working with islamic finance

7/25/2019 Working With Islamic Finance

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Working With Islamic

FinanceIslamic 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 ofsocially 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 bankingand

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.
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Central to Islamic banking and finance is an

understanding of the importance of risk sharing as part

of raising capital and the avoidance ofriba(usury)

andgharar(risk or uncertainty). (To see more on risk,

readDetermining Risk And The Risk

PyramidandPersonalizing Risk Tolerance.)

Islamic law views lending withinterestpayments 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.

Deemedriba(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 itunderwrites. Of equal importance is the

concept ofgharar. Defined as risk or uncertainty, in a
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financial context it refers to the sale of items whose

existence is not certain. Examples ofghararwould be

forms of insurance, such as the purchase ofpremiumsto

insure against something that may or may not occur

orderivativesused tohedgeagainst possible outcomes.

(To read more about insurance or hedges, seeA

Beginner's Guide To Hedging,Understand Your

Insurance ContractandExploring Advanced Insurance

Contract Fundamentals.)

Theequity financingof 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 andassumes a share of the profits and losses. This is

agreed upon with the depositors. What does the

bank invest in? A group ofmutual fundsscreened for
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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 toactively

managedmutual funds,passiveones 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, seeReading The Balance

Sheet,Breaking Down The Balance

SheetandUncovering 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, thedeclining balance

methodcalls 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.
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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 thelessormust own the leased

object for the duration of thelease. A variation on

the lease,'ijarah wa 'iqtinaprovides for a lease to be

written whereby the lessor agrees to sell the leased

object at the lease's end at a predetermined residual
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value. Only the lessor is bound by this promise.

Thelessee, by contrast, is not obligated to

purchasing the item.

4.Islamic Forwards(salamand'istisna): These are

rare forms of financing, used for certain types of

business. These are an exception togharar. 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 bydirect investment (private equity). Islamic scholars

have made some concessions on permissible

companies, as most use debt either to address
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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 toor 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 wanttheir investments to comply with the tenets of

Islam face a dilemma in thatfixed-

incomeinvestments includeriba, which is

forbidden. Therefore, specific types of

investment in real estate, either directly or

insecuritizedfashion (a diversified real estate

fund), could provide steady retirement income

while not running afoul of Sharia law.
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b.Sukuk. In a typicalijara sukuk(leasing bond-

equivalent), 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 asLIBOR. The

issuer makes a binding promise to buy back thebonds at a future date atpar value.Special

purpose vehicles(SPV) are often set up to act

as intermediaries in the transaction.

Asukukmay be a new borrowing, or it may be

the Sharia-compliant replacement of a

conventional bond issue. The issue may evenenjoy 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
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management in Islamic law. This is because it

constitutes the purchase of something with an uncertain

outcome (form ofghirar), and because insurers use fixed

income - a form ofriba- as part of their portfolio

management process to satisfyliabilities.

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.

ConclusionIslamic 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 defned as banking in

consonance with the ethos and value system o Islam and

governed, in addition to the conventional good

governance and risk management rules, by the principleslaid down by Islamic Shariah.1!

"he ob#ective o Islamic banking system is to make a

positive contribution to the ulfllment o socioeconomic

ob#ectives o the society in all spheres, including trade,

industry $ agriculture etc.2!in general, is to promote,

oster and develop the application o Islamic principles,law and tradition to the transaction o fnancial, banking

and related business a%airs and to promote investment

companies. Islamic banks accept deposits which they can

either commit to investment or general deposits. "hey

also have investment accounts with or without

authori&ation. Banks engage in investment activities

based on Musharakah 'e(uity

participation) Mudarabah or Qirad 'agencies), Murabaha,

Bai' Salam 'post delivery sale) and*or leasing

arrangements especially or e(uipment. +n the lending


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side, Islamic banks issued a number o new lending

instruments such asAl Muqarada proft bonds to fnance

large pro#ects andAl-Mudarabah certifcates which were

not issued or specifed pro#ects. Islamic banks practice

conventional short term fnancing on a proft*loss basis.!

2.2 PHILOSOPHY OF ISLAMIC BANKING AND FINANCE

"he prohibition o interest by Islam is the base o the

development o Islamic Banking -helosopghy. "he Islamic

system order based on a set o principles constituting the

concept and philosophy as enunciated eplicitly in the

/uran."his philosophy provides what can be understood

as the Islamic system o social #ustice. 0!In Islamic law

some gain has been prohibited which are generally fed

or i there is no concept o risk shearing. onventional

inance believes in return without risk, whilst Islamic

inance prohibits the latter and enorces the opposite.3!

