Shifting Pakistan’s Banking System Towards Islamic Banking

The National Assembly of Pakistan has taken a significant step towards economic transformation by passing legislation requiring all conventional banks to transition to Islamic banking by 2027. This decision follows the Federal Shariat Court’s directive to eliminate riba (interest) from the financial system and reflects the growing demand for Shariah-compliant banking in the country. As of 2023, Islamic finance already accounts for 21% of Pakistan’s banking sector, and this legislative push aims for full compliance, unlocking significant socio-economic benefits.

Islamic banking in Pakistan has seen remarkable growth over the past decade. According to the State Bank of Pakistan (SBP), the total assets of Islamic banks reached Rs. 7.2 trillion by mid-2023, marking a 24% year-on-year increase. Islamic banking deposits also grew to Rs. 5.8 trillion, representing nearly 23% of the country’s total banking deposits. This growth highlights the public’s preference for Shariah-compliant financial products. However, conventional banking still dominates 79% of the market, showing substantial potential for expansion and the need for a systemic shift.

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Benefits of the Transition:

1. Alignment with Public Preference: A 2022 survey by the SBP found that over 80% of Pakistanis prefer Islamic banking due to religious beliefs. Despite this demand, only 14% of eligible adults have access to Islamic financial services, indicating a large untapped market.
2. Financial Inclusion: Over 100 million adults in Pakistan remain unbanked, according to the World Bank (2023), with many citing religious concerns as a barrier to accessing conventional banking. Islamic banking can address this issue by offering Shariah-compliant solutions, promoting financial inclusion and increasing national savings rates.
3. Economic Stability and Growth: Islamic banking discourages speculative activities (gharar) and relies on asset-backed financing. Countries with higher Islamic banking penetration, like Malaysia and Saudi Arabia, have experienced greater financial stability during global crises compared to conventional banking systems. In Pakistan, interest-free financing models such as Salam and Murabaha could greatly benefit the agricultural sector, which contributes 22.9% to the GDP.
4. Social and Economic Equity: Nearly 70% of small and medium enterprises (SMEs) in Pakistan face difficulties accessing affordable credit. Islamic banking’s risk-sharing and partnership-based models can help bridge this gap, fostering entrepreneurship and reducing income disparities. Globally, Islamic finance assets are expected to reach $4 trillion by 2025, presenting an opportunity for Pakistan to emerge as a regional leader in this growing market.

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Challenges and Solutions:

1. Restructuring Financial Institutions: Pakistan has 42 commercial banks, but only 5 are fully Islamic as of 2023. Converting the remaining conventional banks will require restructuring loan portfolios, training staff, and developing Shariah-compliant products. The SBP has launched a Transformation Plan (2023-2027) to guide banks through this process, offering technical assistance and incentives for compliance.
2. Public Awareness and Trust: Many consumers are unfamiliar with Islamic banking products, leading to skepticism. A nationwide awareness campaign supported by the SBP could educate the public on the benefits and principles of Shariah-compliant banking. The success of existing Islamic banks, such as Meezan Bank (which reported a profit of Rs. 21 billion in 2022), can serve as evidence of the model’s viability.
3. Regulatory Oversight: Strengthening the SBP’s Shariah Governance Framework will be crucial to ensuring compliance with Shariah principles. Additionally, a centralized Shariah Board has been proposed to provide uniform guidelines across all banks.

The transition to Islamic banking is a major shift in Pakistan’s financial system. If successful, it could increase Islamic banking’s market share to 35% of total banking assets by 2027, as projected by the SBP. This transition could also boost GDP growth by at least 0.5% annually, as per a study by the International Monetary Fund (IMF), thanks to increased financial inclusion and risk-sharing.

Pakistan has the potential to become a global hub for Islamic finance, attracting investments from countries like Saudi Arabia, UAE, and Malaysia, where Islamic finance already plays a dominant role. The decision to phase out interest-based banking is not just a religious mandate but also an economic imperative. With robust legislation, stakeholder collaboration, and public awareness, Pakistan’s transition to Islamic banking can transform the financial sector, ensuring inclusivity, stability, and ethical growth. Embracing this model could position Pakistan as a global leader in Shariah-compliant finance.