Islamic finance industry: Diversity of challenges

Islamic banks are constantly challenged with excess liquidity and the country is constantly in dire need of funds. Sounds like a heavenly match. However, their paths often do not cross and union is fraught with challenges.

Recently, the Commodity Exchange of Pakistan, Pakistan Mercantile Exchange (PMEX) developed a Commodity Murabaha product for banks’ treasuries to place excess liquidity. The banks would purchase and sell a variety of commodities on the exchange. The product was allowed to be used by banks as a pilot project for three months from December 2017 till March 2018. And was developed with the close liaison of SBP, SECP, PMEX and Shariah technical advisors of Meezan Bank.

The structure uniquely allowed banks to take delivery of Hi-Speed Diesel. The structure prevalent at say London Metal Exchange lacks the Shariah compliance factor of providing delivery before resale. The trading of this product is on hold. The three months of pilot transactions are under scrutiny at the SECP’s Shariah Advisory Board (SAB) which would like to closely evaluate the transactions’ compliance. Generally, a diverse background of scholars has led to variety of interpretations of Islamic laws which need “Ijtehad” or agreement of scholars. However, this process is a much desired one. The convergence of various schools of thought on processes and products will lead to wider acceptability of Islamic finance within the religious circles and the unbanked population.

Unity in diversity – is a much vied for dream for the Islamic finance industry. The newly constituted Shariah Advisory Committee (SAC) of the State Bank of Pakistan is the rebirth of earlier Shariah Advisory Board. The SAC has various scholars from different schools of thought.

The regulator of the capital markets and NBFI sector, Securities and Exchange Commission of Pakistan has also its own Shariah Advisory Board with its own set of views.

The growth of the Islamic banks has surpassed the conventional banks (Dec 2017: 20% as against 17.5%), driven by various factors topping the list is product innovation. Most banks portfolio has increased due to higher investment in Running Musharaka which provides working capital financing. The sector has also maintained its lead in mainly consumer and commercial auto financing and housing finance.

The industry mired by capital adequacy issues, excess liquidity and lack of trained human resources is crying out loud for the liquidity management GoP instruments and level playing field. “To place even greater restrictions through inclusive diversity of views is pushing us further to the corner” confided a senior banker.

To add to their woes, the current Sukuk availability of Rs 385 billion is due to mature in December, Feb and March, respectively. Where the demand is nothing short of Rs 600-700 billion, the IBs demand for government’s attention towards Sukuk has never fallen short of criticism.

Given all the faults with this argument for liquidity management, project financing provides the swiftest route to scale in a country need of developmental funds. Dr Ishrat Husain rightly points out in his Working Paper “Financial Stability and Islamic Finance” that, “the focus on long-term infrastructure financing with public-private partnerships needs due focus from the IFIs.”

Agri, SME financing and digitization efforts are under way but the speed and scale are too slow to make an immediate economic difference. Not to mention, the Islamic bankers lament, regulatory infrastructure places similar demands on conventional and Islamic banks, forcing IFIs not to think of out the box. The additional challenge of convergence among scholars of various schools seems limiting at the moment, however, it offers long-term benefits.

An enabling environment, including convergence of divergent views among different schools, would hopefully, soon surface to help resolve excess liquidity problem for opening to new segments of the economy for Islamic banking and help realize its full potential unleashed by the Islamic welfare state now on the agenda of the present government.