C O N T E N T S

Chapter # CONTENT Page

No.
Table of contents I
List of tables V
List of figures vi
Executive Summary 1
Chapter-1 Introduction Of Report
1.1 Brief Description 3
1.2 Main Objectives, 4
1.3 Problem statement 5

1.4 Research Methodology 6

1.5 Scheme of Study 6
Chapter-2 Literature Review (contemporary
research)
2.1 Historical Background 8
2.2 Nature and Meaning 12
2.3 Historic Background in Islam 15
2.4 Interest and its impact 15
2.5 The concept and meaning of Islamic 20
banking
2.6 Comparison of Islamic and interest 21
free Banking
2.7 World wide efforts 24
2.8 Strategic alliance of Islamic and 26
conventional banking in Pakistan
Chapter-3 Islamic Modes of Finance 33
3.1 Islamic Alternatives for Interest 32

i
 free financing
3.2 Development of Interest Free system 34
3.3 Financing by lending 36
3.4 Trade related modes of financing 36
3.5 Investment Modes of Financing 38
3.6 Other approved modes of financing 47
3.7 Review of progress 54
Chapter-4 Application of Islamic Financing in
Commercial Banks
4.1 Project Financing 60
4.2 Working Capital Financing 63
4.3 Import Financing 68
4.4 Export Financing 70
Chapter-5 Analysis And Discussion Of Finding Of
Opinion Survey On Interest Free And
Interest Based Banking
5.1 Views on Interest Based and Interest 73
Free Banking
5.2 Views on GoP should introduce 75
interest free banking
5.3 Views on Govt. efforts 76
5.4 Views on the proposition that IFB 78
ensures economic justice
5.5 Views on Reforms in Islamic banking 80
sector are sufficient
5.6 Mixed banking needs Improvement and 81
IFB should be facilitated
5.7 Views on existing structure can be 83
converted into IFB
5.8 Views on two parallel system should 85

ii
 run at the same time
5.9 Preference of interest free bank as a 86
client
5.10 Preference for IFB for employment 87
5.11 Impact of Interest free banking on 89
businesses
5.12 Respondent views on more financial 92
product necessary to be introduced
5.13 IFB can tackle the inflation factor 93
5.14 Respondents views on whether Islamic 95
banking offered is IFB
Chapter-6 Conclusion and recommendations 98

Glossary 100
Bibliography 102
Questionnaire 104

iii
 LIST OF TABLES

Table Content Page

No. No.
5.1 Views on Interest based and Interest free 74
banking
5.2 Respondents views on GoP should introduce 75
interest free banking
5.3 Views on Govt. efforts 77
5.4 Views on the proposition that IFB ensures 79
economic justice
5.5 Reforms in Islamic banking sector are 80
sufficient
5.6 Mixed banking needs improvement and IFB 82
should be facilitated
5.7 Existing structure can be converted into 83
IFB
5.8 Two parallel systems should run at the 85
same time
5.9 Preference of Interest free bank as a 86
client
5.10 Preference for IFB for employment 87
5.11 Impact of IFB on Businesses 90
5.12 More financial products necessary to be 92
introduced
5.13 IFB can tackle the inflation factor 94
5.14 Views on whether Islamic banking offered 95

iv
 is IFB

LIST OF FIGURES

Figure C o n t e n t Page
No. No.
5.1 Interest based and interest free banking 74
5.2 GoP should introduce Interest free 76
banking
5.3 GoP should introduce Interest free 77
banking
5.4 Views on the proposition that IFB ensures 79
economic justice
5.5 Reforms in Islamic banking sector are 81
sufficient
5.6 Mixed banking needs improvement and IFB 82
should be facilitated
5.7 Existing structure can be converted into 84
IFB
5.8 Two parallel systems should run at the 85
same time
5.9 Preference of interest free bank as a 87
client
5.10 Preference for IFB for employment 88
5.11 Impact of IFB on large business 91
5.12 Respondents views on more financial 92

v
 products necessary
5.13 IFB can tackle the inflation factor 94
5.14 Views on whether Islamic banking offered 96
is IFB

EXECUTIVE SUMMARY

The principal animus of the study is to amalgamate the

managerial theoretical knowledge of Islamic banking as it
applies in practice. Primary and secondary data like books,
articles and questionnaire are used in research. Today the
world economic system that is based on interest has
resulted in concentration of wealth in the hands of
selected creating monopoly and widening the gap between the
rich and the poor. In contract Islam encourages circulation

vi
of wealth and regards its role as important to an economy
as the flow of blood to our human body.

Economic justice requires a viable economic system.

Supported by an efficient banking system. Interest based
banking has proved to be inefficient as it fails to
equitably distribute wealth which is necessary for the well
being of making. On the other hand Islamic banking is
efficient and ensures equitable distribution of wealth thus
laying foundation for an inflation free economy and
socially responsible banking. The research team has done
very important surveys, which show us the people perception
about interest free banking.

Results of the survey indicate that people do prefer and

desire for interest free banking system, and have no
specific complaints about such a system. It is possible to
motivate the general public and introduce interest free
banking system with high possibility of success in the
future. Government efforts would be highly appreciated and
would enhance the level of satisfaction of the public.

Told to us By Allah and His Prophet Muhammad (S.A.W.). So

by this report may be the team learns how to do that which
will at end make us prosperous in this earthly living not
by individual, society but whole country and Islamic bloc.
This report will also try to enhance readers understanding
on Islamic economic system and Islamic banking system,
which is part of it.

vii
CHAPTER # 1

INTRODUCTION

A STUDY OF ISLAMIC MODES OF FINANCING BY COMMERCIAL

BANKS

1.1) BRIEF DESCRIPTION:

One of the significant developments in the Muslim world

during the last decade and half is the emergence of Islamic
banking, which has appeared as a powerful movement.

viii
Although some attempts to reorganize banking activities
along the Islamic lines go back to the early 1960’s, the
concept of Islamic banking is even older. In fact, the
strong disapproval of interest by Islam and vital role of
interest in the modern commercial banking system led Muslim
thinkers to explore the ways and means to organize
commercial banking on an interest free basis. However, for
a long time, the idea of Islamic banking remained a mere
wish.

Many discussions have been initiated about the methodology

to be adopted for replacing present-day interest based
financing with Islamic financing. Unfortunately, many of
our planners, economists and financial experts, as well as
the dozen of business and industry, are not fully aware of
the requirement, or the wisdom, of abolishing interest,
with particular reference to a modern economy.

While Muslims generally consider that Islam prohibits

interest, the full extent and nature of the prohibition is
not commonly understood. There is also a feeling in some
quarters that bank interest is different from usury or
interest on consumption loans. It is, therefore, necessary
to discuss, in detail, Islam’s preaching on interest,
before taking up ways and means of adopting interest-free
(Islamic) banking and finance.

Unlike their counter parts elsewhere, Islamic bankers do

not expect to advance money and receive a predetermined sum
on a fixed date in the future. Under the Shariah, the
bedrock of the Islamic faith, they are instead responsible
for ensuring that money is invested in viable projects,

ix
with reliable borrowers. If the project succeeds the banker
shares the profit. If it fails he suffers losses.

1.2) MAIN OBJECTIVE:

Main objective of this research is to present an

overview of Islamic banking and financing, people’s
attitude and preferences towards interest free banking.

1.2.1) Justification

There is a strong need for a riba-free banking system.

Where the product concept was not acceptable it was
primarily due to confusion between riba-free and profit-
free. People perceive a number of emotional benefits from a
product that is based on the tenets of Islam. The objective
is to alleviate the feeling of guilt by following the
tenets of Islam. There is also a belief that Islamic
banking will help fight the ills of the economy of the
country.

This research report is significant because People of

Pakistan are Muslim and live in Islamic system and People
have to live and abide by Islamic Rules and regulations as
told to us By Allah and His Prophet Muhammad (S.A.W.). So
by this report may be the team learns how to do that which
will at end make us prosperous in this earthly living not
by individual, society but whole country and Islamic bloc.
This report will also try to enhance readers understanding
on Islamic economic system and Islamic banking system,
which is part of it.

1.2.2) Limitation of proposed research

x
 The study has focus only on those areas which are
closely related to the research topic. Facts and figures
which although may be important but do not have direct
impact on the research topic have been ignored, because of
the time and resources constraint, it may not be possible
to cover a large sample of borrowers and make in depth
study of some aspects.

The most serious limitation from which the study

suffered was the non-availability of some related data for
analysis purposes.

1.3) PROBLEM STATEMENT;

Application of Islamic banking in Pakistan has been a

rapidly growing tendency in the recent years, the
direction of which is towards interest free banking.
This study has concentrated on appraising the nature
and extent of the applications of Islamic modes of
financing in commercial banks. The analysis on behavior
and attitude of people towards interest free banking in
contrast to interest driven banking has also been a
part of the research theme.

1.4) Research Methodology:

The study is based on secondary as well as primary

data. The Specific methodology is developed after review of
existing literature on the relevant subject. The technique
of Preliminary interviews and questionnaire with informed
persons mainly in the relevant sectors. The sample size of
the research is 28. The methodological approach is however
outlined below:

xi
1.4.1) Secondary sources:

The team used secondary data & tried to get benefit from
different books, newspapers articles and already research
done by different people and organizations such as SBP and
Ministry of Finance Pakistan.

1.4.2) Primary Sources:

Primary data has been supplemented by interviews and

questionnaire with

1. Bank officers.

2. Businessmen.

3. Religious Scholars

4. University professors and other informed person.

1.5) SCHEME OF study:

This report has been divided into six chapters, which cover
the following topics.

First chapter includes introduction, the objectives,

methodology and justification of the study and scheme of
the report.

Second chapter includes literature review, history and

background of interest, its prohibition and Islamic view
point.

Third chapter includes the Islamic modes of financing,

Fourth chapter is towards application of Islamic financing
in commercial banks.

xii
Fifth chapter is based on the analysis of survey, findings
based on people’s preference of Interest free banking and
interest based.

Last chapter is summary, conclusion and recommendations.

CHAPTER # 2

LITERATURE REVIEW

INTRODUCTION

Riba is prohibited in Islam. The strict prohibition and

condemnation of riba appears at four different places in
the Holy Qur’an. There are also numerous Ahadith (Sayings,
deeds or tacit approvals of the Holy Prophet of Islam,

xiii
Peace Be Upon Him), wherein prohibition and condemnation of
riba is ordained in all forms and intent.

In the recent past, a controversy has arisen that interest

paid by banks on deposits or charged on advances does not
tantamount to riba and is hence permissible.

Imran ahmed,(1995) says, It is also argued that the Arabic

word riba means usury and not bank interest. It is,
therefore, proposed to discuss the true nature and meaning
of riba, usury and interest, so that we can understand and
ascertain whether interest comes within the purview of riba
as stipulated in the Shariah.

2.1) HISTORICAL BACKGROUND:

According to Council of Islamic Ideology,(1980), Even prior

to the dawn of Islam, over 1400 years ago, the majority of
ancient philosophers and almost all the religions of the
world had prohibited money lending as a business; riba,
interest or usury. If one goes back into history, as far as
one can, it would be found that lending and borrowing as a
transaction between members of a society was started as a
commercial operation after the switching over from the
barter system to the money system. Money lending with the
earning motive became a common phenomenon in most of the
societies of the world, but people engaged in this business
were generally not regarded respectable during any period
of history.

Asif shah,(1995)says, The doctrine of famous Greek

philosopher Aristotle was, that a piece of money cannot
beget another piece, as the sole natural object of the use
of money was to facilitate exchange and that money cannot
be used as a source of accumulating money at interest.

xiv
Aristotle, therefore, rejected interest on the basis that
‘money is sterile’ and accordingly compared money to ‘a
barren hen, which lays no eggs’. Plato too condemned
interest. In the early years, the Roman Empire had also
prohibited earnings on money lending.

According to Council of Islamic Ideology,(1980), It is

interesting to note that in AD 605; just before the dawn of
Islam, on a tempestuous day, a spark of fire caught the
curtains of Ka’ba (House of ALLAH in Makkah) resulting in
serious damages to the building. For the repair and
reconstruction of the building, contributions were asked
from the general public living in the locality. It was,
however, solemnly announced that for the Holy Building,
only pure, clean and honestly earned money should be
donated; prostitutes and usurious people were specifically
debarred from contributing anything. It is, therefore,
obvious those even among the pagans of Arabia, in the dark
days of civilization usury and interest were considered to
be the money earned by unethical means.

Anwar Muhammad, (2000) says, the end of thirteenth century

saw the decline of the influence of Orthodox Church and the
rise of secular powers. As a consequence, the charging of
interest, which was forbidden by the Church gradually,
started being tolerated. In the Mercantile Era (1500 –
1700) money began to be used on a large scale for
commercial transactions and assumed the role of a factor of
production like land and interest on capital was equated to
the payment for renting of money, similar to the rent of
land.

Anwar Muhammad, (2000) says, In 1740, the city of Verona,

issued a bond at 4% interest, which led to a lot of

xv
controversies. The Benedict XIV wrote to the Bishop of
Italy, firmly emphasizing that it was a sin to take profit
beyond the principal amount given as loan. He specifically
condemned various pleas such as profit on loan was moderate
or that the loan was given to rich person or that it was to
be used for production purposes.

According to Hasan,(2007),journal, In this connection, it

is significant to note that after the establishment of
political supremacy of Islam over a greater part of the
world, the prohibition of usury or interest, which was also
considered as undesirable among non-Muslims, was enforced
more strictly. The prohibition of riba, usury or interest,
by Islam is, therefore, nothing new. Islam allows profits
through trade but prohibits interest because of the
negative effects of the fixed interest-being loans.

Maulana Shafi,(1997) says, As the times passed by, Muslims

gradually began to lose political supremacy in places,
which were being ruled by them, and accordingly the
political ascendancy passed on to Europe. Although in
England during the Middle Ages, charging of interest was
opposed by the Church and prohibited by the state but with
the decline in the influence of the Church and religion,
the practice of usury and interest reappeared
notwithstanding the fact that the charging of usury and
interest was still condemned by Christianity. During this
period, the doctrine that ‘sale transaction is similar to
interest deal’ was revived and the governments enacted
legislation to legalize interest with new dimensions.
Formerly, interest income was restricted to those
individuals who were engaged in the business of money
lending. The western socio-economic structure was then

xvi
organized in such a manner that any person who had little
savings could be assured of interest income without
investing in any business directly. With the advancement of
this system and growth in economic activity, it has now
become almost impossible to participate in any economic
activity without either charging or paying interest. The
Holy Prophet of Islam, Peace Be Upon Him, had predicted
this over 1400 years ago.

