Progress Interest-free Banks in Pakistan

Introduction:

This chapter high light the concept, principle and future of the Interest-free banking around the world particularly and importantly in Pakistan, which is officially; "The Islamic Republic of Pakistan" (www.pakistan.gov.pk). World is experiencing a large-level of growth in Interest-free banking and finance not only in Muslim countries but also in economically big Non Muslim countries like UK , USA and AUSTRALIA where Muslims are in minorities. The attraction which interest-free banking has, encouraging the world. It's unique concept of equality in profit and loss creating a charm for both, lender and borrower, to feel some sort of confidence. This research work has a great importance in respect to the progress of Interest-free banking in Pakistan.

What is an Interest?

Interest is a fixed charge for borrowing money. "The interest that you give in order to increase the wealth of the people, does not increase in the sight of Allah; and the Zakat that you pay in order to win Allah's approval, its payers do indeed increase their wealth" (Surah Al-Rome no. 39)(Shafi and Usmani, 1997, p.67). Forbidden of Interest in Islam is one of the basic Principles. Interest-free activity is depending on the same principle. An activity in which interest is involved either receiving or paying is not allowed in Islam but this does not mean that any activities which help to generate revenue are forbidden. Islam encourages every transaction which helps to generate revenue. It presents different tools to satisfy the basic spirit of business to generate a profit through different business activities.

Concept of Interest-free Activity:

The word interest free seems very simple but it has actually very deep impact not only on business but also on society. The problems, complications and crises society experiencing at present are because of those decisions taken by human during past. The theory, developed by West, increased the gap between rich and poor. Poor becomes the poorest and rich becomes the richest in a society. Islam tries to minimize this gap between two different classes which becomes huge due to the policies adopted by the west. "A financial institution whose statues, rules and procedures expressly state its commitment to the Principle of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations" (Hassan, 1999, p.60). According to Hassan, Islamic law prohibited the interest and the reason behind is; it's bad effects on human life and even more on society. The history evidence that rich people always has influence on the policies. They develop such methods in businesses which only target the benefits of rich. Their policies focus only how to increase their wealth using the middle, lower and working class people. Concept of interest-free business is aiming to allow human to generate revenue in fair and profitable way, without exploiting the others, specially; poor. The basic principle of Islam is equality. In every part of life, Islam emphasises on the equal distribution of human rights regardless of colour, nationality and religion. "Exclusion of interest from financial activities does not necessarily mean that the financier cannot earn a profit. If financing is meant for a commercial purpose, it can be based on concept of profit and loss sharing, for which musharakah and mudarabah have been designed since the very inception of Islamic commercial law" (Usmani, 2005, p.10). Islam trays to develop a culture of co-operation help one another under the umbrella of goodness. Stop exploitation of rights of human for the benefits of others. Interest is like lender charging to borrower extra money with out giving any thing in exchange. Claim extra money without putting any efforts means transfer money from needy person to the lender who already has excess money. It can be concluded in this way; transfer of money from poor to rich and this is contrary to Islamic teaching.

Interest-free Banking:

Interest-free banking is emerging on the world forum as viable player compeer to interest-based banking. "Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of sha'riah" (www.islamic-banking.com). This banking system is capable of satisfy the requirement of the society during different time and this is the reason why interest-free banking system progressing. Interest-free banking appeared on the scene as prominent player almost three decades ago. But the concept of interest-free is not new; it is one of the basic principles of Islam. Quran strictly forbid the Interest (riba). "Allah deprives interest of all blessing and develops charity; and Allah does not like an ungrateful, sinful person" (Suran Al-Baqarah no. 276) (Shafi and Usmani, 1997,p.49). Interest-free banking using the concepts of; profit sharing (mudharabah), joint venture (musharakah), safekeeping (widiah), leasing (ijarah) and cost plus (murabahah). Every school of thoughts agreed that Qur'an prohibits usury, the payment and/or collection of interest. A part of inclusion of interest, Islam restricts some business those are considered unlawful (haraam) due to their nature like sell of alcohol or pork and produce media which contained pornography. In last three decades, Interest-free banking has been introduced in several Muslim countries and recently in non-Muslim countries. Iran, Pakistan and Sudan adopted and implemented complete Islamic laws of banking. "Iran nationalised its bank after the 1979 revolution, in 1983" (Heffernan, S. 1998). They developed Usury-Free Banking Act which only allow the interest free transactions under the Islamic law but overseas' banking operations were exempted by this act.

