Islamic banks to outpace conventional ones

The banking sector is on the rise in Pakistan, but Shariah-compliant banks are leapfrogging and set to outpace the conventional banks in the coming years, as more banks are anticipated to apply for Islamic banking licences.

The Shariah-compliant banks are not only progressing at a faster pace because there is huge demand for interest-free banking, but also “Islamic banking institutions in Pakistan are more profitable than their conventional counterparts and their loan performance is better,” Moody’s Investors Service said in a commentary titled “Pakistan’s Islamic banking industry continues its strong growth trajectory” on Tuesday.

“We expect growth in Islamic banking to continue to materially outpace conventional banking, reaching a market share of total assets and deposits of around 30% by end-2026, with net financing market share at around 33%. We estimate average growth over 2021-2026F to range between 25% and 28% for total assets and deposits, and over 20% for net financing.”

The global research arm of the credit rating agency said it expected that more banks would apply for Islamic banking licences and for conventional banks to convert to fully Islamic banks.

“Faysal Bank Limited, a mid-sized bank with around 3% market share, is already in the process of converting from conventional banking to Islamic.”

The Islamic banking industry in Pakistan has grown by 24% year-on-average over the last decade, showing no signs of slowing, and expanded by 30.6% in 2021 alone.

The Islamic banking assets accounted for 18.6% of the total banking assets at the end of 2021, standing at Rs5,577 billion, up from Rs641 billion in 2011.

Similarly, deposits stood at Rs4,211 billion, holding a 19.4% market share, with average annual growth of 23% over the period.

Net financing amounts to Rs2,597 billion, or 25.7% market share, and has grown even faster than deposits, reaching an average expansion of 29% over the past decade.

“The outperformance of financing is likely driven by more limited availability of Shariah-compliant liquidity products as well as strong demand for financing products,” Moody’s said.

The Islamic banking industry in Pakistan comprises 22 Islamic banking institutions, consisting of five fully-fledged Islamic banks and 17 conventional banks having Islamic banking branches.

During 2021, 500 branches were added to a total of 3,956 branches, and “we expect at least a similar number of new branches to be added yearly over the next five years.”

Increasing use of digital and electronic channels will also support the industry’s growth.

Islamic banking institutions in Pakistan are more profitable than their conventional counterparts and their loan performance is better. For 2021, they reported a return on assets of 1.3% and return on equity of 21.4%, compared to 1% and 14.1% for conventional banks.

“The difference in profitability was due to lower loan loss provisioning needs at the Islamic banks, given their better loan quality and to their lower funding costs.”

Pakistan’s large Muslim population and the country’s modest level of financial inclusion are the bedrock for the development of Islamic finance in the country.

Pakistan has a population of over 210 million people, of which more than 95% are Muslims. A 2014 survey by the SBP indicated overwhelming demand for Islamic banking, particularly among households, but also among businesses.

Pakistani citizens who have voluntarily stayed outside the financial system cite religion as the main reason. At the same time, around three-quarters of the banked population said “they would be willing to switch to Islamic banking, and identified religious satisfaction and the absence of interest as the two biggest reasons,” it said.

According to the World Bank and its Global Findex Database, only around 21% of Pakistan’s adult population had a bank account with formal financial institution in 2017.

Although significant progress has been made over the past few years, with the SBP now estimating financial inclusion at 62%, “this remains well below the 95% financial inclusion in high-income countries or that of regional peers, such as India, whose inclusion rate is over 80%.”

Published in The Express Tribune, May 25^th, 2022.

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