low profit rates & unreliability of consumers on islamic products in pakistan

8/6/2019 Low Profit Rates & Unreliability of Consumers on Islamic Products in Pakistan

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INSTITUTE OF BUSINESS AND TECHNOLOGY

Low Profit Rates & Unreliability of Consumers on Islamic Products in Pakistan

Prepared By

Aamir Ali KhanBM-25128

Anzar IshaquiBM-25167

Shoaib HasanBM-25118

Course Code : MKT-606

MBA (Banking and Finance)

FACULTY OFMANAGEMENT AND SOCIAL SCIENCES

SPRING 2011


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Institute of Business and Technology

INSTITUTE OF BUSINESS AND

TECHNOLOGY

ABSTRACT SUBMITTED BY: Aamir Ali Khan Anzar Ishaqui

Shoaib Hasan

DISCIPLINE: MBA (Banking and Finance)

TITLE OF PROJECT REPORT: Low Profit Rates & Unreliability of

Consumers on Islamic Products in

Pakistan

MONTH OF SUBMISSION: April, 2011

NAME OF PROJECT SUPERVISOR: Dr. Noor Ahmed Memon

ABSTRACTThe root of Islamic banking activity, such as acceptance of deposit and the

rejection of interest, go back to the days when the Prophet Muhammad was stillalive. At the time, people deposited money with the Prophet himself, and Abu

Sedique the first khalif of islam But the Islamic banking system as we now know

it only began to evolve towards the end of the 1960s when several Muslim

countries started to put the idea into practice, early models began emerging in

the 1970s,but found difficulty in implementing full compliance with Islamic

principles. During the same period, Islamic accounting, an essential tool for the

success of Islamic banks, was being developed and in 1973 the first meeting of the Islamic Organization Conference (IOC) in Jeddah discussed the desirability

of abolishing fixed interest rates and creating financial systems based on Islamic

beliefs.


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If we talk about Pakistan Islamic banking emerged as a response to both

religious and economic needs. Efforts for economy wide elimination of Riba

started during 1970s and most of the significant and practical steps were taken in

1980s. The mid-80s attempt was a significant step in the evolution of Islamic

banking system in the country. In a technical sense it was the most advanced

model compared to any other model being practiced anywhere in the world at

that time. However that system fell apart as it did not adequately address issues

such as putting in place an effective Shariah compliance mechanism, giving

emphasis to capacity building, and opting for a flexible and evolutionary

approach. In any case this effort provided a valuable experience that has been

taken into account while formulation of SBPs current strategy to re-launch

Islamic Banking in Pakistan. Amendments in financial system to allow theissuance of new interest-free instrument of corporate financing, promulgation of

ordinance to permit the establishment of Mudaraba companies and floatation of

Mudaraba Certificates, constitution of Commission for Transformation of

Financial System (CTFS), and the establishments of Islamic Banking Department

by the State Bank of Pakistan are some of the key steps taken place by the

governments.

The initiative to re-introduce Islamic Banking in Pakistan was launchedback in 2001 when the government decided to promote Islamic banking in a

gradual manner and as a parallel and compatible system that is in line with best

international practices. But from now consumers trying and willing to accept this

system with low profit rates and ensure about the reliability of Islamic products


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ACKNOWLEDGEMENT

First of all we would like to thank our ALLAH Almighty Who gave us thecourage, health, and energy to accomplish our Project in due time and without

Whose help this study which required untiring efforts would have not been

possible to complete within the time limits.

Motivation, encouragement, guidance, corrections, advices, and overall

support are the key elements required from the supervisor to write and complete

a Project of a good standard and a quality within deadlines. It is a matter of

utmost pleasure for us to extend our gratitude and give due credit to our supervisor DR. NOOR whose support has always been there in need of time and

who provided us with all these key elements to complete our dissertation within

the time frame.

Acknowledgement would be incomplete without extending our gratitude to

one of my shariah staff, Rahim Mujadidi who is in Dubai Islamic Bank Pakistan

Limited, help in data collection made this study possible. Moreover, he has been

supporting us enthusiastically throughout our work to make our Project ready indue time. our thanks is also due to our examiner Dr. NOOR whose valuable

comments and suggestions made colossal contribution in improving our

dissertation. Last but not least, we extend our thanks to our entire family for

moral support and pray for our health and successful completion of our

dissertation within time limits.


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CONTENTS ABSTRACT

ACKNOWLEDGEMENT

1. INTRODUCTION .............................................................................................. 1 1.1. Introduction ............................................................................................... 1

1.2. Purpose of Study ...................................................................................... 4

1.3. Research Objectives ................................................................................ 4

1.4 Hypothesis ................................................................................................. 5

1.5. Data Collection ......................................................................................... 5

1.6. Sampling................................................................................................... 6 1.7. Data Analysis ............................................................................................ 7

1.8. Limitation of the Study .............................................................................. 8

2. LITERATURE REVIEW .................................................................................... 92.1 Literature Review

3. ISLAMIC BANKING IN PAKISTAN ................................................................. 13 3.1. Growth .................................................................................................... 21

3.2. Islamic Banking Products ....................................................................... 22

3.3. Investments ............................................................................................ 23

3.4. Market Share .......................................................................................... 26

3.5 Problems/Prospective..294. DEPOSIT AND RATE OF RETURN ...................................................................

4.1. Security on Deposits and Investments.................................................... 30

4.2. Rate of Return on Deposits and Investments ......................................... 32

4.3. International Dealings ............................................................................. 34

4.4. Taxations ................................................................................................ 36 5. PROBLEMS .................................................................................................... 37

5.1 Lack of Awareness ............................................................................... 38

5.2 Religious Convictions .......................................................................... 41

5.3 Social, Ethical and Cultural Values ...................................................... 44


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6. CONCLUSION AND RECOMMENDATION ........................................................6.1 Conclusion ............................................................................................... 49

6.2 Recommendations ................................................................................... 49


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1Institute of Business and Technology

1. INTRODUCTION

1.1. Introduction

Expansion (1976 to the early 1980s): Islamic banking spread from the Gulf

eastward to Malaysia, and westward to the UK.More then 20 Islamic banks were

established, including international and intercontinental instituions.Islamic

banking association or consultancy bodies also broadened their operations. and

they were offered various Islamic products. Almost all of the pioneers of Islamic

finance in present age, ideally the real alternatives to lending on interest under

an Islamic economic system are profit /loss sharing (PLS) or qard-e-hasan i.e.

loaning without any charge over and above the principal amount. However, in

view of the difficulties faced in practical application of PLS system , a number of other alternatives have been endorsed by the CII as also by other Shariah

scholars 1.,Islamicproducts promotes over the world with the help of more than 300

Islamic financial institutions which is operating in around 75 countries. Over the

years, the Islamic financial landscape has transformed into a vibrant and

competitive mode of global financial intermediation. According to an estimate,

total shariah compliant assets worldwide have grown to about US$ 700 billion

with annual growth exceeding 10.0 percent during the past decade1

- and areprojected to grow to US$ 1.6 trillion by 2012. 2 Islamic banking and Sukuk

represent the most well established forms of Islamic finance, whereas Takaful

and shariah-compliant mutual funds are also evolving rapidly. In terms of

contribution to the global shariah-compliant asset base, Islamic commercial

banks take the lead with a 74 percent share of assets. 3

Islamic financial institutions (IFIs), while not directly impacted by the

repercussions of the global financial crisis, 4 did experience the knock-on risks

transmitted through indirect channels. Notably, to comply with the asset-backing

principle5 of Islamic transactions, one of the preferred asset classes of Islamic

banks is real estate. According to an estimate by Standard & Poors, 6 around

20.0 percent of all financing by IFIs is backed by real estate, and a large number

of commercial banks are vulnerable to the correction in the real estate market


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seen during the last two years. Secondly, given the dearth of shariah-compliant

liquidity management instruments, IFIs have generally resorted to placing funds

in the equity market, which has exposed them to the risk of severe correction in

stock markets around the world, as seen during the course of the financial crisis.

