PROJECT REPORT:

Submitted by:

• Sana Khalid (AF-1625)

• Azka Zaheer (AF-1570)
• Shaheer Ahmed (AF-1568)
• Ammaz Ahmed (AF-1614)

Program and semester: BSAF-5A

Dated: 14TH May 2024

Submitted to: Dr Nosheen

Topic: Islamic Banking in Pakistan

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 TABLE OF CONTENTS:

Introduction .........................................................................03
Islamic banking in Pakistan.................................................03
Instruments of Islamic Banking...........................................04
Working of Islamic Banks...................................................06
Conventional Vs Islamic Banking.......................................08
Advantages...........................................................................09
References ...........................................................................09

Islamic Banking System:

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Introduction:

The concept of “Interest free system” is ought to be the Islamic banking system. A system which
strictly follows guidelines, values and principles of Islamic sharia ’ah. Interest free banking is
just one pillar of Islamic banking, Islamic banking is not only to avoid interest but also to avoid
certain actions and acts that are prohibited in Islam.

Islamic Sharia’ah:

In Arabic shariah means “a correct path”. In Islam, it refers to divine guidelines that Muslim
ought to follow to live moral lives and grow close to Allah. Islamic Shariah is derived from
following four sources:

• The Holy Quran

• The Sunnah of the Holy Prophet (P.B.U.H)
• Ijma (consensus of Ummah)
• Qiyas (analogy)

Islamic banking in Pakistan:

In the 1977-1978, Pakistan trying to be one of those few countries to implement interest-free
system on state level, started taking measures. State Bank of Pakistan (SBP) was agreed to
consider that all commercial banks will setup subsidiaries and conduct shariah products. In 2001,
State Bank issued detailed criteria to establish full-fledge Islamic subsidiaries in private sector,
Meezan Bank, Al-Habib Bank Ltd etc.

Islamic Bank Subsidiaries:

An amendment is the Section 23(1) of the Banking Ordinance 1962 on 4th November 2002,
which was strictly provided that all banks are required to setup Islamic subsidiaries strictly
following Islamic Shariah and Sunnah. Detailed instructions were also provided by the SBP.

• Meezan Bank
• Faysal Bank
• Al-Baraka Bank Ltd

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 • Bank Islami Pakistan Ltd
• Dubai Islamic Bank Pakistan Ltd etc.

Instruments:

Following are the financial instruments in Islamic Finance:

1. Murabaha:

On literal terms, Murabaha means a sale on mutually agreed profit. In this, a client asks banks to
purchase a tangible asset for them, the bank buys that for certain profit over cost and recovers
that from the client in the form of future payments. In Islamic point of view, it is necessary that
the good being demanded by the client is under seller's possession. Thus, the commodity will
remain under risk of the financer during period of sale of commodity by the agent and its sale to
the ultimate buyer. Under this contract, this property of the client cannot be resold to any other
financial institution for the purpose of obtaining further credit. Buy-back agreement is
prohibited.

2. Modaraba

A partnership form in which one person provides capital while the other provides expertise.
Profit is shared on a pre-agreed basis, while loss is borne solely by the capital provider.
“Mudarib” is the one running the business while “Rabbulmaal” provides capital. The conduct of
business is under the framework of the modaraba agreement. The liability of Rabbulmaal is
limited to his investment. The Mudarib may also invest in modaraba with permission of
RabbulMal but in this case, the profit and loss will be equally divided.

3. Ijarah

Ijrah or leasing is the transfer or right to use but not the right to ownership. The bank transfers
the right to use at a pre-determined rate, while assets should be non-perishable, non-consumable,
valuable, quantifiable etc. Ijrah is rent in case of hiring assets and wage in case of hiring people.

4. Musawamah

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In Islamic shariah, it is a kind of sale in which the good or commodity to be traded is bargained
among the seller and the buyer without considering the cost incurred by the former. As the seller
does not disclose the price of the good, it is different from Murabaha. All other conditions
relevant to Murabaha are valid for musawamah as well.

5. Istisna’:

In Islamic Shariah, it is an agreement of manufacturing goods by the seller as specified by the

buyer. Once the good is manufactured or is under completion, it is bought by the buyer at the rate
and time frame specified at the time of contract. The payments can be in the form of lump sums
or installments. It is considered halal in Islam if certain criteria are met like clarity regarding
specifications of goods, price and the delivery time frame. Istisna is used under construction or
manufacturing projects.

6. Musharrakah:

In Islamic law, it refers to a joint business in which two people either share capital or labor to
form a business under partnership. The profit is equally shared among them at pre-determined
ratios, while a loss is borne according to the proportion of capital invested. One or more partners
can decide to be the silent partners and will get a profit ratio not exceeding their capital invested.

