Emerging Markets

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Introduction Banks play a very important role in the economy of every country and Pakistan is no exemption. Banks are custodian to the assets of the general masses thus making them one the most sensitive businesses all over the world. The banking sector has a vital role to play in a contemporary world of money and economy. Many different but integrated economic activities like resources mobilization, poverty elimination, production and distribution of public finance are influenced and facilitated by the banking sector. To cater for special requirements of specific sectors, there is a wide variety of institutions ranging from a central bank to commercial banks and to specialized agencies that constitutes a well developed banking system of Pakistan. The country started without any worthwhile banking network in 1947 but witnessed phenomenal growth in the first two decades and by 1970, it had acquired a flourishing banking sector. The nucleus in the financial system of the country is the State bank of Pakistan. Like the banking system of all other countries, central bank of Pakistan plays the role of central arch in the monetary and fiscal framework and performs activities that are essential for the smooth and proper functioning of the economy and significant for the fiscal operations of the government. State Bank of Pakistan was established on the first of July 1948 under the SBP order 1948 as the central bank of the country. Pakistan’s accelerated economic growth was supported a strong banking sector in the ye ars 2002 to 2007. The banking industry’s assets rose to over $60 billion, the profitability remained high, non performing loan were low, credit was fairly diversified and bank wide system risks were well contained, hence making it Pakistan’s and region’s best performing sector. Almost 81% of banking assets are in private hands and similarly the present foreign stake comes to 47% of total paid-up capital of all the financial institutions that are regulated by Pakistan's central bank, which is the State Bank of Pakistan.

Literature Review Islamic Banking Islamic banking refers to a system of banking or banking activity that is consistent with the principles of Islamic law (Sharia) and its practical application through the development of Islamic economics. Sharia prohibits the payment of fees for the renting of money (Riba) for specific terms, as well as investing in businesses that provide goods or services considered contrary to its principles (Haram) Riba: means an increase over principal in a loan transaction or in exchange for a commodity accrued to the owner (lender) without giving an equivalent counter-value or recompense in return to the other party; every increase which is without an or equal counter-value. Haram: Anything prohibited by the Shariah. Riba is but one of the major undesirable elements of an economic transaction, the others being Gharar (uncertainty) and Qimar (speculation). While elimination of these objectionable aspects in a transaction is indeed a critical aim of Islamic banking system, it is by no means its ultimate objective. At the heart of Islamic Banking is a system of commercial transactions that not only provides Halal modes of commercial transactions by avoiding that which is obnoxious and objectionable, but also fosters ethical, fair and just practices. A key element of Islamic economics is distribution of equitable rewards to the different factors of production. Islamic economic system seeks system of Redistributive justice where concentration of wealth in a few hands is countered and flow of money into economy is fluent. Islamic Banking is, therefore, seen as a lynchpin to achieving the economic and social goals of the Islamic economic system. Gharar: It means any element of absolute or excessive uncertainty in any business or a contract about the subject of contract or its price, or mere speculative risk. It leads to undue loss to a party and unjustified enrichment of other, which is prohibited. Qimar: Qimar means gambling. Technically, it is an arrangement in which possession of a property is contingent upon the happening of an uncertain event. By implication it

applies to a situation in which there is a loss for one party and a gain for the other without specifying which party will lose and which will gain. Halal: Anything permitted by the Shariah.

Islamic financing: Asset-based financing: A key feature of Islamic banking is that unlike conventional banks which deal primarily in money and financial securities, Islamic financing is related to an asset that is a feature of the transaction, and quite often the principal feature itself. From this springs an important distinguishing feature of Islam wherein Islamic financing is always based on illiquid assets that have intrinsic value. Profit to Islamic financing is generated through authentic sale of these assets. Conventional banking, on the other hand, is free of such limitations. It lends money and makes its earnings through this act of lending. Its earnings are unconcerned with the economic fate of its lending.
Role of Interest Spread

Interest spread, the difference between what a bank earns on its assets and what it pays on its liabilities. An increase in the interest spread implies that either the depositor or the borrower or both stand to loose. In the context of developing economies, the lack of alternate avenues of financial intermediation aggravates the adverse impact of increase in spread. Interest spread also has implications for the effectiveness of the bank lending channel. For example, with a commitment to market based monetary policy, the central bank influences the yield on treasury bills that in turn affects the deposit and lending rates. The change in these rates influences the cost of capital that in turn affects the level of consumption and investment in the economy. If the pass through of the changes in yield on treasury bills rate to the deposit and lending rates is asymmetric then this changes the spread, for better or worse, depending upon the nature of asymmetry. If the increase in spread is due to lower return to depositors then this discourages savings; alternatively if it is due to higher charge on loans, investment decisions are affected. In either case the increase in spread has an adverse

bearing upon the effectiveness of bank lending channel of monetary policy and has therefore important implications for the economy.

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