Q1.
What is Islamic Banking?
Ans. Islamic banking has been defined as banking in consonance with
the ethos and value system of Islam and governed, in addition to the conventional
good governance and risk management rules, by the principles laid down by Islamic
Shariah. Interest free banking is a narrow concept denoting a number of banking
instruments or operations, which avoid interest. Islamic banking, the more
general term is expected not only to avoid interest-based transactions, prohibited
in the Islamic Shariah, but also to avoid unethical practices and participate
actively in achieving the goals and objectives of an Islamic economy.
Q2.
What is the philosophy of Islamic banking and finance?
Ans. Islamic Shariah prohibits ‘interest’
but it does not prohibit all gains on capital. It is only the
increase stipulated or sought over the principal of a loan or
debt that is prohibited. Islamic principles simply require that
performance of capital should also be considered while rewarding
the capital. The prohibition of a risk free return and permission
of trading, as enshrined in the Verse 2:275 of the Holy Quran,
makes the financial activities in an Islamic set-up real asset-backed
with ability to cause ‘value addition’.
Islamic banking system is based on risk-sharing, owning and handling
of physical goods, involvement in the process of trading, leasing
and construction contracts using various Islamic modes of finance.
As such, Islamic banks deal with asset management for the purpose
of income generation. They will have to prudently handle the unique
risks involved in management of assets by adherence to best practices
of corporate governance. Once the banks have stable stream of
Halal income, depositors will also receive stable and Halal income.
The forms of businesses allowed by Islam at the time the Holy
Quran was revealed included joint ventures based on sharing of
risks & profits and provision of services through trading,
both cash and credit, and leasing activities. In the Verse II:275,
Allah the Almighty did not deny the apparent similarity between
trade profit in credit sale and Riba in loaning, but resolutely
informed that Allah has permitted trade and prohibited Riba.
Profit has been recognized as ‘reward’ for (use of)
capital and Islam permits gainful deployment of surplus resources
for enhancement of their value. However, alongwith the entitlement
of profit, the liability of risk of loss on capital rests with
the capital itself; no other factor can be made to bear the burden
of the risk of loss. Financial transactions, in order to be permissible,
should be associated with goods, services or benefits. At macro
level, this feature of Islamic finance can be helpful in creating
better discipline in conduct of fiscal and monetary policies.
Besides trading, Islam allows leasing of assets and getting rentals
against the usufruct taken by the lessee. All such things/assets
corpus of which is not consumed with their use can be leased out
against fixed rentals. The ownership in leased assets remains
with the lessor who assumes risks and gets rewards of his ownership.
Q3. What is the history of Islamic
Banking in Pakistan?
Ans. Steps for Islamization of banking and financial
system of Pakistan were started in 1977-78. Pakistan was among
the three countries in the world that had been trying to implement
interest free banking at comprehensive/national level. But as
it was a mammoth task, the switchover plan was implemented in
phases. The Islamization measures included the elimination of
interest from the operations of specialized financial institutions
including HBFC, ICP and NIT in July 1979 and that of the commercial
banks during January 1981 to June 1985. The legal framework of
Pakistan's financial and corporate system was amended on June
26, 1980 to permit issuance of a new interest-free instrument
of corporate financing named Participation Term Certificate (PTC).
An Ordinance was promulgated to allow the establishment of Mudaraba
companies and floatation of Mudaraba certificates for raising
risk based capital. Amendments were also made in the Banking Companies
Ordinance, 1962 (The BCO, 1962) and related laws to include provision
of bank finance through PLS, mark-up in prices, leasing and hire
purchase.
Separate Interest-free counters started operating in all the nationalized
commercial banks, and one foreign bank (Bank of Oman) on January
1, 1981 to mobilize deposits on profit and loss sharing basis.
Regarding investment of these funds, bankers were instructed to
provide financial accommodation for Government commodity operations
on the basis of sale on deferred payment with a mark-up on purchase
price. Export bills were to be accommodated on exchange rate differential
basis. In March, 1981 financing of import and inland bills and
that of the then Rice Export Corporation of Pakistan, Cotton Export
Corporation and the Trading Corporation of Pakistan were shifted
to mark-up basis. Simultaneously, necessary amendments were made
in the related laws permitting the State Bank to provide finance
against Participation Term Certificates and also extend advances
against promissory notes supported by PTCs and Mudaraba Certificates.
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.
As from April 1, 1985 all finances to all entities including individuals
began to be made in one of the specified interest-free modes.
