ECONOMICS OF ISLAM: ISLAMIC PERSPECTIVES OF BANKING IN PAKISTAN

ECONOMICS OF ISLAM: ISLAMIC PERSPECTIVES OF BANKING IN PAKISTAN ABDUL WAHAB ARAIN DR. AHMAD SAEED Research Supervisor, Hamdard Institute of Education and Social Sciences, Hamdard University, Karachi, Pakistan Abstract Economics of Islam, since 14 centuries, is developing on the guidelines of the Holy Book Al- Quran and Shariah-being law and guideline. The concepts, theory and practice of Islamic Financial System are consistent in both the Muslim and Non-Muslim countries. The purpose of this research is to overview the prospects of Islamic Banking System in Pakistan. Another aim of this study is to show scenario of such system to the researchers at local, regional and international level. This paper presents selected literature on the verses of Quran, references from shariah, financial system and banking system. It includes critical analysis of Economics of Islam with special reference to prospects of banking system in Pakistan. The implications for implementation of the suggestions and conclusion may lead to change and improve the existing interest free banking system in Pakistan while providing services to general public in true perspective of Islam. Keywords: Banking, Interest-bearing Banks, Interest-free Banks, Islamic Laws, Islamic World, Riba, Shariah COPY RIGHT 2012 Institute of Interdisciplinary Business Research 478

Definition of Key Terms 1. Banking Islamic Banking System in Pakistan and Other Muslim Countries. 2. Interest-bearing Interest / Riba based banks. Banks 3. Interest-free Banks Islamic Banks. 4. Islamic Laws Shariah Laws of great religion Islam. 5. Islamic World The countries where Islamic rule of Law is practiced in financial matters. 6. Riba Interest for use of money charged and paid to depositors by interest - bearing banks. 7. Shariah Law or jurisprudence of Islam. 1. INTRODUCTION Background The Islamic Banking and Financial System was introduced in Pakistan in 1977-78. There is need for promoting Islamic banking in the country and it requires regulatory framework as per Shariah principle and prohibitation of interest. The history of interest-free banking could be divided into two parts, first, when it was an idea; second, when it became a reality. We will discuss the two periods separately. During the last decade, there seems to be declined in the establishment of new Islamic banks and the established banks seem to have failed to live up to the expectations. The literature of the period begins with evaluations and ends with attempts at finding ways and means of correcting and overcoming the problems encountered by the existing banks. The Economist writes: Muslim theoreticians and bankers have between them devised ingenious ways of coping with the interest problem. One is murabaha. As per Islamic law, one cannot borrow $ 100 million from the bank for one year, at 5% interest, to buy new machinery for the requirement of the factory. For purchasing the machinery, costing to $ 100 million and then buying the stuff from the bank, paying it $ 105 million per year. The difference is that the extra $ 5m is not interest on loan, according to Shariah the bank takes the risk of losing money while it is the owner of the machinery: this is honest trading, as per Quran. Since as per modern communication the bank s ownership may take about few seconds, which involve COPY RIGHT 2012 Institute of Interdisciplinary Business Research 479

small risk, but the transaction is pure. It is not surprising that some Muslims uneasily sniff logicchopping here. In the United States, Mr. Charles Schotte, the US Treasury Department specialist in regulatory issues has remarked: There has never been an application for an Islamic establishment to set up either as a bank or as anything else. In this regard no precedent is available to guide us. However, any bank in the world has to guarantee at least a zero rate of interest and even that might contravene Islamic laws. (ALM 1995). The purpose of economics is also to help realize the humanitarians goals, than the matter may not be just to describe, analyze and predict, but also to compare the actual result with the desired goals. 2. Banking in Economic System of Islam In Pakistan, Islamic Banking and Finance (IB&F) is recognized by both Muslims and non-muslims as an ethical alternative, protecting against the worst excesses of leverage whilst reinstating values, such as trust, which have been lost in conventional finance. A vision leads to the dreams of a society, it is the first step towards the future planning. It is essentially to incorporate the dreams of society about what it would like to be in the future. The motive of the Islamic banking is to realize human well beings. As against the conventional banking, in Islamic finance, lending on the basis of interest in prohibited by the Shariah. The Islamic financial system is driven by trade and production and is intimately linked to the real sector. Islamic banks do not act as pure lenders; they have to be directly involved in trade and investment operations and the trading of debt except at par value. Shariah also prevents Islamic banks from purchasing instruments that carry debtbased credit risks. In addition, Shariah prohibits selling or leasing something which one does not own, and hence excludes the practice of speculative short selling from the Islamic financial system. In essence, the IB&F system derives its fundamental strength from the Shariah COPY RIGHT 2012 Institute of Interdisciplinary Business Research 480

