currently working as Executive Director (Banking) with State Bank of
Pakistan. He is responsible for supervising the work of three
departments namely, Banking Supervision, Banking Policy and Banking
Inspection departments. He has served as Chairman/Member on various
committees/forums constituted to deal with complex banking sector
related issues. He has also served as Chairman of the Committee
responsible for developing documentation for Islamic modes of financing
for introducing Islamic Banking in the country. He also presented a
paper on "Experience of Central Banks in Supervising Islamic Banks
- Pakistan's Experience" at a seminar on "Islamic Financial
Industry" jointly organized by Islamic Research and Training
Institute (IRTI) of the Islamic Development Bank, Jeddah and Centre of
Managerial Development, Alexandria University, Egypt in year 2000.
Over the last three decades Islamic banking and
finance has developed into a full-fledged system and discipline
reportedly growing at the rate of 15 per cent per annum. Today, Islamic
financial institutions, in one form or the other, are working in about
75 countries of the world.
The experience in Islamic banking operations around
the world reveals that transformation of retail banking is not a big
problem. The financial sector in Pakistan is already familiar, at least
to some extent, with the concept of Islamic banking and finance.
However, there are problems in development of instruments for liquidity
management by banks and monetary management by the State Bank of
Pakistan, the main challenge.
The Government of Pakistan has decided that the shift
from conventional banking to Riba free economy would be made in a
gradual and phased manner and without causing any disruptions. Pakistan
is not trying to reinvent the wheel. It can benefit from the experience
of other Muslim countries like Bahrain, Malaysia, Sudan and Iran.
In this exclusive interview with Mansur-ur-Reheman
Khan, Executive Director (Banking), State Bank of Pakistan, effort has
been made to identify the factors impeding the development of Islamic
banking in the country, the central bank policy and the facets of
proposed regulatory framework.
What measures have been taken to eliminate Riba from the prevailing
banking system in Pakistan?
was the basis of creation of an independent state within the undivided
Indo-Pak Sub-Continent. Since its creation, the people of Pakistan have
held the demand for elimination of Riba from the financial system
of Pakistan on the basis of Islamic precepts. All Constitutions of
Pakistan have incorporated, within the principles of policy, the
elimination of Riba as an important objective of the State policy.
Quaid-e-Azam, the father of the nation, in his speech at the occasion of
the inauguration of State Bank of Pakistan (SBP), had expressed the
desire for evolving an Islamic system of banking.
Article 38(f) of the Constitution of the Islamic
Republic of Pakistan, 1973 provides: "The State shall.. eliminate Riba
as early as possible." The Objectives Resolution, now a part of the
Constitution, as well as principles of policy enunciated in the
Constitution also require to establish an order in Pakistan ì[w]herein
the Muslims shall be enabled to order their lives in the individual and
collective spheres in accordance with the teachings and requirements of
Islam as set out in the Holy Quran and Sunnah.".
The measures taken to eliminate Riba are: -
The earliest efforts for finding an alternative to
the interest-based system could be found in a number of reports
submitted by the Council of Islamic Ideology (CII).
Efforts for economy wide elimination of Riba started
during 1970s and most of the practical steps were taken in early 1980s,
which are considered as pioneering work in the Muslim world. Numerous
measures were taken to introduce Riba free banking in Pakistan.
Banking and other relevant laws viz. State Bank of Pakistan Act, Banking
Companies Ordinance, Recovery Laws, Negotiable instruments Act,
Companies Ordinance, etc. were amended to facilitate Riba free
banking system. New regulations were prepared prescribing the modes of
financing, profit distribution mechanism for deposits, financing
facilities by SBP, etc., which constituted ground work for Islamization
of financial system. At that time two important areas were kept outside
the purview of Riba free banking system mainly due to lack of
research in these fields, viz. government borrowings (both local and
foreign) and foreign exchange. However, after 1985, mainly due to lack
of commitment of successive governments to Islamize the economy,
inadequate judicial system and absence of Shariah compliance
mechanism in the banks hampered further research and development in this
A number of Commissions, Committees, Task Forces,
Working groups, etc. have been formed over the years, which have
contributed in thrashing out various issues at conceptual and
operational level. However, extensive research and development is still
needed for complete elimination of Riba.
