913s-2

Comparative Study of Islamic Banking 19

CHAPTER 2

History and Development of Conventional and Islamic Banking in Pakistan

History of Banking Developments in Pakistan

Prohibition of Interest in Islamic Banking

Functions of Islamic Banking

Operations and Products of Islamic Bank

Service Quality of Pakistani Banking Sector

Customer Satisfaction of Pakistani Banking Sector

Performance of Pakistani Banking Sector


Chapter 2

History and Development of Conventional and Islamic Banking in Pakistan

2.1 History of Banking Developments in Pakistan

Pakistan came into existence as the first Islamic republic created in the name of Islam on

August 14, 1947. The government of Pakistan is bound to follow the instructions of Allah

Almighty according to Objective Resolution, passed in 1949. Islam is declared the

official religion of Pakistan according to the first constitution of Pakistan in 1956 and all

rules/ regulations should be according to the instructions of the Holy Quran and Sunnah.

The Council of Islamic Ideology was established under the Constitution of 1962, to

eliminate the interest from the economy especially from banking sector. The Constitution

of Pakistan (1973) requires the elimination of interest (riba) from the economy as soon as

possible. The council consulted a large number of bankers and economists to recommend

some alternatives to replace interest-based financial structure in the economy during

1980s. In 1991, Full Bench of Supreme Court of Pakistan ordered the elimination of riba

from the economy until June 30, 1992.

Pakistani banking sector has witnessed drastic changes over a period of 61 years since its

independence. Initially it suffered from acute shortage of resources and uncertainty due to

prevailing political and socioeconomic conditions. Lack of trained human resource and

professionals resulted into poor quality of products and services. Financial liberalization


and deregulation stimulated the competition among banks due to an expansion of the

banking industry. A large number of banks has initiated their operations in Pakistan and

try to attract the maximum number of customers. The inception of 21st century

heightened the competition among banks regarding service quality to have satisfied

customers for better profitability.

State Bank of Pakistan has undertaken a number of initiatives to ensure stability,

transparency and flexible legislation. The regulatory framework encourages “financial

sector growth, diversification and innovation; healthy competition and risk taking to

ensure a sustainable and aggressive income stream; opportunities for enhancing the

franchise value of banks; prudent behavior and effective risk management and loan

provisioning requirement are stringent enough to discourage infection of the loan

portfolio; safeguarding social obligations and consumer interests” (Economic Survey of

Pakistan, 2007-08).

Pakistani banking sector is continuously improving with diversified pattern of ownership

due to an active participation of foreign and local stakeholder. It experienced an

expansion in its network, size and structure due to beautiful blending of commercial

banks, micro finance institutions and Islamic banks in the country. It resulted into an

increased competition among banks to attract a greater number of customers by the

provision of quality services for long-term benefits. The performance of nationalized

banks deteriorated due to government protection to employees that resulted into the

provision of inferior products and poor services. It also discouraged the private investors


and foreign financial institutions. But liberalization of financial sector by privatization

and deregulation during 1990s encouraged local investors and motivated foreign banks to

start their operations in Pakistan. There are drastic changes in Pakistani banking sector

due to strong competition among public, private and foreign banks.

SBP plays an active role to establish a sound Islamic banking system in Pakistan

according to principles of Sharia’h as mentioned in its mission statement that read “To

promote and develop Islamic Banking industry in line with best international practices,

ensuring Sharia'h Compliance and transparency”. SBP issued detailed criteria in

December 2001 for the establishment of full-fledged Islamic bank in the private sector.

Al Meezan Investment Bank received the license from SBP in January 2002 and started

its operations with the name of Meezan Islamic bank as the first Islamic bank from

March 20, 2002 (SBP, 2002).

In 2002, Islamic banks have started their operations in Pakistan and experienced stiff

competition from its peers as well as from conventional banks. Now there are 6 full-

fledged Islamic banks and 13 Conventional banks offering products and services

according to principles of Sharia’h in different parts of the country. They are competing

in a highly competitive environment for the provision of quality services according to

customers' expectations. Now bank customers are much concerned regarding the quality

of services due to increased awareness. They continue to deal with their current bank

only if they feel satisfied; otherwise they feel no hesitation to switch to other banks.