In the above paragraph, it has been mentioned that laws

were framed for legalizing interest transactions as a
consequence of decline in the influence of the Church.

Dr. Nijat Ullah, (1994) says, It was during this period

that a step was taken to Christening of interest (which may
originally have been a Hebrew or Greek word) resulting in
the complete transformation of its sense. The two terms,
interest and usury, thus developed were given different
treatment, as interest was declared lawful and usury was
prohibited. The word “interest” indicated a reasonable and
moderate rate as against usury, which was symbolized as an
excessive rate of return. Laws were framed for legalizing
the charging and paying of interest on money lending
transactions. The rates of interest were, however,
controlled. During the reign of King Henry VIII in 1745,
national laws were changed to permit interest but a maximum
rate of interest of 10% per annum was fixed. The economists
of those periods argued that the law must fix lower rates
of interest to facilitate growth of business.

Accoring to Maulana shafi,(1997), To conclude, it seems

interesting to give a brief review of the article on usury
in the Encyclopedia of Religion and Ethics. It says that
usury and interest were considered one and the same thing.

xvii
Usury was not used in its modern sense of excessive
interest and it meant interest generally. Judaism, however,
later allowed that God could recover interest from non-Jews
only as a privilege granted to faithful Israelite. The
Christians had similar views about usury and interest. The
early Fathers totally disapproved usury. The decision of
Canonist Conscious was that money lending did not justify a
charge. Augustine placed usury in the category of crime and
denounced the usurers as breed of vipers that gnaw the womb
that bears them. A canon of the third Lateran Council
directed that, manifest usurers shall not be admitted to
Communion, nor, if they die in their sin, shall receive
Christian burial. It was, however, not until 1830 that Holy
Office allowed that interest could lawfully be taken for
money lent to merchants who were in profitable trade.

2.2) NATURE AND MEANING:

According to Qadeeruddin Ahmed, (1994), Riba is an Arabic

word which means “increase”, “addition”, “expansion” or
“growth” and refers to the additional amount, which a
lender recovers from the borrower according to a fixed rate
over and above the principal amount. In the New
Encyclopedia Britannica, usury is explained as compensation
for the use of money regardless of the amount, according to
earlier English law. The Concise Oxford Dictionary,
however, defines usury ass “Practice of lending money at
exorbitant interest, especially at higher interest than is
legal”.

2.2.1) According to Hughes, riba is a term in Muslim

Law as:

xviii
“An excess according to legal standard of measurement or
weight, in one or two homogeneous articles opposed to each
other in a contract of exchange and in which such excess is
stipulated as an obligatory condition on one of the parties
without any return. The word riba appears to have the same
meaning as the Hebrew “neshec” which included gain, whether
from the loan of money or goods or property of any kind. In
Mosaic Law, conditions of gain for the loan of money or
goods were rigorously prohibited”.

According to text in Oxford Advanced Learner Dictionary,

(2002), Riba refers to “excess, addition and surplus” while
the associated verb implies “to increase, to multiply, to
exceed, to exact more than was due, to practice usury”.
Lane’s, Lexicon presents a synthesis, which transcends and
covers most of the earlier authentic definitions of riba.
It says that the common meanings that emerge are: ‘to
increase”, “to augment”, “swelling”, “forbidden”,
“addition”, “to make more than what is given”, “the
practicing or taking of usury or the like”, “an excess” or
“an addition”, “an addition over and above the principal
sum” [that is lent or expended].

According to Ahmed, (1995), It will thus be seen that

originally the word usury meant the fact or practice or
lending money at interest. It came to mean, in later use,
the practice of charging, taking or contracting to receive
excessive or illegal rates of interest for money given as
loan. Usury before reformation amounted to taking of any
amount of interest than what is authorized by law. It is,
therefore, clear that interest charged on a loan is nothing
but usury in the original sense of the word. Subsequently,
laws were enacted specifying the limits within which usury

xix
 could be tolerated. These limits prescribed by law came to
be known as interest.

According to Encyclopedia Americana– International edition,

(1999), “Interest is a charge for the use of money…
Interest has not always been considered a legitimate or
even moral payment. Until the end of middle Ages, any
charge for a loan was generally considered to be usury. The
teachings of Christians, Judaic and Islamic religion, all
condemned in varying degrees, the taking of interest. In
more recent times, however, usury has come to be regarded
as only the charging of illegal rates of interest.”

Encyclopedia Americana,(1999), explains usury as:

“previously interest meant payment to compensate for a loss
suffered by the lender, whereas usury signified a charge
for the use of money”.

According to Stiengass, the word interest by and large has

now been accepted and understood as riba. It is now
proposed to discuss the prohibition of riba, as ordained by
Islam.

2.3) Historic Back Ground in Islam:

Anwar Muhammad, (2000) is of the view, the word “Banking”

has been defined to mean the accepting for the purpose of
lending of investment, of deposits of money from the
public, repayable on demand or otherwise, and withdraw-able
by cheque, draft, and order or otherwise. Accordingly,
banking has two aspects:

1. Deposits accepting and negotiation of certain

credit instruments.

2. Financing in the form of investment or lending.

xx
One of the significant developments in the Muslim world
during the last decade and half is the emergence of Islamic
banking which has appeared as a powerful movement. Although
some attempts to reorganize banking activities along the
Islamic lines go back to the early 60’s, the concept of
Islamic banking is even older. In fact, the strong
disapproval of interest by Islam and vital role of interest
in the modern commercial banking system led Muslim thinkers
to explore the ways and means to organize commercial
banking on an interest free basis. However, for a long
time, the idea of Islamic banking remained a mere wish.

2.4) INTEREST & ITS IMPACT:

Interest, which is the kingpin of modern banking and

financial system, serves as a powerful tool of exploitation
of one segment of society by another. It has created
‘haves’ and ‘have-nots’ and acted as a barrier to the
achievement of maximum welfare for the maximum number of
the people.

Saddiqi in (1993) was of the view, it is in this context

that Islam forbids interest and it is for the achievement
of the egalitarian objective of Islam that the Muslim world
is now embarked on the task of Islamizing the financial
system by unfettering it from the clutches of interest. The
institution of interest is wholly repugnant to the teaching
of Islam. Indeed there is a consensus among Muslim scholars
that ‘Riba’ is prohibited in all forms and manifestations.
The injunctions of the Holy Quran in this regard are
unambiguous and clear. The Quran says:

“Those who swallow ‘Riba’ cannot rise up save as he ariseth

whom the devil has prostrated by (his) touch. That is

xxi
because they say: Trade is just like ‘Riba’, whereas Allah
permitted trading and forbade ‘Riba’. He unto whom an
admonition from his Lord cometh and (he) refraineth (in
obedience thereto), he shall keep (the profits of) that
which is past and his affairs henceforth is with Allah. As
for him who returneth (to ‘Riba’) such are rightful owners
of the Fire. They will abide therein. Allah has blighteth
‘Riba’, and made ‘Sadaqat’ fruitful. Allah loveth not the
impious and guilty.”

2.4.1) Similarly at another Point:

According to Qadeeruddind, (1994), Let us begin by trying

to understand what, according to the Quran and Sunnah,
constitutes ‘interest’. The Quranic term for interest is
‘Riba’ which is used in the Quran, in 11 places in its
literal sense to denote an increase, addition, growth or
height, and in 9 places in the economic sense as generally
employed by the Arabs. The transactions to which the term
‘Riba’ was applied during pre-Islamic Arabia are recorded
in major Muslim works, as follow:

1. A seller would allow credit to the buyer and if

the amount was not paid in time, the date was

extended after increasing the amount payable.

2. A borrower would promise to pay an agreed sum in

addition to the principal, in return for the time

allowed for repayment.

3. A loan for an agreed period would attract a fixed

monthly amount as interest. If repayment was

xxii
 delayed, the loan term was extended and the

amount of interest was increased.

In all these transactions, the additional payment was

called ‘Riba’. No distinction was made between productive
(for trade, agriculture or transportation) or consumption
loans. As a rule, unpaid interest was compounded, but the
term ‘Riba’ embraced both simple and compound interest. The
type of additional payment is further referred to as ‘Riba-
an-Nasia’.

Ahmed, (1995) says, another term ‘Riba-al-Fazal’ was

applied to the credit exchange of different quantities of
like goods. For a kilo of wheat given today, a kilo and
half (say) would be returned after a year. This obviously
amounts to interest, though paid is kind and not in cash.

According to Nawazish ali zaidi,(1987), Thus from the

earliest days of Islam, ‘Riba’ has unanimously been taken
to signify ‘anything of value received by a lender, in
addition to principal, in consideration of the time the
loan remains outstanding’. In its essential form,
therefore, the ‘Riba’ of Jahiliyah Arabia was no different
from the ‘interest’ of the modern age.

2.4.2) QURANIC INJUNCTIONS ON RIBA

Having thus established what was meant by ‘Riba’ during the

time of the Prophet (So, the Quranic verses concerning Riba
are quoted below:

xxiii
1. (We punished the Jews…) because they practiced ‘Riba’

though it was forbidden…

(Chap 4: 160-161)

2. …. Do not consume Riba, increasing and again increasing

….

(Chap 3: 130-132)

3. Those exacting Riba turn rabid…. Because they argue:

Trade (ba’y) is like Riba, whereas Allah permits ba’y

but forbids Riba…. Allah has blighted Riba.

(Chap 2: 275-276)

4. …. Forego outstanding Riba. If you won’t be warned of

war from Allah and His Prophet (S).

(Chap 2: 278-279)

The Quran obviously had no need to define Riba, since it

was a well-known term in general use and there was no

likelihood of ambiguity or misunderstanding.

2.4.3) THE PROPHET (S) ON RIBA

The foregoing Quranic injunctions on Riba are elucidated by

several Ahadith of the Prophet (S), as shown below;

1. At Hajjat-ul-Wida, the Prophet (S) announced the

annulment of all Riba claims. Only the principal

was henceforth repayable to the creditor.

xxiv
 2. The pact between the Prophet (S) and the Banu

Thaqeef provided that they would be entitled to

recover only their principle from their debtors.

3. The Prophet (S) pact with the Christians of Najran

stated that he (S) would be absolved from

protecting them if they practiced usury (Riba).

Later, the Najranites were banished when they

resorted to usury.

4. The Prophet (S) also forbade Riba-al-Fazal

(described earlier) and emphasized that such

increase in kind was Riba, hence not permissible.

2.4.4) The following Ahadith testify to the gravity of

Riba:

1. Allah has cursed all who take or give interest,

or testifies or transcribes such a transaction. (Thus,
anyone even remotely connected with Riba, is accursed).

2. The sin of Riba exceeds thirty-six Zina.

3. Riba has seventy degrees, the least being worse

than material incest. (This emphasizes how heinous the
act of Riba is regarded by Allah).

4. The Prophet (S) enjoined upon creditors not to

receive any presents from their debtors. (This would
indirectly open the way to interest).

5. On the night of Me’raj, the Prophet (S) saw

some persons in a river of blood and others with

xxv
 snakes in theirs bellies. He learnt that these people
had taken Riba in their earthly lives.

And as a general rule, the Prophet (S) ordained that

even where there was some doubt between the permissible
(halal) and the forbidden (haram) the doubtful
(mutashabihat) should also be forsaken.

2.5) THE CONCEPT AND MEANING OF ISLAMIC BANKING:

The Holy Quran does not lay down any injunctions regarding
deposit taking or negotiation of credit instruments. It
merely prohibits a certain mode of financing i.e. interest
based financing. Banking in the form of deposit accepting
or financial intermediation did not exit at the time of the
advent of Islam. In the early days of Islam, financing was
done on a personal basis. The role of credit was, however,
limited to trade and loan financing. Investment funding was
virtually unknown.

Anwar Muhammad, (2000) was of the view, the concept of

interest free financing in varying degrees and forms has
deep historic roots in both secular theory and religious
belief. The past five years have witnessed a resolute
effort on the part of the government to bring about a
radical change in the country’s banking field so that the
interest based system (as developed, refined and practiced
by the western financial institutions) is replaced in
totality with a Riba free system to conform to the basic
teachings of Islam. The Quran has, at a number of places,
explicitly and categorically forbidden Riba in any form;
and for those who practice or derive income from this
source, the Quran has prescribed harsh punishment;
undoubtedly this has been ordained for the welfare of

xxvi
mankind and consequently, it should be our effort as
Muslims to conform to the Quranic injunctions.

Ayub Muhammad, (2002)was of the view, The Ulema and an

element of the learned class have equated the Arabic word
‘Riba’ with interest rather than usury; needless to say,
all religious and all social-political systems have been
against usury and in the modern day western states, laws
have been in place prohibiting usury. As regards interest,
the western financial system equates it as cost of capital,
while the Ulema have taken the narrowest meaning of Riba
and correlated modern day interest with it. Thus, it means
that if Riba and interest is one and the same thing, then
it is essential that interest or Riba should be eliminated.
The prevailing interest based system has failed to solve
the socio-economic problems of mankind. The institution of
interest runs counter to the vision of a just economic and
social order envisaged by Islam. As stated by the council
of Islamic Ideology of Pakistan, the main rationale for
prohibition of interest stems from the concept of justice
between man and man which is the cornerstone of the Islamic
philosophy of social life. Uncertainty is inherent in a
business enterprise.

“O ye who believe; devour not your substance among

yourselves unlawfully, but let it be a trading among you by
mutual agreement.”

(Chap 4: 29)

Asif Shah, (1995) says, The fixity of return on capital

irrespective of the operation results of the business is
unfair both to the user and the provider of funds. The
borrower is required to pay interest irrespective of

xxvii
whether he earns profits or suffers losses. Non-payment of
interest can have serious repercussions and may even lead
to liquidation of the enterprise, which is neither in the
interest of the entrepreneur nor in the interest of the
economy as a whole. The prevailing interest based financial
system hampers capital formation and optimal allocation of
scarce resources in the economy. Islam, on the other hand,
encourages productive activity and does not allow gain from
financial activity without participation in profit and loss.

2.6) COMPARISON BETWEEN ISLAMIC & INTEREST-BASED

BANKING:

According to Ali, (1987), the main objective of an

interest-based bank is to maximize profits through banking
activities mainly lending. This system which is not
conditioned in its operations by any religious commandments
is now well established throughout the world. The following
are some of the economic impacts of the policies generally
pursued by these institutions:

1. A comparatively smaller number of borrowers have

been greatly benefited at the cost of a large number
of depositors. These banks generally act in the
interest of their major clients due to their high
credit rating who also pass on substantial
remunerative business to them.

