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ISLAMIC FINANCE & CAPITAL MARKETS

Digitizing Islamic Banking in Pakistan

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As the Fourth Industrial Revolution unfurls, bringing about groundbreaking advancements in artificial intelligence and technology, the broad inclusivity and scale of these breakthroughs within the business sphere are astonishing.

Predictive data from the Pew Research Center’s Forum on Religion & Public Life suggests a 35% surge in the Muslim population by 2030, culminating in a staggering 2.2 billion individuals, accounting for 26.4% of the world’s entire populace.

A recent study by UK’s digital banking service, Algebra, unveiled that out of 1.7 billion adults without banking access globally, about 800 million are Muslims.

These twin realities—a burgeoning Muslim demographic and a significant population without bank services—advocate a case that surpasses the mere digitization of Islamic finance. It underscores the necessity of incorporating Islamic digital finance as a transformative force, not just a compliant entity.

Islamic banks, by investing significantly in this sphere, can harness the power of technology to offer innovative and frictionless digital solutions to an enormous potential customer base worldwide. Such a strategic move could potentially bolster exports, fortify the Islamic finance sector’s global position, and position Pakistan as a principal hub for Islamic digital finance ventures.

In 2022, Islamic Finance News (IFN), a division of Malaysia’s RED money Group, named the State Bank of Pakistan (SBP) as the premier Central Bank worldwide for promoting Islamic Finance. This accolade from the respected IFN Best Banks Poll underscores the active endorsement and advancement of Islamic conversion by Pakistan’s regulator, the SBP, which aims for a more extensive and more influential Islamic banking sphere by 2028.

Embracing digitization along with affordable internet access and mobile phone penetration can extend the Islamic banks’ reach to a broader segment of the global Muslim population, including those in remote locations. This strategy ensures the consistent provision of innovative and seamless digital solutions across the Muslim world.

While Islamic banking has seen robust growth in countries like Indonesia, Malaysia, and the UK, traditional banking avenues remain vibrant. Pakistan, though, is uniquely positioned to wholeheartedly adopt Islamic banking and assert itself as a pioneer in Islamic banking digitization. The secret to success resides in adopting an inclusive model that stresses collaboration, stakeholder engagement, and strategic planning over a mere lending focus.

Illustrative cases like Indonesia’s Bank Syariah Mandiri (BSM) and Berlin-based Mambu stand as shining examples. BSM’s inception, closely mirroring Pakistan’s current situation, followed an economic and political crisis in Indonesia in 1999. Guided by a mix of business idealism and spiritual values, BSM has thrived.

Mambu, a software house specializing in Software-as-a-Service (SaaS) platforms, is now valued at over $5 billion. The company recently debuted its Sharia-compliant SaaS platform, employing automation, blockchain technology, and electronic contracts to streamline operations and bolster efficiency.

In the pursuit of digitalization, the smartphone emerges as an essential instrument. Ensuring affordable and accessible smartphones must be integral to this strategy. A consensus was reached at the recent ‘Leaders in Islamabad Business Summit 2023’ that connectivity is essential to tackle Pakistan’s myriad issues.

Equipping every citizen with a smartphone, extending network coverage, and crafting economic, educational, and social applications for Pakistan’s 240 million citizens could expedite progress in various areas. While educational and social shifts require time, financial inclusion can be achieved rapidly, creating a documented economy that benefits everyone.

While several apps currently exist, the emphasis should transcend simple transactions or debit/credit operations. The goal should be to provide a comprehensive banking experience where individuals have access to expert advice. As we traverse the Metaverse and navigate virtual orbits for sustenance and entertainment, the average person should feel confident that pressing the ‘X’ button on their screen secures a better and financially stable future.

Islamic digital finance offers precisely that security, especially considering over 1.7 billion people globally lack bank account access. It has the potential to revolutionize the financial scene for more than 1.8 billion underserved Muslims seeking Sharia-compliant solutions for their financial needs.

The restricted market size for Sharia-compliant financial products has impeded banks’ capability to cater to a tech-savvy new generation. As a result, Islamic financial institutions worldwide are actively exploring ways to leverage cloud-native solutions and API-driven architectures to establish an open banking ecosystem.

