An Inevitable Necessity

BSc (Honors) UK, MBA, M.Com, DAIBP, ACCA (UK)

July 19 - 25, 2004






"O Ye who believe! Fear God and give up that remains of your demand for usury (Riba), if you are indeed believers."

The fundamental principle that underpins Islamic financial system is the prohibition of interest (riba). The shariah principles which are the guidelines taken from the Holy Quraan, Sunnah, Haddith, Ijtihad & Ijmah of Muslim scholars disallow riba i.e. to mean any fixed or guaranteed interest payment on cash advances or on deposits.

Muslims are not averse to the legitimate business and profits as Islam encourages people to use money and not to keep their funds idle, but they avoid the modern banks because of the element of Riba that exists in the present day financial system, yet Muslims need banking services as any body else; for safe keeping of their valuables & money, financing trade & business ventures buying a property or car etc.

Here comes the existence of 300 Islamic financial institutions across the globe with multi-billion dollar deposit worldwide. Islamic banking is the fastest growing sector in the financial services industry not only in the Islamic countries but also in the Europe and America as well where the banking giants like Citicorp, UBS, ANZ and HSBC have also made inroads in the Islamic banking.

Similarly in our country a number of players are finding their way into this field like the Meezan Bank, Bank Alfalah, MCB, Standard Chartered etc. The Islamic banks have emerged onto the financial scene only in the last 30 years while the Islamic injunction against Riba is fourteen centuries old why did it took so long to come with an alternative to interest-based banking.

It may be appreciated that history of commercial banking in the western world itself is only two and a half centuries old, having been contemporary with the industrial revolution, when the Muslims were at their lowest ebb politically, economically and financially. The economies of most of the Muslim countries were managed by the colonial powers and Muslims had no or very little say in choosing their own political, economic and financial system.

However, Islamic finance was practiced predominantly in the Muslim world throughout the middle ages fostering trade and business activities in Spain, Mediterranean and Baltic states. Many concepts, techniques and instruments of Islamic finance were later adopted by European financiers and businessmen.



The revival of the Islamic banking coincided with the oil boom of Muslim countries in the early seventies when the financial resources of Muslims received a boost that led them to strive to model their lives in accordance with the ethics and philosophy of Islam.

It was in 1963 in Mit Ghamr, a rural area in Egypt that first Islamic Interest Free Bank, after formal independence from European military occupation, actually came into being. The bank made a good start but was abandoned due to various reasons. The first Islamic Bank in the urban setting was Nasser Social Bank established in 1971 in Cairo. After Nasser Social Bank the next was Dubai Islamic Bank established in 1975. Similarly in Malaysia Tabung Haji was established in 1963-1969. The establishment of Islamic Development Bank Jeddah in 1975 was the major stepping stone and a great achievement of Islamic countries to promote Islamic values in economic and financial systems. To date a number of Islamic financial institutions are working as per Shariah principles. Two major holding companies controlling a number of Islamic banks are Dar al Maal al Islami (DMI) & Al Baraka group established in the early eighties.

In Pakistan the very first such initiative towards Islamic financial system was taken in 1981 when all domestic banks were permitted to accept deposits on the basis of profit & loss sharing. On January 1, 1985 steps were taken to transform the banking system to interest free banking.

The procedure adopted by banks was declared un-Islamic in 1991 by the Federal Shariat Court. A number of appeals were made to the Supreme Court of Pakistan which while rejecting the appeals delivered its judgment on December 23, 1999 directing that all laws involving interest will have no effect by June 30, 2001. The apex court concluded that the present financial system needs radical changes to bring it in conformity with the Shariah principles.

The honorable court directed the government to set up a Commission for Transformation of Financial System and two task forces to achieve the objective. The Commission set up in SBP more popularly known as Hanafi Commission being named after its Chairman I. A. Hanafi submitted its report in August 2001, one task force in Ministry of Finance and the other in Ministry of Law to suggest amendments in legal framework to implement the court decision.

The commission approved seven essentials of Islamic modes of financing viz. Musharika, Modaraba, Murabaha, Musawama, Ijara, Salam & Istisna still keeping the ends open for developing new modes or instruments, modifications or variants subject to their compliance with Shariah.

Modaraba is a business contract in which one party (Rab al Maal) brings capital and the other (entrepreneur/mudarib) brings his personal efforts or expertise. The proportionate share in profits is determined by mutual agreement but the loss is borne only by the owner of capital. The origin of this contract can be traced back to the very birth of Islam when the Holy Prophet Muhammad (PBUH) himself acted as an agent for Hazrat Khadija's trading operations.

In Musharika both parties contribute capital which is mixed in an inseparable manner, both may contribute labor as well.

During the life of the Holy Prophet (PBUH) Modaraba & Musharika were established forms of financing. The Holy Prophet (PBUH) ratified these contracts and himself conducted business in these manners.

Murabaha is agreed profit margin sale with cash or deferred payment of price. A contract in which seller declares his cost & profit, it involves a request by the client to the bank to purchase a certain item for him. This has been adopted by a number of Islamic banks.

Musawama is a general kind of sale agreement wherein unlike Murabaha seller is not obliged to declare his cost to the buyer. The price is settled between buyer and seller without reference to the cost incurred by the seller.

Ijara is an agreement under which the bank leases equipment, a building or other facility to a client against an agreed rental. The rent is so fixed that the bank gets its original investment plus a profit on it.

Salam is advance payment of goods that are to be delivered later. The contract of Salam covers all things which are capable of being definitely described as to quality, quantity & workmanship. Moreover, the date and place of delivery must be agreed upon that can only be changed with mutual consent.

Istisna is the sale at an agreed price when the buyer places an order to manufacture, assemble or construct or cause to do so anything to be delivered at a future date. If goods conform to the specifications the purchaser cannot decline to accept the goods except if there is a defect in such goods. However, if the delivery is not made within the mutually agreed time the buyer may refuse to accept the goods.

The Shariah Board of SBP has recommended these essentials for banks doing Islamic Banking in Pakistan (SBP Press Release April 16, 2004.)

The way out of predicament for Muslims lies in Islamic Shariah, there are no short cuts or ifs and buts, to follow the teachings of Islam in letter & spirit. While SBP has now set the stage and it is high time to make our financial and economic transactions conformant to the Islamic Shariah. A very high responsibility lies on the shoulders of the private sector to come forward towards this fundamental cause. As the state has played its complementary role, keeping the choice open to each and every person who likes to share this joy, with out necessitating a coercive action which curbs the freedom of individuals & enterprises and detracts from Islamic character of the system.



While those who still want to continue with the present financial systems as dictated by their Masters in Europe, America or so called developed world must take a note of war against the God and his Apostle.

As the Quraan says,

"Those who take Riba will not stand but as stands the one whom the demon has driven crazy by his touch, that's why they say, Trade is just like Riba, those are the people of fire."

The writer is Assistant Vice President, Training & Development, Saudi Pak Commercial Bank Lahore. Email: junaid_ghori@hotmail.com