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«The Roots & Development of Islamic Banking in the World & in Pakistan Muhammad Aqib Ali Director and Country Head, International Islamic Finance & ...»

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But the intelligentsia of the country had a sizeable number of such people who sincerely believed that the prevalent commercial interest was not the riba prohibited by the Qur'an. The main conclusions of the Islamization were as follows. First, the Islamization of banking in Pakistan had not met with a success. Most of the finance are still being provided by the savers and the bankers on interest although different terms were being used to camouflage it. Second, the early days of Islamization did see some genuine but inadequate efforts to eliminate interest from the economy but in a period of less than five years most of these efforts had either been reversed or, at least, further progress on them had been halted. Third, a genuine attempt to eliminate interest from the economy would require plugging in all holes for interest-bearing finance. So long as avenues for interestbearing investment were open, the possibility of a successful transition to Islamic system of finance would be well-nigh difficult.

Four, a true Islamic system of finance would require the savers desirous of earning a return on their savings to assume risk as well. The principle of no-risk-no-return will have to be strictly enforced. This will mean a structural change in the role of financial institutions. Five, the macro-economic management of the economy will also need to be in conformity with the Islamic principles to make the experiment of Islamic finance a success. The conceptual debate on the meaning of riba in Pakistan revolves around two important points of view. The first, and by far the most influential, is the one propagated by the religious scholars and commonly believed by the general public. According to this, the prevalent commercial interest in financial institutions is the riba prohibited by the Islamic law. The other view propagated by some modernist scholars such as Fazalur Rahman, Ja'afar Shah Phalwarwi, Mirza Ahmad Ali, Syed Yaqub Shah in sixties of this century argued that the prohibited riba pertained to interest on consumption loans and not on commercial loans as in vogue in the financial institutions.

The Council of Islamic Ideology of Pakistan (formerly Advisory Council on Islamic Ideology) is a constitutional body and consists of scholars of all shades and schools of jurisprudence. The Council in its historic decision of 23 December 1969 categorically pronounced that all forms of interest were riba, irrespective of the purpose, parties, rates and duration involved. It also declared that discounting of bills of exchange, prize on Prize Bonds, interest on Provident Funds, and interest on loans to employees of the government, all fell within the purview of riba. The Federal Shari'ah Court of Pakistan, in November 1991, decreed that riba included all forms of interest including the prevalent system of mark-up. The decision struck from the statute book all those clauses of various laws which had a mention of the term "interest". It asked the Federal Government to devise new laws to replace the existing ones in the light of the Islamic law by 30 June 1992 beyond which date the existing laws will cease to have effect, so far they are related to payment and receipt of interest. But the Federal Government, instead of implementing the decision of the Federal Shari'ah Court, filed an appeal in Supreme Court of Pakistan’s Shariah Appellate Bench. In the meantime, the Supreme Court had issued a questionnaire to solicit opinion of scholars and practitioners on various issues involved in transforming the existing financial system. The questionnaire showed that the Supreme Court would, in all probability, re-examine the whole issue once again. In June 1992, the Commission for Islamization of the Economy issued its first report. The Report on Banks and Financial Institutions was based on the work done by a Working Group appointed by the Commission and consisted of senior bankers and an Islamic scholar. The Report also categorically took the position that all forms of interest were riba and prohibited by the Islamic law.

Akram Khan 1994 states that besides all these authoritative decisions and the earlier writings of the scholars and overwhelming opinion of the Muslim Ummah all over the world that all forms of interest were riba, there still remained a powerful lobby in the bureaucracy and financial circles which tried to confuse the issue. On and off, one could see articles being published in the popular media that the prevalent interest was not prohibited and that there was nothing wrong in the existing financial system.

There was a strong need for disseminating the various aspects of the debate and to argue out the whole case in the popular media.