principles, which assure discipline and responsibility in financial activities that are necessary requirements for financial stability. However, even with the strong fundamental Shariah underpinnings, the Islamic financial system is not immune to risks and can be susceptible to financial crises due to a certain reasons. Firstly, as Islamic finance is closely linked to the real sector, unexpected adverse developments in the real sector may adversely affect the business activities and performance of Islamic banks in the absence of robust and effective risk management practices. Risks in the real sector have been declining consistently in the past decades, as shown by recent studies, while risks in the financial sector have been consistently than those that are not. Nevertheless real economic shocks of large magnitude may create systemic risks in the Islamic financial sector. Second, Islamic banks may be influenced to pursue aggressive speculative investment strategies with higher risk and higher expected returns, particularly during economic upturns, without a concomitant adherence to fundamental and sound risk management standards. The main cause of the current crisis was the fundamental combination of aggressive lending and inadequate risk management leading to a breakdown in confidence between counterparties. Dr. Zeti believes that this will be the key to sustaining the resilience of the Islamic financial system in this current and more challenging international financial environment. The key to this is to embrace Shariah innovation in the development of Islamic financial products. In a highly globalised financial market, innovation has been a key differentiating factor to remain competitive. To achieve this objective, it was important, according to Dr. Zeti, to have strong initiatives that promote Shariah-based innovation in Islamic finance. Islamic banking is based on the principles of Islamic economics, an economic framework in accordance with Islamic law (Shariah). In Islamic economics, Caliphate, the Islamic form of government represents the political unity and leadership of the Muslim world (Islamic political Framework). COPY RIGHT 2012 Institute of Interdisciplinary Business Research 481

Islamic banking refers to a system of banking or banking activity that is consistent with Islamic principles and guided by Islamic economics. In particular, Islamic law prohibits usury, the collection and payment of interest, also commonly called riba. Generally, Islamic law also prohibits trading in financial risk (which is seen as a form of gambling). In addition, Islamic law prohibits investing in businesses that are considered unlawful, or haraam. Islamic finance has been gaining momentum of a global scale for the last 30 years. Many Islamic Banks have sprung-up over the last few years. These changes are occurring both in Muslim and in western countries, and are driven by a global trend amongst Muslims to become more observant of their faith. It might have been the reason why Islamic Banking emerged, however, today Islamic Banking is sought by Muslims and non-muslims die to the benefits it offers. Industry size is currently estimated at more than $400 billion, with projected growth of 15% per annum. Financial institutions around the globe are trying to keep pace with the growing demand for Sharia h complaint products and services. 3. Economics of Islam The Islamic system is based upon the principle of human brotherhood, social and economic justice and equitable distribution of income and individual freedom related to social welfare. On the contrary, under capitalism or socialism, neither social and economic justice nor equitable distribution of income is fully achieved. Besides, human brotherhood can not be ensured without spirituality, also individual dignity, identity and individual freedom is lost. In a market free mutual consent of the buyer and seller, is necessary for any business transaction, according to Islamic jurisprudence. In the light of the following verse of the Holy Qura n, Oh you who have faith, devour not the property of anyone of you wrongfully, except that it be tracing by your mutual consent. (4:29). The Holy Prophet (P.B.U.H) said, leave people alone for God gives them provision through each other. Due to this spirit of freedom in the Islamic way of life, conduct of a large part of the production and distribution of goods & services is left to individuals or groups to freely sell and buy the commodities at an agreeable price. The market mechanism is also integral part of Islamic economic system. COPY RIGHT 2012 Institute of Interdisciplinary Business Research 482

