Working With Islamic

Finance
Islamic finance refers to the means by which
corporations in the Muslim world, including banks and
other lending institutions, raise capital in accordance with
Sharia, or Islamic law. It also refers to the types of
investments that are permissible under this form of law. A
unique form of socially responsible investment, Islam
makes no division between the spiritual and the secular,
hence its reach into the domain of financial matters.
Because this sub-branch of finance is a burgeoning field,
in this article we will offer an overview to serve as the
basis of knowledge or for further study.
The Big Picture
Although they have been mandated since the beginnings
of Islam in the seventh century, Islamic banking and
finance have been formalized gradually since the late
1960s, coincident with and in response to tremendous oil
wealth which, fueled renewed interest in and demand for
Sharia-compliant products and practice.

Central to Islamic banking and finance is an

understanding of the importance of risk sharing as part
of raising capital and the avoidance of riba (usury)
and gharar (risk or uncertainty). (To see more on risk,
read Determining Risk And The Risk
Pyramid and Personalizing Risk Tolerance.)
Islamic law views lending with interest payments as a
relationship that favors the lender, who charges interest
at the expense of the borrower. Because Islamic law
views money as a measuring tool for value and not an
'asset' in itself, it requires that one should not be able to
receive income from money (for example, interest or
anything that has the genus of money) alone.
Deemed riba (literally an increase or growth), such
practice is proscribed under Islamic law (haram, which
means prohibited) as it is considered usurious and
exploitative. By contrast, Islamic banking exists to further
the socio-economic goals of Islam.
Accordingly, Sharia-compliant finance (halal, which
means permitted) consists of profit banking in which the
financial institution shares in the profit and loss of the
enterprise that it underwrites. Of equal importance is the
concept of gharar. Defined as risk or uncertainty, in a

financial context it refers to the sale of items whose

existence is not certain. Examples of gharar would be
forms of insurance, such as the purchase of premiums to
insure against something that may or may not occur
or derivatives used to hedge against possible outcomes.
(To read more about insurance or hedges, see A
Beginner's Guide To Hedging, Understand Your
Insurance Contract andExploring Advanced Insurance
Contract Fundamentals.)
The equity financing of companies is permissible, as long
as those companies are not engaged in restricted types
of business - such as the production of alcohol,
pornography or weaponry - and only certain financial
ratios meet specified guidelines.
Basic Financing Arrangements
Below is a brief overview of permissible financing
arrangements often encountered in Islamic finance:
1. Profit-and-loss sharing contracts (mudarabah).
The Islamic bank pools investors' money and
assumes a share of the profits and losses. This is
agreed upon with the depositors. What does the
bank invest in? A group ofmutual funds screened for

Sharia compliance has arisen. The filter parses

company balance sheets to determine whether any
sources of income to the corporation are prohibited
(for example, if the company is holding too much
debt) or if the company is engaged in prohibited
lines of business. In addition to actively
managed mutual funds, passive ones exist as well
based on such indexes as the Dow Jones Islamic
Market Index and the FTSE Global Islamic Index.
(To find out more about reading company balance
sheets to determine debt, see Reading The Balance
Sheet, Breaking Down The Balance
Sheet and Uncovering Hidden Debt.)
2. Partnership and joint stock
ownership (musharakah). Three such structures are
most common:
a. Declining-Balance Shared Equity: Commonly used
to finance a home purchase, the declining balance
method calls for the bank and the investor to purchase
the home jointly, with the institutional investor gradually
transferring its portion of the equity in the home to the
individual homeowner, whose payments constitute the
homeowner's equity.

b. Lease-to-Own: This arrangement is similar to the

declining balance one described above, except that the
financial institution puts up most, if not all, of the money
for the house and agrees on arrangements with the
homeowner to sell the house to him at the end of a fixed
term. A portion of every payment goes toward the lease
and the balance toward the purchase price of the home.
c. Installment (Cost-Plus) Sale (murabaha): This is an
action where an intermediary buys the home with free
and clear title to it. The intermediary investor then agrees
on a sale price with the prospective buyer; this price
includes some profit. The purchase may be made
outright (lump sum) or through a series of deferred
(installment) payments. This credit sale is an acceptable
form of finance and is not to be confused with an
interest-bearing loan.
3. Leasing ('ijarah/'ijar): The sale of the right to use an
object (usufruct) for a specific time period. One
condition is that the lessor must own the leased
object for the duration of the lease. A variation on
the lease, 'ijarah wa 'iqtina provides for a lease to be
written whereby the lessor agrees to sell the leased
object at the lease's end at a predetermined residual

value. Only the lessor is bound by this promise.

