Topic: An empirical study about Islamic banking comparing to conventional banking: A case study oI

Meezan Bank
CHAPTER 1: Introduction
1.1 Introduction
Global Iinancial industry is one oI the most Ilourished and developed industry in the world. This
industry comprise oI both the banking and non-banking Iinancial institutions. These Iinancial
institutions are core units oI world economies and provide Iinances to the businesses globally.
However in the last Iew years these institutions have Iaced a severe crisis that aIIected the Iinancial
services industry very deeply. This crisis highlighted another important thing which was Ielt globally;
is the drawback oI interest based economic system.
Initially, more or less two decades ago, Islamic banks started their operations and now Islamic
banking is a competitor Iorce Ior conventional banking and rivalling neck to neck. Providing oI
banking and Iinancial services compliance with Sharia law has enhanced to the degree that most oI
non-Islamic banks, western and Middle Eastern both have Ielt to give their attention to this sector as
well.
1.2 Research Background
A banking activity or banking system which is connected with Sharia (Islamic law) rules is led by
banking activity and directed by philosophies oI Islamic economics. Particularly, usuary is Iorbidden
by Sharia,, to pay and receive interest, which is also known as riba in Arabic language. Normally,
Iinancial risk trading is Iorbidden by Sharia as well (that is considered as type oI gamble).
Additionally, investment in the business which is haram by nature (like the business to sale alcoholic
drinks and pork, or business which manuIacture the items opposing to Islamic teachings) is Iorbidden
by Sharia. In ending decades oI 20
th
century, numerous Islamic banks were developed, in order to
serve a speciIic banking and Iinancial market.
According to an estimate there is approximately 1.8 million Muslim population in UK, in other words
3 oI total population. Concentrated population consisting oI 50 oI total UK Muslims communit y
is living in London. More than halI a million Muslim visitors are estimated visiting UK every year
regularly and Muslim population living in whole European Union is estimated 12 million, more
signiIicantly in Germany and France.
A number oI high street retail banks are now tend to provide Islamic Iinancial services and products in
United Kingdom, they are oIIering home Iinance products designed Ior Muslims and current deposit
accounts. The United Kingdom is the birth place oI Iirst retail bank which is completely compliance
with Sharia law in whole western Iinancial world that is Islamic bank oI Britain, FSA authorised it in
year 2004. European Islamic Investment Bank is approved by FSA as well that is Iirst investment
bank Islamic by nature. Moreover, now London is appeared as most signiIicant Iinancial hub with
biggest conventional banks providing Islamic Iinancial services based in Middle East and major
international Iinancial companies.
GulI region and Middle East are most Iocused areas as Iinancial centres Ior Islamic banking and
Iinance. Globally, the assets handled by Islamic Iinancial institutes are approximated to be 1 trillion
dollars maintaining a growth rate oI 10 to 15 in a year.
1.3 Research Objective
Now a days, investment is considered like a Iixed deposit oI a bank, the reason is that it returns a
proIit and the borrowed loan is identiIied like an asset by bank with the same cause. But the proIit oI
both the loans is based on interest. Money is always present in Ior oI loan, whatever the purpose is.the
lenders oI loan (which are both bank and depositor Ior diIIerent borrowers) have not in Iact any
concern about the use oI loan either Ior productivity or Ior consumption; no one have concern about
the consequences oI any productivity process where their capital was utilised. In either case the loan is
consumed or the invested money produced loss, it is must to return the loan back including preIixed
interest rate. In traditions oI Islam, contrasting to mentioned situation, the diIIerence oI loan and
investment is crystal clearly identiIied and provided Ior, nut unluckily, in the present age, act upon
and Iull appreciation is not being seen Ior it.
The Islamic banking examination starts with the comparison oI structure oI banking with conventional
regular banks and will remain with the Islamic banking rules. A big picture on Islamic banking rules
will be provided by the research and it will be compared with system oI conventional regular banking
in order to recognise the diIIerence. This will be explored that that in what ways Islamic banking is
serving the demands oI millions oI Muslims to obvious oI riba (interest) that is Iorbidden by in
accordance with Islamic sharia. This research dissertation has the aim to discover the practicability oI
banking Iree oI interest Irom the perspective oI operational management, and to determine essential
conditions in order to achieve system oI Islamic banking. Pros and cons oI Islamic banking system
will also be provided.
Objective 1: To assess the concept oI wealth in Islam and how Iar it has been changed with time to
time.
Objective 2: To assess the concept oI Interest in Islam and identiIy is interest is allowed in any Iorm?
II interest is prohibited then how bank works?
Objective 3: To assess the Iunction oI Islamic bank in comparison with conventional bank?

. Researcb questions:
"uestion 1: What is the concept oI wealth in Islam?
"uestion 2: What is the concept oI interest in Islam?
"uestion 3: What is the diIIerence between Iunctions oI Islamic and non-Islamic banks?


CHAPTER 2: Literature Review
2.1 History oI Usury and Interest
Until a Iew hundred years ago any extra amount demanded by the lender in addition to his capital was
called usury. Early European philosophers such as Plato (427-347 BC) and Aristotle (384-322 BC)
condemned the practice oI taking usury. Aristotle compared money to a barren hen which laid no eggs
a piece oI money cannot beget another piece oI money, he held. The Roman Empire, in its early
stages, prohibited charging oI usury. The Christian Church prohibited all usurious transactions. The
Iamous incident in Jerusalem where Jesus Christ chased away the moneylenders Irom the Temple was
kept alive in Church preaching. Though usury was practiced all over the Christendom and elsewhere
the Church was consistent and vehement in its condemnation oI usury. (Llewellyn, David T. 1992)
However, by the end oI the thirteenth century several Iactors appeared which considerably
undermined the inIluence oI the Orthodox Church. Eventually, the reIormist group, led by Luther
(1483-1546) and Zwingli (1484-1531), agreed to the charging oI interest on the plea oI human
weakness. (Schlesinger G, 1994) According to Encyclopaedia Britannica, 'In Old English law, the
taking oI any compensation whatsoever was termed usury. With the expansion oI trade in the 13th
century, however, the demand Ior credit increased, necessitating a modiIication in the deIinition oI the
term. Usury then was applied to exorbitant or unconscionable interest rates (El-Gamal, M. 2010). In
1545 England Iixed a legal maximum interest; any amount in excess oI the maximum was usury. The
practice oI setting a legal maximum on interest rates was later Iollowed by most states oI the United
States and most other Western nations. ("aiser, W. 2006)
Thus, beginning in the mid-sixteenth century, the prohibition on usury (in the old sense) was legally
removed in all Western countries. The environment, in which it took place, as evidenced by the above
quote, is noteworthy expansion oI trade and demand Ior credit (El-Gamal, M. 2010). Borrowers
were mainly the rich merchants, and they used the short-term credit Ior buying and selling goods. And
the moneylenders were lending their own money and/or that oI their wealthy clients. The borrowers
knew how much they could make using a given amount oI credit, and they paid the lenders a portion
oI this proIit. This supplied the justiIication Ior demanding the extra amount. (Llewellyn, David T.
1992)
But this justiIication Ior 'limited interest under a particular circumstance was, in the course oI time,
stretched out and applied in general. Support was Iorthcoming on other grounds too.(Varian H 1992)
For example, Sir Francis Bacon (1561-1626) advocated, 'Since oI necessity men must give and take
money on loan and since they are so hard oI heart that they will not lend it, otherwise there is nothing
Ior it, but that interest should be permitted.
Now that the new 'moderate Iorm oI usury interest was legal and 'moral, economic theories
were developed with this limit and justiIication as the base (El-Gamal, M. 2010). Theories Iound their
way into textbooks, more theories were developed, and interest became an integral part oI economic
theory. In practice, the theory was applied universally whether the original conditions that justiIied the
extra payment existed or not. Practice reinIorced theory and, once incorporated into the Ioundations oI
economics, it is now diIIicult to think oI any economic theory or activity without interest being an
integral part oI it. (Llewellyn, David T. 1992)
In 1545, the 'legal maximum interest rate in England was Iixed at ten percent per annum, but it did
not remain Iixed Ior long. It varied Irom time to time and Irom place to place, depending on the
economic and political circumstances. (Llewellyn, David T. 1992) Eventually, the concept oI
'maximum interest ceased to exist, and usury as a word even went into disuse. Today, practically
everywhere, charging and paying interest is legal, no matter how much, and it is acceptable both in
theory and practice.
2.2 The Islamic position on Interest
Islam -the most modern revealed religion is still upholding the righteous prohibition oI Riba (interest)
although not in practice in any oI the Islamic country at governmental level but there is immense
enthusiasm Ior interest-Free Iinancial system in Muslims. The western economists have discussed the
issue at large in the twentieth century and many oI them are also oI the view that the religious
prohibition should be brought back into the conscious oI the people (El-Gamal, M. 2010).
The Holy Book oI Islam, the "ur`an, prohibits the demanding and receiving oI interest in the
Iollowing terms:
O ye who believe' Devour not usury, doubling and quadrupling (the sum lent). Observe your duty to
Allah that you may be successful. (Quran, 3.130)
Again,
O ye who believe' Observe your duty to Allah, and give up what remaineth (due to you) from usury, if
ye are (in truth) believers.
And, if you do not, then be warned of war (against you) from Allah and His Messenger. And, if ye
repent, then ye have your principal (without interest). Wrong not, and you shall not be wronged.
(Quran, 2.278-279)
The Holy Prophet (pbuh) has prohibited accepting oI riba, paying oI riba, and recording and
witnessing it in the Iollowing terms:
Jabir (ra) said that Allah`s Messenger (pbuh) cursed the acceptor oI interest, its payer, and the one
who records it; and the two witnesses; and he said: They are all equal. (Sahih Muslim, Hadith
no.3881)
The prohibition oI riba is clear Irom the above statements in the original sources. However, the
"ur`an did not deIine it the same way it had not deIined gambling, theIt or adultery. What was
meant was assumed understood. And the Prophet (pbuh) did not explain every possible aspect oI riba.
Later on, Ulama (religious scholars) have attempted to deIine the word riba based on the practices
obtaining at the time oI the Prophet (pbuh). But unanimity oI opinion had not been reached on all
aspects. Furthermore, since the reasons Ior the prohibition have not been given in either oI the two
original sources, it is impossible to give a new all encompassing deIinition oI riba under any present
or Iuture conditions. (Usmani Taqi, 1999)
The diIIiculty arises mainly because oI the existence oI two kinds oI riba. One is called riba al-Nasiah
and the other riba al-Fadl. The Iormer relates to money-loans and credit transactions using money, and
was well known and widely practised by the Arabs since long beIore the advent oI Islam hence it is
also called riba al-Jahiliyya. Riba al-Jahiliyya is very similar to the present day interest on loans and
credit sales. (Usmani Taqi, 1999) The core concept is a loan at a pre-agreed rate oI interest. The
variations include a grace period during which there is no interest (similar to today`s credit cards) (El-
Gamal, M. 2006), regular interest payments till the loan is Iully paid (simple interest), and interest on
interest and/or punitive additions beyond the pre-agreed period (Gaus, G. 2008). That this practice
was prohibited by the "ur`anic injunctions there is no disagreement. (Abdul GhaIoor, 1995)
Riba al-Fadl relates to commodity transactions and has been mentioned only in the prophetic
traditions. Here riba may enter when barter-exchanging two diIIerent commodities or due to
diIIerences in quality and/or quantity in the exchange oI the same species. (Usmani Taqi, 1999)
In banking and Iinance, main concern is with money and money-loans. ThereIore what is relevant to
discuss riba al-Nasiah (Dar H. 2005), and there have never been any doubts or diIIerences oI opinion
as to what it meant. The "ur`an has prohibited the taking oI this kind oI riba in the strongest possible
terms. Its authorised interpreter the Prophet (pbuh) has said that accepting, paying, recording
and witnessing it are all equally prohibited. (Usmani Taqi, 1999) On the other hand, the "ur`an also
says, '. then ye have your principal (without interest), thus entitling the lender to the Iull return oI
his capital (Muhammad A. 2008). ThereIore, in order to comply with the prohibition Iully and without
a shade oI doubt, and in order not to inIringe on the right oI the lender, a simple but comprehensive
deIinition is popularly adopted: that in money matters; any addition to the principal sum is riba. This
also accords with the deIinition oI usury in other Iaiths. (Khalil et al, 2000)
2.3 Islamic Banking System
Modern banking system was introduced into the Muslim countries at a time when they were
politically and economically at low ebb, in the late 19th century. The main banks in the home
countries oI the imperial powers established local branches in the capitals oI the subject countries and
they catered mainly to the import export requirements oI the Ioreign businesses. (Ahmad A .1997)
The banks were generally conIined to the capital cities and the local population remained largely
untouched by the banking system. The local trading community avoided the 'Ioreign banks both Ior
nationalistic as well as religious reasons. However, as time went on it became diIIicult to engage in
trade and other activities without making use oI commercial banks. Even then many conIined their
involvement to transaction activities such as current accounts and money transIers. Borrowing Irom
the banks and depositing their savings with the bank were strictly avoided in order to keep away Irom
dealing in interest which is prohibited by religion. (Ahmad A .1997)
With the passage oI time, however, and other socio-economic Iorces demanding more involvement in
national economic and Iinancial activities, avoiding the interaction with the banks became impossible.
