KARACHI: Fitch Ratings said Pakistan’s Islamic finance industry is expected to continue its growth trajectory over the medium term, driven by strong government push and steadily rising public demand for Islamic products.
“However, the industry faces key challenges that could slow its growth such as the still-developing Islamic finance regulatory framework,” the rating agency said in a research report.
In April 2022, the Federal Shariat Court of Pakistan (FSC) stated in a decision that ‘riba’ or interest is prohibited in Islam, including relating to banking transactions. The FSC directed the government to adopt sharia-compliant modes while borrowing from domestic or foreign sources in the future.
The FSC set an implementation timeline of five years to convert the economy of Pakistan into “equitable, asset-based, risk sharing and interest-free economy” by end-2027.
“If the court orders are implemented effectively, the Islamic finance industry could receive a large boost in the medium term. However, uncertainties loom over policy implementation as court judgements on this subject were issued previously but with limited effect on the banking sector,” it added.
Fitch said the Islamic finance industry faces multiple other challenges. This includes still-developing Islamic finance regulatory framework, limited supply of sharia-compliant products and gaps in the distributional channels, with limited outreach in the populous rural areas where 63 percent of the total Pakistani population resided in 2020, according to World Bank. The financial sector in general also remains under-developed, with a challenging business environment.
The size of the Pakistani Islamic finance industry is estimated to have crossed $42 billion at end-1Q22. Islamic banks are the largest contributor to the Islamic finance industry at 67 percent (total assets), followed by sukuk at 26 percent (outstanding amount), Islamic funds at 6 percent (total assets) and takaful at 1 percent (total contributions).
The government seeks to increase financial inclusion through promoting Islamic finance, as part of the National Financial Inclusion Strategy. Only 21 percent of the adult population had a bank account in 2017, with 13 percent of adults citing religious reasons for not having them.
Fitch expects sovereign sukuk issuance to rise on the back of high gross financing needs. In 2021, the government set a target of increasing the share of sharia-compliant instrument in government securities to at least 10 percent by end of 2022-2023. Pakistan’s sukuk market is developing with outstanding volumes of $11 billion at end-1Q22, with 82 percent in local currency. Also, guidelines on issuing green sukuk and bonds were issued in 2021 by the Securities and Exchange Commission of Pakistan.
At end-2021, Islamic banking share reached 18.6 percent of banking sector assets (end-2017: 12.4 percent) and 19.4 percent of deposits (end-2017: 14.5 percent).
State Bank of Pakistan targets the Islamic banking sector to contribute 30 percent to the overall banking industry assets and deposits by 2025. In 2021, Islamic banks’ total assets experienced a sharp growth of 30.6 percent yoy to Rs5,577 billion ($32 billion). Islamic branches of conventional banks contributed significantly to the banking system, with a 45.7 percent share of overall Islamic banking assets by end-2021.
The domestic market share of takaful reached 12 percent at end-2020. The Islamic funds sector had a global market share of 1.9 percent at end-2020.
Other directives issued by the FSC to the government include the deletion of the word ‘interest’ from the relevant laws and make the necessary legislative amendments by 31 December 2022.
The FSC also ruled that laws or provisions of the laws that include the word ‘interest’ would cease to have effect as of 1 June 2022. Additionally, FSC ruled that the government’s previous international financial commitments would be binding, unless renegotiated through mutual agreement of the parties.