The quantum of growing assets and diversity of products nullify the fears expressed by the critics

 Apr 18 - 24, 2005

There could not be two views that Islam prohibits Riba. However, the real issue is transformation of centuries old interest-based into a system which is fully compliant with Shariah. The initial resistance against implementation of Riba-free system was based on the fears that it did not capable of offering an efficient and workable infrastructure. However, the global experience as well as Pakistan's initiative has proved that Islamic financial system is fully capable of replacing the conventional banking system. The only issue is that the strength of Shariah-based system has to be conveyed and understood in its true perspective.

The success made by Meezan Bank, Pakistan's first bank offering full-fledged commercial banking services, proves at least one point the concept is workable and acceptable to the clients. Though, the number of customers using this system may be small at this time but it is growing at a very fast pace. As people understand the nitty-gritty and develop faith in the system, the quantum of assets under Islamic Banking could achieve new heights.

At the time of grant of second full-fledged Islamic Banking license in Pakistan Bank Islami Pakistan Dr. Ishrat Husain, Governor, State Bank of Pakistan said that during last year the total assets of Islamic Banking institutions grew by 224% to Rs44 billion, and the deposits grew by 263% to Rs30.5 billion. This growth can be attributed to the policy of the central bank, which encourages the participation of reputed local and foreign investors in the field of Islamic Banking.

With the issue of this license, the number of Islamic banks has increased to three. These are Meezan Bank, Al-Baraka Islamic Bank and Bank Islami Pakistan. In addition to these banks, 29 branches of 9 conventional banks are providing exclusive Islamic Banking services to their customers in the country. The number of designated branches is also on the rise. A point worth noting is that Pakistan's central bank has virtually stopped issuing licenses for new conventional banks and encouraging licenses for setting up of Islamic banks, Islamic banking subsidiaries and Islamic banking branches.

Another factor indicating the diversification of products and services is the flotation of Islamic mutual funds. Technically there is no difference between an ordinary and an Islamic mutual fund. The only difference is that Islamic mutual funds do not invest in shares of those companies which drive bulk of their income from Riba-based operations and share of those companies which are involved in any business prohibited by Shariah. These funds do buy/sell shares and draw income from dividend. The most heartening point is that the number of such funds and value of asset under their management is growing at very fast pace.

It goes without saying that Modarabas have a history spread more than quarter of a century in Pakistan. It may not be incorrect that Modarabas were the pioneer of Riba-free financial system in Pakistan and these were established in the country when most of the other Muslim countries did not follow such entities. It was a very bold step on the part of the government to allow establishment of Modarabas in the country, evolve regulatory framework and ensure their smooth operations. Over the years these entities did face some problems but proactive approach of the regulators has always helped in overcoming the problems. The consultative approach is also helping in the creation of more conducive working environment.

Initially an overwhelming number of Modarabas were involved in core business of leasing and most of their clients belonged to corporate sector. The situation has changed to a large extent lately. Modarabas are once again trying to cater to the needs of medium and small enterprises. The other positive development is that some specific purpose Modarabas have been floated. The other developments include investment in equities and Murabaha and Musharika arrangements.

Another milestone achieved has been flotation of Shariah-based term finance certificates by Al-Zamin Leasing Modaraba. The positive point was that public offer was oversubscribed. However, it a little disappointing that since then no other Modarabas has made such an effort. It is often said that Modarabas face resource mobilization constraint. Successful flotation of Shariah-based TFCS opened a window, but it has not been utilized properly. One may say that in the declining interest environment businesses were reluctant to lock the funds at a higher rate. According to the new Monetary Policy Statement, the central bank is making efforts to contain rate of inflation in the country by raising interest rates. Therefore, the situation offers an opportunity once again to lock funds in rising interest rates scenario.

Recapitulation of these facts/developments is to show that products/services confirming to Shariah enjoy a latent demand. The level of acceptance is also moderate but the lacking factor is appropriate and timely approach for marketing of these products and services. A vast majority of investors is looking for investment opportunity, which can yield Riba-free income. However, they do not wish to assume any unknown risk and also seek security of their investment.

One of the common fears is that if the return is based on profit and loss sharing basis, it is not possible to quantify and compare with conventional products. However, many analysts are of the view that no financial institutions would be interested in entering into any agreement which could possibly lead to losses. On top of this, best efforts are made to also hedge the risk. Therefore, in most of the cases the probability to incurring loss is negligible.

On of the positive points is that there is no pressure on the central bank or the financial institutions to bid farewell to the conventional interest-based banking system. Now all the efforts are aimed at creating an alternate system, which runs in parallel with conventional banking system. The objective is to offer a credible alternate system and let the masses make their own choice. The strategy is paying off, which is evident from the growing deposits and advances by banks operating according to Shariah.

There could not be two opinions about Riba. Once it has been prohibited by Islam, its use in any form is against the Shariah. However, the two opposite points of view needs to be explored at length. One school of thought believes that the present system does not fall under the connotation of Riba and other group had an opposite point of view. Therefore, the issue has to be discussed at length because each group has its own rationalization.

Yet anther positive factor is that Pakistan is not alone in this endeavor. The efforts are going on in almost all the Muslim countries to eliminate the element of Riba from economic system. While some of the countries may not have made any significant achievement, others are way ahead. Therefore, efforts should be to pool the resources and learn from each others experience. The effort should be to move ahead from the point which has been achieved already.