From July 1, 1985, all commercial banking in Pak Rupees 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.
Deposits in current accounts continued to be accepted but no interest
or share in profit or loss was allowed to these accounts. However,
foreign currency deposits in Pakistan and on-lending of foreign
loans continued as before. The State Bank of Pakistan had specified
12 modes of non-interest financing classified in three broad categories.
However, in any particular case, the mode of financing to be adopted
was left to the mutual option of the banks and their clients.
The procedure adopted by banks in Pakistan since July 1 1985,
based largely on ‘mark-up’ technique with or without
‘buy-back arrangement’, was, however, declared un-Islamic
by the Federal Shariat Court (FSC) in November 1991. However,
appeals were made in the Shariat Appellate Bench (SAB) of the
Supreme Court of Pakistan. 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 the financial system and two Task Forces to plan and implement
the process of the transformation.
The Commission for Transformation of Financial System (CTFS) was
constituted in January 2000 in the State Bank of Pakistan under
the Chairmanship of Mr. I.A. Hanfi, a former Governor State Bank
of Pakistan. A Task Force was set up in the Ministry of Finance
to suggest the ways to eliminate interest from Government financial
transactions. Another Task Force was set up in the Ministry of
Law to suggest amendments in legal framework to implement the
Court’s Judgment. The CTFS constituted a Committee for Development
of Financial Instruments and Standardized Documents in the State
Bank to prepare model agreements and financial instruments for
new system.
The CTFS in its Report identified a number of prior actions, which
were needed to be taken to prepare the ground for transformation
of the financial system. It also identified major Shariah compliant
modes of financing, their essentials, draft seminal law captioned
‘Islamization of Financial Transactions Ordinance, 2001’,
model agreements for major modes of financing, and guidelines
for conversion of products and services of banks and financial
institutions. The Commission also dealt with major products of
banks and financial institutions, both for assets and liabilities
side, like letters of credit or guarantee, bills of exchange,
term finance certificates (TFCs), State Bank's Refinance Schemes,
Credit Cards, Interbank transactions, underwriting, foreign currency
forward cover and various kinds of bank accounts. The Commission
observed that all deposits, except current accounts, would be
accepted on Mudaraba principle. Current accounts would not carry
any return and the banks would be at liberty to levy service charge
as fee for their handling. The Commission also approved the concept
of Daily Product and Weightage System for distribution of profit
among various kinds of liabilities/deposits. The Report also contained
recommendation for forestalling willful default and safeguarding
interest of the banks, depositors and the clients.
According to the Commission, prior/preparatory works for introduction
of Shariah compliant financial system briefly included creating
legal infrastructure conducive for working of Islamic financial
system, launching a massive education and training program for
bankers and their clients and an effective campaign through media
for the general public to create awareness about the Islamic financial
system.
The Finance Minister of Pakistan in his budget speech for the
FY02 declared the following:
“ Government is committed to eliminate Riba and promote
Islamic banking in the country. For this purpose a number of steps
are under way which are:
1. A legal framework is designed to encourage practice of Islamic
banking by banks and financial institutions as subsidiary operations
of their main operations;
2. Consultations and exchanges are undertaken with brother Islamic
countries and renowned institutions of Islamic learning such as
middle eastern countries and Al-Azhar University of Egypt, to
learn more about their experiences and practices;
3. Amendments in HBFC Act are being made in line with the directive
of the Supreme Court. With these changes, HBFC would be fully
Shariah compliant institution, which will play an effective role
both in promotion of Islamic financing method but also in the
development of the important housing sector;
4. Shariah compliant modes of financing like Musharaka and Mudaraba
will be encouraged so that familiarity and use of such products
is enhanced and their adoption at a wider scale made possible.
It is government’s intention to promote Islamic banking
in the country while keeping in view its linkages with the global
economy and existing commitments to local and foreign investors”.
The House Building Finance Corporation had shifted its rent sharing
operations to interest based system in 1989. The Task Force of
the M/O Law proposed amendments in the HBFC Act to make it Shariah
Compliant. Having vetted by the CTFS, the amended law has been
promulgated by the Government. Accordingly, the HBFC launched
in 2001 Asaan Ghar Scheme in the light of amended Ordinance based
on the Diminishing Musharakah concept. A Committee was constituted
in the Institute of Chartered Accountants, Pakistan (ICAP), wherein
the SBP was also represented, for development of accounting and
auditing standards for Islamic modes of financing. The Committee
is reviewing the standards prepared by the Bahrain based Accounting
and Auditing Organisation for Islamic Financial Institutions (AAOIFI)
with a view to adapt them to our circumstances and if considered
necessary, to propose new accounting standards.
