The State Bank of Pakistan (SBP) has unveiled a five-year strategic plan for the Islamic banking sector. The central bank aims to increase the deposit and assets of Islamic banking to 30% of the overall banking industry from c18% currently. It also wants to tilt the loan mix towards small and medium-sized enterprise (SME) and agriculture financing.
In this report, we discuss how achievable these targets are, the planned steps to achieve these goals and what it could all mean for some of Pakistan's listed banks.
Islamic banking targets for next 5 years
The SBP wants to improve the assets and deposits market share of Islamic banks by c12ppts over the next five years. This is an aggressive target given that the sector has gained c5ppts in the past five years (2015-20), but we also think it is achievable:
The Islamic banking sector has huge untapped potential. An SBP survey shows 74% of the banked population is willing to switch to Islamic banking, and 93% of the unbanked population regards interest as prohibited under Islamic law;
The SBP targets require a CAGR of c25%, which is in line with recent trends; and
Conventional banks have been focusing strongly on their Islamic banking operations.
In terms of the financing mix, the SBP wants to increase SME and agriculture financing to 10% and 8% of private sector loans, respectively, compared with a mere 3% and 0.3% currently. We think these targets might be too ambitious, though, as they require increasing SME loans by c60% CAGR and agriculture loans by 140% – moreover, banks will be wary of the high level of risk associated with these sectors.
The strategic pillars
The SBP has highlighted six strategic pillars to achieve the targets:
Strengthen the legal landscape: The SBP aims to introduce a legal framework for Islamic banking and also resolve tax issues to provide a level playing field for Islamic banks.
Enhance the regulatory framework: The central bank will continuously review and amend the regulatory framework for Islamic banks, taking note of developments taking place locally and globally.
Reinforce the comprehensive Shariah governance framework: There is a comprehensive Shariah compliance framework in place for Islamic banks, which the SBP plans to strengthen further.
Improve the liquidity management framework: Liquidity is one of the key issues for Islamic banks, and the SBP aims to take several steps to improve this, including developing shariah-compliant standing facilities and sukuk structures for regular sukuk offerings.
Expand outreach & market development: Launching innovative Islamic products using alternative delivery channels, expanding Islamic microfinance services, focusing on research and development.
Bolster human capital & raise awareness: Holding awareness-raising sessions, increasing the profile of the Islamic Banking Certification Course, ensuring a regular supply of Islamic banking professionals and Shariah scholars.
Implications for listed banks
Meezan Bank (MEBL PA) is the largest Islamic bank in Pakistan with a c35% market share of the Islamic banking industry – this share has remained largely stable over the past five years. We think Meezan should be able to hold on to this share given its strong management and brand, and aggressive growth strategy, targeting rural and underpenetrated areas. If Meezan Bank maintains its market share, the SBP targets imply c25% balance sheet growth over the next five years, which is higher than the 14% IMS (our Pakistan research provider) estimates, further supporting the latter's Buy recommendation.
Bank Islami (BIPL PA) is another pure-play Islamic listed bank that could benefit from high growth in the Islamic banking industry. Faysal Bank (FABL PA), which is aiming to convert to a completely Islamic bank, could also be a beneficiary.
Conventional banks like BAFL (14% assets in Islamic banking with 19% growth in 2020), HBL (8% assets in Islamic banking with 15% growth) and MCB (7% Islamic assets, 34% growth) have taken aggressive steps recently to boost their Islamic banking operations, such as rolling out separate Islamic banking subsidiaries, rebranding and introducing innovative products. With the SBP setting aggressive targets and aiming to improve the regulatory and liquidity framework, the Islamic banking operations of these banks would benefit from higher overall industry growth and could contribute well to bottom-line growth in the medium term.