By Azam Tariq

Islamic banking in Pakistan expanded its footprint in 2025, reaching around 23% of the total banking sector assets, according to the Financial Stability Review 2025 released by the State Bank of Pakistan (SBP).

The report indicates that Islamic banking institutions (IBIs) continued their strong growth trajectory during the year, outpacing conventional banks for the second consecutive year. The expansion was driven by rising customer demand for Shariah-compliant financial services, supported by policy initiatives and regulatory frameworks aimed at promoting Islamic finance in the country.

The asset base of Islamic banks recorded a significant increase, supported by strong growth in both financing and investment activities. Deposit mobilization also remained robust, providing a stable funding base for expansion. The growth in deposits reflects increasing public confidence in Islamic banking products and services, as well as broader efforts to enhance financial inclusion.

The SBP noted that the branch network of Islamic banking institutions expanded at a record pace during 2025, contributing to wider outreach and accessibility. This expansion played a key role in increasing market penetration and attracting new customers, particularly in areas with limited access to conventional banking services.

Asset quality in the Islamic banking segment also improved, with the ratio of non-performing financing declining to 2.4% from 3.5% in the previous year. This indicates better credit management and a strengthening risk profile within the sector, despite broader economic challenges.

The report highlights that investments and financing activities grew at a strong pace, supported by favorable economic conditions and increasing demand for Shariah-compliant products. Islamic banks also benefited from their diversified asset portfolios and strong capital positions, which helped sustain growth and maintain stability.

Despite the strong expansion, profitability indicators showed some moderation. Return on assets and return on equity declined compared to the previous year, reflecting changing financial conditions and cost pressures. However, overall earnings remained stable, supported by volume-driven growth.

The SBP emphasized that Islamic banking continues to play an increasingly important role in Pakistan’s financial system, contributing to diversification and resilience. The sector’s growth aligns with broader policy objectives, including the transition toward a more Shariah-compliant financial system in line with legal and constitutional developments.

The report also notes ongoing efforts by the central bank to strengthen the regulatory and Shariah compliance framework, including the adoption of international standards and the development of Islamic liquidity management tools. These initiatives are expected to support sustainable growth in the sector.

While the outlook remains positive, the SBP highlighted the importance of maintaining strong risk management practices and ensuring compliance with evolving regulatory standards. Continued expansion, supported by innovation and customer outreach, is expected to further increase the share of Islamic banking in the coming years.

Credit: INP-WealthPk