Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Islamic banking and finance wikipedia , lookup
Interbank lending market wikipedia , lookup
History of the Federal Reserve System wikipedia , lookup
Fractional-reserve banking wikipedia , lookup
Shadow banking system wikipedia , lookup
History of banking wikipedia , lookup
Land banking wikipedia , lookup
History of investment banking in the United States wikipedia , lookup
COMMERCIAL BANKING VERSUS ISLAMIC BANKING CHAPTER # 4 COMMERCIAL BANKS VERSUS ISLAMIC BANKS 4.1 COMMERCIAL BANKING IN PAKISTAN: A bank is a commercial or state institution that provides financial services, including issuing money in various forms, receiving deposits of money, lending money and processing transactions. A commercial bank accepts deposits from customers and in turn makes loans based on those deposits. Some banks (called Banks of issue) issue banknotes as legal tender. Many banks offer ancillary financial services to make additional profit; for example, most banks also rent safe deposit boxes in their branches. Central banks are non-commercial bodies or government agencies often charged with controlling interest rates and money supply across the whole economy. They generally provide liquidity to the banking system and act as Lender of last resort in event of a crisis. The banking sector in Pakistan has been going through a comprehensive but complex and painful process of restructuring since 1997. It is aimed at making these institutions financially sound and forging their links firmly with the real sector for promotion of savings, investment and growth. Although a complete turnaround in banking sector performance is not expected till the completion of reforms, signs of improvement are visible. The almost simultaneous nature of various factors makes it difficult to disentangle signs of improvement and deterioration. Commercial banks have been exposed and withstood several types of pressure since 1997. Some of these are: 39 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING Multipronged reforms introduced by the central bank, Freezing of foreign currency accounts. Continued stagnation in economic activities and low growth. Drive for accountability and loan recovery. All these have brought a behavioral change both among the borrowers as well as the lenders. The risk aversion has been more pronounced than warranted. Commercial banks operating in Pakistan can be divided into four categories: 1)Nationalized Commercial Banks (NCBs). 2) Privatized Banks. 3) Private Banks. 4) Foreign Banks. While preparing this report efforts have been made to evaluate the performance of each group which enjoy certain strengths and weaknesses as per procedure followed by State Bank of Pakistan (SBP). The central bank has been following a supervisory framework, CAMEL, which involves the analysis of six indicators which reflect the financial health of financial institutions. These are: 1) Capital Adequacy. 2) Asset Quality. 3) Management Soundness. 4) Earnings and Profitability. 5) Liquidity. 6) Sensitivity to Market Risk. 40 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING Capital Adequacy To protect the interest of depositors as well as shareholders, SBP introduced the risk-based system for capital adequacy in late 1998. Banks are required to maintain 8 per cent capital to Risk Weighted Assets (CRWA) ratio. Banks were required to achieve a minimum paid-up capital to Rs 500 million by December 31, 1998. This requirement has been raised to one billion rupee and banks have been given a deadline up to January 1, 2003 to comply with this. The ratio has deteriorated after 1998. However, it was fallout of economic sanctions imposed on Pakistan after it conducted nuclear tests. The shift in SBP policy regarding investment in securities also led to a fall in ratio. Asset Quality Asset quality is generally measured in relation to the level and severity of non-performing assets, recoveries, adequacy of provisions and distribution of assets. Although, the banking system is infected with large volume of NPLs, its severity has stabilized to some extent. The rise over the years was due to increase in volume of NPLs following enforcement of more vigorous standards for classifying loans, improved reporting and disclosure requirements adopted by the SBP. In case of NCBs this improvement is much more pronounced given their share in total NPLs. In case of privatized and private banks, this ratio went up considerably and become a cause of concern. However, the level of infection in foreign banks is not only the lowest but also close to constant. 