Islamic bank offers a wide range of products on the basis of profit and loss according to

principles of Sharia’h. It develops the sense of collective welfare by sharing the risk

among different stakeholder. While the interest is the central tenet of the conventional

banking and it maximizes the return even at the cost of other stakeholders by transferring

the burden of risk to other parties. It generate exploitative trend that is fatal for the

economy and society. Islamic banks are primarily concerned to eliminate Riba from the

economy by promotion of risk sharing practices for economic prosperity. Islamic banks

work within the limits prescribed by Sharia'h to stimulate business and trade activities.

Galbraith (1975) reported, “The best economic system is one that supplies the most of

what that most people want”. It means that an ideal economic system has the ability to

meet expectations of people what they “want” in a transparent manner. Islamic economic

system is superior because it is based on the principles of justice, transparency and

accountability that ensure substantial economic growth. Islamic bank is beneficial due to

its capability to spread risk in the economy among the concerned parities (depositor,

banker, borrower etc.) according to their contribution (Siddiqui, 1973).

Islam is a complete code of life that consists upon the instructions given by the Allah

Almighty and practices of the holy prophet Muhammad (peace be upon him). The holy

Quran is the written instructions of Allah Almighty for the human beings. It covers all

aspects of human life and all types of activities (i.e. religious, social and economic) that

are performed for the success in this life and in the life hereafter. There are clear

instructions about halal and haraam. Islam is a universal faith that promotes brotherhood,


social equality and fairness in economic activities for the welfare of the mankind

(Chapra, 1985).

The interest-based transactions of conventional banks promote materialistic and

exploitative attitude that is fatal for society. It was proved that equity participation has a

great potential for larger profits along with benefits of decentralized decision-making

(Wieltzman, 1984; 1985). Equity contract is superior to debt contract due to a number of

benefits. It improves the profitability of business units by eliminating the limitations as

imposed by debt. Furthermore, equity based banking contracts stimulate the investment

in the economy (Haque and Mirakhor, 1986). Riba, interest, or usury is strictly prohibited

in Islam as dealing with Riba-based transactions means declaring war with Allah

Almighty and His Messenger (Muhammad, peace be upon him). Interest is an additional

amount paid/received on the principal amount according to an agreement due to a time

period attached thereof. Even a single additional penny on the principal amount or any

other benefit attached with this transaction is considered as Riba (Rehman, 1993).

Uzair (1976) has presented the working structure of Islamic bank and developed a

mechanism to cope with the challenges of risk and interest. Risk of loss is a potential

threat that creates obstacles for productive activities in the economy. The study suggested

that Islamic banks could help to reduce risk to enhance productive activities in the

economy. It is reported that different stakeholders dealing with Islamic bank are risk

neutral and actively engaged in productive activities according to profit and loss based

contracts (Siddiqui, 1973).


Islamic banks affect monetary system by adjusting the demand and supply forces for

money. It is found that Islamic banking system is superior to conventional banking

system as it ensures more stable financial sector (Khan, 1986). In another study, it was

empirically verified that Islamic banking system showed excellent performance by

supporting financial sector in Tunisia (Darrat, 1988). There is an empirical evidence to

find out the influence of Islamic banking practices on monetary stability of Iran. The

study showed mixed results, both for some evidence in favor to support and stabilize

monetary system and somewhat against it (Yousefi, Abizadeh and Mccormick, 1997).

Wilson (1990) remarked the success of Islamic banking that compelled the many

commercial banks to provide Islamic banking products to their clients. It is reported that

profit and loss sharing system generates more profits. On the other hand, interest based

system focus on credit-worthiness. Profitability is more efficient measure for allocation

of funds as compared to credit worthiness. Similarly profit sharing system would be more

stable as compared to interest-based system (Al-Jarhi and Iqbal, 2001).

The existence of two bank streams i.e. conventional banks and Islamic banks poses some

questions about service quality and customers' satisfaction in Pakistan. It is also

important to assess the effect of customer satisfaction on bank performance. Islamic

banks have opened new avenues for acceptance of deposits on interest free-basis and

extend credit facilities excluding interest e.g. Qarz-e-Hasana etc. (Najajmabadi, 1991). It

was found that relationships with bank personnel are important criteria for selection of

bank (Abratt and Russell, 1999).