2. An imbalance has been created in various sectors

of the economy, because the flow of credit is largely
connected with the income generated from the advances
thereby, even ignoring the priority sectors, in some
cases.

xxviii
 3. They also contribute to create inflationary
tendencies, at times.

4. To safeguard their interest, these banks are

harsh when the borrower suffers losses or the value of
security is depreciated, but they soften the terms of
advances when the borrowers are prospering.

5. The conventional banks and the few families who

control them have “access to other people’ capital”,
observes Kotz (1978). He points out that “the
wealthiest and most powerful capitalists operate
through banks.” These banks are also the major
stockholders in and creditors of the largest non-
financial corporations. Mishan, observes that “… it
would be irrational for the lender to be willing to
lend as much to the impecunious as to the richer
members of the society, or to lend the same amounts on
the same terms to each”

Galbraith (1975:295) rightly points out that “those who

least need to borrow and those who are most favored are in
the planning system. Those who most rely on borrowed funds,
or are least favored, are in the market system.”

This situation is unacceptable to Islam.

Dr. Nijat, (1994) says The Islamic banks on the other hand:

1. Contribute towards economic development and

prosperity within the doctrine of Islamic justice and
offer an alternate financial system, which steers
clear of interest.

xxix
 2. Pass on the profit earned by entrepreneurs from
bank financing to a much larger number of
depositors/investors who place their funds with them.

3. Restrict financing to activities which are

ethical and socially desirable.

4. Check inflation and create the capacity to absorb

shocks in recession.

5. Are human and humane and practically sympathize

with those who most need funds or are in temporary
distress or who suffer business losses. This is done
by profit and loss sharing, Zakat and beneficent loans.

6. Operate for maximization of profit but within the

framework, as Islamic banks are also profit oriented
and not charitable organizations.

2.7) World Wide Efforts in Introducing Interest Free

Institutions:

Siddiqui, (l988) says, the first modern experiment with

Islamic banking was undertaken in Egypt under cover,
without projecting an Islamic image, for fear of being seen
as a manifestation of Islamic fundamentalism which was
anathema to the political regime. The pioneering effort,
led by Ahmad El Najjar, took the form of a savings bank
based on profit-sharing in the Egyptian town of Mit Ghamr
in l963. This experiment lasted until l967 (Ready l98l), by
which time there were nine such banks in the country. These
banks, which neither charged nor paid interest, invested
mostly by engaging in trade and industry, directly or in
partnership with others, and shared the profits with their

xxx
depositors Thus, they functioned essentially as saving-
investment institutions rather than as commercial banks.
The Nasir Social Bank, established in Egypt in l97l, was
declared an interest-free commercial bank, although its
charter made no reference to Islam or Shari’ah.

The IDB was established in l974 by the Organization of

Islamic Countries (OIC), but it was primarily an inter-
governmental bank aimed at providing funds for development
projects in member countries. The IDB provides fee- based
financial services and profit-sharing financial assistance
to member countries. The IDB operations are free of
interest and are explicitly based on

El– Ashkar, (1987)says, In the seventies, changes took

place in the political climate of many Muslim countries so
that there was no longer any strong need to establish
Islamic financial institutions under cover. A number of
Islamic banks, both in letter and spirit, came into
existence in the Middle East, e.g., the Dubai Islamic Bank
(l975), the Faisal Islamic Bank of Sudan (l977), the Faisal
Islamic Bank of Egypt (l977), and the Bahrain Islamic Bank
(l979), to mention a few. The Asia-Pacific region was not
oblivious to the winds of change. The Philippine Amanah
Bank (PAB) was established in l973 by Presidential Decree
as a specialized banking institution without reference to
its Islamic character in the bank's charter. The
establishment of the PAB was a response by the Philippines
Government to the Muslim rebellion in the south, designed
to serve the special banking needs of the Muslim community.

El– Ashkar,(1987)says, Islamic banking made its debut in

Malaysia in l983, but not without antecedents. The first
Islamic financial institution in Malaysia was the Muslim

xxxi
Pilgrims Savings Corporation set up in l963 to help people
save for performing hajj (pilgrimage to Mecca and Medina).

In l969, this body evolved into the Pilgrims Management and

Fund Board or the Tabung Haji as it is now popularly known.
The Tabung Haji has been acting as a finance company that
invests the savings of would-be pilgrims in accordance with
Shari’ah, but its role is rather limited, as it is a non-
bank financial institution. The success of the Tabung Haji,
however, provided the main impetus for establishing Bank
Islam Malaysia Berhad (BIMB) which represents a full-
fledged Islamic commercial bank in Malaysia. The Tabung
Haji also contributed l2.5 per cent of BIMB's initial
capital of M$80 million. BIMB has a complement of fourteen
branches in several parts of the country. Plans are afoot
to open six new branches a year so that by l990 the branch
network of BIMB will total thirty-three.

EL_Ashkar, (1987) says, Reference should also be made to

some Islamic financial institutions established in
countries where Muslims are a minority. There was a
proliferation of interest-free savings and loan societies
in India during the seventies (Siddiqui l988). The Islamic
Banking System (now called Islamic Finance House),
established in Luxembourg in l978, represents the first
attempt at Islamic banking in the Western world. There is
also an Islamic Bank International of Denmark, in
Copenhagen, and the Islamic Investment Company has been set
up in Melbourne, Australia. An investment Company was
established in Bahamas in 1977 as a multinational holding
Company under the name of Islamic Investment Company, ICC
Ltd. Its purpose is to establish ‘Mudarbah’ (partnership)
companies in various parts of Islamic countries. The

xxxii
company has established two ‘Mudarbah’ subsidiaries in
Sharjah and Pakistan.

The second example of Islamic banking in the west comes

from Luxemburg, where the Islamic Banking System
International Holding was established in 1978 as a Joint
Stock Company. Its purpose is to establish international
Islamic banks in different parts of western countries to
participate in investment projects in Islamic & non-Islamic
countries.

2.8) Strategic alliance of Islamic and conventional

banking in Pakistan:

According to Nawazish, (1987), Under the new corporate

culture, believing in emerging trend is a fine thing, but
placing those beliefs onto execution, is a test of
strength. To this effect, a courageous step with
conviction, which led Al-Meezan Bank to form an alliance
with ABN AMRO to provide Riba-free services, is a good
beginning. Such step is required to see in a broader
perspective, which would not only be followed by the
consequences, but also have a direct bearing on our local
banking industry.

Ayub Muhammad, (2002) says, since Islamic banking is

passing through the age of infancy, it has been striving to
establish its credibility. It is slowly but gradually,
getting recognition. At present there are at least 200
Islamic banks and financial institutions, operating
globally and are going to multiply during the next decade,
to cover larger area of the world. It is also an
encouraging sign and happy augury that Islamic banking is
receiving support from the government too. Malaysia has

xxxiii
upgraded the status of Islamic banking units divisions, to
offer Islamic banking alongside conventional banks. In
Indonesia, few private banks have converted into Islamic
financial institutions. More than 40 rural banks are
operating under Shariah rules. Thailand has opened Islamic
banking counters in Government Savings Bank (GSB). This is
a healthy sign which needs to be followed and vigorously
maintained by other Muslim states.

According to Akram khan,(1992), Acknowledging the tangible

impact of such growing trend within regional and global
banking industry, various off-shore foreign banks in the
Gulf and other part of the world do not want to lag behind
and lose any opportunity to keep their organizations alive
in this specific growing area of competition. By re-
evaluating their operational strategies, these banks are
establishing Islamic banking units/divisions to offer
Islamic banking operations alongside conventional banking
in their organizations.

According to The News (March 2007), Al-Meezan and ABN AMRO

banks with joint strategic action have not only welcomed
the emerging trend in the banking, but also communicate
their beliefs with conviction towards a just cause, by
offering equal opportunity to all clients to avail Riba-
free services being a long-awaited need of Muslim society
in Pakistan.
The said alliance would bring about an inept change in the
fundamental approach of proactive managers of our banking
industry as well as to arrest their sense of drift to
accept new trends emerging on the horizon of contemporary
banking in other parts of the world.

xxxiv
However, the said alliance has unique role to play and may
yield desired results in given circumstances such as:

Al- Meezan being an investment bank may contribute to

transform the non-interest banking system more
sophisticated and forge greater linkages with conventional
banking.

Al-Meezan is suitably placed to re-evaluate its strategy

from time to time to add more value to its Riba-free
financial products through innovative ideas so as to
survive the competition – even stay ahead of it.

Al- Meezan bank would be in a better position to promote

trust and develop a sense of security among clients.
Establishing its credibility through its persistent efforts
to create awareness and efficacy of Islamic banking system
in existing financial structure etc.

ABN AMRO being a conventional bank, through this alliance

has an important and rather strategic role to play in the
local banking industry. It may identify niche markets and
can have a suitable competitive advantage over other
commercial banks and financial institutions.

Ayub Muhammad,(2002)says, In the light of realignment

trends sweeping the global banking industry, at the same
time seeing the adoption of Islamic banking alongside
conventional banking by regional conventional banks and
financial institutions has given rise to the empowering
belief that our proactive and enterprising bankers being
the harbingers of our local banking Industry, would take
cognizance of such unprecedented change and would
positively respond to the emerging trend, which is need of

xxxv
the hour to welcome a passive revolution in our local
banking industry too.

According to Muhammad Akram, (1992), therefore, with the

modest confidence and cautious optimism, we believe that
any positive step in this regard is not only going to earn
a substantial backing within our banking industry but also
very encouraging and healthy response from business
community too. Moreover, it has been an ardent desire that
our professional conventional bankers may shrug their
feeling of superiority complex and view the emerging
opportunities and trends in its right perspective and play
their positive role in bridging the difference and evolve a
required consensus to introduce Islamic banking in the
light of new arrangements taking place globally.

Should interest free banking be allowed by local commercial

banks and financial institutions (e.g. NBP, HBL, UBL, NDFC
and PICIC), it could be a milestone in the career of these
enterprising managers. They may leave a precious legacy of
trend-setters in our banking industry. The torch hopefully,
they are going to lit will no doubt glow in the coming
century.

Mr. Jamshed, (1996) says, the alliance between Islamic bank

and conventional bank has revealed that what was lacking
previously is the sincerity of purpose – will to change and
commitment to cause, not lack of resources. Now it is
optimistically believed that our banking industry doesn’t
need any further brain storming sessions, marathon meetings
or an exhaustive assignment to introduce Islamic banking
alongside conventional banking. Simply these managers of
conventional banking industry must get rid of disempowering
beliefs by breaking their old pattern of thinking and

xxxvi
replacing them with conviction to act and follow the
emerging regional trend in banking industry in true spirit.

In this regard, a docile initiative of Al-Meezan investment

bank in the form of a working alliance with ABN AMRO is the
right step in the right direction at the right moment.
Introduction of the trend in Pakistan may become a tiny
spark followed by a mighty flame in our future banking
industry, should our thoroughly professional bankers imbued
with sprit of service inclined to read the trend correctly
and allow Islamic banking operations to see the light of
the day in their institutions.

CHAPTER # 3

ISLAMIC MODES OF FINANCING

In God we trust” is inscribed on the American dollar

whereas Pakistani rupee says “Rizq-e-Hilal ain ibadat hay”
(an honest earning is worship).

In America there are institutions created to ensure trust,

not in God, but between the parties, which results a trade
in dollars, while in Pakistan “Rizq-e-Hilal is practically
extinct. The American economy is booming while Pakistani
economy is sliding towards recession.

According to Akram Khan, (1992), Interest is one of the

motives of the modern banking and financing concepts and it
is very much difficult to remove it, without shaking the
system to its base.

xxxvii
Interest in the Islamic terminology is called as “Riba” and
“Riba” is strictly prohibited in Islam. Still all over the
world unluckily including many Muslim countries banking and
financing is done with interest motives.

Anwar Muhammad, (2000) says, Interest plays a vital role in

the modern economy that is the regulation in supply of
money control of credit, fixation of exchange rates, and in
determining the interest climate.

Imran, (1996) says, Interest is also called as mark up,

Riba, service charges, or “suod”. The modern banking and
financing in fact has the following basic principles i.e.,
return, risk and liquidity.

All the banks whether Islamic or western are classified as

variations of the same theme. American economic systems
i.e., free market economy, closer to Islamic system than
the system in Pakistan.

The main spirit of the Islamic system is a free enterprise

and this is what is being practiced in America.

3.1 ISLAMIC ALTERNITIVES FOR INTEREST FREE FINANCING:

Islamic economist wants to get rid of Riba, because

religion strictly forbids it. But they have yet to suggest
an alternative system and explains its working in the
present day conditions,

Quran has already explained it. According to one

explanation of Sura Al-Baqarah,

“Even if the funds are invested in trade, agricultural or

industry, one stands the change either of making a profit

xxxviii
or incurring a loss during the period of time in question.
Hence an interest-bearing transaction entails either a loss
on one side and a profit on the other, or an assured and
fixed profit on one side and an uncertain and unspecified
profit on the other.”

It is this, which could lead to the exploitation of one

person at the hands of the other, some thing the Quran
finds totally abhorrent.

Ayub Muhammad, (2002)says, Islam also argues that in an

interest bearing transaction a person gains money without
working for it; it is said that he simply lives off the
hard work and earnings of others and that “by its very
nature, interest breeds meanness, selfishness, apathy and
cruelty towards others. It leads to the worship of money
and destroys fellow feelings.”

Pakistan was created in the name of Islam on August 14,

1947, since then the interest is playing the cardinal role
in the resources of the allocation of the economy. The
principle of interest as the guiding force is diametrically
opposed to the Islamic system.

The previous governments (except that of late president

Zia-ul-Haq) could not and did not dare to change the well-
dug system based on interest. The government led by late
president Zia-ul-Haq accepted the challenge & took
revolutionary steps to make the country according to
Islamic pattern

According to Saddiqi, (1993), The government is of the firm

view that “Riba” implied on all types of interest and there
is no disagreement over this issue among scholars. Interest

xxxix
has become such an integral part of modern western banking
concept that it can be removed without shaking the whole
structure from the base.

In an Islamic system, there is no place for the capital to

be given at interest. There are 12 Islamic modes of
financing. State Bank of Pakistan for has approved these
complementary in the entire transactions of commercial
banks since July 1985.