The lessee, by contrast, is not obligated to
purchasing the item.
4. Islamic Forwards (salam and 'istisna): These are
rare forms of financing, used for certain types of
business. These are an exception to gharar. The
price for the item is prepaid and the item is delivered
at a definite point in the future. Because there is a
host of conditions to be met to render such contracts
valid, the help of an Islamic legal advisor is usually
required.
Basic Investment Vehicles
Here are some permissible types of investment for
Islamic investing:
1. Equities. Sharia law allows investment in company
shares (common stock) as long as those companies
do not engage in lending, gambling or the production
of alcohol, tobacco, weaponry or pornography.
Investment in companies may be in shares or by
direct investment (private equity). Islamic scholars
have made some concessions on permissible
companies, as most use debt either to address

liquidity shortages (they borrow) or to invest excess

cash (interest-bearing instruments). One set of filters
excludes companies that hold interest-bearing debt,
receive interest or other impure income or trade
debts for more than their face values. A further
distillation of the aforementioned screens would
exclude companies whose debt/total asset ratio
equals or exceeds 33%; companies with "impure
plus non-operating interest income" revenue equal to
or greater than 5% or companies whose accounts
receivable/total assets equal or exceed 45% or
more.
2. Fixed-Income Funds.
a. Retirement Investments. Retirees who want
their investments to comply with the tenets of
Islam face a dilemma in that fixedincome investments include riba, which is
forbidden. Therefore, specific types of
investment in real estate, either directly or
in securitized fashion (a diversified real estate
fund), could provide steady retirement income
while not running afoul of Sharia law.

b. Sukuk. In a typical ijara sukuk (leasing bondequivalent), the issuer will sell the financial
certificate to an investor group, who will own
them before renting them back to the issuer in
exchange for a predetermined rental return. Like
the interest rate on a conventional bond, the
rental return may be a fixed or floating rate
pegged to a benchmark, such as LIBOR. The
issuer makes a binding promise to buy back the
bonds at a future date at par value. Special
purpose vehicles (SPV) are often set up to act
as intermediaries in the transaction.
A sukuk may be a new borrowing, or it may be
the Sharia-compliant replacement of a
conventional bond issue. The issue may even
enjoy liquidity through listing on local, regional
or global exchanges according to an article in
CFA Magazine titled "Islamic Finance: How New
Practitioners of Islamic Finance are Mixing
Theology and Modern Investment Theory"
(2005).
Basic Insurance Vehicles
Traditional insurance is not permitted as a means of risk

management in Islamic law. This is because it

constitutes the purchase of something with an uncertain
outcome (form of ghirar), and because insurers use fixed
income - a form of riba - as part of their portfolio
management process to satisfy liabilities.
A possible Sharia-compliant alternative is cooperative
(mutual) insurance. Subscribers contribute to a pool of
funds, which are invested in a Sharia-compliant manner.
Funds are withdrawn from the pool to satisfy claims, and
unclaimed profits are distributed among policy holders.
Such a structure exists infrequently, so Muslims may
avail themselves of existing insurance vehicles if needed
or required.
Conclusion
Islamic finance is a centuries-old practice that is gaining
recognition throughout the world and whose ethical
nature is even drawing the interest of non-Muslims.
Given the increased wealth in Muslim nations, expect
this field to undergo an even more rapid evolution as it
continues to address the challenges of reconciling the
disparate worlds of theology and modern portfolio theory

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ISLAMIC BANKING AND MODE OF FINANCING

2.1

Islamic Banking

Islamic banking has been defined as banking in

consonance with the ethos and value system of Islam and
governed, in addition to the conventional good
governance and risk management rules, by the principles
laid down by Islamic Shariah.[1]
The objective of Islamic banking system is to make a
positive contribution to the fulfillment of socioeconomic
objectives of the society in all spheres, including trade,
industry & agriculture etc.[2] in general, is to promote,
foster and develop the application of Islamic principles,
law and tradition to the transaction of financial, banking
and related business affairs and to promote investment
companies. Islamic banks accept deposits which they can
either commit to investment or general deposits. They
also have investment accounts with or without
authorization. Banks engage in investment activities
based
on
Musharakah (equity
participation) Mudarabah or Qirad (agencies), Murabaha,
Bai'
Salam (post
delivery
sale)
and/or
leasing
arrangements especially for equipment. On the lending

side, Islamic banks issued a number of new lending

instruments such as Al Muqarada profit bonds to finance
large projects and Al-Mudarabah certificates which were
not issued for specified projects. Islamic banks practice
conventional short term financing on a profit/loss basis.[3]
2.2