Al-Jarhi and Iqbal (2001) defined Riba with reference to Sharia'h scholars as “anything

(big or small), pecuniary or non-pecuniary, in excess of the principal on a loan that must

be paid by the borrower to the lender along with the principal as a condition (stipulated or

by the custom), of the loan or for an extension in its maturity.” It is referred as Riba-al-

qard or Riba-al-Quran that is known as interest on loans in recent age. Islam prohibits all

types of Riba not only on loans but also on other transactions as Riba-al-fadl that is

linked with an exchange of commodities. Similarly, interest is prohibited on all type of

activities i.e. whether it is paid/received on consumption or production activities. It is

reported that that the performance of Islamic banks meets the international standards in

terms of profitability (Iqbal et al. 1998).

2.2 Prohibition of Interest in Islamic Banking

Interest based activities are strictly prohibited in Islam as it is ordered by the Allah

Almighty in the Holy Quran. In Islam, religious, social and economic activities have

strong ties with each other, so economic activities (i.e. earning and spending pattern of

any individual) should be in line with the Islamic principles. Banks are actively engaged

in different economic activities by developing a liaison among various stakeholders for

financial and productive ventures. Banking activities must be interest-free and purely

according to principles of Sharia’h for the welfare of the all segments of the society.


2.2.1 Prohibition of Interest in the Holy Quran

Riba is prohibited step by step by Allah Almighty by conveying its pros and cons in the

Sura-e-Rome (30:39) and finally declared haraam in the Sura-e-Al-Bakara (2:275).

Following verses of the Holy Quran clearly reflects the instructions regarding riba.

“ That which ye given in riba in order that it may increase on (other) people's property

hath no increase with Allah; but that which ye give in charity; seeking Allah's

countenance, hath increase manifold” (30:39).

This is the first stage, to convey the pros and cons of riba. In this verse, Allah Almighty

disclosed the pros and cons of riba and ordered to spread charity. People only consider

extrinsic characteristics of riba to increase their capital manifold and ignores the intrinsic

fatal outcome of riba. You must frequently distribute charity, Zakat and Sadaqaat among

deserving people for sake of increase in your income and success in this life and in the

life hereafter.

“That they took riba, though they were forbidden; and that they devoured men's

substance wrongfully. We have prepared for those among them who reject faith, a

grievous punishment” (4:161)

This holy Verse shows the historical perspectives of riba. There are always a segment of

people even in the previous nations of the world, they are used to practice riba-based


activities and swallow the property of others by hook or crook. These people are warned

for exemplary trial and bad consequences of their deeds.

“O ye who believe! Devour not riba, doubled and multiplied; but fear Allah; that ye may

(really) prosper”. “Fear the fire, which is prepared for those who reject faith”. And obey

Allah and the Messenger; that ye may obtain mercy” (3:130-2).

This holy Verse makes a strong foundation for the prohibition of Riba by declaring it as

unwanted activity. The People are ordered to stop eating the earnings from Riba and

follow the instructions of Allah Almighty. It rejects manifold increase in the Riba and

warns the people. It also inspires the human being to be obedient to Allah Almighty for

ultimate success.

“Those who devour Riba will not stand except as stands one whom the evil one by his

touch hath driven to madness. That is because they say: ‘Trade is like Riba'. But Allah

hath permitted trade and forbidden Riba. Those who after receiving direction from their

Lord, desist, shall be pardoned for the past; their case is for Allah (to judge). But those

who repeat (the offence) are companions of the fire; they will abide therein (forever)”

(2:275).

These verses show the final prohibition of riba by the Creator of this universe. The

persons who eat riba are like those that are touched by satan and became unsound of

mind. They foolishly argue that trade is like riba. But trade is declared halaal and riba is


haram by Allah Almighty. So you must follow the instructions otherwise horrible fire is

waiting for you.

“Allah will deprive riba of all blessing, but will give increase for deeds of charity; for He

loved not creatures ungrateful and wicked” (2:276).

Allah Almighty does not bestow blessings upon riba-based activities and orders to stop

them, as He dislikes the violent. But there are uncountable blessings attached with the

deeds of charity and sadaqaat.

“O ye who believe! Fear Allah and give up what remains of your demand for riba, if ye

are indeed believers” (2:278). “If you do it not, take notice of war from Allah and His

Messenger. But if ye turn back, ye shall have your capital sums. Deal not unjustly, and ye

shall not be dealt with unjustly” (2:279).

These verses are related to desired post prohibition behavior of believers. Believers of

Allah Almighty are required to waive of their interest from borrowers and recover only

principal amount. And if you do not ready to accept then ready for war with Allah and

His Messenger, who can fight with Allah?

