Islamic mode of financing

By ZAHID ANWAR, Chairman, FPCCI Standing Committee on Industry
Aug 04 - 10, 2003

Back in 1948, at the opening ceremony of the State Bank of Pakistan, father of the Nation, Quaid-e-Azam Muhammad Ali Jinnah has said "The adoption of Western economic theory and practice will not help us in achieving our goal of creating happy and contented people. We must work our destiny in our own way and present to the world an economic system based on true Islamic concept of equality of manhood and social justice. We will thereby be fulfilling mission as Muslims and giving to humanity the message of peace which alone can save it and secure the welfare, happiness and prosperity of mankind".

The structure of Islamic Banking and Financial system revolves around prohibition of any predetermined return derived on loan/debt (Riba) and legality of profit. Riba, commonly known as interest, is a certain increase taken as premium from the debtor or cost accrued, irrespective of the outcome of the business. It represents the return on transactions involving exchange of money for money, or the addition, on account of delay in payment, to the agreed price on sale debts. All the three constitutions adopted so far in Pakistan, all reports of the Council of Islamic Ideology and findings of various commissions/committees constituted on the subject of Islamisation of economy/financial system unanimously called for elimination of Riba.

Towards the end of eliminating interest based banking, the State Bank of Pakistan has issued various circulars. The most important circular issued by way of standing instructions to banks is the BCD circular No. 13 dated 20.6.1984, on elimination of 'Riba' from the banking system.

The circular states that:

(i) As from Ist of July 1984, all banking companies will be free to make finances available in any of the modes of financing listed in annexure I. (given below).

(ii) As from 1st January 1985, all finances provided by a banking company to the Federal Government, Provincial Governments, public sector corporations and public or private joint stock companies shall be only in any one of the modes indicated in annexure I (given below).

(iii) As from 1st January 1985 all finances provided by a banking company to all entities, including individuals, shall be on same basis as mentioned in (ii) above.

(iv) As from 1st July 1985, no banking company shall accept any interest bearing deposit. All deposits accepted shall be on the basis of participating in profit & losses of the banking company.


It contains 12 possible modes of financing, divided under three broad headings:

a) Financing by lending.
b) Trade related modes of financing.
c) Investment type modes of financing.

These all are obviously non interest based (NIB) modes of financing.

Under the trade related modes of financing there are given six modes, one of which is 'Morabaha Financing'.


It is purchase of goods by banks and subsequent sale to clients at an appropriate mark-up in price, on deferred payment basis. In case of default there can be no mark up on markup.


(i) Existence of goods for the finance is essential.

(ii) Goods are purchased by the bank from a third party.

(iii) The bank first acquires these goods and then sells the same to the client. For this purpose, the bank may appoint the client as its agent for purchase of the required goods.
(iv) The client makes a purchase agreement with the seller of goods.

(v) The client then informs the bank with a request to credit the purchase price in his Morabaha account.

(vi) When the goods/documents of title are received by the client (banks agent), he sends a letter to the bank confirming receipt, simultaneously offering to purchase the same on markedup price.

(vii) The bank accepts the offer and sells the goods on marked up price to be paid on a definite date in future. Both the marked up price and date of payment are stated in the bank's letter given to the client.

(viii) Each time goods are purchased by the client from the seller on behalf of the bank and then from the bank, the following letters/documents are executed between the bank and the customers availing the Morabaha Finance on the basis of


This agreement is the main agreement for sale and purchase.

a) Morabaha Sale Contract.
b) Local Purchase Order (LPO)
c) Disbursement Request.
d) Agency agreement.
e) Declaration.
f) Premissory note.

Without the above set of documents, no Morabaha transaction will be valid.As described in step (vii) of the operational methodology of a Morabaha transaction that the marked up price is to be paid on a definite date, this means that the particular agreement is for a fixed and definite period. No markup can be charged beyond that period.

The Islamic Bankers under the title of Morabaha Financing are treating this kind of finance as an ordinary interest bearing loan. At the expiry of the fixed term e.g 180 days of the transaction, they simply recover the markup (difference in sale and purchase price) by debiting it to the current account of the client and renew the transaction by preparing a new set of documents and giving it a new reference number.

In their opinion old transaction has been finished and a new transaction has taken place. It is pertinent to note here that:

1. No actual purchase and sale has taken place.

2. Even the client has not paid to the bank the actual purchase price (principal) he has only been debited with the markup (difference between purchase and sale price)

3. Renewal of Morabaha transaction is not permitted but the Islamic bankers are doing so, not only once but again and again and again. In one instance, e.g this process of renewal was carried on for six years, until it was challenged in the court of law and decided against the bank.

4. Renewal of Morabaha transactions is illegal, markup charged by the bank upon renewal is illegal, mere debit and credit entries shown in the Morabaha account statement are fictitions entries, with no actual cash disbursements, with no actual sale and purchase of goods. These are all sham transactions.

5. As every transaction of Morabaha requires signed contracts, Morabaha allowed without supporting contracts, Agency Agreements and LPOs, are without legal support and unauthorised as such no mark up on such one sided. Morabaha is legally justified and is contrary to the basis of Morabaha Investment of Islamic Financing. The Islamic concept of trade and business requires written agreements.