Islam prohibits interest but it does not means, that it

prohibits all gains on capital. "he only increase stipulated

or sought over the principle loan or debt is prohibited in

Islamic sharia law. Islamic principles simply re(uire that

perormance o capital should also be considered while

rewarding the capital. "he prohibition o a risk ree returnand permission o trading, as enshrined in the 4oly

/uran1!, makes the fnancial activities in an Islamic set5

up real asset5backed with ability to cause 6value addition7.

8!


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

sense o morality and e(uity because earning profts

inherently involves sharing risks and rewards.9!Islam

encourages shearing o risk among lender and borrower,

Islamic fnancing system is based on this principle, it has

also another character o owing and handing o real

assets, its involvement in trading, construction and

leasing using Islamic mode o fnancing. :s such, Islamic

banks deal with asset management or the purpose o

income generation. "hey will have to prudently handlethe uni(ue risks involved in management o assets by

adherence to best practices o corporate governance.

+nce the banks have stable stream o 4alal income,

depositors will also receive stable and 4alal income.;!

-roft has been recogni&ed as 6reward7 or 'use o) capital

and Islam permits gainul deployment o surplusresources or enhancement o their value. 4owever, along

with the entitlement o proft, the liability o risk o loss on

capital rests with the capital itsel< no other actor can be

made to bear the burden o the risk o loss. inancial

transactions, in order to be permissible, should be

associated with goods, services or benefts. :t macro

level, this eature o Islamic fnance can be helpul in

creating better discipline in conductive o fscal and

monetary policies.=!


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:ll such things*assets corpus o which is not consumed

with their use can be leased out against fed rentals. "he

ownership in leased assets remains with the lesser that

assumes risks and gets rewards o his ownership. "he

institution may either rent the e(uipment or receive a

share o the profts earned through its use< Islamic leasing

'I#ara wal I(tina) are the same as I#arah ecept that the

lessee can ac(uire ownership o the asset by making

installment payment.1>!

2.3 MAJOR MODES OF ISLAMIC BANKING AND FINANCE

ollowing are the main modes o Islamic banking and

fnance?

1. Murabaha

@iterally it means a sale on mutually agreed proft.

"echnically, it is a contract o sale in which the seller

declares his cost and proft. Islamic banks have adoptedthis as a mode o fnancing. :s a fnancing techni(ue, it

involves a re(uest by the client to the bank to purchase

certain goods or him. "he bank does that or a defnite

proft over the cost, which is stipulated in advance.11!

2. Ijara

I#ara is a contract o a known and proposed usuructagainst a specifed and lawul return or consideration or

the service or return or the beneft proposed to be taken,

or or the e%ort or work proposed to be epended. In

other words, I#ara or leasing is the transer o usuruct or


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

things and wage in case o hiring o persons.12!

3. Ijarah-Wal-Iqtina

: contract under which an Islamic bank provides

e(uipment, 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 o the lease

period, the ownership in the asset would be transerred to

the lessee. "he undertaking or the promise does not

become an integral part o the lease contract to make itconditional. "he rentals as well as the purchase price are

fed in such manner that the bank gets back its principle

sum along with proft over the period o lease.1!

4. Istisna

It is a contractual agreement or manuacturing goods

and commodities, allowing cash payment in advance and

uture delivery or a uture payment and uture delivery.

Istisna7a can be used or providing the acility o fnancing

the manuacture or construction o houses, plants,

pro#ects and building o bridges, roads and highways.10!

5. Bai Muajjal

@iterally it means a credit sale. "echnically, it is a

fnancing techni(ue adopted by Islamic banks that takes

the orm o Aurabaha Aua##al. It is a contract in which the

bank earns a proft margin on his purchase price and

allows the buyer to pay the price o the commodity at a


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

epressly mention cost o the commodity and the margin

o proft is mutually agreed. "he price fed or the

commodity in such a transaction can be the same as the

spot price or higher or lower than the spot price.13!

