June 08, 2022 (MLN): Fitch Ratings, in its latest report, said that the Islamic finance industry in Pakistan is expected to continue its growth trajectory over the medium term, driven by strong government push and steadily rising public demand for Islamic products.
However, the industry faces key challenges that could slow its growth such as the still-developing Islamic finance regulatory framework, it added.
In April 2022, the Federal Shariat Court of Pakistan (FSC) stated in a decision that ‘riba’ or interest is prohibited in Islam, including relating to banking transactions. The FSC directed the government to adopt sharia-compliant modes while borrowing from domestic or foreign sources in the future. The FSC set an implementation timeline of five years to convert the economy of Pakistan into an “equitable, asset-based, risk sharing and interest-free economy” by the end-2027.
As per the report, if court orders are implemented effectively, the Islamic finance industry could receive a large boost in the medium term. However, uncertainties loom over policy implementation as court judgements on this subject were issued previously but with limited effect on the banking sector. The implementation, implications, extent and time frame will be monitored by Fitch.
Fitch noted that Pakistan’s Islamic finance industry faces multiple other challenges. This includes a still-developing Islamic finance regulatory framework, limited supply of sharia-compliant products and gaps in the distributional channels, with limited outreach in the populous rural areas where 63% of the total Pakistani population resided in 2020, according to World Bank. The financial sector in general also remains under-developed, with a challenging business environment.
The size of the Pakistani Islamic finance industry is estimated to have crossed USD42 billion at the end-1Q22. Islamic banks are the largest contributor to the Islamic finance industry at 67% (total assets), followed by Sukuk at 26% (outstanding amount), Islamic funds at 6% (total assets) and takaful at 1% (total contributions).
Pakistan has the second-largest Muslim population in the world with very low banking penetration. The government seeks to increase financial inclusion through promoting Islamic finance, as part of the National Financial Inclusion Strategy. Only 21% of the adult population had a bank account in 2017, with 13% of adults citing religious reasons for not having them, according to the World Bank.
Fitch expects sovereign Sukuk issuance to rise on the back of high gross financing needs. In 2021, the government set a target of increasing the share of the sharia-compliant instruments in government securities to at least 10% by end of 2022-2023. Pakistan’s Sukuk market is developing with outstanding volumes of USD 11 billion at the end-1Q22, with 82% in local currency. Also, guidelines on issuing green Sukuk and bonds were issued in 2021 by the Securities and Exchange Commission of Pakistan.
At end-2021, Islamic banking share reached 18.6% of banking sector assets (end-2017: 12.4%) and 19.4% of deposits (end-2017: 14.5%). State Bank of Pakistan targets the Islamic banking sector to contribute 30% to the overall banking industry assets and deposits by 2025. In 2021, Islamic banks’ total assets experienced a sharp growth of 30.6% YoY to PKR5,577 billion (USD32 billion). Islamic branches of conventional banks contributed significantly to the banking system, with a 45.7% share of overall Islamic banking assets by the end-2021.
The domestic market share of takaful reached 12% in end-2020. The Islamic funds sector had a global market share of 1.9% at the end-2020.
Other directives issued by the FSC to the government include the deletion of the word ‘interest’ from the relevant laws and making the necessary legislative amendments by 31 December 2022. The FSC also ruled that laws or provisions of the laws that include the word ‘interest’ would cease to have effect as of 1 June 2022. Additionally, FSC ruled that the government’s previous international financial commitments would be binding unless renegotiated through mutual agreement of the parties.
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