NationalVOLUME 17 ISSUE # 52

Riba-free banking, a step in the right direction

The government’s announcement of withdrawing its petitions against Sharia-compliant banking should be welcomed as a right step, in the right direction. Its resolve must be appreciated as the plan to introduce interest-free banking would see the light of day sooner or later.

As the people concerned know, the Federal Shariat Court, after almost a decade of litigation, had declared interest (Riba) un-Islamic, and directed the government of Pakistan to frame relevant laws by December 2027, and convert to a Riba-free economy, accordingly. It led to a suit wherein the State Bank of Pakistan (SBP) expressed its inability on the grounds of a deeply-encrypted capitalist system in vogue.

However, on Nov 8, Finance Minister Ishaq Dar announced the government’s decision to withdraw appeals against the Shariat Court verdict. He said the government wanted to eliminate Riba as soon as possible. As per the government decision, both the State Bank and state-controlled National Bank would immediately take back the appeals against the FSC decision.

There is no denying the fact that conversion to a Riba-free financial system demands thorough and extensive research to understand and define what really constitutes Riba. That is important because the shift to an interest-free economy in a complex, globally integrated financial system could be extremely challenging, if not impossible.

According to Sharia experts, Islam prohibits Riba out of the concern that it results in “profiteering and money-making in a multiplication mode of economic exchange”, which doesn’t involve labour and efforts by the owner of economic resources. Islamic banking has grown reasonably fast in the last two decades in Pakistan and many have shifted to it, trusting the fatwa of the Sharia boards of the banks.

Islamic finance experts say interest-free banking doesn’t mean the bank operates on a no-profit, no-loss basis. Unlike a conventional bank that acts purely as a creditor and makes a gain on a loan, the bank-customer relationship in Islamic banking changes according to the mode of finance and the nature of the facility.

The major difference from conventional banking is that Islamic banking is essentially asset-backed. Instead of giving cash to a customer to buy a car, an Islamic bank buys the car itself and rents it out to the customer and gradually transfers the asset’s ownership over a period of time. In other words, the bank becomes the ‘lessor’ and the customer becomes the ‘lessee’.

Experts say the way the transaction is structured may possibly generate the exact same return to both conventional and Islamic banks. But the roundabout way of letting a customer own a car makes the whole process Islamic. Islam, in fact, prohibits interest, not trade. The banking process matters. Islamic banks are not money lenders. They operate as trading and investment houses. Faysal Bank Ltd has already converted and other banks will now be under pressure to make the transition.

It is believed that Faysal Bank would become a full-fledged Islamic lender by the end of 2022 after ring-fencing its residual conventional loan portfolio. It is in the process of surrendering its conventional banking mandate and becoming the country’s sixth Islamic bank. In addition to the existing five players, as many as 17 conventional banks currently operate their Islamic banking branches in Pakistan.

Those desirous of a Riba-free economy say the federal and provincial governments must take the first step to make the banking sector conform to Islamic principles through transition of its own ministries and institutions to Islamic banking. It may announce a plan for converting the National Bank of Pakistan into a Sharia-compliant entity. Large entities like Pakistan State Oil Company Ltd and Oil and Gas Development Company Ltd, along with cash-rich government arms like the Ministry of Finance, should be legally required to place their excess cash in Islamic banks.

As far as the Global Islamic Finance market is concerned, it can be segmented by the Financial Sector into Islamic Banking, Islamic Insurance ‘Takaful’, Islamic Bonds ‘Sukuk’, Other Islamic Financial Institutions (OIFL), and Islamic Funds. By geographic regions, the Islamic Finance market can be segmented into Gulf Cooperation Council (Saudi Arabia, Kuwait, UAE, Qatar, Bahrain, and Oman), the Middle East and North Africa (Iran, Egypt, Rest of MENA), South Asia, and Asia-Pacific (Malaysia, Indonesia, Brunei, Pakistan, Rest of South Asia and Asia-Pacific), Europe (United Kingdom, Ireland, Italy, Rest of Europe).

In fact, Islamic banking is the largest sector in the Islamic finance industry, contributing to 69%, or $1.992 trillion, of the industry’s assets. The sector is supported by an array of commercial, wholesale, and other types of banks. Yet commercial banking remains the main contributor to the sector’s growth.

There were 526 Islamic banks in 2019. However, the number of players is not necessarily indicative of the size of the industry, In terms of assets. The top three markets of Iran, Saudi Arabia, and Malaysia contribute to 63% of the Global Islamic Banking Assets, and Morocco is the fastest growing market in Islamic Banking Assets where assets doubled in 2019.

If Pakistan makes earnest efforts in making its banking sector Riba-free, and enhances its contacts and financial dealings with the countries already running their banks to Sharia principles, it would definitely secure its goal in a decade or so, even if it fails to meet the deadline of 2027, given by the Federal Shariat Court.