6. Mudarabah

: orm o partnership where one party provides the unds

while the other provides epertise and management. "he

latter is reerred to as the Audarib. :ny profts accruedare shared between the two parties on a pre5agreed

basis, while loss is borne only by the provider o the

capital.18!Aurabaha in tandem with Bai Aua##al is a

useul means o fnancing in the Islamic Aortgages arena.

It allows the Bank to purchase the house at spot price and

then sell it to the client over a deerred period thereby

generating a proft or the Bank.19!

7. Musharakah

Ausharakah means a relationship established under a

contract by the mutual consent o the parties or sharing

o profts and losses in the #oint business. It is an

agreement under which the Islamic bank provides unds,which are mied with the unds o the business enterprise

and others. :ll providers o capital are entitled to

participate in management, but not necessarily re(uired

to do so. "he proft is distributed among the partners in


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pre5agreed ratios, while the loss is borne by each partner

strictly in proportion to respective capital contributions.

1;!

8. Bai Salam

Salam means a contract in which advance payment is

made or goods to be delivered later on. "he seller

undertakes to supply some specifc goods to the buyer at

a uture date in echange o an advance price ully paid

at the time o contract. It is necessary that the (uality othe commodity intended to be purchased is ully specifed

leaving no ambiguity leading to dispute. "he ob#ects o

this sale are goods and cannot be gold, silver or

currencies. Barring this, Bai Salam covers almost

everything, which is capable o being defnitely described

as to (uantity, (uality and workmanship.1=!

. !ard "assan #$%%d &%an'

"his is a loan etended on a goodwill basis, and the

debtor is only re(uired to repay the amount borrowed.

4owever, the debtor may, at his or her discretion, pay an

etra amount beyond the principle amount o the loan

'without promising it) as a token o appreciation to the

creditor. In the case that the debtor does not pay an etraamount to the creditor, this transaction is a true interest5

ree loan. Some Auslims consider this to be the only type

o loan that does not violate the prohibition on riba, since


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

the creditor or the time value o money.2>!

2.4 RATIO OF PROFIT

"here is a di%erence o opinion among the Auslim #urists

about the atio o -roft.

In the view o Imam Aalik and Imam Shafi, it is necessary

or the validity o Ausharaka that each partner gets the

proft eactly in the proportion o his investment.

"hereore, i : has invested 0>C o the capital, he mustget 0>C o the proft. :ny agreement to the contrary

which makes his entitled to get more or less than 0>C

will render the musharkah invalid in Shariah.

+n the contrary, the view o Imam :hmad is that the

ratio o proft may di%er rom the ratio o investment i it

is agreed between the partners with their ree consent."hereore, it is permissible that a partner with 0>C o

investment gets 8>C or 9>C o the proft, while the other

partner with 8>C o the investment gets only 0>C or

>C.

"he third view is presented by Imam :bu 4aniah which

can be taken as a via media between the two opinionsmentioned above. 4e says that the ratio o proft may

di%er rom the ratio o investment in normal conditions.

4owever, i a partner has put an epress condition in the

agreement that he will never work or the musharkah and


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will remain a sleeping partner throughout the term o

musharkah, then his share o proft cannot be more than

the ratio o his investment. 21!

2.5 ISLAMIC FINANCING AND ITS GLOBAL EVOLUTION

:s with all things Islamic, the origination o Islamic

fnance goes back to the time o

-rophet Auhammad (Peace be upon Him). "he /ur7an

and the eample o -rophet

Auhammad (Peace be upon Him) provide directbehavioral guide and represent bedrock o Islamic aith to

over one billion Auslims globally. "he -rophet

Auhammad (Peace beupon Him) happened to be a

businessman serving as a trader or Dhadi#a (May Allah

bepleased i!h Her). "he -rophetic eample was the

very epitome o air5trade. eraining rom usury,ensuring transparency in transactions, and total honesty

entitled him :l5 :min '"he trustworthy) in pre5Islamic

:rabia22!

Euring the Islamic Folden :ge,early orms o proto5

capitalism and ree marketswere present in the

aliphate< the frst modern eperiment with Islamicbanking was undertaken in Ggypt under cover, without

pro#ecting an Islamic image, or ear o being seen as a

maniestation o Islamic undamentalism which was

anathema to the political regime. "he pioneering e%ort,


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led by :hmad Gl Ha##ar, took the orm o a savings bank

based on proft5sharing in the Ggyptian town o Ait Fhamr

in 1=8. "his eperiment lasted until 1=892!, by which

time there were nine such banks in the country. "hese

banks, which neither charge nor paid interest, invested

mostly by engaging in trade and industry, directly or in

partnership with others, and shared the profts with their

depositors.20!