In December 2001, SBP issued the Detailed Criteria
for establishment of Islamic commercial banks in the private sector. Al-Meezan
Investment Bank Limited applied under the criteria issued by SBP to
convert itself into an Islamic commercial bank. It was issued the
licence in the name of Meezan Bank Limited to operate as full-fledged
Islamic bank in January 2002. The bank acquired the business of Societe
Generale Bank branches operating in Pakistan and has started commercial
operations in March 2002 as a model Islamic bank in Pakistan. The
regulatory issues like maintenance of Statutory Liquidity Requirement
and Cash Reserve against FE-25 and other deposits have been resolved by
allowing Meezan Bank to maintain these requirements in the form of
Current Account balance with SBP at a reduced level. An Islamic Export
Refinance Scheme has been prepared on Musharika basis, which has
been extended to Meezan Bank as a pilot project.
In order to allow existing banks to open subsidiaries
for Islamic banking, section 23 of Banking Companies Ordinance, 1962 has
been amended and now the banks are authorized to open subsidiaries for
Islamic banking. The separate criteria for establishment of such
subsidiaries by existing banks will be notified shortly.
A scheme for allowing the existing banks to open
standalone branches for Islamic banking operations is being prepared
keeping in view the underlying issues and the international practices in
House Building Finance Corporation Act has been
amended to make its financing Shariah compliant and they have
issued Asaan Ghar Scheme on the basis of diminishing Musharika.
SBP has taken several steps for capacity building in
the areas of Islamic banking and its regulations. Various officers
attended local as well as international seminars and conferences on
Islamic banking held in Iran, Sudan, Bahrain, Lebanon, Egypt etc. The
National Institute of Banking and Finance of State Bank (NIBAF) has
started training of SBP personnel in Islamic Finance. As regards
commercial banks, courses of Institute of Bankers Pakistan were revised
to include topics on Islamic economics, banking and finance. Some other
institutions like International Islamic University, Islamabad and Centre
for Islamic Economics, Karachi have also conducted training courses in
A Committee for development/review and adoption of
accounting standards for Islamic modes of financing was also constituted
in the Institute of Chartered Accountants Pakistan (ICAP) in which SBP
is also represented. The Committee is reviewing the accounting standards
prepared by Accounting and Auditing Organization for Islamic Financial
Institutions, Bahrain (AAOIFI) with a view to adapt them to our
circumstances and if considered necessary to propose new accounting
standards. The Committee has prepared the standards on Murabaha
and Ijara and is now working on Musharika standard. SBP
has also reviewed its Forms of Financial Statements for banks in the
light of AAOIFI standards.
What are the factors impeding the development of Islamic banking in the
we look at our history in Islamic banking, the following factors can be
identified which have impeded the development of Islamic banking in
Pakistan so far:
Ineffective enforcement of contracts and inefficient
system for early recovery,
Declining ethical standards in the society,
Taxation policies, due to which, many borrowers do
not disclose their true income thereby restricting the scope of Musharika
and Modaraba modes of financing,
Absence of Shariah Supervisory Boards in
Non-availability of Shariah compliant
government securities and money market instruments,
Dearth of experienced persons trained in the field of
Lack of research and development in the field of
Islamic finance and economics especially Shariah compliant
Inadequate training to the staff of SBP and banks.
Lack of development in related segments of financial
system like Insurance, debt markets, non bank financial institutions
(with the exception of Modarabas)
Disoriented education system, devoid of Islamic
Lack of public awareness about Islamic economic
Social and cultural factors,
Lack of commitment on the part of successive
governments to Islamize the economy.
The factors under the control of SBP like Shariah
Board in Islamic banks, Shariah audit, training to SBP and
bankers, recovery laws and mechanism, etc. have been/are being
THERE ARE FOUR MAJOR SEGMENTS OF FINANCIAL SYSTEM:
Insurance and non bank financial institutions
Financial Markets (Equity and Debt Markets)
In order to develop an integrated Islamic financial
system, reforms in all these four areas are needed. Currently, only SBP
is working on development of Islamic commercial banks. However, for
their success, significant development in the other three segments is
In order to ensure early enforcement of contracts and
redressal to grieving parties, an efficient judicial system is needed.
An efficient judicial system can prevent willful defaults and promote Musharika
by protecting the rights of contracting parties.
The most challenging area is Islamization of public
debt for which some alternatives have been developed in countries like
Bahrain, Sudan, Malaysia etc.
