We are thankful to Allah who has given us the courage to complete the project. After ALLAH we thank our Parents who have supported us in the ups and downs of Life by Saying, “When the going gets tough, the tough one gets going” Finally we are thankful to our Teachers Prof. Nisar Ahmed and Prof. Abdul Rauf whose tremendous support has made us able to fulfill the requirements of our project.


TABLE OF CONTENT ACKNOWLEDGEMENT...................................................I EXECUITIVE SUMMARY..........................V CHAPTER #: 1 INTRODUCTION....................................1
1.1 Background..................................................................................................................1 1.2 HISTORY OF ISLAMIC BANKING IN PAKISTAN............................................3 1.3 The Current Picture of Islamic Banking in Pakistan .............................................4 1.4 Factors Supporting the Development of Islamic Banking in Pakistan ..................5 (a) Decentralization of Administrative Power ................................................................5 (b) Commendable Developments in the Economy after the Year 2000 .........................6 (c) Participation and Sharing of Islamic or Religious Parties in Political Power ...........6 (d) The Prudential Performance of Islamic Banks and the Risk Taking Attitude of Investors .........................................................................................................................6 PROBLEM STATEMENT...............................................................................................7 OBJECTIVE OF THE STUDY.......................................................................................7 SIGNIFICANE OF STUDY.............................................................................................7

CHAPTER #: 2 LITERATURE REVIEW......................8 CHAPTER #: 3 SAILENT FEATURES AND GROWTH WITNESSED .................................................................10
2.1 Main features Of Islamic Banking...........................................................................10 a)Zero interest and capital guarantee.............................................................................10 b)Lending and investing................................................................................................11 c)Participatory financing...............................................................................................11 d)Interest-free commercial banking..............................................................................13 e)Participatory financing through commercial banks...................................................15 f)Compensation for inflation.........................................................................................15 GROWTH WITNESSED: (SBP ANALYSIS).............................................................16 2.2 Industry Progress and Market Share......................................................................16 ii

Source SBP:......................................................................................................................17

3.1 Problems of Islamic Banks ......................................................................................24 a)PLS financing is unpopular with both Islamic banks and clients. ............................24 b)PLS is not suitable for short-term financing or for the non-profit sector. ................25 c)Lack of developed Islamic financial products, Institutions and markets. .................25 d)Islamic banking in non-Islamic countries is still difficult. ........................................25 3.2 GENERAL CHALLENGES FOR ISLAMIC BANKS .........................................25 a)Establishing appropriate risk and liquidity management techniques.........................26 b)Achieving consistent sharia Supervision...................................................................26 c)Managing the talent pool............................................................................................26 d)Addressing legal and tax restrictions.........................................................................27 3.3 ISSUES AND CHALLENGES OF ISLAMIC BANKING ...................................27 a)Standardization ..........................................................................................................27 b)Public Awareness ......................................................................................................28 c)Training of Banking Professionals.............................................................................28 d)Emphasis on Shari’ah Audit instead of Reliance on Shari’ah Supervision ..............29 e)Institutionalization of Recovery of Debt ...................................................................29 f)Risk Management ......................................................................................................29 g)Accounting ................................................................................................................30 h)Regulation and Control of Islamic Financial Institutions .........................................30 i)Migration from Riba-Based to Riba-Free Banking ...................................................31 j)Legal Framework .......................................................................................................31 k)Shortage of Supportive and Link Institutions ...........................................................32 l)Organizing Relationship with Foreign Banks ............................................................32 m)Long-term Financing ...............................................................................................32 n)Human resource for Sharia'h compliance .................................................................32 o)Unresolved Fiqh Issues .............................................................................................32

1. Survival of Islamic Banking & Finance....................................................................33 1.1 Economic Viability:................................................................................................33 1.2 Stability:..................................................................................................................34 1.3 Challenges to Identity:.............................................................................................34 1.4 Confidence of Depositors and Savers:....................................................................35 2. Likely Shape of Islamic Banking & Finance in Future...........................................35 2.1 Islamic Banks as Pure Financial Institutions:.........................................................35 2.2 Islamic Banks will primarily be Economic Institutions:.........................................36 2.3 Standardization of Islamic Financial Products:.......................................................36 3. Future Challenges for Islamic Banking & Finance..................................................37 iii

3.1 Financial Innovation in Critical Areas:...................................................................37 3.2 Competition:............................................................................................................37 3.3 Misuse of Islamic Banking......................................................................................37 4. Effect of Islamic Banking on Economy and Economic Life....................................38 5. Effect of Islamic Banking on Various Disciplines....................................................38 6. Some Other Relevant Points.......................................................................................39 7. Future Strategy and Outlook (Pakistan Specific)....................................................39

CHAPTER #: 5 RESEARCH DESIGN & METHODOLOGY .......................................................................................43
Theoretical framework...................................................................................................43 5.1 Inventory of Variables.............................................................................................43 5.2 Mode Of Observations............................................................................................44 5.3 Field Data Collection...............................................................................................44 5.4 Hypothesis...............................................................................................................44 5.5 Sampling Design.....................................................................................................45 5.6 Data Collection Methods.........................................................................................45

