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GROWTH OF ISLAMIC BANKING IN PAKISTANGROWTH OF ISLAMIC BANKING IN PAKISTAN
Supervised by:Supervised by:
DR.NAILA NAZIRDR.NAILA NAZIR
Submitted by:AMJAD ULLAH (DAWAR)
M.Sc Final Year
DEPARTMENT OF ECONOMICSDEPARTMENT OF ECONOMICSUNIVERSITY OF PESHAWARUNIVERSITY OF PESHAWAR
Session 2010-2011Session 2010-2011
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GROWTH OF ISLAMIC BANKING IN PAKISTANGROWTH OF ISLAMIC BANKING IN PAKISTAN
The thesis is submitted to the Department ofEconomics University of Peshawar in thepartial fulfillment of the requirement for theAward of
Master Degree in Economics
Submitted by:AMJAD ULLAH (DAWAR)
M.Sc Final Year
Department of EconomicsDepartment of EconomicsUNIVERSITY OF PESHAWARUNIVERSITY OF PESHAWAR
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Session 2010-2011Session 2010-2011
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============================
It is Recommended That the Thesis Prepared by
AMJAD
GROWTH OF ISLAMIC BANKING IN PAKISTAN
Be accepted as fulfilling this part of the requirement for the degree of
Master of Science in Economics.
Supervised By:Supervised By: __________________________________________________
DR.Naila NazirDR.Naila NazirDeportment of EconomicsDeportment of Economics
University of PeshawarUniversity of Peshawar
Approved By:Approved By: ________________________________________________
DR. NAEEM UR REHMAN
Chairman,Department of EconomicsUniversity of Peshawar
External Examiner: ________________________
Department of EconomicsDepartment of EconomicsUNIVERSITY OF PESHAWARUNIVERSITY OF PESHAWAR
Session 2010-2011Session 2010-2011
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IN THE NAME OF ALLAH THE MOST GRECIOUS AND MERCIFUL
We are thankful to Allah who has given us the courage to complete the thesis. After
ALLAH we thank our Parents who have supported us in the ups and downs of Life bySaying, When the going gets tough, the tough one gets going
Finally we are thankful to our supervisor DR. NAILA NAZIR whose tremendous support
has made us able to fulfill the requirements of our thesis.
AMJAD ULLAH
ABSTRACT
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The Banking system in economy works like the blood circulation system of aThe Banking system in economy works like the blood circulation system of a
body. The basic concepts and objectives are common to any banking systembody. The basic concepts and objectives are common to any banking system
whether it be Islamic or conventional banking. The difference lies in methodologywhether it be Islamic or conventional banking. The difference lies in methodology
adopted to achieve these objectives.adopted to achieve these objectives.
In this research study ,growth of Islamic banking ,efforts in the implementation ofIn this research study ,growth of Islamic banking ,efforts in the implementation of
riba free Banking in Pakistan, performance of Islamic Banking, expansion ,riba free Banking in Pakistan, performance of Islamic Banking, expansion ,
sectoral concentration, investment in Islamic banking, problems and issuessectoral concentration, investment in Islamic banking, problems and issues
regarding Islamic banking and different factors that influence the growth ofregarding Islamic banking and different factors that influence the growth of
Islamic banking has been thoroughly analyzed.Islamic banking has been thoroughly analyzed.
All the data is arranged according to the data collected using different sources. TheAll the data is arranged according to the data collected using different sources. Thedata was collected from articles and journals, In-depth Interviews from generaldata was collected from articles and journals, In-depth Interviews from general
public, depositors, and account holders as well as from the officials of differentpublic, depositors, and account holders as well as from the officials of different
Islamic and conventional banks. In this regard a questionnaire was alsoIslamic and conventional banks. In this regard a questionnaire was also
distributed, the total population size for questionnaire is 600 persons, i.e. 300distributed, the total population size for questionnaire is 600 persons, i.e. 300
persons about Islamic banks and 300 persons about conventional banks in persons about Islamic banks and 300 persons about conventional banks in
Peshawar, Dera Ismail Khan, and Bannu werePeshawar, Dera Ismail Khan, and Bannu were asked to express their views duringasked to express their views during
this study.this study.
The replies of the aboveThe replies of the above questionnairequestionnaire show that peoples in Pakistan expect thatshow that peoples in Pakistan expect that
Islamic banks are more helpful for economic development, social balance andIslamic banks are more helpful for economic development, social balance and
human prosperity.human prosperity.
The main finding of the research is that there is a strong need for aThe main finding of the research is that there is a strong need for a riba-riba-freefree
banking system. People perceive a number of emotional benefits from a productbanking system. People perceive a number of emotional benefits from a product
that is based on the tenets of Islam. The objective is to alleviate the feeling of guiltthat is based on the tenets of Islam. The objective is to alleviate the feeling of guilt
by following the tenets of Islam. There is also a belief that Islamic banking willby following the tenets of Islam. There is also a belief that Islamic banking will
help fight the ills of the economy of the country.help fight the ills of the economy of the country.
TABLE OF CONTENTSTABLE OF CONTENTS
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S. NOS. NO TITLETITLE PAGE#PAGE#
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i.i. AcknowledgementAcknowledgement ii
ii.ii. AbstractAbstract iiii
Chapte#1Chapte#1 INTRODUCTIONINTRODUCTION 11
1.11.1 IntroductionIntroduction 11
1.21.2
Purpose of StudyPurpose of Study
66
1.31.3 Research ObjectivesResearch Objectives 77
1.41.4 Limitation of the StudyLimitation of the Study 77
1.51.5 Organization of the StudyOrganization of the Study 88
Chapter#2Chapter#2 LITERATURE REVIEWLITERATURE REVIEW 99
Chapter#3Chapter#3 RESEARCH METHODOLOGYRESEARCH METHODOLOGY 1616
3.13.1 Research MethodologyResearch Methodology 1616
3.23.2 Mode of ObservationsMode of Observations 1616
3.33.3 Field Data CollectionField Data Collection 1717
3.43.4 Sampleling DesignSampleling Design 1717
3.43.4.1.1 Target Population SizeTarget Population Size 17173.43.4.2.2 Sample SizeSample Size 1717
3.53.5 Data Collection MethodsData Collection Methods 1717
3.5.13.5.1 Data collected sourcesData collected sources 1717
Chapter#4Chapter#4 GROWTH AND PROBLEM OF ISLAMIC BANKINGGROWTH AND PROBLEM OF ISLAMIC BANKING 1818
4.14.1 Growth of Islamic BankingGrowth of Islamic Banking 1818
4.1.14.1.1 GrowthGrowth 1818
4.1.24.1.2 Shariah Compliance DevelopmentShariah Compliance Development 20204.1.34.1.3 Shariah StandardsShariah Standards 2222
4.1.44.1.4 Current Industry ReviewCurrent Industry Review 2222
4.1.54.1.5 Industry Progress and Market ShareIndustry Progress and Market Share 2323
4.1.64.1.6 Operating PerformanceOperating Performance 2626
4.1.74.1.7 Outreach ExpansionOutreach Expansion 2828
4.1.84.1.8 Asset QualityAsset Quality 3333
4.1.94.1.9 Financing ProductsFinancing Products 3434
4.1.104.1.10 Sectoral Concentration of FinancingSectoral Concentration of Financing 3636
4.1.114.1.11 InvestmentsInvestments 3737
4.1.124.1.12 Deposits MobilizationDeposits Mobilization 38384.1.134.1.13 Maturity ProfileMaturity Profile 4040
4.1.144.1.14 ProspectsProspects 4141
4.1.154.1.15 AgricultureAgriculture 4646
4.24.2 Problems and IssuesProblems and Issues 4747
4.2.14.2.1 Taxation IssuesTaxation Issues 4747
4.2.24.2.2 Financial Reporting and Accounting StandardsFinancial Reporting and Accounting Standards 4848
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4.2.34.2.3 Islamic Export Refinancing SchemeIslamic Export Refinancing Scheme 4949
4.2.44.2.4 Lack of ExpertiseLack of Expertise 5050
4.2.54.2.5 Other InitiativesOther Initiatives 5050
4.2.64.2.6 Network IssuesNetwork Issues 5151
4.2.74.2.7 Lack of AwarenessLack of Awareness 5252
Chapter#5Chapter#5 RESULT AND DISCUSSIONRESULT AND DISCUSSION 5454
5.15.1 Customer PreferencesCustomer Preferences 5454
5.25.2 Customer UnderstandsCustomer Understands 5656
Chapter#5Chapter#5 MAIN FINDINGS AND CONCLUSIONSMAIN FINDINGS AND CONCLUSIONS 6060
6.16.1 Main Findings And ConclusionsMain Findings And Conclusions 6060
6.26.2 RecommendationRecommendation 6363
QUESTIONNAIREQUESTIONNAIRE
REFERENCESREFERENCES
CHAPTER# 1
1. INTRODUCTION
1.1 INTRODUCTION:
In any economy banks play very important role. A bank is a reliable financial
institution, which has core business of mobilizing the savings of people for
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investment purposes. It receives the money from one group and lends to other
group of people. So bank performs the duty of financial intermediary.