Local banks were established on the same lines as the interest-based Ioreign banks Ior want oI another
system and they began to expand within the country bringing the banking system to more local
people. (Khalil et al, 2000) As countries became independent the need to engage in banking activities
became unavoidable and urgent. Governments, businesses and individuals began to transact business
with the banks, with or without liking it. This state oI aIIairs drew the attention and concern oI
Muslim intellectuals (Iqbal, Zamir and Mirakhor, 2007). The story oI interest-Iree or Islamic banking
begins here. In the Iollowing paragraphs we will trace this story to date and examine how Iar and how
successIully their concerns have been addressed. (Usmani Taqi, 1999)
2.4 Historical Development
The history oI interest-Iree banking could be divided into two parts. First, when it still remained an
idea; second, when it became a reality --by private initiative in some countries and by law in others.
Both periods are discussed separately. The last decade has seen a marked decline in the establishment
oI new Islamic banks and the established banks seem to have Iailed to live up to the expectations. The
literature oI the period begins with evaluations and ends with attempts at Iinding ways and means oI
correcting and overcoming the problems encountered by the existing banks. (Khan M Faheem, 1999)
2.4.1 Interest-Iree banking as an idea
Interest-Iree banking seems to be oI very recent origin. The earliest reIerences to the reorganisation oI
banking on the basis oI proIit sharing rather than interest are Iound in Anwar "ureshi (1946), Naiem
Siddiqi (1948) and Mahmud Ahmad (1952) in the late Iorties, Iollowed by a more elaborate
exposition by Mawdudi in 1950 (1961). Muhammad Hamidullah`s 1944, 1955, 1957 and 1962
writings too should be included in this category. They have all recognised the need Ior commercial
banks and the evil oI interest in that enterprise, and have proposed a banking system based on the
concept oI Mudarabha -proIit and loss sharing.
In the next two decades interest-Iree banking attracted more attention, partly because oI the political
interest it created in Pakistan and partly because oI the emergence oI young Muslim economists
(Adam N. 2005). Works speciIically devoted to this subject began to appear in this period. The Iirst
such work is that oI Muhammad Uzair (1955). Another set oI works emerged in the late sixties and
early seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971) and
Baqir al-Sadr (1961, 1974) were the main contributors. (Ahmad A .1997)
Early seventies saw the institutional involvement. ConIerence oI the Finance Ministers oI the Islamic
Countries held in Karachi in 1970, the Egyptian study in 1972, First International ConIerence on
Islamic Economics in Mecca in 1976, International Economic ConIerence in London in 1977 were the
result oI such involvement. (GhaIoor Abdul, 1997) The involvement oI institutions and governments
led to the application oI theory to practice and resulted in the establishment oI the Iirst interest-Iree
banks. The Islamic Development Bank, an inter-governmental bank established in 1975, was born oI
this process. (GhaIoor Abdul, 1997)
2.4.2 The coming into being oI interest-Iree banks
The Iirst private interest-Iree bank, the Dubai Islamic Bank, was also set up in 1975 by a group oI
Muslim businessmen Irom several countries. Two more private banks were Iounded in 1977 under the
name oI Faisal Islamic Bank in Egypt and the Sudan. In the same year the Kuwaiti government set up
the Kuwait Finance House. (Khan Tariqullah, 1995)
However, small scale limited scope interest-Iree banks have been tried beIore. One in Malaysia in the
mid-Iorties and another in Pakistan in the late-IiIties. (GhaIoor.2002) Neither survived. In 1962 the
Malaysian government set up the 'Pilgrim`s Management Fund to help prospective pilgrims to save
and proIit The savings bank established in 1963 at Mit-Ghamr in Egypt was very popular and
prospered initially and then closed down Ior various reasons.(Sheikh Mahmud. 1992) However this
experiment led to the creation oI the Nasser Social Bank in 1972. Though the bank is still active, its
objectives are more social than commercial. (GhaIoor.2002)
In the ten years since the establishment oI the Iirst private commercial bank in Dubai, more than 50
interest-Iree banks have come into being. Though nearly all oI them are in Muslim countries, there are
some in Western Europe as well: in Denmark, Luxembourg , Switzerland and the UK. Many banks
were established in 1983 and 1984. The numbers have declined considerably in the Iollowing years.
(Iqbal and Abbas. 1987)
In most countries the establishment oI interest-Iree banking had been by private initiative and was
conIined to that bank. In Iran and Pakistan, however, it was by government initiative and covered all
banks in the country. The governments in both these countries took steps in 1981 to introduce interest-
Iree banking (Rahman & Zaharuddin 2006). In Pakistan, eIIective 1 January 1981 all domestic
commercial banks were permitted to accept deposits on the basis oI proIit-and-loss sharing (PLS).
New steps were introduced on 1 January 1985 to Iormally transIorm the banking system over the next
six months to one based on no interest. From 1 July 1985 no banks could accept any interest bearing
deposits, and all existing deposits became subject to PLS rules. Yet some operations were still
allowed to continue on the old basis. In Iran, certain administrative steps were taken in February 1981
to eliminate interest Irom banking operations. Interest on all assets was replaced by a 4 percent
maximum service charge and by a 4 to 8 percent proIit` rate depending on the type oI economic
activity. (Usmani Taqi, 1999) Interest on deposits was also converted into a guaranteed minimum
proIit.` In August 1983 the Usury-Iree Banking Law was introduced and a Iourteen-month change
over period began in January 1984. The whole system was converted to an interest-Iree one in March
1985. (www.sbp.gov.pk)
2.4.3 The last decade
The subject matter oI writings and conIerences in the eighties have changed Irom the concepts and
possibilities oI interest-Iree banking to the evaluation oI their perIormance and their impact on the rest
oI the economy and the world. Their very titles bear testimony to this and the places indicate the
world-wide interest in the subject. (Khalil et al, 2000) ConIerence on Islamic Banking: Its impact on
world Iinancial and commercial practices held in London in September 1984, Workshop on Industrial
Financing Activities oI Islamic Banks held in Vienna in June 1986, International ConIerence on
Islamic Banking held in Tehran in June 1986, International ConIerence on Islamic Banking and
Finance: Current issues and Iuture prospects held in Washington, D.C. in September 1986, Islamic
Banking ConIerence held in Geneva in October 1986, and ConIerence Into the 1990`s with Islamic
Banking` held in London in 1988 belong to this category. The most important one is the Workshop on
the Elimination oI Riba Irom the Economy held in Islamabad in April 1992. (Usmani Taqi, 1999)
Several articles, books and PhD theses have been written on Islamic Banking over time. Special
mention must be made oI the work by M. Akram Khan in preparing annotated bibliographies oI all
published (and some unpublished) works on Islamic Economics (including Islamic Banking) Irom
1940 and beIore. It is very useIul to students oI Islamic Economics and Banking, especially since both
English and Urdu works are included (1983, 1991, 1992). M.N. Siddiqi`s bibliographies include early
works in Arabic, English and Urdu (1980, 1988). Turkish literature is Iound in Sabahuddin Zaim
(1980).
Conventional and Islamic banking- Similarities and Differences
Islamic Financial Institutions (IFIs) are operating in the same society where conventional banks are
operating and perIorm all those Iunctions which are expected Irom a Iinancial institution. IFIs are
assisting business world by providing all the services required to run the economy smoothly, however,
the philosophy and operations are diIIerent. In this section I will analyze the operations and products
oI IFIs in comparison with traditional conventional banks. Any Iinancial system is expected to assist
in running the economy by providing the Iollowing services grouped in two headings. First; Savings
mobilization Irom savers to entrepreneurs and Second; Provision oI general utility services including
transIer oI Iunds, Iacilitation in international trades, consultancy services, saIekeeping oI valuables,
and any other service Ior a Iee. There is no restriction on provision oI such services by IFIs as Ior the
service is not against the Sharia. However there exists diIIerence in mechanism oI Iunds mobilization
Irom savers to entrepreneurs as described Iollowing. Savings mobilization consists oI two phases i.e.
accepting deposits and extending Iinancing and investments (KFH 2007).
2.4.3.1. Deposits
Deposits are collected Irom savers under both type oI institutions Ior reward irrespective a bank is
operating under conventional system or Islamic system. The diIIerence lies in agreement oI reward.
Under conventional system reward is Iixed and predetermined while under Islamic deposits are
accepted through Musharaka and Mudaraba where reward is variable. Under conventional banking
return is higher on long-term deposits and lower Ior short-term deposits. Same is the practice in
Islamic banking to share proIit with depositors. Higher weight Ior proIit sharing is assigned to long-
term deposits being available to bank Ior investing in longer term projects yielding superior returns
and lower weight Ior short-term deposits which cannot be invested in long term projects. The only
diIIerence in conventional and Islamic system lies in sharing oI risk and reward. Under conventional
system total risk is born by the bank and total reward belongs to it aIter servicing the depositors at
Iixed rate while under Islamic system risk and reward both are shared with depositors (Thomas, R.
2006). Reward oI depositors is linked with outcomes oI investments made by IFIs. Under Islamic
Iinancial system only those IFIs will be able to collect deposits who can establish trust in the eyes oI
masses hence leading to optimal perIormance by Iinancial industry. So Ior IFIs working in Pakistan
have succeeded in establishing their credibility in the eyes oI savers as depicted in table 2 (appendix
A) an increasing trend oI deposits collection (SBP, 2010).
2.4.3.2 Financing and Investments
The second phase in savings mobilization process is extension oI credit Iacility to business and
industry Ior return. Both types oI institutions (Islamic and Conventional) are providing Iinancing to
productive channels Ior reward. The diIIerence lies in Iinancing agreement. Conventional banks are
oIIering loan Ior a Iixed reward while IFIs cannot do that because they cannot charge interest. IFIs
can charge proIit on investments but not interest on loans. In conventional banking three types oI
loans are issued to clients including short term loans, overdraIts and long-term loans. Islamic banks
cannot issue loans except interest Iree loans ("arz e Hasna) Ior any requirement however they can do
business by providing the required asset to client ("aiser, W. 2006).
2.5 Current practices
Generally speaking, all interest-Iree banks agree on the basic principles. However, individual banks
diIIer in their application. These diIIerences are due to several reasons including the laws oI the
country, objectives oI the diIIerent banks, individual bank`s circumstances and experiences, the need
to interact with other interest-based banks, etc. Here are the salient Ieatures common to all banks.
(Siddiqui Nejatullah, 1988)
2.5.1 Deposit accounts
All the Islamic banks have three kinds oI deposit accounts: current, savings and investment.
2.5.2 Current accounts
Current or demand deposit accounts are virtually the same as in all conventional banks. Deposit is
guaranteed. (GhaIoor, 2000)
2.5.3 Savings accounts
Savings deposit accounts operate in diIIerent ways. In some banks, the depositors allow the banks to
use their money but they obtain a guarantee oI getting the Iull amount back Irom the bank. Banks
adopt several methods oI inducing their clients to deposit with them, but no proIit is promised. (Khan
Masood, 1985) In others, savings accounts are treated as investment accounts but with less stringent
conditions as to withdrawals and minimum balance. Capital is not guaranteed but the banks take care
to invest money Irom such accounts in relatively risk-Iree short-term projects (Yaquby & Nizam,
2005). As such lower proIit rates are expected and that too only on a portion oI the average minimum
balance on the ground that a high level oI reserves needs to be kept at all times to meet withdrawal
demands.(GhaIoor, 2000)
2.5.4 Investment account
Investment deposits are accepted Ior a Iixed or unlimited period oI time and the investors agree in
advance to share the proIit (or loss) in a given proportion with the bank. Capital is not guaranteed.
(GhaIoor 2000)
2.5.5 Modes oI Iinancing
Banks adopt several modes oI acquiring assets or Iinancing projects. But they can be broadly
categorised into three areas: investment, trade and lending.
2.5.5.1 Investment Iinancing
This is done in three main ways: a) Musharaka where a bank may join another entity to set up a joint
venture, both parties participating in the various aspects oI the project in varying degrees. ProIit and
loss are shared in a pre-arranged Iashion. This is not very diIIerent Irom the joint venture concept. The
venture is an independent legal entity and the bank may withdraw gradually aIter an initial period. b)
Mudarabha where the bank contributes the Iinance and the client provides the expertise, management
and labour. ProIits are shared by both the partners in a pre-arranged proportion, but when a loss
occurs the total loss is borne by the bank. c) Financing on the basis oI an estimated rate oI return.