PHILOSOPHY OF ISLAMIC BANKING AND FINANCE

The prohibition of interest by Islam is the base of the

development of Islamic Banking Phelosopghy. The Islamic
system order based on a set of principles constituting the
concept and philosophy as enunciated explicitly in the
Quran.This philosophy provides what can be understood
as the Islamic system of social justice. [4]In Islamic law
some gain has been prohibited which are generally fixed
or if there is no concept of risk shearing. Conventional
Finance believes in return without risk, whilst Islamic
Finance prohibits the latter and enforces the opposite.[5]
Islam prohibits interest but it does not means, that it
prohibits all gains on capital. The only increase stipulated
or sought over the principle loan or debt is prohibited in
Islamic sharia law. Islamic principles simply require that
performance of capital should also be considered while
rewarding the capital. The prohibition of a risk free return
and permission of trading, as enshrined in the Holy
Quran[1], makes the financial activities in an Islamic setup real asset-backed with ability to cause value addition.
[6]

Islam deems profit, rather than interest, to be closer to its

sense of morality and equity because earning profits
inherently involves sharing risks and rewards. [7] Islam
encourages shearing of risk among lender and borrower,
Islamic financing system is based on this principle, it has
also another character of owing and handing of real
assets, its involvement in trading, construction and
leasing using Islamic mode of financing. As such, Islamic
banks deal with asset management for the purpose of
income generation. They will have to prudently handle
the unique risks involved in management of assets by
adherence to best practices of corporate governance.
Once the banks have stable stream of Halal income,
depositors will also receive stable and Halal income.[8]
Profit has been recognized as reward for (use of) capital
and Islam permits gainful deployment of surplus
resources for enhancement of their value. However, along
with the entitlement of profit, the liability of risk of loss on
capital rests with the capital itself; no other factor can be
made to bear the burden of the risk of loss. Financial
transactions, in order to be permissible, should be
associated with goods, services or benefits. At macro
level, this feature of Islamic finance can be helpful in
creating better discipline in conductive of fiscal and
monetary policies.[9]

All such things/assets corpus of which is not consumed

with their use can be leased out against fixed rentals. The
ownership in leased assets remains with the lesser that
assumes risks and gets rewards of his ownership. The
institution may either rent the equipment or receive a
share of the profits earned through its use; Islamic leasing
(Ijara wal Iqtina) are the same as Ijarah except that the
lessee can acquire ownership of the asset by making
installment payment.[10]
2.3

MAJOR MODES OF ISLAMIC BANKING AND FINANCE

Following are the main modes of Islamic banking and

finance:
1.

Murabaha

Literally it means a sale on mutually agreed profit.

Technically, it is a contract of sale in which the seller
declares his cost and profit. Islamic banks have adopted
this as a mode of financing. As a financing technique, it
involves a request by the client to the bank to purchase
certain goods for him. The bank does that for a definite
profit over the cost, which is stipulated in advance. [11]
2.

Ijara

Ijara is a contract of a known and proposed usufruct

against a specified and lawful return or consideration for
the service or return for the benefit proposed to be taken,
or for the effort or work proposed to be expended. In
other words, Ijara or leasing is the transfer of usufruct for

a consideration which is rent in case of hiring of assets or

things and wage in case of hiring of persons.[12]
3.

Ijarah-Wal-Iqtina

A contract under which an Islamic bank provides

equipment, building or other assets to the client against
an agreed rental together with a unilateral undertaking
by the bank or the client that at the end of the lease
period, the ownership in the asset would be transferred to
the lessee. The undertaking or the promise does not
become an integral part of the lease contract to make it
conditional. The rentals as well as the purchase price are
fixed in such manner that the bank gets back its principle
sum along with profit over the period of lease.[13]
4.

Istisna

It is a contractual agreement for manufacturing goods

and commodities, allowing cash payment in advance and
future delivery or a future payment and future delivery.
Istisnaa can be used for providing the facility of financing
the manufacture or construction of houses, plants,
projects and building of bridges, roads and highways.[14]
5.

