Islamic Banking – A Hedge Against Man-made Crisis

Islamic Banking – A Hedge Against Man-made Crisis

by Mohiuddin Aazim | Published on 9/19/2009

Islamic banking remained least affected by the global financial crisis. It experienced some problems only after this crisis had snowballed into a recession in developed economies affecting growth prospects of Pakistan and other developing countries.

But the industry has almost overcome these problems and now most of its indicators are showing a “reversion towards the usual high growth trend,” according to the latest State Bank report.

The share of the assets of Islamic banking in overall banking industry grew from 3.4 in June 2007 to 5.1 per cent in June 2009: In terms of value, these assets increased 97 per cent—from Rs159 billion to Rs313 billion. Total deposits jumped 120 per cent—from Rs108 billion or 3.1 per cent of the banking industry to Rs238 billion or 5.2 per cent.

And the total financing and investment rose from Rs90 billion to Rs195 billion showing a handsome growth of about 117 per cent. In the last two years, the share of financing and investment of Islamic banks in overall banking industry went up from 2.6 to 4.2 per cent.

Three things have apparently helped in this phenomenal growth. “First, it had a narrow base in June 2007,” says the head of a large local Islamic bank. “Second, Islamic banking has a mass appeal. And third, it has some inbuilt characteristics that offer a better cushion against man-made crises.”

That the unique features of Islamic financing do protect banks from the elements of man-made crises is all but evident: Total assets of top 100 Islamic banks grew more than 66 per cent to $580 billion in 2008 from $350 billion in 2007. In contrast, the asset of top 100 commercial banks in Asia (the region that was not in the centre of the financial crisis) posted only 13.4 per cent growth. And according to reports in international media. global Islamic banking is set to grow up to 30 per cent in 2009 as well.

What has boosted the reputation of Islamic banks as the institutions that can shield their clients against crises is their conservative approach to business, a balanced and ordered appetite for growth, a more equitable risk sharing and focus on the basics of banking as opposed to rapid innovation.

“All these factors, which used to be perceived as weaknesses before the credit crisis began, are now being used as shields against the potential damages of imported stress,” says a Moody’s report adding that in the short-term, in times of crisis, “clients may find it more comfortable doing business with an Islamic bank.”

In Pakistan, clients have really begun to find it comfortable doing business with Islamic banks as is evident from the growing numbers of the Islamic banking branches across the country. In June 2007 there were 162 bank branches providing Islamic banking. These included the branches of six fully-fledged Islamic banks as well as those of the conventional banks.

In June 2009, the number of Islamic banks shot up to 18 and the number of total bank branches providing Islamic banking more than tripled to 528.

Islamic banking facilities are available in almost all parts of the country and they have a strong presence in Karachi—the hub of commercial banking. Besides, Islamic banking offers a wide range of products for both depositors and borrowers.

The availability of suitable modes of financing has attracted corporates as well as consumers towards Islamic banks. These banks have also been able to attract deposits of various types and from different classes of bank clients.

Lately, Islamic banks expanded their corporate clientele also because conventional banks became a bit averse to lending to the private sector after their non-performing loans (NPLs) went up.

A conservative approach to banking has also kept consumer loans portfolio more stable than that of the conventional banks. And Islamic banks have a better mix of fixed and saving accounts than the conventional banks. This is primarily because it is possible for Islamic banks to design fixed deposits schemes without the element of Riba.

Despite all these plus points of Islamic banking it did not entirely escape the after-effects of the global financial crisis and recession. The pre-tax profit of the industry declined about 18 per cent in the last fiscal year. But here again the rate of decline was lower than in case of conventional banks that saw their earnings fall by 31 per cent during this period.

Officials of Islamic banks, however, point out that profitability of Islamic banking has picked up from April-June 2009 quarter wherein its pre-tax profit showed an increase of more than 150 per cent. They hope that the trend would continue as the economy is showing signs of improving after posting a growth of just two per cent in the last fiscal year. In case of Islamic banks, it is the domestic economic slow down that directly affects them.

Islamic bankers say that Islamic banking would grow faster in future once they are able to penetrate into so far unexplored areas of agricultural financing and increase their portfolio of SMEs financing. Till June 2009, the industry had very negligible exposure to agricultural financing and the share of SMEs in overall financing was a mere 8.6 per cent.

Islamic bankers admit that despite a rapid expansion of Islamic banking branches, rural areas are still least-served by them. Wherever Islamic banking outlets operate, they focus on consumer financing rather than on agriculture loaning.

The State Bank has issued guidelines for agricultural financing by Islamic banks and they have made a modest Rs100 million agricultural financing, for the first time, in April-June 2009. Islamic banks are drawing strategies to tap this area of financing keeping in view the thorniest issue of recovery of loans.

SOURCE: http://www.accountancy.com.pk/articles.asp?id=186