Pakistan’s decision to grant a third licence this year for an exclusive Islamic bank has renewed interest in this emerging sector, which is at the heart of continuing demands from devout Muslims seeking to promote banking that is compatible with their religion.
Islam forbids the use of regular interest payments and favours the idea of banks that are driven by religious tenets. For pious Muslims, such banks have to embrace the practice whereby depositors and borrowers become partners in a financial transaction while the bank works as an intermediary. All profits from a business investment by a borrower have to be shared with depositors, which theoretically means that deposits may be scaled down if there are losses from a business transaction. Essentially, this means that returns on the basis of an assured and pre-determined interest rate cannot be assured.
Divisive issue
Pakistan has contended with calls from Islamists seeking a wider transition to Islamic banking. The issue has been divisive and led to a 1992 ruling by the supreme court seeking a full transition of the country’s financial system to an Islamic one.
That ruling was overturned when the government filed an appeal seeking to review the decision on the grounds that Pakistan risked jeopardising its international dealings with key foreign lenders, such as international developmental agencies that would only extend loans on interest-based terms.
However, the government’s decision to issue new banking licences for exclusively Islamic banks appears to be a response to calls from Islamists backed by politically powerful players, such as the main coalition of Islamic parties, the Muttahida Majlis-e-Amal (MMA).
“We have a situation where such vocal players want at the very least to be able to put their own money in an Islamic bank, even if they can’t have a national transition,” says a finance ministry official in Islamabad. “What you see emerging in Pakistan is a dual system of banking.”
Malaysian inspiration
Analysts say that Pakistan appears to be inspired by countries such as Malaysia, where Islamic banking has evolved side by side with conventional banks without disrupting the financial system. The argument is that this helps to tackle criticism from Islamists while also defending the country against being isolated from international financial circles.
“Realistically, you can’t make a fully-fledged transition. It is therefore the best choice to make as much of a transition as you can,” says Sakib Sherani, chief economist at the Pakistan offices of ABN AMRO, the Dutch bank. He says that Pakistani officials seem inspired by the Malaysian example because it helps to tackle the divisions in the country.
Critics warn that Pakistan’s failure to make a fuller transition to Islamic banking is evidence of the ways in which this type of banking continues to face challenges. “Theoretically, you may be able to claim that you’re determined to change. But, in practice, unresolved matters include such issues as the question of depositors not necessarily being inspired if they felt they could lose part of their deposits,” says Suhail Malik, a leading Pakistani economist. “There are still issues in Islamic banking that have to be reconciled with the real world.”
Businessmen say that Pakistan has made progress on this front in the past decade because there have been cases of a group of emerging businesses that remain dedicated to using Islamic banking exclusively. “There is a small but nevertheless growing community of emerging businessmen who have vowed to only use Islamic banking practices,” says the president of a conventional bank. “From credit cards to business loans, their preferred choice is only Islam.”
Changing trends
Dr Malik believes that the decision to extend new Islamic banking licences to work alongside conventional ones reflects important changing trends in Pakistan. In the past year, General Pervez Musharraf, the pro-US military ruler, has promoted the idea of enlightened moderation as an important policy guideline for the country.
General Musharraf’s words are meant to emphasise that although Pakistan remains a predominantly Muslim country, its people should learn to be more tolerant. For Islamic banking, this essentially means accepting the diversity of those willing to only bank in this way without imposing their will on others, bankers say.
Mr Sherani says that the future depends in part on Islamic banks tackling challenges, such as their need for more detailed documentation than conventional banks, before more businessmen pick them as their preferred bank.