Analysis of Questionnaire for Consumers.....................................................................46 Analysis of Questionnaire for Officials.........................................................................61

CONCLUSION................................................................................................................64 RECOMMENDATIONS................................................................................................65 1. ENHANCE KNOWLEDGE AND EXPERTISE......................................................65 2. BUILD STRONG MANAGEMENT TEAMS.........................................................65 3. INSTITUTIONAL CAPACITY ENHANCEMENT................................................65 4. STRENGTH THE REGUALTORY FRAME WORK FOR ISLAMIC BANKING65 5. INTRODUCE A BENCHMARKING PROGRAM..................................................66

REFERENCES..............................................................67 APPENDICES I..............................................................68


The market for Islamic banking has grown rapidly over the past few years, and this healthy growth is expected to continue for the foreseeable future. In many markets, Islamic banking has evolved from being a place offering into being part of the majority financial services scenery. In fact, there are currently more than 300 Islamic financial institutions spread over 51 countries, plus well over 250 mutual funds that comply with Islamic principles. And, over the past decade, the Islamic banking industry has experienced growth rates of 10-15 percent per year—a trend that is expected to continue. Islamic Banking in Pakistan is growing at an excellent pace. Efforts are being made since 1979 to Islamite the financial system for which the SBP initially introduced 12 Islamic modes of financing to replace interest-based instruments. In addition, conventional banks were also allowed to offer Islamic banking services through dedicated Islamic windows. There are 6 full-fledged Islamic and 13 conventional banks conducting Islamic banking in Pakistan at present. The names of the six Islamic banks are: Meezan Islamic Bank, AlBaraka Islamic Bank, Dubai Islamic Bank, Bank Islami Pakistan Limited, Emirates Global Islamic Bank Limited and First Dawood Islamic Bank. According to the quarterly report of the State Bank of Pakistan, the total assets of these Islamic banks now stands at PRS 136 billion, the assets growth rate of Islamic banks is estimated at 10.5% over the period. The assets share of Islamic banking in the overall banking system is estimated to be 3.2% at present. The total of number of Islamic banking branches at Islamic banks and conventional banks is 173. These 173 Islamic banking branches count for less than 1.5% of more than 8500 banking branches of the country. However, its shares in terms of asset percentage of banking industry were just 3.2% while comparing conventional banking assets. The size of the conventional banking is increasing rapidly since the last four years which left the Islamic Banking far behind in the race for banking market. As the people are getting more and more aware of Islamic products and services the need for more well equipped and accurate shariah compliant services are increasing day by day. The expectations and demands of the customers are ever increasing. At the same time, the competitive landscape has changed, with more Islamic financial services institutions in the marketplace than ever before. Current banks and new market entrants are facing vastly different market conditions and need to develop new sources of differentiation beyond compliance with sharia (Islamic law) to compete or remain successful in the future. This paper seeks to analyze the growth it achieved over the years and the factors that played their active part in the development of Islamic banks in Pakistan. With the great achievements of Islamic banks it is facing enormous challenges and problems that are restricting the growth of these banks. We have tried are level best and made all-out efforts to figure out those challenges elaborately. These issues includes challenges relating to standardization, public awareness, training of professionals, cut throat competition, lack of collaboration among Islamic banking institutes, risk management, liquidity management, technology, fiqah related issues etc these are discusses by us in details and v

suggestions have been made to sort these out. Further in the research the growth potential has been anticipated. Bright future has been forecasted but certain challenges are there for the survivability, economic viability, and stability of the Islamic banks. The likely shape of Islamic banks has also been discussed in the prevailing circumstances. Pakistan specific outlook of Islamic banks have been discussed and certain strategies are being suggested by us to discussed by us that would provide a good food for thought to get the optimal results from the Islamic banks in the future. The research is based on Primary data i-e questionnaires and interview that are being conducted from officials and customers and findings from that would be the base of the research project. Qualitative or secondary data, articles and previous researches are extensively analyzed to reach appropriate and reasonable results. The aim of this study is to figure out whether Islamic banking is being affected by conventional banks or not in any way and whether no of branches and profit sharing rates are affecting volume of deposits or not. We have taken these “hypotheses”. Two variables, number of Islamic bank’s branch offices and profit sharing rate are thought to have influence on the volume of deposits. The research indicates conventional banks in some ways affect Islamic banks. That the number of Islamic bank’s branch offices and profit sharing rate significantly affects the volume of deposits in the long run. Yet, the increasing number of Islamic commercial banks and Islamic banking unit in Pakistan has been followed by an increase in the nominal volume of deposits in the banks. So the V.O.D witnessed a sharp increase over the period of time as the number of branches increases according to the SBP statistics. When the number of branches were 17 as per Dec 03 the deposits were Rs 8 billion (0.4%) of the banking industry and similarly when the branches jumped to 207 in sep 07 the deposits swelled up to 124 billion Rs (3.6%) of the banking industry. that clearly justifies the research being held in a realistic and factual way. This finding supported the view that depositors are attracted to put their money in Islamic banks partly due to welfare maximization reasons, not only because of their religious considerations. Moreover, in order to increase the volume of deposits it is suggested that more branch offices of Islamic commercial banks are built. Lastly, Islamic commercial banks should also provide an optimal profit sharing rate in order to attract more depositors.