7. Takaful

It is an alternative to Insurance complying with Islamic Shariah. Participants contribute funds

and that mutual fund is used to provide protection from losses to any one of the participants or
protection of assets. It avoids uncertainty (Ghrar), and gambling (Maysir), promoting social
security, cooperation and shared responsibility.

8. Sukuk

Sukuk also called Islamic bonds, are different from conventional bonds acting as a financial
instrument by Islamic banks. Instead of debt, sukuk bond gives ownership on tangible assets.
Sukuk holder receive profit generated by the asset or project unlike interest payments in bonds.
They mature at a certain date and must be returned along with face value at the maturity date.

9. Salam

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It means a contract for delivering goods on a future date with an advance payment. The seller
must provide specified goods on a future date while the price is paid at the time of the contract.
The quality of goods must be fully satisfied. These objects are goods not including gold and
currencies.

Working of Islamic Banks in Pakistan:

Islamic banking operates on principles derived from Shariah law, which prohibits the payment or
receipt of interest (riba). Instead, Islamic banking transactions are structured to comply with
Islamic law while facilitating similar financial services to conventional banking.

Here are some key principles and mechanisms of Islamic banking:

1. Prohibition of Interest (Riba):

Islamic banking prohibits the payment or receipt of interest, as it's considered exploitative.
Instead, Islamic finance uses profit-sharing arrangements, where profits and losses are shared
between the bank and the depositor/investor.

2. Profit and Loss Sharing (Mudarabah and Musharakah):

These are two main modes of Islamic finance. In Mudarabah, one party provides the capital,
while the other party provides the expertise and management. Profits generated are shared
according to pre-agreed ratios, while losses are borne solely by the capital provider. In
Musharakah, all parties contribute capital and share profits and losses according to their capital
contribution.

3. Asset Backing (Murabahah):

This is a common mode of financing in Islamic banking. Instead of lending money and charging
interest, the bank purchases the asset and sells it to the customer at a higher price, allowing the
customer to pay in installments.

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 4. Islamic Bonds (Sukuk):

Sukuk are financial certificates that comply with Islamic law. They represent ownership in
tangible assets or services, rather than debt obligations. Sukuk holders receive a share of profits
generated by the underlying assets.

5. Prohibition of Speculative Activities (Gharar and Maysir):

Islamic banking prohibits engaging in transactions involving excessive uncertainty (Gharar) and
gambling (Maysir). This principle promotes transparency and risk-sharing in financial
transactions.

6. Avoidance of Haram Activities:

Islamic banking avoids investing in businesses involved in activities prohibited by Shariah law,
such as alcohol, gambling, pork, etc.

7. Islamic Contracts

Contracts used in Islamic banking are based on specific Islamic principles such as Ijara
(leasing), Salam (advance payment for future delivery), Istisna (manufacturing contracts), and
Wakala (agency)

Conventional vs Islamic Banks:

Conventional and Islamic banking differ significantly in their principles, practices, and
underlying philosophies. Here's a comparison:

CONVENTIONAL BANKING ISLAMIC BANKING

1. Basis of operations:
Operates on interest-based transactions. Operates on shariah-compliant principles,
Banks lend money to borrowers with the including prohibition of interest. Instead,
expectation of receiving interest on the loan. Islamic banks use profit sharing etc.

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 2. Financial Products:
Offers a wide range of financial products and
services, i.e. loans, mortgages, deposits, credit
cards etc.
3. Risk and Reward Sharing:
Places the burden of repayment solely on the
borrower. Banks earn interest regardless of
the profitability of borrower's ventures.
4. Underlying philosophy:
Focuses on maximizing shareholder's wealth
and profitability through interest-based
lending and other financial activities.
5. Regulatory Oversight:
It is regulated by conventional banking laws
and regulations set by central banks and
financial regulatory authorities.
6. Investment Criteria:
Invests in a wide range of sectors and
industries, including those considered non-
compliant with ethical or social principles.
Advantages of Islamic banking system:
Offers shariah-compliant alternatives to
conventional financial products, i.e. Islamic
bonds (sukuk), profit-sharing accounts etc.
Emphasizes risk-sharing between the bank
and the depositor/investor. Both parties share
the risks and rewards of the investments.
Aims to promote social justice, ethical finance
and economic stability by adhering to shariah
principles.
Subject to additional regulatory oversight by
Shariah boards, comprised of Islamic scholars
who ensure that banking activities comply
with Islamic principles.
Avoids investments in sectors deemed
unethical or non-compliant with Shariah
principles, such as alcohol, gambling, pork,
and speculative activities.
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Strictly following Islamic banking brings several advantages:

• Transparency
• Justice
• Discouraging speculation
• Stability
• Financial inclusion

References:

• https://www.sbp.org.pk/IB/about.asp#:~:text=Islamic%20banking%20is%20defined%20
as,or%20operations%20which%20avoid%20interest.
• https://aims.education/study-online/islamic-financial-instruments/
• https://www.sbp.org.pk/IB/about.asp