It was decided in September 2001 that the shift to interest free
economy would be made in a gradual and phased manner and without
causing any disruptions. It was also agreed that State Bank of
Pakistan would consider for:
1. Setting up subsidiaries by the commercial banks for the purpose
of conducting Shariah compliant transactions;
2. Specifying branches by the commercial banks exclusively dealing
in Islamic products, and
3. Setting up new full-fledged commercial banks to carry out exclusively
banking business based on proposed Islamic products.
Accordingly, the State Bank issued detailed criteria in December
2001 for establishment of full-fledged Islamic commercial banks
in the private sector. Al Meezan Investment Bank received the
first Islamic commercial banking license from SBP in January 2002
and the Meezan Bank Limited (MBL) commenced full-fledged commercial
banking operation from March 20, 2002. Further, all formalities
relating to the acquisition of Societe Generale, Pakistan by the
MBL were completed, and by June, 2002 it had a network of 5 branches
all over the country, three in Karachi, one in Islamabad and one
in Lahore. The MBL now maintains a long term rating of A+ and
short term rating of A1+, assessed by JCR VIS Credit Rating Co
Ltd, signifying a consistent satisfactory performance.
The Government as also the State Bank are mainly concerned with
stability and efficiency of the banking system and safeguarding
the interests, particularly, of small depositors. With this concern
in mind it has been decided to operate Islamic banking side by
side with traditional banking. The approach is to institute best
practice legal, regulatory and accounting frameworks to support
Islamic banks and investors alike. The year 2002-2003 witnessed
strengthening measures taken in the areas of banking, non-bank
financial companies and the capital markets.
Islamic Banking Subsidiaries
A new clause (aa) was inserted in sub-section (1) of Section 23
of the Banking Companies Ordinance 1962 by an amendment notified
in the Gazette of Pakistan on November 4 2002, which provided
that banks could form subsidiaries for “carrying on of banking
business strictly in conformity with the Injunctions of Islam
as laid down in the Holy Quran and Sunnah.” In January,
2003 the State Bank issued BPD Circular No. 01 outlining detailed
instructions on the remaining two parts of the strategy, viz.
setting up of subsidiaries and Stand-alone branches for Islamic
Banking by existing commercial banks. The criteria for subsidiaries
are almost similar to the criteria for setting up scheduled Islamic
commercial bank with emphasis on complete segregation of accounts
of Islamic banking subsidiaries and the parent banks doing conventional
banking. The subsidiaries shall have minimum paid up capital of
Rs 1,000 million that is equal to the capital requirement for
full-fledged commercial banks.
Islamic Banking through Stand-alone Branches
For Part-III of the strategy, guidelines for opening of stand-alone
branches for Islamic banking by existing commercial banks, enlisting
eligibility criteria, licensing requirements and other operational
details on the subject were issued on January 1 2003. The criteria
pertain to financial strength of the applicant bank as evident
from its capital base (net capital free of actual and potential
losses), adequacy of its capital structure, record of earning
capabilities, future earning prospects of the bank, managerial
capabilities, bank’s liquidity position, track record of
the bank’s adherence to prudential regulations, credit discipline,
quality of customer services and the convenience and the needs
of the population of the area to be served by the proposed branches.
Further, banks seeking permission should have CAMELS rating of
1, 2 and 3 in the last ON-SITE inspection and there should not
be major adverse inspection findings against the bank. The applying
bank is required to submit proposal to the State Bank, outlining
the following details:
• Number of branches along with name of city where the Islamic
Banking Branch (IBB) is to be offered within the next financial
year.
• Products and services to be offered by the IBB including
deposits, financing, investment, etc.
• Method of segregating the funds of IBB from the funds
of commercial banking of the applying bank.
• Infrastructure and logistic requirements, including manpower
and training programs.
• The name, qualification and experience of Shariah Adviser
(s), and
• Accounting aspects, such as accounting policies to be
followed, profit and loss sharing mechanism, manuals, etc.
The bank will also be required to set up Islamic Banking Division
(IBD) at the Head Office/Country Office in Pakistan. The responsibilities
of this Division have been depicted in detail. The bank would
also appoint a Shariah adviser/Shariah Supervisory Committee consisting
of Shariah scholar(s) of repute to advise the IBD on matters pertaining
to Shariah. Moreover, the bank shall ensure that proper systems
and controls are in place in order to ensure segregation of funds
and to protect the interest of depositors. The banks shall ensure
proper maintenance of records for all transactions for disclosure
of assets, liabilities, expenses and income of IBD/IBB(s). The
IBD will also comply with statutory liquidity and cash reserve
requirements determined by SBP.