The Council of Islamic Ideology gave the conceptual lead and the Islamization of financial institution was initiated with an order by the then President to the Islamic Ideology Council on 29th September, 1977 to design a plan for a riba-free Islamic system of economy. The Council assigned this task to a panel of Economists and Bankers who submitted its report in February 1980. The Council examined this Report and with several modifications issued its own Report on the Elimination of Interest from the Economy on June 15th 1980. This report proved to be a milestone in the endeavors for Islamizing of financial institutions in Pakistan. It set out in sufficient detail a complete blueprint for elimination of interest from Pakistan’s economy. Another landmark was achieved when the State Bank of Pakistan prescribes banking operations on Islamic lines. Based on the report of the Council of Islamic Ideology the State Bank of Pakistan started issuing circular to the banks for transforming their operations on the Islamic lines. From 1st January 1981, Islamic windows were opened in all nationalized Commercial Banks. During 1981the State Bank of Pakistan issued several instructions. Very briefly, it prohibited the banks to accept any interest-bearingdeposits and provide finance by interest-bearing lending. For deposits, it introduced the concept of Profit-Loss Sharing (PLS) for various durations, besides current accounts as already practiced. The PLS depositors were now to share in the profit or loss of the banks. The State Bank prescribed maximum and minimum ranges of this sharing and also the formula to work out the banks' management fee. For financing, the State Bank prescribed twelve modes of finance. These modes of finance included musharaka, mudaraba, ijara, ijara wa iktina, equity participation, rent- sharing, mark-up financing for purchase of goods, purchase of property with buy-back agreements, purchase of participatory term certificates, purchase of trade bills, and interestfree loans on the basis of service charge. These modes of finance provided a wide variety of menu to the banks. Other Financial institutions also introduce Islamic schemes. Simultaneously, other financial institutions also started transforming their operations.

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For example, the Investment Corporation of Pakistan (ICP), an investment bank, introduced a Profit-Loss Sharing Investment Scheme. Under this scheme, the ICP accepted deposits and added its own share in proportion to 40:60. The funds thus collected were invested on the stock exchange and the profit was shared with the depositor in proportion to 60:40 but the loss was shared in proportion to capital invested by both the parties. Similarly, the House Building Finance Corporation started providing finance on the basis of rent-sharing. The National Investment (Unit) Trust was also advised by the State Bank to invest its funds on interest-free basis. In brief, during early days there was a lot of enthusiasm for Islamization of the financial institutions. In the beginning the banking entities were reluctant to an extent, to adapt with the newly established interest-free system and endeavored to devise some ways to eliminate interest from their dealings. But very soon they started operating on the basis of mark-up and buy back arrangements. The mark-up and buy-back transactions, as practiced in Pakistan were two very similar techniques. These techniques were in fact camouflaged forms of interest. In the garb of fresh terminology and slogans, the banks kept on operating on the lines of old ways of interest- bearing finance. The Islamic forms of finance such as mudaraba, musharakah, ijarah, ijarah wa iktina,etc were not embraced by most of the banks and financial institutions. But even in those cases where, these Islamic modes of finance were adopted, the banks introduced such changes in their application that the matter became dubious and some form of interest was introduced. (Akram Khan 1994)

Growth/Development & Quantum of Islamic Banking in Pakistan

Islamic banking initiative in Pakistan in a true sense was categorically taken in 1979 when the government preliminarily decided to transform interest based non banking financial organizations like; Investment Corporation of Pakistan (ICP), Bankers Equity, House Building Finance Corporation (HBFC) on Riba free basis. At the same time the government also approved and encouraged commercial conventional banking institutions to provide depository accounts on the basis of profit and loss sharing, these were termed as PLS accounts. From the mid of June 1985, the government barred all the banks from offering interest-based services and products. Nevertheless, all interbank dealings and government linked dealings and the foreign currency accounts were permitted to continue operations on present basis i.e. on interest basis. (Ahmad & Abdul Wajid, 2009). This signaled a new era of Islamic finance in the country as the Supreme Court also issued a ruling against Riba-based transactions and Islamic Ideological Council of Pakistan proposed a system of economy without interest. After the Islamization steps by the Zia regime in mid to late 1980s, strong footing was laid for the enactment of Islamic finance entities in the country. The gradual and steady progress of Islamic banks continued and the industry of Islamic finance thrived as time passed.