1. http://weatdibp/Learning.aspx?2 Islamic Finance Outlook 2009, Standard & Poors, February 2009.3 Islamic Finance - Higher Rewards but Higher Risks, Oliver Wyman, April 2009.4 Islamic Finance 2009, International Financial Services London (IFSL) Research, February 2009.5 Shariah Law prohibits interest-based structured financial products, the mismanagement of which led to the crisis.6 IFIs have to abide by the asset-backing principle which requires that each financial transaction must refer to a

tangible, identifiable underlying asset.7 Islamic Finance Outlook 2009, Standard & Poors, February 2009.

Third, the drying up of global liquidity has had an adverse impact on sukuk

issuance, which has gone down to US$ 14.9 billion in 2008, as against US$ 34.3

billion in the previous year. The emergence of these risks as a consequence of

the financial crisis has brought forth the realization that IFIs, while resilient to

adverse developments, are not risk immune. The ensuing debate on the

supremacy of the tenets of Islamic finance versus conventional finance needs to

take these risk factors into account, given that both conventional and Islamic

financial institutions function in one and the same global economy. Islamic

Finance is one component of global finance and equally exposed to the

developments in international financial markets. The view that IFIs are inherentlysafe because of the prohibition on the use of structured finance vehicles is

countered by the argument that Islamic finance is still not a mature industry, that

there would have been attempts to introduce shariah- compliant securitization

instruments.

Notwithstanding the ongoing debates and arguments, the fact that IFIs

remained relatively unscathed during the initial phase of the crisis does speak of

its virtues in comparison with conventional finance.In Pakistan, since its re-launch 7 in 2002, Islamic banking has grown

progressively. The asset base of the Islamic Banking Institutions (IBIs) 8 on

average has grown at around 59 percent per annum since 2005. The growth in

the deposit base and the ongoing expansion in outreach, based on the number of


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branches, is also impressive. As a proportion of the overall banking industry, the

combined share of Islamic banks, Islamic branches of conventional banks and

Islamic windows 9 is 5.2 percent in deposits, and 5.1% in assets, as of end-June

CY09. State Bank of Pakistans strategic plan for the Islamic banking industry

launched in 2008, 10 aims to increase the size of the industry to 12% by 2012.

8 Historical details in Chapter 4, SBP Financial Sector Assessment 2004, and Chapter 8, SBP Financial StabilityReview 2007-08.

9 IBIs include stand-alone Islamic banks, Islamic banking branches of conventional banks and Islamic windowoperations in conventional branches of conventional banks.

10 IBD Circular No. 6 dated November 10, 2007.11 Strategic Plan for Islamic Banking Industry of Pakistan, September 2008, Islamic Banking Department, State Bank of

Pakistan.

In essence, the focus of the strategic plan is: (i) to extend the outreach of Islamicbanking services by covering a broad-based geographical area and encouraging

product development, (ii) strengthen the shariah-compliance mechanism andregulatory support, while (iii) building the capacity of Islamic banking institutions.Notably, the Islamic banking industry in Pakistan is also stymied with challengesfaced by other jurisdictions such as the need for standardization in shariahrulings on products and services, developing appropriate instruments for liquiditymanagement purposes etc, and the strategic plan aims to overcome thesechallenges, by focusing on the SMEs, microfinance and agriculture sectors.MAJOR ISLAMICMODES AT A GLANCE

Modes & their Close Conventional Equivalents

Islamic Finance Conventional Finance Intermediated Intermediated Not

Intermediated

1. Murabaha None None 2. S alam None Future contracts

3. Istisn aa None None

4. Ij arah Leasing Leasing 5. Mus harakah Shareholding Venture capital

6. Mudarabah None Venture capital


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1.2. Purpose of Study

Pakistan initiated a process of the Islamization of its financial system in

1979. Though the financial system of the country had undergone significant

changes since then, the process of Islamization is yet to take its full course. Although Pakistan is an Islamic country according to its constitution, it is not an

Islamic state, as it does not follow the principal objectives of economic order in

Islam.

It is an irony that very little has been borrowed from the Islamic concept of

economics in the Islamic state of Pakistan, Perhaps the people as well as rulers

of Pakistan have not cared to study in depth the Islamic economic concept, given

by the Holy Prophet (P.B.U.H.) and the pious caliphs. What we have only

succeeded in is making cosmetic changes here and there, and that too, in very

few sectors of economy.

So what are the factors impeding the growth of Islamic Banking System in

Pakistan? The purpose of this study is to discuss the various factors impacting

negatively (or positively) in the implementation of Islamic Banking System in

Pakistan.

1.3. Research Objectives

As such, the purpose of this study is to review the various aspects of

Islamic Banking and to identify the various factors affecting in the implementation

of Islamic Banking in Pakistan and also assess their viability and applicability with

respect to individual and corporate consumers. More specifically the objectives

will be:

y To review the History of Islamic Baking in the Pakistan. This will enable

the readers in understanding the evolution of Islamic Banking and will

consequently enable them in evaluating its need in present times.

y To identify the various factor which has major effect on implementation of

Islamic banking system in Pakistan.


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1.4. Hypothesis

In the light of above, the following hypothesis is developed:

Lack of awareness, low profit rate of return on deposits and investments,

and differences in opinion regarding Islamic Banking Products are creatingobstacles in the investment of Islamic products and promotion and

implementation of Islamic Banking System in Pakistan.

1.5. Data Collection

Lots of secondary data is available about Islamic Banking and their

products and the review of secondary data will aid us in determining the true

factors impacting on Islamic Banking. State bank data will be analyzed and past

editions of various newspapers, magazines,interanet and intrernet will be

reviewed to get valuable information.

Dawn, The News, Jang, and Business recorder are the most credible

newspapers of Pakistan so there current and past editions will be fully explored.

Research reports, which have already been developed on Islamic Banking

and their products, have immense significance and they will form an integral part

of secondary data.Books published on Islamic Banking are another valuable source and for

this purpose, top libraries of Karachi will be visited including Applied Economics

Research Center (AERC), University of Karachi.

Internet is, no doubt, the biggest source of information on any topic. There

is a lot of material about Islamic Banking available on Internet and shall be

referred definitely.

The material published by State Bank of Pakistan, and annual reports of

various banks form another important source of secondary data.

In order to test the research hypothesis, corporate customers and bankers

are identified as main primary source of data. Corporate customers form an

important part of banking industry and their views will be used in the testing of


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hypothesis. Bankers have more knowledge about Islamic Banking than any one

else and their expertise will enable us to find the shortcomings of Islamic Banking

Products..

Personal Interviews will be conducted from reputed religious scholars,economists, and government officials to get first hand knowledge about Islamic

Banking. It is planned that an interview of Adnan Kakakheal who is vising faculty

member of Dabai Islamic Bank, the fastest growing Islamic bank in Pakistan, will

be conducted to get critical information about Islamic Banking Products

1.6. Sampling

Following table illustrates the sources that were identified for sampling.