With five dedicated Islamic banks and 17 additional institutions offering standalone Islamic services, Islamic finance is already extending its footprint in Pakistan’s banking sector. This presents a perfect opportunity to not only support Islamic banking services but also disrupt the field by embracing Islamic digital finance with a global perspective.

Although challenges may seem daunting, significant accomplishments often emerge from discomfort. These challenges, though considerable, offer the potential for substantial benefits through digital disruption in the realm of Islamic finance.


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ISLAMIC FINANCE & CAPITAL MARKETS

How Shariah-Compliant is Islamic Banking?

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Islamic banking has garnered significant attention globally, especially among Muslim communities seeking financial solutions that align with their faith. Rooted in Shariah law, Islamic banking aims to offer an alternative to conventional banking by adhering to principles derived from the Quran and Hadith. But how Shariah-compliant is Islamic banking in practice? This comprehensive blog post explores the core principles of Islamic banking, the mechanisms ensuring Shariah compliance, and the challenges and criticisms faced by the industry.

How Shariah-Compliant is Islamic Banking?

Core Principles of Islamic Banking

Islamic banking operates on several fundamental principles that distinguish it from conventional banking:

  1. Prohibition of Interest (Riba): The most well-known principle is the prohibition of Riba or interest. Instead of earning interest on loans, Islamic banks earn profit through equity participation, trade, leasing, or investment in Shariah-compliant projects.
  2. Risk Sharing: Islamic banking promotes risk-sharing between the bank and its clients. This is achieved through profit and loss sharing (PLS) contracts, such as Mudarabah (profit-sharing) and Musharakah (joint venture).
  3. Ethical Investments: Investments must adhere to ethical and socially responsible principles. Islamic banks cannot invest in businesses involved in activities considered haram (forbidden) such as alcohol, gambling, and pork.
  4. Asset-Backed Financing: All financial transactions must be backed by tangible assets or services, ensuring that speculative practices (Gharar) are minimized.
  5. Transparency and Fairness: Contracts and financial transactions must be transparent, fair, and agreed upon by all parties involved.

Mechanisms Ensuring Shariah Compliance

To ensure adherence to these principles, Islamic banks implement several mechanisms:

  1. Shariah Boards: Each Islamic bank typically has a Shariah board consisting of Islamic scholars and experts in Islamic finance. This board reviews and approves all financial products and services to ensure they comply with Shariah principles.
  2. Shariah Audits: Regular Shariah audits are conducted to assess and verify that the bank’s operations and transactions comply with Shariah guidelines. These audits ensure that any deviations are promptly addressed.
  3. Product Structuring: Financial products are carefully structured to align with Shariah principles. Common products include:
    • Murabaha: A cost-plus-profit financing structure used for purchasing goods.
    • Ijara: Leasing agreements where the bank buys and leases out assets to clients.
    • Sukuk: Islamic bonds representing ownership in a tangible asset or a pool of assets.
    • Takaful: Islamic insurance based on mutual assistance and shared responsibility.
  4. Continuous Education and Training: Islamic banks invest in educating their staff and clients about Shariah principles and the importance of compliance. This helps maintain a high standard of Shariah adherence across all operations.

Challenges and Criticisms

Despite these mechanisms, Islamic banking faces several challenges and criticisms regarding its Shariah compliance:

  1. Standardization: There is no universal standard for Shariah compliance, leading to variations in interpretations and practices across different regions and institutions. This lack of standardization can create confusion and inconsistencies.
  2. Replicating Conventional Products: Some critics argue that certain Islamic banking products are merely replications of conventional banking products with minor modifications to appear Shariah-compliant. This raises questions about the authenticity of these products.
  3. Limited Shariah Expertise: There is a shortage of qualified Shariah scholars with expertise in both Islamic jurisprudence and modern finance. This scarcity can hinder the development and approval of innovative Sharia-compliant products.
  4. Operational Costs: Ensuring Shariah compliance can be costly due to the need for Shariah boards, audits, and continuous education. These costs can make Islamic banking products more expensive than their conventional counterparts.
  5. Market Perception: Some potential customers remain skeptical about the genuineness of Islamic banking, questioning whether it truly adheres to Shariah principles or if it’s merely a marketing strategy.