1.1 Background
Islamic banking has been defined as banking in consonance with the culture and value system of Islam and governed, in addition to the conventional good governance and risk management rules, by the principles laid down by Islamic Shariah. Interest free banking is a narrow concept denoting a number of banking instruments or operations, which avoid interest. Islamic banking, the more general term is expected not only to avoid interestbased transactions, prohibited in the Islamic Shariah, but also to avoid unethical practices and participate actively in achieving the goals and objectives of an Islamic economy. Islamic Shariah prohibits ‘interest’ but it does not prohibit all gains on capital. It is only the increase stipulated or sought over the principal of a loan or debt that is prohibited. Islamic principles simply require that performance of capital should also be considered while rewarding the capital. The prohibition of a risk free return and permission of trading, as enshrined in the Verse 2:275 of the Holy Quran, makes the financial activities in an Islamic set-up real asset-backed with ability to cause ‘value addition’. Islamic banking system is based on risk-sharing, owning and handling of physical goods, involvement in the process of trading, leasing and construction contracts using various Islamic modes of finance. As such, Islamic banks deal with asset management for the purpose of income generation. They will have to prudently handle the unique risks involved in management of assets by adherence to best practices of corporate governance. Once the banks have stable stream of Halal income, depositors will also receive stable and Halal income. The forms of businesses allowed by Islam at the time the Holy Quran was revealed included joint ventures based on sharing of risks & profits and provision of services through trading, both cash and credit, and leasing activities. In the Verse II:275, Allah the Almighty did not deny the apparent similarity between trade profit in credit sale and Riba in loaning, but resolutely informed that Allah has permitted trade and prohibited Riba. Profit has been recognized as ‘reward’ for (use of) capital and Islam permits gainful deployment of surplus resources for enhancement of their value. However, along with the entitlement of profit, the liability of risk of loss on capital rests with the capital itself; no other factor can be made to bear the burden of the risk of loss. Financial transactions, in order to be permissible, should be associated with goods, services or benefits. At macro level, this feature of Islamic finance can be helpful in creating better discipline in conduct of fiscal and monetary policies. Besides trading, Islam allows leasing of assets and getting rentals against the usufruct taken by the lessee. All such things/assets corpus of which is not consumed with their use can be leased out against fixed rentals. The ownership in leased assets remains with the lessor who assumes risks and gets rewards of his ownership.


Islamic banking is a new phenomenon that has taken many observers by seems that the history of interest free banking can be divide in to two parts. First,when it still remained an idea; second,when it became a reality—by private inititative in some countries and by law in others.the last decade has seen a marked deline in the establishment of new islamic bank and the established banks seem to have failed to live up to the expectations.the literature of the period begins with evaluations and ends with attempts at finding ways and means of correcting and overcoming problems encountered by the existing banks The first modern experiment with Islamic banking was undertaken in Egypt The pioneering effort, led by Ahmad El Najjar, took the form of a savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in l963. This experiment lasted until l967 , by which time there were nine such banks in the country. These banks, which neither charged nor paid interest, invested mostly by engaging in trade and industry, directly or in partnership with others, and shared the profits with their depositors (Siddiqi l988). Thus, they functioned essentially as saving- investment institutions rather than as commercial banks. The Organization of Islamic Countries established the IDB in l974, but it was primarily an inter-governmental bank aimed at providing funds for development projects in member countries. The IDB provides fee- based financial services and profit-sharing financial assistance to member countries. The IDB operations are free of interest and are explicitly based on Shariah Principles. Islamic banking is steadily moving into an increasing number of conventional financial systems.It is expanding not only in nations with majority Muslim populations, but also in other countries where Muslims are a minority, such as the United Kingdom and Japan. Similarly, countries such as India, the Kyrgyz Republic, and Syria have recently granted, or are considering granting, licenses for Islamic banking activities. In fact, there are currently more than 300 Islamic financial institutions spread over 51 countries, plus well over 250 mutual funds that comply with Islamic principles. And, over the past decade, the Islamic banking industry has experienced growth rates of 10-15 percent per year—a trend that is expected to continue. Despite the rapid growth, many practitioners and supervisory authorities are unfamiliar with the process by which Islamic banks are introduced into a conventional system, or with the gamut of principles governing Islamic banking. In the following headings we will trace the story of islamic banking to date and examine how far successfully their concerns have been addressed