(Siddiqui & Nejatullah, 1988) Under this scheme, the bank estimates the expected rate oI return on
the speciIic project it is asked to Iinance and provides Iinancing on the understanding that at least that
rate is payable to the bank. (Perhaps this rate is negotiable.) II the project ends up in a proIit more
than the estimated rate the excess goes to the client. II the proIit is less than the estimate the bank will
accept the lower rate. In case a loss is suIIered the bank will take a share in it. (Iqbal Zubair and
Abbas Mirakhour, 1987)
2.5.5.2 Trade Iinancing
This is also done in several ways. The main ones are: a) Mark-up where the bank buys an item Ior a
client and the client agrees to repay the bank the price and an agreed proIit later on. b) Leasing where
the bank buys an item Ior a client and leases it to him Ior an agreed period and at the end oI that
period the lessee pays the balance on the price agreed at the beginning an becomes the owner oI the
item (Wilson, R. 2006). c) Hire-purchase where the bank buys an item Ior the client and hires it to
him Ior an agreed rent and period, and at the end oI that period the client automatically becomes the
owner oI the item. d) Selland-buy-back where a client sells one oI his properties to the bank Ior an
agreed price payable now on condition that he will buy the property back aIter certain time Ior an
agreed price. e) Letters oI credit where the bank guarantees the import oI an item using its own Iunds
Ior a client, on the basis oI sharing the proIit Irom the sale oI this item or on a mark-up basis. (Iqbal
Zamir, 1997)
2.5.5.3 Lending
Main Iorms oI Lending are: a) Loans with a service charge where the bank lends money without
interest but they cover their expenses by levying a service charge. This charge may be subject to a
maximum set by the authorities. b) No-cost loans where each bank is expected to set aside a part oI
their Iunds to grant no-cost loans to needy persons such as small Iarmers, entrepreneurs, producers,
etc. and to needy consumers. c) OverdraIts also are to be provided, subject to a certain maximum, Iree
oI charge. (Iqbal Zamir, 1997)
2.7 Shortcomings in current practices
The current practices oI Islamic banking are under three categories: deposits, modes oI Iinancing (or
acquiring assets) and services. There seems to be no problems as Iar as banking services are
concerned. Islamic banks are able to provide nearly all the services that are available in the
conventional banks. The only exception seems to be in the case oI letters oI credit where there is a
possibility Ior interest involvement. (Siddiqui Nejatullah, 1988) However some solutions have been
Iound Ior this problem --mainly by having excess liquidity with the Ioreign bank. On the deposit side,
judging by the volume oI deposits both in the countries where both systems are available and in
countries where law prohibits any dealing in interest, the non-payment oI interest on deposit accounts
seems to be no serious problem. Customers still seem to deposit their money with interest-Iree banks.
(GhaIoor A M, 2000)
The main problem, both Ior the banks and Ior the customers, seems to be in the area oI Iinancing.
Bank lending is still practised but that is limited to either no-cost loans (mainly consumer loans)
including overdraIts, or loans with service charges only. Both these types oI loans bring no income to
the banks and thereIore naturally they are not that keen to engage in this activity much. That leaves
with investment Iinancing and trade Iinancing. Islamic banks are expected to engage in these activities
only on a proIit and loss sharing (PLS) basis. (Iqbal Zubair and Abbas Mirakhour, 1987)
This is where the banks` main income is to come Irom and this is also Irom where the investment
account holders are expected to derive their proIits Irom. And the latter is supposed to be the incentive
Ior people to deposit their money with the Islamic banks. And it is precisely in this PLS scheme that
the main problems oI the Islamic banks lay. ThereIore this system should look more careIully in the
Iollowing section. (Usmani Taqi,1999)
2.7.1 Problems in implementing the PLS scheme
Several writers have attempted to show, with varying degrees oI success, that Islamic Banking based
on the concept oI proIit and loss sharing (PLS) is theoretically superior to conventional banking Irom
diIIerent angles. (Khan and Mirakhor 1987) However Irom the practical point oI view things do not
seem that rosy. In the over halI-a-decade oI Iull-scale experience in implementing the PLS scheme the
problems have begun to show up.
2.7.1.1 Financing
According to Usmani Taqi (1999) there are Iour main areas where the Islamic banks Iind it diIIicult to
Iinance under the PLS scheme: a) participating in long-term lowyield projects, b) Iinancing the small
businessman, c) granting non-participating loans to running businesses, and d) Iinancing government
borrowing.
2.7.1.2 Long-term projects
As Iqbal Zamir (1997) noticed Islamic Banks are unable or unwilling to participate in long-term
projects. The main reason oI course is the need to participate in the enterprise on a PLS basis which
involves time consuming complicated assessment procedures and negotiations, requiring expertise
and experience. The banks do not seem to have developed the latter and they seem to be averse to the
Iormer. There are no commonly accepted criteria Ior project evaluation based on PLS partnerships.
Each single case has to be treated separately with utmost care and each has to be assessed and
negotiated on its own merits.(Iqbal Zamir, 1997) Other obvious reasons are: a) such investments tie
up capital Ior very long periods, unlike in conventional banking where the capital is recovered in
regular instalments almost right Irom the beginning, and the uncertainty and risk are that much higher,
b) the longer the maturity oI the project the longer it takes to realise the returns and the banks
thereIore cannot pay a return to their depositors as quick as the conventional banks can. Thus it is no
wonder that the banks are averse to such investments. Small scale businesses Iorm a major part oI a
country`s productive sector. Besides, they Iorm a greater number oI the bank`s clientele. Yet it seems
diIIicult to provide them with the necessary Iinancing under the PLS scheme, even though there is
excess liquidity in the banks. (Kazarian Elias,1993)
2.7.1.3 Running businesses
Running businesses Irequently need short-term capital as well as working capital and ready cash Ior
miscellaneous on-the-spot purchases and sundry expenses. This is the daily reality in the business
world. Very little thought seems to have been given to this important aspect oI the business world`s
requirement. The PLS scheme is not geared to cater to this need. (Khan and Mirakhor 1987)Even iI
there is complete trust and exchange oI inIormation between the bank and the business it is nearly
impossible or prohibitively costly to estimate the contribution oI such short-term Iinancing on the
return oI a given business. Neither is the much used mark-up system suitable in this case. It looks
unlikely to be able to arrive at general rules to cover all the diIIerent situations. Added to this is the
delay involved in authorising emergency loans. The enormity oI the damage or hindrance caused by
the inability to provide Iinancing to this sector will become clear that running businesses and
enterprises are the mainstay oI the country`s very economic survival. (Iqbal Zamir, 1997)
2.7.1.4 Government borrowing
In all countries the Government accounts Ior a major component oI the demand Ior credit --both
short-term and long-term. Unlike business loans these borrowings are not always Ior investment
purposes, nor Ior investment in productive enterprises. Even when invested in productive enterprises
they are generally oI a longer-term type and oI low yield. This latter only multiplies the diIIiculties in
estimating a rate oI return on these loans iI they are granted under the PLS scheme. (Iqbal Zamir,
1997)It has been decreed that Iinancial transactions between and among the elements oI the public
sector, including the central bank and commercial banks that are wholly Islamic, can take place on the
basis oI a Iixed rate oI return; such a Iixed rate is not viewed as interest. ThereIore the Government
can borrow Irom the Islamic banking system without violating the Law. However, there is another
serious consequence as continued borrowing on a Iixed rate basis by the government would inevitably
index bank charges to the rate than to the actual proIits oI borrowing entities. (Iqbal Zubair and Abbas
Mirakhour, 1987)
2.7.1.5 Legislation
Existing banking laws do not permit banks to engage directly in business enterprises using depositors`
Iunds. But this is the basic asset acquiring method oI Islamic banks. (Siddiqui Nejatullah, 1988).
ThereIore new legislation and/or government authorisation are necessary to establish such banks. In
Iran a comprehensive legislation was passed to establish Islamic banks. In Pakistan the Central Bank
was authorised to take the necessary steps. In other countries either the banks Iound ways oI using
existing regulations or were given special accommodation. In all cases government intervention or
active support was necessary to establish Islamic banks working under the PLS scheme. (Siddiqui
Nejatullah, 1988) In spite oI this, there is still need Ior Iurther auxiliary legislation in order to Iully
realise the goals oI Islamic banking.
Iran and Pakistan are countries committed to ridding their economies oI riba and have made immense
strides in towards achieving it. Yet there are many legal diIIiculties still to be solved as we have seen
above. In other Muslim countries the authorities actively or passively participate in the establishment
oI Islamic banks on account oI their religious persuasion. Such is not the case in non-Muslim
countries. Here establishing Islamic banks involves conIormation to the existing laws oI the
concerned country which generally are not conducive to PLS type oI Iinancing in the banking sector.
(GhaIoor A M, 2000)
2.7.1.6 Involvement in specialised non-bank activities
It is due to historical reasons that banks have evolved purely as a Iinancial institution. They are suited
to attract money, keep it in saIe custody, lend it under saIety, invest it proIitably and enjoy the
capacity to create the means oI payment. A bank has to maintain a balance between income, liquidity
and Ilexibility. While allocating its Iunds it has to be meticulously sensitive about the Iactors like
capital position and rate oI proIitability oI various types oI loans, stability oI deposit, economic
conditions, inIluence oI monetary and Iiscal policy, ability and experience oI bank`s personnel and
credit needs oI the area. (Khan and Mirakhor 1987) So Iar these banks thrive on a Iixed rate oI return
a portion oI which is passed on by them to the depositor. Thus the entire eIIort oI a bank is directed
towards money management and it is not geared to act as an entrepreneur, trader, industrialist,
contractor or caterer.
The question arises: with all these limitations can a bank claim any competence in trading or
entrepreneurship which is necessary Ior musharakah or mudarba contract, or can it act as an owner oI
a large variety oI heavy machinery, transport vehicles or real estate to take the position oI a lessor or,
can it act as a stockiest to buy and resell the entire stock oI imports and exports that are needed by
genuine traders. (Kazarian Elias, 1993)
Traditional banks do perIorm a certain amount oI project evaluation when granting large medium-and
long-term loans. But doing such detailed evaluation as would be required to embark on a PLS scheme,
such as determining the rates oI return and their time schedule, is beyond the scope oI conventional
banks. So is the detailed accounting and monitoring necessary to determine the actual perIormance.
(Usmani Taqi, 1999)
Under Islamic banking these exercises are not limited to relatively Iew large loans but need to be
carried out on nearly all the advances made by the bank. Yet, widely acceptable and reliable
techniques are yet to be devised. This is conIounded by the Iact that no consensus has yet been
reached on the principles. Both the unprecedented nature oI the task as well as the huge amount oI
work that need be done and the trained and experienced personnel needed to carry them out seems a
daunting prospect. (Siddiqui Nejatullah, 1988)
2.7.1.7 Re-training oI staII
The bank staII will have to acquire many new skills and learn new procedures to operate the Islamic
banking system. This is a time consuming process which is aggravated by two other Iactors. One, the
sheer number oI persons that need to be retrained and, two, the additional staII that need to be
recruited and trained to carry out the increased work. (Usmani Taqi, 1999)
Principles are still to be laid down and techniques and procedures evolved to carry them out. It is only
aIter the satisIactory achievement oI these that proper training can begin. This delay and the resulting
conIusion appear to be among the main reasons Ior the banks to stick to modes oI Iinancing that are
close to the Iamiliar interest-based modes. (GhaIoor A M, 2000)
2.7.1.8 Other disincentives
Among the other disincentives Irom the borrower`s point oI view are the need to disclose his accounts
to the bank iI he were to borrow on the PLS basis, and the Iear that eventually the tax authorities will
become wise to the extent oI his business and the proIits. Several writers have lashed out at the lack oI
business ethics among the business community, but that is a Iact oI liIe at least Ior the Ioreseeable
Iuture. There is a paucity oI survey or case studies oI clients to see their reaction to current modes oI
Iinancing. As such are not aware oI Iurther disincentives that might be there. (GhaIoor A M, 2000)
2.7.1.9 Accounts
When a business is Iinanced under the PLS scheme it is necessary that the actual proIit/loss made
using that money be calculated. Though no satisIactory methods have yet been devised, the Iirst
requirement Ior any such activity is to have the necessary accounts. On the borrowers` side there are
two diIIiculties: one, many small-time businessmen do not keep any accounts, leave alone proper
accounts. The time and money costs will cut into his proIits. Larger businesses do not like to disclose
their real accounts to anybody. (Siddiqui Nejatullah, 1988) On the banks` side the eIIort and expense
involved in checking the accounts oI many small accounts is prohibitive and will again cut into their
own share oI the proIits. Thus both sides would preIer to avoid having to calculate the actually
realised proIit/loss. The commercial banks do Iace an element oI moral hazard owing to the non-
existence oI systematic book-keeping in this sector. Additionally the reluctance oI small producers to
submit their operations to bank audits and the perceived enormous cost oI auditing and monitoring
relative to the small size oI the potential credits makes banks unwilling to extend credit on the basis oI
new modes oI Iinancing to these small producers. These reduced lending to small producers may also
explain the existence oI excess liquidity in the banking system. (Kazarian Elias, 1993)
2.7.1.10 Tax
The bank is a big business and it has to declare its proIit and loss and is legally required to present an
audited account oI its operations. Once the bank`s accounts are known it doesn`t take much Ior the tax
collectors to Iigure out the share oI the businesses Iinanced by the bank under the PLS scheme. Thus
it`s no surprise that businesses are not too very happy about the situation. The Iact that suggestions
have been made to use the banks to collect taxes due has not helped the matter either. (Usmani Taqi,
1999)
2.7.1.11 Excess liquidity
Presence oI excess liquidity is reported in nearly all Islamic banks. This is not due to reduced demand
Ior credit but the due to the inability oI the banks to Iind clients willing to be Iunded under the new
modes oI Iinancing. Some oI these diIIiculties are mentioned under section 4.3.1 Financing. In this
situation where there is money available on the one hand and there is need Ior it on the other but the
new rules stand in the way oI bringing them together! This is a very strange situation --especially in
the developing Muslim countries where money is at a premium even Ior ordinary economic activities,
leave alone development eIIorts. Removal oI riba was expected to ease such diIIiculties, not to
aggravate the already existing ones. (Kazarian Elias, 1993)
2.8 Conclusion
The structures and processes established within an Institution OIIering Islamic Iinancial Services
(IIFS) Ior monitoring and evaluating Shariah compliance rely essentially on arrangements internal to
the Iirm. By being incorporated in the institutional structure, a Shariah Supervisory Board (SSB) has
the advantage oI being close to the market. Competent, independent, and empowered to approve new
Shariah-conIorming instruments, an SSB can enable innovation likely to emerge within the
institution. There are diIIerent model oI Islamic Iinancing Iunctioning including Iranian model,
Malaysian model, Pakistani model etc. However Malaysia being the pioneer in Islamic banking has an
advantage oI running Islamic banking along with conventional banking successIully. Islamic banking
services has strong base in Malaysia and can be adopt as role model while the Islamic banking in
other Islamic countries and around the world is in primary stage. Islamic banking is not very diIIerent
Irom conventional banking Irom the perspective oI the PLS paradigm. On the asset side oI Islamic
banking, only a negligible portion oI Iinancing is based on the PLS principle. Consistent with Islamic
banking experiences elsewhere, a large majority oI Islamic bank Iinancing in Malaysia is still based
on non-PLS modes that are permissible under the Shariah law, but ignore the spirit oI the usury
prohibition. On the liability side, the PLS principle is more widely adopted in structuring Islamic
deposits. Development oI inter bank money market and mudarbah inter bank investment are some oI
the key Ieatures which is only available in Malaysia and can be Iollowed in other Islamic and non
Islamic countries where Islamic banking is Iunctioning.

