COMMENT: Should Islamic banking broaden its base? —Muhammad Aftab
In order to really contribute to the economy, Islamic banks will have to expand their commercial and investment banking services, and various streams of deposits should finance these ventures. They will have to diversify their product mix, making use of their comparative advantage, and not just using the conventional modes
Should Islamic banking broaden its base? All un-serviced sectors say that it should, in case it wishes to finance small enterprises, farmers and the homeless, rather than concentrating on big business.
The growing Islamic banking system in Pakistan has finally been asked to broaden its base and undertake equitable distribution of economic gains. This is urgently needed because the present Islamic banking paradigm is based on replication of conventional banking products and totally relies on debt-based fixed income products. “The total reliance of Islamic banks on debt-based fixed income products and minimising the risks to almost close to those of the conventional banking system is blurring the distinction between Islamic and conventional finance,” Yaseen Anwar, acting governor, State Bank of Pakistan has told bankers.
Despite the fact that the replication of conventional banking products to make them shariah-compliant does pass the shariah permissibility test, but it is insufficient to achieve the larger objectives of an Islamic financial system. These objectives include enforcement of a broad based and equitable distribution of economic gains to help boost business and industry. Ironically, 67 percent financing by the Islamic banks is concentrated in the corporate sector, instead of financing the needs of smaller enterprises.
How did this come about? This concentration has taken place through murabaha, ijarah, and the diminishing musharaka. Most of the corporations have banking and financing relationships with Pakistan’s domestic and foreign-based conventional banks. “The Islamic banks have to offer significant price discounts to attract corporate clients. It reduces the banks’ profit margins and limits their ability to offer better returns to the depositors,” Anwar says.
Islamic banking operations over the last 40 years are seen to be contrary to the natural business model of Islamic finance, which promotes risk and reward sharing and encouraging financing to promising start-ups, which is critical for promoting an entrepreneurial culture. The present practices also confine the access of finance to the well-established businesses and corporations; they leave small and medium enterprises (SMEs) and start-up businesses financially excluded.
Such enterprises are deprived of financing benefits despite the fact that such enterprises offer a huge volume of business. The number of these businesses and industrial units is in millions. These enterprises employ millions of people and act as the economy’s stabilisers when big business and industry face crisis due to domestic or international causes.
Since Islamic banking, under profit and loss sharing (PLS), was launched in Pakistan in the late 1970s, depositors are protesting against paltry profits they receive on their deposits, often much less than the payout by conventional deposits. It has discouraged savings. The Islamic banks retain a large portion of profit, pretending high costs and overheads, and also to cover the risks.
Facts contradict their claim; a recent survey confirmed that the Islamic banks had an 8.7 percent spread, as against 7.19 percent by the conventional banks. Both Islamic and conventional banks have one of the highest spreads in the world. It averages around 7.5 percent for conventional banks. Low interest payouts or profits by both systems leave Pakistan with the lowest savings rate in the world.
In order to really contribute to the economy, Islamic banks will have to expand their commercial and investment banking services, and various streams of deposits should finance these ventures. They will have to diversify their product mix, making use of their comparative advantage, and not just using conventional modes.
Islamic banking should be profitably extended to new areas, like the rural farming sector, comprising more than seven million households. It contributes 20 percent to the annual GDP and is a source of livelihood to 65 percent of the population. Less than 20 percent of these households have access to bank credit. The growing SME sector, too, has a major potential for Islamic banking; it can build low-cost houses and cater to a huge demand of the homeless. For Islamic banking, is the sky not the limit?
The writer is an Islamabad-based journalist and former Director General of APP