Bai Muajjal

Literally it means a credit sale. Technically, it is a

financing technique adopted by Islamic banks that takes
the form of Murabaha Muajjal. It is a contract in which the
bank earns a profit margin on his purchase price and
allows the buyer to pay the price of the commodity at a

future date in a lump sum or in installments. It has to

expressly mention cost of the commodity and the margin
of profit is mutually agreed. The price fixed for the
commodity in such a transaction can be the same as the
spot price or higher or lower than the spot price.[15]
6.

Mudarabah

A form of partnership where one party provides the funds

while the other provides expertise and management. The
latter is referred to as the Mudarib. Any profits accrued
are shared between the two parties on a pre-agreed
basis, while loss is borne only by the provider of the
capital.[16] Murabaha in tandem with Bai Muajjal is a
useful means of financing in the Islamic Mortgages arena.
It allows the Bank to purchase the house at spot price and
then sell it to the client over a deferred period thereby
generating a profit for the Bank.[17]
7.

Musharakah

Musharakah means a relationship established under a

contract by the mutual consent of the parties for sharing
of profits and losses in the joint business. It is an
agreement under which the Islamic bank provides funds,
which are mixed with the funds of the business enterprise
and others. All providers of capital are entitled to
participate in management, but not necessarily required
to do so. The profit is distributed among the partners in

pre-agreed ratios, while the loss is borne by each partner

strictly in proportion to respective capital contributions.
[18]

8.

Bai Salam

Salam means a contract in which advance payment is

made for goods to be delivered later on. The seller
undertakes to supply some specific goods to the buyer at
a future date in exchange of an advance price fully paid
at the time of contract. It is necessary that the quality of
the commodity intended to be purchased is fully specified
leaving no ambiguity leading to dispute. The objects of
this sale are goods and cannot be gold, silver or
currencies. Barring this, Bai Salam covers almost
everything, which is capable of being definitely described
as to quantity, quality and workmanship.[19]
9.

Qard Hassan (Good Loan)

This is a loan extended on a goodwill basis, and the

debtor is only required to repay the amount borrowed.
However, the debtor may, at his or her discretion, pay an
extra amount beyond the principle amount of the loan
(without promising it) as a token of appreciation to the
creditor. In the case that the debtor does not pay an extra
amount to the creditor, this transaction is a true interestfree loan. Some Muslims consider this to be the only type
of loan that does not violate the prohibition on riba, since

it is the one type of loan that truly does not compensate

the creditor for the time value of money.[20]
2.4

RATIO OF PROFIT

There is a difference of opinion among the Muslim jurists

about the Ratio of Profit.
In the view of Imam Malik and Imam Shafii, it is necessary
for the validity of Musharaka that each partner gets the
profit exactly in the proportion of his investment.
Therefore, if A has invested 40% of the capital, he must
get 40% of the profit. Any agreement to the contrary
which makes his entitled to get more or less than 40%
will render the musharkah invalid in Shariah.
On the contrary, the view of Imam Ahmad is that the
ratio of profit may differ from the ratio of investment if it
is agreed between the partners with their free consent.
Therefore, it is permissible that a partner with 40% of
investment gets 60% or 70% of the profit, while the other
partner with 60% of the investment gets only 40% or
30%.
The third view is presented by Imam Abu Hanifah which
can be taken as a via media between the two opinions
mentioned above. He says that the ratio of profit may
differ from the ratio of investment in normal conditions.
However, if a partner has put an express condition in the
agreement that he will never work for the musharkah and

will remain a sleeping partner throughout the term of

musharkah, then his share of profit cannot be more than
the ratio of his investment. [21]
2.5

