This development is credit positive for Islamic banks in Pakistan and the global Islamic finance industry because it promotes standardization across Islamic financial institutions, an issue constraining the growth of the Islamic finance industry. Additionally, these standards will help address Islamic financial institutions'''' persistent liquidity management challenges by establishing a clear framework of Shariah-compliant liquidity instruments.
The SECP is implementing standards issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), an Islamic international non-profit body that prepares accounting, auditing, governance, ethics and Shariah standards for Islamic financial institutions.
One of AAOIFI''''s main goals is to provide a set of standards for Islamic finance transactions similar to the roles of International Accounting Standards and International Financial Reporting Standards for conventional banks and financial institutions. However, only a handful of regulators - including Bahrain, Oman and Pakistan - have so far made AAOIFI standards adoption mandatory.
The report further maintained that implementing these standards will promote Islamic banking in Pakistan, where the State Bank of Pakistan (SBP) is targeting a 20 percent market share of Islamic banks by 2020. As of the end of 2017, Islamic banks'''' had a market share of around 12 percent spread among five full-fledged Islamic banks, including the Islamic banking subsidiary of MCB Bank Limited (B3 stable, b31 ) and 16 conventional banks with standalone Islamic branches.
Although Pakistan has the world''''s second largest Muslim population, the country''''s Islamic bank penetration is lower than that of Gulf Corporation Council countries or Malaysia, which dominate the market. Both the SECP and SBP are committed to enhancing the legal and regulatory environment for the growth of Islamic finance in Pakistan. The SBP is among the few regulators to introduce a comprehensive legal, regulatory and Shariah-compliant framework for the Islamic banking industry.
The report states that SBP''''s initiatives include easing initial capital requirements for Islamic banking subsidiaries, facilitating conversion to Islamic mode, introducing tax neutrality for Shariah compliant banking and crafting exceptions from using the Karachi Interbank Offered Rate (Kibor) as a benchmark for pricing financing. The SECP has introduced three standards related to effective liquidity management, which has been a key challenge facing Islamic banks in Pakistan owing to limited Shariah-compliant investment opportunities and a lack of Shariah-compliant alternatives to standing facilities.
The SBP is currently working to develop liquidity management solutions, including Shariah-compliant open market operations and auctions of domestic sovereign Sukuk on behalf of the government. Domestic sovereign Sukuk issuance is considerably less than the demand, leading Islamic banks to deploy their excess liquidity elsewhere, with more focus on financing compared with their conventional peers.
Indicatively, Islamic banks'''' liquid assets ratio as defined by the SBP was 27 percent as of December 2017, versus the industry average of 54 percent, while their ratio of net financing to deposits was 64 percent, versus the industry average of 50 percent. These liquidity challenges led the SBP in November 2016 to lower the statutory liquidity ratio for Islamic banks to 14 percent from 19 percent. "We expect the new standards to widen the issuer base and increase the availability of Sukuk instruments, thereby facilitating Islamic banks'''' liquidity management framework," the report maintained.