Increased Islamic Banking penetration supports Pakistani banks’ profitability: Moody’s

September 19, 2019 (MLN): The State Bank of Pakistan released its latest Islamic Banking Bulletin on September 13, showing that Shariah-compliant assets had increased by 21% during the Fiscal Year 2019 to reach a market share of 14.4% of total system assets.

According to the report produced by Moody’s regarding Pakistan’s Islamic Banking Sector, a significant portion of Islamic banking customers come from populations that were previously unbanked, thus creating a new revenue source for banks. Additionally, the bulk of these deposits are low-cost, non-remunerated, Shariah-compliant that will boost banks’ interest income and margins.

The State Bank of Pakistan set a goal to increase Islamic assets to 20% of the market, with a focus on lifting structural and regulatory barriers and increasing awareness. In addition, the government is further supporting the growth of Islamic finance in Pakistan through regular sukuk issuances.

As of June 2019, there were five fully fledged Islamic banks in Pakistan, including MCB Bank Limited (B3 negative, b31) subsidiary MCB Islamic Bank Limited, as well as 17 banks with standalone Islamic branches including Allied Bank Limited (B3 negative, b3), United Bank Ltd. (B3 negative, b3), National Bank of Pakistan (B3 negative, caa1) and Habib Bank Ltd. (B3 negative, caa1).

With Pakistan's Muslim population reaching more than 96% of the country's total population and 79% of the population remaining unbanked, according to World Bank data, the potential for Islamic banking penetration is substantial.

As Islamic banking institutions attract more Shariah-compliant deposits, they will benefit from stronger profitability. Islamic banking products are attracting previously unbanked customers, creating new business opportunities for banks to grow their deposit base. Islamic deposits have grown 21% on a compound annual basis for the six-year period through June 2019, outpacing the 11% compound annual growth rate of all other deposit types.

In addition, Islamic deposits do not earn interest under Shariah law, thereby reducing interest expense and generating higher margins and profitability. The return on assets for Islamic banking institutions was 2.3% at the end of June 2019, versus an average of 1.6% for all banks in the system.

As part of the national strategy to increase financial inclusion, the Pakistani government is focusing on a series of initiatives targeting the growth of the Islamic finance industry. These initiatives include the adoption of global reporting standards and the introduction of a Shariah-compliant regulatory framework, such as easing initial capital requirements for Islamic banking subsidiaries, facilitating conversion into Islamic mode, introducing tax neutrality for Shariah-compliant banking and crafting exceptions for using the Karachi Interbank Offered Rate as a benchmark for pricing financing.

In addition, the government is further supporting the growth of Islamic finance through regular sukuk issuances. The Securities and Exchange Commission of Pakistan is also working towards enhancing liquidity management with the creation of an open market and auction platform for sovereign sukuk offerings.

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