But some views whows that the frst modern Islamic

modern banking institution stablished in -akistan in 1=3>.

:s a ormer credit nion. "his was frst Islamic fnancing

movement. sing this idea Ait Fhamr saving Bank

emerged as a rural institution in Ggypt in 1=8. 23!:t

meeting o oreign minister o Islamic countries in Darachi

-akistan in 1=9>, -akistan and Ggypt #ountly proposed or

the establishment o international Islamic Bank or tradeand development this again discussed in 1=9 with

Bangh&i '@ibya) in a meeting which urther suggested or

constituting a committee o eperts or designing this

international Islamic Bank. "his was fnally established in

1=92 as Islamic Eevelopment Bank in Jeddah Saudia

:rabia.28!"he IEB was established in 1=90 by the

+rgani&ation o Islamic ountries '+I), but it was

primarily an intergovernmental bank aimed at providing

unds or development pro#ects in member countries. "he

IEB provides ee based fnancial services and proft5


21/35

sharing fnancial assistance to member countries. "he IEB

operations are ree o interest and are eplicitly based

on Shariahprinciples. 29!

In the seventies, changes took place in the political

climate o many Auslim countries so that there was no

longer any strong need to establish Islamic fnancial

institutions under cover. : number o Islamic banks, both

in letter and spirit, came into eistence in the Aiddle

Gast,2;!. :ter that, numbers o Islamic Bank established

in di%erent Islamic countries. Eubai Islamic Bank in 1=93

in Eubai, aisal Islamic Bank in Ggypt and Sudan in 1=92,

Duwait inance 4ouse in 1=99. Jordan Islamic Bank in

1=9; and Bahrain Islamic Bank in 1=9=2=!

Islamic banking made its debut in Aalaysia in 1=;, but

not without antecedents. "he frst Islamic fnancial

institution in Aalaysia was the Auslim -ilgrims Savings

orporation set up in 1=8 to help people save or

perorming ha""'pilgrimage to Aecca and Aedina). In

1=8=, this body evolved into the -ilgrims Aanagement

and und Board or the "abung 4a#i as it is now popularly

known. "he "abung 4a#i has been acting as a fnance

company that invests the savings o would5be pilgrims inaccordance with Shariah, but its role is rather limited, as

it is a non5bank fnancial institution. "he success o the

"abung 4a#i, however, provided the main impetus or

establishing Bank Islam Aalaysia Berhad 'BIAB) which


22/35

represents a ull Kedged Islamic commercial bank in

Aalaysia. "he "abung 4a#i also contributed l2.3 per cent

o BIABLs initial capital o AM;> million. BIAB has a

complement o ourteen branches in several parts o the

country. -lans are aoot to open si new branches a year

so that by 1==> the branch network o BIAB will total

thirty5three >!

eerence should also be made to some Islamic fnancial

institutions established in countries where Auslims are a

minority. "here was a prolieration o interest5ree savings

and loan societies in India during the seventies. 1!"he

Islamic Banking System 'now called Islamic inance

4ouse), established in @uembourg in 1=9;, represents

the frst attempt at Islamic banking in the Nestern world.

"here is also an Islamic Bank International o Eenmark, in

openhagen, and the Islamic Investment ompany hasbeen set up in Aelbourne, :ustralia.2!

2.6 HISTORY OF ISLAMIC BANKING IN PAKISTAN

-akistan now recogni&ed one o the Islamic fnance

industries in the Norld. Auhammad :li Jinnah as early

1=0;, emphasi&ed on Islamic principles in his address at

inauguration o State Bank o -akistan he said.

(I shall )at*h )ith k++nn+ss th+ )%rk %, %ur r/ani0ati%n in +%lin/bankin/ ra*ti*+s *%matibl+ )ith Islami* id+as %, s%*ial and +*%n%mi*

li,+. W+ must )%rk %ur d+stin in %ur %)n )a and r+s+nt t% th+ )%rld an


23/35


24/35

necessary amendments were made in the related laws

permitting the State Bank to provide fnance against

-articipation "erm ertifcates and also etend advances

against promissory notes supported by -"s and

Audarabah ertifcates. rom July 1, 1=;2 banks were

allowed to provide fnance or meeting the working

capital needs o trade and industry on a selective basis

under the techni(ue o Aishawaka.9!

