ELIMINATING RIBA FROM ECONOMY

GIVING CONSUMERS RIGHT TO CHOOSE THE SYSTEM MAKING TRANSITION EASY

SHABBIR H. KAZMI
Aug 18 - 24, 2008

Only two countries in the world have been created on the basis of ideology, one is Pakistan. The two nation theory explicitly showed that the Muslims and the Hindus of subcontinent are two different breeds of people and also demanded separate sets of systems to live.

The Holy Quran enumerates details of the most comprehensive system for the mankind and also forbids receiving/paying Riba. However, the Riba-free system could not be developed due to various factors, starting from lack of will to fear of being labeled orthodox.

The overwhelming perception, even among the Muslim is that Riba cannot be eliminated completely from the economy because Pakistan is part of a global economic system which has thrived on Riba.

Conventional banking has over 200-year history and has excelled mainly because of people having strong faith in it and constant evolution of its regulatory framework. In Pakistan banking history consists of three eras pre-nationalization, under state control and liberalization, deregulation and privatization.

Pakistan's banking system has always been referred as one of the best, except for a brief period when it became infected due to bad governance. It suffered from two contentious issues: inefficiency and bad governance. This was evident from growing market share of foreign banks and mounting non-performing loans of the nationalized banks.

In an attempt to ensure profitability of these institutions lending rates were constantly increased and return on deposits were kept low. Often adequate provisions were not made against delinquent loans. While nationalized banks continued to post poor performance, exceptionally high spread gave foreign banks opportunity to post huge profit.

As the government decided to improve the regulatory framework and also liberalize, deregulate and privatize the banking system in early nineties more than dozen permissions were given to the private sector to establish commercial banks. Since then Allied Bank, MCB, United Bank and Habib Bank working under control have also been privatized.

The historic judgment declaring conventional banking not fully compliant with Shariah became the turning point. At that time it was decided to facilitate Islamic banking and let it run in parallel with the conventional banking system. It was also realized that changing the system overnight could yield more problems because developing similar but Shariah compliant products would take some time, despite the best and sincere efforts.

To achieve the ultimate objective the first Islamic bank, Meezan Bank was established and conventional banks were also encouraged to establish designated Islamic banking branches. This decision not only provided people an opportunity to make their own choice but inculcated the true spirit of competition.

Earlier in eighties an effort was made to facilitate creation of Modarabas for undertaking Shariah compliant business activities. At one stage the number of Modarabas went as high as 52 but has now reduced to about two dozens. The point worth mentioning is that despite reduction in number of Modarabas, asset under their management have increased substantially. Similarly, nature of the business has become more diversified.

In the past most of the Modarabas were doing leasing as their core business but lately they have revert back to the basic concept of Modaraba. Now they undertake diverse activities, which include from small ticket leasing to equities trading and from trading of commodities to renting out power generation equipment.

Similarly, Islamic mutual funds market has grown at a very fast speed and now substantial assets are under their management. It is estimated that out of total assets amounting to Rs 300 billion under mutual funds about 30% assets are being managed by Islamic mutual funds. The numbers seem credible because Al Meezan Asset Management alone controls assets worth Rs 20 billion. Besides Al Meezan other asset management companies are also managing various types of mutual funds which are Shariah compliant

One of the factors inhibiting growth of Islamic mutual funds is stringent criteria for the selection of products for investment. These funds cannot investment in commercial banks and insurance companies. Similarly, they cannot undertake badla financing. With the increase in flotation of Sukuk another investment option has become available. Pakistan has issued both Rupee and dollar denominated bonds. The response has also been overwhelming. However, the number and size of Sukuks is still too small.

Till recently Islamic banks and all others were forced to accept insurance cover issued by the conventional insurance companies because Takaful operators were not there. Similarly, all those who cindered conventional insurance not compliant with Shariah could not mitigate risk and have to bear huge losses in case of accidents and catastrophes.

At one stage it was suggested to allow the conventional insurance companies to open Takaful windows. However, the move was resisted and only specialized companies were given permissions to undertake this business. At present five Takaful companies are operating in the country undertaking general and life business. The response has been overwhelming because now Islamic banks accept insurance cover issued by the Takaful companies.

To facilitate the clients and the financial institutions the central bank has also prepared model agreements and the same has been by the Modarabas. Preparation of these model agreements will facilitate the financial services providers as well as the clients.

Comparing growth of Islamic banks and other institutions shows that Pakistan has made very significant progress in very brief period. It may be said that what other countries achieved in 30 years, Pakistan achieved the same in less than 5 years. It is mainly because Pakistan benefited a lot from the experience of other countries.

However, it may not be wrong to say that limited availability of qualified and experienced people is becoming a constraint in the proliferation of Islamic financial system in the country. The leading institutions are fully cognizant of the situation. Lately, Meezan Bank has signed MoU with a local university for developing curriculum and faculty for awarding MBA degree in Islamic banking.