Various Factors Implementation in Islamic Banking in Pakistan

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Implementation of IslamicBanking System in Pakistan


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Final Year Project

A Research Report about the Impact of

Various Factors on the Implementation ofIslamic Banking System in Pakistan

Supervisor Name

Riaz Ahmed

Submitted ByMuhammad Rafay Mansoor

Reg IDBB-1-05-2775

DateJanuary 19, 2009


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Submitted ToPAKISTAN AIR FORCE KARACHI INSTITUTE OF

ECONOMICS AND TECHNOLOGY

PROJECT APPROVAL

Project Title: IMPLEMENTATION OF ISLAMIC BANKING SYSTEM IN PAKISTANBy: MUHAMMAD RAFAY MANSOOR 2775

Project Supervisor: Mr. RIAZ AHMEDAcademic Year: 2008

The Board of Advanced Studies at PAF KIET has approved this Project,submitted in partial fulfillment of the requirements for the degree ofBachelor of Business Administration.

Approval Committee:

_______________________ _____________________

Mr. RIAZ AHMED Director AcademicsSupervisor


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LETTER OF TRANSMITTAL

Mr. RIAZ AHMEDProject SupervisorPAF-KIET

Dear Sir,

This report is hereby on the IMPLEMENTATION OF ISLAMIC BANKINGSYSTEM IN PAKISTAN. The report includes problem statement and abrief literature survey and it is part of my BBA (H) program.

I am grateful for your guidance and supervision without which this project

could have not been completed.

Yours Sincerely,

MUHAMMAD RAFAY MANSOOR2775


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LETTER OF AUTHORIZATION

MUHAMMAD RAFAY MANSOOR

Please refer to your initial proposal for undertaking the study on

Implementation Of Islamic Banking System In Pakistan. In the view ofsubsequent meetings and discussions, the initial proposal was finalized.Kindly initiate the study on the finalized Terms of Reference.

RIAZ AHMEDSupervisor


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TABLE OF CONTENTS

Page # Acknowledgements..i

List of Tablesii

List of Figures..iii

1 Introduction1

2 Research Plan32.1 Statement of the Problem.32.2 Review of Related Literature32.3 Statement of the Hypothesis42.4 Data Collection...42.5 Sampling..52.5.1 Non Islamic Banks.5

2.5.2 Bankers and Corporate Customers62.6 Instruments..62.6.1 Questionnaire.62.6.2 Interview..62.6.3 Observations..72.7 Data Analysis..72.8 Time Schedule.82.9 Budget..8

3Limitations...9

4 Dealings, Returns and Standards...104.1 Security on Deposits and Investments.104.2 Rate of Return on Deposits and Investments..114.3 International Dealings..134.4 Experts in Islamic

Banking..144.5 Taxation Policies..164.6 Accounting and Auditing Standards..174.7 Concluding Remarks

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5 Portfolio and Accessibility20


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5.1 Banks and Branches205.2 Customer

Services...215.3 Research and Development...235.4 Shariah Compliant Government Securities and

Money Market...265.5 Products Offered by Other Banks.285.6 Islamic Banking in Rural Areas..315.7 Concluding Remarks

32

6 Other Issues.346.1 Awareness34

6.2 Government Support...366.3 Religious Convictions..396.4 Social, Ethical and Cultural Values...426.5 Concluding Remarks

45

7 Conclusion47

8 Recommendations..48

AppendixAppendix A: Questionnaire for Corporate Customers.49Appendix B: Questionnaire for Bankers.50Appendix C: Frequency Distribution Table for Corporate

Customers...51Appendix D: Frequency Distribution Table for Bankers..52Appendix E: Means Calculated for Corporates and Bankers.53

Bibliography.54


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Acknowledgement

This research has benefited from the contribution of various individuals;this research study could not be completed successfully without their

participation.

First of all, I thank Mr. Riaz Ahmed, my project supervisor, for providing uswith the opportunity and all the guidance to conduct this research. He hashelped me at every step, and beckoned us the right way in every difficultywe faced.

In the end, credit goes to all the people who filled out questionnaires, gavetheir remarks, added valuable ideas, and helped me polish this report.

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List of Tables

Page #

Table 2.1 Sampling Techniques for Primary Sources 5Table 2.2 Interval Scale 7Table 4.1 Computation of Mean for Security on Deposits 10

And InvestmentsTable 4.2 Computation of Mean for Rate of Return on 12

Deposits and InvestmentsTable 4.3 Computation of Mean for International Dealings 13Table 4.4 Computation of Mean for Experts in Islamic Banking 15Table 4.5 Computation of Mean for Taxation Policies 16Table 4.6 Computation of Mean for Accounting and Auditing 18

Standards

Table 5.1 Computation of Mean for Banks and Branches 21Table 5.2 Customer Services 22Table 5.3 Computation of Mean for Research and Development 25Table 5.4 Computation of Mean for Shariah Compliant 27

Government Securities and Money MarketTable 5.5 Computation of Mean for Products Offered by Other 30

BanksTable 5.6 Computation of Mean for Islamic Banking In Rural 31

AreasTable 6.1 Computation of Mean for Awareness 35Table 6.2 Computation of Mean for Government Support 38

Table 6.3 Computation of Mean for Religious Factors 41Table 6.4 Computation of Mean for Social and Cultural Factors 44Table A-1 Frequency Distribution Table for Corporate Customers 51Table A-2 Frequency Distribution Table for Bankers 52Table A-3 Means Calculated for Corporates and Bankers 53

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List of Figures

Page #

Figure 2.1 Gantt chart for Research Study 8Figure 4.1 Responses to Security on Deposits and Investments 11Figure 4.2 Responses to Rate of Return on Deposits and 12

InvestmentsFigure 4.3 Responses to International Dealings 13Figure 4.4 Responses to Experts in Islamic Banking 15Figure 4.5 Responses to Taxation Policies 17Figure 4.6 Responses to Accounting and Auditing Standards 18Figure 5.1 Responses to Banks and Branches 21Figure 5.2 Responses to Customer Services 22Figure 5.3 Responses to Research and Development 25

Figure 5.4 Responses to Shariah Compliant Government 28Securities and Money MarketFigure 5.5 Responses to Products Offered by Other Banks 30Figure 5.6 Responses to Islamic Banking in Rural Areas 32Figure 6.1 Responses to Awareness 36Figure 6.2 Responses to Government Support 39Figure 6.3 Responses to Religious Factors 41Figure 6.4 Responses to Social and Cultural Factors 45

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1 Introduction

Islamic banking has been defined as banking in consonance with the ethosand value system of Islam and governed by the principles and rules laid

down by Islamic Shariah. Interest free banking is a narrow conceptdenoting a number of banking instruments or operations, which avoidinterest. Islamic banking, the more general term is expected not only toavoid interest-based transactions, prohibited in the Islamic Shariah, butalso to participate actively in achieving the goals and objectives of anIslamic economy.

As the most dominant form of Islamic finance, Islamic banking is rapidlytransforming into a viable alternate form of financing. From relativelyhumble beginnings in 1963 when the first Islamic bank was established inEgypt, today Islamic finance boasts of assets of around US$ 1.0 trillion,

and has successfully made inroads into a wide range of products such asinfrastructure and housing finance, asset management, Takaful business,debt issuance via Sukuk, etc. The growth rate, particularly in recent times,has been tremendous and geographically broad-based. Islamic bankinghas also made swift progress in Pakistan since its re-launch in 2002 as aparallel mode of financial intermediation along with conventional financialinstitutions, as evidenced bythe commendable growth rate in excess of 60.0 percent per annum in boththe assets and deposit base. Importantly, this parallel system is movingforward on the strength of its own merit, and not because of any religiousor legal obligation or compulsion. As a proportion of the overall bankingindustry, the combined share of Islamic banks and stand-alone Islamicbranches of conventional banks is 4.2 percent in deposits, and 4.3 percentin assets. In comparison with other countries, these shares reflect animpressive performance in a short span of 6 years: Bahrain, Malaysia andIndonesia have respective shares of 8.0 percent achieved over 30 years,13.0 percent over 25 years and 1.7 percent over the last decade or so. Tocapitalise on the pace and momentum of this growth, SBP has recentlylaunched its Strategic Plan for the Islamic banking industry, whichenvisions increasing its share to 12.0 percent of the overall bankingindustry by 2012. The whole financial system of Sudan has been

transformed to the Shariah compatible basis in strict sense. Iran also hasadopted Islamic banking system at national level, of course with somedifference of opinion on some issues. A significant development in this fieldsince late 1980s has been that conventional commercial banks, both withinand outside the Islamic world, started offering Islamic banking servicesside by side with their normal operations.