R
. Researcb metbodology
. Introduction
The Iollowing chapter describe the research process conducted to achieve the goals oI this research
dissertation. It is important to restate that the aim oI dissertation to Iind out the practicability oI
banking Iree Irom interest Irom the perspective oI operation management, and to establish essential
process oI research deIined by Saunders et al (2007) engaging the Iive core phases which is also
called Research Onion. Adopted research philosophy is considered as Iirst phase. Examination oI
research approach in relation with research philosophy is considered as second phase. This phase is
Iollowed by deliberation oI research strategy that is third phase. Applying the time horizon to
research is reIerred by Iourth phase and last phase determines the adopted method oI data collection.
The procedure oI research involved in this dissertation in accordance with this theory is outlined as
under.
. Researcb bilosopby
In this dissertation the researcher is employing interpretive research philosophy. It is indicated by
Remenyi et al (1998) that to Iind out the situation detail the essential is interpretive philosophy to
recognize the Iact or probably the Iact behind it. This study Iind out the necessary condition and
concept oI banking without interest and the Iact operating on the back oI Islamic banking system. It
reIlects interpretive philosophy principle.
. Researcb pproacb
Two approaches to the business research are identiIied by Saunders et al (2007). Deductive approach
is Iirst, which is applied to where a hypothesis or theory is constructed and then investigated by a
developed strategy oI research. Second approach is inductive that is used where theory is developed
aIter gathering the data like a research Iinding Irom the analysis oI data.
The approach applied in this research is inductive the reason is that the qualitative data is gathered
Irom Pakistani Islamic banking sector, and practicability oI banking without interest is established
through analysis oI data.
. Researcb Strategy
This study implements combined approaches oI case study and exploratory. Only one strategy oI
exploratory case study is adopted Ior achieving the objectives oI research.
3.4.1 Exploratory study method
Strategy oI exploratory study is appropriate to this research like its aim is to investigate practicability
oI banking system in Pakistan without interest. In opinion oI Robson (2002) the strategy oI
exploratory study is a successIul strategy to determine what is going on to Iind out new perspective to
ask question to explore whether Islamic banks` banking services is in Iact Iree oI interest (what is
going on), and theories oI banking without interest is like a game oI words in order to capture the
customers in the name oI Islamic banking (Iin out new perspective to ask question).
Additionally, the analysis carried out in accordance with review oI literature by Justice Taqi Usmani
(2005), the exploratory study on Islamic Iinance, is and additional dimension Ior Islamic banking
research. The research determines an exploratory study on banking without interest in Islamic banks
in accordance with the research conducted by him.
3.4.2 Case study method
The other method that is adopted is case study method to obtain the set objectives oI research. The
method oI case study is elaborated like a strategy Ior conducting research that engages an empirical
examination oI a speciIic modern phenomenon inside its actual liIe background adopting numerous
evidence sources (Robson 2002). The approach oI case study is an appropriate Ior this research with
the reason oI two causes. Firstly, the aim oI the research is to Iind out practicability oI banking
without interest (modern phenomenon) in banking sector oI Pakistan (actual liIe background) and
their Iunctions in accordance with principles provided by Sharia law (numerous evidence sources). In
addition, as highlighted by White (2002) that all case studies can be used to investigate a theory and
inductive to look iI it implements in background oI actual liIe. This research adopts a study oI
empirical case the idea oI banking without interest (theory) to look iI it implements in Pakistani
banking sector (actual liIe background).
Meezan Islamic Bank is selected as an appropriate example in the case study. There are mainly two
reasons Ior this selection. First is the relevance as Meezan Islamic Bank is the premier Islamic bank in
Pakistan and oIIering a one-stop shop Ior innovative value added products and services to their
customers within the bounds oI Shariah Irom personal banking and Iinance to asset management.
ThereIore, Meezan Islamic Bank provides an empirical case to explore the applicability oI interest
Iree banking in pakistani banking sector. The second reason is accessibility. The author oI the
dissertation has relationship in Meezan Islamic Bank that Iacilitates data collection process.
A critical limitation oI the exploratory case study strategy is in relation to number oI available cases.
The dissertation adopts a single case study rather than multiple case studies or survey. A typical
criticism oI case study strategy is diIIicult in generalisation due to two Iactors, subjective nature oI the
approach and qualitative data suitable only to a speciIic context. Justice Taqi Uamani (2005) also
suggested that application oI interest Iree banking is a research subject. However, this dissertation
carries out a single case due extremely limited cases which are available and relevant to the research
objective oI the dissertation. This is because Meezan bank is the Iirst Islamic bank in Pakistan
oIIering wide range oI banking and Iinancial services approved by shariah board. ThereIore Meezan
bank is selected as an appropriate case studied Ior dissertation.

. ime orizons
Given limited time, the dissertation is cross sectional research as it is a snapshot Iinished in the
present period. The cross sectional research is the study oI a speciIic phenomenon or phenomena at a
speciIic time. (Saunders et al 2003).

. Data ollection Metbod
The data collection method consists oI documentation, archival record, Iace to Iace interview and
semi structured interview by phone.

3.6.1 Scope oI Data Collection
In order to meet the research objective the necessary data are qualitative data. The nature oI data
collected Ior the dissertation is qualitative because oI the inductive research approach oI the
dissertation. Saunders et al (2003) conclude that the collection oI qualitative data is one oI attributes
oI inductive approach. The scope oI data collection both involves primary and secondary data.
In order to gather qualitative data, the data collection methods must be qualitatively based. "ualitative
methods enable researchers to investigate situation where little is know about what is there going on,
and arouse more Iormal research in the Iuture (Gillham, 2000). ThereIore, qualitative data collection
methods are suitable because the dissertation aims to explore the applicability oI interest Iree banking
in banking sector which is an area oI research and thereby accord with the situation where little is
know about what is there going on.
These data collection methods accord with the case study strategy, as well as the inductive research
approach. In line with the case study strategy, data is collected in the Iorm oI description. Yin (2003)
identiIies six sources oI collecting evidence Ior a case study including documentation, archival record,
interviews, direct observation, participant observation and physical artiIacts. In line with case study
strategy, the dissertation gathers descriptive data Irom three sources i.e. documentation, archival
records and interviews.

3.6.2 Documentation
The documents are a secondary source oI collecting documentary data Ior the dissertation. The
available documentation consist oI
1. Newspaper clippings and other articles appearing in the mass media including internet.
2. Government regulations and directives relevant to banking sector and particularly to Islamic
banking.
3. Internal administrative documents oI banks where permission have Irom bank.
Two reasons Ior collecting data by documentation are relevance and accessibility. Firstly in terms oI
relevance, Yin (2003) states that documentary inIormation is possibly relevant to every case study
topic. Besides, a number oI documents stemming Irom government and in the mass media or internet
are open and easily accessed.
3.6.3 Archival Records
The available archival records are survey based secondary data such as statistics oI banking sector.
These archival records are mainly source Irom state bank oI Pakistan, Meezan Islamic Bank and
Iinancial Service Authority UK. A critical reason Ior using archival record is reliability. The statistics
provided by government or central bank are reliable secondary data.
3.6.4 Interviews
A series oI interview was conducted to collect in depth primary data. The respondents were consist oI
both product and operation managers oI Meezan Islamic Bank. Given limited time some interviews
were conducted by phone with pre-prepared questions. There are two reasons Ior employing interview
method. Firstly, the interview is an eIIective data collection method in exploratory studies. Robson
(2002) points out three rules oI conducting exploratory research including search oI literature, talking
to experts and conducting Iocus group interview. As an exploratory case study, the dissertation
conducts interview with three key people in Meezan bank as they are expert on key research topic.
During interview, respondent`s opinions were collected by series oI questions addressing the research
objectives. The second reason is data reliability and validity. Interviews are eIIective to collect
reliable and valid data Ior exploratory studies (Cooper and Schindler, 1998).
Interviews, as data collection method oI dissertation have two limitations. Firstly, the interview is lack
oI standardisation. The respondents involved into work are product and operation managers. Each oI
them takes charge oI speciIically Iunctional tasks, and thereby they may be capable to answer
particular questions. The interview question asked depends on the identity oI the respondents.
ThereIore it is diIIicult to standardise the interview. Secondly, the interview may have potential Ior
interviewer bias. Interviewer as well as author oI the dissertation lacks work experience in bank which
may result and inIluence the interpretation and analysis oI the interview content.

3.7 Data Interpretation
Gillham (2000) suggest two necessary steps while carrying out a content analysis oI the interview.
First identiIy key and substantive points and then put them into categories. The two steps procedure is
employed to interpret the data collected by the interviews. These interview contents are Iirstly
identiIied where are key and substantive points in the line with interest Iree banking theoretical
concepts identiIied in the literature review section. Secondly each key and substantive point is
allocated into a series oI categories derived Irom the analytical Iramework oI the literature review
analysis.
3.8 Ethics Issue
According to the regulation on research ethics oI University oI Glasgow, all respondent were directed
to the ethics policy and interviewed respondents are anonymous in the dissertation in order to
maintain commercial conIidentiality and to gain the respondent`s conIidence. The exercise oI
anonymity help in clariIying doubts about inIormation sharing, and thereby the opportunity to provide
biased inIormation is eliminated.

R : Researcb findings and nalysis
4.1 Introduction
One oI the Iorms oI capitalism, which has been Ilourishing in non-Islamic societies, is the interest-
based investment. There are normally two participants in such transactions. One is the Investor who
provides capital on loan and the other Manager who runs the business. The investor has no concern
whether the business runs into proIit or loss; he automatically gets an interest (Riba) in both outcomes
at a Iixed rate on his capital. Islam prohibits this kind oI trading and the Holy Prophet enIorced the
ruling, not in the Iorm oI some moral teaching, but as the law oI land. This chapter will provide an
analysis oI the Iunctioning oI Islamic banking particularly in Pakistan as primary research has been
done in Pakistan.
4.2 Main Findings
bjective 1: Asses the concept of wealth in Islam and how far it has been changed with time to
time.
In order to understand the concept oI wealth in Islam, respondent were ask to explain the economic
goal oI Islam in the light oI "uran? Respondent A: In materialistic economics "Livelihood is the
Iundamental problem oI man and economic developments are the ultimate end oI human liIe". While
according to Islamic economics "Livelihood may be necessary and indispensable, but cannot be the
true purpose oI human liIe". No doubt, Islam is opposed to monasticism, and views the economic
activities oI man quite lawIul, meritorious, and some times even obligatory and necessary. It approves
oI the economic progress oI man, and considers Findings awIul or righteous livelihood an obligation
oI the secondary order. Notwithstanding all this, it is no less a truth that it does not consider
"economic activity" to be the basic problem oI man, nor does it view economic progress as the be-all
and end-all oI human liIe According to the illustration oI the Holy "uran "wealth" in all its possible
Iorms is a thing created by Allah, and is, in principle His "property". Allah delegates the right oI
property over a thing, which accrues to man, to Him. The Holy "uran explicitly says:
'Give to them Irom the property oI Allah which He has bestowed upon you. (24:33). Man has the
"right oI property" over the things he exploits, but this right is not absolute or arbitrary or boundless,
it carries along with it certain limitations and restrictions, which have been imposed by the real owner
oI the 'wealth'. "Seek the other world by means oI what Allah has bestowed upon you, and do not be
negligent about your share in this world. And do good as Allah have done well to you, and do not
seek to spread disorder on the earth." (28:77). the concept oI wealth that has given in "uran is Iorever
and it can not be change with time.
Respondent B: The Holy "uran the disapproval oI monasticism and the order to: "Seek the
benevolence oI Allah." At the same time we Iind in the "uran to restrain Irom the temptations or
delusion Ior worldly liIe. And all these things in their totality have been designated as "Ad-Dunya"
("the mean") - a term which, in its literal sense, does not have a pleasant connotation. Islamic
economics arise Irom two Iacts oI considering economics as the ultimate goal oI liIe and considering
it as a necessity in order to have a prosperous liIe through lawIul means. Even common sense can
suIIice to show that the Iact oI an activity being lawIul or meritorious or necessary separate Irom it
being Findings the ultimate goal oI human liIe and the center oI thought and action. It is, thereIore,
very essential to make the distinction as clear as possible at the very outset. In Iact, the proIound,
basic and Iar-reaching diIIerence between Islamic economics and materialistic economics is just this.
