sovereign Sukuk should be opened for IBIs only, excluding conventional banks.  This step will also help in curbing the clean and collateralized lending by IBIs to conventional banks in contravention of the AAOIFI's Shari’ah Standard No. 30 on tawarruq.

d)Shari’ah Advisory System in Banks: Having a Shari’ah Board in all IBIs may not be mandatory as it has caused unnecessary costs to the IBIs without any visible benefit. One Shari’ah Advisor could be sufficient serving full time to facilitate the banks in day-to-day business as per standardized products approved through process as in (b) above. The Shari’ah BAdvisors might be paid the honorarium, if any, for the meetings attended or work accomplished, and not any regular pay.

Some others steps need to be taken in short/ medium / long run:  

a)Practically, the ability of the Shari’ah advisors to fulfill their mandate is constrained by the time given for the banks affairs, their understanding about finance and access to monitoring systems, complexity of the products and transactions, and effectiveness of their independence. State Bank may maintain a panel of 'SBP Certified Islamic Finance Scholars' for Islamic banks and finance institutions. Its training arm, NIBAF, may design and arrange an advance level rigorous training course on Islamic fiqh, economics, accounting, banking and finance for Shari’ah scholars having sufficient knowledge of Islamic law of contracts, banking, finance and accounting, followed by a comprehensive written Exam.  Only the scholars securing (70) % or more marks may be eligible to become Certified Shari’ah Advisors in Islamic banking system of the country.

b)SBP may nominate, with approval by its Shari’ah Board, any of the Panel members for any IBIs for the period of three years, after which they may be deputed to any other IBIs. SBP may be deciding the monthly salaries, allowances, etc. to the IBIs' RSBM, that SBP will be taking from each IBI keeping in view its number of branches, business, expertise of its Shari’ah scholar, size of internal Shari’ah control and Shari’ah research / review departments, and the level of Shari’ah compliance (lower). 

About Dubai Islamic  Bank in Pakistan

A high powered delegation which included Dubai Islamic Bank's Group Chief Executive Officer Dr. Adnan Chilwan, Board members and senior management held key meetings with the bank's local management to ascertain the current status and future plans. The GCEO hosted two town halls in Karachi and Lahore to a wider audience of more than 1200 staff where he commended the performance given by the bank in 2016, a year that witnessed a 2-fold increase in profitability. Whilst highlighting the successes of DIB at both the Group and country level, Dr. Chilwan also outlined a detailed 2017 growth strategy for the franchise in the country. This newly defined approach repositions the Bank's medium term plans alongside the transformational growth the

Group has achieved in the last few years and effectively aligns the local franchise with DIB Group's overall positioning.

Dr Chilwan commented that Pakistan is a strategic country for DIB Group and the franchise here is an integral part of our ever-expanding global operations. Over the last few years, our consolidated performance at the group level has been highly impressive despite the challenges in the region with regards to liquidity, lower oil prices and general economic slowdown. A thorough reconstitution of the balance sheet in 2016 which included a revamp of funding sources and deployment avenues has not just resulted in significantly enhanced profitability but has also positioned the franchise to take advantage of the positive macroeconomic environment in the country and grow exponentially."

DIB is clear that the reason for success and that of Islamic finance in general in the UAE, has been the fact that we are overall market players, not niche focused. This unwavering belief has been critical to the evolution of both Islamic finance as well as the bank in the country where one enjoys more than 6% share of the overall banking sector and nearly 40% of the Islamic pie. As long every customer, corporate or retail, as a potential client, is on the only one direction for every one - NORTH than one can reach to its goals.

Junaid Ahmed, CEO DIB Pakistan said: "DIB Group has a rich and dynamic history panning more than four decades. As a pioneer of modern Islamic banking, the bank is viewed as the key influencer in the progression and advancements in the field of Islamic finance. From establishment of operations just 11 years ago to a franchise that boasts more than 240 locations across 62 cities in Pakistan, is phenomenal growth indeed and something we are all extremely proud of. Today's gathering is a clear reflection of the Group's commitment to the local franchise in Pakistan as we endeavor to strengthen and grow our business in this market. 

However according to financial statements of the bank in Pakistan for the year ending 2016 the deposits have come down to Rs 129 billion as of Dec 2016 from Rs 136 billion as of Dec 2015.Prifit has enhanced but out of total financing of Rs 95 billion, individual loans have been extended up to Rs 45 billion with nothing to agriculture and less to real sector. Bank has also kept Rs 27 billion in sukuk to earn profit with no risk. This strategy is beyond one's mind. Why State Bank is not looking banks affairs with such angles and in line with macroeconomic objectives, we don't know.

Islamic finance in Russia

Russian International Affairs Council on Russia and its Middle East policy presents a great overview of the current state of affairs of the development of Islamic finance within Russia and the CIS. It discusses the double push by Russian banks to enter into the Islamic financial market, initially during the global financial crisis in 2008 and most recently since 2014 due to the imposition of EU sanctions.

The initial push to issue a $200 million sukuk in 2009 in cooperation with Kuwait Finance House fell through due to complexities, though Ak Bars from Tatarstan was later successful in tapping Middle Eastern investors in 2011 and 2014. An "Islamic window" was launched in the Bashkir branch of the Nizhniy Novgorod-based Ellipse Bank.

It is estimated that Russian Islamic banking could account for up to 5% of the entire financial market in Russia just five years after its legalization. As of now, several Islamic banks have voiced their intention to open branches in Russia. They include Bahrain's Al Baraka, Sudan's Al Shamal, UAE's Al Hilal as well as leading Malaysian banks.