Islamic banking is among the swiftest progressing components in the world’s financial systems; the market distribution of assets in the Islamic finance industry has risen from 2% from the late 1970s to an astounding 15% up to the middle of 1990s (Yousef, 1996). Presently, according to estimates, over 500 (Sania & Shehla 2012) Islamic financial institutions, in more than 90 countries are involved in the funds management of more than roughly 500 billion US dollars in assets. Moreover, over the last decade, the Islamic finance and banking industry achieved an amazing growth rate of 15 to 20 percent per year (Bose & McGee 2008). The Islamic finance entities are not only functioning in the Muslim countries but these are also playing their vital role in other countries where Muslims are a minority, for instance, in the major countries of the world including the United States of America, the Unite Kingdom, China, Australia, and France. Furthermore the products and services offered by these Islamic finance institutes are not only accepted and availed by the Muslims but as well by the people from other religious beliefs and backgrounds. The reason behind the acceptability and attraction towards these Islamic banking products and services is the compliance of Shariah principles that prohibit ambiguity, confusion, exploitation, deceit and fraud and hence these have a great appeal to numerous non-Muslims as well (Venardos, 2006). Islamic banking industry experienced a large-scale boom in many countries around the globe in the last 30 years (from 1980’s). The performance and this encouraging growth-rate was dominated and driven by the variables such as the introduction and effective implementation of large-scale macroeconomic reforms; refined and systematic framework policies in financial structure and systems, the global-scale coordination, integration and liberalization of financial and capital markets, privatization and the presentation of creative and diverse Islamic finance products. All these factors now see Islamic finance attaining new levels of sophistication and making it a reckoning force against the powerful conventional and interest based systems and markets. (Cornelisse and Steffelaar, 2008). As Islamic finance has been able to win worldwide acceptance generally and in Muslim majority regions particularly; by the early 2003 the number of Islamic banks around the globe was 176 with deposits of more than of 147 billion US $. (Ghanadian & Goswami, 2004). Besides many hurdles, Islamic banks in Pakistan grew progressively driven by the motives of Shariah compliance, higher returns and service quality.

The role of all the stakeholders including the central bank – The State Bank of Pakistan has been very positive. For this reason Pakistan has been one of the fastest growing Islamic finance industries in the world having superior statutory and legal framework, Shariah governance experts and governmental support to a reasonable extent. According to Kabir (1999), Pakistan has an effective framework for better Islamic banking regulation and control. The number of fully dedicated Islamic banks operating currently in the country is five with branches in all the 16 major city-centers of the country. They include Meezan Bank (313 Branches) topping all others in terms of branch network; Al-Baraka Islamic Bank, Burj Bank, BankIslami Pakistan and Dubai Islamic Bank Pakistan. In addition to these Islamic banks having a total of 660 branches, there are fourteen nonIslamic banks (conventional banks) that have fully operating Islamic banking branches across the country numbered 440, taking the total number to an amazing figure of 1100 branches nation-wide as stated by the Banking Policy & Regulations Department, State Bank of Pakistan. The growth of IBDs (Islamic Banking Divisions) of conventional banks is also rapid and they are making strides to vie with the dedicated Islamic banks to win maximum customers. The maximum progress banks include Bank Alfalah & Standard Chartered among other foreign conventional banks.

According to a report, up to 2006, registered Islamic banks in Pakistan were six with 99 branches nationwide. (State Bank of Pakistan Islamic Banking Bulletin 2007) The amount of assets held by these Islamic banking institutions was approximately estimated at 1.3 billion US dollars with the total operations at an estimated 2.2% of the aggregate financial and capital markets of the country. The recent statistics of Islamic banking industry in the country speak volumes about robust growth of the system as

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