The west is closely monitoring the performance and operation of Islamic banks worldwide

Mar 27 - Apr 02, 2006

Of late, the state Bank of Pakistan has been moving rapidly towards establishing the essential parameters of Islamic Banking in the country. It has constituted a Shariah Board and would no more allow establishment of new banks functioning on traditional lines. However despite much hype of switching over to Islamic Banking, the process is too slow.

The mode of Islamic Banking is not getting popular as it should have been in a Islamic Country as every Muslim would prefer to earn Riba free income as they essentially like to eat Halal meat. This is the position not only in Pakistan but applies to most of the Islamic Countries, which have introduced Islamic mode of financing including Saudi Arabia. According to a latest survey only 30 to 35 percent of the banks operating in Islamic countries have adopted Islamic Banking. Reason being that it is neither in the interest of depositors nor borrowers. Depositors get much lower returns on profit and loss sharing accounts while depositors pay more in comparison to the conventional mode of banking. The rate of mark-up payable to the House Building Finance Corporation, which claims to follow, the Islamic mode on a housing building loans comes to about 15 percent per annum (as against 12% through conventional banks). The depositors on profit and loss sharing basis receive a return of 5 to 6 percent on their deposits.



Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale in which the seller declares his cost and profit. Islamic banks have adopted this as a mode of financing. As a financing technique, it involves a request by the client to the bank to purchase certain goods for him. The bank does that for a definite profit over the cost, which is stipulated in advance.


Ijarah is a contract of a known and proposed usufruct against a specified and lawful return or consideration for the service or return for the benefit proposed to be taken, or for the effort or work proposed to be expended. In other words, Ijarah or leasing is the transfer of usufruct for a consideration which is rent in case of hiring of assets or things and wage in case of hiring of persons.


A form of partnership where one party provides the funds while the other provides expertise and management. The latter is referred to as the Mudarib. Any profits accrued are shared between the two parties on a pre-agreed basis, while loss is borne only by the provider of the capital.


Musharakah means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business. It is an agreement under which the Islamic bank provides funds, which are mixed with the funds of the business enterprise and others. All providers of capital are entitled to participate in management, but not necessarily required to do so. The profit is distributed among the partners in pre-agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital contributions.


Salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver or currencies. Barring this, Bai?Salam covers almost everything, which is capable of being definitely described as to quantity, quality and workmanship.

In a recent press interview Dr. Shahid Hassan Siddiqui, Chairman Research Institute of Islamic Banking and Finance said that the system designed under the banner of Islamic banking worldwide, including Pakistan, has failed to achieve the objectives of prohibition of Riba as laid down in the Verse 279 of Surah-e-Baqrah, which says' "deal not unjustly". The reason is that Islamic banks are following the benchmarks of interest based banks and are not really adopting the true modes of financing, based on profit and loss sharing i.e Musharaka and Modaraba. The Islamic banks have resorted to large scale financing on Morahaba and Ijara, etc. Like interest-based banks, Islamic banks assumes no responsibility for the operational losses sustained by the entrepreneur availing financing from Islamic bank. The west is closely monitoring the performance and operation of Islamic banks worldwide and many analysts see this system as a mere change of name.

Continuing Dr. Shahid Hassan said that it is unfortunately a fact that the spirit of Shariah is not being fully observed, consequently leading to the continued exploitation of depositors and investors. The number of those Muslim is increasing who either believe that bank interest is not prohibited in Islam while many others feel that on their financing when conventional banks lower their rate of markup/interest and enhance the rate of returns/profits when interest rates are higher in the conventional banking system.

It seems that the State Bank is determined to promote Islamic banking in the country as early as possible. The head of State Bank's Shariah Board had assured that Islamic banking would be promoted on fast track. It is, however, a general feeling that the country, instead of rapid forward movement, needs to think more seriously and move cautiously on this track. The views of people who think that modern interest cannot be equated with Riba also should be given due consideration. There is wide divergence in the interpretation of the nature and structure of Islamic economy. An Islamic economy, for instance, could be defined as the welfare economy characterized by higher employment of resources including labour, broad based distribution of income, wealth and freedom from all forms of corruption, exploitations and inequalities. Analogously, concentration of wealth, feudalism, monopolies and cartels in various enterprises and oligopolistic tendencies are by definition repugnant to the Islamic spirit.

The policies of Islamization of the economy, therefore, needs to focus on land reforms and anti monopoly and anti cartel measures etc. for wider distribution of industrial assets and means of production. Islamic state is obliged to pursue the objective of eliminating poverty through well defined programmes and policies, provide universal literacy and basic health facilities to all the citizens of the state, besides ensuring that nobody dies from hunger. Also, there is no place for wasteful expenditures and ostentatious living in Islam. According to some authors, modern interest is the price paid for the use of capital like any other factor of production and the notion that elimination of interest is a pre requisite of an Islamic economy is the outcome of misinterpretation of the concept of Riba. Keeping all these things in view, sometimes one fails to understand why Islamic scholars in our country are so much obsessed with Riba while other vices in the economy are not paid even scant attention.

Another aspect, which also needs to be taken into account is that, interest plays a pivotal role in the modern economic system which has been developed over centuries through a lot of hard works and it must be recognized that so far there is no serious alternative in theoretical terms to challenge this entrenched system. That is why all attempts to purge economies of the norm of interest have only led to zero sum game involving the reemergence of interest in diverse guises such as 'mark up", "commission", "fees", "premium", "service charges" etc. The present system being in vogue for such a long time cannot be replaced with a stroke of pen. There are many thorny issues, which have still to be resolved. These include the financing of fiscal deficits, assurances of adequate returns to depositors in order to stimulate the saving rate, removal of legal hitches and training of large number of bankers.

Experts are of the view that the State Bank should not act in haste but adopt a gradual approach after taking into account all the relevant factors and also try to keep pace with other Islamic countries, otherwise the financial system of the country which plays a crucial role for the development of the country could face serious problems. In fact, gradual and evolutionary approach towards Islamization of the banking system was approved at the highest level of the government. It may also be mentioned that eight Muslim countries, viz. Malaysia, Indonesia, Bahrain, Saudi Arabia, Sudan, Iran, Kuwait and Pakistan as well as IDB had joined hands and launched Islamic Financial Services Board (IFSB) in October, 2002 for setting standards for Islamic institutions. The report or recommendations of the IFSB probably have not yet been finalized. For proper coordination between different Muslim countries and to avoid sudden disruptions in the financial system of the country, a very cautious approach may be in order.



Basis of Financing

1. Trade and Commerce

Commodity operations


Trade, domestic, foreign

Mark-up and mark-down


PTC, equity participation, leasing, hire-purchase, mark-up

2. Industry

Fixed investment

Equity participation, PTC, Mudaraba, leasing, hire-purchase, mark-up

Working capital

PLS, mark-up

3. Agriculture and fisheries


Mark-up, service charge

Medium- and long-term

Leasing, hire-purchase, PLS, mark-up

4. Housing

Rent-sharing, mark-up

5. Personal advances

Consumers durable



Buyback arrangement

Source: State Bank of Pakistan