Is Pakistan trying to reinvent the wheel or adopting the systems
prevailing in other Muslim countries?
are learning from the experience of other countries. Various officers
have participated in seminars and workshops held in Bahrain, Sudan,
Iran, Egypt, Lebanon, Malaysia etc. A delegation comprising
representatives of Ministry of Finance, SBP and a renowned Islamic
scholar/jurist was sent by the Ministry to Malaysia, Egypt and Saudi
Arabia in October-November, 2001, which met with experts in Islamic
banking and finance, religious scholars, central bankers and relevant
In order to prepare regulations for Islamic banking,
laws and regulations of countries like Malaysia, Bahrain, Indonesia,
Iran etc. are being studied. Further, as discussed earlier, AAOIFI
standards for accounting and auditing of Islamic banks are also looked
into, wherever the guidance is needed.
SBP has also become a founding member of Islamic
Financial Services Board, which is based in Kuala Lumpur, Malaysia. This
board has been established to set and disseminate standards and core
principles for supervision and regulation of Islamic financial services
industry as well as to promote good practices in risk management in the
industry through research, training and technical assistance.
What is the SBP policy and how is it being implemented?
the light of recent Supreme Court judgement the best course of action is
to allow Islamic and conventional banking run parallel till such time
Islamic banking assumes the dominating role. Keeping in view the
enormous challenges in gradual transformation of financial system, the
following three pronged strategy is being followed by SBP for gradual
promotion of Islamic banking in Pakistan:
Open full fledged Islamic
commercial banks in private sector.
Allow existing banks to open subsidiaries for Islamic banking.
Allow existing banks to open stand alone branches for Islamic banking.
In line with first part of this strategy on December
01, 2001, SBP had issued detailed criteria for setting up of Scheduled
Islamic Commercial banks based on Shariah principles in the private
sector. Now full-fledged Islamic banks can be established like Meezan
Bank Limited, which has started commercial operations in March 2002.
As regards second part of this strategy, Banking
Companies (Amendment) Ordinance, 2002, notified in the Gazette of
Pakistan dated November 4, 2002, inter alia, a new clause (aa) has now
been inserted in sub-section (1) of section 23 of the Banking Companies
Ordinance as follows:
"(aa) the carrying on of banking business
strictly in conformity with the Injunctions of Islam as laid down in the
Holy Quran and Sunnah."
Therefore, the scheduled commercial banks are,
henceforth allowed to open subsidiaries for Islamic Banking operations.
Accordingly a Detailed Criteria is being worked out to facilitate the
existing commercial banks to set up subsidiaries for Islamic banking
which will be issued separate licence by the SBP.
As regards third part of this strategy, Guidelines
for opening of standalone branches for Islamic banking by existing
commercial banks, enlisting Eligibility Criteria, Licensing Requirements
and other operational guidelines on the subject have been prepared.
These Guidelines are being discussed with the concerned parties and will
be issued after getting their feedback.
Other initiatives include preparation of Shariah
compliant mechanism for Statutory Liquidity Requirement, Cash Reserve
Requirement and development of Islamic Export Refinance Scheme.
What will be the regulatory framework for commercial banks following the
Riba free system?
banks will be provided a level playing field viz-a-viz their
conventional counterparts. The regulatory framework will focus on the
Prudential Regulations for Islamic banking.
Accounting Standards and Disclosure requirements.
Shariah compliance mechanism within banks.
Shariah audit by external auditors as well as SBP inspection
It would be appropriate to promulgate an Islamic
Banking Law in the country to provide legal cover to Islamic banking
Are the international donors being consulted by the Muslim countries?
SBP is also trying to benefit from the global Islamic banking
experience. As a part of international collaboration, the IMF provided
technical assistance to the Ministry of Finance and the Commission for
Transformation of Financial System. A Technical Assistance Mission
comprising the Fund's experts, on Islamic banking namely Dr. Ghiath
Shubsigh and Mr. Michael Taylor provided guidelines on Islamic financial
system. The Commission had detailed discussion with them on the
practical aspects of transforming the system. Specific issues discussed
with them included:
of the new system.
on Resource Mobilization.
for Monetary Management.
and Regulatory needs of the new system.
The IMF experts believed that there was no prior
reason to believe that the system per se would generate adverse effects
on savings and resource mobilization. They also made presentation on how
the tools for monetary management could be developed within the Riba
free framework. They, however, emphasized the need to review and revamp
the supervisory and monetary mechanism to provide adequate supervision
and regulation of the new system. The IMF has played a facilitating role
in establishment of Islamic Financial Services Board. Therefore,
international donor agencies are receptive to Islamic banking.
Is the experience of Bahrain, Malaysia, Sudan and Iran encouraging?
developments have been made by these countries in the recent past.
