http://www.dailytimes.com.pk/default.asp?page=2010\08\16\story_16-8-2010_pg3_6

Monday, August 16, 2010

COMMENT: Should Islamic banking broaden its base? -Muhammad Aftab

 In order to really contribute to the economy, Islamic banks will have to 
expand their commercial and investment banking services, and various streams of 
deposits should finance these ventures. They will have to diversify their 
product mix, making use of their comparative advantage, and not just using the 
conventional modes

Should Islamic banking broaden its base? All un-serviced sectors say that it 
should, in case it wishes to finance small enterprises, farmers and the 
homeless, rather than concentrating on big business. 

The growing Islamic banking system in Pakistan has finally been asked to 
broaden its base and undertake equitable distribution of economic gains. This 
is urgently needed because the present Islamic banking paradigm is based on 
replication of conventional banking products and totally relies on debt-based 
fixed income products. "The total reliance of Islamic banks on debt-based fixed 
income products and minimising the risks to almost close to those of the 
conventional banking system is blurring the distinction between Islamic and 
conventional finance," Yaseen Anwar, acting governor, State Bank of Pakistan 
has told bankers.

Despite the fact that the replication of conventional banking products to make 
them shariah-compliant does pass the shariah permissibility test, but it is 
insufficient to achieve the larger objectives of an Islamic financial system. 
These objectives include enforcement of a broad based and equitable 
distribution of economic gains to help boost business and industry. Ironically, 
67 percent financing by the Islamic banks is concentrated in the corporate 
sector, instead of financing the needs of smaller enterprises. 

How did this come about? This concentration has taken place through murabaha, 
ijarah, and the diminishing musharaka. Most of the corporations have banking 
and financing relationships with Pakistan's domestic and foreign-based 
conventional banks. "The Islamic banks have to offer significant price 
discounts to attract corporate clients. It reduces the banks' profit margins 
and limits their ability to offer better returns to the depositors," Anwar says.

Islamic banking operations over the last 40 years are seen to be contrary to 
the natural business model of Islamic finance, which promotes risk and reward 
sharing and encouraging financing to promising start-ups, which is critical for 
promoting an entrepreneurial culture. The present practices also confine the 
access of finance to the well-established businesses and corporations; they 
leave small and medium enterprises (SMEs) and start-up businesses financially 
excluded. 

Such enterprises are deprived of financing benefits despite the fact that such 
enterprises offer a huge volume of business. The number of these businesses and 
industrial units is in millions. These enterprises employ millions of people 
and act as the economy's stabilisers when big business and industry face crisis 
due to domestic or international causes.

Since Islamic banking, under profit and loss sharing (PLS), was launched in 
Pakistan in the late 1970s, depositors are protesting against paltry profits 
they receive on their deposits, often much less than the payout by conventional 
deposits. It has discouraged savings. The Islamic banks retain a large portion 
of profit, pretending high costs and overheads, and also to cover the risks.

Facts contradict their claim; a recent survey confirmed that the Islamic banks 
had an 8.7 percent spread, as against 7.19 percent by the conventional banks. 
Both Islamic and conventional banks have one of the highest spreads in the 
world. It averages around 7.5 percent for conventional banks. Low interest 
payouts or profits by both systems leave Pakistan with the lowest savings rate 
in the world.

In order to really contribute to the economy, Islamic banks will have to expand 
their commercial and investment banking services, and various streams of 
deposits should finance these ventures. They will have to diversify their 
product mix, making use of their comparative advantage, and not just using 
conventional modes.

Islamic banking should be profitably extended to new areas, like the rural 
farming sector, comprising more than seven million households. It contributes 
20 percent to the annual GDP and is a source of livelihood to 65 percent of the 
population. Less than 20 percent of these households have access to bank 
credit. The growing SME sector, too, has a major potential for Islamic banking; 
it can build low-cost houses and cater to a huge demand of the homeless. For 
Islamic banking, is the sky not the limit?

The writer is an Islamabad-based journalist and former Director General of APP






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