:s rom :pril 1, 1=;3 all fnances to all entities including

individuals began to be made in one o the specifed

interest5ree modes. rom July 1, 1=;3, all commercial

banking in -ak upees was made interest ree.;!

rom that date, no bank in -akistan was allowed to accept

any interest5bearing deposits and all eisting deposits in

a bank were treated to be on the basis o proft and loss

sharing. Eeposits in current accounts continued to be

accepted but no interest or share in proft or loss was

allowed to these accounts.

4owever, oreign currency deposits in -akistan and on5

lending o oreign loans continued as beore. "he State

Bank o -akistan had specifed 12 modes o non5interest

fnancing classifed in three broad categories.

4owever, in any particular case, the mode o fnancing to

be adopted was let to the mutual option o the banks

and their clients. "he procedure adopted by banks in


25/35

-akistan since July 1 1=;3, based largely on 6mark5up7

techni(ue with or without 6buy5back arrangement7, was,

however, declared un5Islamic by the ederal Shariat ourt

'S) in Hovember 1==1. 4owever, appeals were made in

the Shariat :ppellate Bench 'S:B) o the Supreme ourt

o -akistan.=!

"he ommission or "ransormation o inancial System

'"S) was constituted in January 2>>> in the State Bank

o -akistan under the hairmanship o Ar. I.:. 4anf, a

ormer Fovernor State Bank o -akistan.0>!

: "ask orce was set up in the Ainistry o inance to

suggest the ways to eliminate interest rom Fovernment

fnancial transactions. :nother "ask orce was set up in

the Ainistry o @aw to suggest amendments in legal

ramework to implement the ourt7s Judgment. "he "S

constituted a ommittee or Eevelopment o inancial

Instruments and Standardi&ed Eocuments in the State

Bank to prepare model agreements and fnancial

instruments or new system.

"he 4ouse Building inance orporation had shited its

rent sharing operations to interest based system in 1=;=.

01!"he "ask orce o the A*+ @aw proposed amendments

in the 4B :ct to make it Shariah ompliant. 4aving

vetted by the "S, the amended law has been

promulgated by the Fovernment. :ccordingly, the 4B


26/35

launched in 2>>1 :saan Fhar Scheme in the light o

amended +rdinance based on the Eiminishing Ausharaka

concept. : ommittee was constituted in the Institute o

hartered :ccountants, -akistan 'I:-), wherein the SB-

was also represented, or development o accounting and

auditing standards or Islamic modes o fnancing. "he

ommittee is reviewing the standards prepared by the

Bahrain based :ccounting and :uditing +rgani&ation or

Islamic inancial Institutions '::+II) with a view to adapt

them to our circumstances and i considered necessary,to propose new accounting standards.

It was decided in September 2>>1 that the shit to

interest ree economy would be made in a gradual and

phased manner and without causing any disruptions. It

was also agreed that State Bank o -akistan would

consider or?

1. Setting up subsidiaries by the commercial banks or

the purpose o conducting Shariah compliant

transactions>1 or establishment o ull5Kedged Islamic

commercial banks in the private sector. "he Aee&an Bank

was granted a 6Scheduled Islamic ommercial Bank7

license on January 1, 2>>2, and ormally commenced

operations as a Scheduled Islamic ommercial Bank with

e%ect rom Aarch 2>, 2>>2, on receiving notifcation in

this regard rom the State Bank o -akistan 'SB-) under

section 9 o the State Bank o -akistan :ct, 1=38.

urrently, the Bank is engaged in corporate, commercial,onsumer, investment and retail banking activities.

urther, all ormalities relating to the ac(uisition o

Societies Feneral, -akistan by the AB@ were completed,

and by June, 2>>2 it had a network o 3 branches all over

the country, three in Darachi, one in Islamabad and one in

@ahore.0!

"he Fovernment as also the State Bank is mainly

concerned with stability and eOciency o the banking

system and saeguarding the interests, particularly, o

small depositors. Nith this concern in mind it has been

decided to operate Islamic banking side by side with

traditional banking. "he approach is to institute best

practice legal, regulatory and accounting rameworks tosupport Islamic banks and investors alike. "he year 2>>25

2>> witnessed strengthening measures taken in the

areas o banking, non5bank fnancial companies and the

capital markets.