Efforts made during 1980 for Islamization of Pakistans economy atcomprehensive and nation wide level failed and the current non interestbased (NIB) system was declared un-Islamic by the superior courts in thecountry. Keeping in view that experience, the authorities during the last

one-year or so, have made some important policy decisions. As a part ofpronged strategy, private sector has been allowed to establish Islamic

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banks and the conventional commercial banks have been allowed to setup subsidiaries and stand-alone branches for conducting pure Islamicbanking business. Amendment has also been made in Section 23 of BCO(1962) for establishing subsidiaries by commercial banks to conductexclusive Shariah compliant banking business.

The State Bank issued detailed criteria in December 2001 forestablishment of full-fledged Islamic commercial banks in the privatesector. Al Meezan Investment Bank received the first Islamic commercialbanking license from SBP in January 2002 and the Meezan Bank Limited(MBL) commenced full-fledged commercial banking operation from March20, 2002. Detailed criteria for setting up of Islamic banking subsidiariesand the strategy, guidelines and criteria for opening of stand-alonebranches for Islamic banking by existing commercial banks have also beenissued. Thus, those interested in establishing scheduled Islamiccommercial banks, subsidiaries or stand-alone branches for Islamic

banking may apply to the State Bank of Pakistan, in fulfillment of thedetermined criteria.

The above progress should certainly be regarded as an excellent reflectionon the success and viability of the concept of Islamic banking as theachievement so far in laying a solid foundation is no small matter.However, the Islamic banks performance in achieving various socio-economic objectives is rather modest relatively to the hopes attached tothem in Islamic economic thought. They are facing a number of challengesto ultimately play a decisive role in development of Islamic countries, inparticular, more than half of which is presently classified as the LeastDeveloped Countries.

The main objective in presenting this paper is to deliberate upon the waysand means by which Islamic banking could not only be promoted inPakistan, but also used as a vehicle for fostering socio-economicdevelopment of the country.

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2. Research Plan

2.1 Statement of the Problem

Pakistan initiated a process of the Islamization of its financial system in1979. Though the financial system of the country had undergonesignificant changes since then, the process of Islamization is yet to take itsfull course. Although Pakistan is an Islamic country according to itsconstitution, it is not an Islamic state, as it does not follow the principalobjectives of economic order in Islam.

It is an irony that very little has been borrowed from the Islamic concept ofeconomics in the Islamic state of Pakistan, Perhaps the people as well asrulers of Pakistan have not cared to study in depth the Islamic economicconcept, given by the Holy Prophet (P.B.U.H.) and the pious caliphs. Whatwe have only succeeded in is making cosmetic changes here and there,and that too, in very few sectors of economy.

So what are the factors impeding the growth of Islamic Banking System inPakistan? The purpose of this study is to discuss the various factorsimpacting negatively (or positively) in the implementation of Islamic

Banking System in Pakistan.

2.2 Review of Related Literature

In order to develop the hypothesis for the aforementioned problem, I havereviewed the following literature.

On June 19 2002, an article was published in the Daily Dawn titled

Ulema a hurdle in Islamization process about the recommendations ofgovernment to supreme court quoting ulema as an obstacle in theimplementation of Islamic banking system in Pakistan. The counselstated that the so-called present-day Islamic banking was in fact un-Islamic due to high level of exploitation in these obsolete bankinginstruments that were being portrayed as Islamic.

On February 28 2001, an article was published in Daily Dawn titledIslamic banking and some issues by Abdul Rauf Sivany describingmajor problem areas of Islamic banking. According to the author,general public is unaware of Islamic banking and therefore the central

bank should instruct the banking industry how to conduct general

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awareness programs on Islamic banking to enable the ordinaryPakistani to understand its essence.

On August 13 2001, an article was published in Daily Dawn titledProtection of depositors interest main challenge: Islamic banking by

Jawaid Bokhari describing lack of security and low returns as mainchallenges of Islamic banking. The author states that the real worth ofthe depositors' money is eroded by inflation requiring protection and thetraditional bankers are supposed to ensure returns to the depositorsover and above the rate of inflation to attract deposits while the returnsoffered by Islamic banks are much lower than traditional banks.

On August 30 2004, an article was published in Axcess News titledWhile Lacking Innovation, Islamic Banking Thrives discussing thegrowth prospects of Islamic Banking. According to the author theprogress of Islamic banking has been very slow; that the majority ofMuslims still prefer to deal with conventional banks; and that post-9/11Islamic banking "has lost much of its glow globally". The author addsthat the downward slide will continue unless serious steps are taken topromote transparency and public trust; "innovation not imitation"; andthe scale and status of Islamic finance.

2.3 Statement of the Hypothesis

In the light of the literature reviewed above, the following hypothesis isdeveloped:

Lack of awareness, low return on deposits and investments, anddifferences in opinion regarding Islamic Banking are creatingobstacles in the implementation of Islamic Banking System inPakistan.

2.4 Data Collection

Lot of secondary data is available about Islamic Banking and the review ofsecondary data will aid us in determining the true factors impacting onIslamic Banking. Past editions of various newspapers and magazines willbe reviewed to get valuable information.

Dawn, The News, Jang, and Business recorder are the most crediblenewspapers of Pakistan so there current and past editions will be fullyexplored.

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Research reports, which have already been developed on Islamic Banking,have immense significance and they will form an integral part of secondarydata.

Books published on Islamic Banking are another valuable source and for

this purpose, and Internet is, no doubt, the biggest source of informationon any topic. There is a lot of material about Islamic Banking available onInternet and shall be referred definitely.

The material published by State Bank of Pakistan, and annual reports ofvarious banks form another important source of secondary data.

In order to test the research hypothesis, corporate customers and bankersare identified as main primary source of data. Corporate customers forman important part of banking industry and their views will be used in thetesting of hypothesis. Bankers have more knowledge about Islamic

Banking than any one else and their expertise will enable us to find theshortcomings of Islamic Banking.

2.5 Sampling

Following table illustrates the sources that were identified for sampling.

Table 2.1: Sampling Techniques for Primary Sources

Source PopulationSamplingTechnique

DesiredSample Size

Non Islamic Banks 30Stratified Random

Sampling3

Bankers 50000 Judgment Sampling 250

CorporateCustomers

100000 Judgment Sampling 500

2.5.1 Non Islamic Banks

Non Islamic Banks operating in Pakistan include foreign as well as localbanks. Since these two groups are totally different, so I decided to usestratified random sampling technique. After applying the procedure ofstratified sampling, interviews will be conducted from the top officials ofselected banks on some suitable time.

2.5.2 Bankers and Corporate Customers

Judgment sampling technique will be used for bankers and corporatecustomers. Since population-size of these sources is based on estimation,

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so the most suitable technique of collection information from respondentsis judgment sampling.

2.6 Instruments

For collection of primary data, I decided that following instruments will beused:

1. Questionnaire2. Interview3. Observation

2.6.1 Questionnaire

Questionnaires are very flexible as there are many ways to ask the samequestions from different respondents. So, I planned to preparequestionnaire for

a. Corporate Customersb. Bankers

Since the focus of the study is to find the factors having the mostsignificant impact on Islamic Banking System in Pakistan, so, I decided

that the same set of multiple choice questions will be asked from both setof respondents. A copy of questionnaires is attached at the end of thereport in the appendix section.

2.6.2 Interview

Personal Interviews are the most reliable source of getting informationfrom respondents. For this purpose, I shall interview the people having themost knowledge about Islamic Banking. Following people will be contactedon some future time.

a. Religious Scholarsb. Officials in Banksc. Economistsd. Government Officials

2.6.3 Observation

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Another instrument that will be used in my study is the observation. Peoplewill be observed thoroughly while conducting interviews and gettingquestionnaires filled.

2.7 Data Analysis

After the data collection phase that will be done through questionnaires,interviews and observations, results will be analyzed thoroughly. Since thepurpose of the study is to identify the most critical issues impacting onIslamic banking so in order to test the hypothesis, interval scale will beused.

Interval scale is assignment of numbers to rank items such that

numerically equal distances on the scale represent equal distances in theproperty of factor being measured. Following table shows the interval scaleto be used in this study.