ISLAMIC FINANCING AND ITS GLOBAL EVOLUTION

As with all things Islamic, the origination of Islamic

finance goes back to the time of
Prophet Muhammad (Peace be upon Him). The Quran
and the example of Prophet
Muhammad (Peace
be
upon
Him) provide
direct
behavioral guide and represent bedrock of Islamic faith to
over one billion Muslims globally. The Prophet
Muhammad (Peace be upon Him) happened to be a
businessman serving as a trader for Khadija (May Allah
be pleased with Her). The Prophetic example was the
very epitome of fair-trade. Refraining from usury,
ensuring transparency in transactions, and total honesty
entitled him Al- Amin (The trustworthy) in pre-Islamic
Arabia[22]
During the Islamic Golden Age, early forms of protocapitalism and free markets were present in the
Caliphate; 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 1963. This experiment lasted until 1967 [23], by which
time there were nine such banks in the country. These
banks, which neither charge nor paid interest, invested
mostly by engaging in trade and industry, directly or in
partnership with others, and shared the profits with their
depositors.[24]
But some views whows that the first modern Islamic
modern banking institution stablished in Pakistan in 1950.
As a former credit Union. This was first Islamic financing
movement. Using this idea Mit Ghamr saving Bank
emerged as a rural institution in Egypt in 1963. [25] At
meeting of Foreign minister of Islamic countries in Karachi
Pakistan in 1970, Pakistan and Egypt jountly proposed for
the establishment of international Islamic Bank for trade
and development this again discussed in 1973 with
Banghzi (Libya) in a meeting which further suggested for
constituting a committee of experts for designing this
international Islamic Bank. This was finally established in
1972 as Islamic Development Bank in Jeddah Saudia
Arabia.[26] The IDB was established in 1974 by the
Organization of Islamic Countries (OIC), but it was
primarily an intergovernmental 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 Shariahprinciples. [27]
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,[28]. After that, numbers of Islamic Bank established
in different Islamic countries. Dubai Islamic Bank in 1975
in Dubai, Faisal Islamic Bank in Egypt and Sudan in 1972,
Kuwait Finance House in 1977. Jordan Islamic Bank in
1978 and Bahrain Islamic Bank in 1979[29]
Islamic banking made its debut in Malaysia in 1983, but
not without antecedents. The first Islamic financial
institution in Malaysia was the Muslim Pilgrims Savings
Corporation set up in 1963 to help people save for
performing hajj (pilgrimage to Mecca and Medina). In
1969, 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 Shariah, 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 1990 the branch network of BIMB will total
thirty-three [30]
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. [31] The
Islamic Banking System (now called Islamic Finance
House), established in Luxembourg in 1978, 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.[32]
2.6

HISTORY OF ISLAMIC BANKING IN PAKISTAN

Pakistan now recognized one of the Islamic finance

industries in the World. Muhammad Ali Jinnah as early
1948, emphasized on Islamic principles in his address at
inauguration of State Bank of Pakistan he said.

I shall watch with keenness the work of your Organization in evolving

banking practices compatible with Islamic ideas of social and economic
life. We must work our destiny in our own way and present to the world an

economic system based on true Islamic concept of equality of manhood

and social justice.

[33]

Pakistan has a protracted history of Islamic banking with

the initial attempt to Islamize banking system in 1980s2,
leading to sweeping changes in the Banking Companies
Ordinance, 1962 (BCO62) and associated laws and
regulations to accommodate non-interest based banking
transactions[34]. The Islamization measures included the
elimination of interest from the operations of specialized
financial institutions including HBFC, ICP and NIT in July
1979 and that of the commercial banks during January
1981- June 1985.[35]
Separate Interest-free counters started operating in all
the nationalized commercial banks, and one foreign bank
(Bank of Oman) on January 1, 1981 to mobilize deposits
on profit and loss sharing basis. Regarding investment of
these funds, bankers were instructed to provide financial
accommodation for Government commodity operations
on the basis of sale on deferred payment with a mark-up
on purchase price. Export bills were to be accommodated
on exchange rate differential basis. [36]
In March, 1981 financing of import and inland bills and
that of the then Rice Export Corporation of Pakistan,
Cotton Export Corporation and the Trading Corporation of
Pakistan were shifted to mark-up basis. Simultaneously,

necessary amendments were made in the related laws

permitting the State Bank to provide finance against
Participation Term Certificates and also extend advances
against promissory notes supported by PTCs and
Mudarabah Certificates. From July 1, 1982 banks were
allowed to provide finance for meeting the working
capital needs of trade and industry on a selective basis
under the technique of Mishawaka.[37]
As from April 1, 1985 all finances to all entities including
individuals began to be made in one of the specified
interest-free modes. From July 1, 1985, all commercial
banking in Pak Rupees was made interest free.[38]
From that date, no bank in Pakistan was allowed to accept
any interest-bearing deposits and all existing deposits in
a bank were treated to be on the basis of profit and loss
sharing. Deposits in current accounts continued to be
accepted but no interest or share in profit or loss was
allowed to these accounts.
However, foreign currency deposits in Pakistan and onlending of foreign loans continued as before. The State
Bank of Pakistan had specified 12 modes of non-interest
financing classified in three broad categories.
However, in any particular case, the mode of financing to
be adopted was left to the mutual option of the banks
and their clients. The procedure adopted by banks in