28/35

2.7 ROLE OF ISLAMIC BANKING IN THE DEVELOPMENT

OF THE COUNTRY

Islamic banks and fnancing perorming according to the

sharia law, those are helpul or mobili&ation o resources,and their use in right manner. -@S 'Ausharaka and

Audarabah) and non5-@S 'trading $ leasing) based

categories o modes and strengthening the payments

systems to contribute signifcantly to economic growth

and development.00! Islamic mode o fnancing system

o%ering fnance in short tem, long term, and di%erenttype o instrument or li(uidity management, asset

management etc, or enterprises and pro#ects. "his

creates employment opportunities in the economy. It

would be necessary to create an environment that could

induce fnanciers to earmark more unds or

Ausharaka*Audarabah based fnancing o productive

units, particularly o small enterprises.03!

"he non5-@S techni(ues, as acceptable in the Islamic

Shariah, not only complement the -@S modes, but also

provide Keibility o choice to meet the needs o di%erent

sectors and economic agents in the society. "rade5based

techni(ues like Aurabaha with lesser risk and better

li(uidity options have several advantages vis5P5vis other

techni(ues but may not be as ruitul in reducing income

ine(ualities and generation o capital goods as

participatory techni(ues. I#arah related fnancing that


29/35

would re(uire Islamic banks to purchase and maintain the

assets and aterwards dispose o them according to

Shariah rules, re(uire the banks to engage in activities

beyond fnancial intermediation and can be very much

conducive to the ormation o fed assets and medium

and long5term investments.

+n the basis o the above it can be said that supply and

demand o capital would continue in an interest ree

scenario with additional beneft o greater supply o risk5

based capital along with more eOcient allocation o

resources and active role o banks and fnancial

institutions as re(uired in asset based Islamic theory o

fnance. Islamic banks can not only survive without

interest but also could be helpul in achieving the

ob#ective o development with distributive #ustice by

increasing the supply o risk capital in the economy,acilitating capital ormation, and growth o fed assets

and real sector business activities.

Salam has a vast potential in fnancing the productive

activities in crucial sectors, particularly agriculture, agro5

based industries and the rural economy as a whole. It

also provides incentive to enhance production as theseller would spare no e%ort in producing, at least the

(uantity needed or settlement o the loan taken by him

as advance price o the goods. Salam can also lead to

creating a stable commodities market especially the


30/35

seasonal commodities and thereore to stability o their

prices. It would enable savers to direct their savings to

investment outlets without waiting, or instance, until the

harvesting time o agricultural products or the time when

they actually need industrial goods and without being

orced to spend their savings on consumption.

Small and medium enterprises 'SAG) sector has a great

potential or epanding production capacity and sel5

employment opportunities in the country. Gnhancing the

role o fnancial sector in development o SAG sub5sector

could mitigate the serious problems o unemployment

and low level o eports. "he banks may introduce 6SAG

inancing unds7 with various geographical locations. "he

corporate sector and the commercial banks may set up a

network o such unds under the aegis o SG- by

establishing institutions under syndicate arrangements orotherwise. 08!

eerences

1!Those who consume inteest!" c#nnot st#n$ %on the D#& o' (esuection) e*ce+t #s one

st#n$s th#t is ,ein- ,e#ten ,& S#t#n into ins#nit&. o/& 0u#n A/,## ese 24

The Islamic Golden Age5 #/so sometimes 6nown #s the Islamic Renaissance5 is t#$ition#//&

$#te$ 'om the th to 13th centuies Common E#.5 ,ut h#s ,een e*ten$e$ to the 14th #n$ 17th

centuies ,& moe ecent scho/#shi+. Duin- this +eio$5 #tists5 en-inees5 scho/#s5 +oets5

+hi/oso+hes5 -eo-#+hes #n$ t#$es in the Is/#mic wo/$ conti,ute$ to the #ts5 #-icu/tue5


31/35

economics5 in$ust&5 /#w5 /ite#tue5 n#8i-#tion5 +hi/oso+h&5 sciences5 socio/o-&5 #n$ techno/o-&5

,oth ,& +ese8in- #n$ ,ui/$in- u+on e#/ie t#$itions #n$ ,& #$$in- in8entions #n$ inno8#tions

o' thei own.