In the Holy Qura n, Sunnah and fiqh, significance of the matters related to purchase and sale of merchandise, acquisition and disposal of property, the institution of private ownership have been recognized by Islam, however, it is to be considered as a trust (Amanah) from Allah, because everything belongs to Allah, the Almighty, as Qura n says, To God belongs whatever is in the heavens and whatever is in the earth (2:284). Goals and values These goals and values are: i) Economic well-being within the framework of the moral norms of Islam; ii) iii) iv) Universal brotherhood and justice; Equitable distribution of income; and Freedom of the individual within the context of social welfare. 4. What Islamic Banking is? The Banking system that is consistent with the principles of Islamic law (Shariah), is called Islamic Banking System. The banking system wherein the banking transaction are without Interest / Riba, besides ensuring that all the dealings and affairs of the banking must be according to the Islamic Law / Shariah, is called Islamic Banking. According to Dr. Rafique Younus Misry: Bank can not become Islamic by not using Harram (Unfair) affairs / dealings only but for complete Islamization, it is essential that the bank must run its affairs, and exercise its authority fully consistent with the Islamic principles, i.e. the banking transactions must be without uncertainty, the terms and conditions should be clearly stated while entering into any contract. COPY RIGHT 2012 Institute of Interdisciplinary Business Research 483

The fundamental objections of Islamic economy against interest. Whether for consumption or a reproduction of loan is that it is not fairly earned. The family, the society and the state all have a role to play in human well being, then the question arises as to how they play their role in a befitting manner and does not hinder the effective performance of their role by others. Objectives of Islamic Banking i) To help Muslims execute financial dealings in social value of Shariah. ii) iii) To serve Muslim community in mobilization and utilization of financial resources. To serve Islamic communities in strengthening the economic ability. Sources of Receiving Investment There are the following two sources of receiving investment:- a) Loan. b) Mudarabah or participation. Like conventional banks, the Islamic banks also have two types of Accounts, namely; i) Current Accounts, bearing no profit. ii) Profit & Loss accounts, bearing profit on different schemes on the basis of Mudarabah. Sources of Financing There are the following sources of financing. i) Murabaha. ii) Ijarah. iii) Mushariqah Mutanaqisah. iv) Tawaruq. v) Salam. vi) Istisnah. COPY RIGHT 2012 Institute of Interdisciplinary Business Research 484

Since there is no profit to the Islamic banks, it does not issue loans (Qarse- Hasanah). As per the existing practice, the Islamic banks adopt Musharakah and Mudarabah on deposit side, but do not normally provide loan to their clients, due to certain unavoidable circumstances, and instead, financing is done through Murabaha, Ijarah, Salam or have Musharakah etc. however, sometimes the banks adopt Musharakah in exports, being less risky. Direct Investment The Islamic banks invest their capital in the following business. i) Purchase & sale of shares of different companies. ii) Invest in important projects. iii) Enter into business through their subsidiary companies. iv) Purchase & sale of different currencies. 5. Islamic Financial Transactions - Financial Institutions:- The following financial transactions are dealt with by the Islamic Banks and Bai-Muajjal: It is a contract of sale on credit, in which the seller earns profit on his purchase price but the buyer pays the price of the commodity in future, in lump sum or in installments. He has to mention cost of the commodity and the margin of profit agreed mutually in advance. 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. (Ayub 2009) Mudaraba: Mudaraba is an agreement between two parties, one provides funds and the other provides necessary management. The first party is called Rabbul Maal and the second is called the Mudaraba. Both the parties share profit whereas in case of loss the responsibility rests without provider of the capital. (Ayub 2009) COPY RIGHT 2012 Institute of Interdisciplinary Business Research 485

Musharaka: Musharakah means Shirkah (or sharing).for the joint business on Profit and Loss Sharing basis. Under this agreement, the Islamic Bank provides funds for the business. The profit is distributed among the partners in pre-agreed ratios, but in case of loss, all the partners are responsible according to their proportion of capital contribution. It is an alternate of the interest based financing, having positive effects on both production as well distribution (Usmani-2, 2008). Ijara: Ijara is sale of any asset against a definite cost. It is a contract of leaseing of an asset at a fixed rent payable in cash. It has been adopted as a mode of financing by the Islamic Banks, but it it is not originally a mode of financing. Under this arrangement, the Islamic Banks lease the equipments, buildings or other facilities to a client, against an agreed rental. (Usmani-2 2008) Murabaha: Murabah means sale on mutually agreed profit. It is a contract of sale in which the seller declares his cost and the profit. This has been adopted by Islamic Banks as a mode of financing, wherein; the client requests the bank to purchase a certain item for him, which the bank provides him for a definite profit over the cost as agreed in advance. (Usmani-2 2008) Musawama: Musawama is a type of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former. (Ayub 2009) Bai Salam: Salam is used as a mode of financing, under which, advance payment is made for goods to be delivered at a future date. 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. According to Shariah Laws, no sale can be effected unless the goods are in existence at the time of the bargain, but Salam sale forms an exception given by the Holly Prophet (SAW) himself to COPY RIGHT 2012 Institute of Interdisciplinary Business Research 486