Usually there are two types of banks, conventional banks and Islamic banks. Insimple words Islamic banks operate in interest free system. Prohibition of interest
is ordained in Islam in all forms and intent. This Prohibition is strict, absolute and
unambiguous.
The Holy Qur'an in verse 278 of Surah Al-Baqarah states:
"O ye who believe! Fear Allah and give up what remains of your demand for riba,
if ye are indeed believers."
Verse 2: 279 says:
"If you do it not, take notice of war from Allah and His Messenger. But if ye turn
back; ye shall have your capital sums. Deal not unjustly and you shall not be dealt
with unjustly."
It therefore, follows that interest is prohibited as it leads to injustices and Islam is
against all forms of injustices and exploitations and pleads an economic system,
which aims at securing extensive socio-economic justice1. The Islamic law of
prohibition of riba, which includes interest, was originally not based on economic
Theory but on Divine Authority which considers the charging of interest as an act
of injustice.
Islamic banks appeared on the world scene as active players two decades ago. Butmany of the principles on which Islamic banking is based have been commonly
acceptable all over the world for centuries rather than decades, as it is evident that
Islamic finance was practiced predominantly in the Muslim world throughout the
middle Ages, promoting trade and business activities. In Spain and the
1 (Source:1 (Source: Siddiqui, H. Asrar (1975) Practice and Law of Banking in Pakistan. International Institute of Islamic Economics (1999Siddiqui, H. Asrar (1975) Practice and Law of Banking in Pakistan. International Institute of Islamic Economics (1999
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Mediterranean and Baltic States, Islamic merchants became indispensable
middlemen for trading activities. It is claimed that many concepts, techniques, and
instruments of Islamic finance were later adopted by European financiers and
business persons. "Although the western media frequently suggest that Islamicbanking in its present form is a recent phenomenon, in fact, the basic practices and
principles date back to the early part of the seventh century"
The main issue here is to know about the differences between operations of a
conventional bank and an Islamic bank by focusing on the principles and
instruments of Islamic banking.
It is difficult to say with accuracy which was the first such company or bank that
pioneered this concept of Islamic banking in practice. Some analysts and experts
in the field are of the opinion that, Islamic banking and finance, in the modern
context, first emerged in 1963, when Mit Ghamr Saving Bank began an
experimental project offering interest free banking in Egypt. The project was a
success and lead to the bank opening four new branches by 1967. In the same
year, eight new banks mushroomed offering interest free banking. Due to the
political climate prevailing in Egypt during that period, the success of these
Islamic banks was seen as a threat, and they were forced to close down in 1971.2
2. (Source: Islamic Banking Conceptual Framework and practical operation P.7 by Abdur Rahim Hamdi)
As measure of the success of Islamic banks some traditional riba banks have
started imitating these banks by opening Islamic windows or offering Islamic
investment funds, unit trusts and or manage Islamic accounts for individuals.Among these banks are kilentwort boston ( unit trust ) credit swisse and first
boston ( personal investment account ) UBS ( unit trust fund ) and the Austrian
leaders bank ( unit trust ). Misr bank has Islamic branch. 3
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Some observers are of the opinion that the concept of an "Islamic bank" was born
at the Islamic Summit of Lahore, Pakistan in 1974 which recommended the
creation of an Islamic Development Bank. Since then Islamic banking and
financial institutions have grown rapidly. A 1993 report from the InternationalAssociation of Islamic Banks estimated the then industry to be valued at $80
billion. A more recent article appearing in the Wall Street Journal estimates the
potential market for Islamic investments to be up to $150 billion.4
Malaysia in 1983 passed an Islamic Banking Act to facilitate the growth
Of indigenous Islamic banks and finance companies thus became the first Muslim
economy to issue bonds on an Islamic basis. Since then, some 50-60 institutionshave been established, and are now in the process of forming an Islamic inter-bank
market (i.e. in which banks borrow or lend to each other). Within 10 years of
introducing the Islamic Banking Act, the Malaysian government has taken further
steps to popularize Islamic banking and finance, by allowing conventional banks
to offer Shariah-compliant instruments. The most distinctive feature of Islamic
banking in Malaysia is that it is being embraced by its Chinese and non-Muslim
Population who are opting to deposit their savings or borrow money on an Islamicbasis.
3 Source: http://www .Islamic- finance.net
4. (Source: www. Islamic - banking.com).
The momentous decision of the Pakistani Supreme Court, in Ramadan 1420, to
strike down all laws that condone interest and their orders to the Federal
government to bring all existing financial organizations in line with Islamic
principles is truly path breaking. The world is watching with bated breath to see
how the whole economy faces this challenge.5
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These trends in Malaysia and elsewhere are having a profound effect on the
banking and financial world as a whole. For example, America's Citibank was the
first major conventional bank to establish an Islamic bank in Bahrain, with an
operating capital of $20 million It may be a puny sum, but, it does suggest to somedegree that conventional banks have begun to embrace Islamic banking on a
moderate scale. Here again the point arises, that, there is some difference between
the operations of two banking systems and also there is something which is
attracting conventional banks towards Islamic banking system.6
A significant proportion of the banking system has been Islamized in Pakistan.
Recently the state bank of Pakistan has allowed commercial banks to set up
Islamic banking subsidiaries or provide full Islamic banking facilities through
dedicated branches.7
5. Source: www .alrajhibank.com.sa/Islamicebanks.htm
6. Source: (The Economist, 1996).
7. Source: Article on Islamic Banking, Finance & Economics by Maryam Ayaz Manager Business Development,
Apvision (Private) Limited.
Meezan Bank of Pakistan had conducted a research last year to ascertain, is
Islamic banking really a need of the people 7 The main findings of the research
were that there is a strong need for a riba-free banking system. People perceive a
number of emotional benefits from a product that is based on the tenets of Islam.
The objective is to alleviate the feeling of guilt by following the tenets of Islam.
There is also a belief that Islamic banking will help fight the ills of the economy of
the country.8
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A number of other Western financial institutions have followed suit by Offering
Islamic mutual funds and other investment products. For example, ANZ Grind
lays is now offering financial products that meet Islamic criteria. Germany's fourth
largest bank, Commerz bank, started offering Islamic mutual funds fromDecember 1999. In February 1999, Dow Jones introduced the Dow Jones Islamic
Market index (DJIM) of 600 companies worldwide that comply with the Shariah
laws.
Many Western Academic Institutions are introducing Islamic Economy and
Banking as Subjects, like Harvard University Center for Middle Eastern Studies
(CMES), Durham University, UK, Dow Jones University.etc.
These indicators reflect the rising trend of Islamic banking and finance throughout
the world. This encourages one to know in detail what Islamic banking is all
about, what are its principles and how it is different from conventional banking
system.
8. Source: Meazan Bank annual report 2008-2009
The Amana Fund, the LARIBA bank, in USA and the Halal investment Company
in London is another indicator of the growing salience of Islamic banking
institutions not just in Muslim countries, but in the West as well. These efforts in
different countries for Islamic banking present not only an excellent working
examples for those who did not believe in the practicality of the interest free
banking but also provide a spade work over which the infrastructure of interest
free banking for a country could be built up.
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To review the History and growth of Islamic Banking in Pakistan.
To find out the different factors, how it affect the growth of Islamic
banking.
To review the problem of Islamic Banking in Pakistan.
1.4 Limitation of the Study:
The research is conducted within the following limitations:
To keep the study manageable research is conducted on limited grounds.
The study is conducted on small level and only the important aspects are
considered.
The researcher has tried to collect sufficient data to make an effective
analysis.
Therefore, in this study the results about Islamic banking should be taken only as
indicative and perceptive rather than conclusive.
1.5 Organization of the study:
The whole study is classified into the following chapters
Chapter 1st is about introduction, 2nd Chapter is about literature review,
Chapter 3rd is about research methodology, chapter 4th is about growth and
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problems of Islamic Banking in Pakistan, Chapter 5th is about results and
discussions and Chapter 6th contains main findings and conclusions.
CHAPTER# 2
LITERATURE REVIEW
Kahf (2002) in his paper, interest free banking disagrees with the interest based
banking yet interest free banks have the similar credit risk as by the conventional
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banks. Therefore Base I, II have suggested that the calculation of the minimum
capital requirement should be the same as required by the conventional banks. The
Islamic Banking is different in nature from traditional banking. This article first
discusses the Islamic financial operations then analyzes the Islamic procedurewhich has been introduced in Pakistan since 1985. This article revealed that
islamization has moderate effect on this sector because the banks adopted the
system that is closely resembles to traditional system. Another reason is that they
are state owned The Islamic banking has not been applied the fully procedures as
described by the pillar II of the new Basel Accord. The application of the said
proposals does not create barriers for the Islamic banking and finance.