As regards the status of Islamic banking industry in the country
(End June 2004), Meezan Bank is operating with 10 branches in
5 cities as a full fledged Islamic bank. In addition to it, 5
banks (MCB, Bank of Khyber, Bank Alfalah, Habib Bank AG Zurich
and Standard Chartered Bank) have been issued licenses for 12
dedicated Islamic Banking Branches (IBB) of which 10 branches
are operating in Karachi, Islamabad, Peshawar, Lahore, Faisalabad
and Multan. These banks are planning to offer Islamic banking
products in Quetta, Hyderabad, Gujranwala and other major cities
during the year 2004. SBP has also given in principle approval
for opening 10 more Islamic banking branches during 2004 by MCB
and Bank Alfalah.
Habib Bank Limited and Bank Al Habib Limited have been granted
in principle approval to open two Islamic banking branches. They
are expected to start these branches during the year 2004. At
least five more banks are expected to open Islamic banking branches
during the year ending December, 2004. Applications for two new
full-fledged Islamic banks are also under scrutiny while the license
of a foreign Islamic bank is being converted to Islamic banking.
Some of the banks who are operating Islamic banking branches are
also offering Islamic banking products through their existing
conventional branches by using hub & spoke arrangement. It
will increase the outreach of Islamic banking products in other
cities as well.
Q4. What is the Islamic Banking
Global Scenario?
Ans. Over the last three decades Islamic banking
and finance has developed into a full-fledged system and discipline
reportedly growing at the rate of 15percent per annum. Today,
Islamic financial institutions, in one form or the other, are
working in about 75 countries of the world. Besides individual
financial institutions operating in many countries, efforts have
been underway to implement Islamic banking on a country wide and
comprehensive basis in a number of countries. The instruments
used by them, both on assets and liabilities sides, have developed
significantly and therefore, they are also participating in the
money and capital market transactions. In Malaysia, Bahrain and
a few other countries of the Gulf, Islamic banks and financial
institutions are working parallel with the conventional system.
Bahrain with the largest concentration of Islamic financial institutions
in the Middle East region, is hosting 26 Islamic financial institutions
dealing in diversified activities including commercial banking,
investment banking, offshore banking and funds management. It
pursues a dual banking system, where Islamic banks operate in
the environment in which Bahrain Monetary Agency (BMA) affords
equal opportunities and treatment for Islamic banks as for conventional
banks. Bahrain also hosts the newly created Liquidity Management
Centre (LMC) and the International Islamic Financial Market (IIFM)
to coordinate the operations of Islamic banks in the world. To
provide appropriate regulatory set up, the BMA has introduced
a comprehensive prudential and reporting framework that is industry-specific
to the concept of Islamic banking and finance. Further, the BMA
has pioneered a range of innovations designed to broaden the depth
of Islamic financial markets and to provide Islamic institutions
with wider opportunities to manage their liquidity.
Another country that has a visible existence of Islamic banking
at comprehensive level is Malaysia where both conventional and
Islamic banking systems are working in a competitive environment.
The share of Islamic banking operations in Malaysia has grown
from a nil in 1983 to above 8 percent of total financial system
in 2003. They have a plan to enhance this share to 20 percent
by the year 2010. However, there are some conceptual differences
in interpretation and Shariah position of various contracts like
sale and purchase of debt instruments and grant of gifts on savings
and financial papers.
In Sudan, a system of Islamic banking and finance is in operation
at national level. Like other Islamic banks around the world the
banks in Sudan have been relying in the past on Murabaha financing.
However, the share of Musharaka and Mudaraba operations is on
increase and presently constitutes about 40 percent of total bank
financing. Although the Islamic financial system has taken a good
start in Sudan, significant problems still remain to be addressed.
Like Sudan, Iran also switched over to Usury Free Banking at national
level in March 1984. However, there are some conceptual differences
between Islamic banking in Iran and the mainstream movement of
Islamic banking and finance.
Owing to the growing amount of capital availability with Islamic
banks, the refining of Islamic financing techniques and the huge
requirement of infrastructure development in Muslim countries
there has been a large number of project finance deals particularly
in the Middle East region. Islamic banks now participate in a
wide financing domain stretching from simple Shariah-compliant
retail products to highly complex structured finance and large-scale
project lending. These projects, inter alia, include power stations,
water plants, roads, bridges and other infrastructure projects.