Table 2.2: Interval Scale

The statisticaltools to be usedwith interval scaleare

a. Meanb. Percentage

Mean for various purposes will be calculated using the formula mentionedbelow,

Mean = = fiXi

The aforementioned tools will be used in summarizing and examining thenature of the results. The results will be then:

(i) tabulated for the purpose of analysis, and(ii) figures and graphs drawn from the tabulated data

Degree of Property Code

Very High -2High -1

Average 0Low 1

Very Low 2

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2.8 Time Schedule

Figure 2.1: Gantt chart for Research Study

2.9 Budget

500 copies of Questionnaires for Corporate Customers Rs 1000250 copies of Questionnaires for Bankers 500Computer Time 200Stationary 200Transportation 300Secondary Data Printout 500Books and Magazines 1000Report Printout 500

Mobile Expense 500Report Binding 300Total Expenses Rs 5000

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3 Limitations

This research report is purely an academic work and the research plan istotally fulfilled. Following are the limitations of this research study.

More secondary data could be examined but there might be apossibility that the report might be missing on some criticalinformation in compiling the data altogether.

The sample size is set limited for this research. The CorporateCustomers and Bankers were not easily accessible, and hence, Ionly managed to contact a few of them. Initially, it was thought that

the people from various parts of the country will be contacted butbecause of various constraints sample is only restricted to Karachi.

Some of the Corporate Customers who have filled thequestionnaires didnt have much knowledge about Islamic Bankingtherefore answers were not provided to all the questions. Someeven refused to fill the questionnaire saying the term banking isunislamic so the questionnaire in itself is a contradiction. Some took2-3 days in filling questionnaires so there answers are debatablewhile few just ticked on the answers randomly. Such questionnaireswere discarded from the research.

Initially it was thought the top most and senior religious scholars willbe approached for interview but because of their unavailability, topscholars were not contacted.

Although extreme care has been taken in collection and tabulationof results but there is a possibility that some of the results might nothave recorded correctly and hence chance of minor mistakes in theanalysis phase.

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4 Dealings, Returns and Standards

In this chapter, I have emphasized the areas of accounting for Islamicfinancing, their dealings at different levels, returns to investors, and thedifficulties that are faced in the promotion of Islamic economic system dueto these factors. Since Islamic banking is in embryonic state in Pakistan,many important things are still undefined. I have tried to lionize theseparameters.

4.1 Security on Deposits and Investments

Many depositors and investors have reservations about security of theirmoney. They are not sure whether it is safe in Islamic products or not.Numerous reasons are propounded in this regard, e.g., small size ofIslamic banking industry, unstable returns, uncertainty of its long-termprosperity, and many other direct and indirect parameters.

The most important reason for lack of security is found to be Riba. Thedefinition of Riba, provided by the Supreme Court, includes any increaseover and above the principal amount. It does not take into accountinflation, depreciating value and declining purchasing power of the rupee.

The real worth of the depositors' money is eroded by inflation requiringprotection. The traditional bankers are supposed to ensure returns to thedepositors over and above the rate of inflation. The incentive is offered toattract deposits. Experts point out that the rise in prices is now an everyday phenomenon. Price stability is a thing of the past.

Regarding the impact of security on deposits and investments on Islamicbanking, questions were asked from 50 corporates and 30 bankers. Theresults are shown in the table given below.

Table 4.1: Computation of Mean for Security on Deposits and

Investments

f1 = Frequency for Corporatesf2 = Frequency for Bankers= -0.16= 0.10

Following figure shows the summarized results, as shown in figure both

the groups have rated this factor differently.

Options X f 1 f2 f1X f2X

a -2 8 2 -16 -4b -1 13 6 -13 -6c 0 13 12 0 0d 1 11 7 11 7e 2 5 3 10 6

Total 50 30 -8 -3

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Figure 4.1: Responses to Security on Deposits and Investments

Corporates Bankers

Results are very different for corporations and bankers. Corporations haveshown little interest about low returns. Main reason can be that whenintension is to transact in Halal and Islamic way, amount of return becomesa secondary consideration (or looses significance altogether in manycases). They are contended in compliance with Islamic norms and it is

more important than any other factor.

Bankers have low importance for issue of return. They are dealing indifferent types of investments and securities in Islamic as well as non-Islamic modes. Many of the non-Islamic instruments are more vulnerableand, hence, insecure than current Islamic products, but they are availablein the market. So, security is not a big problem in the eyes of bankers.However, bankers are working hard to improve the security of all types ofinstruments.

4.2 Rate of Return on Deposits and Investments

Government, with the alliance of SBP and other leading financialinstitutions, wants to promote investment in country. Many steps havebeen taken in this regard. One of the important ones is to implementIslamic banking system.

Former State Bank Governor Dr Ishrat Hussain said the interest-basedprevailing system and Riba-free banking mode would run parallel.

Therefore, people who want riba-free products will go to Islamic banks,while the people who want fixed income on investments and deposits willopt for non-Islamic banks. However, return on Islamic products will remainpoint of concern, as it is not stable.

However, return on deposits and investments are bothersome, and manypeople are reluctant towards Islamic products just because of it.

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Regarding the impact of rate of return on deposits and investments onIslamic banking, questions were asked from 50 corporates and 30bankers. The results are shown in the table given below.

Table 4.2: Computation of Mean for Rate of Return on Deposits andInvestments

f1 = Frequency for Corporatesf2 = Frequency for Bankers= -0.20

= -0.27


the groups have rated this factor in a similar manner.

Figure 4.2: Responses to Rate of Return on Deposits andInvestments

Corporates Bankers

The results are, virtually, consistent for both, corporate as well as bankingsectors. Corporations did not heed low returns because it becomes asecondary issue if the intension is Halal and Islamic way of financing. Ingeneral, low return bothered very few companies, or bothered allcompanies in a very negligible amount.

Bankers, on the other hand, seem very comfortable with the issue ofreturn, as it is a routine thing for them. Banks are dealing with returns oninvestments and deposits in all modes of financing, including Islamic

mode. So, it might bother them in initial adoption because of differences interminologies, but they seem comfortable with dealing any type of returnunder any mode of banking/financing.


a -2 6 6 -12 -12b -1 16 6 -16 -6c 0 15 11 0 0d 1 6 4 6 4e 2 6 3 12 6

Total 49 30 -10 -8

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4.3 International Dealings

Islamic bankers have been scrambling for years to cement rapidly growing$200 billion sector into mainstream global finance. Their hard work haspaid off, with the rise in the number of firms offering banking products andservices compliant with Islamic law and Sharia, from a handful in the1970s to about 500 today and global banks such as Citibank and HSBCopening units to cater to roughly 1.2 billion Muslims worldwide. Islamicbanking has a long way to go to compete with conventional financialinstitutions.

Regarding the impact of international dealings on Islamic banking,questions were asked from 50 corporates and 30 bankers. The results areshown in the table given below.

Table 4.3: Computation of Mean for International Dealings


= -0.50

Following figure shows the summarized results, as shown in figure boththe groups have rated this factor quite highly.

Figure 4.3: Responses to International Dealings

Corporates Bankers

Results are almost identical for corporations and bankers and both are

considerably concerned with international dealings, especially in the era ofglobalization and impending WTO regime.

From corporations viewpoint, they have to deal with local as well asforeign stakeholders e.g. shareholders, auditors, customers, etc. so, theyneed smooth international procedures to communicate at all platformseffectively.

Same reasons may be quoted for bankers as that of corporations. Banksdeal with different types of clients that include local and foreign clients e.g.investors, creditors, companies, individuals, etc. who make deposits and

investments in different portfolios.4.4 Experts in Islamic Banking


a -2 20 9 -40 -18b -1 7 9 -7 -9c 0 5 4 0 0d 1 12 4 12 4e 2 6 4 12 8

Total 50 30 -23 -15

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This is, no doubt, one of the core problem areas. It is root-cause of manydifficulties that Islamic banking system faces today. Dilemma is thatMuslim world has either excellent economists, or excellent Islamicscholars, but not a mix of both features. Not too many experts exist whoare good on both the aspects.

Proper academic structure should be implemented to offer undergraduate,graduate, and post-graduate level courses in Islamic economic studies.Furthermore, workshops, seminars, training courses etc. should beregularly arranged for the professionals in the field. It shall result in betterunderstanding of Islamic economic system.

However, some positive proceeds are underway in this regard. Seniorbankers say many other banks also want to start Islamic banking branches

and they are making some in-house preparations as well-but there are notmany Shariah advisors available. Under the rules, banks need to haveShariah advisors well versed in both Islamic financial system as well asconventional banking to supervise Islamic banking to be undertaken bythem-even if it is done through one dedicated branch.