Islamic Banking in Pakistan is growing at an excellent pace. Efforts are being made since 1979 to Islamite the financial system for which the SBP initially introduced 12 Islamic modes of financing to replace interest-based instruments. Hence it has been recommended to set up interest free ‘common pool of funds’ on cooperative basis to replace the existing interest bearing government securities. The SBP initially took steps towards the development of financial instruments based on Islamic principles. Pakistan has witnessed the second wave of Islamization of financial system since 1999. This time the Supreme Court of Pakistan asked the government to take steps towards the elimination of interest from the economy. A meeting held under the chairmanship of the president of Pakistan decided to allow Islamic Banks to operate parallel to conventional banks. In addition, conventional banks were also allowed to offer Islamic banking services through dedicated Islamic windows. Now, six Islamic Banks and 13 conventional banks with a total network of 200 branches offer Islamic Banking products and services. In addition, non-bank financial institutions such as Islamic Mutual Funds, Takaful Companies, Mudaraba Companies, and House Building Finance Corporation etc. are also the active participants. Efforts are also been made for the development of Islamic Sukuk market. Islamic Banking is targeting to capture 10 per cent of the total financial sector in the years to come. Interest-free liquidity management is the major concern for Islamic Banks. The growth of Islamic Banking as ‘rapid pace of growth’, but the details showed that neither the pace of growth matched with the growth in conventional banking, nor its share was improving to capture a bigger piece of cake. The total banking assets of the Islamic Banking increased from Rs.118 billion in December 2006 to Rs.136 billion in March 2007. However, its shares in terms of asset percentage of banking industry were just 3.2% while comparing conventional banking assets. The size of the conventional banking is increasing rapidly since the last four years which left the Islamic Banking far behind in the race for banking market. In terms of deposits, Islamic Banking share was 3% of total banking deposits, though the size of deposits increased substantially during the last 15 months. The deposit rose to Rs.83 billion in December 2006 from Rs50 billion in December 2005. It further rose to Rs.93 billion in the first quarter of 2007 till end of March 2007. The Central Bank is pursuing three-pronged strategy to promote Islamic Banking in Pakistan: • • • To establish full-fledged Islamic banks in the private sector; Setting up of subsidiaries by the existing commercial banks; And separate branches for Islamic Banking by the existing commercial banks;

A Shariah Board is also in place at the State Bank of Pakistan, having experts to guide the Islamic Banking industry. 3

1.3 The Current Picture of Islamic Banking in Pakistan
This new initiative has witnessed a very encouraging response. As compared to our past experience our new approach provides flexibility to the IBIs as regard to products, instruments and Shariah compliance methodology.The names of the six Islamic banks are: Meezan Islamic Bank, Al-Baraka Islamic Bank, Dubai Islamic Bank, Bank Islami Pakistan Limited, Emirates Global Islamic Bank Limited and First Dawood Islamic Bank. According to the quarterly report of the State Bank of Pakistan, the total assets of these Islamic banks now stands at PRS 136 billion, the assets growth rate of Islamic banks is estimated at 10.5% over the period. The assets share of Islamic banking in the overall banking system is estimated to be 3.2% at present. The total of number of Islamic banking branches at Islamic banks and conventional banks is 173. These 173 Islamic banking branches count for less than 1.5% of more than 8500 banking branches of the country. As at end of the year 2003 only one bank operated as a full-fledged Islamic bank and three conventional banks were operating Islamic banking branches. Today there are 6 full fledge licensed Islamic bank and 12 conventional banks have licenses to operate dedicated Islamic banking branches. All of the five big banks in Pakistan are providing Islamic banking services. The total assets of the Islamic banking industry are over Rs. 225 billion as of 30th June 2008, which accounts for a market share of 4.5% of total banking industry assets. The market share of deposits stands at 4.2%. It is also important to compare progress of Islamic Banking in Pakistan with the progress in other countries in order to define an expected path for our industry. Malaysia’s first Islamic Bank commenced operations in 1983 and the market share of the Malaysian Islamic banking system today stands at approximately 13%. The Malaysia’s official target for the Islamic Banking is a 20% market share by 2010. Bahrain’s Islamic banking system is said to have gained a share of around 8% in over 30 years. Similarly in Indonesia Islamic banking was introduced somewhere in mid 90’s. On the other hand, Pakistan has shown much better performance than other global players. The industry progress, during the last five years, in terms of growth in number of institutions, branches, total assets, deposits along with the market share is given in following table


Dec03 4





Total assets Deposits Full fledge Islamic banks Branches of IBs Conventional banks with IBBs Total Islamic banking institutions

13 8 1 10 3 4

44 30 2 23 9 11

71 50 2 37 9 11

119 84 4 93 12 16

206 147 6 186 12 18

(Rs. in Billions) The savings deposits initially grew at a higher rate but lately the fixed deposits category has experienced a relatively better growth rate. This represents the growing interest of the customers in entering into long term relationships with the industry that is gradually building its reputation as a credible Shariah compliant offering.

1.4 Factors Supporting the Development of Islamic Banking in Pakistan
(a) Decentralization of Administrative Power
The responsibility for the adaptation of the market economy, the decentralization or privatization of loss making state-owned financial enterprises and the task of establishing Islamic banks was transferred to the State Bank of Pakistan. The State Bank of Pakistan took the initiative to launch Islamic banking in gradual phases. The emphasis was to promote and establish new full-fledged Islamic Banks rather than continue the transformation of existing conventional banks towards Islamization. Since the year 2000, the State Bank of Pakistan has followed various strategies to promote Islamic Banking such as; (a) the setting up of the criteria for establishing independent Islamic branches or subsidiary branches of Islamic banking; (b) The formation of the Islamic Banking Division at the State Bank of Pakistan and; (c) The establishment of a Shariah Scholar Board at the State Bank of Pakistan. All these above measures have imparted a positive impact on the effective working of Islamic Banking.