Table 2.1: Sampling Techniques for Primary Sources

Source Population SamplingTechniqueDesired

Sample Size

Non Islamic Banks 30 Stratified RandomSampling 3

Bankers 50000 Judgment Sampling 5000

CorporateCustomers 100000 Judgment Sampling 10000

1.6.1. Non Islamic Banks(offering various products)

Non Islamic Banks operating in Pakistan include foreign as well as

local banks. Since these two groups are totally different, so it is decided to

use stratified random sampling technique. After applying the procedure of

stratified sampling, interviews will be conducted from the top officials of

selected banks on some suitable time.

1.6.2. Bankers and Corporate Customers

Judgment sampling technique will be used for bankers and corporatecustomers. Since population-size of these sources is based on estimation, so

the most suitable technique of collection information from respondents is

judgment sampling.


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1.6.3. Observation

Another instrument that will be used in our study is the observation.

People will be observed thoroughly while conducting interviews and getting

questionnaires filled.

1.7. Data Analysis

After the data collection phase that will be done through questionnaires,

interviews and observations, results will be analyzed thoroughly. Since the

purpose of the study is to identify the most critical issues impacting on Islamic

banking so in order to test the hypothesis, interval scale will be used.

Interval scale is assignment of numbers to rank items such thatnumerically equal distances on the scale represent equal distances in the

property of factor being measured. Following table shows the interval scale to be

used in this study.

Table 2.2: Interval Scale

The statistical tools to be used with interval scale are

a. Mean

b. Percentage

Mean for various purposes will be calculated using the formula mentioned below,Mean = X = f iXi

N The aforementioned tools will be used in summarizing and examining the

nature of the results. The results will be tabulated for the purpose of analysis,

and Figures and graphs will be drawn from the tabulated data.

Degree of Property CodeVery High -2

High -1 Average 0Low 1

Very Low 2


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1.8. Limitation of the Study

This research report is purely an academic work, due to time constraints

and hectic academic activities; The research is conducted within the following

limitations:y To keep the study manageable research is conducted on limited grounds.

y The study is conducted on small level and only the important aspects are

considered.

y There was a shortage of time thats why limited data is collected. Still the

researcher has tried to collect sufficient data to make an effective analysis.

y

Some respondents, who have limited knowledge of Islamic banking or noknowledge about the financial modes of conventional and Islamic banking,

also answered the questions; hence the replies of some questions may be

based on their own imagination or thoughts.

y Although majority of our respondents of Islamic banking questionnaire

were account holders of Dubai Islamic Bank, however some of our

respondents had accounts in other Islamic banks too or accounts in

Islamic branches of conventional banks, so the results of this study are not

fully applicable to Dubai Islamic Bank of Pakistan.


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2. LITERATURE REVIEWIslamic Banking: A research on Islamic Banking conducted at university of Malaysia in 1988, which is conducted by Mohamed Arif shows that huge part of population(Muslim) was aware the concept &existence of Islamic banking. Its factthis is new phenomena that has kaen many observers by surprise as per research thirty Islamic banks was working globally at that time an attempt ismade in this paper

(a) To survey the growing literature as Islamic banking in particular.(b) To trace the growth and develop dent of Islamic banking.(c) To highlights its silent fretures.

The first several organizations work to achieve international standardization andharmony to make the banking activities more transparent and attractive. Theachievement of harmonization as well as the performance of the banks is crucialfor the future of Islamic banking.

Modern experiment with Islamic banking was undertaken in Egypt under cover,without projecting an Islamic image. The pioneer effort lead by Ahmed-al-najjar,took the form of savings bank based on profit sharing in the Egyptian townof Mit ghamer in 1983-further the Nasir social bank, established in Egypt in1971was declared an interest free commercial bank, although its charter madeno reference to Islam given the huge potential for developed in the Islamic worldand the increasing of funds being invest invested according to the shariah itsseem perfectly reason able to suppose that the recent growth in Islamic bankingwill continue an accelerated pace. Another legitimate mode of financingrecognized in Islam is an based an equity participation (musharka)in which thepartners use their capital jointly to generate a surplus-profits or losses will beshared between according to the same agreed formula depending on the equityratio the literature also discases the question of central banking in Islamicbanking

M.Iqbal Patel in the article Islamic Banking needs restructinggave the conceptof Restructingof Islamic banking system. He explained towards the values andprinciple to solve the economic problems of mankind from a moral and sociallyresponsible prospective.The Islamic financial system requires that the transaction must be backed by realasset and not shady repackaged sub-prime mortgage that have impacted theglobal financial system. The risk is shared between the bank and the depositor.There is an incentive for both the banks and the depositors/borrowers to ensurethat the deal is sound. The asset-backed financing differs from conventionalbanking which deals with money and monetary papers and not so much tradingin goods and making inventories. The Islamic banking system to encourage savings and capital formation, ensureequitable distribution of income and wealth and justice between the parties canonly be achieved if financing by it is allowed on the PLS and fixed rate


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techniques based on mutually agreed ratios is discarded in totality. Therefore,there is a need to restructure the mode of financing. In this article focus about the abolition of interest which is are the pillars of theIslamic economis system according to Quran ALLAH has permitted trading andprohibited riba

Tools of Islamic bankingMusarakaandMudarabaare based on the concept of profit and loss sharing in this system real asset must be involve and concern therisk factor which is shared between the banks and the depositor. The profitearned through dealing in money or the paper representing them is interestwhich is prohibited in Islam.The Islamic banking system to encourage saving and the capital formationensure equitable distribution of income and wealth and justice between theparties can only be achieved.

A research on the impact of interest rate changes an Islamic bank financingconducted in Malaysia on 3 April 2009 by Radiah Abdul Kader & Yap Kok

Leong. The study about the impact of interest rate changes an demand of Islamicfinancing in a dual banking system. as per research Any change of interest ratewould lead customer who are guided by the profit motive to substitute Islamicfinancing for convectional bank loans and voice versa and in the other scenarioany increase in the base lending rate would induce customers to obtain financingfrom Islamic bank. The study conclude that because customers are profitmotivated Islamic banks in the dual system are exposed to interest rate riskdespite operating on interest free principles

As per this research in Malaysia first time introducing Islamic Banking in1983,which is based on long term objective of Islamic banking system, would runside by side the existing conventional banking system.Rosly provide the theoretical explanation of the impact of interest rate changeson Islamic bank performance in the dual system. He emphasizes that Islamicbanks are exposed to interest rate risks and the root cause of this phenomenonis the overdependence of Islamic banks on BBA financing where the profitrate(financing rate is fixed, means that when interest rates are rising, the baselending rate(BLR)and rates of return on deposits of the conventional bank wouldchange accordingly to changes in the market interest rate.How-ever,the Islamicbank cannot increase the rate of returns on its deposits on its deposits becausethe profit margin of BBA is fixed.

HJ Zaharuddin HJ Abd Rehman wrote an article Islamic Banking Financing ratenot competitivewhich was published in NSTon 21/09/2005 .According to thisarticle consumers having issues against Islamic bank financing pattern-theyclaimed thatthe high profit rate changed by Islamic bank for their financingproducts as compare to the interest rate which is changed by conventional bank.(a)Islamic banks are also offering service for earning profit and is not a welfareinstitution where service are rendered for free.(b)Islamic bank is obligated to fulfill its duty towards investors.


