Islamic financial institutions are rapidly expanding in terms of product lines, sectors and geography. Previously, in 1070’s, there were only Islamic banks offering ijarah and Murabaha based products (Othman and Mara, 2013) operating in GCC and other Muslim countries. But now other sectors like takaful, Islamic microfinance, mutual funds, real estate, shariah screening, and shariah auditors are also operating. Islamic banks are now offering new product lines based on Salam. Istisna, wakala, wadiah offered (Ullah and Patel, 2011). In addition to GCC countries, Islamic banks are now operating in Singapore, UK, Austrailia, Japan, Russia, Germany and several Asian states (Iqbal, 1997). All these institutions are adding into the economic development and they supplement each other in delivery. Moreover, due to asset backed transactions, it also promote real business activities, thus contributing into the economy (Haiss and Sumegi, 2008; Lee, 2011; Asif, Ather, and Isma, 2014; M. S. A. Majid, 2008; Muye and Hassan, 2016). Due to participatory nature of transaction and profit and loss sharing, it promotes circulation of wealth, thus adding into the economy.
Insurance is considered to be an important element of financial system. It promotes trade and development through mitigating risks of financial losses due to various physical hazards. Since insurance doesn’t conform to the religion Islam due to presence of prohibited elements like interest, uncertainty and gambling (Farooq, Chaudhry, Alam & Ahmad, 2010; Maysami & Kwon, 1999), therefore many Muslims avoid the use of insurance. Through research, Muslim scholars developed system of takaful or Islamic insurance which lacks the prohibited elements and confirms to the Islamic teachings. Globally, takaful is growing exponentially and has a double digit growth (World Takaful Report, 2016). Takaful is playing an important in the financial inclusion of the people who were previously excluded due to non shariah compliant nature of insurance. Takaful provides life as well as non-life or general coverages. In general takaful, in case of loss to the business due to fire, earthquake, burglary, floods, voltage fluctuation and other hazards, takaful companies compensate businesses through paying claims and help in continuation of the businesses (Ward and Zurbrueg, 2000). In absence of takaful, businesses had to set aside a considerable amount of money for managing the losses that might occur. While takaful costs relatively lesser amount and the setting aside money is also invested in business bringing more return and expansion (Malik and Ullah, 2016).
Like general takaful, life takaful also called family takaful also plays an important role in economy through promoting savings and ensuring circulation of wealth (Ryan, 1994). Clients pay small and large regular contributions (premiums) in life coverage for longer periods which are onward invested by companies in different areas for returns. They invest in Islamic financial institutions on short and long term basis which onward provide funding to businesses for establishing new and expanding existing businesses. Takaful companies also invest in capital markets and add real estate. Takaful also supports the Islamic banks when they provide financing to their clients activities. Takaful companies cover properties of borrowers, mortgaged and pledged with the Islamic banks and leasing companies and promote business. Without takaful coverage, Islamic banks seldom provide financing to their clients. Insurance and takaful being an effective part of financial system and various studies have found a positive impact of takaful and insurance on economic growth and findings show that there is a positive relationship between insurance and economic growth. Still several studies show insignificant relationship. So, a consensus has not reached on its positive relationship of insurance and takaful with economic growth.
Studies conducted by Haiss and Sumegi (2008), Kugler and Ofoghi (2005), Outreville (1990), Vadlamannati (2008), Cull et al. (2003), Chen et al (2012), Lee (2011) and Asif et al. (2014) finds that insurance has a positive impact on business growth and economy. While some other studies including Webb et al. (2002), finds that there is no significant relationship between insurance and economic growth. Relatively lesser studies have been carried out about impact of takaful on economic development. Muye and Hassan, (2016) finds a positive relationship between development of takaful and economic growth.
Being an emerging business, takaful operators are still facing the challenges of optimal business structure, price competition from conventional insurance companies and regulatory issues. Still takaful sector is a growing area and companies are bringing good profit for their owners (World Takaful report, 2016).
