The Federal Shariah Court of Pakistan (FSC) has issued a court order for the government to eliminate interest from domestic or foreign borrowings by 2027. Riba, as it is known within Islam, is most closely translated in English as 'usury', and is prohibited by the faith. But previous attempts at creating an interest-free economy have failed to materialise, or at least they have had spillover repercussions for the country’s banking sector, according to Fitch Ratings.
FinanceAsia sat down with the rating agency’s global head of Islamic finance, Bashar Al Natoor, and associate director, Saif Shawqi, to discuss what the latest move might mean for Pakistan’s Islamic finance industry.
“The recent regulatory push, if realised, could give a good boost to the Islamic finance industry,” Al Natoor believes. “Additionally, there is a lot of potential because of low banking penetration, and because the government has funding needs.”
As of June 21, Pakistan had $13.6 billion worth of outstanding sukuk, representing 1.8% of the global sukuk market, an analysis by Fitch Ratings for FA revealed. Around $3.5 billion of Pakistani sukuk have been issued year-to-date (as of 21 June 2022), equivalent to 85% of the full sukuk volume issued by the market in the 2021 calendar year.
Despite having the second-largest Muslim population after Indonesia, Pakistan’s Islamic finance industry remains relatively nascent next to other Muslim-majority nations such as Malaysia, Dubai and Kuwait. Moreover, its sukuk listings remain entirely domestic.
“To call a country a ‘hub’ would entail business incoming from the outside; for example, sukuk listings coming in from abroad, or international investors coming in. I would not call Pakistan a ‘hub’; I would call it one of the top 10 Islamic finance markets because of the size of its Islamic banking industry, plus the sukuk industry,” Al Natoor explained.
In contrast, Malaysia has been developing an Islamic finance framework since the establishment of pilgrimage fund, Tabung Haji, in the 1960s, and Kuala Lumpur is home to the renowned International Centre for Education in Islamic Finance (INCEIF) University.
Dubai’s Nasdaq counts multiple international sukuk listings, including three sukuk issuances by the government of Indonesia in June this year, which totalled $3 billion, and a $1.6 billion sukuk issuance by the Saudi Arabia-based Islamic Development Bank (IsDB), in April.
Earlier attempts
The latest court ruling affirms the country’s efforts to promote Islamic finance, but it is not the first time that Pakistan’s government has tried to implement an interest-free environment, Al Natoor shared.
“The recent push is something that is interesting. The way that it's going to pan out is still uncertain,” he said.
Addressing why previous attempts have failed, Al Natoor pointed to the importance of having a stable operating, political, and economic environment, for Islamic finance to flourish.
“I think there have been challenges on all of these three fronts [in Pakistan]. To say that this is the exact reason is difficult, but I think these are the key three factors that did not make these [earlier efforts] a reality.”
Pakistan has been plagued with political turbulence since its establishment in 1947. From the assassination of Benazir Bhutto in 2007, to the recent ousting of prime minister, Imran Khan, following a no-confidence vote in April this year, its political instability remains evident in modern times.
Another challenge for the market – and often a criticism of Islamic finance more broadly – is a lack of coherent standards and guidelines for sukuk issuers to follow.
“This is one of the key challenges in Pakistan,” commented Shawqi.
“The regulators in Pakistan are increasingly looking to adopt the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) Shariah Standards for accounting auditing and governance, but we haven’t seen a complete adoption on the regulatory front.”
“There are many fronts where the regulatory framework in Pakistan needs development, including on the liquidity management side,” he added.
Al Natoor highlighted two key drivers for the success of Islamic finance. The first, he explained, is support by an authoritative government that is able to take a “top-down” approach to implementing rules across the domestic financial ecosystem. He said that it is the responsibility of the government to cultivate an environment that enables Islamic finance to operate “on an equal footing” to conventional finance.
He cited Malaysia as an example of a country where the government has provided support that has been conducive to Islamic finance's development. According to Al Natoor, through incentives and benchmarks set by the government, Malaysia’s ringgit debt market now comprises 60% sukuk, and the share of Islamic banking within Malaysia's wider financial industry is approaching 40%.
The second factor, he explained, offers some balance: it is the “bottom-down” element of demand.
“If you look at Saudi Arabia, Islamic finance counts for around 84-85% of the entire financing in the country, mainly because you have an [entire] customer base that requires Islamic finance,” he said.
Pakistan has this demand, but is yet to fully tap into it, he notioned, partly due to the low penetration in banking and finance. “That is by itself is an opportunity,” he said, citing a World Bank report that found 13% of Pakistan’s unbanked population to be unwillingly to enter the banking sector because of a lack of products that are compliant with religious beliefs. A similar report from 2015 found this number to be 15% for the Middle East.
The country’s large rural population – which the World Bank places at just over 60% – also hampers the development of both Islamic and conventional finance in Pakistan, but is something that can be explored with the rise of fintech.
The country’s burgeoning venture capital industry could also play a key role in this, once it becomes better established, Al Natoor suggested.