“If the debtor is in a difficulty, grant him time till it is easy for him to repay. But if ye

remit it by way of charity, that is best for you, if ye only knew” (2:280). “And fear the

Day when ye shall be brought back to Allah. Then shall every soul be paid what it

earned, and none shall be dealt with unjustly” (2:281).


Finally, these verses are the best examples to promote a sense of brotherhood and

collective welfare by cooperation. Because Allah Almighty inspires the people to give

relaxation to the borrower, if he faces some problems to repay the loan, even to write off

the debt as charity if the lender has capacity. This will be resulted into countless benefits

for individual and for the society as a whole. Eventually, people are responsible for their

deeds before Allah Almighty at the Day of Judgment.

2.2.2 Prohibition of Interest in the Ahadith

The Holy Prophet (Peace be upon him) gave us a complete code of life in the shape of

Islam that covers all aspect of human life (i.e. religious, social, and economic activities).

Islam is the religion of peace, brotherhood and cooperation having prime concern of

welfare being totally submissive to Allah. Islam ensures complete success in this life and

the life hereafter by following the instructions of the Holy Quran and Sunnah (practices

of the holy Prophet Muhammad-Peace be upon him). The holy Quran has clearly

declared an interest as haraam and people are prohibited to practice it. Similarly, the Holy

Prophet Muhammad (Peace be upon him) discouraged interest based activities and

strictly prohibited to practice it. Prohibition of riba is depicted from following Ahadith.

Abu Saad al Khudri (R.A) narrated that the Holy Prophet (Peace be upon him) said:

“Gold for gold, silver for silver, wheat for wheat, barely for barely, dates for dates and

salt for salt, like for like, payment being made hand by hand. If anyone gives more or

asks for more, he has dealt in riba. The receiver and giver are equally guilty” (Muslim).


Abu Hurayrah (R.A.) narrated that the Holy Prophet (Peace be upon him), said: “There

will certainly come a time for mankind when everyone will take riba and if he does not

do so, its dust will reach him” (Abu Daud).

Jabir (R.A) narrated that the Holy Prophet (Peace be upon him), cursed the receiver and

the payer of riba, the one who records it and who witnesses to the transaction and said:

“They are all alike (in guilt)” (Trimizi).

Ans Ibn Malik (R.A) narrated that the Holy Prophet (Peace be upon him), said: “When

one of you grants a loan and the borrower offers him a dish, he should not accept it; and

if the borrower offers a ride on an animal, he should not ride, unless the two of them have

been previously accustomed to exchanging such favors mutually” (Kitab al Buyua).

Abu Hurayrah (R.A) narrated that the Holy Prophet (Peace be upon him), said: “On the

night of Ascension I came upon people whose stomachs were like houses with snakes

visible from the outside. I asked Gabriel (A.S.) who they were. He replied that they were

people who had received riba” (Musnad Ahmed).

Abu Hurayrah (R.A) narrated that the Holy Prophet (Peace be upon him), said: “Allah

would be justified in not allowing four persons to enter paradise or to taste its blessings;

he who drinks habitually, he who takes riba, he who usurps an orphan's property without

right, and he who is undutiful to his parents” (Kitab al Buyua).


2.3 Functions of Islamic Bank

Business organization is primarily originated for the sake of profit by performing lawful

activities. Banks are also one of the business organizations that provide a set of products

and services to generate profits. Inception of Islamic banking practices in Pakistan

created multiple threats and opportunities to meet customers' expectations by the

provision of quality services. It initiated a healthy competition for Islamic banks to

compete with their peers and conventional banks for greater profits. It was observed that

the banking industry experienced stiff competition with banks and with other financial

institutions to attract potential customers (Hull, 2002).

Islamic bank works as a trading concern and financial intermediary to perform interest-

free activities purely according to principles of Sharia’h. It is a welfare organization that

promotes business and trade activities by pooling the financial resources for the sake of

profit and loss for mutual benefit. It is found that Islamic bank performs activities in the

right direction towards human development. It plays a positive role towards economic

development having main focus on human development while performing its functions

(Al-Harran, 1993). It is documented that banks have witnessed more profits on Murabaha

facilities as compared to conventional loans due to profit and loss base of Islamic

products (Ebraim, 1999).

Islamic banks perform a variety of fund-based and non-fund based functions to facilitate

their customers. Some important functions are displayed in figure 2.1.