Bahrain is the leading centre for Islamic finance in the Middle
East region. The establishment of the Prudential Information and
Regulatory Framework for Islamic Banks (PIRI) by the BMA in conjunction
with AAOIFI has gone a long way towards establishing a legal and
regulatory framework to meet the specific risks inherent in Islamic
financing structures.
The BMA has quite recently signed MoU with the London Metal Exchange
(LME) to pool assets to develop and promote Shariah compliant
tradable instruments for Islamic banking industry. The arrangement
is seen as a major boost for industry’s integration in the
global financial system and should set the pace for commodity-trading
environment in Bahrain. BMA has also finalized draft guidelines
for issuance of Islamic bonds and securities from Bahrain. In
May 03, the Liquidity Management Centre (LMC) launched its debut
US$ 250 million Sukuk on behalf of the Government of Bahrain.
National Commercial Bank (NCB) of Saudi Arabia has introduced
an Advance Card that has all the benefits of a regular credit
card. The card does not have a credit line and instead has a prepaid
line. As such, it does not incur any interest. Added benefits
are purchase protection, travel accident insurance, etc and no
interest, no extra fees with no conditions, the card is fully
Shariah compliant. It is more secure than cash, easy to load up
and has worldwide acceptance. This prepaid card facility is especially
attractive to women, youth, self employed and small establishment
employees who sometimes do not meet the strict requirements of
a regular credit card facility. Saudi Government has also endorsed
an Islamic-based law to regulate the kingdom's lucrative Takaful
sector and opened it for foreign investors.
Islamic banks have also built a strong presence in Malaysia, where
Standard & Poor's assigned a BBB+ rating to the $600 million
Sharia-compliant trust certificates (called sukuk) issued by Malaysia
Global Sukuk Inc. Bank Negara Malaysia (BNM) has announced to
issue new Islamic Bank licences to foreign players. The Financial
Sector Master plan maps out the liberalisation of Malaysia's banking
and insurance industry in three phases during the next decade.
It lists incentives to develop the Islamic financial sector and
enlarge its market share to 20 percent, from under 10 percent
now. A dedicated high court has been set up to handle Islamic
banking and finance cases.
In United Kingdom, the Financial Services Authority is in final
stages of issuing its first ever Islamic banking license to the
proposed Islamic Bank of Britain, which has been sponsored by
Gulf and UK investors. The United States of America has appointed
Dr. Mahmoud El Gamal, an eminent economist/expert on Islamic banking
to advise the US Treasury and Government departments on Islamic
finance in June 2004.
Q5.
What are the Major modes of Islamic banking and finance?
Ans.
Following are the main modes of Islamic banking and finance:
MURABAHA
Literally it means a sale on mutually agreed profit. Technically,
it is a contract of sale in which the seller declares his cost
and profit. Islamic banks have adopted this as a mode of financing.
As a financing technique, it involves a request by the client
to the bank to purchase certain goods for him. The bank does that
for a definite profit over the cost, which is stipulated in advance.
IJARAH
Ijarah is a contract of a known and proposed usufruct against
a specified and lawful return or consideration for the service
or return for the benefit proposed to be taken, or for the effort
or work proposed to be expended. In other words, Ijarah or leasing
is the transfer of usufruct for a consideration which is rent
in case of hiring of assets or things and wage in case of hiring
of persons.
IJARAH-WAL-IQTINA
A contract under which an Islamic bank provides equipment, 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 of the lease period, the ownership in the asset would
be transferred to the lessee. The undertaking or the promise does
not become an integral part of the lease contract to make it conditional.
The rentals as well as the purchase price are fixed in such manner
that the bank gets back its principal sum alongwith with profit
over the period of lease.
MUSAWAMAH
Musawamah is a general and regular kind 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. Thus, it is different from Murabaha in respect
of pricing formula. Unlike Murabaha, seller in Musawamah is not
obliged to reveal his cost. Both the parties negotiate on the
price. All other conditions relevant to Murabaha are valid for
Musawamah as well. Musawamah can be used where the seller is not
in a position to ascertain precisely the costs of commodities
that he is offering to sell.
ISTISNA A
It is a contractual agreement for manufacturing goods and commodities,
allowing cash payment in advance and future delivery or a future
payment and future delivery. 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.