(b) Commendable Developments in the Economy after the Year 2000
The economy of Pakistan has made commendable progress since the year 2000. It is a well-established fact that the decade of the 1990s was a lost decade for Pakistan. While many developing countries made substantial economic progress. Pakistan lurched from one economic crisis to another mainly of its own making. Commercial banks and other financial institutions became the instruments of political patronage and profit for certain sub-sections of society. The average economic growth was between 3-4% per annum. During the years 2000-2005 the average economic growth increased to 7-8% per annum. The depth and efficiency of financial intermediation in Pakistan has improved. The bank assets to GDP ratio rose from 49.1% in 1997 to 55.6% in 2005 and the deposit to GDP ratio – an indicator of the level of financial savings- rose from 38.7% in 1997 to 43.1% in 2005. More significantly, equity market capitalization grew from a mere 10.3% of GDP in 2000 to 37.1% of GDP in 2006.

(c) Participation and Sharing of Islamic or Religious Parties in Political Power
When Pakistan became an independent nation, the Ulema (Religious leaders or Muslim Scholars) did not wait long to demand their share of power in running the new state. Jamat-i-Islami made the achievement of an Islamic Constitution its central goal. In February 1948, Maulana Maududi, while addressing the Lahore Law College, demanded that the Constitutional Assembly should unequivocally declare: 1. That the sovereignty of the State of Pakistan is vested in Allah and the government of Pakistan shall be only an agent to execute the Sovereign’s Will. 2. That the Islamic Shariah shall form the inviolable basic code for all legislation in Pakistan. 3. That all existing or future legislation which may contravene, whether in letter or in spirit, the Islamic Shariah shall be null and void and be considered ultra vires (beyond the legal capacity) of the constitution. 4. That the powers of the government of Pakistan shall be derived from, circumscribed by and exercised within the limits of the Islamic Shariah alone.

(d) The Prudential Performance of Islamic Banks and the Risk Taking Attitude of Investors
When compared to conventional banks the performance of Islamic banks is more commendable because Islamic banks distribute higher profits. According to the survey of 2007 80.9% of respondents said that Islamic banks distribute higher profits when compared to conventional banks in Pakistan. In same study we found that investors were prepared to take a risk in the case of Islamic banks, with 88.48% of respondents saying that they would continue their financial dealing with Islamic banks, even though the risk with these banks was higher than the conventional banks. 6

“To identify whether Islamic banking can grow where conventional banking has deep roots”

In relation to the previous text mentioned. The following objectives, which are being tested, researched and being implemented in detail by our research thesis. 1) To analyze current issues regarding Islamic banking 2) To analyze what shape Islamic baking industry takes in future in Pakistan. 3) To analyze what or what type of challenges Islamic banking face in coming years. 4) Analysis regarding whether Islamic banking can grow in an environment where conventional banking sector has deep roots 5) To highlight the strength of the relationship between the deposits of Islamic banks, and its ‘rate of profit’ of both savings and investment deposit facilities. These are the objectives, which we want to attain by conducting our research. In general we will gather information & conduct our research that what are the growths, features, limitations of Islamic banking in Pakistan and all over the world. Factors, which will affect our economy after implementing the aforementioned system, will also be discussed in our research.

It is expected that the study will provide an appraisal of the factors that have a vital influence on the growth of Islamic banking system in Pakistan. The recommendations and solutions may help the senior Shariah Officials to further enhance the growth level of Islamic banking sector in Pakistan



Hussain, Dr Ishrat (2004) gave a comprehensive outline on the evolution of Islamic banking in Pakistan. He presented his paper at a seminar on Islamic bankinh held at the Islamic Chamber of commerce and industry building, Karachi sponsored by meezan bank limited. In his speech he says that islam doesnot contradict growth, it promotes sustainable development and growth. Socio- economic justice is the main objective of Islamic economy. Prohibition of riba is the corner stone of Islamic financial transactions. He then discussed the measure taken for islamization in Pakistan. He discussed the application of zakat on Muslim citizens of Pakistan. Ariff, Mohamed concludes that Islamic banking is a new phenomenon that has taken many observers by surprise. The whole banking system has been islamized in both Iran and Pakistan. In addition, there are some thirty Islamic banks in operation in other parts of the globe, including the Jeddah-based Islamic Development Bank (IDB) but excluding numerous non-bank Islamic financial institutions What is more, the speed with which Islamic banks have sprung up and the rate at which they have progressed make it worth-while to study them systematically by University of Malaya, taken from Asian-Pacific Economic Literature, Vol. 2, No. 2 (September 1988), pp. 46-62 Rashid, Hassan says that Interest-free banking seems to be of very recent origin. The earliest references to the reorganization of banking on the basis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naeem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed 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 recognized the need for Islamic commercial banks and the evil of interest in that enterprise, and have proposed a banking system based on the concept of Mudarabha - profit and loss sharing. In the next two decades interest-free banking attracted more attention, partly because of the political interest it created in Pakistan and partly because of the emergence of young Muslim economists. Works specifically devoted to this subject began to appear in this period. The first such work is that of Muhammad Uzair (1955). Another set of works emerged in the late sixties and early seventies. Abdullah alAraby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main contributors. M. Chopra, Umer(2003) argued the “Maulana Mawdudi’s contribution Islamic economics. The corner stone of Mauawdudi was the well being of man kind in keeping with the central objectives of the shariah. He analysed problems of muslims and offeres them solutions. Most of the muslim countries are depending on foreign non muslim countries so they have to follow the rules of that country Tahir, Sayyid(1992) says that the elimination of riba is not an issue. Almighty Allah has set guidelines for us through examples set by the prophet fourteen centuries ago. Thus elimination of riba may prove to be the most important factor towards islamization of society. Gafoor A.L.M Abdul (1999) discussed the historical development of Islamic 8