Figure-2.1

Functions of Islamic Bank

Source: Generated

General Investment Fund

Specific Investment Fund

Long Term Musharika, Mudaribah and Diminishing Musharika etc.

Short Term Murabaha, Salam, Muajjal, Istisna etc.

Medium Term

Ijarah, Ijarah-Wa-Iqtina etc.

Accepts Deposits

Islamic Bank

Advance Loans (Financing Products)

Primary Functions Agency & Gen. Utility Functions

Non

-Fun

d B

ased

Ser

vice

s

Fun

d B

ased

Ser

vice

s


Islamic banks perform two types of functions i.e. fund based and non-fund based. Fund

based activities are called primary functions of Islamic bank i.e. acceptance of deposits

from savers on profit & loss basis and lend money to deficient individuals/business units

on profit and loss basis. Islamic Bank accepts deposits against savings and current

accounts. It accepts deposits against investment/savings accounts to generate income

under specific investment account or general investment account. Islamic Bank invests

this amount into different profitable ventures as an agent and shares the consequences.

Bank may receive deposits from people under current account and do not pay any interest

but may charge a fee for its services. Islamic banks lend money to borrowers for short-

term, medium-term and long-term investment (Musharika, Mudariba, Ijara, Salam,

Murabaha etc.) on the basis of profit and loss. In this way depositor, bank and borrower

share risk of loss according to a valid sales contract. It creates a strong economy on the

principles of transparency and accountability.

Uzair (1976) suggested the working structure of Islamic bank and explained its functions.

Banking transactions are undertaken among three parties i.e. actual users of the capital or

entrepreneurs; the bank as an intermediary and partial user of funds; the suppliers of

funds or depositors. The study recommended that all the transactions should be based on

profit and loss contracts among the concerned parties and exclusively interest-free. It is

also reported that Islamic banks could promote savings and investment activities by

determination of an equilibrium profit sharing ratio between depositors and borrowers

(Siddiqui, 1979).


Islamic bank performs some non-fund based functions like agency services and general

utility services. Islamic bank can act as an agent to provide the different types of services

like collection of cheques, collection of dividends, execution of standing orders, and

purchase/sale of securities. It also performs the general utility services e.g. a collection of

utility bills, foreign exchange remittances, providing Hajj services, currency exchanges

and ATM services etc. There is a sharp increase in the volume and market share, which is

depicted in table 2.1 as under

Table-2.1

Financial Performance of Islamic Banks

Indicators FY03 FY04 FY05 FY06 FY07 FY08

(March)

Assets of Islamic Banks 12,915 44,143 71,493 119,294 205,212 200,415

Deposits of Islamic Bank 8,397 30,185 49,932 83,840 146,945 141,933

Share in Bank Assets 0.50% 1.40% 2.10% 2.90% 4.20% 4.10%

Source: Economic Survey of Pakistan, 2007-08

Islamic banks have shown tremendous growth during the recent years. Islamic banks are

offering a variety of products and services to its customers. They strive to expand their

operations and perform multiple functions to attract the prospective customers for greater

profit. It requires the quality initiatives to retain valued customers by meeting their

expectations for better performance. Islamic bank proved a successful experience in

Pakistan and gained popularity among general public.


2.4 Operations and Products of Islamic Bank

Islamic banks are trade oriented financial institutions that provide interest free deposits

and investment opportunities for the people. It accepts deposits from general public under

general investment fund and specific investment fund that is clearly mentioned in the

agreement between the bank and the customer while opening their bank accounts. Islamic

bank actively performs several operations to provide a variety of products according to

customers' requirements. It deals with different types of customers i.e. depositors,

borrowers and service users. It provides credit facilities, financing products, funds

transfer facilities and other services according to customers' needs.

Table-2.2

Financing Products offered by Islamic Banks (in %)

Financing Products FY03 FY04 FY05 FY06 FY07 FY08*

Murabaha 79.4 57.4 44.4 48.4 38.9 38.7

Ijarah 16.5 24.8 29.7 29.7 25.4 24.2

Musharka - 1 0.8 0.8 0.9 1.3

Diminishing Musharka 1.2 5.9 14.8 14.8 25.1 24.8

Salam 1.6 0.7 1.9 1.9 1.4 1.6

Istisna - 0.4 1.4 1.4 0.9 2.4

Qarz/Qarz-e-hasna - - - - - -

Others 1.3 9.8 3 3 7.1 6.7

Source: Economic Survey of Pakistan, (2007-08). *(March2008)


Figure 2.2 reflects operations of bank for the provision of service to customers.

