The two key stakeholders have played their role of creating enabling environment, now the public has to repose its faith in the system


Nov 17 - 23, 2003





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 pornography.

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 religions.

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 banking.


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 Muslim countries.




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 limitations.


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 banking.

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 price.


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.