banking. Modern banking was introduced in Muslim countries when they were politically and economically not strong. In this article he discussed historical development of Islamic banking, current practices problems in implementing the pls scheme and Islamic banking in non-Muslim countries. The history of Islamic banking can be divided in two parts. On remained as an idea and second one is when it became a reality. The earliest organizations of banking on the basis of profit sharing rather then interest are found in Anwar Quershi, maeem siddiqi Economists, mainly conventional ones, believe that depositors are attracted to deposit their money in banks because of the opportunity cost of holding cash in hand is high when the interest rate is also high (Romer, 2001, p. 346; Athukorala and Sen, 2004, p. 498). This can easily be explained by the utility maximization (cost minimization) idea, as a depositor will choose an action that will maximize their welfare or satisfaction. The question of whether depositors of Islamic banks are also motivated by the returns of the money or the profit sharing rates has been recently answered at least by Gerrard and Cunningham (1997), Metawa and Almossawi (1998), Haron and Ahmad (2000), and Ghafur (2003). Gerrard and Cunningham (1997) find that even in a country that is not a Muslim country like Singapore, Muslims are still maintaining their beliefs so that they “would retain deposits within the Islamic banking movement, even if the Islamic bank at which they deposited their money made no profits in any one year” (Gerrard and Cunningham, 1997). However, they suggest that Islamic banks should aim for profit, because 20.7% of their Muslim respondents would withdraw their deposits if “an Islamic bank does not generate sufficient profits to enable a distribution to take place in any one year” (Gerrard and Cunningham, 1997). Metawa and Almossawi (1998) come across a different conclusion from Gerrard and Cunningham (1997). Metawa and Almossawi (1997) conducted research in Bahrain, and find out that the bank selection decision by depositors is mainly religious-based, and then followed by rate of return. It may be said that in a country with most of the people embrace Islam such as Bahrain, rate of return is not the primary variable that influence the volume of deposits in its Islamic banks.


2.1 Main features Of Islamic Banking
The salient features of the proposed system are: • • There is no interest on deposits, but capital is guaranteed. Lending and investing are treated differently; loans are interest-free but carry a service charge, while investing is on a profit-and-loss-sharing (mudaraba) basis. Commercial banks will grant loans but they will not engage in investment financing. Investment financing will be done through investment banks and investment companies. Value erosion of capital due to inflation is compensated.

With these features the proposed system simply avoids the many problems faced by Islamic banking, including its inability to set up and operate interest-free banks in most countries of the world. The problem of inflation is not clearly treated by any system of banking, but it is a general problem and is treated as such in the third book. But Islamic banking deals with it in an effective manner.

a) Zero interest and capital guarantee
Muslims are prohibited by their religion to deal in interest (riba) in any way. Giving and receiving as well as witnessing are all prohibited. Thus an Islamic banking system cannot pay any interest to its depositors; neither can it demand or receive any interest from the borrowers. Nor could the banks witness or keep accounts of these transactions. But the lender is entitled to the return of his capital in full. This is a Qur’anic order.1[2]The proposed system is in accordance with these Islamic requirements. A basic rule of commercial banking is capital guarantee. The capital entrusted to the bank by a depositor must be returned to him in full. The proposed system fully complies with this requirement. Islamic banking as practised today does not provide capital guarantee in all its deposit accounts. In many countries, this is one of the two main objections to permitting the establishment of Islamic banks. There is no objection to paying zero interest on deposits. Thus, by paying zero interest and guaranteeing capital, the proposed system satisfies both the riba-prohibition rule of Islam and the capital guarantee requirement of conventional Banking Acts. This enables it to obtain permission to set up and operate as a deposit bank in all countries of the world, while obeying the riba-prohibition rule and qualifying to be an “Islamic” bank. This is of great importance to Muslim minorities living in non-Muslim countries. Furthermore, the existence of interest-free banks in all countries will also remove the many difficulties faced today by Islamic 1 10

banks in transacting international business.

