There is increasing resentment regarding
capitalistic system due to its tendency to make the rich richer and
the poor poorer. The talk about many bank's callous treatment of small
businesses is getting louder. Questions are being raised whether it is
ethical to charge interest on loans, and criticism is also being
levelled at investment in trades and industries, which do harm to
people, such as those concerned with tobacco, gambling and
Even in the industrialised societies, the excesses
of the free market system, the relentless and unfettered pursuit of
profit and the unduly materialistic approach, the so-called the
'unacceptable faces of capitalism', are causing widespread concern.
Individuals and corporates have become hostage to the fluctuations of
interest rates and overdrafts. Small businesses especially have borne
the brunt of harsh and callous treatment by their banks. A question is
often raised whether it is ethical to charge interest on a loan.
A system, which has lain dormant for centuries, has
been emerging and evolving over the decades — the Islamic economic
system. This system combines the profit motive with a welfare ethic
and in which the individual is obliged not only to strive for his own
betterment but to contribute to the good of society as a whole. This
system is based on profit and loss sharing, where risk is shared
between bank and borrower and the bank's profits are shared with its
customers. This system often sounds alien to the propagators of
conventional banking system.
However, in the last decade or so, the viability of
Islamic system has been realised. Several banks undertaking
interest-based operations for ages have set up units operating on
Islamic injunctions. The idea that ethics should have a part in
financial matters has taken root and, around the world 'ethical
investment groups' of bankers and fund managers have emerged. They
invest their clients' funds according to the principles of various
The Islamic economic and financial system has
rapidly expanded from mid seventies, since the establishment of
Islamic Development Bank. Over the years, the steps taken by the
Government of Pakistan (GoP) to bring the country's economic system
into conformity with Islamic injunctions have been much appreciated as
offering a model that is invaluable to other Muslim countries. There
is a desire among many to see the whole of Pakistan's economic system
Islamised as soon as possible. However, it a mammoth job needing
research, the setting up of controls and designing of new operational
procedures and documentation. Undue haste could be disastrous and lead
to chaos, which would surely be exploited by the critics to discredit
the whole Islamic system.
Around the globe, many Muslim countries are trying
to bring their economic and banking system in conformity with Islamic
injunctions — thus far with mixed results. A new system has to face
up to the entrenched culture of the existing one — the prevailing
powerful interest based banking and economic system. That is why, even
in Muslim countries there is resistance to Islamic banking, which is
very often mischievously and deliberately linked with backwardness and
with anti-scientific and ultra conservative sentiments.
Many Muslims themselves still doubt that an Islamic
economic order with its divine origin is capable of meeting
contemporary financial needs. The reasons are easy to understand. The
long subjugation of the Muslims under the colonial rule sapped their
self-confidence and gradually they began to look at all issues through
the eyes of their rulers. It only recently that Muslims have become
aware of the weaknesses and failing of the conventional systems and
have started to realise that Islamic option is capable of solving not
only their own problems but those of the world at large.
In an in-house paper prepared by International
Monetary Fund (IMF), in the recent past, observed that in times of
recession an Islamic economic and banking system seems to have greater
capacity to absorb shocks than the convention system. Indeed, whether
it is in bank syndication, venture capital or trade finance, it is
very often the Islamic financial institutions that show the way.
Islamic banking has generated enormous interest globally and it is no
longer confined to Muslim world. Even the banks involved in
conventional banking for ages have either established subsidiaries or
divisions to facilitate those clients, who want to participate in Riba-free
The process of Islamisation of financial system in
Pakistan started nearly two decades ago. It is aimed at completely
eliminating Riba from economy. It is a mammoth task and has often
faced snags. Initially the aim was to make the change in one go. Since
the task is mammoth and often faced snags, the revised strategy is to
develop and implement a parallel system to facilitate those who are
more keen and let the others gradually join it at their own will.
Since there are a number of stakeholders in the
financial system, each has to make its own contribution. The two-key
stakeholders, players and the regulators, have the most important role
to play in creating the enabling environment. However, the most
important role is that of clients. They have to decide, at their own,
whether they wish to join the Riba-free system or want to continue
with the convention banking. Since the clients are not really worried
about the mechanics of the system and their outlook is linked with the
security and return on their funds. They are often not aware about the
underlying contracts with the banks.
It may not be wrong to say that now Pakistan has
emerged as a leading player among the Muslim countries in the area of
Islamization of financial system. Establishment of Modarabas opened
the vista and now the country has the first Islamic bank. Most of the
commercial banks have either established separate windows for Riba-free
banking or are in the process of creating such a facility. The central
bank has evolved an elaborate regulatory framework to oversee the
operations of banks offering Riba-free services. The central bank is
benefiting from the experience of other countries as well as playing
an important role towards achieving the common objective of all the
ISLAMIC BANKING AND FINANCE
Islamic banking and finance is part of the broader
concept of Islamic economics, introducing the value system and ethics
into economic sphere. Because of this ethical foundation, Islamic
banking and finance is more than a system of mere commercial
transactions. The ability of an institution to attract clients depends
not only on its profitability but on the perception that its is
following Islamic injunctions. The core of Islamic banking system is
elimination of Riba and the guidelines are provided by Qur'an and
Sunnah, the two main sources of Islam, commonly referred to as the
Shariah. Although, Riba in a broad sense means any unlawful advantage
by way of excess or deferment, in the context of financial
transactions it is commonly understood to mean any form of interest.