Bankers say if they fail to find Shariah advisors from amongst thegraduates of Deeni Madaris they will turn to the departments of Islamiclearning of reputed universities including the Islamabad University that hasinternational institute of Islamic economics attached with it. Sources in theSBP say if the Shariah advisors fulfill the criteria laid down for them under

the set of rules for Islamic banking it is irrelevant whether they come fromDeeni Madaris or conventional universities.

According to the revised Fit and Proper Criteria issued by the IslamicBanking Department of the State Bank, the Shariah adviser must possessa degree from any recognized Waffaqul Madaris (Dares-e-Nizami) with aminimum of second class Bachelor Degree with Economics. Or, he mustpossess a degree from Waffaqul Madaris with Takhassus fil Fiqh(specialization in Islamic law) and sufficient understanding of banking andfinance.

Alternatively, the Shariah adviser must possess a postgraduate degree inIslamic jurisprudence/ Usooluddin or LLM (Shariah) from any recognizeduniversity with exposure to banking and finance.

Regarding the impact of experts on Islamic banking, questions were askedfrom 50 corporates and 30 bankers. The results are shown in the tablegiven below.

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Table 4.4: Computation of Mean for Experts in Islamic Banking

f1 = Frequency for Corporates

f2 = Frequency for Bankers= -0.65

= -0.97

Following figure shows the summarized results, as shown in figure boththe groups have rated this factor very critically.

Figure 4.4: Responses to Experts in Islamic Banking

Corporates Bankers

Corporations and banks, both, are highly conscious about the lack ofexperts in Islamic banking, banks being somewhat more conscious.

The fear is about authenticity of already scarce number of experts. Banksare bound to appoint Shariah advisors before plunging in Islamic products.Banks fear that if they fail to acquire advisors of required skills andexpertise, or if advisor did not proved effective for them, then the wholeproject shall be marred. They will have to roll back it and bear theconsequences. After all, they cannot risk their banks at the mercy ofhandful of people.

Because of meticulous attitude of banks, corporations are also hesitant ininvesting the banks that dared to start Islamic products. Companies do not

want to entangle their money in such places that are already uncertainabout their future prospects.

4.5 Taxation Policies


a -2 15 9 -30 -18

b -1 14 13 -14 -13c 0 12 6 0 0d 1 4 2 4 2e 2 4 0 8 0

Total 49 30 -32 -29

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Taxation policies are one of the most important issue under the paradigmof standardization of accounting rules for Islamic banking system that willfacilitate the dealings at all platforms.

It is believed that government will face problems in developing secondary

market for Islamic debt instruments and financial products. There are legaland taxation issues involved in launching this type of financing in the localmarket. The review of legal and tax regulatory aspects should come handin hand with continuous research and development in the productdevelopment.

Regarding the impact of taxation policies on Islamic banking, questionswere asked from 50 corporates and 30 bankers. The results are shown inthe table given below.

Table 4.5: Computation of Mean for Taxation Policies


= 0.37


the groups have rated this factor differently.


a -2 7 1 -14 -2b -1 10 4 -10 -4c 0 18 10 0 0d 1 8 12 8 12e 2 6 3 12 5

Total 49 30 -4 11

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Figure 4.5: Responses to Taxation Policies

Corporates Bankers

Big differences in opinions exist between corporate and banking sector.From corporations perspective, mean of (-0.08) indicates that most ofthem have little or no problem in paying tax in Islamic process. After all,they are paying taxes on other transactions also. So it bothers very little to

companies how they pay it, what bothers more is that they have to pay it.

From banks viewpoint, mean of (+0.37) suggests that banks have had toadjust with taxation in Islamic mode because they are responsible to levy itfor government. They have to negotiate all the techniques with SBP, govt.,and other bodies. They have to materialize them in effective manner. So,banks face some problems in Islamic way of taxation.

4.6 Accounting and Auditing Standards

Senior bankers have urged for changing accounting mechanism of existingbanking system should State Bank of Pakistan (SBP) wanted to launchtrue Islamic financial system in the country.

Uncertainty in accounting principles involves revenue realization,disclosures of accounting information, accounting bases, valuation,revenue and expense matching, etc. Thus, the results of Islamic bankingschemes may not be adequately defined, particularly, profit and lossshares attributed to depositors.

Sources in the leasing industry said that under the directives of State Bankof Pakistan (SBP), the Institute of Chartered Accountants of Pakistan(ICAP) has prepared an Islamic Financial Accounting Standard for leasingbusiness. This standard would be called IFAS-2 Ijarah. It is applicable withcertain qualifications. However, this standard does not apply toagreements that are contracts for services and that do not transfer the rightto use assets from one contracting party to other.

Regarding the impact of absence of accounting and auditing Standards on

Islamic banking, questions were asked from 50 corporates and 30bankers. The results are shown in the table given below.

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Table 4.6: Computation of Mean for Accounting and AuditingStandards

f1 = Frequency for Corporatesf2 = Frequency for Bankers= 0.10

= -0.23

Following figure shows the summarized results, as shown in figure boththe groups have rated this differently with bankers showing more concernfor it.

Figure 4.6: Responses to Accounting and Auditing Standards

Corporates Bankers

Very different opinions are obtained about the accounting and auditingstandards for Islamic banking system. Corporations have given low priorityto these standards. Reason might be that they have virtually no, or verylittle, role in the formulation of these standards and policies. The keyplayers are ICAP, SECP, SBP, and other similar authorities. Corporationsare supposed to follow the standards only. So, they showed no interest fordevelopment of accounting and auditing standards for Islamic banking onthe same grounds.

Bankers, on the other hand, are somewhat conscious. But, overall, theyare comfortable in dealing with it because these standards for Islamic

banking are nothing more than just new standards or different standards.They have been, and are, dwelling with so many rules and standards ofaccounting. They might feel awkward in the beginning but will get used toIslamic accounting system very quickly.

4.7 Concluding Remarks


a -2 6 2 -12 -4b -1 10 10 -10 -10c 0 15 12 0 0d 1 11 5 11 5e 2 8 1 16 2

Total 50 30 5 -7

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In conclusion, it is observed that overall impression about the Islamicbanking system is quite convoluted. People, companies, and in mostcases, banks themselves are uncertain as how to deal with certainsituations. Investors and depositors fear that they will get low return or noreturn at all. Some even think their money shall be lost in Islamic method

of banks. These notions need to be eradicated sagaciously.

Furthermore, dearth of experts in Islamic finance is very big problem. Veryfew scholars of international acclaim exist who are equally good in Islamiclaws and economics. We need many more such researchers. Islamicbanking procedures are quite different from those of conventionalcounterparts; hence, inconsistencies in dealing with them keep the foreigninvestors from Islamic banking. So the standardization of auditing,accounting, taxation, and overall banking system should be ensured. Inthis way, Islamic banks would better face the modern challenges atinternational level.

5 Portfolio and Accessibility

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In this chapter, I have tried to evaluate the products and services that areoffered by the Islamic banks, and tried to see whether they fulfill thedemands of people or not. It is also examined what other features need tobe added in the available repertoire to enhance the transactions on higherlevel. Furthermore, the role of government is evaluated in the perspectiveof encouraging Islamic financing by launching its own securities andinstruments. Accessibility of the Islamic banks/their branches is alsocanvassed thoroughly.

5.1 Banks and Branches

Islamic banking is in nascent stage yet. However, it is growing gradually inPakistan. Only Meezan Bank is the only full-fledged Islamic bank operatingcurrently, and several other banks are in the process of starting it.

Government and State Bank of Pakistan are working enthusiastically topromote Islamic banks. Several commendable measures have alreadybeen taken. Firstly, SBP has decided not to issue any more licenses forconventional/non-Islamic banking. Licenses will be issued only for Islamicbanking. Secondly, the State Bank has allowed commercial banks to setup Islamic banking subsidiaries or provide full Islamic banking facilitiesthrough dedicated branches. Many other steps are also underway.

However, commercial banks hold some reservations about some decisionsof SBP. Many local and foreign banks say they are making in-housepreparations to start Islamic banking through dedicated branches but noneof them is ready to set up an Islamic banking subsidiary.

"It is far easier to start with a dedicated branch rather than with asubsidiary," says a top banker whose bank has submitted to the SBP aplan for starting Islamic banking through a dedicated branch. Under therules, an Islamic banking subsidiary has to be a public limited companyand must be listed on the stock exchange with a paid-up capital of Rs 1

billion.