Pakistan since July 1 1985, based largely on mark-up

technique with or without buy-back arrangement, was,
however, declared un-Islamic by the Federal Shariat Court
(FSC) in November 1991. However, appeals were made in
the Shariat Appellate Bench (SAB) of the Supreme Court
of Pakistan.[39]
The Commission for Transformation of Financial System
(CTFS) was constituted in January 2000 in the State Bank
of Pakistan under the Chairmanship of Mr. I.A. Hanfi, a
former Governor State Bank of Pakistan.[40]
A Task Force was set up in the Ministry of Finance to
suggest the ways to eliminate interest from Government
financial transactions. Another Task Force was set up in
the Ministry of Law to suggest amendments in legal
framework to implement the Courts Judgment. The CTFS
constituted a Committee for Development of Financial
Instruments and Standardized Documents in the State
Bank to prepare model agreements and financial
instruments for new system.
The House Building Finance Corporation had shifted its
rent sharing operations to interest based system in 1989.
[41] The Task Force of the M/O Law proposed amendments
in the HBFC Act to make it Shariah Compliant. Having
vetted by the CTFS, the amended law has been
promulgated by the Government. Accordingly, the HBFC

launched in 2001 Asaan Ghar Scheme in the light of

amended Ordinance based on the Diminishing Musharaka
concept. A Committee was constituted in the Institute of
Chartered Accountants, Pakistan (ICAP), wherein the SBP
was also represented, for development of accounting and
auditing standards for Islamic modes of financing. The
Committee is reviewing the standards prepared by the
Bahrain based Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI) with a view to adapt
them to our circumstances and if considered necessary,
to propose new accounting standards.
It was decided in September 2001 that the shift to
interest free economy would be made in a gradual and
phased manner and without causing any disruptions. It
was also agreed that State Bank of Pakistan would
consider for:
1. Setting up subsidiaries by the commercial banks for
the
purpose
of
conducting
Shariah
compliant
transactions;
2. Specifying branches by the commercial
exclusively dealing in Islamic products, and

banks

3. Setting up new full-fledged commercial banks to

carry out exclusively banking business based on proposed
Islamic products.[42]

Accordingly, the State Bank issued detailed criteria in

December 2001 for establishment of full-fledged Islamic
commercial banks in the private sector. The Meezan Bank
was granted a Scheduled Islamic Commercial Bank
license on January 31, 2002, and formally commenced
operations as a Scheduled Islamic Commercial Bank with
effect from March 20, 2002, on receiving notification in
this regard from the State Bank of Pakistan (SBP) under
section 37 of the State Bank of Pakistan Act, 1956.
Currently, the Bank is engaged in corporate, commercial,
Consumer, investment and retail banking activities.
Further, all formalities relating to the acquisition of
Societies General, Pakistan by the MBL were completed,
and by June, 2002 it had a network of 5 branches all over
the country, three in Karachi, one in Islamabad and one in
Lahore.[43]
The Government as also the State Bank is mainly
concerned with stability and efficiency of the banking
system and safeguarding the interests, particularly, of
small depositors. With this concern in mind it has been
decided to operate Islamic banking side by side with
traditional banking. The approach is to institute best
practice legal, regulatory and accounting frameworks to
support Islamic banks and investors alike. The year 20022003 witnessed strengthening measures taken in the
areas of banking, non-bank financial companies and the
capital markets.

2.7
ROLE OF ISLAMIC BANKING IN THE DEVELOPMENT
OF THE COUNTRY

Islamic banks and financing performing according to the

sharia law, those are helpful for mobilization of resources,
and their use in right manner. PLS (Musharaka and
Mudarabah) and non-PLS (trading & leasing) based
categories of modes and strengthening the payments
systems to contribute significantly to economic growth
and development.[44] Islamic mode of financing system
offering finance in short tem, long term, and different
type of instrument for liquidity management, asset
management etc, for enterprises and projects. This
creates employment opportunities in the economy. It
would be necessary to create an environment that could
induce
financiers
to
earmark
more
funds
for
Musharaka/Mudarabah based financing of productive
units, particularly of small enterprises.[45]
The non-PLS techniques, as acceptable in the Islamic
Shariah, not only complement the PLS modes, but also
provide flexibility of choice to meet the needs of different
sectors and economic agents in the society. Trade-based
techniques like Murabaha with lesser risk and better
liquidity options have several advantages vis--vis other
techniques but may not be as fruitful in reducing income
inequalities and generation of capital goods as
participatory techniques. Ijarah related financing that