BAI MUAJJAL
Literally it means a credit sale. Technically, it is a financing
technique adopted by Islamic banks that takes the form of Murabaha
Muajjal. It is a contract in which the bank earns a profit margin
on his purchase price and allows the buyer to pay the price of
the commodity at a future date in a lump sum or in installments.
It has to expressly mention cost of the commodity and the margin
of profit is mutually agreed. 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.
MUDARABAH
A form of partnership where one party provides the funds while
the other provides expertise and management. The latter is referred
to as the Mudarib. Any profits accrued are shared between the
two parties on a pre-agreed basis, while loss is borne only by
the provider of the capital.
MUSHARAKAH
Musharakah means a relationship established under a contract by
the mutual consent of the parties for sharing of profits and losses
in the joint business. It is an agreement under which the Islamic
bank provides funds, which are mixed with the funds of the business
enterprise and others. All providers of capital are entitled to
participate in management, but not necessarily required to do
so. The profit is distributed among the partners in pre-agreed
ratios, while the loss is borne by each partner strictly in proportion
to respective capital contributions.
BAI SALAM
Salam means a contract in which advance payment is made for goods
to be delivered later on. 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. 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.
Barring this, Bai?Salam covers almost everything, which is capable
of being definitely described as to quantity, quality and workmanship.
Q6. Can Islamic banks play any
role in economic development of the Country?
Ans. Islamic banks, while functioning within
the framework of Shariah, can perform a crucial task of resource
mobilization, their efficient allocation on the basis of both
PLS (Musharaka and Mudaraba) and non-PLS (trading & leasing)
based categories of modes and strengthening the payments systems
to contribute significantly to economic growth and development.
Sharing modes can be used for short, medium and long-term project
financing, import financing, pre-shipment export financing, working
capital financing and financing of all single transactions. In
order to ensure maximum role of Islamic finance in development
of the economy it would be necessary to create an environment
that could induce financiers to earmark more funds for Musharakah/Mudarabah
based financing of productive units, particularly of small enterprises.
The non-PLS techniques, as acceptable in the Islamic Shariah,
not only complement the PLS modes, but also provide flexibility
of choice to meet the needs of different sectors and economic
agents in the society. Trade-based techniques like Murabaha with
lesser risk and better liquidity options have several advantages
vis-à-vis other techniques but may not be as fruitful in
reducing income inequalities and generation of capital goods as
participatory techniques. Ijarah related financing that would
require Islamic banks to purchase and maintain the assets and
afterwards dispose of them according to Shariah rules, require
the banks to engage in activities beyond financial intermediation
and can be very much conducive to the formation of fixed assets
and medium and long-term investments.
On the basis of the above it can be said that supply and demand
of capital would continue in an interest-free scenario with additional
benefit of greater supply of risk-based capital alongwith more
efficient allocation of resources and active role of banks and
financial institutions as required in asset based Islamic theory
of finance. Islamic banks can not only survive without interest
but also could be helpful in achieving the objective of development
with distributive justice by increasing the supply of risk capital
in the economy, facilitating capital formation, and growth of
fixed assets and real sector business activities.
Salam has a vast potential in financing the productive activities
in crucial sectors, particularly agriculture, agro-based industries
and the rural economy as a whole. It also provides incentive to
enhance production as the seller would spare no effort in producing,
at least the quantity needed for settlement of the loan taken
by him as advance price of the goods. Salam can also lead to creating
a stable commodities market especially the seasonal commodities
and therefore to stability of their prices. It would enable savers
to direct their savings to investment outlets without waiting,
for instance, until the harvesting time of agricultural products
or the time when they actually need industrial goods and without
being forced to spend their savings on consumption.
Banks might engage in fund and portfolio management through a
number of asset management and leasing & trading companies.
Such companies/entities can exist in the economy on their own
or can be an integral part of some big companies or subsidiaries,
as in the case of Universal Banking in Europe. They would manage
Investors Schemes to mobilize resources on Mudarabah basis and
to some extent on agency basis, and use the funds so collected
on Murabaha, leasing or equity participation basis. Subsidiaries
can be created for specific sectors/operations, which would enter
into genuine trade and leasing transactions. Low-risk Funds based
on short-term Murabaha and leasing operations of the banks in
both local as well as foreign currencies would be best suited
for risk-averse savers who cannot afford possible losses, in PLS
based investments. Under equity based Funds, banks can offer a
type of equity exposure through specified investment accounts
where they may identify possible investment opportunities from
existing or new business clients and invite account-holder to
subscribe. Instead of sharing in the bank’s profit, the
investors would share the profits of the enterprise in which funds
are placed with the bank taking a management fee for its work.
