SBP Simplifies Conversion for Conventional Banks to Islamic Banking

State Bank of Pakistan (SBP) has taken a progressive step in promoting Islamic banking by revising the criteria for converting conventional banking branches into Islamic branches. This change aligns with SBP’s broader objectives to foster a Shariah-compliant financial environment across the country. Over the past few years, the Islamic banking sector in Pakistan has witnessed substantial growth, and these new guidelines are expected to further accelerate this trend. The revised rules not only aim to simplify the process for conventional banks but also enhance transparency and facilitate customers during the transition.

State Bank Of Pakistan and Islamic Banking

The renewed focus on Islamic banking transformation is part of Pakistan’s broader economic goals. Following a decision by the Federal Shariah Court, the SBP is mandated to assist in phasing out interest-based banking, aligning the country’s financial system with Islamic principles. The SBP’s “Vision 2028” is a roadmap to enable this transition, where Islamic banking is expected to become the preferred mode of banking for Pakistanis.

Islamic banking in Pakistan has already shown a strong upward trajectory, comprising over 20% of the country’s total banking assets. The updated guidelines issued by SBP will likely propel this figure further, as they ease the process of converting conventional banking assets and branches into their Islamic counterparts.

New Criteria for Branch Conversion

Licensing Fee and Annual Branch Conversion Plan

One of the most significant changes brought about by the SBP is the waiver of any licensing fee for banks converting their conventional branches into Islamic banking branches. This waiver incentivizes conventional banks to take steps toward the transformation without the financial burden of licensing fees.

All conventional banks, whether they already have Islamic operations or are intending to start, are now required to submit an Annual Branch Conversion Plan (ABCP). This plan should be in line with the bank’s overall strategy to shift operations towards Islamic banking. By October 31 of each year, banks must forward the ABCP to the SBP’s Banking Policy & Regulations Department (BPRD) and the Islamic Finance Policy Department (IFPD). This formalized procedure allows the SBP to maintain a comprehensive overview of the conversion landscape, ensuring that the transitions align with the broader objectives of Islamic finance.

Customer Communication

A significant part of the conversion guidelines focuses on enhancing transparency and clarity for customers. Banks must inform both the general public and account holders of the conversion of conventional branches into Islamic branches at least three and a half months before the change is implemented. Notifications must be shared across multiple channels, including print (newspapers), online (websites), and direct branch communication.

The updated criteria provide banks with a structured mechanism to obtain customer consent for converting their accounts from conventional to Islamic. Banks can use digital channels, making the process more convenient and ensuring customers are well-informed. Customers who consent to the change will have their accounts converted accordingly. However, for those who dissent, the bank is obligated to provide options to either transfer the accounts to another conventional branch or close them based on the account holder’s choice.

It’s also worth noting that the rules ensure that non-Muslim customers’ accounts will only be converted if they provide explicit consent, respecting religious and cultural differences.

Accounts Excluded from Conversion

Certain types of accounts are excluded from the conversion process. These include accounts under litigation, accounts of deceased persons, accounts involved in disputes, and dormant/inactive accounts. By doing so, the SBP ensures that the transition is as smooth as possible, preventing potential legal complications or customer dissatisfaction during the conversion.

Related: State Bank Of Pakistan Voted As Best Central Bank For Promoting Islamic Finance

Virtual Conventional Cost Centers

One of the key changes in the SBP’s revised guidelines is the permission for banks to establish virtual conventional cost centers temporarily. These cost centers are intended to manage assets and deposits that cannot be immediately converted during the transition period. While these centers facilitate a smoother shift from conventional to Islamic banking, they are restricted from conducting any new business, enhancing current operations, or rolling over conventional assets.

The virtual cost centers are essentially a temporary measure to help banks streamline their operations while ensuring compliance with Islamic principles. This approach provides banks with more flexibility to deal with assets that may not be easily convertible and ensures a seamless transition to an Islamic framework.

Additionally, the banks are mandated to develop Standard Operating Procedures (SOPs) for the conversion process, outlining roles and responsibilities for both field and head office staff. These SOPs are expected to cover all stages of conversion, including pre-conversion planning, customer notification, account transfer processes, and compliance reviews.

Role of the Shariah Compliance Department

The SBP’s guidelines place a strong emphasis on adherence to Shariah principles throughout the conversion process. Each bank’s Shariah Compliance Department (SCD) is responsible for conducting periodic internal reviews to ensure compliance, especially during the management of virtual cost centers and collateral securities. After each review, the SCD must submit a report to the bank’s Shariah Board to confirm that all operations and procedures align with Islamic law.

This system of checks and balances underscores the SBP’s commitment to maintaining the integrity of Islamic banking principles, ensuring that every step of the conversion is thoroughly scrutinized and compliant.

SBP’s Approval

The entire conversion journey for a bank starts with seeking in-principle approval from the State Bank of Pakistan. Upon evaluation of the bank’s conversion request and strategy, the State Bank of Pakistan may grant this approval. Once granted, the bank can initiate the branch conversion process according to its ABCP.

After completing all the required steps and ensuring compliance with the revised criteria, banks will then apply for licenses for their new Islamic banking branches. As part of this process, the bank’s Shariah Board must issue a certificate confirming that the conversion has adhered to all Shariah standards. The conventional branch licenses will subsequently be surrendered, marking the final step in the conversion process.

Notably, these rules also apply to microfinance banks, expanding the reach of Islamic banking to a broader segment of the financial sector.

Islamic Banking in Pakistan

With these revised guidelines, the SBP is set to reinforce its commitment to fostering an environment where Islamic banking can flourish. Pakistan’s Islamic finance sector has already experienced significant growth over the last decade, and the SBP’s continuous policy support is expected to maintain this momentum. Islamic banking assets currently make up around 20% of the total banking assets in the country, and it is projected that this figure could rise to 30% by 2025 as more conventional banks opt for Shariah-compliant operations.