In no circumstances, the concept that is given in "uran about wealth can be change.
ut these two commands you said from Quran seems contradictory to each other?
Apparently one might Ieel that the two commands are contradictory, but the Iact is that according to
the "uranic view, all the means oI livelihood are no more than just stages on man's journey, and his
Iinal destination lies beyond them. That destination is the sublimity oI character and conduct, and,
consequently, the Ielicity oI the other world. The real problem oI man and the Iundamental purpose oI
his liIe is the attainment oI these-two goals. But one cannot attain them without traversing the path oI
this world. So, all those things too which are necessary Ior his worldly liIe, become essential Ior man.
It comes to mean that so long as the means oI livelihood are being used only as a path leading towards
the Iinal destination, they are the benevolence oI Allah, but as soon as man gets lost in the mazes oI
this pathway and allows himselI to Iorget his real destination, the very same means oI livelihood turn
into an "temptation, or delusion" into a "trial" as "uran explains "And know that your possessions and
your children are but a trial" (8:28).
bjective 2: Asses the concept of Interest in Islam and identify is interest is allowed in any
form? If interest is prohibited then how bank works?
Respondent were ask to explain the concept oI interest in Islam and explain why is it prohibited?
Respondent A: The word use in "uran against interest is Riba. The deIinition oI Riba is derived Irom
the "uran and is unanimously accepted by all Islamic scholars. There are two types oI Riba, identiIied
to date by these scholars namely 'Riba An Nasiyah' and 'Riba Al Fadl'.
'Riba An Nasiyah' is deIined as excess, which results Irom predetermined interest (sood) which a
lender receives over and above the principle (Ras ul Maal) while 'Riba Al Fadl' is deIin First oI all, we
should realize that there is nothing in the entire creation oI the world, which has no goodness or utility
at all. But it is commonly recognized in every religion and community that things which have more
beneIits and less harms are called beneIicial and useIul. Conversely, things that cause more harm and
less beneIit are taken to be harmIul and useless. Even the noble "uran, while declaring liquor and
gambling to be haram, proclaimed that they do hold some beneIits Ior people but the curse oI sins
they generate is Iar greater than the beneIits they yield. ThereIore, these cannot be called good or
useIul; on the contrary, taking these to be acutely harmIul and destructive, it is necessary that they be
avoided.
The case oI Riba An Nasiyah is not diIIerent. Here the consumer oI Riba does have some casual and
transitory proIits apparently coming to him, but its curse in this world and in the HereaIter is much too
severe as compared to this beneIit. The Riba consumer suIIers such a spiritual and moral loss that it
virtually takes away the great quality oI being 'human' Irom him. An intelligent person who compares
things in terms oI their proIit and loss, harm and beneIit can hardly include things oI casual beneIit
with an everlasting loss in the list oI useIul things. Similarly no sane and just person will say that
personal and individual gain which causes loss to the whole community or group is useIul. In theIt
and robbery Ior example, the gain oI the gangster and the take oI the thieI is all too obvious but it is
certainly harmIul Ior the entire community since it ruins its peace and sense oI security. The
prohibition oI Riba Al Fadl is intended to ensure justice and remove all Iorms oI exploitation through
'unIair' exchanges and to close all back-doors to Riba An Nasiyah because in the Islamic Shariah,
anything that serves as a means to the unlawIul is also unlawIul.
Respondent B; "uran says about riba,:
"O those who believe Iear Allah and give up what still remains oI the Riba iI you are believers. But iI
you do not do so, then be warned oI war Irom Allah and His Messenger. II you repent even now, you
have the right oI the return oI your capital; neither will you do wrong nor will you be wronged." Al
Baqarah 2:278-9
These verses clearly indicate that the term Riba means any excess compensation over and above the
principal which is without due consideration. However, the "uran has not altogether Iorbidden all
types oI excess; as it is present in trade as well, which is permissible. The excess that has been
rendered haram (prohibited) in "uran is a special type termed as Riba. In the dark ages, the Arabs
used to accept Riba as a type oI sale, which unIortunately is also being understood at the present
times. Islam has categorically made a clear distinction between the excess in capital resulting Irom
sale and excess resulting Irom interest. The Iirst type oI excess is permissible but the second type is
Iorbidden and rendered Haram.
Philosophically, interest is prohibited due to the perceived exploitation oI one class oI people by
another. In the case oI consumption loans which are generally made to people who neither have the
luxury oI savings to neither meet urgent personal needs nor have access to any other means oI
acquiring Iinancing; the prohibition oI interest is mainly Ior humane purposes. In the case oI loans Ior
productive purposes, it is not deemed Iitting Ior lenders oI capital Iunds to be assured oI receiving a
rate oI return while users oI such Iunds--the entrepreneurs--have no assurance oI direction and
magnitude oI returns. It is socially unjust to guarantee a predetermined return Ior any one party when
the existence oI entrepreneurial proIit is uncertain.
Interest is also viewed as a transIer wealth Irom the poor to the rich, thus increasing the inequality in
distribution oI wealth, which is contrary to the Islamic social interest which stands Ior co-operation
and brotherhood. Moreover, it is thought that interest creates an idle class oI people who receive their
income Irom accumulated wealth, thus depriving the society oI their labour, skills, and enterprises.
ut there are some scholars that argue on prohibition of all type of interest and say that 'Commercial
interest did not exist in the days of Prophet and only Riba as practiced during the days of the Prophet
was only Usury`.
Respondent A: There are two important points in this statement. First riba as practised during the days
oI the prophet was only usury and the second is commercial interest did not exist in the days oI
prophet.
This claim that riba as practised during the days oI the prophet was only usury is groundless, since
Islam when prohibiting something does not only prohibit one Iorm oI it that is prevalent, but all Iorms
that might erupt in Iuture. The changed state does not change the ruling Ior eg. "ura'n has prohibited
the Iollowing:
a) Liquor (Khamar): During the time oI Prophet its Iorm and the way oI production was totally
diIIerent Irom that oI the present day liquor but the ruling remains unchanged even though the Iorm
has changed.
b) Pork (Khinzeer): Irrespective how clean the present day breeding oI pigs in high class Iarms may
be, pork will stay prohibited and cannot be rendered halal (legal).
c) Corruption/Immorality (Al Fahsha): Although a lot oI sophisticated ways have been developed oI
this evil Irom the time oI "ura'nic revelations prohibiting it, the ruling stands Iorever.
The same applies to interest and gambling. By claiming that it was in a diIIerent Iorm during
Prophet's time does not change its ruling. It remains unchanged just as in case oI Khamar, Khinzeer
and Al Fahsha.
This claim that commercial interest did not exist in the days oI prophet is also wrong. II one glances
through the Islamic and pre Islamic history oI Arabia, it will be evident that the interest type at that
time was not restricted to usury but loans were granted Ior commercial and proIitable purposes. To
quote some examples:
a) "The tribe oI Umro bin Aamir used to take interest Irom the tribe oI Mughairah. At the advent oI
Islam, Mughairah owed heavy interest to Umro bin Aamir." In this narration, the transactions oI
interest between two tribes oI Arabia have been pointed out who actually operated as trading
companies; both tribes were very wealthy. Could it be that two wealthy tribes transacted interest just
Ior personal need and expenses? The interest was simply commercial!
b) History oI the city oI Ta'iI tells us that it was only second to Makkah in trade (their main exports
being liquor, raisins, currants, wheat, wood etc) and industry (major being leather and dyeing). The
tribe oI 'SaqeeI'' (Jewish tribe) advanced cash on interest, not only to the natives oI Ta'iI, but the
business community oI Makkah as well eg. the tribe oI Mughairah who were their permanent
customer. This advancement, which was not only restricted to cash but also to commodities between
wealthy tribes oI TaiI and Makkah who were usually traders and businessmen, was only Ior their
commercial purposes and not Ior their consumption and personal needs. One oI the ways oI receiving
interest was to double the principle amount plus interest in case oI non payment oI loan and this
practice was applied to both cash as well as commodities. They had become accustomed to it.
At the time oI signing the peace treaty with the people oI Ta'iI, the Prophet imposed conditions: i)
Total elimination oI interest based transactions. ii) Giving up oI interest owed to and Irom them.
Respondent B: It is important to understand what commercial interest and usury are at this point.
Commercial interest or Tijarti sood is Interest paid on loan taken Ior productive & proIitable purposes
while Usury or SaIri sood is Interest paid on loan taken Ior personal need and expenses. When
Muslim countries became subjugated to west in their economic Iield, some westernized Muslims in
the 19th century, on one side, saw the increasing progress oI the west in trade and industry and on the
other side saw the shattering economic condition oI Iellow Muslims states. They also became
conscious oI the Iact that banking is inevitable in the Iield oI trade and industry not only on national
level but also internationally. This prompted them to say that only usury is haram (illegal) but not
commercial interest because rendering commercial interest haram would pose irresolvable problems
to their way up to industrialization and economic progress. They only included usury in the term
"Riba" as categorically prohibited in "ura'n and sunnah and Ireed commercial interest Irom it calling
it totally diIIerent Irom the western concept oI interest. ThereIore, some scholars said that the
prohibition oI Riba was restricted to usury while commercial interest was perIectly Islamic. This is a
misunderstanding among the Muslims as interest oI any kind is not allowed in Islam.
What is the position of Islam about simple and compound interest? If any of the interest is not allowed
then how your bank works is or what modes of financing you are offering to your customer? How did
you make that interest free or sharaih based?
Respondent C: Simple Interest ( Sood-e-MuIrid) and Compound Interest (Sood-e- Murakkab) is a
type oI Riba an Nasiyah which is also prohibited in Islam. Simple Interest is the Interest calculated
only on the initial investment while Compound Interest is reinvestment oI each interest payment on
money invested, to earn more interest. During the pre-Islamic era, when a borrower used to Iail to pay
back the principal and interest charged on him, then the lender used to extend the loan on the
condition that the interest will also become part oI the loan (essentially Compound Interest). To
eradicate this abominable practice oI the period oI ignorance, this verse was revealed. O believers,
take not doubled and redoubled interest, and Iear God so that you may prosper." (Surah Al 'Imran,
verses 130-1) By mentioning the practice oI doubling and redoubling, it was condemned and declared
unlawIul in view oI its adverse impact on the community and the selIishness that it bred. It does not
mean that iI there is no doubling and redoubling (i.e., iI there is simple interest, in today's jargon),
then it is lawIul. Since the aIorementioned verse prohibits the compound interest only, some people
misinterpret it even today that compound interest alone is Iorbidden in Islam, not the simple interest.
They Iail to see that there is absolute prohibition oI simple interest in a number oI other "uranic
verses. The reason that the above verse speciIically uses the words "doubled and redoubled interest is
to highlight the shameIul aspect oI compound interest and not to limit the scope oI riba only to
compound interest. Now your question about the modes oI Iinancing, Islamic banking in Pakistan
works on the principle oI Musharakah derived Irom one oI the Hadess 'Allah Subhan-o-Tallah has
declared that He will become a partner in a business between two Mushariks until they indulge in
cheating or breach oI trust (Khayanah). The literal meaning oI Musharakah is sharing. The root oI
the word "Musharakah" in Arabic is Shirkah, which means being a partner. It is used in the same
context as the term "shirk" meaning partner to Allah. Under Islamic jurisprudence, Musharakah
means a joint enterprise Iormed Ior conducting some business in which all partners share the proIit
according to a speciIic ratio while the loss is shared according to the ratio oI the contribution. It is an
ideal alternative Ior the interest based Iinancing with Iar reaching eIIects on both production and
distribution. The connotation oI this term is little limited than the term "Shirkah" more commonly
used in the Islamic jurisprudence. For the purpose oI clarity in the basic concepts, it will be pertinent
at the outset to explain the meaning oI each term, as distinguished Irom the other. "Shirkah" means
"Sharing" and in the terminology oI Islamic Fiqh.
It looks like profit and loss sharing but how does it implemented in your bank?
Yes it is based on proIit and loss sharing principle which is allowed in islam. Basically, Musharakah
can be divided into two kinds. (1) Shirkat-ul-milk (Partnership by joint ownership): It means joint
ownership oI two or more persons in a particular property. This kind oI "Shirkah" may come into
existence in two diIIerent ways. a) Optional (Ikhtiari): At the option oI the parties e.g., iI two or more
persons purchase equipment, it will be owned jointly by both oI them and the relationship between
them with regard. to that property is called "Shirkat-ul-Milk Ikhtiari" Here this relationship has come
into existence at their own option, as they themselves elected to purchase the equipment jointly. b)
Compulsory (Ghair Ikhtiari): This comes into operation automatically without any eIIort/action taken
by the parties. For example, aIter the death oI a person, all his heirs inherit his property, which comes
into their joint ownership as a natural consequence oI the death oI that person.
(2) Shirkat-ul-Aqd (Partnership by contract): This is the second type oI Shirkah, which means, "a
partnership eIIected by a mutual contract". For the purpose oI brevity it may also be translated as
"joint commercial enterprise." Shirkat-ul-Aqd is Iurther divided into three kinds.(i) Shirkat-ul-Amwal
(Partnership in capital) where all the partners invest some capital into a commercial enterprise.(ii)
Shirkat-ul-Aamal (Partnership in services) where all the partners jointly undertake to render some
services Ior their customers, and the Iee charged Irom them is distributed among them according to an
agreed ratio. For example, iI two people agree to undertake tailoring services Ior their customers on
the condition that the wages so earned will go to a joint pool which shall be distributed between them
irrespective oI the size oI work each partner has actually done, this partnership will be a shirkat-ul-
aamal which is also called Shirkat-uttaqabbul or Shirkat-us-sanai or Shirkat-ul-abdan. (iii) Shirkat-ul-
wujooh (Partnership in goodwill). The word has its root in the Arabic word Wajahat meaning
goodwill. Here the partners have no investment at all. They purchase commodities on deIerred price,
by getting capital on loan because oI their goodwill and sell them at spot. The proIit so earned is
distributed between them at an agreed ratio.
