Islamic

Banking
and Finance
Bank & Banking
Bank

an organization that provides various financial

services, for example keeping or lending money.
(Oxford Learners Dictionary)

Banking

The businessconductedor services offered by a

bank:
with thisaccount, you areentitledto free
banking (Oxford Dictionary)
History of Banking
Banking in Babylonia
Banking existed in Babylonia in the second millennium B.C.
Mostly deposits were in the shape of cattle, grain, other
crops and precious metals
Borrowers paid interest to lenders on loans

Egypt
Grains were stored in The Centralized State Warehouse
History of Banking
The system continued till, even after, private banks dealing
in coinage and precious metals

o Medieval Age (1000AD-1450AD)

Famous Bank Medici was founded in Medieval Italian
Cities of Florence, Venice and Genoa in 1397
Founder: Giovanai Medici
These Banks made loans:

a. To princes, both for wars and their lavish life style

b. To Merchants engaged in International Trade
History of Banking
Trading families, like Bardi and Peruzzi were dominant in
Florence in the 14 century and established their families
'banks and expended their branches on other parts of Europe
Both banks extended substantial loans (Bardi: 90000 gold
florins and Peruzzi: 60000 gold florins) to Edward Three of
England to finance the hundred years war against France
Medieval Banks business was through the bill of exchange.

Example:
The bankers would take deposits in one city, make a loan to
someone transporting goods to another city, and then take
repayment at the destination
History of Banking
Bill of Exchange
a written order to a person requiring them to make a specified
payment to the signatory or to a named payee; a promissory
note.

Dutch and British

17th and 18th centuries Dutch and British introduced
Fractional Reserve Banking/Fractional Deposit Lending
o America
American Independence 1776 AD
First Chartered Bank in Philadelphia in 1781 AD
History of Banking
There were seventeen more banks by 1794 AD
1838 AD New York Free Banking Act was adopted because
of private banks failure and worthless notes
Islamic Banking in Pakistan
An economic system based on equity and social justice has
been in the countrys historical roots. Jinnah the father of the
nation, in his speech at inauguration of State Bank of
Pakistan, in 1948 AD expressed the desire for evolving such
economic system in the country:

We must work our destiny in our own way and present to the
world an economic system based on true Islamic concepts of
equality of manhood and social justice.
Islamic Banking in Pakistan

The Government of Pakistan is bound to follow instructions

of Allah Almighty according to Objective Resolution 1949
AD
Islam is the state religion (Constitution of Pakistan 1956 AD)
Steps should be taken to enable the Muslims (of Pakistan) to
order their lives, in individual and collective spheres, in
accordance with the teachings and requirements of Islam as
set out by Quran and Sunnah. (Constitution of Pakistan 1956 AD)
The Council of Islamic Ideology was established under the
constitution of 1962 AD to eliminate the interest from
Pakistani Economy
Islamic Banking in Pakistan
In 1973 AD the Constitution of Pakistan demands the
elimination of the interest
State shall eliminate Riba as early as possible {Article
38(F)}
All existing laws shall be brought in conformity with the
injunctions of Islam and no law shall be enacted which is
repugnant to these injunctions {Article 227}

The process of economy wide Islamization of the banking

system in Pakistan was initiated after a declaration by then
president in February 1979. The government planned to
remove the interest from economy within three years.
Pre Judgment
First Phase
Starting from 1979
Islamic Banking in Pakistan
1981-Orinance Promulgated for the establishment of
Modaraba Companies and floatation of Modaraba
Certificates.
Amendments were made in BCO (Banking Companies
Ordinance) 1962 for the incorporation of financing on
Musharaka and PLS mode basis.
1981- Deposit Counters on PLS basis
It was directed that the deposits so received would be used
for financing the commodity operations.
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 Musharaka.
Islamic Banking in Pakistan
From July 1, 1985, all commercial banking was made
interest-free.
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.
The State Bank of Pakistan had specified 12 modes of non-
interest financing classified in three broad categories
namely:
Loan Financing
Trade Related Financing
Investment Mode of Financing
Ruling of Federal Shariah Court (November 14, 1991) & Supreme Court
Judgment (December 19, 1999)

