Key Note Address of Mr. Muhammad Kamran Shahzad Deputy Governor State Bank of Pakistan at The 3rd International Conference & Exhibition on Islamic banking & Takaful Islamabad, 2nd November 2009 Organized by

First of all I would like to congratulate the organizers of this 3rd International Conference & Exhibition on Islamic Banking and Takaful on organizing this auspicious event. Such international events are needed for projecting the efforts of Pakistan in the promotion of Islamic banking and Takaful as well as for the sake of knowledge sharing and dissemination.

 Islamic banking has grown at a rapid pace in past few years. Both the local and global Islamic Financial Services Industry (IFSI) shared this trend. The main drivers of this tremendous growth are (1) faith based nature of Islamic Finance, (2) surplus liquidity in the GCC market, and (3) the interest of world’s influential financial centres. In Pakistan, this growth has resulted from the highly positive response of private sector to policies for promotion of Islamic banking and finance introduced after 2001 by the State Bank of Pakistan. Collectively these factors have contributed to evolution of new and innovative products by Islamic Financial Industry in tandem with a strong and Shariah Compliant regulatory framework. According to an estimate, total Shariah compliant assets worldwide have grown to about US$ 700 billion – with annual growth exceeding 10.0 percent during the past decade  - and are projected to grow to US$ 1.6 trillion by 2012.   

These facts primarily have two important implications; (1) Islamic Finance is there to stay with a continual increase in its share in world financial industry, and (2) Islamic Finance is not confined to traditional boundaries and is attracting clients from major world economies like UK, Japan, China, France, Singapore, Hong Kong and US. The focus is not merely confined to Muslim countries as there is a growing need to redefine and reposition the Islamic Financial Services Industry in global economy in order to fully appreciate its potential. The diverse locations as Africa, Syria, and Sri Lanka are also on the roadmap.

The global market perceives Islamic Finance as an advantageous opportunity to diversify that will not affect their existing business adversely. Interestingly, Islam at times is related to conservatism but Islamic finance has proven a radical and choice enhancing avenue. The ethically oriented financial solutions are closely tied with overall social benefit. Islamic financial institutions (IFIs), while not directly impacted by the repercussions of the recent global financial crisis, did experience the knock-on risks transmitted through indirect channels like downturns in real estate and equity markets coupled with a rise in Non-performing financing emanating from slow-down in economy. The emergence of these risks as a consequence of the financial crisis has brought forth the realization that IFIs, while resilient to adverse developments, are not risk immune. The defining features of Islamic Finance are its close links with the real economy and inbuilt prohibitions against interest, excessive uncertainty and speculation. Looking at the Islamic financial intermediation model, we will see that it is based on:

• Involvement of real economic activity for generation of income and wealth,
•  Ethical and social responsibility,
• Avoidance of over leveraging and excessive speculative activities, and
•  Inclusive financial services growth such that all segments of the population get access.

The asset base of the Islamic Banking Institutions (IBIs) in Pakistan on average has grown at around 59 percent per annum since 2005. The growth in the deposit base and the ongoing expansion in outreach, based on the number of branches, is also impressive. As a proportion of the overall banking industry, the combined share of Islamic banking industry is 5.2 percent in deposits, and 5.1 percent in assets, as of end-June 2009. In 2008 as well assets of Islamic banking industry grew by 34% as compared to growth of overall banking industry by 8.8%. State Bank of Pakistan’s strategic plan for Islamic banking industry launched in 2008, aims to increase the size of the industry to 12.0 percent (of total banking assets) by 2012. In essence, the focus of the strategic plan is: (i) to extend the outreach of Islamic banking services by covering a broad-based geographical area and encouraging product development, (ii) strengthen the Shariah-compliance mechanism and regulatory support, while (iii) building the capacity of Islamic banking institutions. Islamic banking industry is duly supported by the non-banking Islamic financial sectors like Takaful, Islamic Mutual and Pension Funds, Modarabas etc., which are playing a complementary role for development of a comprehensive Islamic financial system.

The Islamic Financial Services Industry needs to further strengthen itself to continue its growth and acceptability. The main target areas include:  (1) financial inclusion of SME, Agriculture and Microfinance, (2) Regulatory and Shariah Compliance Framework, (3) awareness and capacity building, and (4) greater coordination with stakeholders both locally and globally.

Financial Inclusion
The three most notable financially excluded areas are Microfinance, Agriculture finance, and SME. In my view Islamic finance is better placed to cater to the needs of these sectors, as people that are reluctant to deal with the conventional finance on religious grounds would have access to financial services. Moreover, this will help in achieving the most important objectives of the Islamic economic system, that is, fair distribution and non-exploitative economic dealings. State Bank has announced policies for Islamic microfinance  and would encourage the sponsors and promoters to establish Islamic microfinance institutions, which can provide financial services to the public in accordance with their faith. Reducing transaction costs is particularly important for enabling access for micro and small enterprises, which can be achieved through technology based solutions or using the vast network of mosques and religious places at a very low cost.