PRINCIPLES OF INTEREST-FREE BANKING:

Interest-free banking depending on rules and principles created by God. Those rules and principles came to human's knowledge through holy book (Quran), sent by God, and his messenger (Muhammad, PBUH)

Interest (riba)

Interest is the extra money a borrower paying to the lender because he/she used his/her money. Interest is a fixed rate charged by lender on his/her money with the consent of borrower. The basic criticism on interest is; lender is not sharing loss with borrower. Although lender only asking fixe interest on his/her money in case of huge profit. Non-conventional banking system depends on; the share of both in any case, either profit or loss.

Gharar and Maysir

Uncertainty (Gharar), speculation (Maysir) or anything which leads to injustice or unfair with any one due to any transaction is prohibitive according to Sha'riah laws. Gambling is not allowed in Islam.

Unethical business

Islam is a religion for every human. It always tries to create a peaceful, friendly and ethical environment in the whole society. Islam does not allow any transaction which involves anything like alcohol, illicit drugs and tobacco.

FUNDAMENTAL OF INTEREST-FREE BANKING

Islamic commercial law is actually based on four basic principles. The fundamental of first Islamic business principle is profit and loss sharing, the second is based on fixed service fees and charges; third is based on free of cost and no charges. The other principles are changing with the situation of the business and its operation (Bellalah and Ellouz, 2004). The overall concept regarding interest-free banking among the people is that such banking system is not for commercial transactions. This is completely a wrong concept. Sha'riah presents the different tools through which commercial transactions can be performed successfully.

Musharakah (partnership)

Sharing is the literal meaning of musharakah. In the context financial meaning, it is joint enterprise; where all the partners of the business share profit or loss of the joint enterprise. It means a financier in non-conventional system can suffer a loss. Under the interest-based system or conventional system a bank who allows industrialist and/or trader to use depositor's money for the business. As a result of good profit in a business depositor only gets the fixed rate of interest on his deposit regardless of how much borrower earn with the help of depositors' money. The other possibility in business is loss but depositor is not contributing in loss. He/she only interested in their fixed share. On contrary Islam clearly mentioned that financer must have to participate in both, profit and loss. It is being summarised from the above that industrialist/trader has to share the profit with the depositor and it will provide a benefit to common people rather than rich.

Mudarabah (trust financing)

"Mudarabah is a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise" (Usmani, 2002). 1st partner or investor called "rabb-ul-mal" and the 2nd partner who does the management part of the business called "mudarib". 1st partner has no right to participate in the management; in case of loss in this type of business, he is also not sharing it as he has not invest any thing unless any negligence and dishonesty found at his part. He will only be responsible for that loss. It is being observed and experienced that there are some areas where musharakah and mudarabah does not fulfil the economic requirement of the business. In this case interest-free banking develops some new areas under the guidance of Islamic rules to satisfy the financial needs of the business.

Murabaha (cost plus financing)

In "murabaha" mode of financing, the seller discloses the actual cost he paid to get the particular commodity and plus his share of profit in it. This share of profit may be based on either a percentage or could be a fixed lump sum amount.

Bai-mua'jjal (deferred payment sale)

In this contract of sale parties agree that the payment of price shall be deferred. This selling price could be more then the actual cash price, need to be decide at the time of sale. Payment date can be specified in different ways like two months after the sale or 90 days etc.

Ijara (leasing)

Ijara is a contract in which the owner of a product transfer its usufruct to some other person on the basis of mutually accepted considerations.

Quard Hassan

Quard Hassan means beneficial loan. Chapra has defined it as a loan which is returned at the end of he agreed period without any interest or share in the profit or loss of the business.