Bahrain and Malaysia have adopted the parallel approach with separate
laws and regulations for development of Islamic banking in their
countries. Bahrain has taken a lead in setting up the Accounting and
Auditing Organization for Islamic Financial Institutions (AAOIFI), which
has prepared accounting, auditing, governance and Shariah standards for
Islamic financial institutions. They are establishing International
Islamic Financial Market for liquidity management of Islamic banks and
have also issued Ijara and Salam Sukuk as
successful instruments for government borrowings. Bahrain has also
prepared a Prudential Information and Regulatory Framework for Islamic
banks, which is being consulted by us as well. An active Islamic funds
market has also developed in Bahrain.
In Malaysia, the Islamic banks now account for about
8.8 per cent of total financial sector. They have also developed Islamic
securities market, Islamic debt market and Takaful (Islamic
Insurance) companies. They have developed various instruments for
government borrowings like Government Investment Issues, Bank Negara
Negotiable Notes, Ijara bonds, Global Islamic Ijara Sukuk,
etc. However, some debt instruments have been issued on the concept of
Debt trading, which is not permitted by the Shariah scholars of
other Muslim countries.
Sudan and Iran have made efforts for transformation
of economy to Islamic principles. Sudan, although with shallow financial
markets, has developed Shariah compliant monetary policy
instruments like Government Musharika Certificates (GMC) and
Central bank Musharika Certificates (CMC).
GMCs are medium-term paper with one year maturity,
traded by Bank of Sudan (BoS) on behalf of the government. The
underlying GMC Fund includes state-owned enterprises. GMCs are issued in
tranches and sold at auctions.
CMCs are short-term highly liquid paper with no
maturity for smoothing short-term fluctuations of liquidity and traded
at a very short notice by BoS and commercial banks. The underlying fund
consists of BoS shares in commercial banks and their fair value is
calculated quarterly on the basis of profits of the underlying shares.
They have also developed some good alternatives as
lender of last resort facility to commercial banks like Liquidity
Deficit Financing Window. BoS provides temporary liquidity support to
banks, which cannot exceed 10 per cent of bank's current local currency
deposits in the previous week for a period of one week. The financing is
free if paid within one week, after which BoS charges banks 90 per cent
of their profits received from using its financing during the whole
period. Number of applications for this kind of financing is limited to
two in a month and not more than four in a quarter.
What is the role of Islamic Financial Services Board?
Islamic Financial Services Board (IFSB) was established with the signing
of the Articles of Agreement of the IFSB on November 03, 2002 by the
founding members. These included Bahrain Monetary Agency, Bank
Indonesia, Bank Markazi Jomhouri Islami Iran, Central Bank of Kuwait,
Bank Negara Malaysia, State Bank of Pakistan, Saudi Arabian Monetary
Agency, Bank of Sudan and Islamic Development Bank.
A proposal was made two years ago to establish an
organization to spearhead the development of a uniform set of
prudential, supervisory and disclosure standards for the Islamic
financial services industry internationally. This proposal was
crystallized and endorsed during a consultative meeting of a group of
Central Bank Governors, and officials from the Islamic Development Bank
(IDB), the Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI) and the International Monetary Fund (IMF) in
Prague in September 2000 during the occasion of the lMF-World Bank
Annual Meetings. The endorsement set in motion the formation of a
preparatory committee, with officials from Bahrain, Iran, Malaysia and
Sudan, and representatives from the IMF, IDB and AAOIFI, to develop the
terms of reference and operational structure for the Islamic Financial
Services Board. In a meeting of Governors in April this year, Malaysia
was mandated to lead a Steering Committee for the establishment and
inauguration of the Islamic Financial Services Board in Kuala Lumpur.
The historic event on 3-11-2002 is the culmination of this extensive
two-year consultative process.
The IFSB will serve as an association of central
banks; monetary authorities and other institutions, entrusted to develop
and promulgate internationally accepted prudential regulatory standards
and best practices. In advancing this mission, the Board will examine
the extent to which existing international best practices need to be
adapted and complemented to be consistent with Shariah
principles. The IFSB will liaise and collaborate with other
international standard setting bodies to achieve the common goal of
international financial stability. In addition, the Board will also
focus on the development of risk management instruments, cultivate sound
risk management practices and facilitate the implementation of robust
risk control mechanisms in Islamic financial institutions through
research, training and technical assistance. This would encompass the
adoption of international best practices on risk management standards as
well as the development of new risk management techniques in conformity
with Shariah injunctions.