Another potential area is Agriculture and agro based industry. Agriculture finance could prove to be a very powerful tool for poverty alleviation especially in agrarian economies like Pakistan. This is even more pertinent nowadays as the Agriculture finance could lead to food self-sufficiency thus helping the domestic economy to reduce and stabilize commodity prices.  While, most banks do not have rural branch network or/and agricultural lending expertise. As a result, significant number of Agriculture population still relies heavily on informal financial arrangements and there is a need for development of products for Islamic agriculture finance by Islamic banking industry. Realizing the importance of this sector, State Bank has issued Guidelines for Islamic Agriculture Finance, which can be used by Islamic banks in this regard.  

Regulatory and Shariah Compliance Framework
Devising a regulatory framework for Islamic finance is challenging as some regulations are imposed from a Shariah standpoint while most of the conventional banking regulations based on prudential standards are also applicable. Collaborative efforts across jurisdictions have improved credibility of Islamic Finance in the global financial industry. Many international institutions like Islamic Financial Services Board, Accounting and Auditing Organization for Islamic Financial Institutions, Islamic Development Bank, International Islamic Financial Market, International Islamic Rating Agency are playing a key role in this regard. Pakistan has played an active role in these initiatives and would continue to support them.

The legal and regulatory framework for Shariah compliance in Pakistan is regarded as among the best ones in the world duly supported by the Constitution of Islamic Republic of Pakistan, judicial system and supporting legislation, regulations and supervision. We have further strengthened it in the Draft Banking Act, which includes specific  provisions relating to Islamic banking and addresses the concerns like banker-customer relationship, deposit taking, legal cover to Shariah Board of State Bank and Shariah Advisors of Islamic banks, issues in liquidation, etc. We are further augmenting the regulatory framework by adopting or adapting the international standards issued by above mentioned international organizations in a gradual manner after a careful study in collaboration with the stakeholders. Shariah compliance inspection of Islamic banking institutions recently started by State Bank and the requirements for publishing the report of Shariah Advisor in annual accounts would boost the public confidence. Recently, one of the conventional bank has been granted permission by the State Bank to convert their Islamic banking branches into an Islamic banking subsidiary. We would encourage the other players having Islamic banking branches to convert themselves into Islamic banking subsidiary, whether individually or jointly.

Capacity building and awareness
The envisaged phenomenal growth in Islamic finance will further amplify the human resource needs. Developing human resource would be a greater challenge as Islamic banks need professionals that not only understand Islamic finance but also have appropriate skill set for banking operations.  The Human resource need would particularly be more pressing in areas like product development, risk management, Shari’ah compliance and audit. The growing demand for Islamic banking professionals necessitates a corresponding growth in Islamic finance training. As a part of our Strategy for Islamic Banking, we plan to establish an Islamic finance training institute in collaboration with the Islamic banking industry in near future. Islamic banking industry also needs to follow the good example set by Takaful operators in developing a generic campaign for Islamic banking and finance for greater awareness among public.

Coordination with Stakeholders
Coordination is also required among various government authorities to ensure a level playing field for Islamic Financial Institutions. Some countries, like Malaysia, UK, Singapore and most recently France; have used tax neutrality and exemptions to help kick start IBs besides providing a level playing field for competing with the well established conventional banking. In Pakistan, amendments in tax laws have been introduced to facilitate Islamic banking transactions and we are coordinating with Securities and Exchange Commission of Pakistan for development of Non-bank Islamic financial institutions.

SBP plans to further streamline the cross border coordination with international institution by taking initiatives like; (1) seek technical assistance from IRTI/IDB, IFSB and INCEIF for education, training and conferences, (2) supporting IIFM in workshops for development of Islamic financial market, (3) encouraging Islamic financial institutions of Pakistan to seek membership in IFSB and opening of overseas branches.

Conclusion
Globally Islamic Financial Services Industry has made commendable progress in the last few years. The pace of growth remained much higher compared to the conventional finance industry. All major stakeholders and industry experts unanimously expect the trend to continue in medium to long term.  I agree with positive outlook of the global Islamic Financial Services Industry, but there is no room for complacency. There is still a lot to be done. We have to move forward and work for achieving the core and fundamental objective of an Islamic economic system. Last but not the least, the State Bank will continue its efforts to strengthen regulatory infrastructure in order to ensure that Islamic banking in Pakistan continues to grow fast and on sound footings.