Ahmad & Hassan (2007) explained in their study in Bangladesh regarding
regulations and performance Islamic banking. The most important finding of this
research article is that there is lack of regulatory framework for its proper
functioning according to Shariah. There is also lack of interbank money market
which also affects the performance of the Islamic banking. The discrimination has
also been observed regarding legal reserve requirements. The researcher suggested
that in Bangladesh the independent banking act should be constituted to control,
guide and supervise the operations and practices of the Islamic banking. So that
the legal support to the stake holders may be provided.
Naser & Shahin (2004) have also studied about problems, challenges and
opportunities facing by the Islamic banking in United Kingdom. The data was
collected from the senior officials of the banks. The main problem faced in the
United Kingdom that is heterogeneous and potential clients. Furthermore the lack
of expert staff and competition from the conventional banks also faced in United
Kingdom. It has been concluded that the e-banking can play pivotal role for the
success of Islamic banking. There is need to sit together to the UK officials and
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Islamic banking representatives to discuss the challenges of the Islamic Banking.
There is need to recruit professional individuals who have the know how about the
Islamic banking. It is contended that the perceptions of senior. So that such
problems may be resolved by using such strategy.
Abdullah (2007) found that Malaysia is the first country who played the vital roll
in Islamic banking. It also introduced the dual banking as well as pure Islamic
banking. In this article an innovation has been brought out that is hire purchase
and also known as alijara WA iqtana. The Islamic banking is going very
successful but there is still need to bring changes by the policy makers. To make
strengthen the Islamic banking transactions there is need to develop strong legal
framework. There is also needed to make strong both the operational regularity
and substantive laws to resolve problems relating to Islamic banking.
The shariah should be analyzed to make new innovations instead to impose
restrictions. There is need to explore the potential and wisdom of Shariah. There is
immense need of cooperation is required to make collaboration among Shariah
scholars, researchers, academicians and researchers to conduct the study in depth
to make strong Islamic products. The government and other agencies should also
make efforts for the new avenue of Islamic banking and hire purchase. The most
important is that the government should remove the uncertainty regarding Islamic
hire purchase.
Garas (2007) explained in his book that Globalization has affected our life
politically, economically and financially. There are both aspects in this
globalization. The positive aspect is that there is the movement of human capital
and new technology among countries. On the other side of the coin the
government is unable to control the flow of capital. The oil prices flourished the
investment in GCC countries and also encouraged the Islamic finance .There is no
doubt that Islamic financial institutions having potential for growth but still there
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are certain challenges. There are two types of these challenges internal and
external. Internal challenges include that the customers still rely on the
conventional banking system and the numbers of the current IFIs are not enough
to meet the requirements to international transactions. Furthermore the transactionsystem is still premature to attract new clients. There is also lack of unified
regulatory system for the products and transactions.
Iqbal and Khan (1998) said in their book that the global growth of Islamic
banking is taking advantages of its uniqueness to meet the challenges of growth
though the status of the Islamic banking is growing rapidly. But still the
institutional arrangement is necessary to take part in the global economy. The
Shariah compatibility should be judged by qualified Shariah scholar because for
any medical problem the person will consult with the medical specialist to get best
solution. Thats why the solution of the problem in Shariah, it can be taken from
the qualified Sharia scholar to get the exact decision. This way a good institutional
structure may be developed. I believe it may be the right time to start simply with
an international association of shariah scholars for the finance industry.
Hameed and Basheer (2003) have conducted an analysis about the financial
record of seven banks in Malaysia and Bahrain. The purpose of this article was to
analyze the Islamic financial products viability to interest based contracts. It
analyzes that Islamic banks pay Zakat and finance economic activities according
to Shariah. However it concludes that there is need to make legal frame work so
that the Islamic financial products may regulate in the Islamic financial market
Samad, A. Gardner, D. & Cook, J.B. Another article has been written in which the
author determine the determinants of the Islamic Bank Profitability. This article
demonstrates that all sources of funds are correlated with the profitability. It has
also been observed that inflation and interest rate also affect the Islamic financial
products. This study found that there was no significant variation in earning
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between Islamic banks in competitive and monopolistic market. However there
was strong evidence that benefit of the investors has been observed in
monopolistic market. The study demonstrated that banks performed well in
competitive market then their counterpart. Therefore protectionism policy adoptedby the Muslim governments is inappropriate and could distort future progress of
Islamic Banking. In the end it has been recommended that establishment of more
banks will make it more viable and efficient.
Stefflar and Cornilisse (1995) said in their book that, the process of privatization
of banks has not been connected with the Islamization. Islamic banks have brought
no change regarding stability of the banks. The performance of the Islamic banks
is not up to the mark. Then theoretical comparison has been given of Islamic
banks and conventional banks. In the end of the article the author concludes that
the effect of Islamization is greater but less effective.
Amad and Kahf said that the Islamic banking have discovered Islamic
economics. Islamic banking is a system which really follows the Shariah rules and
regulations and Islamic economic system also abide by the Shariah. In 1950 to
1960 a study was conducted in Egypt and Malaysia regarding interest free
banking. But this study did not put any face value for Islamic banking. The first
Islamic bank was established in 1994 in Dubai and international Islamic Banks
was established in 1976 and now it has 53 member countries. Now a days Islamic
bank has been established almost in all the countries around the globe. Some
institutes have been established in America even small in numbers bit they are
using Islamic financing. The purpose is to create strategic alliance between Ulama
and Bankers. Further to develop Banking techniques by this Alliance.
Today Islamic banking is really in immense need of rethinking to compete in this
rapidly growing world. There is also need to redefine the structure for success in
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future. The Islamic banking has really been appreciated by the conventional
banking and it also finding ways to become main stream banking. The Islamic
banks should enhance their efficiency to cope up new projects. Merger of the
Islamic banks is compulsory for the survival in this era. There is need to increasethe size, capital and should create ability to create assets.
Haron (2004) Identified the determinants of the profitability are more important
for the researches. In past decades the researchers has been found determinants for
the profitability. But all previous study has been conducted for the conventional
banks. The Islamic banks are still waiting for such kind of study. The Kahf has
been conducted study about the determinants of profitability of Islamic banking.
The researcher has been identified the internal and external determinants of the
profitability of the Islamic Banking. The money supply also plays an important
role for the profitability of the Islamic banks.
Zubair and Hassan (2007) defined that the rapid growth with the Islamic
financial institutions especially banks, assessment of their performance have also
flourished. The performance should be evaluated with reference to social
responsibility and legal frame work. This article tells us that Islamic banking is not
out of fault. Some ratio analysis has been conducted two views the performance of
the Islamic banks. Traditional banking has also been compared with the ratios of
current Islamic banking.
Iqbal (1998) used empirical data for empirical study which has been conducted in
1990-1998 on Islamic Banking. The analysis in this article revealed that the
growth of this banking is slow but it is not matter of worry because at the initial
stage the growth of the institutions is seen slow and when the industry matures
then it starts goes to up. This study revealed that there was no mobilization of
funds because the Muslim community does not involve in interest based system.
Consequently they keep their savings in personal lockers rather than in a bank.
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After that in coming days the Islamic financial institutions attracted these savings
and deposit growth of these institutions increased. After that some conventional
banks started to officer the Islamic products. In nineties the Islamic mutual funds
were also developed and some deposits also converted to that side. Theperformance of the Islamic banks considered quite good and Islamic banks found
good capitalize, stable and profitable.
The profitability ratio of these banks is considered reasonable according to
international standard. But the current rates on assets of these banks do not
considered good. However some variations have been observed in Islamic banks
in terms of growth and performance. Another paper concludes that there is no any
sort of difference in Islamic & conventional banks with respect to profitability and
liquidity. However the study finds significant difference in credit performance.
The conventional banking is existed in the whole world. But innovation is the core
key to survive for the long run. Islamic banking has introduced by following this
notion. Interest free banking is in the initial stage therefore facing some
challenges. The regulatory frame work of interest free banking is poor and proper
interbank money market is not available. The Basal II suggested that Islamic
banking has the same risk like interest based banking therefore it is suggested that
calculation of capital is required as desired by interest based banking. In this
growing world there is need to rethink that how can efficiency of this banking be
improved. The growth of this banking is bit slowly but there is no need to get
worry because growth is found slow at infancy stage. In this paper the attempt has
been made that how the Islamic banking working in Pakistan.
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CHAPTER#3
RESEARCH METHODOLOGY
3.1 Research Methodologies:
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This study would explore & review the research done on Islamic banking by
different researchers and scholars. This research work used data collection direct
from the financial Statements of the banks, both Islamic and conventional and also
from the reports of State Bank of Pakistan; another source is direct from thecustomer of the both kinds of banks, documents researches and interviews of the
relevant authorities. Fieldwork was conducted during the months of December and
January of year 2010-2011. Although all replies were collected in personnel at the
allocated areas, the primary data collection applied obtaining the information from
peoples through filling of questionnaires, observation, and interview methods.
