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IMF advises policymakers to ensure level-playing field for Islamic banks

By Erum Zaidi
June 22, 2017

KARACHI: The International Monetary Fund (IMF) on Wednesday advised the government to provide a level-playing field to Islamic banks in order to maintain the industry’s fast growth pace in a country with 96 percent Muslim populations.  

“Rather than forcing a transition toward a fully-fledged IB (Islamic banking) industry, policy makers should focus on putting in place an enabling environment that levels the playing field with the conventional industry, and let market forces play their role,” IMF said in a multi-country report: ensuring financial stability in countries with Islamic banking. “Since opting for the latter, the IB industry has experienced rapid growth and the IBs in Pakistan have also increased the share of risk-sharing financing (Musharakah and Mudarabah).”

The IMF said additional reforms are needed to address gaps “with respect to consolidated supervision, consumer protection, the resolution framework, and the absence of liquid secondary markets”.

“Ongoing reforms with respect to capital adequacy ratio and liquidity framework need to be expedited. Concentrations in bank financing, maturity mismatches and development of interbank markets warrant attention and further efforts are needed to develop deep Sukuk markets.”

The Washington-based lender said the industry is at its evolutionary stage and it expanded at compound annual growth rate of nearly 50 percent between 2002 and 2005 and reached a market share of 11.4 percent by end 2015. The central bank eyes 15 percent of banking system assets for Islamic banks by end of the next year.

Citing the World Bank’s financial inclusion database Findex, it said only 13 percent adult population – more than half of the country’s population – has a bank account. Around 96 percent of the country’s population is Muslims, indicating a latent appetite for Islamic financial products.  

“Facilitative regulatory support has been propelling the growth of Pakistan’s IB sector,” it added. “The large Muslim population and low market penetration also suggest that there is substantial upside potential for further growth.”

The Fund, however, noted that full-fledged IBs – four domestic IBs and two subsidiaries of foreign-owned banks – are subject to the same prudential requirements as conventional banks, including the minimum capital requirement (MCR) regime, the minimum capital adequacy ratio (CAR), large exposure, loan classification, provisioning and related party lending.

The Banking Companies Ordinance 1962 governs regulation of both Islamic and conventional banks. The ordinance was amended in 2002 to authorise the carrying on banking business in conformity with the injunctions of Islam.

Conventional banks are also allowed to offer IB services through stand-alone branches/window operations, with nominal capital allocation from their existing capital based on risk-weighted assets of these branches. IBIs are allowed to offer profit and loss sharing (PLS) deposit accounts similar to unrestricted investment accounts.

Six full-fledged IBs had CAR of 14 percent by the end of 2015, significantly above the prescribed minimum of 10 percent, but below conventional banks. The non-performing financing ratio of two percent is significantly below the average for conventional banks of 12 percent. IBs are also profitable and liquid but the profit margins and liquidity levels are, however, lower than their conventional counterparts, IMF said in its report.

The Fund said customer deposits fund close to 85.3 percent of the industry’s assets. Since the funding is mostly in local currency the exchange rate risk is low. It said there is a dearth of funding options like Sukuk, “thereby potentially creating maturity mismatches with financing structure.”

“Despite witnessing growth over the years, the domestic Sukuk market is still confronted with issues such as lack of short term and long term Sukuk of high quality, absence of a secondary market for trading, and identification of assets for sovereign Sukuk,” it added.

The Fund called for additional reforms to address gaps with respect to consolidated supervision, consumer protection, the resolution framework, and the absence of liquid secondary markets.

“Ongoing reforms with respect to CAR, liquidity framework and DIS (deposit insurance scheme) need to be expedited. Concentrations in bank financing, maturity mismatches and development of interbank markets warrant attention and further efforts are needed to develop deep Sukuk markets,” it said. “The SBP has an extensive database on IBs operations, but inconsistencies in the data methodologies in IBs audited accounts could affect data quality for policy formulation.”