Commercial banks are reluctant in starting Islamic banking on a wide scalemainly because they are not sure if the government really wants to convertthe financial system into Islamic one, and if so, then how and when?

Another reason is that the banks themselves do not believe that interest-free banking is possible. Many even doubt if, at all, the present interest-based banking is violating any of the Islamic laws.Regarding the impact of lack of banks and branches on Islamic banking,questions were asked from 50 corporates and 30 bankers. The results are

shown in the table given below.

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Table 5.1: Computation of Mean for Banks and Branches

f1 = Frequency for Corporatesf2 = Frequency for Bankers

= -0.68= -0.57


Figure 5.1: Responses to Banks and Branches

Corporates Bankers

Corporations and bankers are almost equally concerned with the lack ofIslamic banks, and their available branches. Corporations do not want todeposit or invest in an industry that is very small, lacks expertise andexperience, and lots of speculations and rumors are in the air about it.

Similarly, banks are facing lots of difficulties in launching full-fledgedIslamic system, as well as starting dedicated branches. They lack Islamicexperts, professional skills and exposure in Islamic banking, andsomewhat stringent conditions from SBP for maintaining certain levels offunds and financial ratios, etc.

5.2 Customer Services

Marketing is always the integral, and one of the most influential parts ofany business. Banking, especially Islamic banking is no exception to it. Acompany might be better than its competitors in terms of quality, andstandards, but might be taken over by competitors just because of poorpromotion, customer services, and marketing strategies for its productsand services. This gets more important when the business is in inception,or customers/clients lack sufficient knowledge about the industry.

In my view, the growth of Islamic banking and products is more of amarketing problem than any other aspect. Pakistani financial institutionsand banks are well equipped with professionals who are qualified,experienced, and forward-looking.


a -2 10 6 -20 -12b -1 21 13 -21 -13

c 0 14 4 0 0d 1 3 6 3 6e 2 2 1 4 2

Total 50 30 -34 -17

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But the core issue is promotion of Islamic banking as industry and tocreate awareness in customers (individuals, corporations, banks, etc).Customer services is one of the most important aspect of marketingstrategy that interacts with clients at lowest level, i.e., communicates withthem directly. This can be effective tool in achieving the aforementioned

objectives. Banks should ensure that their customer services are wellinformed about the latest progressions in this industry on international leveland specially the position and policies of their own bank. They should telltheir clients/customers about all the intricacies and implications of this newindustry because they do not have enough exposure towards Islamicbanking.

Regarding the impact of customer services on Islamic banking, questionswere asked from 50 corporates and 30 bankers. The results are shown inthe table given below.

Table 5.2: Computation of Mean for Customer Services

f1 = Frequency for Corporatesf2 = Frequency for Bankers= -0.62= -0.07

Following figure shows the summarized results, as shown in figure boththe groups have rated the impact of this factor differently.

Figure 5.2: Responses to Customer Services

Corporates Bankers

Big differences exist in the opinions of both the sectors about theimportance of customer services provided. Interestingly, a customerservices are main responsibility of banks rather than corporations, butcorporations are more concerned about it than are the banks. I think thatthis result is the crux of problems of awareness about Islamic banks.

Corporations want to invest and deposit in Islamic instruments but theylack adequate information and experience, so they are reluctant in doingso. As the results show, most of the corporations have rated the lack ofcustomer services as area of high concern for them. If proper steps aretaken in this regard, the situation will change positively,


a -2 14 4 -28 -8b -1 12 5 -12 -5c 0 18 12 0 0d 1 3 7 3 7e 2 3 2 6 4

Total 50 30 -31 -2

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Unfortunately, banks have not taken the customer services in high priority.Most of the banks are continuing with the existing policies of customerservices, and do not update the knowledge of the staff to entertain theclients properly. Very few banks have taken this issue seriously, and havetaken necessary measures to keep their staff members abreast of the new

policies and procedures of Islamic banking. However, this is not enough,and banks still need to go a long way in this regard. They should arrangeworkshops, seminars, and training programs etc. for the staff.

5.3 Research and Development

Like in any other industry, research and development (R&D) will play a keyrole for Islamic banking in answering conflicting situations, coming up with

new solutions, and making the things easy. Importance of R&D is realizedat all levels in Pakistan. Lot of R&D work is being done and lot more needsto be done.

Ishrat Hussain, Former Governor of SBP, particularly spoke of thedifficulties of putting Shariah into practice in case of the government'sfinancial operations, which he pointed out, would need a lot of innovationsand research to find solutions of many problems that confront officials. Forexample, he said, the government through a variety of debts and publiclending is now financing the deficit of the government budget. "But howwould you do this in an Islamic system to mop up finances when there are

no assets?"

The emergence of Islamic banking has coincided with the rapid growth ofresearch into so-called Islamic economics including an extensive literature,periodicals and scholarly journals devoted to Islamic fiscal and monetarypolicy, and finance and banking. Today it is difficult to avoid theinternational attention paid to the Islamic banking phenomena by themedia, by scholars and by the banking community. Surveys of the Islamicbanking market have recently appeared, among others, in the BritishFinancial Times and Middle East Economic Digest.

The researchers find that the flow and symmetry of information betweenlenders and investors is crucial to the likely success of PLS financing(Aggarwal and Yousef 1996; Kuran 1995; Masoud 1989).The results of theresearch along these lines are promising in that they adequately rationalizethe behavior of Islamic banks in the market place and provide theoreticallyjustifications for the observable facts. The general facts about financing inIslamic banking which have emerged in the past few years have providedresearchers with the impetus to focus their study of Islamic banking andfinance on the apparent divergence between Islamic banking in practiceand in theory.

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It should be emphasized that the theoretical results employed to analyzethe practice of Islamic banking were developed long ago, and have beenapplied to the study of credit market problems in other developingcountries. Research into the problems of Islamic banking and financewould be greatly served by studies that are grounded in sound economic

analysis and systematic modeling. This need not imply that the tenets ofneoclassical economic methodology should be indiscriminately imposed onevery modeling effort of an Islamic economic issue.

Interdisciplinary historical research into the origin, rationale and workingsof the Islamic financial system is a second avenue of research that holdsgreat promise, but has rarely been looked into. It must be remembered thatthe basic Islamic legal framework and instruments in use today weredeveloped by jurists back in the Middle Ages, undergoing much refinementat the time, but little since then. How these instruments worked in medievalMuslim societies may have a great deal to tell us about their potential

today.

Finally, there is little doubt that our understanding of the potential of Islamicinstruments would be greatly enhanced by concerted empiricalexamination of their performance in the market place. This would includecross-sectional studies of Islamic banks focusing on their utilization ofspecific instruments, their performance relative to conventional banks, andtheir contribution to sectoral-financing. In addition, emphasis should beplaced on empirical testing using panels of transactions within banks toinvestigate the contractual characteristics of the menu of Islamic financialinstruments. Unfortunately, the biggest obstacle to this empirical agendastems from the paucity of data provided by Islamic banks on theiroperations. With few exceptions, Islamic banks have been averse toreleasing information on a regular and detailed basis. This fact aloneaccounts for lack of any serious empirics. Ironically, Islamic banks havethe most to gain from enabling researchers to better understand thecapacity and limitations of the instruments they employ in financing. Allinnovations require research and development that in turn draws on basicresearch in universities and laboratories. Islamic finance became a subjectof academic research in the 1980s, and every year it is discussed at high-profile conferences, yet the resources devoted to it hardly match the

challenges facing the industry.

Regarding the impact of research and development on Islamic banking,questions were asked from 50 corporates and 30 bankers. The results areshown in the table given below.

Table 5.3: Computation of Mean for Research and Development


a -2 10 6 -20 -12b -1 19 8 -19 -8c 0 11 6 0 0d 1 8 7 8 8e 2 2 3 4 8

Total 50 30 -27 -4

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Following figure shows the summarized results, as shown in figurecorporates have rated this factor more critically than bankers.

Figure 5.3: Responses to Research and Development

Corporates Bankers

From viewpoint of corporations, they realize the importance of R&D. Theybelieve that progress in R&D will bring solutions to many obscureproblems. But corporations cannot get involved directly in R&D activities ofIslamic banking; they can only rely upon the results and propositions ofresearch conducted by financial institutions. They will carefully scrutinizethe outcomes of research in order to develop better understanding ofIslamic instruments before investing in them. As we already know, many

corporations are willing to invest in Islamic products, but they hesitatebecause of many unanswered questions. Only research will rectify thesequestions.

