Over the past decade, Pakistan’s banking sector has experienced a transformative shift with the rapid rise of Islamic banking. Once a niche player, Shariah-compliant banking has now outpaced its conventional counterpart, both in growth and profitability, reshaping the financial landscape significantly.
As of June 2024, the Islamic banking (IB) asset base has expanded to an impressive Rs9.7 trillion, comprising 18.7% of the overall banking industry. Full-fledged Islamic banks hold a dominant share of Rs6.4 trillion (12.3%), with an additional Rs3.2 trillion (6.4%) contributed by Islamic banking branches (IBBs). A decade ago, Islamic banking’s market share stood at just 10.4%, but today, both IB and IBB have outperformed the sector with compound annual growth rates (CAGR) of 24.8% and 23.8%, respectively, compared to conventional banking’s 15.4% growth over the same period.
This surge in Islamic banking is driven by several factors. Following the 2008 financial crisis, Pakistani banks shifted their focus towards sovereign lending, prioritizing government investments over consumer and business loans. This trend was further accelerated by the government’s fiscal needs, with investments-to-deposits ratios reaching 95.2% across the industry by June 2024. However, Islamic banking stands out with lower investment-to-deposit ratios—58.5% for IBB and 62.3% for IB—compared to conventional banks, which reached 105.2%.
The growth of Shariah-compliant banking can also be seen in the increasing number of branches. By March 2024, Islamic banking institutions accounted for 30.5% of all bank branches in Pakistan, a significant jump from 12.1% in 2014. The branch network for IB tripled from 868 to 2,806, while IBBs saw an astounding 391% increase from 467 to 2,295. In contrast, conventional banking branches grew by just 19.9% during the same period.
This rapid expansion raises a key question: Are financial institutions increasing their Islamic networks due to public demand for Shariah-compliant products, or is it due to pressure from the State Bank of Pakistan? Regardless, the Islamic banking sector has successfully captured a growing number of depositors, with the share of Islamic deposits rising to 22.6% of the industry’s total, up from 10.6% in 2014.
Despite conventional banking’s operational efficiency—boasting average deposits per branch of Rs1.96 billion compared to IB’s Rs1.6 billion and IBB’s Rs1.1 billion—Islamic banks are now claiming a larger share of the industry’s profits. During the first half of FY24, Islamic banking institutions accounted for 27.8% of the total net income, with IBB contributing an additional 20.8%.
However, the sector’s profitability is not solely due to better performance. Regulatory advantages, such as the absence of a minimum deposit rate, have allowed Islamic banks to operate with lower costs. While this has been a point of contention for many customers, complaints have largely fallen on deaf ears.
As Pakistan’s banking sector continues to evolve, it’s clear that Islamic banking is poised to play an increasingly significant role in the financial landscape, shaping the future of banking in the country.