3.1.1) Non-Interest Based Financing

Over the last decade or so, a series of changes have been

introduced in the legal framework and the operations of
Pakistan’s financial system, with the intent to
progressively eliminate interest-based transactions from
the economy. The strategy has been to devise a spectrum of
financial instruments, which at one end are quite close to
present prevailing practices, and at the other end,
represent an Islamic perspective on conducting business.

Council of Islamic Ideology, (1980) says, a phased strategy

was adopted by the government regarding introduction of
Islamic modes of financing in banking and other financial
institutions, with the advice of various committees and
groups of experts, under the overall umbrella of the
Council of Islamic Ideology. Here is an assessment of the
government’s efforts in this area and the progress that has
so far been made towards achieving the goal of Islamization
of the financial system in the country. It also seeks to
discuss the rationale and the progress made so far in
eliminating interest from financial transaction at the
institutional level.

3.2) Development of Interest-Free System:

xl
Imran, (1995) is of the view, A panel of economists and
bankers were appointed by the council for examining the
technical aspects and recommending ways and means for
transforming the banking system into an interest-free
system. On receipt of an interim report from the panel in
1978, the council submitted a detailed report on the
elimination of interest from the economy. The report
contained an alternate mechanism to replace interest in
domestic banking transaction but observed that the interest
could not be eliminated from international trade
transactions by single country.

According to Asrar,(1993), The Council’s report dealt in

broad terms, but comprehensively, with the major
issues, problems and strategy relating to elimination of
interest from commercial banks, specialized financial
institutions, central banking and government transactions.
It also dealt with modalities of financing arrangements for
different sectors of the economy on an interest-free basis.
In view of the complexity of the task, the report suggested
that elimination of interest might be made gradually under
a phased program spread over a period of three years. It
also laid down a plan of action with an order of priority
for elimination of interest from different sectors. It
recommended elimination of interest from government
transactions in the first phase, followed by elimination of
interest from the assets side of the operations of the
commercial banks and other financial institutions,
eliminating finally in deposits of the banks becoming
interest free in the true sense of the term. The report
emphasized that the ideal Islamic techniques to replace
interest in the banking and financial sector are

xli
profit/loss sharing. However, the report gave due
recognition to the difficulties that would have risen as a
result of changing the whole system to profit/loss sharing
in one step. It therefore, gave qualified approval to
certain other methods being used in conjunction with
profit/loss sharing like leasing, hire purchase, Baiye
Muaajal (deferred sale), investment auctioning and
financing on the basis of normal rate of return. However,
cautioning against the danger that such methods could open
a back door for interests, it emphasized that their use
could be kept to the minimum extent that may be unavoidable
necessary under given conditions and that their use as
general techniques of financing must never be allowed.

Ayub Muhammad, (2002)says, The Council recognized that in

order to re-shape the banking system on Islamic footing, it
was essential to make necessary changes in the existing
banking laws so as to bring them in conformity with the
Islamic legal and ethical rules. The Council took note of
the reservations about the operations of profit and loss
sharing system as the main mode of financing to replace
interest in Pakistan, in the prevailing circumstances. The
council (1980) accordingly recommended some modes of
financing as a temporary measure. The State Bank of
Pakistan, in line with the council’s recommendations,
specified the following twelve modes of Islamic financing
which have been further classified into three categories.

3.3) Financing By Lending:

This category includes the following two modes.

• Loans with Service Charge

xlii
These are interest-free loans on which the bank may recover
a service charge not exceeding the proportionate cost of
operations, excluding the cost of funds and provision for
bad and doubtful debts. The State Bank will determine the
maximum service charge permissible to each bank from time
to time.

• Qarz-e-Hasna

These are loans given on compassionate grounds, free of any

interest or service charge, and repayable if and when the
borrower is able to pay.

3.4) Trade Related Modes of Financing:

This category includes the following modes.

• Mark - up

According to Saddiqi H.,(1993), It is a sale in which the

margin of profit or mark-up to the seller is mutually greed
upon between the buyer and seller in advance. The payment
of sale price may be either in lump sum or in installments.
In this mode, the financial institutions, instead of
lending, make purchase of portion of the company’s assets
or inputs, which are subsequently sold back to the company
when the loan fills due at a price including mark-up.
Instead of a penalty for the late payments, timely
repayment of loans provides rebates on the agreed mark-up.
Although, mark-up was introduced to provide short-term
financing, the State Bank, in 1985, extended this mode to
term financing as well. At present, mark-up financing is
the main instrument, which is issued by the financial
system for working capital loans. Given the characteristics
of bank’s asset operations, which are largely short term

xliii
and oriented towards financing domestic and import trade as
well as input requirements of the industry and agriculture,
they are amenable to mark-up lending operations. This is
the most popular mode of financing in Pakistan at present.

• Markdown

Through this mode, trade bills and notes of credit are

purchased on the basis of markdown in price. Markdown here
refers to reduction in price below the original sale price,
usually because of a decrease in the general level of
prices, special sales, soiled and damaged goods,
overstocking and competition.

• Buy-back

Under the buy-back arrangement, clients sell some moveable

or immovable goods to bank and immediately buy-back the
same at higher price (with mark-up payable at a future
date). There is also a provision for levy of liquidated
damages in case of client’s default. Certain categories of
documentary bills are also purchased and sold under the
buy-back agreement.

• Leasing

It is relatively a new method of long-term financing under

which the lessor retains the ownership of the asset and
lessee has possession and use of assets on payment of
specified rentals over a specific period.

• Hire purchase

In this system, banks and other financing institutions can

provide finance for purchase of various fixed assets under

xliv
joint ownership arrangement. In addition to repayment of
the principal, they would receive a share in the nature of
net rental out of the profits earned on t he assets.

• Development Charge

Financing for development of property on the basis of a

Development Charge.

3.5) INVESTMENT TYPE MODES OF FINANCING:

It includes the following.

• Musharaka Or Profit And Loss Sharing (PLS)

It is a temporary in that both the customer and the bank

contribute financially on the basis of sharing profit and
loss (PLS). Under this arrangement, the customer will
operate and manage the venture, while the bank will
evaluate and monitor the performance.

• Equity Participation

This will allow the banks to purchase shares of the listed

corporations.

• Participation Term Certificates (PTC) & Modaraba

Certificates

Accoring to Saddiqi H.,(1993), The Participation Term

Certificates (PTCs) are negotiable instruments and are
issued by a company upon terms and conditions contained in
an agreement in consideration of any fund, money,
accommodation received or to be received b y the company
whether in cash or in specie or against any promise,
guarantee, undertaking or indemnity issued to or in favor

xlv
or benefit of the company. Instead of receiving interest, s
in the case of debentures, the holders of PTCs share in the
profit and losses of companies. Modaraba certificates are
the share certificates issued to the subscriber of funds
for the business of corporate body registered Modaraba
Company under Modaraba Companies & Modaraba (Floatation &
Control) Ordinance, 1980, in terms of which Modaraba
Certificate means a certificate of definite denomination
issued to the subscriber of the Modaraba acknowledging
receipt of money subscribed by him.

• Rent sharing

According to Hasan,(2007),journal, This will allow banks to

form partnerships with their clients in the purchase of
property on the basis of sharing in the rental or any other
income from the property.

Although the State Bank of Pakistan has described 12 modes

of financing, the banks in Pakistan have, by and large,
confined their main operations to the following modes: -

• Loans with service charge/Mark-up

• Buy-back agreement.

• Hire purchase.

• Musharaka/Modaraba.

The following section elaborates upon the prevailing modes

of financing in terms of their concept, application and
mechanism as to how they have fitted into the existing
financial system. It also touches upon other financial
instruments, which though come under the domain of Islamic

xlvi
banking, but their application has been limited to a
certain extent.

Modes of Financing:

Imran, (1996)says, The Sharia and financial experts have

identified two categories i.e. direct and indirect forms of
financial accommodation. The first category includes the
Qarz-e-Hasna and Profit-Loss Sharing System. The indirect
financial accommodation system has been described in three
major categories: (a) Trade-based Modes, (b) Leasing-based
modes, and (c) the Service-based modes. Under the direct
accommodation system, risk bearing is in exact proportion
of the investment of the concerned parties and is for the
entire period of the use of funds. Whereas under the
indirect financial accommodation, the level of risk bearing
can be different and substantially reduced, but not totally
eliminated.

The modes of financing falling under both direct and

indirect forms of financial accommodation are described as
follows:

Qarz-e-Hasna System

Under this system, the lender has a claim only on the

principal amount. He is also obliged to reschedule or
postpone the repayment of the principal amount, if the
borrower’s condition is such that he does not have the
ability to pay. However, this mode is not feasible for
commercial organizations like banks, and branches of
nationalized commercial banks in Pakistan do not use this
system for their usual operations.

xlvii
Equity - Based Financing

The PLS financing may be both for an indefinite period

(stocks or shares) or a definite period (in the nature of
temporary or Redeemable Capital). It may take three forms,
namely, Modaraba or simple profit loss sharing, Musharaka
or partnership, and the corporation or a joint stock
company.

Modaraba

Technically, in Modaraba one party provides the necessary

capital and the other party provides human capital that is
needed for the economic activity to be undertaken. This
maybe termed as an agency partnership. In this type of
contract, the bank supplies full financing to an agent-
manager (Modarib) for trading and industrial purposes
whereas the Modarib contributes in the form of his skill
and experience. In consideration, he gets an agreed
percentage of the profit actually realized. This form of
contract reflects directly how Islamic concepts value labor
or pure human behavior. In case, no profit is realized or a
loss occurs from normal business or natural causes, the
bank bears all the loss and the Modarib receives no reward
for his efforts.

According to Hasan,(2007), journal, conceptually, a

Modaraba is an investment fund for which resources are
obtained through sale of certificate to subscribers.
Commercial banks serve either as managers or as
subscribers. In Pakistan, the sponsor of a Modaraba has to
be a company and must be registered under the Modaraba
Companies and Modaraba (Floatation and Control) Ordinance,
1980. The Modarib provides management expertise along with

xlviii
not less than 10% of the total amount of the Modaraba fund
offered for subscription, while the Modaraba certificate
holders subscribe 90%. Besides, a Modaraba company solely
engaged in the floatation and management of Modaraba cannot
be registered unless its paid-up capital stands at not less
than Rs. 2.5 million.

A Modaraba can be multipurpose (having more than one

specific purpose) or it can either be fixed or for an
indefinite period of time. A Modaraba floated for a fixed
period of time, or for a specific purpose, gets terminated
automatically as soon as its period expires, or its purpose
is accomplished. The following conditions have been set out
for a Modaraba under the Modaraba Companies and Modaraba
(Floatation and Control) Ordinance, 1980:

• Modaraba shall be a legal person. It shall sue and be

sued in its own name;

• Assets and liabilities of each Modaraba shall be

separate and distinct from each other as well as from
that of the Modaraba Company;

• For each Modaraba, separate bank account, funds,

assets and liabilities shall be maintained;

• No Modaraba shall be liable for the liabilities or be

entitled to benefit from the assets or any other
Modaraba or Modaraba company.

The company of a Modaraba is tax exempt if not less than

90% of its profit in a year is distributed to the Modaraba
certificate holders.

A Modaraba, an Islamic mode of finance revised as part of

the Islamization of the economy during the eighties, is

xlix
conceptually similar to a close-ended limited partnership
where a management company provides expertise while
investors provide capital. Shares of the Management Company
as well as certificates of investment by the passive
investors are traded on the stock exchange. The Modaraba
form of organization, therefore, does not define its
activities; so long as its activities are sanctioned as
“Islamic” by a religious board, it can engage in almost any
line of business. About 70% of Modaraba income comes from
leasing, less than 1% comes from banking and stock market
investments, and the remainder comes from trading and other
lines of business. Modarabas were especially popular with
sponsors because they had the advantage of being exempt
from income tax. This exemption has now been withdrawn for
Modarabas that because operational more than three years
ago.

A Modaraba Ordinance was enforced in 1980 for promoting

business in accordance with the injunction of Islam, which
prohibits Riba. As a result, the efforts for interest free
business were initiated in the country, and in 1985, two
Modarabas named B.R.R. Capital Modaraba and First Habib
Modaraba were formed and listed on the Karachi Stock
Exchange. Although the pioneering Modarabas were small and
limited in scope of activity, the floatation of First
Grindlays Modaraba, First Prudential Modaraba and First
Sanaullah Modaraba, proved to be a turning point in
Modaraba business and therefore, a number of such companies
were formed in the country.

So far primarily the specialized credit institutions,

especially the Banker’s Equity Ltd, have managed Modarabas.
The first Modaraba Company in the private sector was

l
incorporated in November 1982 and floated its first
(multipurpose) Modaraba enterprise in early 1985, valued at
Rs. 25 million. Modaraba certificates are traded and quoted
on the stock exchange.

The government policy of privatization and deregulation of

the economy and easing of fiscal and banking regulations
have opened new avenues of investment thus diversifying the
financial sector. In this context, Modarabas along with new
investment banks will play a pivotal role in strengthening
and developing the capital market activities.

Musharaka

Like Participation Term Certificates (PTCs) no statutory

definition of Musharaka has been specified. However, the
Musharaka contract is bilateral arrangement between the
financial institution and the user of funds. Moreover,
Musharakah contracts are not documented in the form of a
negotiable instrument and cannot be traded like other
financial assets on the capital market.

According to Qadeeruddin, (1994), Musharaka or partnership

is a form of business arrangement in which partners pool
their capital and labor to undertake any
commercial/industries. In the context of Islamic banking,
Musharaka is described as a joint venture between a bank
and a business entity geared for certain operations and may
terminate within a specified period of time, or when
certain conditions are met. Musharaka contract may be for
any specific project up to its completion or in the form of
redeemable investment by the bank –––– also known as
“Decreasing Musharaka”. This can be explained in the
context of medium and long-term operations where a ‘self-

li
liquidating’ form of partnership can be agreed upon;
whereby the ownership of the whole project or operation,
would be transferred to the partner (customer) after an
agreed period during which the bank would have retrieved
its principal and would have shared in the profits and
losses realized during that period.

While Musharaka companies typically provide long-term

capital for industrial investment, they have so far been
used to fund the working capital requirements of the
industrial and trade sectors not as a loan but as akin to
cash credit or overdraft accounts in which operations could
be carried out by deposit and withdrawal of funds.
Musharaka companies are deemed to be temporary partnerships
under which the commercial bank and the client share in the
profit or loss generated by the working capital supplied by
each to the project. In practice, the profit-sharing
arrangement is drawn up on the basis of future profit
projections that, in turn, are based on past averages, duly
adjusted according to the future plans and projections
overall state of the economy, and the industry in which the
firm operates. The client, for his managerial
responsibilities, receives an agreed proportion of
projected profits from the partnership, with the balance
divided between the bank and the client in a mutually
agreed ratio within the maximum and minimum ratios laid
down by the State Bank of Pakistan. If a loss results, it
is to be shared by the client and the bank in the ratio of
their contributions to the funds employed in the project.