41 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING Management Soundness Given the qualitative nature of management, it is difficult to judge its soundness just by looking at financial accounts of the banks. Nevertheless, total expenditure to total income and operating expenses to total expenses help in gauging the management quality of any commercial bank. Pressure on earnings and profitability of foreign and private banks caused their expenditure to income ratio to rise in 1998. However, it started tapering down as they adjusted their portfolios. An across the board increase in administrative expenses to total expenditure is visible from the year 1999. The worst performers in this regard are the privatized banks, mostly because of high salaries and allowances. Earnings and Profitability Strong earnings and profitability profile of banks reflects the ability to support present and future operations. More specifically, this determines the capacity to absorb losses, finance its expansion programme, pay dividend to its shareholders and build up adequate level of capital. Being front line of defense against erosion of capital base from losses, the need for high earnings and profitability can hardly be overemphasized. Although different indicators are used to serve the purpose, the best and most widely used indicator is return on assets (ROA). Net interest margin is also used. Since NCBs have significantly large share in the banking sector, their performance overshadows the other banks. However, profit earned by this group resulted in positive value of ROA of banking sector during 2000, despite losses suffered by ABL. 42 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING Foreign currency deposits became less attractive due to the rise in forward cover charged by the SBP. Banks reduced return on deposits to maintain their spread. However, they were not able to contain the decline in ROA due to declining stock and remuneration of their earning assets. Liquidity Movement in liquidity indicators since 1997 indicates the painful process of adjustments. Ratio of liquid assets to total assets has been on a constant decline. This was consciously brought about by the monetary policy changes by the SBP to manage the crisis-like situation created after 1998. Both the cash reserve requirement (CRR) and the statutory liquidity requirement (SLR) were reduced in 1999. These steps were reinforced by declines in SBP's discount rate and T-Bill yields to help banks manage rupee withdrawals and still meet the credit requirement of the private sector. Sensitivity To Market Risk Rate sensitive assets have diverged from rate sensitive liabilities in absolute terms since 1997. The negative gap has widened. Negative value indicates comparatively higher risk sensitivity towards liability side, while decline in interest rates may prove beneficial.6 4.1.1 Deposit Mobilization 6 Kazmi, Shabbir H. (2003, Dec). SBP Executive Director thought. Commercial banking in pakistan: State bank of pakistan, 2006 43 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING Deposit mobilization has dwindled considerably after 1997. Deposits as a proportion of GDP have been going down. Growth rate of overall deposits of banks has gone down. However, the slow down seems to have been arrested and reversed in year 2000. Group-wise performance of deposit mobilization is the reflection of the varying degree with which each group has been affected since 1998. Foreign banks were affected the most due to their heavy reliance of foreign currency deposits. They experience 14 per cent erosion in 1999. However, they were able to achieve over 2 per cent growth in year 2000. Private banks showed similar recovery. Deposit mobilization by NCBs seems to be waning after discontinuation of their rupee deposit schemes linked with lottery prizes. Growths in their deposits were on the decline. Despite the decline NCBs control a large share in total deposits. Aggressive posture of private banks in mobilizing more deposits in year 2000 is clearly reflected in their deposit growth, from 1.9 per cent in year 1999 to 21.7 per cent in year 2000. This has also helped them in increasing their share in total deposits to over 14 per cent in year 2000. Despite offering negative real rate of returns on deposits, the banking sector recorded double-digit deposit growth for third year in a row, primarily on the back of a continuing improvement in the country’s external account. 44 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING 4.1.2 Credit Extension Bulk of the advances extended by banks is for working capital, which is self-liquidating in nature. However, due to an easing in SBP's policy, credit extension has exceeded deposit mobilization. This is reflected in advances growing at 12.3 per cent in year 1999 and 14 per cent in year 2000. Group-wise performance of banks in credit extension reveals three distinct features. 1) Foreign banks curtailed their lending. 2) Continued dominance by NCBs. 3) Aggressive approach being followed by private banks. 45 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING Private banks were the only group that not only maintained their growth in double-digit but also pushed it to over 31 per cent in year 2000. With this high growth, they have surpassed foreign banks, in terms of their share in total advances in year 2000. 