The development of Islamic finance in Russia is hampered by the absence of a necessary legal framework. For instance, Russian laws do not contain definitions of such terms as "an Islamic financial institution" or "bank acting in compliance with the principles of Sharia law", as well as a number of other terms specific to this type o f banking."

A not often discussed topic is raised, that of a potential Russian wariness of the links of Saudi Arabia to Islamic finance. It is said that Russia has been trying to limit Saudi influence in the Muslim regions of the North Caucasus and the Volga Federal District since the early 2000s. Some Russian security officials confirm that they believe the exposure of the Russian banking industry to Islamic finance would lead to an upsurge in covert Saudi influence in the country.

This fear is also underpinned by the role that the Jeddah-based Islamic Development Bank (IDB) plays in the expansion of this industry. IDB is actively involved in the negotiations with the Russian Central Bank to introduce Islamic banking in the country and supports a proposal to transform Tatars tan into a regional hub of Islamic finance."

Some facts about Islamic banking in Pakistan

As a fast-growing emerging market and a major economy within the countries of the Organization of Islamic Cooperation, Pakistan has a mature financial industry that, in the recent past, has been focusing on broadening the Sharia-compliant sector in a country with more than 190 million people. While steps to implement interest-free banking were implemented as early as the late 1970s, and, from 1985, all commercial banking in rupees was made interest-free, the success in the Islamisation of the country's banking industry remained limited due to the lack of a real legal framework for the industry and too few products. The situation is at status quo till now.

However, Islamic finance is expected to take off in Pakistan in coming years due to new regulations on Sharia-compliant banking, new industry-supporting regulatory bodies, as well as rising demand from foreign investors and the large Muslim population, experts suggest.

According to the latest Global Islamic Finance Report, growth of Islamic banking in Pakistan has been at a cumulated 30 per cent over the past five years, which is above the average global rate. If this trend continues, it can be expected that by 2017 Islamic banking assets in the country will be worth $17.6 billion.

This growth is required to be supported by the strategy of the State Bank of Pakistan, which seeks to double the number of Islamic banking branches from about 1,200 and increase the market share of Sharia-compliant banking from around 10 per cent to at least 15 per cent before the end of the decade. Some economists say Islamic banking could potentially gain as much as 20 per cent of market share in the medium term, which would make Pakistan an important global player in this sector.

 "In fact, 15 per cent is a modest aim," Mohammad Humayon Abbas Dar, Islamic economist, Sharia consultant and founding editor of the Global Islamic Finance Report, is quoted saying in a Pakistani newspaper. "Indeed, if Islamic banking in Pakistan fails to achieve 20 per cent share in the market by 2018, by all indicators, it has failed to reach its potential."

Mohammad Shoaib Ibrahim, CEO of Karachi-based Islamic finance service provider First Habib Modaraba, wrote in an article for Islamic Finance News, "Presently, the Islamic financial services industry of Pakistan consists of Islamic banks, microfinance banks, Islamic mutual funds, modaraba (Islamic asset management] institutions, takaful companies and Islamic real estate investment trusts).

"The branch network of Islamic banks is continuously expanding throughout the country at a fast pace and catering to the demand for Sharia-compliant banking products.

Among the central bank's actions were the introduction of the Sharia Governance Framework for Islamic Banking last year, which clarifies the roles and responsibilities of various units of Islamic banking institutions. It also launched a centre of excellence to groom the highly skilled staff the Islamic finance industry needs.

Pakistan's Ministry of Finance in July announced a 2 per cent income tax cut for all Sharia-compliant listed manufacturing companies, hoping more would switch their business accounts from conventional banks and that their employees and associates would turn to Islamic banking as well.

The Securities and Exchange Commission of Pakistan, which supervises all Islamic finance service providers other than banks, for its part set up the Islamic Finance Department, which regulates and oversees this Islamic capital market sector. The department's support in product development and promotion of market awareness have helped reorganize the Islamic capital market and has been a boost for Sharia-compliant finance service providers, Islamic finance products and market instruments.

On a larger scale, the government seems to be stepping up its use of Sharia-compliant financing to fund infrastructure deals, mainly in energy and transport. This April, banks arranged a ten-year sukuk worth $955 million for a hydropower plant, the largest energy deal using Islamic financing in the country.

Ishaq Dar, Finance Minister, says the country wants to make Islamic finance its "first choice" for infrastructure and long-term financing needs and shift up to 40 per cent of its debt financing to Islamic sources from conventional ones. This includes infrastructure projects worth $45 billion planned by the government in partnership with China to establish the China-Pakistan Economic Corridor, the largest infrastructure programme for Pakistan to date.

But still Pakistan lacks legislation on Islamic Banking and Finance and potential campaign to create awareness in the masses.

Focusing on Shari'ah governance in regulating the Islamic banking institutions

Islamic banking and finance has developed consistently over last four decades despite serious global financial crises time to time. This values based finance system can serve the real purpose of financial intermediation to create sustainable value in the real economy at national and global levels. But, Islamic finance institutions (IFIs) are using 'Islamic' equivalents of almost all conventional products for financing and liquidity / risk management, from 'over draft' to the most toxic derivatives to compete with the conventional banks in profitability. This has created credibility problem for Islamic system of finance.  It refers to need for strengthening the governance of the IFIs. Islamic banking practices in two categories of jurisdictions namely the countries where mainstream approach based on AAOIFI's Shariah Standards prevails and the countries like Malaysia where specific approach has been adopted on a number of juristic issues.  Although the approach is apparently different, but practically Islamic banks in both categories of countries are replicating many conventional products to get comparable returns in financial markets. It is suggested for reorientation of the regulatory and governance framework enabling Islamic banks to contribute for stability of the national and global financial systems. There has to be one basis for products approval and decision making, and AAOIFI's Shari’ah Standards could be the best such basis.