3.2 Mode of Observations
In-depth structured interviews have been selected for banking officials and
questionnaire for observational tools to gather primary data in the form of
feedback from general public or account holders. Secondary data has been
collected from State Bank of Pakistan (SBP) and different sources that are
manipulated later. The logic for using this questionnaire is to insight into the
growth potential and future prospects of Islamic banking through identifying the
perception of general public regarding Islamic banking.
3.3 Field Data Collection
The data was collected from general public of different Islamic and conventional
banks and from different Islamic baking officials. The questionnaire was
distributed, was filled out and was received on same day. During the process when
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they were filling the questionnaire I stay there in order to over come any difficulty
faced by the respondent in filling out questionnaire.
3.4 SAMPLELING DESIGN
3.4.1 TARGET POPULATION SIZE:
The total population sizes for questionnaire 300 persons at Islamic banks and at
300 conventional banks in Peshawar, Dera Ismail Khan, and Bannu were asked to
express their views during this study.
3.4.2 SAMPLE SIZE:
The sample size for this study would be 600.
3.5 Data Collection Methods
3.5.1 Data collected sources:
from articles and journals
from Economics Books
by Questionnaires
by In-depth Interviews
by Internet
CHAPTER#4
GROWTH AND PROBLEM OF ISLAMIC BANKING
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4.1 GROWTH OF ISLAMIC BANKING:
4.1.1 Growth:
Islam was the basis of creation of an independent state within the undivided Indo-
Pak Sub- Continent. All Constitutions of Pakistan have incorporated, within the
Principles of policy, the elimination of Riba as an important objective of the State
Policy. Quaid-e-Azam, the father of the nation, in his speech at the occasion of the
Inauguration of State Bank of Pakistan, had expressed the desire for evolving an
Islamic system of banking. In Pakistan Islamic banking emerged as a response to
both religious and economic needs. Efforts for economy wide elimination of Riba
started during 1970s and most of the significant and practical steps were taken in
early 1980s. It was a very bold and comprehensive exercise. Pakistan was among
the three countries in the world that had been trying to implement interest free
banking at comprehensive / national level.
Numerous measures were taken to introduce interest free banking in Pakistan.Banking and other relevant laws viz. State Bank of Pakistan (SBP) Act,
Companies Ordinance, recovery laws, negotiable instruments act, etc. were
amended to Facilitate interest free banking system and the industry was given a
specific Timeline to convert to the Islamic banking system.
State Bank Pakistan also gave the industry the products which it was allowed to
use without any change or exception. Islamic banking was rolled out country-
wide. New regulations were prepared prescribing the modes of financing, profit
distribution mechanism for deposits, financing facilities by State Bank of Pakistan,
(SBP) etc. which constituted ground work for Islamization of financial system.
The mid-80s attempt was a significant step in the evolution of Islamic banking
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system in the country. In a technical sense it was the most advanced model
compared to any other model being practiced anywhere in the world at that time.
The efforts and practical steps undertaken in the 1980s to Islamize the economy
at national level are considered As pioneering work in the Muslim world as thisbecame important reference Material for other countries which undertook the path
towards introduction and establishment of an Islamic banking system. In early 90s
the whole exercise was challenged in the Federal Shariat Court and the procedure
adopted by banks in Pakistan since July 1, 1985 was declared un-Islamic by the
Federal Shariat Court (FSC) in November 1991. The system was based largely on
mark-up technique with or without buy-back arrangement. The Federal Shariat
Court (FSC) declared that various provisions of the laws held repugnant to the
injunctions of Islam in its Judgment dated November 14, 1991 would cease to
have effect as from July 1, 1992.
In a meeting held on September 4, 2001 under the Chairmanship of the President
of Pakistan, attended by officials of the Ministries of Finance and Law, Governor
State Bank of Pakistan, Chairman and some members of the Council of Islamic
Ideology and the Chairmen, and the two Task Forces it was decided that the shift
to interest free economy would be made in a gradual and phased manner and
without causing any disruptions. It was also agreed that State Bank of Pakistan
would offer three institutional options.
1) Setting up subsidiaries by the commercial banks for the purpose of Conducting
Shariah compliant transactions;
2) Specifying branches by the commercial banks exclusively dealing in Islamic
Products with all safeguards to ensure integrity and purity of Islamic banking
operations,
3) Setting up a new full-fledged commercial bank to carry out exclusively
banking business based on proposed Islamic products.
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As a result of these efforts, in 2001, an Islamic Banking Division was established
in the Banking Policy Department at Sate Bank of Pakistan (SBP). This time
around, concerted efforts were made by Sate Bank of Pakistan (SBP) to undertakeIslamic Banking in its true spirit and also keeping in view the lessons learnt from
the experience of Bahrain, Malaysia and Saudi Arabia etc. in this area.
Accordingly, steps have been taken to set up a parallel banking system, so that an
enabling environment is ensured for the sector, avoiding any serious repercussions
of entire transformation of financial sector.
4.1.2 Shariah Compliance Developments:
The present re-launch of Islamic Banking in Pakistan by the State Bank of
Pakistan has been based not only on the lessons learnt from the history of Islamic
Banking efforts in Pakistan but also on the experiences of other countries in the
world that are currently known for their leadership role in this banking sector. The
basic difference, in Sate Bank of Pakistan (SBPS) current policies regarding
Islamic banking and the previous efforts, is the approach adopted Islamic Bank of
Pakistan (SBPS) by wherein the introduction of Islamic Banking is being viewed
more as a change management issue rather than as a religious or a legal issue.
This basic difference in approach defines the policies on Islamic Banking and is
primarily responsible for the success achieved so far. It was decided to promote
Islamic banking in a gradual manner and as a parallel and compatible system that
is in line with best international practices. Following the pronouncement of the
government to shift to interest free economy in a phased manner without causing
any disruptions the effort was envisaged to be based on a market driven and
flexible approach. Furthermore this approach is also helping build a broad based
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financial system in the country to enable all segments of the population to access
financial services.
Shariah compliance is the most important aspect of Islamic finance. TheCredibility of Islamic Banking Institutions (IBIs) not only depends on the financial
health of the institution but also on its adherence to the Shariah.
Under the current strategy for promotion and development of Islamic Banking as a
parallel, viable and compatible system, State Bank of Pakistan has put in place a
comprehensive Shariah Compliance Structure.
The Shariah Compliance Framework established by State Bank of Pakistan
consists of:
1. Shariah Board at Sate Bank of Pakistan
2. Shariah Advisor
3. Essentials & Model Agreements of Islamic Modes of Financing
Instructions and Guidelines for Shariah Compliance in Islamic
Banking Institutions
4. Shariah Advisors Forum
5. Shariah Compliance Inspection
6. Standardization of Shariah Practices- Adoption of AAOIFI
(Accounting and Auditing Organization for Islamic Financial Institutions)
4.1.3 Shariah Standards:
Each Islamic Banking Institution (IBI) is required to work under the guidance of a
Shariah advisor. To keep this process more objective, broad based and responsive
to the market conditions Sate Bank of Pakistan (SBP). Shariah Board has
approved Fit & Proper Criteria for Shariah advisors of Islamic Banking
Institutions (IBIs). According to these Criteria, minimum required Shariah and
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contemporary educational qualification as well as experience and Exposure for
becoming a Shariah Advisor has been defined. Moreover, to minimize conflict of
interest, it has been specified that a person cannot work as Shariah Advisor for
more than one Islamic Banking Institution (IBI) in Pakistan. Further, it has beenspecified that a Shariah Advisor shall not hold any executive/non-executive
position in any other financial institution, except working as Shariah Advisor of
Islamic mutual funds of the sameIslamic Banking Institution (IBI). In addition to
that, Shariah Advisors of Islamic Banking Institution (IBIs) have been barred from
having any substantial interest in or becoming employee of some types of
organizations like exchange Companies, corporate brokerage houses or stock
exchange.
These provisions in Fit and Proper Criteria for Shariah Advisors has ensured
Objectivity in evaluation criteria, minimization in conflict of interest and
Induction of new lot of Shariah advisors in the market.
4.1.4 Current Industry Review:
This time there has been a shift in the approach from the legal & regulatory
perspective to that of dealing with the whole affair of introducing Islamic banking
in Pakistan as a change management issue. As compared to our past experience
our new approach provides flexibility to the Islamic Banking Institution (IBIs) as
regard to products, instruments and Shariah compliance methodology. This new
initiative has witnessed a very encouraging response. As at end of the year 2003
only one bank operated as a full-fledged Islamic bank and three conventional
banks were operating Islamic banking branches. Currently there are 6 full fledged
licensed Islamic banks (IBs) and 12 conventional banks have licenses to operate
dedicated Islamic banking branches (IBBs). All of the five big banks in Pakistan
are providing Islamic banking services.