Banks can also offer open-ended Multiple Equity Funds to be invested
in stocks.
Small and medium enterprises (SME) sector has a great potential
for expanding production capacity and self-employment opportunities
in the country. Enhancing the role of financial sector in development
of SME sub-sector could mitigate the serious problems of unemployment
and low level of exports. The banks may introduce ‘SME Financing
Funds’ with various geographical locations. The corporate
sector and the commercial banks may set up a network of such Funds
under the aegis of SECP by establishing institutions under syndicate
arrangements or otherwise.
Q7. What are the features of
State Bank’s Islamic Export Refinance Scheme?
Ans. State Bank of Pakistan has introduced a Musharakah-based
Islamic Export Refinance Scheme (IERS) to meet the export financing
requirements of banks conducting operations under Islamic Modes.
IBIs can avail this facility under both parts of SBP’s Export
Finance Scheme (EFS). The framework of the IERS is based on the
concept of Profit & Loss Sharing. The State Bank shares the
actual profit of the Musharakah pool of the Islamic Bank. However,
in case the actual profit of the pool is more than ongoing rates
under conventional EFS, the excess profit so received by SBP would
be credited to the Takaful fund, a reserve fund to be maintained
by SBP under Islamic modes for risk mitigation that would be used
to meet future losses arising on implementation of IERS. Salient
features of the Scheme are as under:
1. The facility is allowed only against transactions, designed
on the basis of Islamic Modes of financing approved by the Shariah
Advisor/Board of the concerned bank.
2. Each Islamic bank shall be under obligation to create a Musharakah
pool (having a minimum of 10 companies - to be achieved in first
year of operations) consisting of financing to blue chip companies
on Islamic modes. The blue chip companies shall mean such companies
involved in the export business or other business or both, or
a manufacturing concern marketing their products in Pakistan or
abroad, who have i) good track record on the stock exchange or
ii) have a rating of minimum B + or equivalent by the rating agencies
approved by the State Bank for rating banks in Pakistan, such
rating should be acceptable to the bank as per its own lending
policies, for advancing loans, or iii) companies having Return
on Equity (ROE) during last three years which should be at least
higher than the rates of finance prescribed by the State Bank
during those years on its conventional EFS. In case of a company
which is in operation for less than three years, the ROE of the
available number of years shall be considered. The Islamic Bank
shall ensure that companies selected for Musharakah Pool under
the above criteria does not have adverse Credit Information Bureau
report as also export overdues of more than one year.
3. The State Bank will share in the overall profit (gross income
less any provision created under Prudential Regulations during
the period plus amount recovered against prior periods’
losses and reversal of provision) earned by the Islamic bank on
the Musharaka pool under the provisions of the IERS calculated
on daily product basis.
4. If, on the basis of the annual audited accounts of the Islamic
Bank, the profit accruing to the SBP is more than the profit paid
to the SBP on quarterly basis as per un-audited accounts of earnings
of the pool, the difference shall be deposited by the Islamic
bank, within 7 days of its determination, in a special non remunerative
reserve fund viz. “Takaful Fund” to be maintained
at the office of the SBP BSC (Bank), where the head office/country
office of the concerned bank is situated. This arrangement shall
remain effective for all intents and purposes for the duration
of the agreement.
5. If, on the basis of the annual audited accounts of the pool,
the share of the State Bank in the profit works out to be less
than the amount, which has already been paid to the State Bank
on provisional basis, the State Bank will refund the excess amount
involved out of balance held in the Takaful Fund, if any.
6. In the event of loss suffered on the Musharakah pool on the
basis of annual audited accounts, the Islamic bank and the State
Bank shall share the loss in the proportion of their share of
investment in the Musharakah Pool expressed on daily product basis.
The share of loss to State Bank will first be met out of credit
balance in the Takaful Fund, if any. The loss not met from the
Takaful Fund shall be borne by the State Bank.
7. In case of loss, the Islamic bank shall be entitled to claim
refund on account of share of profit paid by it to SBP on provisional
basis, alongwith SBP’s share in the loss of principal amount
extended to the Musharakah pool.
Q8. Is it permissible for an
Islamic bank to impose penalty for late payment?
Ans. In Islamic law it is permissible to penalize
a debtor who is financially sound but delays payment of debt without
any genuine reason. Such act of the debtor is unjust as the Prophet
(PBUH) has said, "A rich debtor who delays payment of debt
commits Zulm".
