MICROCAPITAL STORY: State Bank of Pakistan (SBP) Issues Guidelines for Islamic Microfinance Services

The State Bank of Pakistan (SBP) recently issued ‘Guidelines for Islamic Microfinance Business by Financial Institutions,’ a series of guidelines intended to increase the scope of microfinance services and products which comply with Islamic law (Shari’a or Sharia) and to bring providers of such microfinance services under its regulatory umbrella. ‘Halal’ – literally ‘permissible’ in Arabic – refers to practices which are sanctioned by the Shari’a. The SBP guidelines specify provisions whereby four types of institutions can offer halal microfinance services to clients: Islamic financial institutions, Islamic microfinance institutions, conventional financial institutions, and conventional microfinance institutions (MFIs). At the end-year 2006, there were six full-fledge Islamic banks (pg 3) and 12 conventional banks with Islamic banking branches in Pakistan. As yet, no Islamic microfinance institutions have been established in the country.

Islamic banking forbids the charging and payment of interest and requires that bond-like securities represent fractions of an equity asset, rather than fractions of a loan. The idea is that Islamic financial institutions must share both profits and losses with their clients. Many of the largest global financial companies, including Deutsche Bank and JPMorgan Chase, have established successful halal banking branches. Professor of economics at Durham University in Britain and co-editor of the essay collection The Politics of Islamic Finance, Rodney Wilson estimates the total assets within halal banking systems is just under USD 500 billion. Hussein A. Hassan, Vice President of Global Markets and member of the Board of Directors of Deutsche Bank, has asserted that a ‘modest estimate’ for the future annual increases in deposits of Islamic finance is 20 percent, which would make it the fastest-growing banking sector in the world for years to come.

Pakistan itself certainly provides anecdotal evidence for Hassan’s prediction. In just three years, from end-year 2003 to end-year 2006, the number of Islamic banking branches in the country has increased from 17 to 150 (pg 3). From the Third to the Fourth Quarter 2006, the total assets in the Islamic banking sector increased 24 percent to 118.2 billion rupees (USD 1.95 billion) (pg 2). The same quarter, total deposits grew from 66 billion rupees (USD 1.1 billion) to 83.7 billion rupees (USD 1.4 billion), a boost of 27 percent. The growing popularity of Islamic banking in the country necessitated providing options for provision of Islamic microfinance services by microfinance and commercial banks, as well as allowing full fledge Islamic microfinance banks in the country.

The recent guidelines are not the first of their kind handed down by the State Bank. Microfinance is still a relatively new concept in the country, but the Pakistani government recognizes that microfinance is “an important poverty alleviation tool.” Therefore, the SBP has adopted microfinance policies and regulations that support sustainability and private sector investment. Previous regulation includes the Microfinance Institutions Ordinance (2001), which was designed to promote the establishment of MFIs, the Prudential Regulations for Microfinance Banks/Institutions (2001), the Prudential Regulations for Microfinance Banks/Institutions (2007), and the Khushhali Bank Ordinance (2000), which founded the Khushhali Bank, a public private partnership designed to increase outreach of microfinance services and to provide a model for the private sector to follow.

According to the Performance Indicators Report 2005 (PIR-2005) which was issued by the Pakistan Microfinance Network (PMN), a network made up of microfinance banks, commercial banks, leasing companies, and NGOs, the total amount of assets in the Pakistan microfinance market in 2005 was just under USD 13.4 million. The PIR-2005 also reported USD 2 million in commercial liabilities, a 2:1 debt-to-equity ratio, and a gross loan portfolio of USD 5.7 million. Currently, 19 microfinance providers in Pakistan report to the Microfinance Information eXchange (MIX Market). These institutions report a combined total of 827,000 active borrowers and a loan portfolio of USD 144.8 million.

By Elizabeth Nelson, Research Assistant

Additional Resources:

Trading Markets: “Guidelines for Islamic Microfinance Business”

Pakistan Times: “State Bank of Pakistan Issues Guidelines for Islamic Microfinance Business”

The American: “Islamic Banking: Is it Really Kosher?” by Aaron MacLean

State Bank of Pakistan (SBP)

State Bank of Pakistan: About Microfinance

State Bank of Pakistan: Islamic Banking Bulletin, February 2007

Deutsche Bank

Deutsche Bank Press Release: “Deutsche Bank Launches Shari’a Mutual Fund Capability“

JPMorgan Chase

Zawya.com: “Deutsche Bank (DB) Directors“