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4.1.5 Industry Progress and Market Share:
Islamic banking maintained its high growth trajectory during quarter Apr-Jun
2010. The total assets of Islamic banking institutions (IBIs) increased to Rs 411
billion in June 2010 from Rs 313 billion in June 2009, showing an impressive
growth of 31%. The deposits spearheaded the growth with 39% increase during
the year. The investment and financing however did not show the same pace of
momentum and have shown comparatively tenuous growth at 21% which is
indicative of the difficulties being faced by Islamic Banking Institution (IBIs) in
assets acquisition.1
1 Source: SBP Data
Figure 4.1 Shares and Growth of Islamic Banking
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Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
The assets, deposits and net investment & financing have posted growth rates of
31, 39 and 21 percent, respectively. The high growth in various components of
Islamic banks balance sheet has enabled the Islamic Banks to make further inroads
in the overall banking industry in Pakistan; the shares of assets, deposits and
investment & financing increased to 6.1, 6.4 and 4.6 percent respectively during
the quarter ended June 2010. The branch network increased to 667 branches from
651 in December 2009.
Table 4.1: Industry Progress and market share
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Rupees in billion and shares and growth in Percent
June.10 Dec.09 Dec.0
8
June. 07 Dec.0
6
Dec.05 June.04 Dec.03
Total Assets
Share in industry
Growth (YoY)
411
6.1
31.3
366
5.6
32.7
276
4.9
34
206
4
73.1
119
2.8
65.3
71
2
63.6
44
1.5
238.5
13
0.5
Deposits
Share in industry
Growth (YoY)
330
6.4
38.6
283
5.9
39.9
202
4.8
37.4
147
3.8
75
84
2.6
68
50
1.8
66.7
30
1.3
275
8
0.4
Net Financing & Investment
Share in industry
Growth (YoY)
23.5
4.6
21.2
226
4.5
21.3
235
4.6
21.2
138
3.5
89
73
2.3
52.1
48
1.7
60
30
1.3
200
10
0.5
Total Islamic Banking
Institutions 19 19 18 18 16 11 11 4
Total No. 0f Branches 667 651 515 289 150 70 48 17
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
Growth ratio may slow down marginally largely due to continuously rising base.
The Islamic Banking Institution (IBIs) are flush with liquidity since last couple of
years due to continued growth in deposits coupled with the dearth of liquidity
management instruments. The excessive liquidity in Islamic Banking Institution(IBIs) could also be partly attributed to the cautious approach of Islamic Banking
Institution (IBIs) in assets acquisition. The prime target market of Islamic Banking
Institution (IBIs) has usually been the big conglomerates and Multinational
Corporation (MNCs). This in turn enables them to maintain a sound quality of
their financial and investment portfolio. However this squeezes the profit margins
of Islamic Banking Institution (IBIs) as due to the peculiar nature of their
clientele, clients are able to solicit credit on their own terms. Moreover this also
leaves the Small and medium enterprises (SMEs) and startup business ventures
devoid of Islamic financial services. the Islamic Banking Institution (IBIs) have
fared relatively well during and post 2008 global financial markets crises; however
the recent floodsworst in the history of Pakistanare likely to adversely affect
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asset quality of banks including Islamic Banking Institution (IBIs.) Consequently,
the performance of the banking system including Islamic Banking Institution
(IBIs) during the coming few quarters may remain under stress.
4.1.6 Operating Performance:
The operating performance of Islamic Banking Institution (IBIs) remained weaker
than the banking system. The based on Return on Assets (ROA) and Return on
Equity (ROE) of Islamic Banking Institution (IBIs) at 0.8% & 6.9% was relatively
lower than the industry average of 1.1% and 10.6%, the Return on Assets (ROE)
though improved to 6.9 % in June 2010 compared to 6.0 % in June 2009. The
major source of Islamic Banking Institution (IBI) income, at around 80 %, is
mark-up income compared to around 70 percent for the conventional banks, which
is indicative of low diversification of Islamic Banking Institution (IBIs) sources of
Income compared to the conventional banks.
Table 4.2 Performance Indicators
June.10 Mar. 09 Jan.08 Industry
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Capital
Capital to Total Assets
(Capital- Net NPAs) to Total Assets
7.0%
12.4%
11.4%
9.6%
10.4
9.2
9.9
8.2
Assets Quality Ratio
NPFs to Financing
Net NPFs to Net Financing
Provisions to NPFs
Net NPAs to Total Capital
Real estate financing to Total Financing
FCY Denominated Financing to Capital
5.0%
2.4%
54.4%
11.6%
10.8%
11.1%
7.3%
3.8%
50.0%
15.8%
11.3%
5.8%
6.5
2.8
58.8
11.5
10.8
9.6
12.9
3.8
73.2
17.2
2.3
16.1
Earnings and Profitability
Net Income to Total Assets (ROA)
Return on Equity (ROE)
Net Interest Income to Gross Income
Non- Interest Income to Gross Income
Trading & Fx Gains (Losses) to Gross
Income
Operating Expense to Operating Expense
Spread Between Financing & Deposit Rate
0.8%
6.0%
82.0%
18.0%
6.1%
65.1%
29.7%
7.1%
0.8%
7.0%
81.1%
18.9%
7.0%
70.2%
32.2%
7.7%
0.8
6.9
80.7
19.3
8.0
71.8
32.1
7.7
1.1
10.8
74.7
25.3
7.8
52.6
36.7
6.9
Liquidity
Liquid Asset to Total Assets
Liquid Asset to Deposits
Avg. Matunity of Liabilities (Days)
Avg. Matunity of Assets (Days)
24.8%
32.6%
308.25%
708.43%
26.8%
34.5%
387.6%1
638.72%
25.8
32.2
383.55
595.73
34.2
45.3
417
594
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
The operating expense to gross income ratio of Islamic Banking Institution (IBIs)
is also much higher than the industry. Specifically, expense to gross income ratio
of Islamic Banking Institution (IBIs) is 71.8 % compared to 52.8 % of the
industry. The high level of operating expenses are however advisable to their
expansion drive rather than inefficiency. The Islamic Banking Institution (IBIs)
branch network more than doubled during last two years; the branches opened
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particularly during last one years would be achieving break evens during next 2-3
quarters, thus enabling the Islamic Banking Institution (IBIs) to improve their
expense to income ratios. Interestingly personnel expenses of Islamic Banking
Institution (IBIs) are lower than the industry median (though 7 it has graduallyincreased in last few quarters), which may be indicative of relatively weaker
quality of human resource of Islamic Banking Institution (IBI).
The spread (based on actual yield on the financing less deposits) is relatively
higher for Islamic Banking Institution (IBIs) at 7.7 percent compared to the
industry average of 6.9 percent as at end-June 2010. The higher spread of Islamic
Banking Institution (IBIs) is largely coming from a lower level of (NPFs)
compared with their conventional counterparts. The relative better assets quality
enabled them to earn better yield on their financing portfolio than the industry as a
whole. Nonetheless, higher spread remains an area of concern as it reflects sub-
optimal returns to the deposits, both for Islamic Banking Institution (IBIs) and
conventional banks.
4.1.7 Outreach Expansion:
The branch network of Islamic Banking Institution (IBIs) has increased to 667
branches by end-June 2010. With addition of 210 and 143 branches in 2008 and
2009, an increase of 29 branches in during Jan-Jun 2010 does not seem very
impressive. The slowdown in branch expansion is reflected in both the full-fledged
Islamic banks (IBs) and Islamic banking branches of conventional banks (IBBs).
The slowdown is attributable to fast pace expansion of branch network during last
two years with current focus on making the branches fully operational. Further, the
growth in branch network during next 1-2 years would largely be emanating from
conventional banks having Islamic banking branches (IBBs) both through
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conversion of existing conventional branches into Islamic Banking Branches
(IBBs) and new Islamic Banking Branches (IBBs).
The Islamic Banking (IBs) accounts for 416 branches and Islamic bankingbranches (IBBs) accounts for 183 branches while the rest 68 are sub branches of
both Islamic Banking (IBs) and Islamic banking branches (IBBs). The
geographical coverage of Islamic banking extends across the four provinces, Azad
Kashmir, Northern areas and Federal capital covering 84 cities. The province-wise
data reveals that Sindh, Punjab, Balochistan, Khyber-Pakhtunkhwa and Azad
Kashmir accounts for 223, 297, 73, 34, and 7 branches respectively, while the rest
32 branches are in the Federal Capital.653 branches are in the banked areas whileonly 14 branches which represent a minuscule 2.3 percent are in the unbanked
areas.
