Islamic Banking industry: A rising force in global finance

July 21, 2023 (MLN): Islamic Banking Industry (IBI) has been growing at a rapid pace, not only in Muslim-majority countries but also in other parts of the world with its share in total banking assets increasing from 12% to 20% during the period from 2017 to 2022, as per a report by A. F. Ferguson & Co., a member of PWC.

IBI now accounts for a 20% share in total assets, 25% in advances, and 22% in deposits of the overall banking industry as of December 2022.

The asset side of the IBI has now reached 7.23 trillion, marking a surge of Rs4.96tr from 2017 to 2022.

Moreover, investments by the IBI during the period 2017 to 2022 have surged by 5.71x to stand at 3.05tr.

The deposits and advances side has grown significantly by 3.26tr and 2.35tr respectively.

At present, the IBI network comprises 22 Islamic Banking Institutions, including 5 full-fledged Islamic Banks (IBs) and 17 conventional banks (80% of the total) having Islamic Banking Branches (IBBs).

State Bank of Pakistan (SBP) is actively engaged in the promotion and capacity building of IBIs. It has also proactively issued regulations and guidelines to create a level playing field for IBs.

Complementing these initiatives, the Government has introduced different policies and incentives to encourage Islamic banking.

As per a study conducted by SBP and Department for International Development, UK, 67% of the sole proprietors prefer only Islamic banks.

The study further depicts that around 74% of the banks are willing to switch to Islamic banking.

In April 2022, Federal Shariat Court instructed provincial and federal governments to complete the necessary legislative process to ensure a Riba-free banking system in Pakistan by Dec-27.

While conversion to Islamic banking is a significant step, it is not without challenges.

Islamic banking has added considerably to financial inclusion. As the pie is getting bigger, this does not mean share is being taken away from the conventional banking system, it is actually adding New to Industry,” Mr. Irfan Siddiqui, President & CEO, Meezan Bank Limited (PSX: MEBL) said.

Considering that majority of banks have IBBs, they may have some experience with relevant products, services and technology. However, Islamic banking size and maturity at these conventional banks may largely vary.

They can hence be divided into the following 3 broad categories:

• Banks operating with a significant number of IBBs
• Banks operating with fewer IBBs
• Banks operating without any IBBs

Following are some key areas where banks might face challenges, which can only be addressed by executing a comprehensive, holistic Islamic transformation and conversion programme:

People & Culture

People are the cornerstone of successful Islamic conversion. There may be limited set of capacity/ capabilities forcing banks to considerably upskill resources on Islamic finance and Shariah compliant products.

Technology

One of the major enablers for conversion is technology infrastructure, capable of providing requisite functionalities and scale to accommodate transformation and operations on an ongoing basis.

For banks having any IBBs, some form of core technology platforms may be available. Depending on current Islamic product sophistication/ scale and destination/ growth model post-conversion, certain institutions may significantly augment or amend systems and create scalability.

Policies & Processes

Banks with IBBs may already have some set of policies and procedures that they can leverage, depending upon their intended diversity of operations. However, they may still have to review and update existing practices to align with an expanded scope of Islamic Banking in terms of business line and product diversity.

Retail Business

Retail banking may probably be one of the largest impact areas in the conversion journey for banks with IBBs or otherwise.

For banks without IBBs, an extensive deposit or lending product development, review and approval cycle may be followed by systematic conversion guidelines and consent on the layout of converted products.

Product designing and benchmarking are to be complemented by requisite documentation changes which may be onerous, particularly in the case of the lending segment.

Retained Earnings

Conversion of retained earnings is a critical consideration and banks may need to formally raise this with Sharia governance boards for resolution.

Corporate & Investment Banking

Depending on the presence of an Islamic banking window, thrust may have to be on designing an entire product suite for corporate and investment banking or a new product introduction to extend the menu.

Non-Performing Loans

Managing NPLs is a major challenge for banks, regardless of their being conventional or Islamic. However, converting to Islamic may bring forth incremental NPL challenges.

Banks may need to develop new NPL management and collection strategies and processes compliant with Shariah principles, such as in relation to restructuring or rescheduling loans.

Borrowings & Treasury

Borrowing and treasury will also have similar product and documentation implications, as applicable broadly to retail and corporate/ investment businesses, albeit with varying complexities and implications.

“The transition to Islamic banking must be planned meticulously. Every aspect be it systems, products, processes, HR, or business feasibility, needs careful evaluation from an implementation perspective,” Mr. Yousaf Hussain, President & CEO, Faysal Bank Limited (PSX: FABL) said.

Customer is imperative to the process and his/ her sentiments must be in focus at all times. One of the biggest challenges was mindset conversion.

"We had to transform people through conversion-oriented capacity augmentation. Mindset and culture transformation that we were able to achieve was the most significant,” he further added.

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