What are the rules applied to fulfill and maintain this Musharakah?
Common conditions are the existence oI Muta'aqideen (Partners), capability oI Partners Must be sane
& mature and be able oI entering into a contract. The contract must take place with Iree consent oI the
parties without any Iraud or misrepresentation and the presence oI the commodity. This means the
price and commodity itselI. Musharakah or Shirkat-ul-amwal is a relationship established by the
parties through a mutual contract. ThereIore, it goes without saying that all the necessary ingredients
oI a valid contract must be present here also. For example, the parties should be capable oI entering
into a contract; the contract must take place with Iree consent oI the parties without any duress, Iraud
or misrepresentation, etc. The capital in a Musharakah agreement should be "uantiIied (Ma'loom)
meaning how much, SpeciIied (Muta'aiyan) meaning speciIied currency, Not necessarily be merged
meaning the mixing oI capital is not required and Not necessarily be in liquid Iorm like Capital share
may be contributed either in cash/liquid or in the Iorm oI commodities. In case oI a commodity, the
market value oI the commodity shall determine the share oI the partner in the capital. II all the
partners agree to work Ior the joint venture, each one oI them shall be treated as the agent oI the other
in all matters oI business. Any work done by one oI them in the normal course oI business shall be
deemed as authorized by all partners.
AIter entering into a Musharakah contract, partners have the right to sell the mutually owned property
since all partners are representing each other in Shirkah and all have the right to buy & sell Ior
business purposes. The right to buy raw material or other stock on cash or credit using Iunds
belonging to Shirkah to put into business.The right to hire people to carry out business iI needed. The
right to deposit money & goods oI the business belonging to Shirkah as depositor trust where and
when necessary. The right to use Shirkah's Iund or goods in Mudarabah. The right oI giving Shirkah's
Iunds as hiba (giIt) or loan. II one partner Ior purpose oI investing in the business has taken a "ard-e-
Hasana, then paying it becomes liable on both.
How do you compute profit and loss in Musharakah?
The ratio oI proIit Ior each partner must be determined in proportion to the actual proIit accrued to the
business and not in proportion to the capital invested by him. E.g. iI it is agreed between them that 'A'
will get 1 oI his investment, the contract is not valid. It is not allowed to Iix a lump sum amount Ior
anyone oI the partners or any rate oI proIit tied up with his investment. ThereIore iI 'A' & 'B' enter
into a partnership and it is agreed between them that 'A' shall be given Rs.10,000/- per month as his
share in the proIit and the rest will go to 'B', the partnership is invalid. II both partners agree that each
will get percentage oI proIit based on his capital percentage, whether both work or not, it is allowed. It
is also allowed that iI an investor is working, his proIit share () could be more than his capital base
() irrespective whether the other partner is working or not. Eg. iI 'A' & 'B' have invested Rs.1000/-
each in a business and it is agreed that only 'A' will work and will get 2/3rd oI the proIit while 'B' will
get 1/3rd. Similarly iI the condition oI work is also imposed on 'B' in the agreement, then also the
proportion oI proIit Ior 'A' can be more than his investment. II a partner has put an express condition
in the agreement that he will not work Ior the Musharakah and will remain a sleeping partner
throughout the term oI Musharakah, then his share oI proIit cannot be more than the ratio oI his
investment. However, Hanbali school oI thought considers Iixing the sleeping partners share more
than his investment to be permissible. It is allowed that iI a partner is not working, his proIit share can
be established as less than his capital share.
II both are working partners, the share oI proIit can diIIer Irom the ratio oI investment. Eg. X & Y
both have invested Rs.1000/- each. However X gets 1/3rd oI the total proIit and Y 2/3rd, this is
allowed. This opinion oI Imam Abu HaniIa is based on the Iact that capital is not the only Iactor Ior
proIit but also labours and work. ThereIore although the investment oI two partners is the same but in
some cases quantity and quality oI work might diIIer. II only a Iew partners are active and others are
only sleeping partners, then the share in the proIit oI the active partner could be Iixed at higher than
his ratio oI investment eg. 'A' & 'B' put in Rs.100 each and it is agreed that only 'A' will work, then 'A'
can take more than 50 oI the proIit as his share. The excess he receives over his investment will be
compensation Ior his services All scholars are unanimous on the principle oI loss sharing in Shariah
based on the saying oI Syedna Ali ibn Talib that is "Loss is distributed exactly according to the ratio
oI investment and the proIit is divided according to the agreement oI the partners."
ThereIore the loss is always subject to the ratio oI investment e.g. iI 'A' has invested 40 oI the
capital and 'B' 60, they must suIIer the loss in the same ratio, not more, not less. Any condition
contrary to this principle shall render the contract invalid.
How to terminate or cancel Musharakah?
II the purpose oI Iorming the Shirkah has been achieved. For example, iI two partners had Iormed a
Shirkah Ior a certain project Ior e.g. buying a speciIic quantity oI cloth in order to sell it and the cloth
is purchased and sold with mutual investment, the rules are simple and clear in this case. The
distribution oI proIit will be as per the agreed rate whereas in case oI loss, each partner will bear the
loss according to his ratio oI investment.
Every partner has the right to terminate the Musharakah at any time aIter giving his partner a notice
that will cause the Musharakah to end. For dissolving this partnership, iI the assets are liquidated, they
will be distributed pro-rata between the partners. However, iI this is not the case, the partners may
agree either to liquidate the assets or distribute the assets as they are.
In case oI a death oI any one oI the partners or any partner becoming insane or incapable oI eIIecting
commercial transaction, the Musharakah stands terminated. In case oI damage to the share capital oI
one partner beIore mixing the same in the total investment and beIore aIIecting the purchase, the
partnership will stand terminated and the loss will only be borne by that particular partner. However,
iI the share capital oI all partners has been mixed and could not be identiIied singly, then the loss will
be shared by al II one oI the partners wants termination oI the Musharakah, while the other partner or
partners like to continue with the business, this purpose can be achieved by mutual agreement. The
partners who want to run the business may purchase the share oI the partner who wants to terminate
his partnership, because the termination oI Musharakah with one partner does not imply its
termination between the other partners.
However, in this case, the price oI the share oI the leaving partner must be determined by mutual
consent. II there is a dispute about the valuation oI the share and the partners do not arrive at an
agreed price, the leaving partner may compel other partners on the liquidation or on the distribution oI
the assets themselves.
bjective 3: Asses the function of Islamic bank in comparison with conventional bank?
Respondent were ask to explain the Iunctioning oI Islamic banks in comparison with conventional
banks.
Respondent A: The conventional banking, which is interest based, mainly perIorms deposit creation,
Iinancing, agency services, issuing LC and advisory services. All Iorms oI bank deposits are governed
by the law oI qard as a consequence oI which the account holder may withdraw only the assets
deposited. Any increase on it will be interest. It has already been discussed that iI the purpose oI the
lender is business or security and not providing Iinancial assistance, then to get an excess amount is
also interest, which is prohibited in Islam just like usury. There is a consensus oI Muslim scholars on
the point that the transactions in Fixed Deposit and Savings Account is prohibited because the bank
pays excess to their account holders over their actual capital, which is interest. The Islamic Fiqh
Academy Jeddah in their 2nd session has Iurther endorsed such transactions as interest based
transaction. ThereIore it is illegal Ior a Muslim to keep their deposits in such accounts. As Iar as the
current account is concerned, the bank does not pay any excess (interest) over the actual capital,
thereIore holding such an account is allowed.
To sum up, proIit given on Iixed deposit and savings accounts is interest and thereIore prohibited.
However iI the banking system is based on Islamic principles, Musharakah play a very important role.
ThereIore it will now discuss how the bank is operating on Musharakah basis. A bank has two sides,
one where it receives deposits Irom customers which is called the liability side and the other where it
advances Iinance to investors and businessmen which is called the asset side. Both sides can operate
on Musharakah basis. As Iar as deposits are concerned, Musharakah is the only instrument in which
money can be received Irom customers meaning that every depositor will become a partner in bank's
business through their deposited money. However, Ior the asset or Iinance side, there are other
instruments apart Irom Musharakah but those instruments are not working in Pakistan. Now the role
oI bank as an agent. Banks under Islamic Shariah acts as an agent (on Al-Wakalah basis) oI the
customer and carries out the transaction on his behalI. Moreover it can charge agency Iee Ior the
services. The agency Iee is being charged on Payment / receiving oI cash on behalI oI the customer,
Inward bill oI collection, Outward bill oI collection, LC opening and acceptance, Collection oI export
bills or bills oI exchange etc. In this case the undertaking or guarantee commission and take-up
commission can be Islamized. Bank will charge an agency Iee Ior accepting the bills, which is bought
at Iace value.
As Iar as bank role as a guarantor is concerned, the bank or Iinancial institute gives a guarantee on
behalI oI its customer but according to Shariah, guarantee Iee cannot be charged. Normally
conventional banks charge Iee Ior letter oI guarantee and shipping g Most oI the advisory services
provided by the Iinancial institutes are carried out easily in compliance with Shariah as long as the
nature oI business is halal which includes Financial advisory services, Privatization advisory services,
Equity placement, Merger & acquisition advice, Venture capital, Trading (Capital market operations),
Cash & portIolio management advice and Brokerage services (Purchase & buying oI share oI
companies involved in halal business, a Iee is charged Ior it). Musharakah is being use Ior Import
Financing as well. There are two types oI bank charges on the letter oI credit provided to the importer.
First Service charges Ior opening an LC and second Interest charged on LCs, which are not opened on
Iull margin. Collecting service charges Ior this purpose is allowed, but as interest cannot be charged in
any case. Musharakah is the best substitute Ior opening the LC. The bank and the importer can make
an agreement oI Musharakah beIore opening the LC. II the LC is being opened at zero margins then
an agreement is made, in which the bank will become Rqb-ul-Maal and the importer. The bank will
own the goods that are being imported and the proIit will be distributed according to the agreement. II
the LC is being opened with a margin then a Musharakah agreement is made. The bank will pay the
remaining amount and the goods that are being imported will be owned by both oI them according to
their share oI investment. The bank and the importer, with their mutual consent can also include a
condition in the agreement, whereby; Musharakah will end aIter a certain time period even iI the
goods are not sold. In such a case, the importer will purchase the bank's share at the market price. A
bank plays two very important roles in Exports. It acts as a negotiating bank and charges a Iee Ior this
purpose, which is allowed in Shariah. Secondly it provides export-Iinancing Iacility to the exporters
and charge interest on this service. These services are oI two types Iirst Pre shipment Iinancing and
second Post shipment Iinancing.
The most appropriate method Ior Iinancing exports is Musharakah. Bank and exporter can make an
agreement provided that the exporter is not investing; other wise Musharakah agreement can be made.
Agreement in such case will be easy, as cost and expected proIit is known.
The exporter will manuIacture or purchase goods and the proIit obtained by exporting it will be
distributed between them according to the predeIined ratio. A problem that can be encountered by the
bank is that iI the exporter is not able to deliver the goods according to the terms and conditions oI the
importer, then the importer can reIuse to accept the goods, and in this case exporter's bank will
ultimately suIIer. This problem rectiIied by including a condition in Musharakah agreement that, iI
exporter violates the terms and conditions oI import agreement then the Bank will not be responsible
Ior any loss which arises due to this negligence. This condition is allowed in Shariah as the Rabb-ul-
mal is not responsible Ior any loss that arises due to the negligence oI Mudarib.
Post shipment Iinance is similar to the discounting oI the bill oI exchange. The bank has adopted an
alternate method which is allowed under shariah law. The exporter with the bill oI exchange can
appoint the bank as his agent to collect receivable on his behalI. The bank charges a Iee Ior this
service and provide interest Iree loan to the exporter, which is equal to the amount oI the bill, and the
exporter will give his consent to the bank that it can keep the amount received Irom the bill as a
payment oI the loan. Here two processes are separated, and thus two agreements will be made. One
will authorize the bank to collect the loan on his behalI as an agent, Ior which he will charge a
particular Iee. The second agreement will provide interest Iree loan to the exporter, and authorize the
bank Ior keeping the amount received through bill as a payment Ior loan. These agreements are
correct and allowed according to Shariah because collecting Iee Ior service and giving interest Iree
loan is permissible
4.3 Interpretation oI Iindings
Philosophically, interest is prohibited due to the perceived exploitation oI one class oI people by
another. Interest is also viewed as a transIer wealth Irom the poor to the rich, thus increasing the
inequality in distribution oI wealth, which is contrary to the Islamic social interest which stands Ior
co-operation and brotherhood. Moreover, it is thought that interest creates an idle class oI people who
receive their income Irom accumulated wealth, thus depriving the society oI their labour, skills, and
enterprises. In the case oI consumption loans which are generally made to people who neither have
the luxury oI savings to neither meet urgent personal needs nor have access to any other means oI
acquiring Iinancing; the prohibition oI interest is mainly Ior humane purposes. In the case oI loans Ior
productive purposes, it is not deemed Iitting Ior lenders oI capital Iunds to be assured oI receiving a
rate oI return while users oI such Iunds -the entrepreneur- have no assurance oI direction and
magnitude oI returns. It is socially unjust to guarantee a predetermined return Ior any one party when
the existence oI entrepreneurial proIit is uncertain.