Nonetheless, financial institutions are busy in research, and trying to comeup with reasonable answers to all the questions that are propoundedtowards Islamic banking system. Lots of work is underway. But the moreimportant thing is that they conduct research in effective way, becausetheir publications and announcements about proceeds in Islamic bankingcan persuade individuals, companies, and other clients towards Islamicway of financing.

However, the realization of importance of R&D is less in bankers ascompared to corporations and other clients. Bankers should realize thatresearch could play the role of glue among bankers, Islamic financing, andclients. They will have to put more funds in R&D, work more diligently, andtry to be more effective.

5.4 Shariah Compliant Government Securities and

Money Market

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Securities and financing instruments issued by the government orgovernment bodies are considered the safest of all others. Liquiditymanagement conforming to the rules of Shariah is a big challenge. In theabsence of an Islamic instrument for liquidity-management scares not onlythe already existing institutions but also those commercial banks that planto start Islamic banking through dedicated branches. The answer lies indeveloping sort of Islamic T-bills.

The Meezan Bank has already developed the module of Ijarah Sukuk orIslamic T-bills and it is currently under review at the State Bank.The SBP sources say what delays the approval of the design for theproposed Islamic T-bills is that the government has to identify the assets toback up this instrument

Bankers who are well versed with Islamic banking say government assetsin organizations like Pakistan Steel can be securitized under such Islamicmodes like Salam or Istisna. But they admit that it may take thegovernment months to work out their nitty-gritty. The State Bank is at anadvanced stage of setting up an Islamic banking department and SBPofficials say that once the department starts working issues likedevelopment of Shariah-based liquidity management instruments wouldreceive immediate attention.

Few years back, a team of Islamic banking experts from Bank Negara(central bank of Malaysia) and other financial institutions conducted a five-

day orientation course on Islamic banking in Karachi. SBP officials as wellas commercial bankers attended the course. Some of them told Dawn thatthe issue of setting up an Islamic inter-bank money market was discussedat length.

The Malaysian experts were of the view that an urgent need exists forintroducing such instruments in Pakistan after the SBP has allowed thecommercial banks to start Islamic banking and one full-fledged Islamicbank has already been in operation. Under an agreement between theState Bank of Pakistan and the Bank Negara Malaysia, the two centralbanks offer technical assistance to each other.

Some participants of the course told Dawn that one of the majorinstruments used in the Islamic inter-bank market in Malaysia ismudarabah inter-bank investment (MII) that can also be introduced inPakistan. MII refers to a mechanism whereby a deficit Islamic bankinginstitution can obtain investment from a surplus Islamic banking institutionbased on mudarabah or profit sharing.

Regarding the impact of non-availability of Shariah compliant governmentsecurities and money market on Islamic banking, questions were askedfrom 50 corporates and 30 bankers. The results are shown in the tablegiven below.

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Table 5.4: Computation of Mean for Shariah Compliant GovernmentSecurities and Money Market

f1 = Frequency for Corporates

f2 = Frequency for Bankers= -0.46= -0.63

Following figure shows the summarized results, as shown in figure bothgroups have responded in almost a similar manner.

Figure 5.4: Responses to Shariah Compliant Government Securitiesand Money Market


a -2 10 7 -20 -14

b -1 15 10 -15 -10c 0 15 9 0 0d 1 3 3 3 3e 2 5 1 10 2

Total 48 30 -22 -19

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Corporates Bankers

Results are somewhat similar here. Currently, government-ownedfinancing instrument are not available. However, some instruments shallbe launched shortly. All the companies that are interested in Islamicfinancing mode are eager to invest in such securities. Similarly, othercompanies that are not interested in Islamic mode of financing, mightinvest in such securities for other reasons, e.g., to diversify theirinvestment portfolio, or, for a consistent and safe return, or just forexperience, or to sniff how the Islamic banking looks like.

Banks, on the other hand, are relatively more involved in this issuebecause investment tools and financing instruments are a routine activityfor them. Many Islamic financing instruments are already out in the marketbut private institutions own them.

5.5 Products Offered by Other Banks

To compete in the market, Islamic banking system will have to providecounterparts of all the financing instruments that are offered by non-Islamic

banks. Furthermore, these products have to have better, or equal at least,quality than those of competitors. After all, investors will deposit in theseproducts and services.

Unfortunately, Islamic banks do not have very diverse portfolio to offer, butserious efforts are underway. Some instruments are to be launchedshortly. Efforts should be focused to combine Islamic financing instrumentswith latest technological advancements, and facilitate in globaltransactions. Islamic banks will have to counter the products, like, ATMs,credit cards, debit cards, and other plastic money products, on-linetransactions via Internet as well as mobile.

Islamic versions for Insurance, Leasing, mutual funds, brokerage houses,and investment banks need to be promoted on institutional level ofreciprocating. Dr. Ishrat Hussain, Former Governor SBP, says that riba-free, and interest-based systems will run in parallel. However, he said thebanks had been allowed to bring forward the Islamic products and Shariahcompliant banking system to ensure the availability of Islamic bankingproducts for the people.

The Former SBP chief believed that Takaful or cooperative insurance isthe right step forward towards the breakdown and removal of mental

blocks and bottlenecks in the way of insurance in the Muslim culture. Hesaid that any bank or financial institution that has some innovative product

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to offer to the investors or general-public could seek State Bank'spermission to open a window for Islamic banking or even a bank. "We areready to give permission to such banks," he said.

There is a large information deficit in the Islamic financial industry that

hampers its further growth and development. The absence of ratingagencies, especially agencies that would rate products and institutions onthe basis of their Shariah compliance, is the best example of this deficit.

The banks have to seriously examine the prevailing situation. They have torealize that what the Pakistani market genuinely lacks in productinnovation. The banks have to now analyze the market to ascertainwhether it is a saturated or a young market. If they find it to be young, thenthey have to concentrate on growth and product development. Markets aregroomed on product innovation and financial engineering. The financialsector is faced with tough decisions. Either to compete in a cutthroat

market, in which no one can survive, or compete through diversifiedproducts relying on product innovation and market expansion. In the end,the Islamic banking consumer will rely on them to ensure that he goeshome with at least the same benefits and satisfaction that a conventionalbanking system provides and at times even better.

Regarding the impact of non-availability of products offered by other bankson Islamic Banking, questions were asked from 50 corporates and 30bankers. The results are shown in the table given below.

Table 5.5: Computation of Mean for Products Offered by Other Banks

f1 = Frequency for CorporatesOptions X f

1

f2

f1

X f2

Xa -2 7 6 -14 -12b -1 18 11 -18 -11c 0 16 9 0 0d 1 6 4 6 4e 2 3 0 6 0

Total 50 30 -20 -19

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f2 = Frequency for Bankers= -0.40= -0.63

Following figure shows the summarized results, as shown in figure bothhave responded in a similar fashion.

Figure 5.5: Responses to Products Offered By Other Banks

Corporates Bankers

Results are the same as for the previous aspect (lack of governmentowned securities, and money market). Reasons are, largely, also the sameas for previous one.

Corporations are conscious about the nature and quality of Islamicfinancing tools. They want more options to invest in. Unless attractiveIslamic instruments are available, they are not able to invest in Islamic

system. Even the companies that do not want to be in Islamic bankingsystem might want to invest in Islamic securities to diversify theirinvestments, to get better understanding of Islamic financing, or any otherreasons.

Banks have the responsibility of creating the Islamic versions of financinginstruments and to implement them successfully, so, they bear moreresponsibility than corporations. Banks are networked with SBP,government, and other financial institutions and some products are inpipeline for launching. More efforts are needed amidst all this.

5.6 Islamic Banking in Rural Areas

This is another understated point. More than 70% population of Pakistanlives in rural areas, villages, and other underdeveloped areas. Numbers ofbranches of bank are almost negligible in such areas, let alone thebranches of Islamic banks.

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Islamic banks have very limited branches in the urban areas and cities,and these are not so easily accessible by all people from all parts of thecities. So, Islamic banks should not only increase the number of branchesin cities, where core business and trade occurs, but also open branches inrural areas. These areas are, in fact, tremendous business opportunity if

handled sagaciously.

Bankers argue that banking has two sides, one is liability and the other isasset. Liabilities cover deposits and their mobilization. The assets aregenerally generated and concentrated in the urban areas, whereas, ruralareas are never able to generate enough business. They only providedeposits since they are more inclined towards Shariah compatible banking.Right now, deposits are not the biggest challenge, since there are faith andconviction driven. Assets on the other hand are commercial ventures. Theyare not easily generated, as most people are afraid of the informationsharing involved in Islamic Banking, and believe, that Islamic Banking is

more cumbersome, involving lot of documentation.