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(c)They also needs to pay the staff salary which means the profit must be earn topay.The following factors answer the issue of why the Islamic bank financing rate isaveragely higher than the conventional.

a) The principles value of Halal.

b) The professional Shariah screening and auditing.c) The high potential players in the market.d) On the other hand, the home loans offered by Conventional banks are

seemingly very attractive as the rate charged in the first year is relativelylow. However, the rate for the remaining years will fluctuate as it isdependence on the Base Lending Rate (BLR) in the market. For exampleif the current BLR is 6 %, therefore the rate is equal to 6.25 % as the rateis equal to BLR + 0.25 %. What if BLR rises to 11 % or higher as hashappened in the past Malaysian economic crisis?

e) In the contrary, this will not occur in Islamic Banks because the sellingprice has already been fixed and agreed in the contractual agreement by

both parties. The Islamic Banks profit rate does not have any relation tothe BLR rate, thus it will not increase. In fact, it may even be reduced if theIslamic Banks were to provide rebate (ibra).

This article belongs with speech of Dr.Shamshad Akhter-Governor of State Bankof Pakistan- addressing 14 th world Islamic banking conference. In this speechshe was talk about competiton, growth and sustainability. All over the worldreceiving great work in form of innovation of new Islamic product which ispossible because of involment of consumer, they can convey the banker whichsort of product they need- she said in debate regarding the progress of Islamicfinance with the help of genuine effort Islamic finance giving to which market andalso discuss about the key drivers which can help the enhance the efficiency andcompetitiveness of Islamic finance and enhance its sustainability talk about thechallenges of new market to Islamic finance because of the issue of haramproductwhich is forbidden investment as concern of shariah approval due to allIslamic aspects same permits discuss about the mechanism of Islamic finance,principle of Islamic finance flexible, constructive and innovative.In this speech she talked about the drivers of enhancing efficiency andcompetiveness, as (1) Financial engineering and innovation.(2)Global financial centers and their regulators.(3)Standard governance and prudential regulation and supervisory guidance.(4) Development and adoption of simple and standard and cost effective legalframework for contract associated.(5)Flexible and practical application and enforcement of shariah principles and itsinjections and its acceptability by public.

Salman Ahmed Shaikh in the article critical analysis of the current Islamicbanking system published on 11/08/2007.In this article writter discussed about the critism an Islamic bank system thecurrent Islamic modes of financing are no different then conventional system


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nothing can be changed an consumable products including money but rent canbe changed an tangibles like property or any assets. The technique is to then sellthe asset a profit or given the assets on rental basis to earn profit the articlehas delighted the defect of investments.The article outlines the economic teaching of Islam with regard t o income,

earning and spending. It compares interest rate with rent and with profit andshows that interest is equivalent neither rent nor profit. Its also analyzes thelogical arguments put faword in favor of interest by different economists andrefutes any economy and refutes and logical justification of interest.

This research is conduct by Abdul Hameed M.Bashir(who is the part of department of economics-Grambling state University).This research paper intendto analyze the banking system and the overall financial environment effect theperformance of Islamic banks,especially to examine the relationship betweenprofitability and the banking characteristic, after controlling for economic and

financial structure indicators.This research provides summary statistics pertaining to Islamic banks size andprofitability and also with the help of regression analysis to determine theunderlying determinants of Islamic bank performance and also discuss theinternal characteristics include bank size,leverageloans,short term financing, andownership and while studying the relationship between banks internalcharacteristic and performance the the impact of external factors such asmacroeconomic, regulatory and financial market environment are controlled.In other words we can say The study examines the determinants of Islamicbanks performance across eight Middle Eastern Countries between 1993 to19998.A variety of internal and external banking characteristics were used topredict profitability and efficiency.In general, our analysis of determinants of Islamic bank performance profitabilityconfirms pervious findings, controlling for macroeconomics environment, financialmarket structure, and taxation, the result indicates indicate the high leverage andlarge laons to assets ratios lead to higher profitability.

.


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3. ISLAMIC BANKING IN PAKISTAN

3.1. Growth

Islam was the basis of creation of an independent state within the

undivided Indo-Pak Sub- Continent. All Constitutions of Pakistan have

incorporated, within the principles of policy, the elimination of Riba as an

important objective of the State policy. Quaid-e-Azam, the father of the nation, in

his speech at the occasion of the inauguration of State Bank of Pakistan, had

expressed the desire for evolving an Islamic system of banking. In Pakistan

Islamic banking emerged as a response to both religious and economic needs.

Efforts for economy wide elimination of Riba started during 1970s and

most of the significant and practical steps were taken in early 1980s. It was a

very bold and comprehensive exercise. Pakistan was among the three countries

in the world that had been trying to implement interest free banking at

comprehensive / national level.

Numerous measures were taken to introduce interest free banking in

Pakistan. Banking and other relevant laws viz. SBP Act, Companies Ordinance,

recovery laws, negotiable instruments act, etc. were amended to facilitate

interest free banking system and the industry was given a specific timeline to

convert to the Islamic banking system.

State Bank Pakistan also gave the industry the products which it was

allowed to use without any change or exception. Islamic banking was rolled out

country-wide. New regulations were prepared prescribing the modes of financing,

profit distribution mechanism for deposits, financing facilities by SBP, etc. which

constituted ground work for Islamization of financial system. The mid-80s attempt

was a significant step in the evolution of Islamic banking system in the country. In

a technical sense it was the most advanced model compared to any other model

being practiced anywhere in the world at that time. The efforts and practical steps

undertaken in the 1980s to Islamize the economy at national level are


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considered as pioneering work in the Muslim world as this became important

reference material for other countries which undertook the path towards

introduction and establishment of an Islamic banking system. In early 90s the

whole exercise was challenged in the Federal Shariat Court and the procedure

adopted by banks in Pakistan since July 1, 1985 was declared un-Islamic by the

Federal Shariat Court (FSC) in November 1991. The system was based largely

on mark-up technique with or without buy-back arrangement. The FSC

declared that various provisions of the laws held repugnant to the injunctions of

Islam in its Judgment dated November 14, 1991 would cease to have effect as

from July 1, 1992.

In a meeting held on September 4, 2001 under the Chairmanship of the

President of Pakistan, attended by officials of the Ministries of Finance and Law,

Governor State Bank of Pakistan, Chairman and some members of the Council

of Islamic Ideology and the Chairmen, and the two Task Forces it was decided

that the shift to interest free economy would be made in a gradual and phased

manner and without causing any disruptions. It was also agreed that State Bank

of Pakistan would offer three institutional options:

Setting up subsidiaries by the commercial banks for the purpose of conducting

Shariah compliant transactions;y Specifying branches by the commercial banks exclusively dealing in

Islamic products with all safeguards to ensure integrity and purity of

Islamic banking operations,

y Setting up a new full-fledged commercial bank to carry out exclusively

banking business based on proposed Islamic products.

y As a result of these efforts, in 2001, an Islamic Banking Division was

established in the Banking Policy Department at SBP. This time around,concerted efforts were made by SBP to undertake Islamic Banking in its

true spirit and also keeping in view the lessons learnt from the experience

of Bahrain, Malaysia and Saudi Arabia etc. in this area. Accordingly, steps

have been taken to set up a parallel banking system, so that an enabling


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environment is ensured for the sector, avoiding any serious repercussions

of entire transformation of financial sector.

Sh aria h Compliance Developments

The present re-launch of Islamic Banking in Pakistan by the StateBank of Pakistan has been based not only on the lessons learnt from the

history of Islamic Banking efforts in Pakistan but also on the experiences of

other countries in the world that are currently known for their leadership role

in this banking sector. The basic difference, in SBPs current policies

regarding Islamic banking and the previous efforts, is the approach adopted

by SBP wherein the introduction of Islamic Banking is being viewed more as a

change management issue rather than as a religious or a legal issue.