Corporation

lii
The ‘Corporation’ or the business of joint stock companies
is well known. Modern corporation constitutes a combination
of Modaraba and Sharika al-Inan. It is a type of
partnership in which the amount of capital of the partners
and the ratio of profit distribution may be
disproportionate, power of appropriation in the property or
participation in the affairs of Musharaka may be different
and each partner is an agent to the other partners. All
shareholders are partners. Some of them who also act as
directors are like Modaribs by virtue of their
responsibility for management of the company. This form of
business is Islamic. However, speculative and other
unhealthy practices need to be eliminated and the rights
and obligations of the directors of companies rationalized.

3.6) Other Approved Modes of Financing:

According to Qadeeruddin, (1994), The bulk of financing

under the Islamic system is equity oriented. In this mode
of financing, the risk and losses are shared by the
financier along with the entrepreneur in the ratio of their
respective capitals. The profits are, however, shared in an
agreed ratio. Equity financing may be carried out in
various forms including participation in equity of joint
stock companies or share in partnership or in the form of
temporary equity on profit and loss sharing basis for the
working capital requirements for a specific period. As the
financing under this mode is based on profit and loss
sharing, Islamic banks pay more attention to the
profitability of the project and not merely on collateral.

According to the Council of Islamic Ideology, (1980),Some

other modes of financing have also been in practice in the

liii
Islamic framework, usually referred to as second-line
techniques, like Bayie Muajjal-Murabaha (usually translated
as mark-up technique), Ijara (Leasing), Hire-purchase,
Bayie Salam (deferred sale), Ju’alah (service charge), etc.
the Council of Islamic Ideology in its report (1980) had
observed that these secondary type of modes, though free of
interest element in the form in which they have been
presented in the context of Islamic financial system,
should be used to the minimum extent that may be
unavoidably necessary, so that the same could not become a
back-door for interest. However, in view of the
difficulties faced in practical application of equity-
based/Musharaka system, various Islamic banks are using
these modes under supervision of their religious
supervisory boards. Salient features of these modes are as
follows:

Murabaha (Sale for Mark-up)

This is the case where a partner approaches the bank

requesting a certain item (be it a commodity or machinery
or raw materials) be bought and/or acquired for him for a
specific price. He would indicate in advance his agreement
to re-purchase this item from the bank at a profit to be
agreed upon with the bank, in advance. So the profit
element is pre-determined. Although the profit element is
known, which makes it look like interest; it is not so.

Bayie Muaajal (Deferred Sale)

The term ‘Bayie Muaajal’ as recommended by the Council of

Islamic Ideology was based on the technique of Bayie
Murabaha. It has been defined as a sale in which the margin
of profit is mutually agreed upon between the buyer and the

liv
seller. Payment of the sale price along with the agreed
profit may be immediate or deferred (in the case of banks,
it will mostly be deferred) and either in lump sum or in
installments. For this kind of transaction to be consistent
with the Shari’ah rules, certain conditions must be
satisfied. First, goods to be traded should be real,
tangible goods and not papers or credit documents.
Secondly, the seller should take possession of the goods,
before selling them to the client. Third, the rate of mark-
up should not be tied to the length of period over which
the financing is to be provided and the price should be
settled once for all and there should be no change in it
after finalizing of the sale contract.

Bayie Salam (Deferred Delivery Sale)

In this transaction, advance payment is made to the

producer / manufacturer / supplier for deferred supply of
the specified goods at a future date. The jurists have
unanimously treated it as a permissible mode of business
provided the following important conditions are met: only
those commodities would be eligible that can be precisely
determined in terms of quality and quantity; period for
delivery of goods on the specified date and place. It is
also argued that commodity purchased through Bayie Salam is
not to be re-sold without taking its physical possession.

Because of its specific characteristics, Bayie Salam is

particularly suited for agricultural financing. The bank
can enter into an agreement with the farmer for the future
purchase of agricultural products and make the payment at
the time of contract. The assets of the farmer could be
used as collateral for the amount of finance to guard
against fraud or negligence, but any financial loss

lv
incurred in the operation will have to be fully borne by
the financing bank.

Ijara (Leasing)

The capital market in Pakistan has witnessed a rapid growth

in leasing business in the context of the Islamization of
the financial system. With certain conditions, leasing is
an approved mode of Islamic financing along with other
forms. Leasing is a contractual agreement, whereby the
lesser grants right to the lessee to use his
property/specific assets for a specified period of time, in
consideration of a certain payment known as rent.

According to Ali zaidi,(1987), In Ijara or leasing mode of

financing, assets are given out on lease to credit-worthy
clients and the ownership of assets remains with the
lessor. The lessee, however, enjoys possession of the
leased out assets in accordance with the provisions of the
contract concluded between the lessor (financial company)
and the lessee (borrower). Financing under Ijara or leasing
largely remains unrelated to size of assets or capital base
of the lessee, but depends principally on the ability of
his cash flow to service payments of the lease rentals.
Under this mode of financing, no restriction is imposed on
the type of assets to be leased out. The rental charged to
the lessee is computed in a way to recover the cost of the
leased out assets covering the operating cost of the lessor
along with some element of profit.

Ijara appears to be suitable means to raise investment

funds, especially for those enterprises, which hold
insufficient assets and capital base to meet normal
collateral requirements. The basic security under an Ijara

lvi
contract is ownership of equipments. The title of ownership
of equipments remain with the leasing company, and in case
of a serious default on the part of the lessee, the
equipments are repossessed.

Mohsin Khan,(1985),journal, says, It must be emphasized

that the modern leasing is compatible with the Islamic mode
of Ijara financing, as it is based on the same fundamental
concept of Ijara according to which one does not have to
own an asset in order to enjoy its benefits.

Lease can be classified into two types namely, financing

lease and operating lease. In case of financing lease, the
lessor enters into a contract by which all the cost
invested can be recovered, and the lessee uses the leased
out equipments accordingly, as if he has purchased them on
loan. Under this type of lease, the lessee is furnished
with the equipments, that is, loan in kind, and the
contract term is relatively longer which is almost equal to
service life of the leased out equipments. It is not
possible for the lessee to cancel the agreement before its
expiry date even if he finds the leased out equipments
necessary during the term. From this, it follows that in
lease financing, the lessee assumes the risk of
obsolescence and incurs maintenance cost of the leased out
equipments during the contract term.

In case of operating lease, the lessor, on the other hand,

does not necessarily expect to recover all the cost
invested while entering into a contract. In this type of
leasing system, the lessee uses the equipments only for a
desired period and major consideration is given to the use
of equipments. Unlike financing lease, the lessee can
generally cancel the contract in the operating lease before

lvii
its expiry date. This leasing system takes charge of
maintenance of the leased out equipments. By offering such
a service, the leasing companies keep the leased out
equipments in good conditions so that they can sell them to
other users in the market without loss.

Leasing in Pakistan began with an investment of the

International Finance Corporation (IFC) in 1981. Many
leasing companies have been formed since then as
subsidiaries of banks or other financial institutions.
Modarabas are also involved in leasing. Competition
pressures amongst almost 25 operating leasing companies
have promoted specialization. Leasing practices are varied
with some leasing companies requiring additional collateral
to be pledged, while others prefer to lease only to better-
known companies. In general, leasing is restricted to
equipment with a ready resale value. Leases have started
financing longer maturities and the proportion going to
finance equipment has increased, owing to tax incentives.

In the last five years, the leasing industry in Pakistan

has been growing at the rate of 70 to 80% per annum. The
leasing industry provides about 3% of the capital funds in
the country and has total assets of about Rs. 6 billion.
Notwithstanding this remarkable growth, its 3% contribution
to capital investment is still low compared to the 7% in
some other Asian countries.

Leasing companies are a relatively new phenomenon in

Pakistan, dating to the late 1980s. Leasing provides a
means to finance growth without using normal overdraft
facilities and has the advantage enabling less expense to
be claimed on taxes. Leasing companies have shown steady
progress over the years. The first leasing company was

lviii
listed on the stock exchange in 1985. For the next two
years, no leasing company was floated. Leasing regulations
were being processed, and as such there was a break on
permission for new leasing companies. As a consequence of
the new regulations framed for leasing business, companies
incorporated under the Companies Ordinance 1984, were not
allowed to engage in leasing business. Special permission
had to be sought from the relevant authorities for this
purpose and a minimum capital of Rs. 50 million was made a
pre-requisite for getting the Certificate of Commencement
of Business. As of August 15, 1994, there were 22 leasing
companies listed on the stock exchange. Most of the
Modarabas have also undertaken leasing as their main
business. Recently, local, as well as foreign banks, DFIs
and investment banks have also entered the leasing market.
The Asian Development Bank (ADB) has allowed lines of
credit to five leasing companies. Year-wise listing of
leasing companies is as follows:

Notwithstanding its phenomenal growth, the contribution of

leasing to total investment financing is quite paltry, at
around 3% as against 30% in advanced industrialized
countries.

Leasing has grown quite rapidly over the last five years.
Competition has increased, and presently, there are 22
leasing companies listed on the stock exchange with a total
paid up capital of Rs. 2.04 billion along with several
Modarabas that are engaged in leasing. Although the
industry has become quite competitive, it is still
dominated by 4 large players which represent about three
fourth of the leasing business. These are National
Development Leasing Corporation (NDLC) (30%), First

lix
Grindlays Modaraba (17%), Orix Leasing (14%) and First
B.R.R. Capital Modaraba (11%).

Ijara Wa-Iqtina’ (Hire Purchase)

A hire-purchase agreement is a hiring agreement along with

a condition that at the end of the hire, the lessee will
take ownership of the hired article by purchasing the same.
Such an agreement may be considered as a synthesis of two
contracts i.e. a trading contract and a hiring contract.
The transfer of title depends on the nature of the deal in
respect of payment, either lump sum or by trenches. When
the amount of acquisition value and the agreed rent is paid
in full, the complete ownership is passed on to the hirer.
Given its nature, the hire-purchase mode of financing has
been used primarily for the acquisition of equipment,
machinery, and consumer durables. Since banks cannot
increase the amount of installment to cover losses in the
event of delays in payments, there is room for misuse of
this mode, thus necessitating closer scrutiny of loan
application by banks.

Istisna’a (Turnkey)

It is a form of turnkey contract whereby the bank

undertakes directly or by deputing the client or through a
third party to finance the erection and commissioning of
factories or projects at a fixed cost, including the bank’s
profit. While the bank will pay the price of the equipment,
etc, forthwith, the client will deliver the plant at any
specified date. This can be adopted where an arrangement
already exists for sale of the said plant to the client or
any third party.

3.7) REVIEW OF PROGRESS:

lx
The process of Islamization of the financial system was
initiated in 1979-80, when the specialized credit
institutions in the public sector reoriented their
financial activities toward non-interest bearing
operations. Subsequently, the legal framework of Pakistan’s
financial and corporate system was modified to accommodate
changes necessitated by the planned switchover to an
interest-free system on an economy wide basis. In June
1980, a new financial instrument called Participation Term
Certificate (PTC) was introduced to replace debentures.
These certificates were based on the principle of profit
and lost sharing, aimed at providing medium and long-term
funds for industrial and other financing. Moreover, to
regulate financing on the basis of Modaraba [a contract
between the bank and an agent/manager (Modarib) where the
bank supplies full financing for trading and industrial
purposes and the Modarib contributes in the form of his
work and experience], a comprehensive Modaraba Companies
Ordinance was also promulgated in June 1980.

Anwar Muhammad,(2000)says, In 1981, the operations of

commercial banks were partially brought under the new
system by opening PLS deposit counters. After the
introduction of PLS accounts, banks and financial
institutions had to find ways to use these funds in
interest-free avenues of investment. Banks started with
mark-up pricing as a first step towards eliminating
interest from their advances, while Participation Term
Certificates were introduced to substitute for existing
interest-based capital requirements of their clients on the
basis Musharaka (temporary partnership on profit/loss
sharing basis) for provision of finance to trade and

lxi
industry in the corporate sector on a selective basis. Two
other arrangements, introduced for financing fixed
industrial investment were ‘Leasing’ and ‘Hire-purchase’.
Under the former, a commercial bank or financial
institution rented the equipment to project sponsors for a
given payment over a pre-determined period while under the
latter, the agreed payment included an element for the
acquisition of equity as well as rent. The specific terms
of all three instruments were left to be negotiated freely
between the commercial bank or financial institution and
the project sponsor.

The period 1979 to 1985 saw a fairly active policy on the

part of the government to Islamize the financial system.
The original intention of the government was to eliminate
interest from all domestic banking and financial
transactions within a period of three years beginning from
February 10, 1979. Though this time framework did not prove
practicable, the government seemed to be in earnest to move
speedily towards attaining the goal of an interest free
economy. At first, a parallel system was put in operation
in which savers had the option to keep their savings in
interest bearing or in profit-loss sharing savings media.
In June 1984, it was announced by the government that the
parallel system would end in the course of 1984-85 in as
far as the operations of commercial banks and other
financial institutions were concerned. Accordingly, the
entire assets side of the banks was transformed into non-
interest-based modes of financing, except for past
commitments, which were allowed to run into maturity
according to the original terms of the contract. The other
exception related to lending of foreign loans, which

lxii
continued to be governed by the terms of the loans. New
steps were instituted on January 1, 1985, to formally
transform the banking system over the following six months
to one based on no interest, thereby completing the first
phase of bringing the entire financial system under Islamic
principles. As of that date, all finance provided by banks
to the government, public sector corporations, and public
or private joint stock companies is to be only on the basis
of the specified Islamic (non-interest-bearing) modes of
financing. From July 1, 1985, no banking company was
allowed to accept any interest-bearing deposits except
foreign currency deposits, which continued to earn fixed
interest rate. As of that date, all deposits accepted by a
banking company share in profit and loss of the banking
company, except deposits received in current account on
which no interest or profit is given by the banking company
and whose capital sum is guaranteed.

