There is a need for some 12 million homes in the country, mostly for low-and-middle income groups, while Pakistan’s banks disbursed $2 billion in housing and construction loans in 2021, up 85% year-on-year.

Karachi: Pakistan’s Islamic retail banking sector is expected to see impressive growth especially due to an increase in Islamic mortgage lending as more customers choose Sharia finance when buying or building a home. 

Pakistan is the world’s second most populous Muslim country and the demand from its 227 million people for Islamic financial services is expanding fast – albeit from a low base. 

Islamic banking assets in Pakistan have increased at a compound annual growth rate of around 24% in the last 10 years, according to Ahmed Ali Siddiqui, head of product development and Sharia compliance at the Meezan Bank, Pakistan’s largest Islamic bank. This, he said, has been fuelled by a strong appetite for Sharia-compliant alternatives to traditional banking products, especially consumer finance.

According to the central bank, the State Bank of Pakistan (SBP), by the end of 2020, the country had five Islamic banks and 17 conventional banks offering Sharia-compliant financial products, holding a combined PKR4.269 trillion ($24.4 billion) in total banking assets. It said Islamic finance had a 17% market share of these assets at that time, a proportion that is growing.

One reason for the expansion is that very few banks in Pakistan were offering and actively marketing traditional standard mortgages, either Islamic or non-Islamic in early 2020, according to Muhammad Nassir Salim, acting head of Islamic banking at HBL, the country’s largest bank by assets. And according to the World Bank, banking is a nascent market with plenty of room for growth - 70% of Pakistanis remained unbanked as of 2017, with Pakistanis being reluctant to use banks to obtain financing of any kind, both Islamic and non-Islamic, said Salim. Reasons include high bank fees and a traditional cash economy. Strict implementation of foreclosure laws to seize property owned by defaulting borrowers, a lack of standardised property documentation across the country, the rising cost of property and fragmented land records have also deterred Pakistanis from borrowing money to own property. Indeed, money borrowed for mortgages amounted to just 0.3% percent of the country’s gross domestic product (GDP), according to a November 2021 International Finance Corporation (IFC) study. This is  significantly lower than the 3.4% average for South Asia, according to the IFC.

Islamic finance purveyors are attempting to step into this gap and they have the support of the government and the SBP, who are trying to boost borrowing liquidity in Pakistan to encourage the house building and property market, encouraging Islamic and conventional borrowing. In October 2021, the government launched a markup subsidy scheme ‘Mera Pakistan Mera Ghar’ (My Pakistan My Home), to help Islamic and conventional banks provide financing to consumers for building and buying houses at very low rates. Using the scheme, borrowers can obtain up to Pakistan Rupees PKR10 million ($57,300). It involves harmonised application systems including user-friendly applications, simple criteria for success, low fees and the ability to demonstrate income through proxy data of income generated by similar businesses. It can also use rental agreements and utility bills to assess personal wealth, rather than having to submit books or tax returns.

Housing shortage

The goal is solving one of the country’s biggest social and economic problems - a shortage of affordable housing. There is an estimated shortage of 12 million residential units in the country, mostly for low-and-middle income groups, according to the central bank. As well as dealing with this social problem, the government is hoping to boost economic growth, with the construction sector currently only contributing 2.5% to GDP, according to the SBP.

Many bankers and real estate professionals believe the scheme has the potential to expand interest-free solutions to untapped households in urban as well as rural areas of the country, especially those attracted to Islamic lending.

“We see a higher customer inclination towards Islamic finance either in low-cost housing or other projects on the back of increasing awareness, a solid regulatory drive and strengthening Islamic home finance product suites at banks,” said Mohammed Hassan Bakshi, former chairman, Association of Builders and Developers of Pakistan and an existing member of the government’s National Coordination Committee on Housing Construction and Development.

“The introduction of mortgages will have a direct and positive impact on retail banking,” said HBL’s Salim, adding more branches are needed to handle the paperwork and liaise with borrowers. “The subsidy scheme will encourage the unbanked population to open accounts…to start transferring their salaries to an account or [use it] for business purposes,” Salim said.

Islamic lending 

As for HBL’s Islamic lending, it is based on an ‘HBL Diminishing Musharakah’ system, where the ownership of the new asset is divided into units. The bank leases its share of an asset to the customer against rental payments, with the customer purchasing units from the bank until full ownership is achieved.

Meezan Bank’s Siddiqui said Islamic home finance was popular because it represented a real partnership between banks and their borrowers: “Islamic banks have a direct ownership stake in Musharakah asset and hence, bear ownership related risks like property loss, destruction and expenses like property Takaful [Islamic insurance] up to their share,” he said. “This differs significantly from conventional finance where banks only provide loans, charge interest and register property mortgages.” He said there has also been growth in Pakistan Islamic developer and builder finance under Istisna policies that allow parties to contract the proceeds of a future asset sale before it is built, alongside Diminishing Musharakah lending, he added.

Siddiqui believes such policies can offer popular end-to-end Sharia-compliant financing from builder to the end consumer. He noted that the Pakistan Mortgage Refinance Company (PMRC) has issued a sukuk (Islamic bond) consisting of home finance portfolios based on the concept of Shirkat-ul-'Aqd partnerships, where proceeds are divided under a pre-existing contract.

A swift and immediate take up of the government programme has already led to there being “70,000 and 80,000 low-cost housing units at various stages of planning, construction and completion in various cities in three provinces,” said Bakshi. 

According to the central bank, Pakistan banks disbursed PKR355 billion rupees ($2 billion) in housing and construction loans in 2021, up 85% year-on-year. Siddiqui noted that 60% of the figure comprises of Islamic finance. Low-cost housing loans reached PKR38 billion ($217.79 million) at the end of December 2021, with 45% being Islamic finance.

This is no mean feat, said Bakshi, given accessing finance has required borrowers to generate formal documentation about the legal and business affairs, which they have lacked in the past. Moreover, the resulting boost to the construction industry and its suppliers will give a “much needed boost to the economy” – helping a sector that has been struggling with high prices of raw materials such as steel and cement. 

Another recent change, introduced by the central bank in August 2021, may grow Pakistan’s property market still further. It allowed non-resident Pakistanis, who number 9 million (according to the Overseas Pakistanis Foundation), to access financing, both Islamic and traditional, from Pakistani banks to build and buy homes in the country.

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