Introduction to Islamic Banking

The term Islamic banking refers to a banking activity or a system of banking that is in consonance with the basic principles of Islamic Shraiah(rules and values set by Islam). Islamic banking is also known as interest free banking system as the Shariah disallows the acceptance of Riba or interest rate for the accepting and lending of money. In Islamic banking system, a business that offers good interest rates or services is strictly prohibited and it is in fact considered Haraam(forbidden). Islamic banking offers the same facilities as conventional banking system except that it strictly follows the rules of Shariah or Fiqh al- Muamlat.

The Origin, History and Evolution of Islamic Banking

The origin of Islamic banking system can be traced back to the advent of Islam when the Prophet himself carried out trading operations for his wife. The Mudarbah or Islamic partnerships has been widely appreciated by the Muslim business community for centuries but the concept of Riba or interest has gained very little diligence in regular or day-to-day transactions. The first model of Islamic banking system came into picture in 1963 in Egypt. Ahmad Al Najjar was the chief founder of this bank and the key features are profit sharing on the non interest based philosophy of the Islamic Shariah. These banks were actually more than financial institutions rather than commercial banks as they pay or charge interest on transactions. In 1974, the Organization of Islamic Countries (OIC) had established the first Islamic bank called the Islamic Development Bank or IDB. The basic business model of this bank was to provide financial assistance and support on profit sharing. By the end of 1970, several Islamic banking systems have been established throughout the Muslim world, including the first private commercial bank in Dubai(1975), the Bahrain Islamic bank(1979) and the Faisal Islamic bank of Sudan (1977).

Islamic Banking In Pakistan

Pakistan has a protracted history of Islamic banking with the initial attempt to Islamize banking system in 1980s, leading to sweeping changes in the Banking Companies Ordinance, 1962 (BCO62) and associated laws and regulations to accommodate non-interest based banking transactions. Some specific developments around this period are noteworthy: In 1979, two Government-owned mutual funds in Pakistan, the NIT and ICP, started to eliminate interest from their operations by eschewing investment of their funds in interest bearing securities. Investor scheme of ICP was substituted as from October 1, 1980 by a new scheme based on profit and loss sharing. The state-run House Building Finance Corporation (HBFC) also eliminated interest from its operations from July 1, 1979. In June 1980, legal framework was amended to permit issuance of a new, interest-free

instrument of corporate financing called Participation Term Certificate (PTC). A new law, namely, the Modaraba Companies and Modarabas Ordinance, 1980 along with the Modaraba Companies and Modaraba Rules, 1981 was promulgated to introduce modarabas, as a two-tier fund structure, for undertaking Shariah compliant businesses. In 1984, the Banking and Financial Services Ordinance, 1984 amended seven laws and Banking Tribunals Ordinance, 1984 provided a new system of recovery of non-interest based modes of financing. From January 1, 1981, separate interest-free counters started operations in all the nationalized commercial banks to mobilize deposits on profit and loss sharing basis. Concurrently, banks were prohibited from specified interest based transactions, which resulted in development of Islamic modes of financing. Finally, SBP issued BCD Circular No. 13 of 1984 that called for elimination of Riba from the banking system and in January 1, 1985 all financing to Federal and Provincial Governments, public sector corporations and public or private joint stock companies was directed to be only through interest-free modes. From July 1, 1985 all commercial banking in Pak Rupees was made interest free.3 Resultantly, profit and loss sharing (PLS) deposits, as a percentage of total deposits, rose from 9.2% at the end of 1981 to 61.6% by end of 1985. These measures resulted in a country-wide roll out of Islamic banking. However, the premature and sudden conversion of banking system to Islamic system coupled with the lack of preparedness and understanding among financial institutions and public posed difficultly in implementation. The Federal Shariat Court challenged some emerging products and processes and declared them un-Islamic. The Shariat Appellate Bench of the Supreme Court upheld the decision of the Federal Shariat Court and offered guidelines to address the issues involved, setting a timeline for implementation. This decision was later set aside in a review petition filed by the United Bank. In recent years, Islamic banking and finance in Pakistan has experienced phenomenal growth. Islamic deposits held by fully-fledged Islamic banks and Islamic windows of conventional banks at present stand at 9.7% of total bank deposits in the country: meaning that every 10th rupee is now being deposited in an Islamic bank account. Similarly, assets managed by banks offering Islamic financial services are 8.6% of total banking assets in the country. Net Islamic savings and investments are 8.19% of the total savings and investment in the banking sector in Pakistan. Total Islamic banking assets in Pakistan stand at Rs837 billion ($8.5 billion), which is only a fraction of the total global Islamic financial assets of $1.631 trillion. Once considered a global powerhouse for Islamic financial thinking, Pakistan is now far behind a number of other countries, which have expended more energy into developing the Islamic banking and finance sector. The Government of Pakistan has given the Islamic banking project to the State Bank of Pakistan (SBP), the central bank, which has very ably helped Islamic banking and finance grow

by issuing guidelines to conduct Islamic banking business, and regulating and supervising the institutions offering Islamic banking and finance. The government, however, has failed to develop the country as a centre of excellence for Islamic banking and finance, despite it having a number of strengths especially in ensuring Shariah authenticity of financial products. Pakistan maintains a very strict view on Shariah matters, and the SBP has ensured that no controversial practices creep into the countrys Islamic banking and finance sector. It was because of this strict Shariah supervision and control by the SBP (along with the Shariah advisory board of a Pakistani Islamic bank, BankIslami) that BankIslami won the prestigious Shariah Authenticity Award at the Global Islamic Finance Awards held in Kuala Lumpur in November 2012. This strength in Islamic banking should be further developed to make Pakistan as a centre of excellence for Shariah authenticity in the global industry. Currently there are six licensed fully fledged Islamic Banks and twelve conventional banks with standalone Islamic Banking Branches in Pakistan. Islamic banking department of state bank of Pakistan controls all the activities of Islamic banks. There are many Islamic banks working in Pakistan. The list of banks is given below: Dubai Islamic Bank Pakistan Ltd Al-Baraka Bank Pakistan Ltd Bank Alfalah Islamic Banking Meezan Bank Limited Standard Chartered Bank (Islamic Banking) Askari Bank Ltd (Islamic Banking) MCB Islamic Baking UBL Islamic Banking HBL Islamic Banking National Bank of Pakistan NBP Islamic Banking Bank Al Habib Islamic Banking Burj Bank Limited Pakistan Dawood Islamic Bank Limited Emirates Global Islamic Bank Limited