Figure-2.2

Operations of Islamic Bank

General Investment Fund

Specific Investment Fund

Long Term Musharika, Mudaribah and Diminishing Musharika etc.

Short Term Murabaha, Salam, Muajjal, Istisna etc.

Medium Term

Ijarah, Ijarah-Wa-Iqtina etc.

Accept Deposits

Islamic Bank

Advance Loans (Financing Products)

Primary Functions Agency & Gen. Utility Functions

Non

-Fun

d B

ased

Ser

vice

s

Fun

d B

ased

Ser

vice

s

Cus

tom

ers

Cus

tom

ers

Cus

tom

ers

Cus

tom

ers

Bank Services Bank Customers

Service Quality

Customer Satisfaction


2.4.1 Acceptance of Deposits

Islamic banks are striving to capture the maximum number of customers to compete with

conventional banks by providing a large number of products as an alternative for interest

based products. Islamic banks supervise deposits (as Mudarib or investment manager).

Profit or loss is shared between banker and the customers according to an agreed ratio. It

is found that customers are rapidly moving from conventional banks to Islamic banks due

to growing trust in the Islamic banking products and practices. There are different types

of customers (i.e. individuals, households, corporate bodies, financial institutions as well

as government and private organizations) that eager to engage in long term relationships

with the Islamic banks (SBP, 2007). The comparison of various contributors to deposits

of Islamic banks is given in figure 2.3

Figure-2.3

Contributors towards Deposits of Islamic Bank

Source: SBP, 2007


Service experiences may create positive or negative feelings and perceptions among

customers. If they have positive feelings regarding bank services as satisfied customers

they may repeat their transactions with the bank. On the other hand, dissatisfied and

unhappy customers may think to switch to other bank. An empirical study was

undertaken regarding the structure and performance of Pakistani banking sector. The

findings showed that equity capital and loans have a positive impact on the bank's

profitability while deposits affect it negatively (Arby, 2003).

2.4.2 Financing pattern and Products of Islamic banks Islamic banks provide a variety of financing products according to principles of Sharia’h

to cope with the challenges of the recent age. These products may be categorized as

short-term, medium-term and long-term according to their specific characteristics.

Islamic banks provide Short-term products like Murabaha; Istisna; Salam and Muajjal

etc. to meet running finance requirements of different business units. Ijarah and Ijarah-

Wa-Iqtina are a medium term financing options offered to the customers. Long-term

financing options consist of Musharika, Mudariba and Diminishing Musharika. It inspires

the people to deal on the basis of profit and loss to enhance the spirit of cooperation. It is

observed that Murabaha and Ijarah financing are very popular among people. But

Mudarbaha is least preferred option with 0% weight-age. It may be due to lack of

supportive financial environment. Increasing contribution of Diminishing Musharika

shows the banks' vigilance to diversify their portfolio by attracting a maximum number of

customers (SBP, 2007).


The financing contribution of each option is reflected in figure 2.4.

Figure-2.4

Contribution towards Financing Products of Islamic Bank

Source: SBP, 2007

Khan (1985) reported that Islamic bank could participate in productive activities by the

provision of funds on profit and loss basis to different industries e.g. manufacturing and

agriculture etc. In the agriculture sector, Islamic banks could participate: by the provision

of inputs to farmers; financing the purchase of inputs; provision of funds at a crucial

stage of harvesting; provision of funds for supportive activities like effective marketing

of farm output. The expansion of the banking industry requires a study to assess service

quality in relation to customers' satisfaction and its influence on bank performance.


2.5 Service Quality of Pakistan Banking Sector

Service is defined as a set of benefits delivered from the service provider to the service

consumer. It is reported that services have four key features that differentiate it from

goods i.e. intangibility, perishability, inseparability and heterogeneity (Parasuraman et

al., 1985). It is observed that service quality is a major factor in reference to customer

acquisition and retention (Galloway and Ho, 1996). It shows the organization’s ability to

meet customers’ desires and needs (Hanson, 2000). Service quality is an important input

of customer satisfaction in the banking sector (Spreng and Machoy, 1996; Gefan, 2002;

Ibáñez et al. 2006; Saravanan and Rao, 2007). Dimensions of service quality differ due to

many factors i.e. prevailing environment, political conditions, socio-cultural differences,

technological advancements and demographic characteristics. Service quality is a

multilevel and multidimensional concept that varies in meanings among researchers

(Cronin et al., 2000). Banks operating in Pakistan have realized the importance of service

quality to expand their operations and portfolio. It is reported that service quality leads to

customer satisfaction in the Pakistani banking environment (Jamal and Naseer, 2003).