A free marketis # tem th#t economists use to $esci,e # m#6et which is 'ee 'om

economic inte8ention #n$ e-u/#tion ,& -o8enment5 othe th#n +otection o' +o+et& i-hts9i.e. no e-u/#tion5 no su,si$i:#tion5 no sin-/e monet#& s&stem #n$ no -o8enment#/

mono+o/ies;.

1!Mu!""!# F!$%!& I'!() M. *. +2,,7-.#slamicBankin$ (Presen!a!ion)%etrieved rom +

-apershttp?**www.oppapers.com*essays*Islamic5Banking*1903=

2! D. S!$# H!%!/ S$##$0u$. +2,,1-QIslamicBanking? "rue Aodes o inancingR Hewhori&on.http?**www.n&ibo.com*IB2*truemodes.pd

! H!%%!/$/) M#!.QMoney and Bankin$ in#slam&% Islamabad ? Institute o policy studies Islamabadand international research in Islamic economics. Aoneyand Banking in Islam. p.=9.http?**islamiccenter.kaau.edu.sa*arabic*Aagallah*-d*+ld551*Aedhat2.pd

0!N A"# M"/ +2,,7-Islamic Banking?-resent and uture hallenges ournal o Mana$emen!and Social Sciences Tol. , Ho. 1, 'Spring 2>>9) >151>epar!men! o *conomics, #ns!i!u!e o Business +

echnolo$y (B#*.)3!Islamic inance Gplained By Suyan Fulam Ismail,hie Gecutive, 1st Gthical @td.www.1stethical.com

8!Mu!""!# AuQan bank survive with outinterestUR State Bank o
http://www.oppapers.com/essays/Islamic-Banking/174593http://www.oppapers.com/essays/Islamic-Banking/174593http://www.nzibo.com/IB2/truemodes.pdfhttp://islamiccenter.kaau.edu.sa/arabic/Magallah/Pdf/Old-3-1/Medhat_23.pdfhttp://islamiccenter.kaau.edu.sa/arabic/Magallah/Pdf/Old-3-1/Medhat_23.pdfhttp://www.1stethical.com/http://www.oppapers.com/essays/Islamic-Banking/174593http://www.oppapers.com/essays/Islamic-Banking/174593http://www.nzibo.com/IB2/truemodes.pdfhttp://islamiccenter.kaau.edu.sa/arabic/Magallah/Pdf/Old-3-1/Medhat_23.pdfhttp://islamiccenter.kaau.edu.sa/arabic/Magallah/Pdf/Old-3-1/Medhat_23.pdfhttp://www.1stethical.com/


32/35

-akistanhttp?**www.sbp.org.pk*departments*ibd*Survive.pd

9!ahul humal+ and m+la Sa*anin+18- Q:n

:pplication o Islamic Banking -rinciples to Aicrofnance.Regional Bureau or :rab States, nited HationsEevelopment -rogramme, in cooperation with the AiddleGast and Horth :rica egion, Norld Bank

;!Ibid

=!Ibid

1>!D K! A Hu%%!$/ +2,,4- QBanking eOciency in

Bahrain Islamic vs conventional BanksR -aper Ho. 8;Islamic Eevelopment Bank. Islamic esearch and "rainingInstitute.

11!SBP +2,,2-9Flossary o IslamicinanceR http?**www.sbp.org.pk*publications*islamic*book1*glossary.pd

12!D!:# I%&!"$; B!/,2>>=.!www.sbp.org.pk*ibd*a(s.pd

10!,Ibid

13!Ibid

18! AIMS=UK QFlossary< Islamic Banking andinanceR www.learnislamicfnance.com

19!Su>!/ +2,,7-. 9Islamic inance GplainedR1st [email protected]. www.1stethical.com
http://www.sbp.org.pk/departments/ibd/Survive.pdfhttp://www.sbp.org.pk/departments/ibd/Survive.pdfhttp://www.sbp.org.pk/publications/islamic/book1/glossary.pdfhttp://www.sbp.org.pk/publications/islamic/book1/glossary.pdfhttp://www.dawoodislamic.com/AskMufti.aspxhttp://www.sbp.org.pk/ibd/faqs.pdfhttp://www.learnislamicfinance.com/http://www.1stethical.com/http://www.sbp.org.pk/departments/ibd/Survive.pdfhttp://www.sbp.org.pk/departments/ibd/Survive.pdfhttp://www.sbp.org.pk/publications/islamic/book1/glossary.pdfhttp://www.sbp.org.pk/publications/islamic/book1/glossary.pdfhttp://www.dawoodislamic.com/AskMufti.aspxhttp://www.sbp.org.pk/ibd/faqs.pdfhttp://www.learnislamicfinance.com/http://www.1stethical.com/


33/35

1;!AIMS=u>9. ited? 0 13,2>>=.! www.learnIslamicinance.com.