b) Lending and investing
In conventional banking, depositing is a form of investment for the savers where the capital remains unharmed while a known income (in the form of interest) is promised. To the bank’s lending is a form of investment where the capital and a known return are assured; the return will also cover all their costs. Since Islam prohibits dealing in interest in any form this type of banking is not acceptable to the Muslims. In Islam, there is a clear difference between lending and investing — lending can be done only on the basis of zero interest and capital guarantee, and investing only on the basis of mudaraba (profit-and-loss-sharing). Conventional banking does make this differentiation. But an Islamic bank has to take this into consideration in making a system to cater to the Muslims. Therefore such a system has to provide for two subsystems — one to cater to those who would “lend” and another for those who wish to invest. In this system, the depositors are considered as lenders to the bank and, since a Muslim lender cannot receive any interest, he lends without interest but with the assurance that his capital will be returned in full. This applies to demand (current account) deposits as well as to savings deposits. The bank, in turn, lends (the depositors’ funds) to the borrower who should return the capital in full plus the costs of the bank’s services and a remuneration (or profit) to the bank for providing these services. This suits some depositors and some borrowers. The second objection to Islamic banks as they operate today is that their assets are not readily measurable (since they are tied up in equity-type investments where neither capital nor return are guaranteed), and to put a reasonable value on these assets will require enormous amounts of effort and experience. In this system, the depositors’ capital and return (albeit zero) are guaranteed; and the bank’s assets are also guaranteed and their costs are fully covered; and the accounting procedures are well defined and easy. As such the bank’s assets are computable. Therefore the proposed method should attract no objection from any banking authority, thereby enabling interest-free (or Islamic) banks to be set up in all countries of the world.

c) Participatory financing
This would cater to the needs of those Muslim capital-holders who wish to earn an income using their capital without involving themselves in riba. The Islamic option for this group is the concept called mudaraba, which is usually translated as profit-andloss-sharing but is in fact profit-sharing-and-loss-absorbing. The basic idea is that two parties, one with capital and the other with know-how, get together to carry out a project. If the project ends in profit they share the profit in a predetermined proportion; if it results in loss the entire loss is borne by the financier. The investor is essentially a sleeping partner. He provides the financing and then shares the profit or absorbs the loss. It is the responsibility of the entrepreneur to present a good project proposal, convince the financier that it is viable and profitable, and provides proof that he is able, qualified and experienced to carry out the project successfully. The intermediary is at once both an entrepreneur and a financier. When 11

he accepts funds from an investor, he is an entrepreneur; and when he finances a project submitted by an entrepreneur, he is a financier. The function of the intermediary is very important. He is responsible for identifying good projects for financing as well as for monitoring its progress and ensuring it’s proper accounting and auditing. But he (the intermediary) plays no part in managing the project or in making policy decisions. The intermediary is a separate physical and legal entity, independent of both the investors and the entrepreneurs. But he (she/it) is an equal partner in every project he finances so that he has full legal right to the physical and financial assets of all the projects and has full access to all the books. This arrangement assures the investors that their investment is safe and that the profit and loss account given to them is reliable and clear. Islamic Banking actually took root in 1975 with the establishment of the Islamic Development Bank, an inter-governmental bank; and the Dubai Islamic Bank, a private one. The question of establishing interest-free banks and thus freeing the Islamic economies from riba had influenced the minds of Muslim thinkers. But the immediate movement for their establishment was the excess cash the oil-rich middleeastern countries earned following the 1973 oil-price increase. Thus the primary need for these banks was the investment aspect of banking, and not the transaction (i.e. current account operations) aspect. We believe that an Islamic banking system should separate these two aspects of banking and devise two separate schemes suitable to the different requirements. It is the failure to do so that has resulted in Islamic banking facing the problems it faces today. There are Muslim capital-owners in all countries, in the oil-rich countries and the very rich in all countries, having millions and billions, and those in the rich non-Muslim countries living in small communities. Each will benefit from this participatory financing scheme. One important feature of participatory financing is that the entrepreneur need not provide security for the financing he receives. The project itself is the security, and the intermediary, being an equal partner in the enterprise, is its protector. This should play a very beneficial role in discovering and developing new entrepreneurial and other talents in the society, especially at the micro level. Financing by lending Traditionally, commercial banks performed two functions: money transfer services, including all current account operations, and money lending. The latter brought in the major part of the bank’s income while the former enabled it to “create” money and to lend more money than it actually possessed. The primary concerns of the bank were the security of its capital and the ability of the borrower to pay the interest — not the end use of the lent money. Whether it was intended for establishing a new enterprise, to expand an existing one, to bridge a cash flow problem of a running concern, or to be used by a small business, by a sole-owner enterprise, or for consumption purposes, etc. was not the prime concern of the bank. Also it doesn’t matter how the borrower kept his accounts. The borrower must pay back all the capital and the pre-fixed amount of interest, no matter how he achieved that. In the case of Islamic banks, however, the end use mattered because the return on their “investment” (they do not lend) depended


on how the profit/loss was achieved and how it was computed. The questions of true and proper bookkeeping by the borrowers (or entrepreneurs) and the auditing of these accounts, and that of determining the actual profit/loss to the investment by the bank are still being discussed. The inability to resolve these questions is at the bottom of many of the problems faced by Islamic banks. In the proposed system, only the financing of new enterprises is recognised as willing to mudaraba-type financing. The fact that the intermediary becomes an equal partner in the new enterprise avoids the difficulties caused by the above questions.