4.1.3 Banking Spreads Over the years there has been a declining trend both in lending and deposit rates. Downward trend in lending rates was due to SBP policy. The realized trend in lending rates was in line with monetary objectives of SBP, though achieved with lags following the sharp reduction in T-Bill yields in year 1999, needed to induce required change in investment portfolio of banks. Downward trend in deposit rates was almost inevitable. One can argue that banks should have maintained, if not increased, their deposit rates to arrest declining growth in total deposits. However, this was not possible at times of eroding balance sheet, steady earnings were of prime importance. Consequently banks tried to find creative ways of mobilizing deposits at low rates. However, due to inefficiencies of the large banks, the spread has remained high. 4.1.4 Asset Composition Assets of banking sector, as per cent of GDP, have been on the decline. Slowdown in asset growth was also accompanied by changing share of different groups. Negative growth in the assets of foreign banks during 1998 and 1999 was the prime reason behind declining growth in overall assets of the banking sector. Share of NCBs have been decreasing since 46 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING private banks were allowed to operate in 1992. In terms of asset share, private banks are now as large as foreign banks. 4.1.5 Problem Bank Management The central bank is the sole authority to supervise, monitor and regulate financial institutions. It is also responsible to safeguard the interest of depositors and shareholders of these institutions. Lately, SBP took actions against two private banks, which became a threat to viability of the financial system in the country. These were Indus Bank and Prudential Commercial Bank. On the basis of detailed investigations, the license of Indus Bank was cancelled on September 11, 2000. After successful negotiations, management and control of Prudential Bank handed over to Saudi-Pak group. 4.1.6 Outlook Commercial banks have been going through the process of restructuring. There are efforts to reduce lending rates. The SBP has been successful in implementing its policies. Most of the banks have been able to adjust to new working environment. The proposed increase in capital base will provide further impetus to financial system in the country. In the post September 11 era, the GOP borrowing from SBP and commercial banks is expected to come down substantially and private sector borrowing to increase. However, a temporary decline in repayment ability of borrowers may increase provisioning for the year 2001. The situation is expected to improve in year 2002. 47 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING Unless efforts are made by banks to shrink spread, depositors will not be able to get return that corresponds with the rate of inflation in the country.7 4.2 COMMERCIAL BANKS MAKING HAY ROLE IN THE ECONOMY Banks earning, during 2006,grew by as much as 32 percent to reach Rs 60.1 billion as against Rs.45.6 billion in 2005. Commercial banks in Pakistan have made the most of the liberalization policies and reforms within the financial sector, which has given them the freedom to determine their lending and deposit rates as well as host of other charges. Their earnings, during 2006, grew by as much as 32 percent to reach Rs 60.1 billion as against Rs 45.6billion in 2005. The National Bank of Pakistan earned a profit after tax of Rs 17.02 billion, MCB bank Rs 12.14 billion, UBL Rs 9.47 billion, ABL Rs 4.40 billion, the Bank of Punjab Rs 3.80 billion. Askari bank Rs 2.25 billion, and Habib metropolitan Rs 2.1billion .The profits were driven mainly by rising net interest income of the banks which increased by 33 percent to Rs 115 billion in 2006 as compared to Rs 86 billion in the previous year. Growth in interest income came especially from higher spreads between lending and deposit rate of the banking sector. According to the state bank data, average spread of the banking sector during 2006 went up by 110 bps to 7.4 percent as compared to 6.3 percent in the preceding year and 4.1 percent in 2004.Non-interest income of the bank grew by 29 percent to Rs 43.2 billion. Dividend income also showed an unusual growth of 60 7 State bank of Pakistan, (2006) Annual report Karachi 48 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING percent, driven mainly by the record payout by mutual funds and other corporate. The huge profits earned during 2006 and the fact that this was the fifth consecutive year of positive profitability growth posted by the banking sector, is a proof that financial sector continuous to reap hay while the sun shines. This must be pleasant development for the shareholders of the banks and to a certain extent could be attributable to the increased efficiency of financial institutions following privatization. However, this is only a part of story.8 4.2.1 Financial Sector Reforms Financial sector reforms, particularly interest rate libralization and gradual reduction in the tax rate on the banking companies, also seem to have played a crucial role in raising the profitability of banks. In the last few months, some of the financial institutions have been offering higher returns on bigger amounts of deposits for longer dated maturities. In order to fulfill their social responsibility, banks could also be advised to provide