1=!SBP +2,,2- Q:/ on Islamic Banking.R S!a!e Bank oPakis!an% +nline! ited? 0 2>,2>>=.!www.sbp.org.pk*ibd*a(s.pd.

2>!"aken orm website source can be visitathttp?**www.irf.org*articles*articles>13>*isislamicbankingislamic.html

21!U%"!/$) M T!0$. +2,,6-Q#n!roduc!ion !o #slamic

0inanc& karachi -akistan ? Aaktaba maariul /urankarachi, 2>>8.e%p 12%

22!Su?!/) F!#(&!/ +2,,7-)Q"he eOciency o Islamicbanking industry in Aalaysia? oreign vs domesticbanks.R Humanomics, 3olume 41, no% 1, pp% 526-574%

2!R!#) R.K.) 18&.L"he march toward sel5determinationL, paper presented at the irst :dvancedourse on Islamic Banks, International Institute o IslamicBanking and Gconomics, airo, 2; :ugust l9 September.

20!S$##$0$) M.N.) +188-.LIslamic banking? theory andpracticeL, in A. :ri%

23!@$&%/ R#/ +15-QIslamic Banking and itsImpact on international fnancial shcheme QHew 4ori&on.-5;

28!S$##$0$u$ S!$# Hu%%!$/. +14-QIslamic BankingQoyal Book o -519

29!Ibid

2;!Mu!""!# A$ +188) QIslamic BankingRniversity o Aalaya
http://www.learnislamicfinance.com/http://www.sbp.org.pk/ibd/faqs.pdfhttp://www.irfi.org/articles/articles_301_350/is_islamic_banking_islamic.htmlhttp://www.irfi.org/articles/articles_301_350/is_islamic_banking_islamic.htmlhttp://www.learnislamicfinance.com/http://www.sbp.org.pk/ibd/faqs.pdfhttp://www.irfi.org/articles/articles_301_350/is_islamic_banking_islamic.htmlhttp://www.irfi.org/articles/articles_301_350/is_islamic_banking_islamic.html


34/35

2=!D. *$!u##$/ A"!# +185-"he -resent state oIslamic fnance movementR International Institute oIslamic Gconomics -5;

>!M!/) *!

1!S$##$0$) M.N.) +188-.LIslamic banking? theory andpracticeL,

2!M. S!(!# +2,,8--erormance o Islamic bankingand conventional banking in -akistan? a comparativestudy. niversity o SD+TEG. School o "echnology

$Society!/uaid5e5:&am8 Speech a! !he ounda!ion layin$ s!oneo !he S!a!e Bank o Pakis!an, 1st July 1=0;.

0!D S!"%!# A>85>1

9!SBP. +2,,2-:/ +n Islamic Banking. '2>>2)StateBank o -akistan.+nline! ited? 0 2>, 2>>=.!www.sbp.org.pk*ibd*a(s.pd.

;!Ibid
http://www.asafas.kyoto-u.ac.jp/kias/contents/pdf/kb1_2/09mehboob.pdfhttp://www.asafas.kyoto-u.ac.jp/kias/contents/pdf/kb1_2/09mehboob.pdfhttp://www.sbp.org.pk/ibd/faqs.pdfhttp://www.asafas.kyoto-u.ac.jp/kias/contents/pdf/kb1_2/09mehboob.pdfhttp://www.asafas.kyoto-u.ac.jp/kias/contents/pdf/kb1_2/09mehboob.pdfhttp://www.sbp.org.pk/ibd/faqs.pdf


35/35

=!SBP +2,,7-Q-akistan7s Islamic Banking Sectoreview. 2>>52>>9R IS@:AI B:HDIHF EG-:"AGH"

0>!Ibid

01!Ibid

02!A;;u/!/ + 2,,7- 9aith and inance

working with islamic finance

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