Compatibility of Interest-free banking with Conventional banking:

Like interest-based banking, interest-free banking system also has a same motive and practice. Except that interest-free banking works under the Sha'riah laws which strongly prohibited the involvement of interest and recommend the sharing of profit and loss between contracted parties. As a result of this, new concept being introduced called Profit-Loss-Sharing (PLS). The products which interest-based banking system offers; like current accounts, saving accounts, insurances, and mortgages are more or less same but the element of interest is being treated in different way. The practice of fixed interest rate in conventional banking system is the difference between two systems. "The practices and situations are not so different from conventional banking such as the cost of funds are closely related to interest rates and guarantees are nearly as important in Islamic banks as they are in the conventional banks" (Hassan, 1999). Political and religious matters play very important role either to transform the whole financial system of the country into Islamic financial system at once or implement it step by step and gradually. As world experienced in Iran; 1983 Usury Free Banking Law completely replaced the interest-based banking system. Iran has 98% Muslim population (www.cia.gov) and the response they got from the people was quite positive. Sudan also implemented the interest-free banking system with Iran. Conventional banking system very strongly implemented and penetrated all over the world before the interest-free came on the scene of financial pages. It is still not easy for non-conventional banking system to make a place to breath. Due to these situations some Muslim and Non-Muslim countries are adopting the interest-free banking system with conventional, which is already exists, banking system. Bahrain and Malaysia are the examples. Such a dual system creating an opportunity for the people to invest either in conventional or in interest-free system or either get benefit of both systems. Due to successful approach of such parallel system of banking; Malaysia became the hub of interest-free banking. This premature dual system is an important and positive break to the world economy and it could move towards greater Islamization. Regardless of such performance interest-free system is still significantly smaller than conventional system. Hard work needs to be done to get the desire results and compete the conventional banking system especially during this crises time.

Empirical research

Interest-free banking and its implementation:

Interest-free banking is still living its early life but that is not to say that such concept is completely new and never being tried before in the world. In Malaysia during mid-forties and during mid-fifties in Pakistan this interest-free system were being tested but due to some reasons neither of it survived. The Conference of the Finance Ministers of the Islamic Countries held in 1970 at Karachi and 1st International Conference on Islamic Economics in 1976. Next year in 1977 International Economic conference in London became the reason of Interest-free banking system. This was the time when the demand of implication of theory in practice became stronger. 90% of the population in Pakistan belongs to Muslim religion. Among those 70% are Sunni Muslims and 20% are Shi'a Muslims. In 1979, the first part of the economic reform began in Pakistan and Zakat was imposed on all savings accounts. The issues were raised; 1st the banks are not the custodians of the money that's why banks can not distribute the Zakat, 2nd who will provide the surety that the money will be delivered to deserving people. Apart of the above, Shi'a Muslims have their own way to distribute the Zakat and that's why government of Pakistan separate them from this process of Zakat deduction. Now every Shi'a Muslim has to submit the declaration about their religion as a Shi'a Muslim and then the banks eliminate them form the Zakat deduction process. During mid 80's, General Zia-ul-Haq was President of Pakistan, non-conventional banking system being introduced. Continue............ "Assets held by fully Sha'riah-compliant banks or interest-free banking windows of conventional banks, rose by 28.6%, to $822bn from $639bn in 2008. This is in striking contrast to The Banker's 2009 "Top 1000 World Bank Rankings" released in July, which showed annual asset growth of just 6.8% at conventional banks". (www.ameinfo.com) "The Islamic finance industry continues to build a solid track record: the compound annual growth rate for 2006-2009 is 27.86%, with assets forecast to hit $1033bn in 2010". (www.ameinfo.com)

Challenges to Interest-free banking:

"We are getting to the point that we are holding informal talks at an early stage with clients and we help them explore whether there are viable Islamic options in the syndications market or with capital market instruments" says Khan ( Everett-Heath, Tom)

Issues and Problems facing Conventional banking:

Policies and Laws are being developed for the benefits of state and people. Departments either Government and/or private establish under the policies and laws of the country. Same procedure applies on banking industry. Sound banking system reflects the stability of the economy in any country. "Islamic bank embraces the philosophical underpinning of ethical banking which is the quest to make a market in money, but not to make money in the market (Green, 1989)". The basic concept of interest-free banking is to operate business on the basis of demand rather then the need of the society and people. It is being observed; their businesses are mostly in those areas where demand is high. Need of the people is not the priority in interest-based banking. Their decisions are not always in favour of society, infect they only focused on the profit generating options. This is one of the problems which unbalanced the society and increase the gap between, rich and poor, two classes. It is a general opinion among the bankers that the global financial crisis accelerates the interest in interest-free banking among the people and it provides a chance to interest-free banking system to capture the market. This opportunity is only arises because of the problems in interest-based banking system. "In the second quarter the industry lost $3.7 billion, credit quality dropped to all-time lows, the troubled-bank list reached a 15-year high and federal reserves backing deposits fell to their lowest level since the savings and loan crisis" (Adler, Joe).