Procedure adopted for the Islamization of the financial system was declared
un-Islamic. However, Government and some banks appealed to the Shariah
Appellate Bench (SAB) of Supreme Court against aforesaid verdict of FSC
(Federal Shariah Court).
The SAB delivered its judgment on December 23, 1999 rejecting the
appeals and directing that laws involving interest would cease to have effect
finally by June 30, 2001.
In the judgment, the Court concluded that the present financial system had
to be subjected to radical changes to bring it into conformity with the
Shariah. It also directed the Government to set up, within specified time
frame, a Commission for transformation of financial system and two Task
Forces to plan and implement the process of transformation. The Court
indicated some measures, which needed to be taken, and the infrastructure
and legal framework to be provided in order to have an economy
conforming to the injunctions of Islam.
The Judgment December 1999
The Supreme Court Concluded that:
All prevailing forms of interest, either in banking transactions or
in private transactions falls within the definition of Riba.
Any interest stipulated in government borrowings acquired from
domestic or foreign sources are Riba and clearly prohibited by
the Holy Quran.
The present financial system, based on interest, is against the
injunctions of Islam.
In order to bring it in conformity with Shariah-radical changes
are required.
Supreme Courts Definition of Riba & New Judgment of SAB SC
Any amount big or small, over the principal, in a contract of
loan or debt is Riba prohibited by the Holy Quran,
regardless of whether the loan is taken for the purpose of
consumption or for some production activity.
The Shariat Appellate Bench of the Supreme Court on June
24, 2002 set aside its earlier judgment in which it had
directed the government to eliminate Riba from economy by
June 30, 2002. Further, the bench remanded the case back to
the Federal Shariat Court for a fresh decision.
Failure of Previous Efforts
1. Absence of Shariah compliance mechanism in financial
institutions.
2. Non-availability of Shariah compliant government securities.
3. Ineffective enforcement of contracts and inefficient system
for early recovery.
4. Lack of continued research and development in the field of
Islamic finance and economics.
5. Inadequate training to the staff of SBP and banks.
6. Disoriented education system devoid of Islamic principles.
7. Lack of public awareness about Islamic economic system.
8. Weak political resolve of successive governments for
Islamization of economy.
Post Judgment
Second Phase
Starting from 2001
Current Strategy
Gradual approach for transformation of economy
Full fledged Islamic banks be established in Private Sector
Islamic banking Subsidiaries in existing banks be allowed
Stand alone branches for Islamic banking be allowed in existing
banks
Policy Objectives
Introduce, promote and implement Islamic Banking in
Pakistan
As a parallel banking system
Comparable and compatible to conventional banking system
Shariah compliant
LEGAL FRAMEWORK
Legal Framework
Applicable Laws
Banking Companies Ordinance, 1962
State Bank Of Pakistan Act, 1956
Banks Nationalization Act, 1974
Foreign Exchange Regulations Act, 1947
Financial Institutions (Recovery of Finances) Ordinance, 2001
Companies Ordinance, 1984
Banking Companies Ordinance, 1962
Banking Companies Ordinance fully supports Islamic
Banking
Definitions [sec. 5]
Loans, advances and credit includes finance as defined in
Banking Tribunals Ord. 1984, which covers non-interest based
modes of financing.
Shariah Compliance Regime
Shariah Compliance Mechanism
SBP Shariah Shariah Board at Shariah
Board IBIs AdvisorsForum

Essentials and Instructions and Adoption of

model agreements guidelines for AAOIFI Shariah
of Islamic Modes of Shariah Compliance standards
financing