The underlined policy of Islam is the protection of
the weak against exploitation by the strong. This policy has led to
the formulation of a rule of general application to the effect that
all transactions should be devoid of uncertainty and speculation. This
objective can only be achieved if the contracting parties have
complete knowledge of the terms of the transactions in which they
engage. The system also rejects the concept that a borrower is liable
for the repayment of the funds borrowed and a predetermined return on
those funds, regardless of the performance of the borrower's business.
Under the Islamic system, the interest is replaced with the concept
that the lender is also to assume the risks of the borrower's business
and share in the profits and losses of the business.
Money is not considered to be capital on which a
return may be obtained, but only 'potential capital' requiring the
services of an entrepreneur to put it to actual productive use. The
lender who advances money for trade or production can only contract to
receive a share of the profit because he is just a part owner of the
enterprise's capital and has to share in the risk of the enterprise.
The traditional Islamic financial instruments have been Modaraba,
Musharaka and other instruments like Ijara and Murabaha.
In years subsequent to the Holy Prophet, Islamic
jurists analysed the transactions approved or disapproved by the
Qur'an and Sunnah, in an attempt to determine those interests which
Shariah sought to ensure and those practices that were to be avoided.
This methodology provided a mechanism whereby Islamic law could keep
pace with changing times. It is important to note that in its
application to business and finance, the Shariah recognises change and
as a policy matter encourages flexibility in business and commercial
practices, provided those practices are consistent with certain broad
SOURCES OF FUNDS
There are three basic sources of funds for Islamic
banks: equity capital, transaction deposits and investment deposits.
Equity capital represents the owners' investment and like investors in
conventional banks. Transaction deposits are the equivalent of demand
deposit accounts in a conventional bank. Investment deposits are the
principal source of funding for an Islamic bank. These deposits are
quite similar to an equity investment because there is neither a fixed
rate of return on the deposit nor a guarantee on the return of the
principal amount of the deposit. Investment deposits can be tied to
the overall performance of the financial institution or can be limited
to a specific project or investment undertaken by the institution.
Islamic banks are required to obtain their earnings
through profit-sharing investment or fee-based investments.
Profit-sharing investments are preferred as these are more beneficial
to society, but are more difficult to structure and implement and are
less common than fee-based transactions. The fee-based transactions,
commonly known as Murabaha, is essentially a cost plus sale
transaction. Islamic financial institutions also have the flexibility
to engage in leasing transactions.
The different structure of Islamic institution,
particularly the focus on profit-sharing transactions, may present
challenges to the institution's management. In making an investment,
Islamic bank would not rely primarily on the net worth of the
borrower. Instead, it would base its investment on its analysis of the
commercial viability of the borrower's enterprise. The analysis
involved in such transactions is significantly more complicated and
risky. In addition, investments or financing that are dependent on the
success of the financed enterprise require significantly greater
monitoring and attention after these have been made than do
conventional asset-based loans.
There is a growing realisation that Islamic bankers
and economist have a unique contribution to make to the modern
financial world. One of the key issues is development of Shariah
compliant products and to market them. They should not expect people
to give up the conventional banking services they are used to just to
join an Islamic bank as such. It is not enough, in itself, to Islamise
a bank, for customers are not attracted to a bank by its piety, but by
practical factors such as location, personal relationships and
especially by the kind of services they offer.
If Islamic banks wish to exploit their fullest
potential, education and training of their staff is must. In general,
customers tend to be cynical, believing either that interest is merely
replaced by fees and charges which match the interest rate or that
they will simply get no interest. There is an urgent need for Muslims
everywhere to be informed that this is not the case and to be shown
the whole range of services being offered by the banks offering Riba-free
While it is true that the players and the
regulators have accomplished their mission to a large extent. A lot
more has to be done for creating the awareness among the general
public. Most of the apprehensions, regarding Riba-free banking system
are due to lack of complete knowledge. The scholars have to play the
key role in educating the public.
This is a kind of partnership where one partner
gives money to another for investing in a commercial enterprise. The
investment comes from the first partner, Rab-ul-Mall, while the
management and work is an exclusive responsibility of the other,
Mudarib, and the profit is share in a predetermined ratio.
It means a joint venture formed for conducting some
business in which all partners share the profit according to a
specific ratio while loss is shared according to the ratio of the
contribution. It has been divided into two kinds, partnership by joint
ownership (Shirkat-ul-milk) and partnership by contract (Shirkat-ul-Aqd).
It is a particular kind of sale where the seller
expressly mentions the cost of the sold commodity he has incurred, and
sells to another person by adding some profit thereon. It is not a
loan given on interest; it is a sale of a commodity for cash/deferred
This mode of financing is usually used to finance
the agricultural sector. The seller undertakes to supply specific
produce to the buyer at a future date in exchange of an advanced price
fully paid at spot. The price is in cash but the supply of purchased
goods is deferred.
Commonly known leasing and defined as a medium-term
mode of financing, which involves purchasing, and subsequently
transferring the right of use of equipment and machinery to the
beneficiary for a specified period of time, during which the provider
of funds retains the ownership of the asset.
It is a sale transaction where a commodity is
transacted before it comes into existence. It is an order to
manufacturer a specific commodity for the purchaser. The manufacturer
uses his own material to manufacture the required goods. Under this
arrangement, price has to be fixed with consent of all parties
involved and all other necessary specifications of the commodity have
also to be fully settled.
It is an agreement where a buyer purchases
something from time to time; each time there is no offer or acceptance
or bargain. There is one master agreement where all terms and
conditions are finalised. There are two types of Istijrar, one, where
the price is determined after all transactions of purchase are
complete and the other, where the price is determined in advance but
the purchase is executed from time to time.