To address these challenges and enhance Shariah compliance, several measures can be taken:

  1. Developing Universal Standards: Efforts should be made to develop and adopt universal standards for Shariah compliance. Organizations like the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) are working towards this goal.
  2. Enhancing Shariah Governance: Strengthening Shariah governance frameworks and increasing the number of qualified Shariah scholars can improve compliance and innovation in Islamic banking.
  3. Transparency and Education: Increasing transparency in product structuring and operations, along with educating the public about the principles and benefits of Islamic banking, can build trust and acceptance.
  4. Innovation and Differentiation: Developing truly innovative and differentiated Islamic banking products that go beyond merely replicating conventional products can enhance authenticity and attractiveness.

Islamic banking, with its foundation in Shariah principles, offers a viable alternative to conventional banking for Muslims and ethically-minded individuals worldwide. While it faces challenges and criticisms regarding its Shariah compliance, ongoing efforts to standardize practices, enhance governance, and promote innovation are crucial for its growth and success. By addressing these issues, Islamic banking can better fulfill its promise of providing ethical, equitable, and Shariah-compliant financial solutions.


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ISLAMIC FINANCE & CAPITAL MARKETS

Afghanistan Central Bank Joins Global Islamic Economics Forum in Malaysia

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The Afghanistan Central Bank, also known as Da Afghanistan Bank, has recently sent a delegation to Malaysia to participate in the Global Forum of Islamic Economics and Finance. This forum aims to foster discussions on the development of Islamic banking, support for small and medium-sized enterprises (SMEs), and the expansion of financial markets. Haseebullah Noori, the spokesperson for the Central Bank, emphasized the significance of this event, highlighting that representatives from central banks and financial institutions from various countries are expected to attend.

Noori stated, “A delegation from the Afghanistan Central Bank traveled to Malaysia to attend the Global Forum of Islamic Economics and Finance. Representatives from central banks, Islamic banks, and financial institutions worldwide will also participate in this forum.” This gathering presents an excellent opportunity for Afghanistan to strengthen its financial sector and align with global banking standards.

In addition to attending the forum, the Afghan delegation is scheduled to meet with several Malaysian officials to discuss establishing and enhancing bilateral relations. These meetings aim to address various economic challenges and explore potential collaborations that could benefit both countries.

Economic experts in Afghanistan believe that standardizing the banking system and developing Islamic banking are crucial for the country’s economic growth. Shaker Yaqoubi, an economist, remarked, “The more our banking system in Afghanistan meets global standards, the better we can align with the global economy. Regulated trade and investment will take shape, and given that Afghanistan is an Islamic country, Islamic banking is a crucial need.”

The Chamber of Commerce and Investment in Afghanistan also stressed the importance of addressing the challenges related to money transfers through banks during these meetings. Mohammad Younis Momand, First Deputy of the Chamber of Commerce and Investment, expressed his hopes, stating, “We hope the global community and the Central Bank’s proposals will address Afghanistan’s banking issues so that the problems we face with money transfers can be resolved.”

Abdul Nasir Rashtia, another economist, added, “The more we normalize our relations with the world and lift sanctions and restrictions, the better we can expand our international trade and provide more facilities for traders.” The lifting of sanctions and restrictions is seen as a critical step towards enhancing Afghanistan’s economic stability and growth.

Previously, the acting governor of the Afghanistan Central Bank met with the Deputy Secretary-General of the United Nations to discuss the negative impact of international sanctions on Afghanistan’s banking sector. The acting governor emphasized that these sanctions have hindered the country’s financial stability and urged for their removal to foster economic growth.

The participation of the Afghanistan Central Bank delegation in the Global Forum of Islamic Economics and Finance is a strategic move towards integrating Afghanistan’s banking system with international standards and promoting the growth of Islamic banking. This initiative aligns with the broader goal of stabilizing Afghanistan’s economy and fostering sustainable development through enhanced financial cooperation and economic integration.