2.6 Customer Satisfaction in Pakistani Banking Sector

Islamic banks are competing for more customers with each other besides stiff competition

with conventional banks. Customer satisfaction is getting importance due to expansion of

banking industry and innovative products according to customers’ needs across the globe

especially in Pakistan. It is an action of fulfilling a need, desire, demand or expectation.


Overall satisfaction is the outcome of customer's evaluation of a set of experiences that

are linked with the specific service provider (Westbrook, 1981). Customer satisfaction is

important due to an increased competition in banking sector (Bartell, 1993; Haron et al.

1994; Chakravarty et al. 1996; Chitwood, 1996; Kotler, 2003). It is concluded that

customer satisfaction enhances the reputation of the bank in the service environment

(Bontis, Booker and Serenko, 2007).

2.7 Performance of Pakistani Banking Sector

Islamic banks require performance evaluation to compete with conventional banks in

Pakistan. Bank performance should be evaluated due to stiffer competition and

customers' awareness of service quality. Performance of an organization could be

assessed by resource-based view as explored by a number of researchers (Wernerfelt,

1984; Barney, 1986). It could be linked with market orientation, organizational learning,

human resource productivity, quality improvement or any other component (Day, 1994;

Banker and Sinkula, 1999; Santos-Vijande et al., 2005).

Khalid (2006) reported that the performance of Pakistani banking sector had improved

after privatization. Similarly, banking industry in Pakistan has shown an unprecedented

growth as the best performing sector having banking assets of more than $ 60 billions.

Almost 81% of banking assets are owned by the private sector while foreign investors

contributed 47% of total paid up capital (Akhtar, 2007).


The performance of Pakistani banking sector during last few years is shown in Table 2.3.

Table-2.3 Performance of Banks in Pakistan Indicators 2006-07 2007-08

No. of Braches 7852 8233

Nationalized Commercial Banks 1690 1715

Private Banks 5597 5935

Specialized Banks 534 534

Foreign Banks 31 49

Assets (Rs. Billion) 4351.9 5155.1

Nationalized Commercial Banks 836.2 1017.2

Private Banks 3173 3845.2

Specialized Banks 119 1199

Foreign Banks 223.8 172.9

Net Advances (Rs. Billion) 2427.7 2694


Private Banks 1807.2 2044.4

Specialized Banks 70.6 72.2


Deposits (Rs. Billion) 3255 3852





Net Investment (Rs. Billion) 836.7 1275.5





Source: Economic Survey of Pakistan, 2007-08


Islamic banks are successfully competing with the conventional banks by capturing a

reasonable share of the market. Islamic banks enjoyed tremendous growth within a

shortest possible time. Similarly assets, deposits, financing and customers became

manifold within few years. Financing products offered by Islamic banks became popular

among people due to flexible terms and conditions. The impressive growth of Islamic

banks can be associated with the introduction of new financing products according to

principles of Sharia’h as an alternative for Riba-based financing products offered by

conventional banks. The performance of the Islamic banks is given in the Table 2.4.

Table-2.4 Performance of Islamic Banks in Pakistan

(Rs. in Billion)

Descriptions Dec-07 Dec-06 Dec-05 Dec-04 Dec-03

Total Assets 206 118 72 44 13 % of Banking Industry 4.3 2.9 2.1 1.4 0.5 Deposits 147 83 50 30 8 % of Banking Industry 4.1 2.8 1.9 1.2 0.4 Financing & Invest. 138 72 48 30 10 % of Banking Industry 3.6 2.4 1.8 1.3 0.5 Number of Full Fledge Islamic Banks 6 4 2 2 1 Number of Conventional Banks With Islamic Banking Branches

12 12 9 7 3

No. of Branches 289 150 70 48 17 Source: Islamic Banking Bulletin by SBP, 2008.

913s-2

Documents

pakistan pakistan

banking industry

constitution of pakistan

pakistan prohibition

government of pakistan

islamic republic

state bank of pakistan

official religion of