Islamic Banking and Profitabiltiy in Pakistan

Page 1 of 34

Islamic Banking and Profitabiltiy in Pakistan

By | April 2008
Page 1 of 34
1. Introduction
In the last two decades, Islamic banks have grown in size and number around the world. Islamic banks operate in over 60 countries, but in Iran, Pakistan and Sudan, the entire system has been converted to Islamic banking. In other countries, banking systems are dominated by secular/conventional banking institutions operating parallel to Islamic banks, yet Islamic banking is the fastest growing segment of the credit market in Muslim countries (that have Islamic banks). Since the 1970’s, their market share has risen from 2% to about 15% today as measured by assets in the banking system. The market’s current annual turnover is estimated to be $70 billion, compared with a mere $5 billion in 1985, and was projected to hit the $100 billion mark by 2000. This trend began with the oil booms of the 1970’s and 1980’s, but now Islamic banks are generally the product of private initiative in non-oil-exporting countries .

It is therefore imperative to study the growth of this sector in Pakistan and how it is affecting profitability of the banking sector since this has far reaching implications on its implementability and sustainability in the emerging financial services sector in Pakistan

1.1 Background: The Evolution of the Pakistani Banking Sector Islamic banking is a financial innovation, and has come to be seen as the most 'visible' aspect of Islamization. In Pakistan it was introduced with the wave of Islamization in the mid eighties and finally in December 1999, the Supreme Court banned riba in banks, saying it was not in the spirit of Islam (Hassan, 2002). The Islamic financial system is founded on the absolute prohibition of the payment or receipt of any predetermined, guaranteed rate of return. This closes the door to the concept of interest and precludes the use of debt-based instruments. The system encourages risk-sharing, promotes entrepreneurship, discourages speculative behavior, and emphasizes the sanctity of contracts. Islamic law...