This basic difference in approach defines the policies on Islamic

Banking and is primarily responsible for the success achieved so far. It was

decided to promote Islamic banking in a gradual manner and as a parallel and

compatible system that is in line with best international practices. Following

the pronouncement of the government to shift to interest free economy in a

phased manner without causing any disruptions the effort was envisaged to

be based on a market driven and flexible approach.

Furthermore this approach is also helping build a broad based

financial system in the country to enable all segments of the population to

access financial services.

Shariah compliance is the most important aspect of Islamic finance.

The credibility of Islamic Banking Institutions (IBIs) not only depends on the

financial health of the institution but also on its adherence to the Shariah.

Under the current strategy for promotion and development of IslamicBanking as a parallel, viable and compatible system, State Bank of Pakistan

has put in place a comprehensive Shariah Compliance Structure.

The Shariah Compliance Framework established by State Bank of

Pakistan consists of:


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1. Shariah Board at SBP

2. Shariah Advisor

3. Essentials & Model Agreements of Islamic Modes of Financing

Instructions and Guidelines for Shariah Compliance in Islamic Banking

Institutions

4. Shariah Advisors Forum

5. Shariah Compliance Inspection

6. Standardization of Shariah Practices- Adoption of AAOIFI(Acco unting a nd Aud iting O r g a niz a ti on f or Islam i c Fin a nc i al Instit uti ons) Shariah Standards

Each Islamic Banking Institution (IBI) is required to work under the

guidance of a Shariah advisor. To keep this process more objective, broad

based and responsive to the market conditions SBP Shariah Board has

approved Fit & Proper Criteria for Shariah advisors of IBIs. According to this

Criteria, minimum required Shariah and contemporary educational

qualification as well as experience and exposure for becoming a Shariah

Advisor has been defined. Moreover, to minimize conflict of interest, it has

been specified that a person cannot work as Shariah Advisor for more than

one IBI in Pakistan.

Further, it has been specified that a Shariah Advisor shall not hold

any executive/non-executive position in any other financial institution, except

working as Shariah Advisor of Islamic mutual funds of the same IBI. In

addition to that, Shariah Advisors of IBIs have been barred from having any

substantial interest in or becoming employee of some types of organizations

like exchange Companies, corporate brokerage houses or stock exchange.

These provisions in Fit and Proper Criteria for Shariah Advisors has

ensured objectivity in evaluation criteria, minimization in conflict of interest

and induction of new lot of Shariah advisors in the market.


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Current Industry Review

This time there has been a shift in the approach from the legal &

regulatory perspective to that of dealing with the whole affair of introducing

Islamic banking in Pakistan as a change management issue. As compared toour past experience our new approach provides flexibility to the IBIs as regard

to products, instruments and Shariah compliance methodology. This new

initiative has witnessed a very encouraging response. As at end of the year

2003 only one bank operated as a full-fledged Islamic bank and three

conventional banks were operating Islamic banking branches. Currently there

are 6 full fledged licensed Islamic banks (IBs) and 12 conventional banks

have licenses to operate dedicated Islamic banking branches (IBBs). All of

the five big banks in Pakistan are providing Islamic banking services. The

total assets of the Islamic banking industry are over Rs. 477 billion as of DEC,

2010 which accounts for a market share of 6.4% of total banking industry

assets. The market share of deposits stands at 6.5%. Total branch network of

the industry comprises of more than 700 branches with presence in over 50

cities & towns covering all the four provinces of the country.

The industry over the years has managed to offer a wide array of

products encompassing almost the\ entire range of Islamic modes of financing that are able to cater to the needs of majority of the sectors of the

economy. Also it has been noticed that the industry has a good financial

performance. Foreign investment in Pakistani Islamic banking industry is

giving the industry a unique look through which success transfer is taking

place as experiences are being shared leading to the development of the

local industry.

SBP has over the years attempted to develop a supportive Regulatory andSupervisory Framework having special emphasis on Shariah Compliance that is

in line with the best international practices. The aim is to align our industry with

the international best practices so as to enhance the credibility and international

stakeholders confidence in Islamic banking efforts of SBP. This will in turn not

only boost the image of our country but will also be instrumental in attracting


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foreign investment. Pakistan has adopted a three tiered, somewhat unique,

Shariah Compliance Mechanism and process to ensure a deeper and extensive

Shariah compliance supervision on an on-going basis.

The data for period ended Dec-2010, shows that asset financingactivities of Islamic banks have revived besides substantially higher assets

and deposits growth. The profitability indicators have also shown marked

improvement as compared to the preceding quarter. The financing and

investment portfolio of Islamic banks reached Rs 477.0 billion in Dec 2010

comparatively better as compare to previous, depicting an increase of 6.4

percent during the last quarter. In terms of market share, total assets,

financing & investment and deposits reached 5.1 percent and 4.2 percent and

5.2 percent, respectively, at end Dec-2010. The branch network of 6 full-

fledged Islamic banks and 12 conventional banks (with dedicated Islamic

banking branches-IBBs) increased to 528 branches in DEC 2010.

The State Bank of Pakistan issuing "Islamic Banking Bulletin" for the

second quarter ended on June 30, 2010 said that current growth rate of

Islamic banking industry has envisioned to achieve a share of 12 percent by

2012 as per Islamic banking strategy plan.

The growing depositors confidence is well reflected in last quarter,

which shows an increase of 15.5 percent in the deposits. The deposit base of

Islamic banks stood at Rs. 238 billion at end-Dec 2011 compared to Rs 206

billion in the previous quarter-end.

Total liabilities of Islamic banks have increased by 13.3 percent to Rs

274 billion from Rs 242 billion during the quarter. While the net assets and

equity increased by around 7 percent each. There is an increase of 6 percent

in the reserves to one billion rupees and then appropriated profits increased

by 79 percent to Rs 900 million in last quarter.


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The most of the indicators of the Islamic banking in Pakistan showed

reversion towards the usual high growth trend. It may be recalled that the

Islamic banks also witnessed some slowdown as a result of the financial

stress of recent times.

The financing portfolio has increased by 3 percent quarter on quarter

basis. This is encouraging, as during the last quarter the financing had

actually declined by Rs 10 billion. The resurgence in financing is

accompanied by 9.3 percent increase in investment. The increased financing

may be reflecting the improving economic outlook of the country.While the

investment has largely increased due to 3rd issuance of Ijarah Sukuk.

Nonetheless, there is a welcome increase of Rs 2.4 billion in Musharika

financing, though Modaraba financing declined by almost 50 percent.

Nonetheless, the net mark-up income increased from Rs 7.8 billion to Rs 15.4

billion-a healthy 94.0 percent growth. Non-mark up income increased by a

hefty 213.2 percent from Rs 0.5 billion in SEP 2010 to Rs 1.6 billion in June

Islamic Finance has made commendable progress in the last few years. The

growth rate remained consistently higher than the conventional finance

industry, culminating in continuously rising share of Islamic finance in the

local and global financial markets. The SBP is leading the way in Pakistanand has envisioned to achieve a share of 12 percent by 2012 in its Islamic

banking strategy plan. A relatively restricted branch network coupled with the

preferred policy of some conventional banks having IBBs (Islamic Banking

Branches) to borrowing funds from their head offices has partly contributed to

this skewed distribution.


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Figure 3.1 Deposits of Islamic Banking Industry

The rapid growth experienced during the year 2004 was primarily due to

the entry of Albaraka Islamic bank and an aggressive strategy adopted by Bank

Alfalah. Similarly the entry of four new full fledged Islamic banks i.e. Dubai

Islamic, Emirates Global, Dawood Islamic & BankIslami during 2006 and 2007

contributed towards the healthy growth in overall deposits position during these

years.

