Indeed, during the last ten years, Islamic banking in Pakistan has grown at a whirlwind pace to transform the financial sector. The asset base of the Islamic banking industry grew to Rs9.7 trillion by the end of June 2024 and attained 18.7 per cent of the total industry. Full-fledged Islamic banking institutions contributed Rs6.4 trillion or 12.3 per cent, while IBBs added Rs3.2 trillion to the industry, or 6.4 percent.
While traditional banks grew by a CAGR of 15.4%, the Islamic banking institutions have grown by 24.8% in the last ten years. Islamic branches have grown by 23.8%. That signifies that they were strong performers. Ten years ago, Islamic banking used to account for only 10.4% of the market; however, its growth has been steady and significant.
Lending from the Government Forms the Majority
The banking system of Pakistan has been investing predominantly and lending more to the government since the outbreak of the 2008 financial crisis, rather than lending to the businesses and consumers. These fiscal needs have been fueled by the government, causing the industry’s investments-to-deposits ratio (IDR) to reach 95.2%.
As a matter of fact, though, the IDR of conventional banks stands at 105.2%. Most institutions, however, have begun borrowing from others, including State Bank, just to meet their respective government lending targets. On the Islamic side, this is much more lowly: the IDR of the branch of Islamic banking is 58.5%, and the IDR of a fullfledged Islamic bank is 62.3%.
Islamic Banks Make Headway
Islamic banks have witnessed an impressive explosion in their branch network that accounts for 30.5 per cent of the total banking branches spread across the country. In June 2014, Islamic banks had accounted for just 12.1 percent of the total banking branches. The number of Islamic branches has registered a growth of a massive scale. Full-fledged IB branches have increased threefold from 868 to 2,806, while Islamic banking branches have grown by a whopping 391 percent during the same period-from 467 to 2,295 respectively.
This expansion is the most critical factor responsible for the increasing deposit base of the Islamic banks. The total deposits in the sector have scaled up to Rs32.5 trillion, out of which the share of the Islamic banks stands at 22.6% as of June 2024 from 10.6% a decade earlier. This rate of growth insinuates a massive shift in customer preference toward Shariah-compliant banking.
Difficulty in Mobilizing Funding
For all its success, though, the Islamic banking sector lags in deploying funds efficiently. That edge belongs to conventional banks, with average deposits per branch standing at Rs1.96 billion, versus Rs1.6 billion for Islamic banks and Rs1.1 billion for Islamic branches.
However, Islamic banks have grabbed a greater share of the industry’s profits. The Islamic banks accounted for 27.8% of the industry’s net income over FY24’s first half, whilst an additional 20.8% was captured by Islamic branches. Such strong profit delivery performance has been obtained despite their relatively smaller footprints in both the overall balance sheet and the branch networks.
Regulatory Benefits
An undoubtedly important reason why Islamic banks have done so well on the profitability front is regulatory advantage. One of the principal advantages of avoiding the minimum deposit rate requirements has saved Islamic banks a lot of cost, thus contributing to their overall performance. However, this move has generated heated controversy as such critics think that it would actually fall heaviest on the customers. The regulators have pretty much ignored such complaints.
The business of Islamic banking in Pakistan continues to grow, sustained more and more on regulation benefits as well as growing preferences for Shariah compliant financial instruments. As monetary easing commences, coupled with improved economic conditions, the outlook for the Islamic banks is very optimistic and should grow provided issues of operational efficiency are addressed.
This changing landscape throws up many questions: are customers flocking to Islamic banks because they believe that Islamic banks are in full compliance with Shariah principles, or because they are hotspots for an industry-in-the-pick, taking off into the stratosphere? The result is the same, if for different reasons. Pakistan’s financial framework is undergoing a sea change with Islamic banking.
