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Banishing Interest from Pakistan Economy

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Islamic banking have become a $65 billion industry in terms of assets held

By: Muhammad Mahmud,
Apr 17 - 23, 2000

The historic decision of Shariah Appellate Bench of the Supreme Court of Pakistan while declaring all laws that deal with the payment of interest as repugnant to the injunctions of Islam, ruled that all such laws should cease to have effect from June 30, 2001.

The bench observed that a variety of Islamic modes of financing had been developed by Islamic scholars, economists and bankers that may serve as a better alternative to interest. Hence, the transactions of interest cannot be allowed to continue forever on the basis of necessity.

A number of industrialists and businessmen, while appreciating the decision of the Supreme Court declaring interest as un-Islamic, have called it as a positive sign for country's economy. However, to prove their point in practice a will has to be done by the government and the business community while safeguarding the value to money held by the people.

Although the Islamic economic principles are as old as the Qur'an itself, modern Islamic economic thinking is relatively a new phenomenon which has emerged as a consequence of the Islamic awakening in the Muslim World during the post-war era thanks to the writings and efforts of Mawdudi in the Indian sub-Continent and Hasan al-Banna and Sayyid Qutb in Egypt. Mawdudi's 'Interest' in late 30s and Qutb's 'Social Justice in Islam' in 50s opened the floodgates to literature on Islamic economic philosophy and system.

The most prominent characteristic of the Islamic economic system that distinguishes it from capitalism, as the majority of Islamic economists perceive, is prohibition of interest. According to them, the prohibition of interest is absolute and includes both institutional and non-institutional transaction of interest. Therefore, the Islamic evaluation of modern banking and investment focuses on the evils of the institution of interest. Now a rationale that bears a promise of giving modern man a new and just institution of investment and banking without interest has developed.

Islamic Financial Institutions in Operation

Islamic banking is no longer a mere theoretical proposition. They have become a $65 billion industry in terms of assets held. Yet this represents less than 1% of bank assets world-wide.

Real impetus to Islamic banking and investment practice came after the establishment of the Islamic Development Bank, Jeddah, in 1975 through co-operation of member countries of the Organisation of Islamic Conference (OIC). The period since then has witnessed a sustained growth of Islamic banks and other financial institutions. Islamic banks and other financial institutions are not confined to any specific geographical region. They are located in the Muslim World as well as in the West.

The moment one comes across the term "Financial Institution" the first and foremost thing that strikes one's mind is "Interest". One may wonder how a finance company can function without earning interest. The fact is, it is feasible; it has worked successfully in the Gulf and other countries and has proved to be viable beyond doubt.

Following the decision of Supreme Sharia Court's decision, Government of Pakistan has constituted a high level commission to supervise the process of transformation of the existing financial system to the one conforming to Sharia. As per Supreme Court decision the commission, is to chalk out a strategy, within two months, to evaluate, scrutinise and implement the report of the Commission for Islamisation of the Economy as well as the report of Raja Zafarul Haq Commission, after considering the views of leading banks, religious scholars, economists, the State Bank of Pakistan and the Finance Division. The strategic plan so finalised shall be sent to the ministries of Law, Finance and Commerce, and all the banks and financial institutions to take implementation steps.

The Ministry of Law and Parliamentary Affairs is to form a task force comprising its officials and two Shariah scholars from the Council of Islamic Ideology or from the Commission on the Islamisation of Economy to draft new law covering new interest-free financial instrument and prohibition of Riba. The recommendations of the task force shall be vetted and finalised by the "Commission for Transformation", set up in the State Bank of Pakistan.

The Supreme Court observed that an effort to eliminate only Riba, in isolation from banking system, would be more harmful than helpful due to intricate inter-dependence of different vital economic sectors. An efficient course will have to first identify and strengthen the existing critical economic sectors falling under Shariah for isolating Riba-based system for its proper treatment.

This situation will automatically put pressure on our Riba-based banking system to innovate itself into Islamic system to attract depositors investing in parallel Shariah-based sectors. The small investors have suffered a lot due to inefficiency and dishonesty of entrepreneurs who enjoy high living standards while the investors face erosion of their capital due to inflation, bitter experience over their investments with Pakistani entrepreneurs.

It is not possible to successfully implement the Islamic tenets of interest-free banking unless fairplay to the investors through legal framework mandating transparency and disclosure of information on the part of individual and corporate vying for interest free money. Realising this paramount requirement, Supreme Court has recommended free availability of the following data:

1 - Individual's Credit History

That no individual is to be allowed to get utilities connections, open any bank account or obtain a loan unless his credit report received from a credit bureau is clean. These bureaux are non-government entities and by paying a nominal fee any organisation can access the databases for requisite information.