Regarding the impact of concentration of Islamic banking in urban areasrather than rural areas, questions were asked from 50 corporates and 30bankers. The results are shown in the table given below.

Table 5.6: Computation of Mean for Islamic Banking in Rural Areas


Following figure shows the summarized results, as shown in figure bothgroups have shown less concern for this factor.

Figure 5.6: Responses to Islamic Banking in Rural Areas


a -2 3 3 -6 -6b -1 19 7 -19 -7

c 0 12 12 0 0d 1 6 6 6 6e 2 10 2 12 4

Total 50 30 -7 -3

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Corporates Bankers

Bankers and corporations realize this fact, but they are not very muchconcerned about it. Results of survey are also same roughly. The reasonsfor not bothering the concentration of Islamic banks and/or branches incities, and urban areas rather than in rural areas are numerous.

Most important reason is that banks facilitate in economic activities,investments, trade, and earnings. Since most of the businesses are

present in cities banks have opened most of their branches in cities. Thisreason is obvious, and simple, and single handedly can be rated as onlycompulsion. In fact, almost all of the banks and other financial institutionsare headquartered in Karachi, including SBP, the Central Bank ofPakistan. Reason is that Karachi is the economic hub of Pakistan, and isthe center of all financial infrastructures.

Similarly, most of the corporations and other businesses are alsoheadquartered in urban areas and cities. They are, like banks, notbothered by the lack of branches in rural areas, because it does nothamper their businesses. Therefore, banks and companies have givenvery little, or virtually no importance to this aspect, and the conditions donot seem to change in future.

5.7 Concluding Remarks

In conclusion, the chapter in a glance suggests that the Islamic banksshould open more branches so that they become accessible by more

customers, and people get better services.

Research and development should be further emphasized and newsolutions should come up to meet modern challenges.

Customer services needs to be improved drastically. Clients are not gettingenough information, so they are unaware of new proceeds in Islamicbanking. On the other hand, staff of the banks is not trained aboutintricacies of Islamic financing. So, they need be trained.

Although government is advocating Islamic financing system, but the

efforts are in the way, and Islamic T-bills soon will come. Furthermore,Islamic banks should enhance the available products domain by adding

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high-tech facilities, e.g., ATMs, credit and debit cards, smart cards, onlineand mobile banking, etc.

Another major factor is that most of the banks and branches are in urbanareas, while almost 80% population lives in rural areas, so they cannot

access them. But banks say that all the economic and business dealingsoccur in cities, so no need of banks in rural areas. However, things shouldchange.

6 Other Issues

What really are the reasons for the lack of progress at the practical levelabout the application of Islamic Banking? Different people may have

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different perceptions on the issue. Proponents of the Islamic bankinggenerally attribute it to the lack of will and commitment of the successivegovernments and of the government machinery at various levels. Whilethis view carries weight one cannot ignore other dimensions of the issue.Most important being the impression at various levels that Islamic banking

has not been in practice anywhere in the world in its real spirit andtherefore in the absence of the tested alternative Islamic model there islittle likelihood of a successful beginning, instead any new experiment maybackfire. Though this impression may not hold ground, it does indicatetowards a general lack of awareness about the Islamic bankingalternatives that are already in practice.

6.1 Awareness

Awareness of something is always the first drop of rain. Lack of awarenessas the foremost factor hampering the growth of Islamic banking inPakistan.

In Pakistan, public is unaware, or has distorted information of Islamicbanking. Therefore, the first step to be taken is to create awareness inpeople as well as in bankers. Awareness is more, a sort of, problem ofmarketing campaign than any thing else.

The foremost pre-requisite in this regard is mass awareness about the

concept of Islamic banking among the general public and the education ofbankers and the business community. Efforts are needed at changing thegeneral perception about return on financial savings/assets and creatinggenuine demand for Islamic banking. Through a comprehensive campaign,people must be made to understand that Islamic banking does not meanfree loaning to the business and industry and that the savers can justifiablytake return on the basis of results of the business activity undertaken withthe help of their funds. Similarly, industrialist and the business communityneed to be persuaded to raise more and more equity-based funds insteadof loans.

The depositors and investors who have been avoiding the banking channelso far due to involvement of Riba would approach Islamic Banks only whenthey are assured that their funds would be invested in Shariah compliantactivities. Therefore, credibility of Islamic banks is the most importantaspects and the key to success and development of the emergingdiscipline. The clients would need to be assured of Shariah compliancethat funds are kept separate from their conventional deposits, andfinancing is provided purely on the basis of Islamic modes. Islamic bankswould also need to ensure that their funds are not invested in Haram andindecent activities. Companies with excessive reliance on debt financing

will also be excluded, and hence gearing ratios will need to be monitored.

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This also highlights the need for education and training of all thestakeholders.

Training of banks personnel and creating awareness among the peopleabout the true nature of Islamic banking is an aspect demanding concerted

efforts on the level of war footing. Banks should conduct generalawareness programs on Islamic banking to enable the ordinary Pakistanito understand its essence, e.g. through their respective web sites,workshops, seminars, short training courses, etc.

The universities and other educational institutions are urged to producepeople knowing Shariah as well as principles of finance. Further, Islamicbanking and finance is a part of Islamic economic system the very basis ofwhich revolves around justice and morality. All-out efforts need to be madeby the Government, the religious and political leadership and intelligentsiain general for enhancing morality of the populace. For this purpose,

foolproof documentation of transactions, amendment in tax and otherrelevant laws are essential requirements. Only a well thought out plan withcommitted and sustained efforts could lead to success and ultimately totransformation of the economy.

Regarding the impact of awareness on Islamic banking, questions wereasked from 50 corporates and 30 bankers. The results are shown in thetable given below.

Table 6.1: Computation of Mean for Awareness



Figure 6.1: Responses to Awareness

Options X f 1 f2 f1X f2Xa -2 31 12 -62 -24b -1 12 12 -12 -12c 0 6 6 0 0d 1 0 0 0 0e 2 1 0 2 0

Total 50 30 -72 -36

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Corporates Bankers

Lack of awareness is rated as very significant reason by bankers as wellas by corporate. Both realize the importance of it, and feel the need toimprove the level of knowledge about Islamic mode of financing.

For corporate and common people, enough literature should be availablein printed form e.g. books, papers, newspapers, magazines etc. andelectronic media e.g. Internet, TV, radio etc., and regular workshops,seminars, symposiums, training courses etc. should be available for

bankers and for interested corporate.

Although the steps are, and being, taken in this direction. But moreimpetus and more effectiveness is required. Government can play asignificant role here in collaboration with banks, SBP, and other financialinstitutions. Additionally, Islamic scholars, educational institutions, learnedpeople etc could play pivotal role within their domain.

In short, awareness is the main problem, at every level, and should beimproved by using all the resources.

6.2 Government Support

Government can play the most important role for upbringing Islamicbanking system in Pakistan. It owns the largest resources, and authenticitythan any other body. Government realizes these facts and is serious totake the bull by the horns.

Former World Bank officer Shahid Javed Burki, who also served as

Pakistan's finance minister for a brief time in the 1990s, says that inPakistan pragmatism has usually prevailed over piety and efforts toIslamize the banking system have been largely cosmetic, rather thanreplace conventional institutions, he says, Pakistan is likely to movetowards a system of parallel banking and financial institutions that providegreater choice to the Muslim consumer.The 'central issue' in Pakistani politics over the years, argues Vali Nasr ofthe Naval Postgraduate School, Monterey, has been the expansion ofstate power and the resistance these efforts have provoked.

In Pakistan, he argues, successive governments have manipulated Islamic

symbols not only to shore up state legitimacy, but also to cast their re-distributive policies in a favorable political light.

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Another author, Charles Kennedy, reviews the efforts of Islamic legalexperts to secure a judicial ruling that riba is repugnant to Islam, andtherefore, that all federal and provincial laws that provide for riba must bebrought into conformity with Islamic law.

His analysis underscores the essentially political rather than legalcharacter of this question. Even Zia-ul-Haq, who professed to want togovern Pakistan according to Islamic precepts, and who in 1979 publiclypledged to eliminate riba from Pakistan within three years, nonethelessopted for 'prudential, incremental' changes that did not seriously challengethe operations or the corporate interests of domestic banks or Pakistan-based affiliates of multinational banks, argues Mr. Kennedy.