Initially, Islamic finance as a movement made strides on two fronts. First, individual financial institutions started operating in many countries in parallel with the conventional banks. Second, efforts were made to pool the resources/experiences under the lead of Islamic Development Bank. As the Islamic financial and business activities have become more developed as well as global feature, there is a need for effective liquidity management and enhance coordination among the Islamic financial institutions. The establishment of Liquidity Management Centre in Bahrain in 2002 was a landmark.

Initially, Islamic finance movement was facing some serious problems. These were the outcome of difference between theory and practice. Since the Islamic financial system was considered a threat to conventional banking system, deliberate effort by some quarters was also made to highlight the weaknesses of the emerging system. However, very few critic of Islamic system acknowledge the fact that the history of conventional system was spread over centuries. The system has improved only after encountering serious problems. But at no stage no one termed the conventional system 'unworkable'. All the efforts made were aimed at improving the system. Therefore, the proponents of Islamic system should also try to remove all those weaknesses which are being pointed out by the critics.

In this regard, efforts of Pakistan's central bank must be appreciated. With the help of Shariah scholars, the SBP has prepared various proto type agreements and placed them on its website. To further facilitate the banks, the SBP has also established Islamic Banking Department and also hired the services of Shariah scholars. Commercial banks offering Islamic Banking have also constituted their Shariah Boards. All these efforts have been made to facilitate development of Islamic Banking in the country.

Yet another effort of the regulators needs specific mention, establishment of Religious Board for the Modaraba sector. This Board was conspicuous for its absence for around three years. It was often said that in the absence of this Board flotation of new Modarabas had virtually come to stand and still. At one stage, the regulators were of the view that there was no need for this Board. However, the sector was of the view that the Board was need of the time because it is not possible for each Modaraba to have its own Board. With the constitution of this Board there are reports that at least four new Modarabas will be floated shortly.

One of the most recent developments is that rules for flotation and management of Takaful (Insurance companies based on Shariah) have been prepared. This will pave the way for the establishment of Takaful entities. This will open another chapter in the history of Islamization of financial systems in the country. Some sponsors have already expressed their interest in the flotation of such entities and now the time has come to make this dream come true.

The story will not be complete without mentioning the flotation of Sukuk Bonds by the Government of Pakistan. This flotation hit the headlines as the government successfully floated Bonds worth US$ 600 million. Initially, the plan was to float Bonds worth half a billion dollars only but the response encouraged the government to accept higher bids. The positive point was that these Bonds have been floated at very competitive coupon rate.

Following the foot steps of the government, WAPDA is also planning to float Rs8 billion Sukuk Bonds in the domestic market. If WAPDA succeed in achieving the target it would be its largest Bond issue. It is expected that it would also pave the way for the flotation of such bonds by the corporate sector. Till recently, the corporate sector has relied mostly on the interest-based term finance certificates.

However, it is yet to be seen how the government and corporate entities are going to lock their future fund requirements in the rising interest rates scenario. Most of the analysts are of the view that in the rising interest rates scenario it has become all the more important for the government and the corporate sector to mobilize extra funds expeditiously to contain their financial cost.


The response to Islamization of financial system in Pakistan has been overwhelming. Saying this, it is also important to say that a lot more needs to done. Whatever success has been achieved so far is a drop in the ocean. The market size is enormous but also enjoys huge growth potential. It is only up to the players and the regulators to create the enabling environment and enjoy the fruits.

It is also necessary to reiterate that there is no need to reinvest the wheel. A lot of work has been done globally and Pakistan must take its advantage. Not only the work is going one in the Muslim countries but institutions like Euromoney are busy in creating market awareness. In this regard, the work of Islamic Finance and Communication Services must also be looked at. They compile and disseminate the latest information. It will not be wrong to say that they are a preferred source of information to know the latest development around the globe.

Saying this it is also necessary to point out that local players should come up with both the asset and liability products to suit the market needs. One such move has been flotation of Islamic Mutual Funds. The point to be known to all is that most of these funds have been floated by those who are in the business of conventional banking business. This clearly shows that the conventional banks have realized the potential and there to grab the opportunity.

It is also important to point out that nearly two dozen domestic and foreign banks are operating in Pakistan. As against this only one Islamic bank offers full-fledged commercial banking services. Another institution has been granted Islamic banking license. And only six banks have established designated Islamic banking branches. The number of such branches is too small keeping in view the total number of bank branches in the country.

It was said in the past that banks do not offer Islamic Banking facilities in the country. Now it is the time for the critics to review their performance and also suggest the measures to further improve the working environment. Raising the slogan that Riba is prohibited by Islam does not serve the purpose. The effort should be to ensure transformation from conventional interest-based operations to Riba-free environment.

The beginning has been made and now it is responsibility of all the stakeholders to make Islamic Banking institutions stronger and prove the critics wrong. The critics have been saying that Islamic banking is not a workable proposal.

Having ushered in Islamic banking in the country, now greater responsibility is on the shoulders of players as well as the regulators to get ready to eliminate the element of Riba from the economy. Over the years, Modaraba, Musharika and Murabaha arrangements have begin to become a norm and the effort must continue.

It is the responsibility of all the Muslims to ensure smooth transformation of the economic system. Regulators have created the enabling environment and now it is the responsibility of all to strengthen it further.