According to Nawazish,(1987), The picture on the

liabilities side of the banking system has undergone a
comprehensive change since the introduction of interest-
free-banking. Saving and time deposits no longer earn a
fixed return. Banks declare profits, payable on these
deposits at six-monthly intervals based on their operating
results, and these vary from period to period and from bank
to bank. The rates of profit are worked out by a formula
that determines net profit accruing to a bank and allocates
them to the remunerative liabilities according to their
maturities. Allocations are based on different weights
assigned to liabilities according to their relative
maturities. The system has in general been found to be
compatible with Islamic teachings except the fact that

lxiii
profits declared by banks contain a substantial element of
interest. While bank liabilities (other than foreign
currency deposits) are composed of either current account
deposits, on which no profit is distributed by the bank, or
PLS deposits, three broad categories of non-interest modes
of financing by lending, that is, loans not carrying any
interest, on which the banks may recover a service charge,
and also Qarz-e-Hasana (interest-free loans on
compassionate grounds). Second, there is trade-related
financing, including mark-up, purchase of trade bills,
lending on a buy-back basis, leasing, hire purchase, and
financing for development of property on the basis of a
development charge. The State Bank of Pakistan fixes
maximum and minimum rates of charges on these from time to
time. Third, lending can take place under investment
financing, including Musharakah (Partnership), equity
participation and purchase of shares, Participation Term
Certificates, Modaraba Certificates, and rent sharing.
While the State Bank of Pakistan determines the ratio for
sharing profits, losses are proportionately shared among
all the financiers.

Mohsin, (1985),is of the view, Transactions with the

government, however, are still based on interest; moreover,
the government obtains financing through the sale of bonds,
purchase of which b y the private sector is facilitated by
the provision of bank credit at fixed rates. Effective
April 1, 1985, all finance provided to private sector
entities, including individuals, is also limited to the
specified modes. As of July 1, 1985, no banks can accept
any interest bearing deposits, and all existing deposits
become subject to PLS rules. Deposits in current account

lxiv
continue to be accepted as in the past, that is, with no
share in the profit or losses of banks (equivalent to no
interest previously). Foreign currency deposits and loans
from abroad, however, continue to be exempted from the new
regulations. The State Bank of Pakistan specifies broad
ranges of charges for the various modes of lending as
guides for commercial banks. The stress has been on
introducing new modes of financing without, as far as
possible, altering the basic functioning and structure of
the banking system.

There have been no changes in the instruments and

effectiveness of monetary policy; bank supervisory and
regulatory controls have also remained broadly unchanged.
Based on guidelines issued by the State Bank of Pakistan,
commercial banks have modified their procedures and
practices to accommodate the new system.

The first phase of transformation that is, shifting from

interest-based on non-interest-based banking, has been
largely completed without major problems. However, further
shifts toward a system based entirely on PLS principles
(rather than on mark-up), equity participation, and the
absence of guarantees on deposits and loans, will entail
basic changes in the economy and the society ––– changes
that will be time-consuming and difficult to implement.
Important pre-requisites for such a transformation would be
a further deregulation of the banking system and increased
competition, changes in the attitude of banks towards
medium-term and long-term lending, comprehensive retraining
of staff of handle project-type lending operations, reform
of the auditing systems to more accurately determine true
profit levels, establishment of an efficient capital

lxv
market, growth of a secondary financial market including
specialized investment banking institutions, the
establishment of an efficient judicial arbitration system,
and a new legal framework to allow speedy settlement of
disputes and protection for borrowers.

CHAPTER # 4

APPLICATION OF ISLAMIC FINANCING IN

COMMERCIAL BANKS

4.1) PROJECT FINANCING:

The concept of Musharakah and Mudarabah is based on some

basic principles. As long as these principles are fully
complied with, the details of their application may vary
from before touching the details.

1. Financing through Musharakah and Mudarabad does

never mean the advancing of money. It means
participation in the business and in the case of
Mushartakah, sharing in the assets of the business to
the extent of the ratio of financing.

2. An investor/financier must share the loss

incurred by the business to the extent of his
financing.

3. The partners are at liberty to determine, with

mutual consent, the ratio of profit allocated to each
one of them, which may differ form the ratio of

lxvi
 investment. However, the partner who has expressly
excluded himself form the responsibility of work for
the business cannot clam more than the ratio of his
investment.

4. The loss suffered by each partner must be exactly

in the proportion of his investment.

Keeping in view these basic principle project financing is

discussed below

In the case of project financing, the traditional method of

Musharakah or Mudarabad can be easily adopted. If the
financier wants to finance the whole project the form of
Mudarabah can come into operation. If investment comes from
both sides, the form of musharakah can be adopted. In this
while the investment comes from both, a combination of
Musharakah and Mudarabad can be brought into play according
to the rules already discussed. (Nawazish Ali,1987).

According to Fuad_ul_Qmar,(2000), Since Musharakah or

Mudarabad would have been effected from the very inception
of the project, no problem with regard to the valuation of
capital should arise. Similarly the distribution of profits
according tot eh normal accounting standards should not be
difficult. However, if the financier wants to withdraw from
the Musharakah, while the other party wants to continue the
business, the latter can purchase the share shall be
discussed in detail later on (while discussing the
financing of working capital).

4.1.1) FINANCING OF A SINGLE TRANSACTION

According to Fuad_ul_Qmar,(2000), Musharakah and Mudarabad

can be used more easily for financing a single transaction.

lxvii
Apart from fulfilling their day to day needs of small
traders, these instruments can be employed for financing
imports and exports. An importer can approach a financier
to finance him for that single transaction of import alone
on the basis of Musharakah or Mudarabad. The banks can also
use these instruments for import financing. If the letter
of credit has been opened without any marking, the form of
Mudarakah can be adopted and if the L/C is opened with some
margin, the form of Musharakah or a combination of both
will be relevant. After the imported goods are cleared from
the port, their sale proceeds may be shared by the importer
and the financier according to a pre-agreed ratio.

When goods are imported, the ownership of the goods shall

remain with the financier to the extent of the ratio of his
investment. This Musharakah can be restricted to an agreed
term, and if the imported goods are not sold in the market
up to the expiry of the term, the importer may himself
purchase the share of the financier, making himself the
sole owner of the goods. However, the sale in this case
should take place at the market rate or at a price agreed
between the parties on the date of sale, and not at pre-
agreed price at the time of entering into Musharakah. If
the price is pre-agreed the financier cannot compel the
client / importer to purchase it.

Maulana Shafi (1997), was of the view, Musharakah will be

even easier in the case of export financing. The exporter
has a specific order form abroad. The price on which the
goods will be exported is well known before hand, and the
financier can easily calculate the expected profit. He may
finance him on the basis of Musharakah or Mudarabah, and
may share the amount of export bill on a pre-agreed

lxviii
percentage. In order to secure himself form any negligence
on the part of the exporter, the financier may put a
condition that it will be the responsibility of the
exporter to export the goods in full conformity with the
conditions of the L/C. in this case. If some discrepancies
are found, the exporter alone shall be responsible, and the
financier shall be immune from any loss due to such
discrepancies, because it is caused by the negligence of
the exporter. However being a partner of the exporter, the
financier will be liable to bear any loss, which may be
caused due to any reason other than the negligence or
misconduct of the exporter.

4.2) WORKING CAPITAL FINANCING:

According to Maulana mufti, (1997), where finances are

required for the working capital of a running business, the
instrument of Musharakah may be used in the following
manner:

• The capital of the running business may be evaluated

with mutual consent:

• The value of the business can be treated as the

investment of the person who seeks finances his share
of investment. The Musharakah may be affected for a
particular period, like one year or six months or
less. Both the parties agree on a certain percentage
of the profit to be given to the profit to be given to
the financier which should not exceed the percentage
of his investment, because he shall not work for the
business. On the expiry of the term, all liquid and
non-liquid assets of the business are again evaluated,

lxix
 and the profit may be distributed on the basis of this
evaluation.

According to Fuad, (2000), although according to the

traditional concept, the profit cannot be determined unless
all the assets of the business traded as “constructive
liquidation” with mutual consent of the parties, because
there is no specific prohibition in shariah against it. It
can so mean that the working partner has purchased the
share of the financier in the assets of the business, and
the price of his share has been determined on the basis of
valuation keeping in view the for example, the total value
of the business of ‘A’ is 30 units, ‘B’ finances another
20 units, raising the total worth to 50 units, 40% having
been contributed by ‘B’ and 60% by ‘A’. it is agreed that
‘B’ shall get 20% of the actual profit’s t the end of the
term, the total worth of the ‘B’ is purchased to 100 unit.
Now, if the share of ‘B’ is purchased by ‘A’ he should have
paid to him 40 units, because he owns 40% of the assets of
the business. But in order to reflect the agreed ration of
profit in the price of his share, the formula of pricing
will be different. Any increase in the value of the
business shall be divided between the parities in the
ratio of 20% and 80% because this ratio was determined in
the contract for the purpose of disturb action of profit.

Since the increase in the value of the business is 50

units, these 50 units are divided at the ratio of 20:80,
meaning thereby that ‘B’ will have e earned 10 units. These
10 units will be added to his original 20 units, and the
price of this share will be 30 units.

According to Shafi,(1997), In the case of loss, however,

any decrease in the total value of the assets should be

lxx
divided between them exactly in the ratio of their
investment, i.e. in the ratio of 40/60. therefore, if the
value of the business has decreased n the above example, by
10 units reducing the total number of units to 40, the loss
of 4 units shall be borne by ‘B’ (being 40% of the loss).
These 4 unit shall be deducted from his original 20 units
and the price of his share shall be determined as 16 units.

• Sharing in the gross profit only: Financing on the

basic of Musharakah according to the above procedure
may be difficulty in a business having a large number
of fixed assets, particularly in a running industry,
because the valuation of all its assets and their
depreciation or appreciation may create accounting
problems giving rise to deputes. In such cases,
Musharakah may be applied in another way.

According to Dr. Nijat ,(1994), The major difficulties in

these cases arise in the calculation of indirect expenses,
like deprecation of the machinery, salaries of the staff
etc. in order to solve this problem, the parties may agree
on the principle that instead of net profit, the gross
profit will be distributed between the parties, the is the
indirect expense shall not be deducted from the
distributable profit. It will mean that all the indirect
expenses shall be borne by the industrialist voluntarily,
and only direct expenses like these of raw material direct
labor, electricity etc. shall be borne by the Musharakah.
But since the industrialist is offering his machinery,
building and staff to the Musharakah voluntarily, the
percentage of his profit may be increased to compensate him
to some extent.

lxxi
Let us take practical example. Suppose a ginning factory
has a building worth Rs.22 million, plant and machinery
valuing Rs.2 million and the staff is paid Rs.50,000/- per
month. The factory sought finance of Rs.5000,000/- form a
bank on the basis of Musharakah for a term of one year. It
means that after one year the Musharakah will be
terminated, and the profits accrued up to that point will
be distributed between the parties according to the agreed,
ratio. While deterring the profit, all direct expense will
be deducted from the income. The direct expenses may
include the following.

1. The amount spent in purchasing raw material.

2. The wages of the labor directly involved in processing

the raw material.

3. The expense for electricity consumed in the process of

ginning.

4. The bills for other services directly rendered for the

Musharakah.

So far as the building, the machinery and the salary of

other staff is concerned, it is obvious that they are not
meant for the business of the Musharakah alone, because the
Musharakah will terminate within one year, while the
building and the machinery are purchased for a much longer
term in which the ginning factory will use them for its own
business which is not subject to this one year Musharakal.
Therefore the whole cost of the building and the machinery
cannot be borne by this short-term Musharakah. What can be
done at the most is that the depreciations caused to the
building and the machinery during the term of the
Musharakah is included in the expenses.

lxxii
But in practical terms, it will be very difficult to
determine the cost of depreciation and it may cause
disputes also. Therefore there are two practice al ways to
solve this problem.

El– Ashkar,(1987),says, In the first instance, the parties

may agree that the Musharakah portfolio will pay an agreed
rent tot eh client for the use of the machinery and the
building owned by him. This rent will be paid to him form
the Musharkah fund irrespective of profit or loss accruing
to the business.

The second option is that instead of paying rent to the

client, the ratio of his profit is increased.

1. Running Musharakah account on the basis of daily

products: Many financial institutions finance the
working capital of an enterprise by opening a running
account for them from where the clients draw different
amounts at different intervals, but at the same time,
they keep returning their surplus amounts. Thus the
process of debit and credit goes on up to the date of
maturity, and the interest is calculated on the basis
of daily products.

Keeping in view the basic principle of Musharakah the

following procedure may be suggested for this purpose.

• A certain percentage of the actual profit must be

allocated for the management.

• The remaining percentage of the profit must be

allocated for the investors.

• The loss, if nay should be borne by the investors only

in exact proportion of their respective investment.

lxxiii
• The average balance of the contributions made to the
Musharkah account calculated on the biases of daily
products shall be treated as the share capital of the
financier.

• The profit accruing at the end of the term shall

be calculated on daily predict basis and shall be
distrusted accordingly.

Maulana Shafi,(1997),says, If such an arrangement is agreed

upon between the parties, it does not seem to violate any
basic principle of the Musharakah. However this suggestion
needs further consideration and research by the experts of
Islamic jurisprudence. Practically, it mean that the
parties have agreed to the principle that the profit
accrued to the Musharakah portfolio at the end of the term
will be divided on the capital utilized per day, which will
lead to the average of the profit earned by each rupee per
day. The amount of this average profit per rupee per day
will be multiplied by the number of the days each investor
has put his money into the business which will determine
his profit entitlement on daily product basis agreement can
be made. The bank will pay the remaining amount and the
goods that ate being imported will be owned by both of them
according to there share of investment.

4.3) IMPORT FINANCING:

According to Dr. Siddique, (1994), Musharakah can be used

for Import Financing as well. There are two types of bank
charges on the letter of credit provided to the importer:

1. Service charges for opening an LC

2. Interest charged on LCs, which are not opened on full
margin.

lxxiv
Collecting service charges for this purpose is allowed, but
as interest cannot be charged in any case, experts have
proposed two methods for financing Lca.

1. Based on Musharakah / Mudarabah

2. Based on Murabahah

4.3.1) Musharakah / Mudarabah:

This is the best substitute for opening the LC. The bank
and the importer can make an agreement of Mudarabah or
Musharakah before opening the LC.

If the LC is being opened at zero margin then an agreement

of Mudarabah can be made, in which the bank will become
Rqb-ul-Maal and the importer Mudarib. The bank will own the
goods that are being imported and the profit will be
distributed according to the agreement.

If the LC is being opened a margin then a Musharakah

agreement can be made. The bank will pay the remaining
amount and the goods that are being imported will be owned
by both of them according to their share of investment.