The Islamic Banking Institutions (IBIs) branch network is however largely
concentrated in big cities and banked areas. The need is for Islamic Banking
Institution (IBIs) to focus more on the unbaked and rural areas so that a larger
populace can access Islamic banking at their doorsteps. The conventional banks
having Islamic banking branches are in an advantageous position to convert their
existing conventional branches in these areas into Islamic banking branches.
Table 4.3 Islamic Banking Branch Network
Type
Islamic Banking
Name of Bank No of Branches
Al Baraka Islamic Bank 29
BankIslami Pakistan Limited 70
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Dawood Islamic Bank Limited 42
Dubi Islamic Bank Pakistan Limited 36
Emirates Global Islamic Bank Limited 58
Meezan Bank Limited 181Sub Total 416
Islamic Branches of Conventional Banks
Askari Bank Limited 29
Bank Alfalah Ltd 06
Bank Al Habib 60
Faysal Bank Limited 10
Habib Bank Limited 11
Habib Metropolitan bank 04
MCB Bank Limited 11
National Bank of Pakistan 08
Soneri Bank Limited 06
Standard Chartered Bank 11
The Bank of Khyber 19
The royal Bank of Scotland 03
United Bank Limited 05Sub Total 183
Sub BranchesAskari Bank Limited 02
Banklslami Pakistan Limited 32
Dawood Islamic Bank Limited 08Emirates Global Islamic Bank Limited 02
Meez Bank Limited 21The bank of Khyber 03
Sub Total 68
Grand Total 667Source: Banking Policy & Regulations Department, State Bank of Pakistan.
Table 4.4 Province wise Break-up of Islamic Banking Branch Network
Type Islamic Banking
Type Islamic Branches of Conventional Banks
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The Bank of Khyber 2 12 3 2 19
The Royal Bank of Scotland 1 2 3United Bank Limited 1 3 1 5
Faysal Bank Limited 1 2 4 3 10
SAIBBs Total 2 8 32 83 47 183
Type Sub Branches
Source: Banking Policy & Regulations Department, State Bank of Pakistan
Table 4.5 City wise Break-up of Islamic Banking Branch NetworkS.No Cities No of Branches S.No Cities No of Branches
Bank Name AzadKashmir
Bolochistan FederalCapital
KP NorthernAreas
Punjab Sindh Grand Tota
Albaraka Islamic Bank 1 2 3 15 8 29
Banklsiami Pakistan Ltd 1 8 2 5 1 30 23 70
Dawood Islamic Bank Ltd 1 2 1 18 20 42
Dubai Islamic bank Pakistan Ltd 3 2 4 16 11 36
Emirates Goble Islamic Bank Ltd 3 2 6 27 20 58
Meezan Bank Limited 2 4 9 17 84 65 181
IB.Total 4 19 19 36 1 190 147 416
Bank Name AzadKashmir
Bolochistn FederalCapital
KP NorthernAreas
Punjab Sindh GrandTotal
Askari Bank Limited 2 1 5 14 7 29
Bank AL Habib Ltd 1 1 2 2 6
Bank Alfalah Ltd 1 3 3 39 14 60
Habib Bank Ltd 1 1 2 4 3 11Habib Metropolitan Bank Ltd 1 3 4
MCB Bank Limited 1 1 1 5 3 11
National Bank of Pakistan 2 1 3 2 8
Soneri Bank Ltd 1 1 1 1 2 6
Standard Chartered Bank Pak 1 1 3 3 3 11
Askari Bank Limited 1 1 2
BankIslami Pakistan Ltd 1 3 3 2 9 14 32
Dawood Islamic Bank Ltd 3 5 8
Emirates Global Islamic Bank 1 1 2
Meezan Bank Limited 1 2 11 7 21
The Bank of Khyber 1 1 1 3
Sub Branches Total 1 5 5 24 29 68
Grand Total 7 34 32 73 1 297 223 667
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12345
67891011121314151617181920
212223242526272829303132333435
363738
394041424344454647484950
PunjabArifwalaAttockBahawalpurChahwalDaska
Dera Ghazi KhanFaisalabadGojraGujar KhanGujranwalaGujratHafizabadJaranwalaJhangJhelumKamokiKasurKhanewalKhushabLahore
Mandi BahauddinMain ChannuMainwaliMultanOkaraPakpattanPindi GhaibRahim Yar KhanRawalpindiSadiqabadSahiwalSargodheSheikhupuraSialkotTexila
Taba Tex SinghVehariWah Cantt
SindhBadinHyderabadKarachiLarkanaMatiariMirpur Khas
NawabashahSakarandSanghar
SukkurTando AdamTando Allahyar
14321
2271110922341214113
121242116312363131
142
117185113412512
5152535455
565758596061626364656667
68697071727374757677
78
79
8081
Khyber PakhtunkhwaAbottadadBannuBatkhelaCharsaddaChitral
Dera Ismail KhanHangedHaripurKohtManshraMardanMingora
NowsheraPeshawarSwabiTankTimergara
Balochistan
ChamanGawadarHub ChowkiKuchlackLoralaiMuslim BaghPishinQilla SaifullahQuettaZhob
Federal CapitalIslambad
Northern AreasGiligit
Azad KashmirMirpur AJKMuzaffarabad
111111
3132651329211
11113111221
32
1
43
Pujab TotalSindh TotalKP TotalBalochistan TotalFederal Capital Total
Northern Areas TotalAzad Kashmir Total
297223733432
17
Grand Total 667Source: Banking Policy & Regulations Department, State Bank of Pakistan
4.1.8 Asset Quality:
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During the quarter Apr-Jun 2010 the non-performing financing has increased
substantially Year over Year (YoY) basis, however there is a decrease of around
10 percent on Quarter on Quarter (QoQ) basis. The net non-performing financingshows similar Year over Year (YoY) and Quarter on Quarter (QoQ) trends.
Table 4.6 Non- performing Financing & Assets
Rupees in million
Growth
Jun-09 Mar-10 jun-10 YoY QoQ
NPF
Provision
Net NPF
NPA
Net NPAs
1,803.2
788.7
1,014.4
1,953.2
1,030.9
11,871.3
5,935.7
5,935.6
13.628.6
6,659.8
10,649.9
6,261.8
4,388.1
12,454.4
4,921.1
490.6
693.9
332.6
537.7
377.4
-10.3
5.5
-26.1
-8.6
-26.1Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts
The Non-performing asset (NPAs) and net Non-performing asset (NPAs) also
have similar inclining trends. However, on a positive note the recovery has
improved substantially both on Year over Year (YoY) and Quarter on Quarter
(QoQ) basis. The slowdown in (NPF) and Non-performing asset (NPA) coupled
with better recovery derive reflects positively on asset management of the IBIs.
The infection ratio, net infection ratio, and Non-performing asset (NPA) to capital
ratio, of Islamic Banking Institution (IBI) are better than the industry at end-June
2010. The assets infection as depicted by (NPFs) to financing ratio at 6.5% is
almost the half of the industry average which stood at 12.9%. The net Non-
performing asset (NPFs) to net financing ratio at 2.8% is also much better than the
industry average of 3.8%. Similarly the net Non-performing asset (NPAs) to
Capital ratio of Islamic Banking Institutions (IBIs) at 11.5% is also better than the
industry average of 17.2%. The improved asset quality of Islamic Banking
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Institutions (IBIs) can be evidenced from rapid fall in infection ratio both on gross
and net basis while there is an increase in provisions against (NPFs). The only
concern seems to be an increase of 4.7 percentages in foreign currency exposures
as percent of capital. The foreign currency exposure in financing for IslamicBanking Institutions (IBIs) at 9.6% is also much lower than the industry median of
16.1% at the quarter end and hasshown a declining trend for the Islamic Banking
Institutions (IBIs). The exposure ofIslamic Banking Institutions (IBIs) on the real
estate sector is much higher at 10.8% than the industry average of 2.3% at end-
June 2010. Nevertheless, the recent economic slowdown due to massive flooding
in the country can potentially reverse these encouraging trends.
4.1.9 Financing Products:
The financing mix remained concentrated in Murabaha financing. In fact, the
Murabaha financing has rebounded during the quarter under review from 37.1% to
44.1% of the financing. There is a slight decline in Discount Margin (DM)
financing, Salam and Istisna modes. Nonetheless, Murabaha, Ijarah and Discount
Margin (DM) constitute around 87 % of the financing.
Table 4.7 Financing Mix Rupees in billion
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Source: Annual Accounts except for June 2010, data for which is based on Unedited Quarterly Accounts
The financing through participatory modes remained at extremely low levels both
due to low demand and Islamic Banking Institutions (IBIs) reluctance to increase
their risk appetite. Similarly, use of financing modes like Salam and Istisna, which
can be used to finance nontraditional sectors like agriculture and Small and
medium enterprises (SME), remained lack luster.