How Interest-free Banking deal with these problems and issues:

Interest-free banking works on the basis of profit and loss-sharing which brings social and economic benefits to borrowers, lenders and communities. Welfare of society through promotion of equity and facilitate the poor by providing the credit. This step generates more business activities, the opportunities of job and assists the common people to earn some income. Abdul Gafoor (2003) mentioned that Interest-free banks have been using their energies in charity works. Directly or indirectly they are financing those projects which are under control of charity organisations for the purpose to help the needy and deserving member of the society. "The vast majority of sha'riah-complaint institutions have been conducting their business in a conservative manner, and they avoided credit derivatives and other complex structured assets that turned toxic for interest-based banks" Al-Yousuf says (GCC Regional Report). Investors are looking towards interest-free banking and it is very important for bankers to learn lessons about good banking. Al-Yousuf emphasises that we have to understand the fundaments of credit concept and requirement of our customers. He added; the ability of income-generating and capital appreciation; attracted the investor towards this newly presented system of banking. During early eighty's Islamic banking were trying to entre in Non-Muslim countries and Equality in every part of life established balance among different things. The concept of distribution of profit is creating a difference between two systems.

Reference:

• Abdul Gafoor, A. L. M. 2003. 'Meeting the financial needs of Muslims: A comprehensive scheme', International Journal of Islamic financial Services, 5(3):29-36.
• Adler, Joe. American Banker, 8/28/2009, Vol. 174 Issue 164, p1-3, 2p graphs; (AN44080593), Business Resource Premier.
• Bellalah, M. and Ellouz, S. (2004) Islamic Finance, Interest Rates and Islamic Banking: A Survey of the Literature. Finance India, 18, pp. 533
• Everett-Heath, Tom. MEED: Middle East Economic Digest, 12/110/2004, Vol. 48Issues 50, p41-42, 2p, 2 color; (AN 15583031), Business Source Premier.
• Green, C. F. 1989. 'Business ethics in banking', Journal of Business Ethics, 8: 631-634.
• Heffernan, S. 1998. 'Modern banking in theory and practice' Banking structure around the world, pp115. John Wiley and Sons.
• Hassan, M. K. (1999). Islamic banking in theory and practice: The experience of Bangladesh, Managerial Finance, pp.60.
• Shafi, M. Taqi Usmani, M. (1997) The Issue of Interest, Pakistan, Darul Ishaat
• Taqi Usmani, M. (2005). An Introduction to Islamic Finance, Pakistan: Maktaba Ma'Ariful Qur'an
• Taqi Usmani, M. (2002). An Introduction to Islamic Finance, Arab and Islamic Laws Series Kluwer Law International, pp.12.
• Hamid, S. A. 2006. 'Philosophy and practice of Islamic economics and finance'. [online] URL: Accessed 15th November 2009.

Online Reference:

• Available on: https://www.pakistan.gov.pk/ [Assessed on 4th November. 2009]
• Available on: https://www.islamic-banking.com/what_is_ibanking.aspx [Assessed on 18th November. 2009]
• Available on: https://www.cia.gov/library/publications/the-world-factbook/geos/ir.html [Assessed on 19th November 2009]
• Available on: https://www.ameinfo.com/214968.html [Assessed on 26th November 2009]
• Available on: https://web.ebscohost.com/ehost/pdf?vid=16&hid=8&sid=ade97da4-867f-45ac-be43-8423498e48ec%40sessionmgr10 GCC Regional Report July/August 2009 by Gordon Platt, Islamic Finance. [Assessed on 21st November, 2009]

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