the general rule provided the goods are defined and the date of delivery is fixed. 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 because these are regarded as monetary values; exchange of which is covered under rules of Bai al Sarf, i.e. mutual exchange is hand to hand without delay. Barring this, Bai Salam covers almost everything which is capable of being definitely described as to quantity, quality and workmanship. (Ayub- 2008). Istisna: It is a kind of sale transaction where a commodity is transacted before its coming into being. Under Istisna, a manufacturer is asked to manufacture a specific commodity for the purcher at a fixed price on a given date in future, the manufacturer or builder agrees to produce or build good or building at a given price in future. Price can be paid in installments, step by step as agreed between the parties. Istisna a can be used for providing the facility of financing the manufacture or construction of houses, plants, projects, and building of bridges, roads and highways. The present day BOT (Build Operate and Transfer) agreements may be completed through Istisna (Usmani-2 2008) 6. Banking Services The Islamic Banks provide the following banking services to their clients:- The banking services include; i) Issuing guarantee letters. ii) Opening L.C iii) Issuing Drafts. iv) Encashing the Bills of Exchange. v) Providing locker service to the clients. COPY RIGHT 2012 Institute of Interdisciplinary Business Research 487

7. Present State of Affairs of Islamic Banking Although, so many Islamic banks have set up their business and are running successfully, yet it is a fact that Murabaha as a method of purchase and sale and Ijarah as a contract of utilizing anything are working successfully in the bank, but these are not the modes of financing according to the Shariah, being not profitable in distribution of wealth. As such, it is necessary that the alternative to this system is the participation in Profit & Loss or advancing loans on the Qarse-Hasanah basis. 8. Islamic Banks in Pakistan In Pakistan, the under-mentioned banks are functioning and providing their services on Islamic Financial System:- (i) Meezan Bank Limited (Over 300 Branches in 90 Cities). (ii) Al Baraka Bank formerly Emirates Global Islamic Bank, 50 Branches in 25 Cities. (iii) (iv) Bank Islami Pakistan Limited (102 Branches in 49 cities). Dubai Islamic Bank Pakistan Limited (100 Branches). (v) Burj Bank Limited, formerly Dawood Islamic Bank Limited, (50 Branches in 17 cities). 9. Suggestions The following suggestions are given for running the Islamic Financial System according to Islamic Laws:- i. The states need to prepare a strategy that the Islamic banks necessarily advertise their products and services to meet people s expectations to raise the number of customers. ii. Pakistan and other Muslim states need to shape policies of Islamic Banking and Bank s services according to Shariah Law under International co-operation to ensure that customers investments are operated on Islamic principles / law. iii. Islamic Monetary Fund an international organization is need of the time to be established to support financial institutions. COPY RIGHT 2012 Institute of Interdisciplinary Business Research 488

iv. The facts / literature shows that the banking services are not fully islamized, due to implementation problems, hence it is imperative that all the Islamic Banks and the conventional Banks, which are operating Islamic Banking counters, need to adopt a uniform policy to implement the Interest-free Banking System as a mandatory to Islamic States. v. Participatory financing is a unique feature of Islamic Banking, and can offer responsible financing to socially and economically relevant development projects. This is an additional service Islamic banks offer over and above the traditional services provided by conventional commercial banks. vi. Interest groups and Researchers working in the field of Islamic Banking need to provide opportunities to conduct research studies according to the community needs on the principles of Islamic Laws. 10. Conclusion Islamic banking is a very young concept. It has already been implemented in few Muslim countries; there are Islamic banks in many Muslim countries and a few in non-muslim countries as well. Despite the successful acceptance there are problems, these problems are mainly in the area of financing. With only minor changes in their practices, Islamic banks can get rid of all the problems relating to financing and offer a clean and efficient interest-free banking. The present Islamic Banking system may be modified according to Shariah Laws using only two forms of financing, (i) loans with a service charge and (ii) Mudaraba participatory financing both of which are acceptable to all the Muslim Scholars. Islam focuses on people and their desires, rather than production. All the Shariah rules increment each other. This means Islamic banking system is more than proficient of being practical and impact has a flourishing history of dealing with economic issues. Such a system will offer an effective banking system where Islamic banking is obligatory and a powerful alternative to conventional banking where both co-exist. Additionally, such a system will have no problem in obtaining authorization to operate in non-muslim countries. COPY RIGHT 2012 Institute of Interdisciplinary Business Research 489

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