The bank and importer, with their mutual consent can also
include a condition in the agreement, whereby: Musharakah
or Mudarabah will end after a certains time period even if
the goods are not sold. In such a case, the importer will
purchase the bank’s share at the market price.

4.3.2) Murabahah:

At present Islamic banks are using Murabahah, to finance

LC. These banks themselves import the required goods and
then sell these goods to the importer on Murabahah
agreement.

lxxv
Murabahah financing requires the bank and the importer to
sign at least two agreements separately; one for the
purchase of the goods, and the other for appointing the
importer as the agent of the bank (agency agreement). Once
these two agreements are signed, the importer can negotiate
and finalize all terms and condition with the exporter on
behalf of the bank.

4.4) EXPORT FINANCING:

According to El– Ashkar,(1987), A bank plays two very

important roles in Exports. It acts as a negotiating bank
and charges a fee for this purpose, which is allowed in
shariah. Secondly it provides export-financing facility to
the exporters and charge interest on this service.

These services are of two types

1. Pre shipment financing

2. Post shipment financing

As interest cannot be charge in any case, experts have

proposed certain methods for financing exports.

Pre Shipment Financing

The most appropriate method for financing exports is

Musharakah or Mudarabah. Bank and exporter can make an
agreement of Mudarabah provided that the exporter is not
investing; other wise Musharakah agreement can be made.
Agreement in such case will be easy, as cost and expected
profit is known.

The exporter will manufacture or purchase goods and the

profit obtained by exporting it will be distributed between
them according to the predefined ration.

lxxvi
A problem that can be encountered by the bank is that if
the exporter is not able to deliver the goods according to
the terms and conditions of the importer, then the importer
can refuse to accept the goods, and in this case exporter’s
bank will ultimately suffer. This problem can be ratified
by including a condition in Mudarabah or Musharakah
agreement that, if exporter violates the terms and
conditions of import agreement then the Bank will not be
responsible for any loss which arises due to this
negligence. This condition is allowed in Shariah as the
Rabb-ul-mal is not responsible for any loss that arises due
to the negligence of Mudarib.

Murabahah

Murabahah is being used in many Islamic Banks for export

financing. Banks purchases goods that are to be exported at
price that is less than the price agreed between the
exporter and the importer. It then exports goods at the
original price and thus earns profit.

Muhabahah financing requires bank and exporter to sign at

least two agreements separately, one for the purchase of
goods and the other for appointing the exporter as the
agent of the bank (that is agency agreement). Once these
two agreements are signed, the exporter can negotiate and
finalize all the terms and conditions with the importer on
behalf of the bank.

Post Shipment Financing

Post shipment finance is similar to the discounting of the

bill of exchange. Its alternate Shariah compliant procedure
is discussed below:

lxxvii
Ahsan Ali (1996) was of the view, that the exporter with
the bill of exchange can appoint the bank as his agent to
collect receivable on his behalf. The bank can charge a fee
for this service and can provide interest free loan to the
exporter, which is equal to the amount of the bill, and the
exporter will give his consent to the bank that is can keep
the amount revived from the bill as a payment of the loan.

Here two processes are separated, and thus two agreements

will be made. One will authorize the bank to collect the
loan on his behalf as an agent, for which he will charge a
particular fee. The second agreement will provide interest
freeloan to the exporter, and authorize the bank for
keeping the amount received through bill as a payment for
loan.

These agreements are correct and allowed according to

Shariah because collecting fee for service and giving
interest free loan is permissible.

lxxviii
CHAPTER # 5

PRESENTATION OF RESEARCH AND ANALYSIS OF

QUESTIONAIRE.
This chapter is based on the research conducted to know the
opinion of selected persons on different aspects of the
interest free and interest based banking. The survey
respondents were bankers, businessmen, informed persons,
and religious scholars. They were interviewed through
questionnaire their response have been reported and
discussed in this chapter, question by question.

5.1) VIEWS ON INTEREST BASED AND INTEREST FREE BANKING:

The first question inquired into the preference of the

respondents about interest free based banking system as in
Table 5.1. As many as 92.9% respondents favored interest
free banking system, 3.6% respondent were not clear and
sure, and only 3.6% favored interest based banking system.

lxxix
TABLE 5.1
Views on people response on Interest Based and Interest
Free Banking
Favor Favor No
Respondents interest interest response Total
Category based free Not sure Responden
# % # % # % ts
#
1. Bankers 1 14.3 5 71.4 1 14. 7
3
2. Businessmen 0 0 7 100 0 0 7
3. Other informed 0 0 7 100 0 0 7
person
4. Religious 0 0 7 100 0 0 7
Scholars
Total 1 3.6% 26 92.8 1 3.6 28
Figure: 5.1

Interest Based & Interest Free Banking

100 93

80

60
40

20 4 4
0
Favor interest based Favor interest free No response Not
sure

lxxx
Mostly people favored IFB system because of their faith and
belief without any concrete reason, as per their religions
believes. It is established that respondent’s hold firm
believe in Islamic mode of financing due to religion
factor. They belief in this system, that it is fair.

5.2) VIEWS ON GOP SHOULD INTRODUCE INTEREST FREE

BANKING:

The vast majority of respondents 92.6% suggested that the

govt. of Pakistan should introduce interest free banking
system while 3.5% were not in favor of this system and rest
of 3.6% kept their response reserved.

TABLE 5.2

Respondents Views on GOP should Introduce Interest Free

Banking

Yes No Not
Respondents Sure Total
Category Respondents
# % # % # %
1. Bankers 5 71.4 1 14.3 1 14. 7
3
2. Businessmen 7 100 0 0 0 0 7
3. Other informed 7 100 0 0 0 0 7
person
4. Religious 7 100 0 0 0 0 7
Scholars
Total 26 92.6 1 3.6 1 3.6 28

lxxxi
Figure: 5.2

GOP should introduce interest free

banking
4.0% 4.0%

Yes
No
Not Sure

93.0%

An important aspect which has emerged from current study

was that laws and regulations are present, and Supreme
Court of Pakistan has already given its ruling regarding
that. But the Government is reluctant. The Government
should slowly and gradually implement it.

5.3) VIEWS ON GOVERNMENT EFFORTS:

The respondents were asked whether Government efforts so
far made are upto the mark or not Maximum of the
respondents expressed their views indicating that the
Government efforts about introducing interest free banking
system are not satisfactory. Table 5.3 and the chart
clearly describe that 89.3% respondents are not satisfied
with the efforts and only 7.1% are of the opposite view
while 3.6% have no idea about Government efforts.

lxxxii
TABLE 5.3
Views on Govt. Efforts

Respondents Yes No No Total

Category response Responde
/ idea nts
# % # % # %

1. Bankers 0 0 7 100 0 0 7
2. Businessmen 1 14.3 6 85.7 0 0 7
3. Other 1 14.3 6 85.7 0 0 7
informed person
4.Religious 0 0 6 100 1 14.3 7
Scholars
Total 2 7.1 25 89.3 1 3.6 28

Figure: 5.3
GOP should introduce interest free
banking
3.6 7.1

Yes
No
No response / idea

89.3

Here once again people expressed Government efforts that

the Government is just doing lip service and no serious
efforts are in progress as people see no solid/concrete
form. According to their views, Government is divided over

lxxxiii
this issue because some minds are of capitalist thinking
and are slaves of the west.

5.4) VIEWS ON THE PROPOSITION THAT “IFB ENSURES

ECONOMIC JUSTICE”

As per 5.4 “IFB ensures economic justice in the country and

society,” As many as 89.3% of the respondents says that the
proposition was right as where 7.1% did not agree with the
view and 3.6% were not sure on it.

It is established that IFB is one of the factors that

ensure economic justice, as proper distribution of wealth
is done. So it creates economic justice.

Islam accepts the basic system of market economy, like

right of innate ownership, freedom of enterprise and the
competitive environment of business and industry. The Holy
Prophet (Peace be upon him) is reported to have allowed the
competitive price mechanism to balance the demand and
supply of goods for efficient allocation of resources. The
limitations are only to take care of some moral, religious
and cultural perceptions that give a place to the state to
ensure the desired norms. Such limitations are necessary
for Islamic Shariah.

lxxxiv
TABLE 5.4
Views on the proposition that “IFB Ensures Economic
Justice”

Respondents Agree Don’t Not

Category agree Sure Total
Respondents
# % # % # %
1. Bankers 5 71.4 1 14. 1 14. 7
3 3
2. Businessmen 7 100 0 0 0 0 7
3. Other informed 7 100 0 0 0 0 7
person
4. Religious 6 85.7 1 14. 0 0 7
Scholars 3
Total 25 89.3 2 7.1 1 3.6 28

Figure: 5.4

Views on the proposition that IFB Ensures

Economic Justice
7.10% 3.60%

Agree
89.30% Don’t-Agree
Not Sure

lxxxv
5.5) VIEWS ON WHETHER REFORMS IN ISLAMIC BANKING SECTOR
ARE SUFFICIENT

It is generally held that Government has been trying for

introduction of an interest free banking system.
Respondents were give their views that, 57.1% subjects were
not satisfied with the sufficiency of these reforms. Only
3.6% subject expressed their satisfaction while 39.3%
respondents were not sure whether these reforms are
sufficient or not sufficient.

TABLE 5.5
Views on “Reforms in Islamic Banking Sector are
Sufficient”
Respondents Agree Don’t Not Total
Category agree Sure Responden
# % # % # % ts
1. Bankers 1 14. 3 42.9 3 42.9 7
3
2. Businessmen 0 0 3 42.9 4 57.1 7
3. Other informed 0 0 5 71.4 2 28.6 7
person
4. Religious 0 0 5 71.4 2 28.6 7
Scholars
Total 1 3.6 16 57.1 11 39.3 28

lxxxvi
Figure: 5.5
Views on Reforms in Islamic Banking Sector
are Sufficient

39.30% 3.60%

Agree
Don’t-Agree
57.10%
Not Sure

it is established that Government create awareness in

public by using media about Islamization of banks.

5.6) VIEWS ON MIXED BANKING OR PARALLEL SYSTEM NEEDS

IMPROVEMENT AND IFB SHOULD BE FACILITATED:

as in table 5.6, as many as 71.4% subjects were in favor of

converting existing system into an interest fee banking
system, 7.1%, were against it and 21.4% subjects were not
sure about mixed banking improvements.

lxxxvii
TABLE 5.6

Views on “Mixed Banking Needs Improvement and IFB

should be facilitated”

Respondents Agree Don’t Not

Category agree Sure Total
Respondents
# % # % # %
1. Bankers 5 71.4 2 28. 0 0 7
6
2. Businessmen 6 85.4 0 0 1 14. 7
3
3. Other informed 6 85.7 0 0 1 14. 7
person 3
4. Religious 3 42.6 0 0 4 57. 7
Scholars 1
Total 20 71.4 2 7.1 6 21. 28
4

Figure: 5.6

Views on“Mixed Banking Needs Improvement and IFB

should be facilitated
21.40%

7.10%

Agree
Don’t-Agree
71.40%
Not Sure

lxxxviii
5.7) VIEWS ON CONVERSION OF EXISTING STRUCTURE INTO
IFB.

The respondents were asked whether in their view the

existing structure can be converted into IFB views but no
clear majority opposed or favored it, However, relatively a
large number of respondents, accounting for 46.4% of the
total did not support this proposition. As where 42.6% were
of the view that existing structure can be converted into
IFB system, while 10.7% are strictly against IFB system and
they are of the view that this structure cant be converted
into IFB system. 57% Bankers who were the main opponents of
this system are not sure whether existing structure can be
converted into IFB system or can not be converted.

TABLE 5.7
Views on Existing Structure Can be Converted into
IFB

Respondents Yes No Not Total

Category Sure Respondents
# % # % # %
1. Bankers 1 14. 2 28. 4 57. 7
3 6 1
2. Businessmen 5 71. 0 0 2 28. 7
4 6
3. Other informed 4 57. 0 0 3 42. 7
person 1 6
4. Religious 2 28. 1 14. 4 57. 7
Scholars 6 3 1
Total 12 42. 3 10. 13 46. 28
6 7 4

Figure: 5.7

lxxxix
 Views on Existing Structure Can be Converted into IFB

46.40%
42.60%

Yes
No
10.70% Not Sure

5.8) VIEWS ON “TWO PARALLEL SYSTEMS SHOULD RUN AT THE

SAME TIME”

xc
Most of the respondents (71.4%) indicated that it would not
be possible or feasible to run two parallel systems i.e.,
interest free and interest based banking system while 28.6%
subjects were of the opinion that two parallel systems
could run at the same time table 5.8.

TABLE 5.8

Two Parallel Systems should run at the same time

Respondents Yes No Total
Category # % # % Respondents
1. Bankers 3 42.6 4 57. 7
1
2. Businessmen 2 28.6 5 71. 7
4
3. Other informed 1 14.3 6 85. 7
person 7
4. Religious 2 28.6 5 71. 7
Scholars 4
Total 8 28.6 20 71. 28
4

Figure: 5.8

Two Parallel Systems should run at the same time

28.60%

Yes
71.40%
No

xci
5.9) PREFERENCE OF INTEREST FREE BANK AS A CLIENT

96.4% of the respondents opted to be the clients of an

interest free bank and only 3.6% opted for interest based
banking system.

This factor is very encouraging for IFB system banks that

the overwhelming portion of public belonging to different
segments of the society prefer to be clients of the IFB
(Interest Free Bank). So interest free banks can attract
large portion of deposits and can launch different schemes.

TABLE 5.9

Preference of Interest Free Bank as a Client

Respondents Yes No Total
Category # % # % Respondents
1. Bankers 6 85.7 1 14. 7
3
2. Businessmen 7 100 0 0 7
3. Other informed 7 100 0 0 7
person
4. Religious 7 100 0 0 7
Scholars
Total 27 96.4 1 3.6 28

xcii
Figure: 5.9

Preference of Interest Free Bank as a Client

3.60%

Yes

No

96.40%

5.1O) PREFERENCE FOR IFB FOR EMPLOYMENT

Most of the respondents 78.6%, prefered to become employees

of the interest free bank (IFB). The remaining 21.4% did
not want to become employees of interest free bank as they
were having good career of their own and were satisfied
with their work.