would require Islamic banks to purchase and maintain the

assets and afterwards dispose of them according to
Shariah rules, require the banks to engage in activities
beyond financial intermediation and can be very much
conducive to the formation of fixed assets and medium
and long-term investments.
On the basis of the above it can be said that supply and
demand of capital would continue in an interest free
scenario with additional benefit of greater supply of riskbased capital along with more efficient allocation of
resources and active role of banks and financial
institutions as required in asset based Islamic theory of
finance. Islamic banks can not only survive without
interest but also could be helpful in achieving the
objective of development with distributive justice by
increasing the supply of risk capital in the economy,
facilitating capital formation, and growth of fixed assets
and real sector business activities.
Salam has a vast potential in financing the productive
activities in crucial sectors, particularly agriculture, agrobased industries and the rural economy as a whole. It
also provides incentive to enhance production as the
seller would spare no effort in producing, at least the
quantity needed for settlement of the loan taken by him
as advance price of the goods. Salam can also lead to
creating a stable commodities market especially the

seasonal commodities and therefore to stability of their

prices. It would enable savers to direct their savings to
investment outlets without waiting, for instance, until the
harvesting time of agricultural products or the time when
they actually need industrial goods and without being
forced to spend their savings on consumption.
Small and medium enterprises (SME) sector has a great
potential for expanding production capacity and selfemployment opportunities in the country. Enhancing the
role of financial sector in development of SME sub-sector
could mitigate the serious problems of unemployment
and low level of exports. The banks may introduce SME
Financing Funds with various geographical locations. The
corporate sector and the commercial banks may set up a
network of such Funds under the aegis of SECP by
establishing institutions under syndicate arrangements or
otherwise. [46]

References

[1] Those who consume interest94 cannot stand [on the Day of Resurrection] except as one
stands that is being beaten by Satan into insanity. Holy Quran Albaqra Verse 275
The Islamic Golden Age, also sometimes known as the Islamic Renaissance, is traditionally
dated from the 7th to 13th centuries Common Era., but has been extended to the 15th and 16th
centuries by more recent scholarship. During this period, artists, engineers, scholars, poets,
philosophers, geographers and traders in the Islamic world contributed to the arts, agriculture,

economics, industry, law, literature, navigation, philosophy, sciences, sociology, and technology,
both by preserving and building upon earlier traditions and by adding inventions and innovations
of their own.
A free market is a term that economists use to describe a market which is free from
economic intervention and regulation by government, other than protection of property rights
(i.e. no regulation, no subsidization, no single monetary system and no governmental
monopolies).

Muhammad Faisal Ijaz, M. Z. (2007). Islamic

Banking (Presentation). Retrieved from O
Papershttp://www.oppapers.com/essays/IslamicBanking/174593
[1]

Dr. Shahid Hasan Siddiqui. (2001) Islamic

Banking: True Modes of Financing New
horizon.http://www.nzibo.com/IB2/truemodes.pdf
[2]

Hassanien, Medhat. Money and Banking in

Islam. Islamabad : Institute of policy studies Islamabad
and international research in Islamic economics. Money
and Banking in Islam. p.
97.http://islamiccenter.kaau.edu.sa/arabic/Magallah/Pdf/O
ld-3-1/Medhat_23.pdf
[3]

Noor Ahmed Memon (2007) Islamic Banking:

Present and Future Challenges Journal of Management
and Social Sciences Vol. 3, No. 1, (Spring 2007) 01-10
Department of Economics, Institute of Business &
Technology (BIZTEK)
[4]

Islamic Finance Explained By Sufyan Gulam Ismail,

Chief Executive, 1st Ethical Ltd.www.1stethical.com
[5]

Muhammad Ayub Can bank survive with out

interest? State Bank of
[6]

Pakistanhttp://www.sbp.org.pk/departments/ibd/Survive.p
df
Rahul Dhumale and Amela Sapcanin (1998) An
Application of Islamic Banking Principles to Microfinance.
Regional Bureau for Arab States, United Nations
Development Programme, in cooperation with the Middle
East and North Africa Region, World Bank
[7]

[8]

Ibid

[9]

Ibid

Dr Khaled A Hussain (2004) Banking efficiency in

Bahrain Islamic vs conventional Banks Paper No. 68
Islamic Development Bank. Islamic Research and Training
Institute.
[10]