Figure 3.2 Bank Wise Share of Deposits*

S our ce: SBP Q uar t e rly R epo r t Dec+2010

The bank wise share of deposits as on Jun-09 is presented in the Figure.Over all the share of Meezan Banks deposits is dominant while among IBDs

(Islamic Banking Divisions of Conventional Banks having IBBs) of conventional

banks Bank Alfalah is leading the group.

However the new entrants like Dubai Islamic and BankIslami have also

managed to capture good share in relatively shorter period of time. Going

forward the remaining two full fledged players i.e. Dawood Islamic and Emirates

Global are also expected to catch up with other competitors.

Deposits structure consists of Fixed Deposits, Saving Deposits, Current

Accounts non remunerative and other deposits. Savings, Fixed and Current

account (non remunerative) of customers deposits are 32%, 36% and 20%

respectively of Overall Deposits and Other accounts.


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* S our ce: SBP Q uar t e rly R epo r t J un-09

Growt h (Branc h Network)

The share of full fledged Islamic banks in overall branch network of the

industry has increased over period of time. Furthermore, it shows that during the

year 2008 highest growth rates in overall branch expansion were experienced

wherein two new full fledged Islamic banks (Meezan Islamic Bank & BankIslami)

and four conventional banks having IBBs commenced operations. As the full

fledged banks consolidate themselves it is expected that the rate of growth innetwork expansion will increase at a much higher pace.

Currently Islamic Banking is available through 6 full-fledge Islamic banks

and 12 conventional banks having Islamic banking branches. The experience as

reported by some of these banks is that around 10% to 15% customers walking

into their branches are new to banking. These are the people that have remained

away from the conventional banking system because of their beliefs. Additionally

those who have been using conventional banking but minimizing the depth of their relationship again based on their beliefs tend to deepen their relationship

with an Islamic bank thus again contributing to the size of the banking sector

from within its existing coverage and base. From the above figure we can identify

the growth of Islamic Banking by Branch network, as this is the statistics from


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2002 where there was only 6 Branches of Islamic Banks as up to June - 2009

there are 528 branches.

3.2. Islamic Banking Products

These are Islamic products which is discussed following

1 Customers Deposits2 Fixed deposits3 Savings deposits4 Current accounts -Remunerative5 Financial Institutions Deposits6 Remunerative deposits7 Non Remunerative deposits8 Murabaha9. Ijarah10 Musharaka11 Mudaraba12. Diminishing Musharaka13. Salam14 Istisna15 Qarz-e-Hasna

3.3. Investments

dec-2010 the Investments has been 4.5% (194Bn) with respective to

Industry growth Initially due to non availability of Shariah compliant instruments

the Islamic banking institutions suffered from a relative disadvantageous position.

Specifically, until the issuance of WAPDA Sukuk in November 2005, there was

no approved security for meeting the Statutory Liquidity Requirement.

Subsequently KSEW Sukuk has also been categorized as SLR eligibleinstrument. Meanwhile SBP has provided the industry with a level playing field

through a separate SLR regime and limit on investment in shares. Currently for

meeting the SLR requirements Islamic Banking Institutions have been allowed to

maintain SLR at 9% of their TDL on an overall basis, with investment in SLR

eligible Sukuk not exceeding 7% of their TDL (however, individual holding in


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Sukuk of one issuer shall be limited to 5 percent of total TDL) and remaining in

the shape of cash in hand, balance with NBP in current account, and balance

with State Bank of Pakistan in Special Deposit Account.

The direct investment by the Islamic banks are not the same ratio as theconventional banks are doing, the main reason of that is the conventional banks

are operating from more than decades where as the Islamic banking just had

start recently by getting the full fledge licenses from the State Bank of Pakistan

during 2002, from that starting point Islamic banks are now growing at the very

high pace, as we have already known from the above discussion that Islamic

Banking has high growth rate than the conventional banking.

Figure 3.5 Islamic Banking Industry Investment

*

S our ce: SBP Q uar t e rly R epo r t J un-09


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Up June-2009 Meezan Bank continued to enjoy the highest share in

overall investments made by the industry and Bank Alfalah in line with the size of

its balance sheet leads the category of conventional banks having IBBs.

June 2009 compared with Rs.185 billion in March 2009. In terms of marketshare, total assets, financing & investment and deposits reached to 5.1% and

4.2% and 5.2%, respectively at end June 2009. The branch network of 6 full

fledged Islamic banks and 12 conventional banks (with dedicated Islamic banking

branchesIBBs) increased to 528 branches in June 2009.

The financing portfolio has increased by 3 percent QoQ. This is

encouraging as during the last quarter (Jan-Mar 2009) the financing had actually

declined by Rs 10 billion. The resurgence in financing is accompanied by a QoQ

9.3 percent

Figure 3.6 Assets of Islamic Banking Industry


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*Source: SBP Quarterly Report Jun-09

Sou r o f unds une - 9

2

Borrowing Capital of

und ther Liabilities eposit



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As from the above graph we van see that the main source of Funding in

Islamic Baking is Customer Deposits, which contributes 72% of its total funding

and remaining 7% is from Borrowing, and 14% and 7% Capital and other

liabilities. From this figure it can be easily identified that the people are

diversifying from conventional to the Islamic Banking.


This figure shows the fine combination of financing and investing of the

funds used by Islamic banks in june-2009, as we can easily identified that 67% of

spending is done in the financing and investing section and separately financing

contributes 52% and Investing 15% where as the placement portion is about

14%.

3.4. Market Share

As mentioned earlier SBP worked on a three pronged strategy for

promotion of Islamic Banking i.e.

1. Allow new full fledged Islamic banks in the private sector,

2. Allow the conventional banks to set up Islamic banking subsidiaries

3. Allow the existing conventional banks to open Stand-alone Islamic

banking branches.

The first and third options have been exercised so far and none of the

commercial banks have so far set up a subsidiary for Islamic banking.


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Figure 3.8 Market Share

*

S our ce: SBP Q uar t e rly R epo r t J un-09

The change in policy approach from the legal & regulatory perspective to

that of dealing with the whole affair of introducing Islamic banking in Pakistan as

a change management issue has received a very encouraging response. Under

the current policy first Islamic banking license was granted on 31st January,

2002. Since then the industry has been continuously showing impressive growth.In 2003 only one bank operated as the full fledged Islamic bank and two

conventional banks were operating Islamic banking branches.

The total assets of the Islamic banking industry accounted for a market

share of about 0.5% and the total branch network comprised of 17 branches.

Today we have 6 full fledged Islamic banks and 12 conventional banks are

operating dedicated Islamic banking branches.

As on 30th June 2009, the total assets of the Islamic banking industry

were around Rs. 313 billion which accounts for a market share of about 5.1%.

The total branch network of the industry comprises of over 528 branches with

presence in over 50 cities & towns and covering all the four provinces of the

country.


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It is also important to compare progress of Islamic Banking in Pakistan

with the progress in other countries15. Malaysias first Islamic Bank commenced

operations in 1983 and the market share of the Malaysian Islamic banking

system today stands at approximately 13%. Bahrains Islamic banking system is

said to have gained a share of around 8% in over 30 years. Similarly in Indonesia

Islamic banking was introduced somewhere in mid 90s. According to Bank

Indonesia, Islamic banking assets reached in March, 2009 to 1.67 percent of total

assets as compared with 0.7 percent in 2003 and currently the deposits stand at

1.69% and financing at 2.60% of the total banking sector.