TABLE-5.10
Preference for IFB for Employment
Respondents Yes No Total
Category # % # % Respondents
1. Bankers 6 85.7 1 14.3 7
2. Businessmen 6 85.7 1 14.3 7
3. Other informed 5 71.4 2 28.6 7
person
4. Religious 5 71.4 2 28.6 7
Scholars
Total 22 78.6 6 21.4 28

xciii
Figure: 5.10

Preference for IFB for Employment

21.40%

Yes

No
78.60%

It is established thatEncouraging factor for interest free

banks are that they can get employees from a large pool of
candidates available to join and to be part of the interest
free banks. So they can get qualified people for their
bank, who will run interest free bank effectively and
efficiently.

xciv
5.11) IMPACT OF INTEREST FREE BANKING ON BUSINESSES
(SMALL, MEDIUM, AND LARGE)

In this respect, impact of interest free banking is

ascertained on small, medium and big businesses
respectively. Most of the respondents are of view that
interest free banking create positive impact on all these
businesses and in return the economy of the country will
get benefit. (Small business 67.9%, medium 64.3% & big
60.7% positive impact as is clear Table 5.11).

The second largest proportion of subjects belongs to not

sure or no idea category; 28.6%, small, 35.7%medium and
35.7% big/large businesses in turnover, have no idea
whether this will have positive or negative impact on
businesses. And only 3.6% in small businesses, 0% in medium
businesses and 3.6% in large businesses were of the view
that it will have negative impact on businesses, which is
very less portion of respondents.

xcv
 TABLE 5.11
Respondents view on Impact of IFB on Businesses (Small, Medium, Big).
Respondents Total Small Businesses Medium Businesses Large Businesses
Category Respondent
s
Positi Negativ Not Positiv Negativ Not Positiv Negati Not
ve e sure e e Sure e ve Sure
Impact Impact Impact Impact Impact Impact
# % # % # % # % # % # % # % # % # %
1. Bankers 7 6 85. 1 14. 0 0 5 71. 0 0 2 28. 5 71. 0 0 2 28.
7 3 4 6 4 6
2. Businessmen 7 4 57. 0 0 3 42. 4 57. 0 0 3 42. 3 42. 1 14. 3 42.
1 9 1 9 9 3 9
3. Other 7 5 71. 0 0 2 28. 5 71. 0 0 2 28. 5 71. 0 0 2 28.
Informed 4 6 4 6 4 6
Persons
4. Religious 7 4 57. 0 0 3 42. 4 57. 0 0 3 42. 4 57. 0 0 3 42.
Scholars 1 9 1 9 1 9
Total 28 1 67. 1 3.6 8 28. 18 64. 0 0 10 35. 17 60. 1 3.6 1 35.
9 9 6 3 7 7 0 7
Figure-5.11

Impact on IFB on large business

36%

60%
4%
positive impact
negative impact
not sure
5.12) RESPONDENT VIEWS ON MORE FINANCIAL PRODUCTS
NECESSARY TO BE INTRODUCED

When the respondents were asked whether more financial

products of IFB need to be introduced, 53.6% of the
respondents said. Yes while 32.1% of the subjects said No.
the remaining 14.3% were not sure whether more products are
necessary or not asked; Table 5.12.

TABLE 5.12
Respondent views on more financial products necessary
to be introduced

Respondents Yes No Not Tot

category Sure al
# % # % # %
1. Bankers 3 42.9 2 28.6 2 28. 7
6
2. Businessmen 3 42.9 2 28.6 2 28. 7
6
3. Other informed 6 85.7 1 14.3 0 0 7
Persons
4. Religious 3 42.9 4 57.1 0 0 7
Scholars
Total 15 53.6 9 32.2 4 14. 28
3

Figure: 5.12

Respondent views on more financial products

necessary to be introduced

14.30%

Yes

32.20% No
53.60%
Not Sure
 In 5.12 results, Views of respondents that how credit
under interest free banking will be backed. In this
question almost all of the respondents said that in Islam
trust is the main thing on the basis of which loan will be
repaid by the businessmen and they will not show losses. So
the banks should finances the business which maintains
proper accounts and have enough collateral. One thing
more, management participation, which is key component,
is essential and shows surety that credit will be
backed.

5.13) IFB CAN TACKLE THE INFLATION FACTOR

In question regarding inflation factor, it was found that

64.3% of the subjects were not sure whether interest free
banking system can tackle the inflation factor or not.
Because they are of view that only economist know about
this sure. 32.1% of the respondents defended that IFB can
tackle the inflation factor, only research is essential to
completely get rid of it or handle it while 3.6% are of
view that interest free banking system can handle inflation
factor.
TABLE 5.13

IFB can Tackle the Inflation Factor

Respondents Yes No Not Sure To

ta
# % # % # %
l
1. Bankers 2 28.6 1 14.3 4 57.1 7

2. Businessmen 1 14.3 0 0 6 85.7 7

3. Other informed 2 28.6 0 0 5 71.4 7
Persons
4. Religious 4 57.1 0 0 3 42.6 7
Scholars
Total 9 32.1 1 3.6 8 64.3 28
Figure: 5.13

IFB can Tackle the Inflation Factor

64.30% 32.10%

Yes

No
3.60%
Not Sure

5.14) RESPONDENTS VIEW ON WHETHER ISLAMIC BANKING

SYSTEM CALLED TO BE IFB.

A question was asked to know about the respondent opinion

about the appropriate term / name of Islamic banking
whether it should be called Islamic banking or interest
free banking or some other name should be given to it. Most
of the respondents (64.3%) were not sure that what is
offered as Islamic banking or where interest free banking,
25%of the respondents agreed while 10.7% didn’t agreed to
it.

Islamic banking in Pakistan is actually a change management

issue and is being handled as a religious and a legal
issue. There is tremendous need for this type of banking
both at the micro and the macro level. If people don’t
handle it appropriately people would lose a major
opportunity and an important need of the people.

All Pakistanis have to brand the Islamic banking as

business banking because if the proposed system is a
balanced banking system there why is it branded as Islamic
banking?

TABLE 5.14

Respondents view on whether Islamic banking offered is

IFB

Respondents Yes No Not Sure Tot

al
# % # % # %

1. Bankers 2 28.6 0 0 5 71.4 7

2. Businessmen 2 28.6 1 14.3 4 57.1 7
3. Other informed 2 28.6 1 14.3 4 57.1 7
Persons
4. Religious 1 14.3 1 14.3 5 71.4 7
Scholars
Total 7 25 3 10.7 18 64.3 28
Figure: 5.14

Respondents view on whether Islamic banking

offered is IFB

64.30% 25.00%

Yes

No
10.70%
Not Sure

It is perceived that only Islam prohibits interest,

therefore, any banking that does not allow interest-based
contracts is Islamic banking. But the belief that only
Islam prohibits interest is incorrect. In fact Judaism and
Christianity also prohibit interest.

By calling it Islamic banking it not only has to explain

the shortcomings of interest based banking but it also has
to explain the assumptions of Islam as religion.

Solution for this is that we should call it business

banking. The brand business banking is short, easily
pronounceable, easy to remember, and most importantly,
explains the nature of the product well in terms of its
unique selling proposition.

This branding strategy will also enable us to position it

as a functionally viable banking because any banking
system. That supports business is considered functional.
With such positioning the proposed system gets removed from
the religious platform and is positioned on the business
platform.

CHAPTER # 6

CONCLUSION AND RECCOMENDATIONS

The preceding discussion makes it clear that Islamic
banking is not a negligible or merely temporary phenomenon.
Islamic banks are here to stay and there are signs that
they will continue to grow and expand. Even if one does not
subscribe to the Islamic injunctions against the
institution of interest, one may find in Islamic banking
some innovative ideas, which could add more variety to the
existing financial network.

Results of the survey indicate that people do prefer and

desire for interest free banking system, and have no
specific complaints about such a system. It is possible to
motivate the general public and introduce interest free
banking system with high possibility of success in the
future. Government efforts might be highly appreciated and
would enhance the level of satisfaction of the public.

With sufficient efforts and training the existing system

can be converted into interest free banking system. If
impossible to do so at once, government may take gradual
steps to interest free banking system.

Interest free system is more economical benefited. Every

person was involved in profit and loss .

One of the main selling points of Islamic banking, at least

in theory, is that, unlike conventional banking, it is
concerned about the viability of the project and the
profitability of the operation but not the size of the
collateral. Islamic banks on a profit-sharing basis would
finance good projects, which might be turned down, by
conventional banks for lack of collateral. It is especially
in this sense that Islamic banks can play a catalytic role
in stimulating economic development. In practice, however,
Islamic banks have been concentrating on short-term trade
finance which is the least risky.

Part of the explanation is that long-term financing

requires expertise which is not always available. Another
reason is that there are no back-up institutional
structures such as secondary capital markets for Islamic
financial instruments. It is possible also that the
tendency to concentrate on short-term financing reflects
the early years of operation: it is easier to administer,
less risky, and the returns are quicker. The banks may
learn to pay more attention to equity financing, as they
grow older.

Islamic banks tend to behave as though they had a captive

market in the Muslim masses who will come to them on
religious grounds. Many Muslims find it more convenient to
deal with conventional banks and have no problem about
shifting their deposits between Islamic banks and
conventional ones depending on which bank offers a better
return. This might suggest a case for more Islamic banks in
those countries as it would force the banks to be more
innovative and competitive. Another solution would be to
allow the conventional banks to undertake equity financing
and/or to operate Islamic 'counters' or 'windows', subject
to strict compliance with the Shariah rules. There is need
for specialized Islamic financial institutions such as
mudaraba banks, murabaha banks and Musharika banks which
would compete with one another to provide the best possible
services.
 GLOSSARY

• Al-Wadiah Safe Keeping

• Bai'muajjal Deferred-Payment Sale

• Bai'salam Pre-Paid Purchase

• Baitul Mal Treasury

• Fiqh Jurisprudence

• Hadith Prophet's Commentary on Qur'an

• Hajj Pilgrimage

• Halal Lawful

• Haram Unlawful

• Ijara Leasing

• Iman Faith

• Mithl Like

• Mudaraba Profit-Sharing

• Mudarib Entrepreneur-Borrower

• Muqarada Mudaraba

• Murabaha Cost-Plus Or Mark-Up

• Musharaka Equity Participation

• Qard Hasan Benevolent Loan (Interest Free)

• Qirad Mudaraba

• Rabbul-Mal Owner Of Capital

• Riba Interest
• Shariah Islamic Law

• Shirka Musharaka
 BIBLIOGRAPHY

a) The Council of Islamic Ideology, June 1980, ‘Report on

Elimination of Interest from the Economy’ Government
of Pakistan;.

b) Anwar Muhammad, 2000; ‘Islamicity of Banking and

Modes of Islamic Banking’, International Islamic
University, Malaysia.

c) Ayub Muhammad, Dec. 2002, “Islamic Banking and

Finance Theory and Practice’, 1st Edition, State Bank
of Pakistan Karachi.

d) Saddiqi H. Asrar, 1993, ‘Practice and Law Banking

in Pakistan’, 5th Edition. Laureate Packages, Karachi.

e) BBC News South Asia September, 2002,

www.bbcnews.com.

f) The News (March 2007),

g) 2007-08, Economist magazine.

h) Hasan, June, 2007, “business journal”.

i) AL QURAN, Chapters 2,3 and 4.

j) Asif Jamshed shah, 1995, strategic issues in

Islamic banking, chairman, bank of Punjab.

k) Imran Ahmed Khan, 1995, concept of riba and

Islamic banking, Niazi publications.

l) Dr. Nijat ullah Siddique, 1994, banking without

interest, Islamic publications.

m) Oxford advanced dictionary.

n) El– Ashkar, 1987, Islamic banking.

o) Encyclopedia American, International

Edition,1999.

p) Muhammad akram khan, 1992, Islamic banking in

Pakistan, Islamic education congress.

q) Maulana mufti shafi,1997, Issues of interest

including commercial interest, urdu bazaar Karachi.

r) Nawazish ali zaidi,1987, Eliminating interest

from banks in Pakistan, Royal book company.

s) Justice(Rtd) qadeeruddin ahmed, 1994, what is

riba, Salimco printer Karachi.

t) Fuad_ul_Qmar, 2000, Islamic banking(theory and

practice), Zed books,UK.

u) Mohsin Khan,1985, Journal of Monetary Economics,

Islamic Interest Free Banking.

v) Ahsan Ali,1996, Socio-Economic Rationale for

Interest-Free Financing and Certain Conceptual.

w) Kotz,1978.

x) Galbraith,1975.
 QUESTIONNAIRE

A research on application of Islamic financing in

commercial banks is in progress and your valued opinion is
required for this. So kindly fill it up and return it in
time.

Thanks in advance for your cooperation.

Name: ………………………….……. Age: ……………………………

Educational Qualification: ………………….

Occupation: ……………………

1. Do you prefer interest based banking or interest free

banking?

Interest Based No Yes

Why?…………………………………………………………………..
…………………………………………………………………………………………………………………………………………
…………………

a) Interest free No Yes

Why?
……………………………………………………………………………………………………………………………………….

2. If yes to Q1 (b) do you recommend that Government of

Pakistan should introduce interest free banking system
in whole of Pakistan and How?

3. Government efforts made so far for interest free

banking is satisfactory?
 Agree Don’t Agree Not Sure
Please elaborate
……………………………………………………………………………………………………………………………………….

4. Interest free banking ensures economic justice in the

country?

Agree Don’t Agree

Why: ………………………………………………………………………

5. Present Islamic reforms in banking are sufficient?

No Yes Not Sure

6. Existing mixed banking system needs to be improved and
complete interest free banking should be facilitated?

No Yes Not Sure

7. The existing structure can be converted into interest
free banking system?

No Yes Not Sure

8. Two parallel systems i.e., interest free and interest
based banking should run at the same time?

No Yes
9. If you have the opportunity to choose bank, as a
client, will you prefer to become client of interest
free bank?

No Yes
10. If you have the opportunity to choose bank as an
employee, will you prefer to become employee of
interest free bank?

No Yes
11. What impact the Islamic financing will have on small
businesses (Having turnover less than Rs.5 Million?

______________________________________________________
______________________________________________________
______

12. If you Favor IFB (Interest Free Banking) do you think

more financial products are necessary to be introduced
into the financial market.

No Yes

If Yes, what kind of products?

______________________________________________________
______________________________________________________
____________

13. Under IFB how it will be ensured that loan will be

returned back by businessmen as they show losses.
______________________________________________________
______________________________________________________
____________

14. Under IFB how inflation factor will be tackled.

______________________________________________________
______________________________________________________
____________

15. Do you think that what is being offered, as Islamic

Banking is not Islamic Banking but Interest Free
Banking?

No Yes Not sure

16. Please comment/ give your views on any aspect of the
IFB, not covered by afore stated questions, but which
are important in your opinion.
______________________________________________________
______________________________________________________
____________