Islamic Banking – Myths & Misconceptions

Islamic banking has evolved in Pakistan and the market share has consistently increased from 14.9% at the end of 2019 to 19.6% by the end of September 2023.  Comprising 22 Islamic Financial Institutions, Pakistan’s finance sector now has six full-fledged Islamic banks and 16 Islamic banking divisions of conventional banks operating across 131 districts. 107 new Islamic banking branches were added in this period bringing the total number to 4,534, and Islamic banking counters (in conventional banks) to 1,834.

Islamic banking offers a robust, resilient alternative to conventional banking, built on the core principles of fairness, transparency, and social justice. Rooted in Shariah law, Islamic banking prohibits interest (riba) and speculative activities (gharar), ensuring that financial transactions are grounded in tangible assets and mutual benefit. This ethical foundation promotes a balanced risk-and-reward system, aligning the interests of both banks and customers, which makes it particularly appealing during times of economic instability.

As a profitable, well-regulated, and competitive sector, Islamic banking has gained significant traction globally, supported by robust regulatory frameworks and increasing consumer demand for ethical finance. The industry, while rooted in centuries-old traditions, has evolved to incorporate innovative financial products that meet modern needs. From sukuk (Islamic bonds) to mudarabah (profit-sharing investments), Islamic banking offers a diverse array of options that cater to both retail and corporate clients, contributing to its steady growth and global recognition.

Understanding the true nature and benefits of Islamic banking empowers more individuals and businesses to make informed decisions about their financial practices. This leads to increased participation in a financial system that prioritises equitable wealth distribution, social welfare, and sustainability. As Islamic banking continues to expand, its ability to foster financial inclusion, economic stability, and ethical investment further strengthens its position as a viable alternative to conventional banking, paving the way for a more just and sustainable global financial system.

To dispel several myths and misconceptions that continue to persist, I would like to share a few clarifications:

Myth 1: Islamic Banking is Only for Muslims

One of the most prevalent misconceptions is that Islamic banking is exclusively for Muslims. In reality, Islamic banking is based on principles of Shariah law, which emphasizes ethical practices and fairness. These principles are universal and can appeal to anyone seeking a transparent and ethical financial system. Islamic banks welcome customers of all faiths and backgrounds, offering products that comply with Shariah law but are beneficial to anyone looking for ethical financial solutions.

Myth 2: Islamic Banking is Not Profitable

April to June quarter 2023 saw Islamic assets raised by PKR 586 billion, and by end June crossed te coveted 8 trillion mark. The deposit base was marked at 5870 billion, bringing the market share to 21.9% in the overall banking industry.  During the period under review, net investments and financing of IBI unveiled a quarterly rise of PKR 354 billion and 98 billion respectively.  The market share in the overall industry was recorded at 16.1% and financing at 27.6%.

The provided data clearly dispels another common myth, that Islamic banking is less profitable than conventional banking. Critics often argue that the prohibition of interest (Riba) and speculative transactions (Gharar) limits profitability. However, Islamic banks employ profit-sharing, leasing, and other trade-based mechanisms that can be equally, if not more, profitable. These banks often invest in real assets and share both profit and risk with their clients, which can lead to sustainable and equitable financial growth. One strong point to note is the research and selection process of investment projects, where all possible doubts are addressed, and the best way forward is confirmed in the list of the tested Shariah principles.

Myth 3: Islamic Banking is the Same as Conventional Banking with Different Terminology

Some skeptics believe that Islamic banking is merely conventional banking under a different name, using Islamic terminology to appeal to a niche market. While it’s true that Islamic banking uses terms like “Murabaha” (cost-plus financing), “Ijara” (leasing), and “Mudaraba” (profit-sharing), the underlying principles differ significantly. Islamic banking is fundamentally asset-based and focuses on ethical investing, risk-sharing, and social justice. It avoids activities considered harmful to society, such as investing in alcohol, gambling, and other prohibited industries.

Myth 4: Islamic Banking is Unregulated and Less Secure

Islamic banks are subject to rigorous regulatory standards and oversight, similar to their conventional counterparts. They adhere to both national and international banking regulations and follow guidelines set by bodies like the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB). These regulations ensure that Islamic banks maintain high standards of transparency, accountability, and security. Moreover, the SBP has also developed a separate set of regulations for Islamic Banking industry.

Myth 5: Islamic Banking Cannot Provide Competitive Financial Products

Islamic banks offer a wide range of financial products and services, including savings accounts, home financing, business loans, and investment funds. These products are structured to comply with Shariah principles while remaining competitive in the market. For instance, a Murabaha contract can be used for home financing, where the bank buys the property and sells it to the customer at a profit, allowing for home ownership without interest.

For example, Faysal Bank offers competitive, yet inclusive financial products by developing a wide range of Shariah-compliant solutions tailored to meet diverse customer needs, including personal and corporate banking services. These products have been instrumental in positioning the Bank as  the second largest Islamic Bank in Pakistan. Meezan Bank has grown to be the largest and various conventional banks are converting their most prominent branches into Islamic banking windows. Islamic banks have also embraced digital banking to provide convenient and modern services.

Emphasizing the historical roots and cultural context of Islamic finance, Faysal Bank presents another example of industry leadership in promoting the ethical and financial benefits of Islamic banking to a diverse audience. Their Noor Card is one of the most innovative Islamic products. It is based on the principle of Tawarruq and involves Musawamah financing. Tawarruq refers to the process of purchasing a commodity for a deferred payment through Musawamah.

Pakistan’s Bold Vision: Achieving Full Shariah Compliance in Banking by 2027

Given these favorable conditions and the concerted efforts of stakeholders across the industry, Pakistan’s goal of achieving full Shariah compliance for all banking assets by 2027 is not only realistic but also well within reach.  Through public awareness, regulatory support, innovative product development, transparent performance metrics, and emphasizing historical legitimacy, Islamic banking continues to grow and gain wider acceptance.

Pakistan’s banking industry has taken a proactive approach in not only strengthening its position within the national economy but also setting a global example for Islamic banking. By implementing comprehensive regulatory frameworks, fostering innovation in financial products, and promoting Shariah-compliant banking practices, Pakistan has established a robust financial ecosystem. The growth of Islamic banking in the country has been driven by increasing customer demand for ethical finance, government support, and the strategic efforts of key players in the banking sector. Pakistan’s model offers valuable insights for other markets looking to develop or enhance their Islamic banking sectors, as it demonstrates how a balanced blend of tradition and modern financial practices can successfully serve both local and international markets.

The writer is a communications professional. She can be reached at [email protected]

Disclaimer: The views expressed here are solely the author’s and do not necessarily reflect the opinions and beliefs of ARY News or its management.