Islamic loan books shift towards profit-sharing in Indonesia, Pakistan

Wednesday, 6 May 2015 00:34 -     - {{hitsCtrl.values.hits}}

Reuters: The make-up of Islamic banks’ loan books is changing in Pakistan and Indonesia with the growing use of profit-sharing contracts that could help Islamic finance win more customers in the two largest Muslim-majority countries. Over the past year Pakistan and Indonesia have stepped up efforts to develop their Islamic finance sectors, with regulators and religious scholars addressing criticism that the industry often merely mimics conventional finance. The shift towards profit-sharing contracts, shown in central bank data, could help Islamic finance gain ground in two markets which have a combined population of about 430 million but where Islamic banks hold less than 10% of total banking assets. Growing demand for participatory financing tools and improved client awareness of Islamic finance are behind the change, said Abdullah Ghaffar, head of investment banking at Al Baraka Bank Pakistan, a unit of Bahrain’s Al Baraka Banking Group. This is encouraging a shift away from murabaha, a cost-plus-profit arrangement in which one party buys merchandise for another. Murabaha is often criticised for its resemblance to a conventional interest-bearing loan. “A significant majority of sharia advisors and scholars in Pakistan are openly pushing their respective institutions to reduce their murabaha exposures,” said Ghaffar. Murabaha has been the workhorse of Islamic bank financing globally, but after years of dominance the structure is losing favour in some areas to profit-sharing contracts such as musharaka, istisna and salam, which are seen by many scholars as closer to the economic principles of Islam. As of December, murabaha represented 30.1% of financing extended by Islamic banks in Pakistan, down from 40.6% a year earlier, central bank data shows. Istisna and musharaka financing doubled during the same period, representing a combined 19.4% of financing by Islamic banks, up from 12.3% a year earlier. In Indonesia, the change is more gradual as murabaha still represents over half of all financing by Islamic banks. But musharaka financing has increased by 27.7% from a year earlier and at the end of December accounted for a quarter of all Islamic bank financing, a report from Indonesia’s capital market regulator shows. Not all musharaka contracts have the same profit-sharing characteristics, but authorities want to move the industry away from debt-based contracts, said Rully Pahlevy, business department head for small and medium-sized enterprises at Bank Muamalat Indonesia. “Murabaha is still very common, but the national sharia board wants to grow the use of sharaka (partnership).” Limits The changes have an economic as well as a religious rationale: In Pakistan, several cement and sugar companies have moved away from murabaha in search of simpler documentation and greater flexibility in repayments, said Ghaffar. “Relatively speaking, sugar mills opt more for salam than istisna. Benefits are fairly the same.” Accounting issues limit the use of ijara (a sale and lease-back contract) and istisna (project financing), said Pahlevy at Bank Muamalat. “Ijara is harder to apply in the bank accounting-wise as it requires depreciation. For istisna, there is also an accounting problem when the object of the financing is not completed.” The shift away from murabaha is by no means universal, however; the format has actually been gaining ground in some mature Islamic banking markets. In Malaysia, murabaha represented a quarter of Islamic bank financing as of December, up from 20.3% a year earlier. Official statistics are unavailable in most Gulf countries, but Dubai Islamic Bank, the largest sharia-compliant lender in the United Arab Emirates, has also seen an increase in murabaha. As of December, over a third of the bank’s financing assets were murabaha-based. They rose 67.7% in 2014 compared to 23.9% growth for all other financing types. The rise of murabaha in such cases may be because Islamic finance has reached mainstream status in those countries; sharia-compliant banks hold around a fifth of total banking assets in the UAE. This means Islamic banks are competing head-on with conventional rivals rather than merely catering to a staunchly religious customer base. The competition may be prompting them to choose murabaha because it is more familiar and priced more closely in line with conventional finance than other Islamic options.

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