On the other hand, Pakistan has shown much better performance than

other global players. At certain point of time, 6 full-fledged Islamic banks and 14

conventional banks with Islamic banking branches were operating. Due to

merger of Habib Bank AG Zurich Pakistan Operations with Metropolitan Bank

Limited and Prime Commercial Bank Limited with ABN Amro Bank N.V. Pakistan

(now RBS Bank), the total number of conventional banks having Islamic banking

branches today stands at 12.

Islamic banks are currently able to offer at least 75% of the product range

available in contemporary conventional banking. On the consumer banking side,

clean lending products like Personal Loans and Credit Cards still pose achallenge. On the corporate side working capital loans are a challenge.

None of the banks have any Microfinance or Agriculture business although

a few have started offering financing to SME sector.

This offers a huge opportunity to extend the reach of the banking sector

and multiply the size of Islamic banking geometrically. It also clearly points out

the direction that has to be taken. In the existing coverage area, both

geographical and customer type, there is need to enrich the offerings through

product development and extension of distribution channel and network

Additionally there is need to extend the coverage to those sectors that are not

being covered by Islamic banking i.e. Microfinance and Agrifinance and also to


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deepen the offerings in the sector with significant potential but limited presence

i.e. the SME, infrastructure and housing sectors.

It can be seen that although Islamic banks have an amount-wise 4.2%

market share in financing, however, their share in number of borrowers is just0.9%. It is because of following factors:

1. Products: 93% customers of banking industry are availing Consumer and

Agriculture finance facilities. In consumer finance, a large number of

customers are from the credit card or personal loan sectors. However,

Islamic banks have no such products and their financing to Agriculture

sector is also negligible.

2. Geographical outreach: Conventional banks have a network of more than7800 branches in all parts of the country, through which they can extend

financing. However, IBIs being new institutions have just over 582

branches (around 5.1% of total) as of end June, 2009.

3. Technical Assistance: State Bank has arranged technical assistance in the

areas of SME, Agriculture, Microfinance, etc. which is being availed by

conventional banks through which they are developing products for these

sectors.However, no such assistance has been provided to/availed by IBIs as yet.

Despite these issues, it is believed that Islamic banking can grow at a much

faster

3.5 PROBLEMS/PROSPECTIVE

THE Idea of Islamic Banking is still hot these days in Pakistan. Either

completely new Islamic institute are being emerged or recent traditional banks

are opening additional branches focusing in Shariah-based Financing

products/services. But still consumers doubt that how much are they Islamic?

Average consumer of the Islamic banks in Pakistan they still have doubt in

their mind from the scratch to the main services provided by Islamic Banks.

Consumers would be open to the thought of acquire Islamic banking products


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and services given that the organization that is offering the service is renowned,

and better customer service features such as ATM access, phone banking and

so on, are offered. This provides a great prospect for Islamic financial

organizations in a market that already have many other competitive existing

commercial banks. If Islamic financial organizations can make on their

understanding and status in the monetary world, In Pakistan, a number of

consumers would not adopt halal banking products because they feel insecure

that what will happen if credit facilities were taken away. In the Islamic monetary

structure money is not lent out, as an alternative it is an asset-backed scheme

where monetary organizations invest in projects. Consequently, financial

organizations deal in equity, not debt. To counter this inadequacy, some banks

have started issuing debit cards. These cards are alike to the credit cardsexcluding the actuality that they use the consumers own funds as an alternative

of trust on any credit. Another concern is that of sharing profits and not losses. A

lot of consumers who have been using the Islamic banking services were not

educated about the loss sharing concept earlier. This would designate that some

economic organizations have been assuring profits. In fact, it breaches the

fundamental law of Islamic financing structure that is, relating compensations to

risk. Any kind of money earned on investment without risk is simply interest more

than profit, so, it reveals the fact that, in order to recognize how the Islamic

structure makes a distinction between profit and interest, they have to look at the

dissimilarities in financial beliefs. Because past experiences have already shown

that the rationale of monetary and financial standing is very important for a

consumer to select a particular bank. In capitalist theory, capital and

entrepreneurs are taken care of as two separate identities of production where

the first identity acquires interest and the second identity is permitted to get the

profit. It is implicit that interest is a fixed return to offer capital, and profit can

simply be produced after allocating the fixed return to land, labor and capital. On

the contrary, the Islamic monetary sys does not regard as capital and

entrepreneurs as separate identities of production.

4. DEPOSIT AND RATE OF RETURN


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In this chapter, we have emphasized the areas of accounting for Islamic

financing, their dealings at different levels, returns to investors, and the difficulties

that are faced in the promotion of Islamic economic system due to these factors.

Since Islamic banking is in embryonic state in Pakistan, many important things

are still undefined. We have tried to lionize these parameters.

4.1. Security on Deposits and Investments

Many depositors and investors have reservations about security of their

money. They are not sure whether it is safe in Islamic products or not. Numerous

reasons are propounded in this regard, e.g., small size of Islamic banking

industry, unstable returns, uncertainty of its long-term prosperity, and many other

direct and indirect parameters.The most important reason for lack of security is found to be Riba. The

definition of Riba, provided by the Supreme Court, includes any increase over

and above the principal amount. It does not take into account inflation,

depreciating value and declining purchasing power of the rupee. The real worth

of the depositors' money is eroded by inflation requiring protection. The

traditional bankers are supposed to ensure returns to the depositors over and

above the rate of inflation. The incentive is offered to attract deposits. Sourcessaid that Dr Tariq Hasan had proposed that the indexation should be allowed to

protect the real value of principal amount. Experts point out that the rise in prices

is now an every day phenomenon. Price stability is a thing of the past.

Regarding the impact of security on deposits and investments on Islamic

banking, questions were asked from 50 corporates and 30 bankers. The results

are shown in the table given below.

Table 4.1: Computation of Mean for Security on Deposits and Investments Options X f 1 f 2 f 1X f 2X

A -2 8 2 -16 -4B -1 13 6 -13 -6C 0 13 12 0 0d 1 11 7 11 7e 2 5 3 10 6


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f 1 = Frequency for Corporatesf 2 = Frequency for Bankers X1 = -0.16 X2 = 0.10

Following figure shows the summarized results, as shown in figure both

the groups have rated this factor differently.

Figure 4.1: Responses to Security on Deposits and Investments

Corporates Bankers

Results are very different for corporations and bankers. Corporations have

shown little interest about low returns. Main reason can be that when intension is

to transact in Halal and Islamic way, amount of return becomes a secondary

consideration (or looses significance altogether in many cases). They are

contended in compliance with Islamic norms and it is more important than any

other factor.

Bankers have low importance for issue of return. They are dealing in

different types of investments and securities in Islamic as well as non-Islamic

modes. Many of the non-Islamic instruments are more vulnerable and, hence,

insecure than current Islamic products, but they are available in the market. So,

security is not a big problem in the eyes of bankers. However, bankers are

working hard to improve the security of all types of instruments.

Total 50 30 -8 -3


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4.2. Rate of Return on Deposits and Investments

Government, with the alliance of SBP and other leading financial

institutions, wants to promote investment in country. Many steps have been

taken in this regard. One of the important ones is to implement Islamic bankingsystem.

State Bank Governor Dr Ishrat Hussain said the interest-based prevailing

system and Riba-free banking mode would run parallel. Therefore, people who

want riba-free products will go to Islamic banks, while the people who want fixed

income on investments and deposits will opt for non-Islamic banks. However,

return on Islamic products will remain point of concern, as it is not stable.

However, return on deposits and investments are bothersome, and manypeople are reluctant towards Islamic products just because of it. Shoukat Tareen

says that return on deposits is low because of currently prevailing low interest

rates.