By addressing key issues such as money transfer challenges and advocating for the lifting of sanctions, Afghanistan aims to create a more conducive environment for trade and investment. The focus on Islamic banking, given Afghanistan’s cultural and religious context, further underscores the importance of this financial model in the country’s economic landscape.

As Afghanistan continues to navigate its economic challenges, the efforts of the Central Bank to engage with international counterparts and seek collaborative solutions are vital. The outcomes of the forum and subsequent meetings with Malaysian officials are anticipated to pave the way for significant advancements in Afghanistan’s financial sector, contributing to the overall economic resilience and prosperity of the country.


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ISLAMIC FINANCE & CAPITAL MARKETS

ICB Islamic Bank Faces Challenges in Repaying Depositors

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By Ameer Yaqub

The ICB Islamic Bank, which emerged from the collapse of Oriental Bank in 2008, is currently grappling with a severe liquidity crisis that has left it unable to repay depositors. This situation underscores the vulnerabilities within the bank and the broader challenges facing the Islamic banking sector in Bangladesh.

The crisis has had a direct impact on depositors. Abdul Hamid Mahbub, with a deposit of Tk 1,00,000 at the bank’s Moulvibazar branch, recently faced the stark reality of the bank’s financial troubles. “On Tuesday, I went to the bank with a cheque for Tk 55,000, but the branch manager said they had no money at the time,” Mahbub told The Daily Star. Similar stories are being reported across other branches, including in Dhaka’s Paltan and Karwan Bazar areas.

In a bid to mitigate the crisis, ICB Islamic Bank sought Tk 50 crore in collateral-free liquidity support from Bangladesh Bank (BB) on January 31. However, this plea was denied two weeks later due to the bank’s existing liabilities, which total Tk 425 crore. BB’s Off-site Supervision Department has since requested the Banking Regulation and Policy Department to take corrective measures, as the bank’s operations are severely hampered by the liquidity crunch.

The liquidity crisis is compounded by a range of systemic issues. ICB Islamic Bank is dealing with frozen deposits, a significant capital shortfall, and high levels of defaulted loans. As of the end of 2023, the bank faced a capital shortfall of Tk 1,823 crore, with 87% of its total loans amounting to Tk 790.4 crore classified as bad.

The crisis has also affected the bank’s ability to pay its employees. Currently, ICB Islamic Bank employs 350 people across 33 branches, and delays in salary payments have become routine. According to Muhammad Shafiq Bin Abdullah, the bank’s managing director, the influx of depositors seeking withdrawals has exacerbated the situation. “This year, we repaid our depositors Tk 50 crore,” Shafiq noted, emphasizing the unprecedented nature of the current crisis.

Legal complexities surrounding the bank’s ownership have further muddied the waters. Issues stemming from its previous owner, Orion Group, have left ambiguities regarding current ownership, and a related case is still pending in court. This uncertainty has hindered efforts to stabilize the bank and secure necessary funds.

ICB Islamic Bank’s roots trace back to 1987 when it operated as Al-Baraka Bank. It was rebranded as Oriental Bank in 2004 and later dissolved by the central bank in 2006 due to significant irregularities. The restructured bank renamed ICB Islamic Bank in 2008, saw Swiss ICB Group and Malaysian investors take majority ownership. Despite these changes, the bank has struggled to achieve financial stability.

Efforts are ongoing to address the liquidity crisis. Md Mezbaul Haque, executive director and spokesperson of Bangladesh Bank, highlighted that a large portion of ICB Islamic Bank’s funds are tied up with leasing companies, contributing to the liquidity shortfall. “We asked the Malaysian shareholder of the bank to inject fresh funds,” he stated, expressing hope that the crisis could be resolved soon.

ICB Islamic Bank’s struggle to navigate this crisis is a crucial test for the resilience of the Islamic banking sector in Bangladesh. While the bank’s management remains hopeful, the path to recovery will require strategic interventions, regulatory support, and renewed confidence from depositors and stakeholders.


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