‘FBL likely to get Islamic banking licence this month’

KARACHI: The State Bank of Pakistan (SBP) would likely grant Faysal Bank Limited (FBL) a new license this month, allowing it to operate as the country’s second-largest Islamic bank, its official said.

“The conversion of FBL’s operations to Islamic banking is nearly complete. Ninety percent of the bank’s assets, deposits, and balance sheet have been converted to Islamic finance. There is only one conventional branch remaining out of our total of 650 branches, and it will be converted to Islamic as early as next week,” Syed Majid Ali, chief financial officer at FBL said in an interview with The News.

According to our plans and discussions with SBP, “we may give up our current license after we convert 85–90 percent of our conventional branches to Islamic”, he said. “We submitted an application for a license to function as a bank that applies the interest-free principles of Islamic finance in all its operations,” Ali added.

“The SBP is expected to approve the bank's conversion by December 20. We are prepared to surrender our current license on December 31 because everything is going really well. The bank will open as a full-fledged Islamic bank on January 1, 2023, In Sha Allah.”

He said the bank started converting its branches in 2016, with 211 of them becoming Islamic. This was the largest conversion in the world and was extremely complicated due to its extensive branch network, balance sheet size and variety of product offerings.

“We had no role model to follow when we started the conversion process. The main obstacle was where to begin. The difficulties of a continuing strategic shift from a traditional banking system to Islamic banking had to be addressed,” Ali noted.

The Islamic financial sector in Pakistan faces a shortage of qualified, high-quality human resources, he opined.

“We lack the personnel or Islamic bankers necessary to carry out a conversion process. For the bank to convert to Islamic, it must build the required capabilities,” he said, and added that it needs qualified staff who can match the financing instrument to the customer's needs by comprehending the customer's business model. Additionally, banks must create Islamic products. They ought to be able to run those products on their systems.

The FBL is completing its conversion journey at a time when the government has intensified efforts to drive Pakistan’s economy away from Riba. The government has already started the process to assure the conversion to Islamic instruments by 2027.

Ali said the bank started working on its business transformation strategy in August 2014 after conducting a thorough analysis of FBL’s products and portfolios and realising that a conversion of this scale has a learning curve that necessitates ongoing changes. In addition, a gradual transition is necessary to prevent threats to the bank’s stability.

The initial plan was to finish this conversion process in December 2020, however, the board of directors allowed two more years to ensure a smooth transition to the new business model.

“We needed to look at the bank’s many problems, such as how we would convert interest-based government securities like bonds and treasury bills. In addition, the government does not issue sukuks (Islamic bonds) frequently. Our approach was to focus on what can be done and with the passage of time, as our learning improved; we were able to find solutions to more complicated issues.”

To the question if the bank has been prepared for the difficult macroeconomic environment marked by dwindling foreign reserves and a growing external funding gap after the conversion, which was exacerbated by the floods, he replied, “Political factors are at play in the current economic crisis. We have a loan-based economy. The real issue is the rapid reduction of our foreign exchange reserves.”

He believes international lenders would be willing to finance the country once there is political stability. Due to increased imports and decreased exports, the country constantly has a trade deficit. So, we finance the current account deficit through foreign borrowings.

According to him, the conversion of the bank does not expose it to any new challenges rather in these challenging times, Islamic banks will be able to manage their borrowing customers in a better way as they are involved with them at operational level and have a better insight of the issues being faced by their customers,

Ali hopes the country's Islamic finance industry will benefit from FBL becoming a fully-fledged Islamic bank. He thinks the bank is now in a position to assist the industry with the conversion process. Banks can use FBL’s illustration of a smooth switch to Islamic financial products as a reliable guide.

He said there are discussions in some banks about conversion but they are at the primary level. Nobody has decided a complete conversion. To render Pakistan’s economy Riba-free in accordance with the Shariah Court’s ruling, the central bank may issue regulations that require all banks to gradually move from the conventional model to an Islamic one.

Business transformation benefits all banks, whether they are big, medium-sized, or small. Although the bank’s balance sheet may differ, its customer base is often similar. “We find a small customer in a big bank and a large customer in a small bank. The conversion process is going to be the same irrespective of the size of the bank,” he said.

However, the capital problems facing small banks would not be resolved by the conversion. Such a thought was a fallacy that weak banks that could not meet the capital requirements should be turned into Islamic banks to reduce their risks.

Conversion has no financial benefit for undercapitalised financial institutions. Revamping the workflow, accounting, and core banking IT systems for the financially troubled bank would be expensive. The weaker bank would only get stronger if its business grows and clientele increases rather than if the model changes, he added.

Islamic finance is seen as a key feature that could help attract more people into the financial system. It can boost financial inclusion especially in the rural areas where a majority of households in the country of about 230 million avoid interest-based finance, mostly for religious reasons.

On the lending side, Faysal Bank has been a very strong player. In terms of corporate financing, it competes with the big banks, Ali said. Following conversion, the bank's emphasis would be more on the financing side than on sukuk investment. “The advance-to-deposit ratio at the bank is 65 percent and we intend to keep it at this level.”

The bank wants to capitalise on its branch network, expanding it to 1,000 over the next two-three years, he said.

Converting conventional banks could enable them to tap the rising demand for Sharia-compliant products. Since it is the largest borrower in the country, the conversion is also advantageous to the government.

The traditional commercial banks mobilise deposits and make a profit from investing in risk-free T-bills and Pakistan Investment Bonds. According to Ali, the government would need to offer some assets through sukuk structure in order to obtain financing from Islamic banks. The asset-backed nature of Islamic finance makes sukuk the perfect choice for funding infrastructure projects and would bring discipline in the government’s borrowings forcing it to ensure that current expenses were not funded by borrowing. “We fully understand this will not happen overnight however; this will set the direction.”

Banks face a serious threat from financial technology firms because they may simply capture the flow of money depriving banks from a major source of revenue. He said a select few banks in Pakistan are embracing new technologies quickly however, on an overall basis the understanding and realisation of this threat is not there. “The banks should focus more on digitalisation and work closely with fintechs,” Ali added.