Regarding the impact of rate of return on deposits and investments on

Islamic banking, questions were asked from 50 corporates and 30 bankers. The

results are shown in the table given below.

Table 4.2: Computation of Mean for Rate of Return on Deposits andInvestments

f 1 = Frequency for Corporatesf 2 = Frequency for Bankers X1 = -0.20X2 = -0.27


the groups have rated this factor in a similar manner.

Figure 4.2: Responses to Rate of Return on Deposits and Investments

Options X f 1 f 2 f 1X f 2Xa -2 6 6 -12 -12b -1 16 6 -16 -6c 0 15 11 0 0d 1 6 4 6 4e 2 6 3 12 6

Total 4 30 -10 -8


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Corporates Bankers

The results are, virtually, consistent for both, corporate as well as banking

sectors. Corporations did not heed low returns because it becomes a secondary

issue if the intension is Halal and Islamic way of financing. In general, low return

bothered very few companies, or bothered all companies in a very negligible

amount.

Bankers, on the other hand, seem very comfortable with the issue of

return, as it is a routine thing for them. Banks are dealing with returns on

investments and deposits in all modes of financing, including Islamic mode. So, it

might bother them in initial adoption because of differences in terminologies, but

they seem comfortable with dealing any type of return under any mode of

banking/financing.

4.3. International Dealings

Islamic bankers have been scrambling for years to cement rapidly growing$200 billion sector into mainstream global finance. Their hard work has paid off,

with the rise in the number of firms offering banking products and services

compliant with Islamic law and Sharia, from a handful in the 1970s to about 300

today and global banks such as Citibank and HSBC opening units to cater to

roughly 1.2 billion Muslims worldwide.

Islamic banking has a long way to go to compete with conventional

financial institutions. The Islamic Financial Services Board (IFSB) secretarygeneral, Rifaat Ahmed Abdul Karim says that IFSB is also starting to prepare a

standard on corporate governance that will focus on investment account holders

(IAH) of Islamic banks. In addition, it will start working on a standard on

transparency and market discipline soon.


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Regarding the impact of international dealings on Islamic banking,

questions were asked from 50 corporates and 30 bankers. The results are shown

in the table given below.

Table 4.3: Computation of Mean for International Dealings

f 1 = Frequency for Corporatesf 2 = Frequency for Bankers X1 = -0.46X2 = -0.50


the groups have rated this factor quite highly.

Figure 4.3: Responses to International Dealings

Corporates Bankers

Results are almost identical for corporations and bankers and both are

considerably concerned with international dealings, especially in the era of

globalization and impending WTO regime.From corporations viewpoint, they have to deal with local as well as

foreign stakeholders e.g. shareholders, auditors, customers, etc. so, they need

smooth international procedures to communicate at all platforms effectively.

Options X f 1 f 2 f 1X f 2Xa -2 20 9 -40 -18b -1 7 9 -7 -9c 0 5 4 0 0d 1 12 4 12 4e 2 6 4 12 8

Total 50 30 -23 -15


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Same reasons may be quoted for bankers as that of corporations. Banks

deal with different types of clients that include local and foreign clients e.g.

investors, creditors, companies, individuals, etc who make deposits and

investments in different portfolios. Banks have to ensure homogeneous policies

and procedures for all local and international dealings to avoid conflicts and

obscurity.

4.4. Taxations

Taxations are one of the most important issue under the paradigm of

standardization of accounting rules for Islamic banking system that will facilitate

the dealings at all platforms.

Shoukat Tareen (chairman, Pakistan Bankers Association; and Chief Executive, UBL) realizes this and suggests substantive changes in taxation and

loan recovery policies.

It is believed that government will face problems in developing secondary

market for Islamic debt instruments and financial products. There are legal and

taxation issues involved in launching this type of financing in the local market.

The review of legal and tax regulatory aspects should come hand in hand with

continuous research and development in the product development.

Regarding the impact of taxation policies on Islamic banking, questions

were asked from 50 corporates and 30 bankers. The results are shown in the

table given below.

Table 4.4: Computation of Mean for Taxation Policies

f 1 = Frequency for Corporatesf 2 = Frequency for Bankers X1 = -0.08X2 = 0.37

Options X f 1 f 2 f 1X f 2X A -2 7 1 -14 -2

B -1 10 4 -10 -4C 0 18 10 0 0D 1 8 12 8 12E 2 6 3 12 5

Total 4 30 -4 11


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the groups have rated this factor differently.

Figure 4.4: Responses to Taxation Policies

Corporates Bankers

Big differences in opinions exist between corporate and banking sector.

From corporations perspective, mean of (-0.08) indicates that most of them have

little or no problem in paying tax in Islamic process. After all, they are paying

taxes on other transactions also. So it bothers very little to companies how they

pay it, what bothers more is that they have to pay it.

From banks viewpoint, mean of (+0.37) suggests that banks have had to

adjust with taxation in Islamic mode because they are responsible to levy it for government. They have to negotiate all the techniques with SBP, govt., and other

bodies. They have to materialize them in effective manner. So, banks face some

problems in Islamic way of taxation.

5. PROBLEMSWhat really are the reasons for the lack of progress at the practical level

about the application of Islamic Banking? Different people may have different

perceptions on the issue. Proponents of the Islamic banking generally attribute itto the lack of will and commitment of the successive governments and of the

government machinery at various levels. While this view carries weight one

cannot ignore other dimensions of the issue. Most important being the

impression at various levels that Islamic banking has not been in practice


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anywhere in the world in its real spirit and therefore in the absence of the tested

alternative Islamic model there is little likelihood of a successful beginning,

instead any new experiment may backfire. Though this impression may not hold

ground, it does indicate towards a general lack of awareness about the Islamic

banking alternatives that are already in practice.

5.1 Lack of Awareness

Lack of Awareness something is always the first drop of rain. Dr Ishrat

Hussain, Governor State Bank of Pakistan, ranks lack of awareness as the

foremost factor hampering the growth of Islamic banking in Pakistan.

In Pakistan, public is unaware, or has distorted information of Islamic

banking. Therefore, the first step to be taken is to create awareness in people aswell as in bankers. Awareness is more, a sort of, problem of marketing campaign

than any thing else.

The foremost pre-requisite in this regard is mass awareness about the

concept of Islamic banking among the general public and the education of

bankers and the business community. Efforts are needed at changing the

general perception about return on financial savings/assets and creating genuine

demand for Islamic banking. Through a comprehensive campaign, people mustbe made to understand that Islamic banking does not mean free loaning to the

business and industry and that the savers can justifiably take return on the basis

of results of the business activity undertaken with the help of their funds.

Similarly, industrialist and the business community need to be persuaded to raise

more and more equity-based funds instead of loans.

The depositors and investors who have been avoiding the banking

channel so far due to involvement of Riba would approach Islamic Banks onlywhen they are assured that their funds would be invested in Shariah compliant

activities. Therefore, credibility of Islamic banks is the most important aspects

and the key to success and development of the emerging discipline. The clients

would need to be assured of Shariah compliance that funds are kept separate


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from their conventional deposits, and financing is provided purely on the basis of

Islamic modes. Islamic banks would also need to ensure that their funds are not

invested in Haram and indecent activities. Companies with excessive reliance on

debt financing will also be excluded, and hence gearing ratios will need to be

monitored. This also highlights the need for education and training of all the

stakeholders.

Training of banks personnel and creating awareness among the people

about the true nature of Islamic ban

low profit rates & unreliability of consumers on islamic products in pakistan

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