4.1.10 Sectoral Concentration of Financing:
Jun-09 Mar-10 Jun-10
Murabaha
Ijarah
Musharaka
Mudaraba
Diminishing Musharaka (DM)
Salam
Istisna
Others
Total
58.0
26.2
3.7
0.9
45.3
2.9
4.8
2.3
144.3
60.8
22.7
2.8
0.4
51.3
6.5
10.6
7.0
162.1
72.4
23.8
6.0
0.4
46.4
3.2
6.4
5.4
164.0
Murabaha
Ijarah
Musharaka
Mudaraba
Diminishing Musharaka (DM)
Salam
Istisna
Others
Total
40.2
18.2
2.6
0.7
31.4
2.0
3.3
1.6
100.0
37.5
14.0
1.7
0.2
31.7
4.0
6.6
4.3
100.0
44.1
14.5
3.7
0.2
28.3
2.0
3.9
3.3
100.0
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The Islamic Banking Institutions (IBIs) financing concentration does not show
much sign of improvement and is concentrated in a few sectors. Though the trend
is in line with the overall banking industrys financing the same cannot be deemeddesirable. The Islamic Banking Institution (IBI) financing is confined to sectors
like Textile, Chemical & pharmaceutical and Individuals, where Islamic Banking
Institutions (IBIs) have around 18.3, 9.1 & 19 % concentration compared to 16.9
& 4.1 and 12.8 % respectively for the rest of the banking industry.
Table 4.8: Financing Concentration-percent share
Jun-09 Mar-10 Jun-10 IndustryChemical and Pharmaceuticals
Agribusiness
Textile
Cement
Sugar
Shoes and Leather garments
Automobile and transportation equipment
Financial
InsuranceElectronics and electrical appliances
Production and transmission of energy
Individuals
Others
Total
7.1%
1.0%
20.5%
2.2%
2.8%
1.6%
2.6%
1.1%
0.0%1.1%
4.5%
22.8%
36.4%
100.0%
10.5%
0.6%
20.6%
2.8%
6.0%
1.2%
2.0%
1.0%
0.0%1.0%
4.5%
20.1%
31.6%
100.0%
9.1%
1.1%
18.3%
3.5%
3.6%
1.1%
1.9%
1.3%
0.0%0.9%
4.8%
19.1%
36.4%
100.0%
4.1%
5.8%
16.9%
2.5%
2.3%
0.6%
1.6%
1.2%
0.0%1.6%
9.4%
12.8%
41.1%
100.0%
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
The concentration in a few sectors implies concentration of risk as well. For
instance, the likely distress to Textile sector due to expected higher cotton prices
(resulting from losses in floods) may adversely affect the textile sector and its
financiers. Moreover, the financing to the individuals is very sensitive to the
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overall economic activity and in times of distress there are higher chances of
defaults.
4.1.11 Investments:
The investments of Islamic Banking Institutions (IBIs) have shown substantial
growth of Year over Year (YoY) 46% andQuarter on Quarter (QoQ) 7.0% in June
2010. The Year Over Year (YoY) growth primarily represent the Rs 14.4 billion
(GoP) Ijarah Sukuk and Rs 6.8 billion PIA Sukuk issued in September and
October 2009, respectively. There is a substantial decline of 12 percent in
investment in shares during the quarter, though investments in shares remained
marginally positive on Year over Year (YoY) basis.
Table4.9 Investments
Rupees in million
Growth
Jun-09 Mar-10 Jun-10 YoY QoQ
Federal Government Securities
Fully paid up ordinary Shares
TFCs, Debentures, Bonds, & PTCs
Other investment
Investment by type
Held for trading
Available for sale
Held to Maturity
Surplus/ (deficit) on revaluation
Net investments
17,073.6
1,678.5
19,408.3
15,891.9
--------
127.6
39,904.9
11,211.4
(31.8)
53,539.8
27,081.1
1,997.9
24,866.2
19,564.4
--------
---------
59,147.0
11,465.8
254.3
72,892.7
27,032.7
1,757.6
26,173.8
23,841.6
--------
--------
64.717.5
11,697.2
110.7
77,999.7
58.3
4.7
34.9
50.0
--------
---------
62.2
4.3
(447.9)
45.7
(0.2)
(12.0)
5.3
21.9
---------
-------
9.4
2.0
(56.4)
7.0
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
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In terms of investment types, investments are largely concentrated in Held for sale
and Held to maturity categories, while there are negligible securities in Held for
trading categorylargely a result of lack of Shariah compliant tradable securities.
The constraint on availability of proper investment avenues is a major constrain on profitability of Islamic Banking Institutions (IBIs). The constraint is more
disturbing in wake of rapid growth in deposits.
The State Bank of Pakistan (SBP) and the domestic and international Islamic
banking community are striving to evolve effective and efficient Shariah
compliant liquidity management tools.
4.1.12 Deposits mobilization:
The deposit mobilization remained strong during Apr-Jun 2010. The Year over
Year (YoY) and Quarter on Quarter (QoQ) growth in deposits remained robust at
38.5% and 14.1 % respectively. The YoY growth in deposits is largely coming
from the customer deposits at 40.6 percent. All the customer deposit typesfixed,
saving and currenthave shown close to 40 percent YoY growth. Similar trends
have continued during the quarter ended June 2010.
Figure 4.02
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
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The comparative analysis of composition of deposits of Islamic Banking
Institutions (IBIs) and industry reveals that the behavior of Islamic Banking
Institution IBI depositors and conventional banks depositors is almost similar.
Table 4.10 Breaks of Deposits
Rupees in million & growth in percent
Growth
Jun-09 Mar-10 Jun-10 YoY QoQDeposits
Customers
Fixed Deposits
Saving Deposits
Current Accounts- Remunerative
Current Accounts- Non Remunerative
Others
Financial Institutions
Remunerative Deposits
Non-remunerative Deposits
Currency WiseLocal Currency Deposits
Foreign Currency Deposits
238,168.5
219,079.4
88,871.8
75,176.1
---------
53,165.4
1,866.1
19.089.2
19.039.8
49.4
255,474.1
12,694.5
289,090.3
274,106.4
113,179.6
94,321.1
----------
64,086.7
2,518.9
14,983.8
14,813.4
170.5
272,091.3
16,999.0
329,778.3
308,067.0
123,484.7
105,162.7
-----------
76,676.9
2,742.7
21,711.3
21,340.1
471.2
312,488.5
17,289.8
38.5
40.6
38.9
39.9
------
44.2
47.0
13.7
12.1
651.3
38.6
36.2
14.1
12.4
9.1
11.5
------
19.6
8.9
44.9
44.1
117.7
14.8
1.7
Source: Annual Accounts except for June 2010, data for which is based on Unedited Quarterly Accounts.
The similar depositors preferences in Islamic Banking Institutions (IBIs) and
overall banking industry may reflect that Islamic Banking Institutions (IBIs) need
to do better with reference to the vast potential of the market. A stronger evidence
of this assertion came from high level of non-remunerative current accounts in
Islamic Banking Institutions (IBIs). This implies that the Islamic Banking
Institutions (IBIs) have to focus more aggressively on their awareness campaign
together with effective marketing of Islamic banking as offering Shariah compliant
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returns to the depositors. Possibly, a combined marketing campaign by Islamic
Banking Institutions (IBIs) under a single banner.
4.1.13 Maturity Profile:
The maturity profile of assets and liabilities of Islamic Banking Institutions (IBIs)
closely resembles that of the banking industry at end-June 2010. The average asset
maturity of Islamic Banking Institution (IBI) as of June 2010 is concentrated in 3-
month maturity. On the liability side, the average maturity is also concentrated in
shorter tenor.
The maturity gaps as of June 2010 depict higher gaps in shorter tenors as
compared to longer tenors. This trend is also consistent with the industry behavior.
Table 4.11 Maturities of Assets and Liabilities
Jun-09 Mar-10 Jun-10 Industry
Maturing upto 3 months
Maturing from 3 months to 1 yr
Maturing from 1 yr to 5 yrs
Maturing after 5 yrs
Assets
37.7 40.1 42.9 43.4
22.5 22.8 22.6 27.0
26.4 26.7 25.1 17.8
13.3 10.4 9.4 11.9
Maturing upto 3 months
Maturing from 3 months to 1 yr
Maturing from 1 yr to 5 yrs
Maturing after 5 yrs
Liabilities
58.6 51.7 54.3 55.8
25.2 28.2 25.5 21.3
11.0 14.9 15.0 16.9
5.2 5.2 5.2 6.0
Maturing upto 3 months
Maturing from 3 months to 1 yr
Maturing from 1 yr to 5 yrs
Maturing after 5 yrs
Gap- asset share minus liabilities share
(20.9) (11.7) (11.4) (12.4)
(2.7) (5.3) (3.0) 5.7
15.4 11.8 10.1 0.8
8.0 5.2 4.3 6.0
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
4.1.14 Prospects:
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While the number and operations of Islamic banks are fast expanding, this
segment of the market is still small relative to the appetite for Islamic finance.
