Islamic Banking in Pakistan

History of Islamic banking in its present form dates back to approximately four decades when it started initially as a niche market for the faith sensitive clientele; the same now is an integral component of the global financial system. Owing to the strengths of being based on real economic activity and being devoid of excessive leveraging, imprudent risk taking while encouraging investment disclosure and setting higher standards of corporate governance, Islamic finance is increasingly winning confidence across the globe. Pakistan witnessed an emergence of Islamic banking in response to both religious and constitutional needs. The history of Islamic banking in Pakistan matches with that of the global emergence of Islamic banking; the process, which began in 1960s, made considerable headways in 1980s. Some landmark changes were introduced in the legal framework during the period that included amendments in the Banking Companies Ordinance, enactment of Modaraba Companies and Modaraba Framework etc.

However, the experiment of the 80s could not produce desired results mainly due to abrupt transformation without having necessary operational and regulatory framework in place for the growth of the industry.

Efforts towards Shariah compliant banking system in Pakistan were re-launched in 2001-02. The new paradigm was based on a model that allowed Islamic banking to operate in the country as an alternative and parallel system with three types of Islamic banking institutions; (i) Full fledged Islamic banks, (ii) Islamic banking subsidiaries of conventional banks and (iii) Islamic banking branches of conventional banks. This approach has proved to be a success as reflected by its considerable growth; by March 31, 2018, Islamic banking industry’s share in overall banking industry’s assets and deposits stood at 13.5 percent and 14.6 percent, respectively. The network of Islamic banking industry consisted of 21 Islamic banking institutions (5 full-fledged Islamic banks and 16 conventional banks having standalone Islamic banking branches) with a network of 2,589 branches spread across the country. In addition, 1,283 Islamic banking windows (Islamic counters at conventional branches) are providing Shariah compliant banking services.

Considering Shariah compliance as the most essential element of Islamic banking, State Bank of Pakistan since beginning has put in place a comprehensive and robust multi-tiered Shariah compliance mechanism. Main components of the framework are: a) Shariah board at the Central Bank, b) Shariah board comprising of at least three members at bank’s level, c) mandatory internal Shariah audit, d) Shariah inspection. State Bank of Pakistan is among pioneer regulators that  introduced Shariah compliance inspection of Islamic banking in the country.

Promoting Islamic finance as a viable and competitive component of the financial system through enabling legal, regulatory and supervisory environment has remained an important component of SBP’s strategic goals. SBP has also issued a survey based research report entitled, " Knowledge, Attitude and Practices of Islamic Banking in Pakistan" (KAP study), that has quantified the demand of Islamic banking in Pakistan for the very first time. Capitalizing on the overwhelming demand as highlighted by this survey promoting Islamic finance can increase the prevalent relatively low saving rate in the country, which can contribute towards higher growth of the economy. Being cognizant of potential of Islamic finance to contribute significantly towards financial inclusion by extending the outreach of the financial system to the masses who are voluntarily out of the system due to faith reasons, Islamic Banking & Finance has been made an integral part of National Financial Inclusion Strategy of Government of Pakistan (GoP).

The GoP has also demonstrated strong commitment towards the development of Islamic finance in the country. To this end, a high level Steering Committee for Promotion of Islamic Banking was constituted in December 2013. The committee completed its tenure of two years in 2015 and submitted a comprehensive set of recommendations aimed at addressing challenges faced by the industry. Subsequently, an Implementation Committee was formed under the Chairmanship of the Governor, State Bank of Pakistan. Under the Implementation Committee, four sub-committees have been formed; (i) Sub-Committee on Legal & Regulatory Framework, (ii) Sub-Committee on Taxation, (iii) Sub-Committee on Islamic Capital Market and (iv) Sub-Committee on Awareness & Capacity Building. Some of the major achievements from this platform include launch of All Share Islamic Index, establishment of Islamic Finance Department at Securities & Exchange Commission of Pakistan and extension of tax neutrality for Islamic financial institutions and their customers. SBP is not only providing support and assistance in functioning of these committees but is also assisting GoP for issuance of domestic and international sukuk.

In its supporting role, State Bank of Pakistan is addressing the awareness and misconception issues as well as the capacity building of the industry. To this end, SBP is pursuing a multi-pronged strategy that consists of seminars, conferences, targeted programs and focused discussions for business community, academia, bankers and policy makers. Moreover, in order to ensure adequate supply of trained human resource to the industry as well as to act as incubator for research, SBP in collaboration with the Government, industry and other stakeholders has helped in establishing three Centers of Excellence at leading business schools of the country: including Institute of Business Administration (IBA), Karachi, Lahore University of Management Sciences (LUMS), Lahore and Institute of Management Sciences (IMSciences), Peshawar. These centers are working efficiently to improve quality of human resource and provide the much needed boost to the emerging Islamic finance industry through dedicated research.

SBP is committed to facilitating Islamic Banking industry by providing a conducive growth environment. In recognition of its efforts, SBP was voted as the Best Central Bank for 2017 in promoting Islamic finance by a poll conducted by Islamic Finance News (IFN), an arm of REDmoney Group, Malaysia. SBP has also won this award in 2015.