Shariah PLS and Pool Shariah

Compliance (on- Management Governance
site) inspection Framework Framework
SBP Shariah Board
A central Shariah Board established at SBP and is fully
functional
Current membership consists of six persons
Three Shariah Scholars
Chartered Accountant
Lawyer
Banker representing the industry as well as SBP
SBP Shariah Board
Formally established in December 2003
So far has held over 56 meetings
Approved Essentials of Islamic Modes of Financing and
prepared Essentials for Diminishing Musharaka
Approved 9 Model Agreements
Approved and Revised Fit & Proper Criteria for Shariah
Advisors
Approved structure of Government Ijarah Sukuk, WAPDA,
PIA, KSEW (Karachi Shipyard & Engineering Works) &
NIP (National Industrial Parks) Sukuk
Approved Instructions and Guidelines for Shariah
Compliance in IBIs SGF (Shariah Governance Framework)
and other Regulations
Shariah Governance Framework at IBIs
Revised instructions issued through IBD (Islamic Banking
Department) Circular No. 1 of 2015:
Role of Board of Directors (BOD)
Role of Executive Management (EM)
Shariah Board (SB) comprising of at least three Shariah Scholars
including Chairman and RSBM (Resident Shariah Board Member)
Shariah Compliance Department (SCD)
Internal Shariah Audit (ISA)
External Shariah Audit
Conflict Resolution
Competence of Organs dealing with Shariah Governance
Framework
Fit and Proper Criteria (FAPC)
Report of Shariah Board
 SGF: Role of Key Stakeholders
BOD Ultimately responsible and accountable for ensuring full conformity of the IBIs operations with
Shariah principles
To introduce necessary mechanisms and risk management systems to safeguard the interests of profit
and loss sharing (PLS) depositors
To appoint and remunerate Shariah Board of IBI
Meeting with the SB at least on a half yearly basis
Enhanced focus on Shariah non-compliance risk

Shariah Approve all products or services and validate relevant documentations (e.g. forms, contracts,
Board agreements, legal documentations, product manual, etc.)
Empowered to consider, decide and supervise all Shariah related matters
All decisions, rulings, fatawa of the SB are binding on IBI
Responsible and accountable for Shariah related decisions
Prepare a report on the IBIs Shariah Compliance, based on the reports of internal Shariah audit and
external Shariah audit
Prescribe enforcement actions on internal Shariah audit and Shariah compliance reports

Executive Responsible for implementation of the SGF decisions, fatawa and guidelines given by SB
Manageme Provide complete and accurate information to SB to seek approval for procedure manuals, products
nt programs and structures, process flows, related agreements and contracts
Educate and train key internal stakeholders about Islamic Banking
Improve overall Shariah compliance and show Zeri tolerance on Shariah non-compliance
SGF: Role of Key Stakeholders
Responsibilities of RSBM
To oversee the procedures to be adopted for implementation of decisions of
Shariah Board
To provide explanation/clarification to management and staff in the light of
decisions, rulings, fatawa already issued by the SB
To provide guidance to the IBI regarding the Shariah aspects of new products
/ideas
To guide the SCD in Shariah compliance reviews of key business areas on a
test check basis
To respond to Shariah related queries of IBIs clients regarding IBIs products
and services
To facilitate the SCD and Training Department in designing and conducting
training activities
To submit at least a quarterly report to the SB, for ractification of all
explanations /clarifications
To submit a periodic report to the SB on the overall Shariah compliance
environment of the IBI
SGF: Role of Key Stakeholders
Shariah Compliance Department

To work under the overall guidance and supervision of the

SB and reports to the SB
To oversee the procedures to be adopted for
implementation of the resolutions, pronouncements and
fatawa of the SB
To serve as the Secretariat to the SB
To act as conduit between SB and management
To conduct Shariah compliance review
To ensure enforcement of Shariah Audit Report
To design/arrange training on Islamic banking including
Shariah compliance
SGF: Role of Key Stakeholders
Internal Shariah Audit Unit

To report directly to Board Audit Committee (BAC)

To prepare Internal Shariah audit plan, reviewed by the SB,
approved by the BAC
To prepare and submit Internal Shariah audit report to BAC
incorporating enforcement/ corrective actions determined by
the SB
To report, on periodic basis, to the SB regarding the status of
compliance of audit observations
SGF: Role of Key Stakeholders

External Shariah Audit

To have independent and objective assessment of

compliance to SGF
To conduct evaluation/assessment of Shariah compliance of
an IBI