The Islamic solutions commonly reIerred to as ProIit & Loss Sharing (PLS), suggest an equitable
sharing oI risks and proIits between the parties involved in a Iinancial transaction. In the banking
business, there are three parties - the entrepreneur or the actual user oI capital, the bank which serves
as a partial user oI capital Iunds and as a Iinancial intermediary, and the depositors in the bank who
are the suppliers oI savings or capital Iunds. There are two diIIerent partnerships oI the type
mentioned in Islam: the partnership between the depositors and the bank, and the partnership between
the entrepreneur (the borrower) and the bank.
Under this proposal, Iinancial institutions will not receive a Iixed rate oI interest on their outstanding
loans; rather, they share in proIits or in losses oI the business owner to whom they have provided the
Iunds. Similarly, those individuals who deposit their Iunds in a bank will share in the proIit/loss oI the
Iinancial institution. As opposed to the present system oI banking, where bank proIits arise Irom the
diIIerence between the interest it receives Irom borrowers and the interest it pays to its depositors, the
source oI bank proIits in interest Iree banking is the diIIerences in the proIit sharing ratios. The
entrepreneur and the bank agree upon sharing oI the proIit with a higher proportion going to the
entrepreneur, while the depositors share a comparatively smaller proportion oI the bank's proIits. The
Islamic principle oI Sharakah stipulates that the partners are Iree to determine the extent oI their
proIit-sharing ratio regardless oI their capital contributions. Losses, on the other hand, are to be shared
strictly in proportion to their capital contributions. In the case oI the division oI the proIits between a
Iinancial institution and various borrowers, however, it is suggested that the central bank should be
able to control the proIit/loss share ratio. This practice will not only reduce unhealthy competition
among Iinancial institutions, but also enables the central bank to inIluence the allocation oI resources
among various sectors oI the economy according to national priorities and monetary policy directives.
To ensure timely payment oI the loan plus the institution's share oI the proIits (iI any), a Iine could be
imposed on those borrowers who do not pay on time. To conIorm to the principals oI the Shariah,
these Iines must be deposited with the government treasury rather than given to individual Iinancial
institutions. Other punishments such as conIiscation oI property and blacklisting delinquent borrowers
are also suggested. Two problems have been cited as inherent in the traditional banking system, both
arising Irom the asymmetric availability oI inIormation between the two parties involved in a
Iinancial transaction. Adverse selection reIers to the possibility that potential borrowers who are the
most likely to produce an undesirable outcome are the ones who more actively seek out a loan, and
are thus the most likely to be selected. Moral hazard occurs when the borrower engages in activities
undesirable by the lender aIter the loan has been granted. The PLS system addresses both issues.
Since the proIit and loss sharing emphasises distribution oI both risk and proIits between the lender
and the borrower when a loan is made, the lending institution need only worry about the proIitability
oI the proposed project Ior which the loan is requested rather the credit-worthiness oI the Iirm to
which they are lending. This leads to more conservative decisions made by the lender and to a more
careIul monitoring oI the borrower.
Similarly, in the western banking model, heavy-handed bank regulation and the availability oI deposit
insurance have replaced the need Ior monitoring bank activities by depositors. Consequently, as Iar as
small depositors are concerned, deposits in one bank are very similar to deposits in another bank, and
hence there is no need to monitor bank activities. The Islamic, interest-Iree system, on the other hand,
imposes the burden on depositors oI gathering inIormation about the saIety, soundness, risks, and
proIitability oI the bank. This will eventually lead to a sounder banking system, although the
unwillingness oI depositors in the short run to go through the lengthy process may lead to short-term
reduction oI savings in the banking system. Islamic banking research concentrates, in part, on
addressing the compatibility oI this mode oI Iinance with the current global Iinancial environment.
For example, the argument that without interest the monetary authorities have no control over
monetary policy may be discounted by emphasising other methods oI monitoring credit such as
imposing limits on cash base oI the economy or through reserve requirements on banks. The question
oI government borrowing, especially Irom overseas sources, may also be resolved through allowing
the payment oI a rate oI return that varies depending on the rate oI growth oI the economy or the
inIlation rate.


CHAPTER FIVE: DISCUSSION & RECOMMENDATION
5.1 Discussion
There are several key Iindings Irom this study that met the research objective. In Islam, there is no
separation between mosque and state. Business, similarly, cannot be separated Irom the Islamic
religion. The Shariah (Islamic law) governs every aspect oI a Muslim`s religious practices, everyday
liIe, and economic activities. Muslims, Ior example, are not allowed to invest in businesses considered
non-halal or prohibited by Islam, such as the sale oI alcohol, pork, and tobacco; gambling; and
prostitution. In Islamic contracting, gharar (uncertainty and risk) is not permitted, i.e., the terms oI the
contract should be well deIined and without ambiguity. For example, the sale oI Iish Irom the ocean
that has not yet been caught is prohibited. The prohibition oI gharar is designed to prevent the weak
Irom being exploited and, thus, a zero-sum game in which one gains at the expense oI another is not
sanctioned. Gambling and derivatives such as Iutures and options, thereIore, are considered un-
Islamic because oI the prohibition oI gharar. More importantly, Muslims are prohibited Irom taking or
oIIering riba. What constitutes riba, however, is controversial and has been widely debated in the
Islamic community. Some view riba as usury or excessively high rate oI interest. But the majority oI
Islamic scholars view riba as interest or any predetermined return on a loan. The basis Ior the
prohibition oI riba in Islam may be traced to the common medieval Arabic practice oI doubling the
debt iI the loan has not been repaid when due. This practice in its extreme Iorm had led to slavery in
medieval Arabia because oI the absence oI bankruptcy legislation that protects the borrower Irom
Iailed ventures. ThereIore, the prohibition oI riba can be viewed as part oI Islam`s general vision oI a
moral economy. In Islamic economics, the lender should bear the risk oI the venture with the
borrower because it is deemed that neither the borrower nor lender is in control oI the success or
Iailure oI a venture. Thus, a unique Ieature that diIIerentiates Islamic banking Irom conventional
banking, in theory, is its proIit-and-loss sharing (PLS) paradigm. Under the PLS paradigm, the ex-
ante Iixed rate oI return in Iinancial contracting, which is prohibited, is replaced with a rate oI return
that is uncertain and determined ex-post on a proIit-sharing basis. Only the proIit-sharing ratio
between the capital provider and the entrepreneur is determined ex-ante. PLS contracts, in general,
allow two or more parties to pool their resources Ior investment purposes and to share the
investment`s proIit and loss. The PLS paradigm is widely accepted in Islamic legal and economic
literature as the bedrock oI Islamic Iinancing. Islamic bank Iinancing, which adheres to the PLS
principle, is typically structured along the lines oI two major types oI contracts: musharkah (joint
venture) and mudarabah (proIitsharing). Musharkah contracts are similar to joint venture agreements,
in which a bank and an entrepreneur jointly contribute capital and manage a business project. Any
proIit and loss Irom the project is shared in a predetermined manner. The joint venture is an
independent legal entity, and the bank may terminate the joint venture gradually aIter a certain period
or upon the IulIilment oI a certain condition. Mudarabah contracts are proIit-sharing agreements, in
which a bank provides the entire capital needed to Iinance a project, and the customer provides the
expertise, management and labour. The proIits Irom the project are shared by both parties on a pre-
agreed (Iixed ratio) basis, but in the cases oI losses, the total loss is borne by the bank.
Most theoretical models oI Islamic banking are based on the mudarabah (proIitsharing) and/or
musharakah (joint venture) concepts oI PLS. There are, however, other Iinancing contracts that are
permissible in Islam but not strictly PLS in nature. In practice, however, Islamic banking is not very
diIIerent Irom conventional banking Irom the perspective oI the PLS paradigm. On the asset side oI
Islamic banking, only a negligible portion oI Iinancing is based on the PLS principle. Consistent with
Islamic banking experiences elsewhere, a large majority oI Islamic bank Iinancing in Malaysia is still
based on non-PLS modes that are permissible under the Shariah law, but ignore the spirit oI the usury
prohibition. On the liability side, the PLS principle is more widely adopted in structuring Islamic
deposits. However, in practice, Islamic deposits are not interest-Iree.
There are several possible reasons Ior the poor adoption oI the PLS paradigm in practice. First, unlike
conventional banking, PLS Iinancing encounters severe principalagent problems. Moral hazard
problems associated with ex-post inIormation asymmetry, Ior example, are especially signiIicant in
PLS Iinancing because the entrepreneur (borrower) has incentive to under-declare or artiIicially
reduce reported proIit. Also, in the case oI musharkah contracting, the entrepreneur has an incentive
to undertake high-risk projects because the entrepreneur is actually given a call option whereby he or
she gains on the upside but bears no losses at all on the downside. PLS Iinancing, thus, requires more
costly monitoring. Second, the adoption oI PLS Iinancing is disadvantaged by a lack oI management
and control rights. In musharkah Iinancing, Ior example, the bank provides all the risk capital, but the
management and control oI the project is mostly in the hands oI the entrepreneur. The lack oI
management and control, in particular, accentuates the principalagent problems associated with PLS
Iinancing. Along with these there is several diIIerent aspect oI banking system which is not included
in this report and need to be addressed and recommended Ior Iurther research including Islamic
interbank money market, Islamic government debt securities market, Islamic insurance market,
mudarbah interbank investment mechanism and government investment issues.
5.2 Limitation oI Research
The Iindings are drawn Irom relatively small size oI respondent and the richness oI inIormation
gathered may be weakened by the number oI respondents. However, every attempt was made to
obtain a diverse set oI inIormation. One oI the main objectives was to Iound that Islamic banking is
really interest Iree or not. Some oI the respondents Iound it diIIicult to answer practically but more on
theoretically. There are some limitations in my question asked to respondent due to limited knowledge
on the issue. Most oI the question asked were closed questions and did not oIIer many possible
answers. It restricted respondent to address the issues in diIIerent prospective and this research
limited. Some open question may help the respondent to address those issues which is not included in
the Iindings and can make this research more valuable and inIormative to the readers.
By gathering Iurther research more quantitative and qualitative validity is required so that all issues
related can be studied on much wider range. A large survey oI banks Irom wider demographic group
would appropriate and then it would be a larger study. A more comprehensive research should be
developed to understand that question leIt to be answer in this research.
5.3 Implication
Broadly speaking, banks have three types oI diIIerent customers: depositors, borrowers and seekers oI
bank`s other services such as money transIer. Since services do not generally involve dealing in
interest Muslims have no problem transacting such businesses with conventional banks; neither do
Islamic banks experience any problems in providing these services. Among the depositors there are
current account holders who too, similarly, have no problems. It is the savings account holders and the
borrowers who have reservations in dealing with the conventional banks. The main concern Ior
Islamic bank is the savings account holders. As the name itselI indicates the primary aim oI the saving
account depositor is the saIe-keeping oI his savings. It is correctly perceived by the conventional
banker and he guarantees the return oI the deposit in tot. The banker also assumes that the depositor
will preIer to keep his money with him in preIerence to another who might also provide the same
guarantee iI the depositor is provided an incentive. This incentive is called interest, and this interest is
made proportional to the amount and length oI time it is leIt with the bank in order to encourage more
money brought into the bank and leIt there Ior longer periods oI time. In addition, the interest rate is
Iixed in advance so that the depositor and the banker are Iully aware oI their respective rights and
obligations Irom the beginning. And laws have been enacted to guarantee their enIorcement. In
Economic theory the interest is oIten taken to be the 'compensation the depositors demand and
receive Ior parting with their savings. The Iact that the depositors accept the paid interest and that,
given other things being equal, they preIer the bank or the scheme which oIIers the highest interest
proves the banker`s assumption correct. The scheme is simple, transparent and seems to have satisIied
the requirements oI all types oI savers -- Irom teenagers to old-age pensioners, Irom individuals to
large institutions, pension Iunds and endowments, Irom small amounts to millions, and Irom a Iew
weeks or months to years -- which it has survived over centuries and operates across national, cultural
and religious borders. The situation is very diIIerent in the Islamic banks. Here too the depositor`s
Iirst aim is to keep his savings in saIe custody. Islamic bankers divide the conventional savings
account into two categories (alternatively, create a new kind oI account): savings account and
investment account. The investment accounts operate Iully under the PLS scheme -- capital is not
guaranteed, neither is there any pre-Iixed return. Under the savings account the nominal value oI the
deposit is guaranteed, but they receive no Iurther guaranteed returns. Banks may consider Iunds under
the savings accounts too as part oI their resources and use it to create assets. This is theory. In
practice, however, the banks preIer, encourage and emphasise the investment accounts. This is
because since their assets operate under the PLS scheme they might incur losses on these assets which
losses they cannot pass onto the savings accounts depositors on account oI the capital guarantee on
these accounts. In the process the Iirst aim oI the depositor is pushed aside and the basic rule oI
commercial banking --capital guarantee-- is broken. It is suggested that all Islamic banks guarantee
the capital under their savings accounts. This will satisIy the primary need and expectation oI an
important section oI the depositors and, in Muslim countries where both Islamic and conventional
banks coexist, will induce more depositors to bank with the Islamic banks. At the same time, it will
remove the major objection to establishing Islamic banks in non-Muslim countries. It has already seen
that all the problems oI the Islamic banks arise Irom their need to acquire their assets under the PLS
scheme. A simple solution does, in Iact, already exist in the current theories oI Islamic banking. It
need only be pointed out and acted upon. As the models provide loans with a service charge, it is
suggested that the Iunds in the deposit accounts (current and savings) be used to grant loans (short-
and long-term) with a service charge. By doing this the Islamic banks will be able to provide all the
loan Iacilities that conventional banks provide while giving capital guarantee Ior depositors and
earning an income Ior themselves. Furthermore, and it is important, they can avoid all the problems
discussed in section under problems in implementing PLS Scheme. This would also remove the rest
oI the obstacles in opening and operating Islamic banks in non-Muslim countries. The bonus Ior the
borrowers is that the service charge levied by the Islamic banks will necessarily be less than the
interest charged by conventional banks.