2 - Industries' Rating

Reputed rating agencies, namely (I) Standard and Poor's (ii) Moody's (iii) DCR and (iv) Fitch-IBCA are referred to by the financial institutions and lending institutions for reporting about credit ratings of the borrowers before extending loans, whether the borrower is a corporate body or other institution.

The Security Exchange Commission, USA, grants them licence and monitors their quality of work. In Pakistan to regulate the business of credit rating companies, the Credit Rating Companies Rules 195 were framed by the federal government under Section 33 of the Securities and Exchange Ordinance but these rules have not been usefully applied whereas in the USA individuals, corporations, banks and financial institutions and even municipalities are all rated by the credit companies and their credit rating is relied upon by the investors before investing into the bonds or other instruments floated or offered for investment to the public. These ratings are instituted on the philosophy of right to know.

A regulatory legal framework and transparency and prudential measures are a must to safeguard the investors in Pakistan from deprivation of billions in the shape of Taj Company and Co-operatives scams. A comparison between the size of the economy and number of listed companies can be a guide to the loose regulatory framework that encourages rogues to fleece investor and creditors in the disguise of "Limited Liability" Laws.

Unlike Western countries, there are no laws in Pakistan against insider trading by major shareholders, which is conflict of interest, a crime in the West. The market indexes in the West like Dow Jones (USA), FTSE (UK) and Nikkei (Japan) were developed by third parties while in Pakistan, the Karachi Stock Exchange (KSE) 100 index is maintained by the stock market itself and has come under adverse comment from the minister of finance due to its speculative characteristics. This index serves the purpose of a few players in the market by luring innocent investors into investment, thus cyclically depriving them of their hard-earned money. This also requires transmission by introducing independent transparency.

3 - Debt Markets In Pakistan

We have an inactive debt market and its savings have been repeatedly wiped out, as debt markets are not in a position to provide the necessary "hedge" to the investors. The result of this under-developed debt market is the promotion of Riba which is being channelled into banking system as industries want long-term finance, they have to resort to the banking, which in turn results in promoting Riba transactions. If the concept of Islamic debt through Musharika certificates is adopted on urgent basis, lot of equity/funds can be made available through developed debt markets and in that way reliance on banks can be reduced.

4 - Establishment of Data Collections Firms

The financial institutions should encourage experts, lawyers and others to establish firms for keeping track of the clients, individuals, corporations who commit default so that they could be brought before the competent courts by facilitating service of the process of the courts on them and also trace their properties and assets whether standing in their names or benami to facilitate recovery through execution of decrees.

Effect on savings

The state has to insure constant economic growth by ensuring uninterrupted supply of additional savings from public. Savings are the fuel for growth, without it the economy will wither. The saver has to be protected to increase our dismally low rate.

In order to give incentive for saving, purchasing power of currency-in which savings is stored-must not erode with time. The biggest fault is with the government who has monopoly to print any amount of currency and cause erosion of money value to currency.

The guiding principle of Islamic financial system is the removal of exportation of man. If we keep in mind that Islam does not prohibit improvement of economic lot of the individual, the bureaucratic fiscal policies and their implementation will have to adjudicate to check exploitation of the people. The hallmark for judging the justifiability has to take priority. The government has to review all its policies in accordance with this consideration, including taxation and income distribution. These policies determine the very basis of economic activity. It should also make the criterion of furnishing the cost of money provided as capital to reproductive enterprises.

Government's stance

There are doubts in many financial and public circles that the verdict of supreme count will bring about drastic changes abruptly causing disruption and may result in the collapse of economy. These fears are so wide spread that government of Pakistan has to issue statement clarifying their stance in the following terms:

i) All banking transactions, contracts, agreements, commitments, obligations, investments in, and by, banks and returns there upon are completely protected and will remain so until such time that the modified arrangements are worked out in the light of the recommendations of the Commission for Transformation to be set-up in the State Bank of Pakistan;

ii) The commitments of the Federal Government to individuals, organisations, banks or other entities, in terms of their investments and returns are fully protected and will continue to remain so in the future until these are modified appropriately in the light of the recommendations of the Commission for Transformation;

iii) Financial relations of the Federal Government with the State Bank of Pakistan and those of and between Provincial Governments and local authorities will be carried out on the same lines as at present. Appropriate changes in these arrangements will be recommended by the Commission for Transformation.

iv) The standards currently applicable for individuals, firms, corporations, organisations and other bodies for accessing the money and capital markets will remain enforce until these standards are amended by the law;

v) The financial commitments and obligations of the Federal Government to the foreign governments, banks, financial institutions and other entities are not affected; and

vi) All recovery proceedings currently in hand, either in courts or by the creditors, will remain unaffected."


While every Pakistani entrepreneur would like to see and interest free Pakistan, the success and implementation of supreme court decision forbidding Riba will depend greatly on the transformation process encompassing formation of new rules, transparency of information and quick accountability of the entrepreneurs.