their services in the rural areas and to the neglected sectors of the economy to help the government in its efforts to reduce poverty in the country. By moving in the right direction, financial system of a country can play a pivotal role in achieving national development and social objectives 4.3 ISLAMIC BANKING IN PAKISTAN: 8 Rizvi, Shamim Ahmad. (2007). Commercial Banks Making Hay. Pakistan and Gulf Economist, June Vol no 23.p 25-26 Karachi 49 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING Islamic banking has been defined as banking in consonance with the ethos and value system of Islam and governed by the principles and rules laid down by Islamic Shariah. Interest free banking is a narrow concept denoting a number of banking instruments or operations, which avoid interest. Islamic banking, the more general term is expected not only to avoid interest-based transactions, prohibited in the Islamic Shariah, but also to participate actively in achieving the goals and objectives of an Islamic economy. Islamization of banking and financial system of Pakistan was started in 1977-78. Pakistan was among the three countries in the world that had been trying to implement interest free banking at comprehensive/national level. But as it was a mammoth task, the switchover plan was implemented in phases. An Ordinance was promulgated to allow the establishment of Mudaraba companies and floatation of Mudaraba certificates for raising risk capital. Amendments were also made in the Banking Companies Ordinance (BCO), 1962 to include provision of bank finance through PLS, mark-up in prices, leasing and hire purchase. Over the last three decades Islamic banking and finance has developed into a full-fledged system and discipline reportedly growing at the rate of 15 per cent per annum. The Government of Pakistan has decided that the shift from conventional banking to Riba free economy would be made in a gradual and phased manner and without causing any disruptions. Pakistan is not trying to reinvent the wheel. It can benefit from the experience of other Muslim countries like Bahrain, Malaysia, Sudan and Iran. 50 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING In December 2001, SBP issued the Detailed Criteria for establishment of Islamic commercial banks in the private sector. Al-Meezan Investment Bank Limited applied under the criteria issued by SBP to convert itself into an Islamic commercial bank. It was issued the licence in the name of Meezan Bank Limited to operate as full-fledged Islamic bank in January 2002. The bank acquired the business of Societe Generale Bank branches operating in Pakistan and has started commercial operations in March 2002 as a model Islamic bank in Pakistan. The regulatory issues like maintenance of Statutory Liquidity Requirement and Cash Reserve against FE-25 and other deposits have been resolved by allowing Meezan Bank to maintain these requirements in the form of Current Account balance with SBP at a reduced level. An Islamic Export Refinance Scheme has been prepared on Musharika basis, which has been extended to Meezan Bank as a pilot project. SBP has taken several steps for capacity building in the areas of Islamic banking and its regulations. Various officers attended local as well as international seminars and conferences on Islamic banking held in Iran, Sudan, Bahrain, Lebanon, and Egypt etc. The National Institute of Banking and Finance of State Bank (NIBAF) has started training of SBP personnel in Islamic Finance. As regards commercial banks, courses of Institute of Bankers Pakistan were revised to include topics on Islamic economics, banking and finance. Some other institutions like International Islamic University, Islamabad and Centre for Islamic Economics, Karachi has also conducted training courses in Islamic banking. A Committee for development/review and adoption of accounting standards for Islamic modes of financing was also constituted in the Institute of Chartered Accountants Pakistan (ICAP) in which SBP is also 51 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING represented. The Committee is reviewing the accounting standards prepared by Accounting and Auditing Organization for Islamic Financial Institutions, Bahrain (AAOIFI) with a view to adapt them to our circumstances and if considered necessary to propose new accounting standards. The Committee has prepared the standards on Murabaha and Ijara and is now working on Musharika standard. SBP has also reviewed its Forms of Financial Statements for banks in the light of AAOIFI standards. GROWTH OF ISLAMIC BANKS IN PAKISTAN: 4.3.1 Return on Deposits of Meezan and Albaraka Islamic banks: The deposits with the Islamic banks have increased to 180 billion rupees. Meezan is seeing deposits around 200 billion rupees by the end of this year. Meezan is the first and the largest Islamic bank in Pakistan. Its share in this banking sector stands around 45 per cent. 52 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING Meezan bank is offering 3-11 per cent return on deposits. Return on deposits totally depends on the maturity period. Investment in Islamic banking is