(i) Loans not carrying any interest on which the banks may recover a service charge not exceeding the
proportionate cost oI the operation, excluding the cost oI Iunds and provisions Ior bad and doubtIul
debts. The maximum service charge permissible to
each bank will be determined by the Central Bank Irom time to time
(ii) "ard-e-hasana loans given on compassionate grounds Iree oI any interest or service charge and
repayable iI and when the borrower is able to pay.
It is suggested that 50 percent oI the Iunds in the loan` (i.e. current and savings) accounts be used to
grant short-term loans. A Iee is to be charged Ior providing these loans.
An appropriate way oI levying such a Iee would be to require prospective borrowers to pay a Iixed
amount on each application, regardless oI the amount required, the term oI the loan or whether the
application is granted or rejected. Then the applicants to whom a loan is granted may be required to
pay an additional prescribed Iee Ior all the entries made in the banks registers. The criterion Ior Iixing
the Iees must be the actual expenditure which the banks have incurred in scrutinising the applications
and making decisions, and in maintaining accounts until loans are repaid. These Iees should not be
made a source oI income Ior the banks, but regarded solely as a means oI maintaining and managing
the interest-Iree loans. It is clear Irom the above that the need Ior having cash loans as one mode oI
Iinancing, and that this service should be paid Ior by the borrower. Though the details may vary, but
seem to suggest that the charge should be the absolute cost only. Further it is suggested that a
percentage oI this absolute cost be added to the charge as a payment to the bank Ior providing this
service. This should enable an Islamic bank to exist and Iunction independently oI its perIormance in
it`s PLS operations. The idea oI participatory Iinancing introduced by the Islamic banking movement
is a unique and positive contribution to modern banking. However, as it has seen earlier, by making
the PLS mode oI Iinancing the main (oIten almost the only) mode oI Iinancing the Islamic banks have
run into several diIIiculties. II, as suggested in the previous section, the Islamic banks would provide
all the conventional Iinancing through lending Irom their deposit accounts (current and savings), it
will leave their hands Iree to engage in this responsible Iorm oI Iinancing innovatively, using the
Iunds in their investment accounts. They could then engage in genuine Mudaraba Iinancing. Being
partners in an enterprise they will have access to its accounts, and the problems associated with the
non-availability oI accounts will not arise.
5.4 Recommendation Ior Banks
Encourage the application oI mudharabah and musharakah Iinancing via the setting up oI a special
Iund or subsidiary to undertake these modes oI Iinancing. Islamic banks need to carry out studies to
identiIy the potential areas in which these modes oI Iinancing will be most Ieasible
Devise a comprehensive approach to risk management and appropriate mechanisms to mitigate risks.
This is due to the diIIerent contractual relationship in Islamic Iinancial transactions between Islamic
banks and their customers thus giving rise to distinct risk attributes. It is also important Ior the asset
and liability committee in Islamic banks to Iocus on building a Iinancially sound portIolio to sustain
the competitive edge oI Islamic banks in a dual banking environment.
Strategic steps will be taken to prepare the Islamic banking industry players to be among the best
managed institutions, capable oI capitalising on the unique Ieatures oI Islamic banking to achieve
signiIicant competitive edge. The recommendations involve measures to ensure that the scarcity oI
skilled manpower in Islamic banking is adequately addressed. In addition, the development oI
management teams and the continuous application oI benchmarking to elevate the perIormance level
will be given due Iocus.
Benchmarking is essential Ior Islamic bank to be at par with international best practices. Hence, a
benchmarking programme will be introduced to Iacilitate banks in evaluating their relative eIIiciency,
identiIying the perIormance gaps and Iormulating strategies to improve and deliver the best results.
To increase the pool oI bankers and operators who are knowledgeable and competent, EIIorts will be
directed to promote human capital development to support the envisaged growth oI the industry.
Establishing an industry-owned institution on Islamic banking and Iinance dedicated to train and
supply a suIIicient pool oI Islamic bankers and operators as required by the industry.
To build capable and innovative management teams committed to Islamic banking, the employment
oI experienced and qualiIied staII, including expatriates to Iacilitate transIer oI knowledge and
expertise will be encouraged. The recruitment oI expatriates will complement the eIIorts made to
build the skills oI the domestic industry players.
IntensiIy research and development eIIorts in the Iield oI Islamic banking and Iinance. These
initiatives will be undertaken independently by the Islamic bank as well as on a collective basis via
the industry-owned research and training institute.
5.5 Recommendation Ior Financial Regulator
One oI the pre-conditions to sustain the continuous growth oI Islamic banking is a comprehensive
legal inIrastructure to seek any legal redress arising Irom Islamic Iinancial transactions. A suIIicient
number oI competent lawyers and judges equipped with sound knowledge and expertise in both
Shariah and civil laws is needed to handle legal matters on Islamic Iinancial contracts to promote
conIidence amongst the industry practitioners and customers.
SpeciIic measures will be taken to promote a healthy competitive culture among the Islamic banks
and create suIIicient market depth to build distinct competitive advantage in a dynamic Iinancial
environment. Among the initiatives in this direction entail the issuance oI new Islamic banking
licenses as well as the stimulation oI Islamic Iinancial engineering in product development and risk
management.
Concerted eIIorts will be directed to create a separate and viable platIorm Ior Islamic banking to
Iunction eIIectively in parallel with conventional banking and insurance. The legal, regulatory and
Shariah Iramework oI Islamic banking will be strengthened Iurther through the review oI the existing
laws and guidelines governing the industry. Code oI ethics will be one oI the core determinants in
disciplining the industry with less emphasis on central bank`s intervention.
Complementary measures will also be taken to create and increase awareness amongst the public on
the concept and advantages oI Islamic banking as well as customer education on misperceptions.
Encourage Islamic banking institutions and operators to embark on regular promotional programmes
on Islamic banking. Islamic banking institutions and operators will be encouraged to Iorm strategic
alliance with institutions oI higher learning to enhance knowledge on Islamic banking; and enhance
the teaching oI Islamic banking in school curriculum and in institutions oI higher learning.
To stimulate greater competition and to accelerate greater international integration, consideration
will be given to issue Islamic banking licenses to qualiIied Ioreign Islamic banking players that have
presence in the global Islamic banking industry.
5.6 Recommendation Ior Further Research
A comprehensive research is needed Ior pragmatic solution as most oI the theoretical concepts about
Islamic banking need practical solution. Financial models should be developed to identiIy the long
term and short term dynamics between Islamic investments and conventional deposits.
Further research on Islamic interbank money market, Islamic government debt securities market and
Islamic insurance along with their practical solution can make Islamic banking a worldwide
phenomena and easy to implement in non Islamic countries.
5.7 Conclusion
Islamic banking is a very young concept. Yet it has already been implemented as the only system in
two Muslim countries; there are Islamic banks in many Muslim countries and a Iew in non-Muslim
countries as well. Despite the successIul acceptance there are problems. These problems are mainly in
the area oI Iinancing. With only minor changes in their practices, Islamic banks can get rid oI all their
cumbersome, burdensome and sometimes doubtIul Iorms oI Iinancing and oIIer a clean and eIIicient
interest-Iree banking. All the necessary ingredients are already there. The modiIied system will make
use oI only two Iorms oI Iinancing -- loans with a service charge and Mudaraba participatory
Iinancing -- both oI which are Iully accepted by all Muslim writers on the subject. Such a system will
oIIer an eIIective banking system where Islamic banking is obligatory and a powerIul alternative to
conventional banking where both co-exist. Additionally, such a system will have no problem in
obtaining authorisation to operate in non-Muslim countries.
Participatory Iinancing is a unique Ieature oI Islamic banking, and can oIIer responsible Iinancing to
socially and economically relevant development projects. This is an additional service Islamic banks
oIIer over and above the traditional services provided by conventional commercial banks.

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Appendix A: Glossary
Amana (Demand deposits): Deposits held at the bank Ior saIekeeping purpose. They are guaranteed in
capital value and earn no return.
Bay: stands Ior sale. It is oIten use as preIix in reIerring to diIIerent sales-based modes oI Islamic
Iinance.
Fatwa: Legal opinion issued by a qualiIied scholar on matters oI religious belieI and practice.
Fiqh (Islamic jurisprudence): It reIers to Islamic jurisprudence that covers all aspects oI liIe: religious,
political, social and economic. Fiqh is mainly based on interpretations oI the "ur`an and Sunna
(sayings and deeds oI the prophet).
Fiqh al-Muamalat: Islamic Commercial Jurisprudence.
Gharar: Literally, uncertainty, hazard, chance or risk. Technically, sale oI a thing which is not present
at hand; or the sale oI a thing whose consequence or outcome is not known; or a sale involving risk or
hazard in which one does not know whether it will come to be or not, such as Iish in water or a bird in
the air.
Hadith: saying, deeds and reaction oI Prophet Muhammad (peace be upon him) narrated by
companions.
Hawalah: literally means bill oI exchange, cheque, and draIt. Technically, reIers to an arrangement
whereby a debtor passes on the responsibility oI payment oI the debt to a third party who owes Iormer
a debt.
Halal: That which is permissible according to Shariah Law.
Haram: UnlawIul according to the Shariah. It indicates transactions which are not
permissible under Islamic law.
Hibah: Literally giIt. A giIt awarded voluntarily in return Ior a loan.
Ijarah: leasing. The subject matter in a leasing contract is an asset, such as machinery, airplanes, cars,
or ships, which generate usuIruct over time. This usuIruct is sold to lessee at a predetermined price.
The lessor retains the ownership oI the asset with all the rights and responsibilities that go with
ownership.
Istisna: reIer to a contract whereby a manuIacturer (contractor) agrees to produce (build) and deliver a
well described good (or premise) at a given price on a given date in the Iuture.
Ju`ala (Service charge): A party pays another a speciIied amount oI money as a Iee Ior rendering a
speciIic service in accordance to the terms oI the contract stipulated between the two parties. This
mode usually applies to transactions such as consultations and proIessional services, Iund placements
and trust services.
KiIala: It is a pledge given to a creditor that the debtor will pay the debt, Iine, or liability. A third
party becomes surety Ior the payment oI the debt iI unpaid by the person originally liable.
Mudaraba (Trustee Iinance contract): Rabb -al- mal (capital`s owner) provides the entire capital
needed to Iinance a project while the entrepreneur oIIers his labor and expertise. ProIits are shared
between them at a certain Iixed ratio, whereas Iinancial losses are exclusively borne by rabb-al-mal.
The liability oI the entrepreneur is limited only to his time and eIIort.
Murabaha (Markup Iinancing): The seller inIorms the buyer oI his cost oI acquiring or producing a
speciIied product. The proIit margin is then negotiated between them. The total cost is usually paid in
installments.
Musharaka (Equity participation): The bank enters into an equity partnership agreement with one or
more partners to jointly Iinance an investment project. ProIits (and losses) are shared strictly in
relation to the respective capital contributions.
"ard Hassan (BeneIicence loans): These are zero-return loans that the "ur`an encourages Muslims to
make to the needy Banks are allowed to charge borrowers a service Iee to cover the administrative
expenses oI handling the loan. The Iee should not be related to the loan amount or maturity.
"ur`an: Islamic scriptures believed by Muslims to be God's revelation to the Prophet (peace be upon
him).
Riba`: Literally, an excess or increase. Technically, an increase, which in a loan transaction or in
exchange oI a commodity, accrues to the owner (lender) without giving an equivalent counter value or
recompense in return to the other party.
Shariah (Islamic Law): The Islamic Law extracted Irom the "ur`an and Sunnah (sayings and deeds oI
the Prophet)
Sunnah: The Sunnah is the most important source oI the Islamic Iaith aIter the "ur`an and reIers to
the Prophet`s (peace be upon him) example as indicated by his practice oI Iaith. The only way to
know the Sunnah is through the collection oI Ahadith, which consist oI reports about the sayings,
deeds and reaction oI the Prophet (peace be upon him)
TakaIul: Arabic name Ior insurance based on Shariah rules. An Islamic Insurance is a collective
protection scheme. It literally means solidarity. TakaIul reIlects solidarity and is akin to mutual
insurance.
Umma: Community oI the IaithIul within Islam
Wadiah: A saIe custody contract between the depositor (customer) and the custodian (bank).
Wikala: An Agency contract which may include in its terms a Iee Ior the agent. Same contract can
also be used to give a power oI attorney to someone to represent another`s interests.
Zakat: Religious tax to be deducted Irom wealth to be paid to the needy.