Beside other institutions, insurance and reinsurance companies are considered vital for economic development (Outreville, 1990; Arena, 2008; Vadlamannati, 2008). They also support the economic system of a country and encourage circulation of wealth. At one side, they provide a choice to clients for savings in shariah compliant mode (Ryan, 1994) while at the other side, they compensate the financial losses of the businesses due to fire, earthquake, and floods and keep their business continue (Ward and Zurbrueg, 2000). Clients pay their savings in the form of contributions (premiums) to takaful companies while there is always a time gap between premium and claim payment. Takaful Companies utilize this time gap and invests the collected premiums in avenues where they can get best and safe return. Mostly, they invest in Islamic banks through murabaha and ijarah income certificates, sukuk, stock of companies which are engaged in shariah compliant businesses, mutual funds etc. Moreover, takaful companies provide financial protection to business enterprises like factories, distribution, transport and many other businesses against the risk of fire, natural calamities, riots and many others. They compensate the business if any loss occurs due to these risks and keep the businesses going, thus adding to the national productivity and circulation of wealth.
Takaful business was first commenced in 1979 at Sudann (Kwon, 2007; Sherif and Hussnain, 2017). Since Muslims avoid conventional insurance due to presence of riba, uncertainty and gambling, therefore, as an alternative to insurance, takaful was developed as it doesn’t invite objections by the religious scholars (Farooq et al 2010). Moreover, takaful companies started establishing in Malaysia after the passage of Takaful Act ordinance introduced. Over the period of 40 years, there were more than 300 takaful companies operating globally (World Takaful Report, 2016).
First Islamic bank was established in Egypt in 1964 (Idiab and Ahmad, 2011). Dubai Islamic bank, the first Islamic commercial bank was established in 1975 and dozens of Islamic banks were established after 1980. (Shinsuke, 2012; Okon, 2013). Presently more than 500 Islamic financial institutions are operating globally (Qorchi, 2005). In Pakistan, assets of the Islamic banking industry up to June, 2018 reached to Rs 2482 billion while market share of Islamic Banks has reached to 12.9 percent in assets and 14.8 percent in deposits of the total banking industry. The number of fully dedicated Islamic banks are five (5) and number of conventional banks with Islamic banking branches are sixteen (16), whereas, the total Islamic banking branches are 2,685 (SBP, 2018).
In last quarter of 2018, assets of Islamic banks operating in Pakistan increased by 8.1% i.e. from Rs. Rs. 200 billion to 2658 billion. Deposits grew by 9.9% from Rs. 198 billion to Rs. 2203 billion while in banking market, share of Islamic banks in terms of deposits reached to 15.5% and assets reached to 13.5%. Looking at different deposit products, it is found that increase in current and fixed deposit is 12.3% and 8.9% respectively and saving deposits enhanced by 3.1%. Profitability of islamic banks in last quarter of 2018 also increased as recorded profit before tax was found to be Rs. 34 billion while last year in the same quarter, it was Rs. 23 billion (SBP, 2018).
World average penetration of insurance is around 6% of its gross domestic product (GDP). In 2014, global insurance premium totaled to USD 4778 billion. (Sigma Study, 2015 Swiss Re Insurance Company). Insurance penetration in India is around 3.9% of its GDP. While in Pakistan, insurance penetration is less than 1% of its GDP (Insurance association of Pakistan, 2017). One of the major reasons for such a low penetration is the declaration of insurance as prohibitive by religious scholars due to presence of such elements which are not acceptable in Islam. Ismail et, al. (2017) reports world total takaful contribution was 14.9 billion US$ in 2015 with a growth rate of 14%. General takaful contribution is around 83% while life takaful has a share of 17%. In Pakistan, takaful was introduced in 2006. In almost eight years, market share of takaful has reached to 5% and is still growing. Moreover, the global takaful market is growing at a rate of 14%, while conventional insurance is growing at 5.5% (Earnest & Young, 2014). Pakistan is a Muslim majority country having around 200 million population with 97% Muslims. It is located in south east part of Asia. In Pakistan more than 40 insurance companies are operating.
In 2014, insurance companies were allowed to establish their window takaful operations. Presently there are five dedicated takaful companies and more than 15 insurance companies are providing window takaful services (SECP, 2014). Insurance penetration in Pakistan is less than 1% of GDP which is one of the lowest in the region. Takaful companies hold almost 5% of the total insurance / takaful market (Insurance Association of Pakistan, 2016). Takaful is growing at a much higher rate than insurance, so it is important to investigate the effects of religious beliefs on financial exclusion. While the increasing growth of takaful is indicating its acceptability among people, it is important to find its impact on economic growth.