safe, secure and to the satisfaction of the investors, who abhor to use interest money. Beside our own equity, deposits are the main source of financing for the domestic Islamic banks 53 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING ALBARAKA ISLAMIC BANK ACTUAL DECLARED/PAID PROFIT RATES ON DEPOSITS PLS SAVING Type of Deposit 2006 2007 Jul - Sep Oct - Dec Jan - Mar Apr - Jun Jul - Sep Oct - Dec PLS Savings 2.60% 2.63% 2.65% 2.65% - - INCENTIVE ACCOUNTS Type of Deposit 2006 2007 Jul - Sep Oct - Dec Jan - Mar Apr - Jun Jul - Sep Oct - Dec Incentive Accounts 3.65% 3.69% 3.71% 3.71% - - KHAZANA ACCOUNTS Type of Deposit Khazana Accounts Rs. 250,000 to Rs. 4,999,999 Rs. 5,000,000 to Rs. 9,999,999 Rs. 10,000,000 to Rs. 24,999,999 Rs. 25,000,000 to Rs. 49,999,999 Rs. 50,000,000 to Rs. 99,999,999 Rs. 100,000,000 to Rs. 499,999,999 Rs. 500,000,000 and above 2007 Jan - Mar Apr - Jun Jul 4.55% 4.55% 4.72% 4.72% 4.95% 4.95% 5.11% 5.12% 5.79% 5.79% 6.35% 6.35% 9.00% 9.00% - Sep Oct - Dec - 54 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING TERM DEPOSITS Type of Deposit 2006 2007 Term Deposits Jul - Sep Oct - Dec Jan - Mar Apr - Jun Jul 7 Days Notice 1.10% 1.12% 1.13% 1.13% 1 Month 3.48% 3.52% 3.54% 3.54% 3 Months 5.80% 5.88% 5.96% 5.96% 6 Months 5.96% 6.04% 6.12% 6.12% 1 Year 6.13% 6.21% 6.29% 6.29% 2 Years 6.85% 6.93% 7.01% 7.01% 3 Years 8.23% 8.33% 8.42% 8.42% 5 Years 9.06% 9.17% 9.27% 9.27% - Sep Oct - Dec - AMI ACCOUNTS Type of Deposit 2006 2007 AMI Accounts Jul - Sep Oct - Dec Jan - Mar Apr - Jun Jul 3 Months 5.80% 5.88% 5.96% 5.96% 6 Months 5.96% 6.04% 6.12% 6.12% 1 Year 6.13% 6.21% 6.29% 6.29% 2 Years 6.68% 6.93% 7.01% 7.01% 3 Years 8.23% 8.33% 8.42% 8.42% 5 Years 9.06% 9.17% 9.27% 9.27% - Sep Oct - Dec - FOREIGN CURRENCY SAVINGS ACCOUNTS Type of Deposit 2006 2007 Jul - Sep Oct - Dec Jan - Mar Apr - Jun Jul - Sep Oct - Dec US Dollars UK Pound Euro DM 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% - 4.4 SBP POLICIES. 55 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com - COMMERCIAL BANKING VERSUS ISLAMIC BANKING In the light of recent Supreme Court judgment the best course of action is to allow Islamic and conventional banking run parallel till such time Islamic banking assumes the dominating role. Keeping in view the enormous challenges in gradual transformation of financial system, the following three-pronged strategy is being followed by SBP for gradual promotion of Islamic banking in Pakistan: Three-pronged strategies for the promotion of Islamic banks. 1.Open full fledged Islamic commercial banks in private sector. 2.Allow existing banks to open subsidiaries for Islamic banking. 3.Allow existing banks to open stand-alone branches for Islamic banking. In line with first part of this strategy on December 01, 2001, SBP had issued detailed criteria for setting up of Scheduled Islamic Commercial banks based on Shariah principles in the private sector. Now full-fledged Islamic banks can be established like Meezan Bank Limited, which has started commercial operations in March 2002. As regards second part of this strategy, Banking Companies (Amendment) Ordinance, 2002, notified in the Gazette of Pakistan dated November 4, 2002, inter alia, a new clause (aa) has now been inserted in sub-section (1) of section 23 of the Banking Companies Ordinance as follows: "(aa) the carrying on of banking business strictly in conformity with the Injunctions of Islam as laid down in the Holy Quran and Sunnah." Therefore, the scheduled commercial banks are, henceforth allowed to open subsidiaries for Islamic Banking operations. Accordingly a Detailed Criteria is being worked out to facilitate the existing commercial banks to 56 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com COMMERCIAL BANKING VERSUS ISLAMIC BANKING set up subsidiaries for Islamic banking, which will be issued separate licence by the SBP. As regards third part of this strategy, Guidelines for opening of standalone branches for Islamic banking by existing commercial banks, enlisting Eligibility Criteria, Licensing Requirements and other operational guidelines on the subject have been prepared. The Islamic Financial Services Board (IFSB) was established with the signing of the Articles of Agreement of the IFSB on November 03, 2002 by the founding members. These included Bahrain Monetary Agency, Bank Indonesia, Bank Markazi Jomhouri Islami Iran, Central Bank of Kuwait, Bank Negara Malaysia, State Bank of Pakistan, Saudi Arabian Monetary Agency, Bank of Sudan and Islamic Development Bank. The IFSB will serve as an association of central banks; monetary authorities and other institutions, entrusted to develop and promulgate internationally accepted prudential regulatory standards and best practices. In advancing this mission, the Board will examine the extent to which existing international best practices need to be adapted and complemented to be consistent with Shariah principles.9 9 Qureshi, Shujauddin. (2007, February). Economy and the Banks New Clothes. NewsLine. Karachi. http://www.meezanbank.com,http:// www.albaraka.com.pk 57 SAQIB ALI (GRAPHICS DESIGNER) www.mbastudent.yolasite.com