ISLAMIC BANKING IN PAKISTAN (C-TN6-00207)

C O N F I D E N T I A L ISLAMABAD 016739 E.O. 12958: DECL: 08/25/2016 TAGS: PINR ECIN EFIN KTFN PK SUBJECT: ISLAMIC BANKING IN PAKISTAN (C-TN6-00207) REF: STATE 1582324 Classified By: DOS CLASSIFICATION GUIDE BY MARY TOWNSWICK ¶1. (C) Summary. With limited government support, Islamic banking has gained momentum in Pakistan in the past three years. The State Bank of Pakistan (SBP) reports that the capital base of the Islamic banking system has more than doubled since 2003 as the number of Islamic banks operating in Pakistan rose from one to four. A media analysis of Islamic banking in Pakistan cites an increase in the number of conventional banks providing Islamic banking services from three to ten -- leading to a four-fold increase in the bank branches offering Islamic banking services between 2003-2006. The SBP states that under Pakistani law, Sharia Boards do not regulate Islamic banks; the State Bank of Pakistan does. Sharia Boards are limited to monitoring Islamic banking transactions to ensure compliance with Sharia principles. Moreover, SBP notes that it subjects Islamic banks and Islamic banking transactions to the same anti-money laundering prudential regulations and general regulatory framework as conventional banks. End Summary. -------------- THE RISE OF ISLAMIC BANKING IN PAKISTAN -------------- ¶2. (C) Kamran Shehzad, the Executive Director of SBP, and Pervaiz Saeed, head of the Islamic Banking Department at SBP, state that while SBP does not provide any specific incentives to promote the establishment of Islamic banks, SBP has facilitated the growth of Islamic banking in Pakistan by allowing commercial banks to establish Islamic banking subsidiaries and provide full Islamic banking facilities through dedicated branches -- leading to a four-fold increase in the bank branches offering Islamic banking services between 2003-2006. Shehzad and Saeed also note that SBP established the Islamic Banking Department at SBP in September 2003 to approve Islamic banking license applications which enabled the establishment of three Islamic banks in the past three years. Thus, the capital base of the Islamic banking system has more than doubled since 2003 as the number of Islamic banks operating in Pakistan rose from one to four. SBP reports that the following four Islamic banks operate in Pakistan today: Meezan Bank, Albaraka Bank, Dubai Islamic Bank and Bank Islamic Pakistan. SBP indicates that it has recently issued licenses to two additional Islamic banks -- Emirate Global Islamic Bank and First Dawood Islamic Bank, which have yet to establish operations. SBP officials link the rise in Islamic banking in Pakistan to world-wide increased interest in Islamic banking. Per SBP, Islamic banks control approximately 2.2% of total bank assets in Pakistan. ¶3. (U) The July 31-August 6 Pakistan and Gulf Economist magazine cover story analyzes the status of Islamic banking in Pakistan. While the magazine reports that Islamic banking is taking hold in Pakistan -- citing the increase in the number of conventional banks providing Islamic banking services (from three to ten between 2003-2006) and the increase in bank branches offering Islamic banking services (from seventeen to seventy-three) -- it laments the slow pace of growth. -------------- ISLAMIC BANKS FOLLOW SAME REGULATORY FRAMEWORK AS COMMERCIAL BANKS -------------- ¶4. (C) SBP's Shehzad and Saeed state that Islamic banks must adhere to the same general regulatory framework as interest-based banks. Shehzad and Saeed note that this means that the same anti-money laundering prudential regulations apply to Islamic banks and Islamic banking transactions as to commercial banks and transactions. Financial disclosure requirements are also the same. SBP indicates it requires the same minimum capital paid up requirement of Rs. 2 billion (equivalent to 33.33 million USD) and minimum capital adequacy ratio of 8% for establishing an Islamic bank. Islamic banks also must follow the same rules if they wish to open new branches. Shehzad and Saeed describe Islamic banks as public limited companies that are listed on the stock exchanges of Pakistan. Accordingly, Islamic banks are required to offer 50% of their shares to the public. SBP officials confirm that SBP scrutinizes the funding sources and financial products of prospective Islamic banks, as it does for commercial banks. According to SBP, the oversight structure and corporate governance framework are the same for Islamic banks and interest-based banks. -------------- SHARIA BOARDS INSPECT AND REGULATE TRANSACTIONS NOT BANKS -------------- ¶5. (C) SBP officials affirm that under Pakistani law SBP regulates the Islamic banks through the same regulatory framework as applied to commercial banks. Shehzad and Saeed state that the role of Sharia boards is limited to ensuring that all Islamic banking transactions are in conformity with Sharia principles. Per SBP, the Sharia board is comprised of two Sharia scholars, one chartered accountant, one lawyer and one banker. Saeed is the Secretary of the Sharia board, whose role is to safeguard SBP's interests -- which he states is primarily to ensure Islamic banking systems and transactions do not pose a greater money-laundering risk -- and look after the interests of the Islamic banking industry by making certain that Islamic banking transactions follow Sharia principles. With these additional safeguards in place, Saeed contends that Islamic banking transactions are more secure from illicit flows than regular transactions. SBP officials note that Islamic banks in Pakistan do not deal in forwards, options and longer-term financing schemes. Shehzad also reports that Islamic banks' decisions regarding which currencies to use are determined by market forces. ¶6. (C) Comment. Given the regulatory structure applied to Islamic banks and Islamic banking transactions in Pakistan, post does not view the Islamic banking system in Pakistan as more vulnerable to use or abuse by money launderers, terrorists or their financiers than traditional interest-based banks. If intelligence reports or other information to the contrary exists, post would be interested to know and will follow-up. Though Islamic banking still has not penetrated the mainstream market in Pakistan, its market share is growing. Post will continue to monitor the evolution of Islamic banking in Pakistan. End Comment. BODDE