Pakistan, in light of its past experience, is launching a gradual and steady approachto Islamic banking. Despite rapid expansion in industry, the share of Islamic
banking in the total banking system is a modest 4.0%. Moreover, it only caters for
around 32,000 borrowers through around 300 branches relative to the country-
wide 5 million borrowers (or 4.8 million excluding microfinance borrowers)
tapped through 7,700 branches by conventional banks. Financing and investment
levels of Islamic banks barely range around Rs77 billion, which is below 3% of
the total banking systems advances. On the product side, Islamic banks so far
offer about 75% of products.
currently available in conventional banking while clean lending for consumer
financing products, like personal loans and credit cards, still pose a challenge.
Islamic banks operate exclusively in large cities with some now venturing into
secondary cities but they are absent from rural areas where there is great potential
for business growth. Global interest in Islamic finance industry and Pakistans
success in laying basic foundation and core infrastructure of Islamic financial
system lends confidence that the country has good potential and prospects to
further exploit this industry. Going forward, however, it is important that Pakistan
adopts a more calibrated and coordinated approach and strategy for the
development of Islamic finance industry.
Islamic banking can serve as a key vehicle to improve and strength the access to
development finance by bringing in financial innovation that can cater adequately
to diverse demands of the population as well as corporate sectors and countrys
infrastructure financing requirements, while ensuring that it nurtures faith based
system of financing consistent with the Shariah principles. Major elements of this
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strategy would require both industry and SBP to closely work together on multiple
fronts. Some of the key areas of focus include: Aggressive deposit mobilization to
augment domestic financial savings of the country. Although late starter, Islamic
banks have phenomenal potential to exploit resource mobilization. Substantialsavings have still not been channeled into the financial system because of
reservations relating to interest based system or return deficiencies of the
conventional system. Islamic banks, besides catering to the needs of small
depositors through profit and loss sharing basic accounts with no Charges need to
tap high net worth investors and companies which are increasingly being driven to
the attractive options and returns being offered by more innovative players
worldwide. Fast adaptation of these practices by the Islamic finance industry will
be helpful in competing more effectively with conventional banks in raising
deposits. Resource mobilization is critical for Islamic finance industry to grow
effectively and meet the alternative requirements of economy and society.
Despite these issues, it is believed that Islamic banking can grow at a much faster
pace than conventional banking. This paper outlines and discusses in detail the
specific steps to be taken. State Bank of Pakistan (SBPs) policies towards Islamic
Banking will be:
1. Liberal for branch licensing of Islamic Banking Institutions (IBIs)
2. Encouraging and supportive of Islamic Banking Institutions (IBIs) in using
alternate delivery channels in order to extend their outreach
3. Encouraging foreign Islamic banks to establish Islamic Banks in Pakistan
4. Encouraging the establishment of Islamic microfinance banks
5. Providing enabling environment for Islamic Banking Institutions (IBBs) of
conventional banks to convert into Islamic banking subsidiaries.
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To achieve the target market share of 12%, an increase in coverage of the existing
banking segments and entry into new segments of microfinance, agriculture,
infrastructure and Small and medium enterprises (SME) finance will be targeted.
Based on the above direction of State Bank of Pakistan SBPs policy and feedback
from the industry, following forecast for the industry has been developed:
Table 4.12 Annual Growths (In Million)
2008 2009 2010 2011 2012
Expected Deposit Size 215,938 340,128 499,036 722,109 907,064
Annual Growth Rate -------- 58% 47% 45% 26%
Expected Financing Size 184,641 277,153 413,594 600,014 731,591
Annual Growth Rate -------- 50% 49% 45% 22%
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
It is forecasted that by 2012 Islamic banking deposits will reach in the range of
Rs. 900-1000 billion and financing in the range of Rs. 700-800 billion. The
growth rates of these deposits are expected to be in the range of 45-60% in next
three years. Thereafter the growth is expected to be around 25% as the market
would mature having a larger base and greater competition with the conventional
counterparts. The Islamic Banking Institutions (IBIs) are expected to achieve this
target on the basis of canalizing funds from huge untapped markets and supportive
role of State Bank of Pakistan (SBP) in regulations and allowing opening of
branches in new business places. State Bank of Pakistan (SBP) will follow
relatively liberal branch expansion policies for Islamic banking or at least at par
with conventional banking. Based on State Bank of Pakistan (SBPs) projections
and the feedback from the industry, following are projections for expansion in the
branch network:
The IBIs in the next three years will expand their branch network at a faster pace.
However, after the year 2011, the growth in branch network is expected to settle
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down. Although this is an ambitious plan however the industry is comfortable with
it and it is also in line with the inspirational market share.
To increase the outreach of Islamic banking offerings, the industry will beencouraged to enter the Microfinance and Agriculture sectors, in addition to the
Small and medium enterprises (SME) sector. Some Islamic banks are already
focusing on the Small and medium enterprises (SME) sector and getting a good
response from customers. The basic approach to entering these segments would be
to maximize the leveraging of the existing conventional banking infrastructure and
introducing Islamic banking products through these. State Bank of Pakistan (SBP)
will introduce the Shariah compliance mechanism and segregation of Islamic
banking business on the balance sheet and income statements. The specific steps
planned for each of these sectors will be as follows:
The central bank will use the conventional Microfinance strategy and focus more
on adding the aspects peculiar to Islamic banking. As a first step, State Bank of
Pakistan (SBP) has already issued guidelines for offering Islamic Microfinance
Services. According to these guidelines various types of institutional arrangements
have been suggested for provision of Islamic microfinance services which include.
1. Establishing full-fledged Islamic Microfinance Bank (MFB)
2. Islamic microfinance services by full-fledged Islamic Banks
3. Islamic microfinance services by Conventional banks
4. Islamic microfinance services by Conventional Microfinance Banks
For each type of arrangement, a detailed framework has been provided outlining
the systems and controls to be adopted and application procedure as well as
different options available toMicrofinance banks bank (MFBs) by which Islamic
microfinance services can be offered. Going forward help will be provided to the
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banks offering Islamic microfinance for developing products through joint forums
of experts from State Bank of Pakistan (SBP) as well as the participating banks.
Incremental volumes for Microfinance will therefore be ensured. At the same time
some conversion is also expected to take place.
Recently announced Microfinance strategy envisions 3 million borrowers by year
2010. It is expected that around 4-5 percent of the borrowers will be using Islamic
microfinance facilities. SBP expects that growth in Islamic microfinance will pick
up gradually as Islamic banks will expand to new areas after consolidating their
position in core sectors like corporate and consumer finance. Moreover,
establishment of dedicated Islamic microfinance bank(s) and introduction of
Islamic microfinance services by conventional Islamic Microfinance Banks
(MFBs) will give a boost to the sector. The estimated market size has been
forecasted as follows:
Table 4.13 Microfinance
Microfinance 2008 2009 2010 2011 2012
Expected Volume 10 100 500 1000 2000
% of Islamic Banking 0.01% 0.04% 0.1% 0.2% 0.3%
Financing ------ ------- -------- --------- ---------
Annual Growth Rate ------ 900% 400% 100% 100%
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
4.1.15 Agriculture:
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State Bank of Pakistan (SBPs) approach would remain the same as that for other
development finance sectors. A task force has been constituted that consists of
experts from participating banks and State Bank of Pakistan (SBP). This
committee is in the process of developingproducts that can be offered by banksundertaking Agriculture credit. These products are expected to be operationally
ready by the end of the year. Meanwhile State Bank of Pakistan (SBP) will be
issuing guidelines and then regulations for this sector. Keeping in view the
inclination of end users for getting finance through Shariah-compliant products,
scope of this market is huge; State Bank of Pakistan (SBP) expects the following
volumes from this sector:
Table 4.14 Expected Agricultural Growths
Microfinance 2008 2009 2010 2011 2012
Expected Volume 370 1400 4100 12000 21000
% of Islamic Banking 0.2% 0.5% 1% 2% 3%
Financing ------ ------- -------- --------- ---------
Annual Growth Rate ------ 278.4% 193% 193% 75%
Source: Annual Accounts except for June 2010, data for which is based on Unaudited Quarterly Accounts.
4.2 PROBLEMS AND ISSUES:
4.2.1 Taxation Issues:
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State Bank of Pakistan (SBP) has put in place a process that is comprehensive and
provides the necessary groundwork to all the government departments concerned
to enable them executing their part of the change in rules. This process consists offorming a committee at Institute of Charted Accounting of Pakistan (ICAP) that
determines the accounting treatment of Islamic transaction modes.
Based on the accounting treatment, changes needed in the tax rules to provide
same effective taxation treatment to Islamic transactions as that provided to
conventional transactions are made State of Pakistan (SBP) initially took up the
issue of double taxation on Murabaha transactions with the Central Board o