SBP (2002)Glossary of Islamic

Finance http://www.sbp.org.pk/publications/islamic/book
1/glossary.pdf
[11]

Dawood Islamic Bank

Ltd http://www.dawoodislamic.com/AskMufti.aspx
[12]

SBP.(2002) FAQ on Islamic Banking. State Bank of

Pakistan. [Online] [Cited: 4, 20,
2009.]www.sbp.org.pk/ibd/faqs.pdf
[13]

[14],Ibid
[15]

Ibid

AIMS-UK Glossary; Islamic Banking and

Finance www.learnislamicfinance.com
[16]

Sufyan (2007). Islamic Finance Explained1st Ethical

iLtd.UK. www.1stethical.com
[17]

AIMS-uk.(2007) An over view of Islamic mode of

Financing. AIMS-Uk. [Online] 2007. [Cited: 4 15,
2009.] www.learnIslamicFinance.com.
[18]

SBP (2002) FAQ on Islamic Banking. State Bank of

Pakistan. [Online] [Cited: 4 20,
2009.]www.sbp.org.pk/ibd/faqs.pdf.
[19]

Taken form website source can be visit

athttp://www.irfi.org/articles/articles_301_350/is_islamic_b
anking_islamic.html
[20]

Usmani, M Taqi. (2006) Introduction to Islamic

Financ karachi Pakistan : Maktaba maariful Quran
karachi, 2006. e.p 37.
[21]

Sufian, Fadzlan (2007), The efficiency of Islamic

banking industry in Malaysia: Foreign vs domestic
banks. Humanomics, Volume 23, no. 3, pp. 174-192.
[22]

Ready, R.K., 198l. 'The march toward selfdetermination', paper presented at the First Advanced
Course on Islamic Banks, International Institute of Islamic
Banking and Economics, Cairo, 28 August l7 September.
[23]

Siddiqi, M.N., (1988). 'Islamic banking: theory and

practice', in M. Ariff
[24]

Wilson Rodeney (1995) Islamic Banking and its

Impact on international financial shcheme New Horizon.
P-8
[25]

Siddiqiui Shahid Hussain. (1994) Islamic Banking

Royal Book Co P-17
[26]

[27]

Ibid

Muhammad Ariff (1988) Islamic Banking

University of Malaya
[28]

Dr. Ziauddin Ahmad (1985) The Present state of

Islamic finance movement International Institute of
Islamic Economics P-8
[29]

Man, Zakariya, (1988). 'Islamic banking: the

Malaysian experience'\
[30]

Siddiqi, M.N., (1988). 'Islamic banking: theory and

practice',
[31]

M. Shahzad (2008) Performance of Islamic banking

and conventional banking in Pakistan: a comparative
study. University of SKOVDE. School of Technology
&Society
[32]

Quaid-e-Azam: Speech at the foundation laying stone

of the State Bank of Pakistan, 1st July 1948.
[33]

Dr Shamshad Akhtaar, (2007). "Pakistan Islamic

Banking; Past Present and Future". Karachi Paksitan :
State Bank of Pakistan,
[34]

Mehboob UL-HASSAN (2007) The Islamization of

the Economy and the Development of Islamic Banking in
Pakistan Kyoto Bulletin of Islamic Area Studies, 12(2007), pp. 92-109http://www.asafas.kyotou.ac.jp/kias/contents/pdf/kb1_2/09mehboob.pdf
[35]

Shaikh A. Hamid (2006) Philosophy and practice

of Islamic economics and finance Southern New
Hampshire University Working Paper No. 2006-01
[36]

SBP. (2002)FAQ On Islamic Banking. (2002)State

Bank of Pakistan.[Online] [Cited: 4 20, 2009.]
www.sbp.org.pk/ibd/faqs.pdf.
[37]

[38]

Ibid

SBP (2007) Pakistans Islamic Banking Sector

Review. 2003-2007 ISLAMIC BANKING DEPARTMENT
[39]

[40]

Ibid

[41]

Ibid

[42]Accountant

( 2007) Faith and Finance;the

evaluation and of Islamic banking. (July- August
2007).The Pakistan Accountant,P-7. ACCA Karachi
[43]

Ibid P- 8

SBP. (2002). FAQ on Islamic Banking. State Bank of

Pakistan.[Online] [Cited: 4 20, 2009.]
www.sbp.org.pk/ibd/faqs.pdf.
[44]

[45]

Ibid Page-2

[46]

Ibid