A heavy non-performing portfolio and default on part of the clients
is a serious problem confronting the financial institutions all
over the world including Pakistan. This problem could be a threat
to success of Islamic banking system. If clients do not honor
their commitment in respect of timely payment of a debt created
in installment sale, Murabaha, leasing or do not pay banks’
share of profit in participatory modes or do not deliver goods
at stipulated time in Salam and Istisna’a, it could cause
irreparable loss to the system, the banks and financial institutions
and ultimately to savers and the economy. The jurists allow punishment
(T´azir) to such borrower in the form of fine. In the opinion
of some Maliki jurists a delaying borrower would be obliged to
pay for charitable activities. In view of the severity of the
problem, all Shariah bodies like Islamic Fiqh Academy of the OIC,
Shariat Appellate Bench of the Supreme Court of Pakistan, etc.
have approved the provision of penalty clause in the contractual
agreements that keeps a balance between the requirement in view
of severity of the problem and that of the Shariah conditions/principles
to keep the fine difference between interest and Murabaha profit
intact. However, the penalty proceeds would be used for charity
because penalty on default in repayment cannot become an automatic
source of income for the creditor.
Q9.
Can Islamic banks claim solatium or liquidated damages on account
of late payment/default by the clients?
Ans. The
contemporary Shariah scholars have evolved a consensus that banks
are authorized to impose late fees on the delinquent. But proceeds
of such penalty are to be used for charity purposes. Only the
court or any independent body can allocate any part of the penalty
as liquidated damages / solatium for the banks.
Liquidated
damages can be given to banks in case of default on the part of
banks’ clients provided it is based on actual financial
loss. The court may reasonably adjust the amount of compensation.
The ‘actual financial loss’ cannot be the loss in
terms of conventional ‘opportunity cost’. It has to
be proved by the bankers themselves to the satisfaction of the
court or any arbitrator. However, some Shariah Boards allow Islamic
banks to charge from the defaulter the rate realized by them on
their Murabaha portfolio during a specific period. They also recommend
that the financial condition of the client be taken into account.
Q10. There is a perception
in the West and the USA that Islamic banks finance terrorists.
What is the true situation?
Ans. In the post –9/11 global scenario
anti money laundering measures by regulatory authorities of banking
and finance have gained extraordinary importance. It is pertinent
to indicate in this regard that Islamic banks, by their nature,
are less likely to engage in money laundering and other illegal
activities. They cannot undertake activities which are detrimental
to society and its moral values and have to go through an exhaustive
test of Shariah compliance. They are not allowed to invest in
narcotics, casinos, nightclubs, breweries etc. This requires that
the clients of Islamic banking must have business which should
be socially beneficial for the society, creating real wealth and
adding value to the economy rather than making paper transactions.
Therefore, a stringent ‘Know Your Customer’ (KYC)
policy is an inbuilt requirement for an Islamic bank.
The Governor, State Bank of Pakistan while addressing an international
seminar on “The Financial War on Terrorism and the Role
of Islamic Banking” held in London on April 7, 8 2003, observed
that Islamic modes of financing and deposit-taking discourage
questionable/undisclosed means of wealth which form the basis
of money-laundering operations. The Islamic banks disclosure standards
are stringent because they require the customers to divulge the
origins of their funds in order to ensure that they are not derived
from un-Islamic means. Islamic financing modes are used to finance
specific physical assets like machinery, inventory, and equipment.
Further, the role of Islamic banks is not limited to a passive
financier concerned only with timely interest payments and loan
recovery. Islamic bank is a partner in trade and has to concern
itself with the nature of business and profitability position
of its clients. To avoid the loss and reputational risk, the Islamic
banks have to be extra vigilant about their clientele. As such,
Islamic banks are less likely to engage in illegal activities
such as money laundering and financing of terrorism than conventional
banks.
However, the existence of rogue elements cannot be ruled out in
any type of organization. Keeping this in view, Pakistan has adopted
a strategy by adopting uniform international standards to ensure
fair play by all kinds of banks and financial institutions also
including Islamic banks. After reviewing its existing systems
and procedures, it has developed a multiple-track strategy in
its financial war on terrorism and money laundering. It has also
put in place stringent regulations in order to effectively curb
money laundering. The ‘Know Your Customer’ (KYC) regulation
has been sharpened to provide more detailed guidelines to banks/DFI’s
for due diligence in respect of customers. All banks are required
to properly investigate transactions which are out of character
with the normal operation of the account involving heavy deposits/withdrawals/transfers.