Dr Ishrat said that the government's strategy was to move graduallytowards transformation of Islamic financial system without disrupting the

system.

The Former SBP chief said the government and the central bank had sentexperts to different countries to study the Islamic banking system andfound that there was not a single country where the Islamic bankingsystem was in practice 'completely'. However, he asserted that there wasno pressure from any side, including the IMF and World Bank, on the issueof switching of the system.

Former Prime Minister of Pakistan Shoukat Aziz said the modern financialsystem had not been constructed overnight rather it had evolved overcenturies, adding it has been thoroughly tested, applied and measured forits ability to meet the needs of fast expanding and increasingly complexeconomies of the world.

It is widely recognized, accepted, voluntarily adopted and practiced simplyfor its efficiency, reliability and safety, he said, adding, however, this doesnot mean that "we cannot challenge the system, in fact given the system ofbeliefs that we subscribe to, we should never hesitate to challenge theconflicting practices."

He said, undoubtedly, it was the responsibility of the government to createthe necessary space and enabling environment so that such incrementalsteps could be adopted out of free choices made by private individuals andinstitutions.

Some Islamic scholar agree upon that government has the most influentialrole, and can help in implementation of Islamic banking system. However,they agree that it should be a gradual process i.e. evolution, rather thanrevolution. But Islamic scholar says conventional banking should beeradicated rather than going on simultaneously.

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Regarding the impact of government support on Islamic banking, questionswere asked from 50 corporates and 30 bankers. The results are shown inthe table given below.

Table 6.2: Computation of Mean for Government Support


Following figure shows the summarized results, as shown in figure boththe groups have rated the impact in a similar manner.

Figure 6.2: Responses to Government Support


a -2 14 8 -28 -16b -1 20 12 -20 -12c 0 10 5 0 0d 1 4 5 4 5e 2 2 0 4 2

Total 50 30 -40 -23

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Corporates Bankers

While interpreting the above results, I find that bankers and corporate areequally concerned about the severity of role of government that it couldimpart over successful materialization of Islamic banking system inPakistan.

Both the sectors view the government as patron, who beckons the way for

other sectors and institutions. Government is looked forward as tospearhead this entire campaign.

Government also realizes its placement in the bigger picture, and is takingthe decisions in a broader perspective that would impact the overallperformance of Islamic banking system.

6.3 Religious Convictions

The counsel of federal government informed the Supreme Court thatPakistan's religious scholars were, in fact, main hurdle in the Islamizationprocess in the country.

According to the counsel, the religious scholars are hampering Islamizationof Pakistan. The counsel stated that the so-called present-day Islamicbanking was in fact un-Islamic due to high level of exploitation in theseobsolete banking instruments that were being portrayed as Islamic.

The present day Islamic banking was based on inefficient and obsolete

instruments, being circumscribed to exploit the religious sentiments ofinnocent Muslims, the counsel stated.

The counsel said that all the jurists of Fiqah Jaferia were unanimous intheir view that the non-Muslim citizens of an Islamic state were notprohibited from dealing in Riba. He said that the Holy Quran was clear thatit was applicable only to the Muslims as the Surah that prohibits dealing inRiba, addresses "Momineen".

The counsel stated that Holy Quran permitted adjustment to the changingneeds of the time, and referred to Allama Iqbal's essay titled

"Reconstruction of Islamic Thought". He said that when Holy Quranenjoined on the Muslims to keep their horses ready, it did not mean that

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Muslims should not use any other means to protect themselves from theenemy except horses. The present-day horses, he stated, were tanks andF-16 aeroplanes.

Financial institutions undertaking leasing business are making greater use

of financing lease than of operating leases. Experts in Shariah considerfinancing leases incompatible with Islamic teaching. Many 'developmentfinance institutions' (DFIs) are mobilizing savings through schemes thatgive returns, which are hardly distinguishable from interest. Grey areas aredeveloping even in the operation of institutions like National InvestmentTrust, which were previously thought of having eliminated interest. Itseems that there is no agency to oversee the working of the variousschemes being employed by DFIs to mobilize savings from the viewpointof Shariah.

The State Bank of Pakistan has laid down the minimum and maximum

rates of profit a bank can share in the case of Musharaka or purchase ofPTCs or Mudaraba certificates. Experts in Shariah consider such astipulation incompatible with Islamic teachings. Due attention has not beenpaid to eliminate un-Islamic features characterizing the operations ofseveral constituents of money and capital market in Pakistan other thanbanks and DFIs. Nothing has been done so far, for example, to reform theinsurance business and the stock exchange operations in the light ofIslamic teaching.

The Muslim scholars and economists have miserably failed so far toprovide a practical, simple, safe and workable substitute for interest. Theinterest-no doubt it has been prohibited by Islam (and also by Christianityand Judaism) and there are many moral and socio-economic justificationsfor this prohibition-provides a very simple and practical mechanism toestablish and govern the relationship between the lender and the borrower.

It is brought to the notice of the common reader that the Quran and theSunnah have abolished interest but have not recommended any substitute.Modaraba and Musharika have not been referred to anywhere in theQuran or the Hadith. These are actually forms of business organizationswhose rules and regulations were laid down by classical Muslim jurists of

middle ages. Even those classical jurists did not introduce these conceptsof Modaraba and Musharika as substitutes of interest. The scholars ofrecent period are excessively fanaticized by Modaraba and Musharika andhave set them up as Islamic substitutes of interest. But these scholarshave not yet been able to modify these concepts to the changed socio-economic circumstances of modern age and the needs of modern complexeconomies.

Regarding the impact of religious factors on Islamic banking, questionswere asked from 50 corporates and 30 bankers. The results are shown inthe table given below.

Table 6.3: Computation of Mean for Religious Factors

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= -0.37

Following figure shows the summarized results, as shown in figurecorporates have rated this factor more critical than bankers but overallresults are quite similar.

Figure 6.3: Responses to Religious Factors

Corporates Bankers

Results of survey reveal that bankers and corporate share almost similarviews about the religious aspects to bother Islamic banking negatively.Islamic scholars are looked upon as experts in Islamic affairs and theiropinions are taken as dictums. Bankers, corporate, and common peopleare not so expert in these things, so they heavily depend upon scholars.So, they feel that Islamic-scholars should play vital role in shaping upsolutions to the modern challenges, especially in economic and financial.Since after the provision of SBP that all banks that intend to do Islamicbanking will have to have at least one Shariah advisor, the bankers andcorporate realize the importance of religious aspects more than before.They are nonplussed when different schools of thoughts propoundthwarting justifications. So, the need of the hour is that Islamic scholarsmaintain unison amongst themselves as much as possible.

6.4 Social, Ethical and Cultural Values

The Islamic economic system in Pakistan is still underdeveloped and willremain that way for a long time to come.' Long time Pakistani civil servantand World Bank official Parvez Hasan looks at issues of poverty and social


a -2 17 5 -34 -10b -1 11 10 -11 -10c 0 9 7 0 0

d 1 7 7 7 7e 2 5 1 10 2Total 49 30 -28 -11

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justice in Pakistan, arguing that ethics cannot be separated fromeconomics. Pakistan has done a very poor job for poverty alleviation, Mr.Hasan maintains.

The Council on Foreign Relations' Isobel Coleman examines the impact of

Islamization on women. This is not merely an ideological question ofinequality, she argues. Gender discrimination retards development andexacts a large toll on both present and future generations, she says.

Experience proves that our financial institutions that have entered intoprofit sharing agreements with business houses have generally sufferedmost adversely. Sadly, we have a plethora of companies that maintainfalse, or inaccurate, books of accounts to ensure that the banks are deniedtheir fair share of profits. Some mechanism will have to be evolvedwhereby companies will not be able to maintain false accounts and claimthat they have suffered losses when in fact they are operating profitably.

Thus, is it that it is now the lenders and not the borrowers who requireprotection? Is it right that the borrowers should receive interest-free loansthat they may or may not repay? Should the rich grow richer and the poorpoorer? This is far from being in conformity with the spirit of Islam.

Justice Munir A. Sheikh, senior member of the Supreme Court ShariahAppellate Bench, says that Pakistani society was not ready for the Islamicsystems as the level of honesty in the country was low.

He made the observation when the federal government counsel arguedthat under the Islamic mode of banking, the investors would get nothing ifthe other partner made a statement that no profit had been earned, JusticeMunir A. Sheikh agreed that the level of honesty in our society was lowand the apprehension that the investor would get nothing was notmisplaced.

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Various Factors Implementation in Islamic Banking in Pakistan

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