d) Interest-free commercial banking
As we saw earlier, commercial banks performed two functions: money transfer services (including all current account operations) and money lending. In general, the former does not involve any interest. On the other side of the balance sheet, we have two types of deposits: current account (demand) deposits and savings deposits. Here too, the former generally does not involve any interest. Therefore current account operations and money transfer operations are free of riba on both sides of the balance sheet. As such all commercial banks are interest-free banks with respect to these operations. The problem, then, arises only in respect of savings deposits on the one side and loans on the other, because both invites interest. Muslims do wish to avoid dealing in interest in order to comply with their religious belief, and limits itself to finding a simple, logical and easily executable methodology of achieving this objective. The approach adopted is to “first take a closer look at modern banking practices and find out whether and where the prohibited riba (interest) occurred and then to see whether it could be eliminated from the existing practices and then to check if the resulting system was still feasible.” On the deposit side, what the depositor receives in addition to his capital is the interest. This is riba (pure interest) by definition. If a Muslim refuses this interest because it is prohibited by his religion, then this side of the balance sheet is free of riba.On the other side of the balance sheet, we have the “interest” collected by the bank from the borrower. Ideally, the bank uses the funds it receives from depositors to grant loans to clients. But the “interest” it charges the borrowers is more than the interest it pays the depositors. This is because the bank has to cover, besides the interest paid to the depositor, the costs the bank bears in collecting and giving the funds as well as in accounting, administration, safekeeping, etc. The “interest” charged by the bank is divided into several components. Then each of these components is studied to see if it contained the prohibited riba. The idea is that if any one component contained such riba then to see if it could be removed. If some components are free of riba, and others containing riba can be removed, then we have T

h 13

an “interest” which is free of riba. If this can be achieved and if the resulting system is practical, then we have a riba-free system that is also workable. And, since it was originally derived from the conventional model it should also be compatible with it. This “interest” collected by the bank from the borrower is a cost to the borrower, of obtaining this amount of financing. Therefore, it is named the Cost of Borrowing (CoB) and is considered as consisting of six components: interest (paid to the depositor), services cost, overheads cost, risk premium, profit, and compensation for the value erosion of capital due to inflation. It is shown that only the first component falls under the definition of riba and all others are free of it. Since the population refuses to accept any interest paid by the bank (on religious or other grounds) the bank need not collect this component from the borrower. Thus this CoB is free of interest, despite the fact that it looks like the conventional “interest”. So, the whole commercial banking system becomes riba-free. In countries such as Pakistan, Iran and the Sudan where interest-free banking is mandatory, the system described in this section will be immediately relevant and will overcome all the problems the current practices in these countries find it difficult to solve. All that an existing bank has to do to change over to this system. We have already seen that this system should face no objection from banking authorities in non-Muslim countries, and since it is compatible with the conventional system it is easy to set up and operate such banks with the minimum of delay and difficulties (including staff training). Furthermore, unlike the conventional system, this system is transparent, rests on a firm theoretical foundation, and provides management information that is very useful for effective monitoring and control. Loan default insurance The risk premium is one of the six components of the cost of borrowing. In conventional banking, the risk premium against default and delays is included in the interest and the bank bears the risk. The interest rate increases as the probability of risk increases; high-risk advances (such as unsecured loans) bearing a higher interest rate than low-risk ones.. The premium depends on the amount of the loan, and not on the repayment period. The premiums paid by the members go into a collective fund. Any loss suffered by a member-bank due to bad loans is made good from this fund. On complete repayment of a loan the borrower will be paid part of his premium, after allowing for the administrative costs of the scheme and reimbursements to the banks . This is a fresh proposal, and has three main benefits. One, this takes away any risk the bank runs due to non-payment of loans; thus making the bank a pure service provider. Then commercial banking becomes a service industry in the true sense. And, the burden of repayment is shifted to the borrower. Two, since the recovery of the loans are guaranteed the depositors are assured of their capital. This prevents the need for


t 14

deposit insurance.2Three, there is an ongoing debate among Islamic scholars about imposing a fine on a defaulting or delaying borrower, by the bank, fearing that it may amount to riba.In such cases the banks are expected to resort to the courts, which have powers to recover the amount due and/or impose a fine. But this is a costly and timeconsuming process that can be misused. The new suggestion shifts that burden to the insurance company.

e) Participatory financing through commercial banks
Commercial banks enjoy a benefit that investment banks and investment companies do not. They are able to “create” money they acquire through their current account operations. The process, called credit creation. Briefly, it means that commercial banks can lend more money than they actually have in their custody. How much more depends on the particular circumstances of the concerned bank, but it can be anywhere from five to nine times. This is also called financing with bank money. This ability is combined with the concepts of investment accounts (introduced by Islamic banks) and the mudaraba participation, to produce participatory financing through commercial banks. This will enable commercial banks to participate-finance many more projects than investment banks or investment companies could do with the same amount of money. But this is a new concept traditional banks are not capable of. Bankers who wish to engage in this activity will have to have entrepreneurial talents and they have to acquire the necessary skills. But what is suitable to say here is that this will allow low-yield and/or long-duration projects, which will be unattractive to investment banks and companies, also to be commercially financed. A two-percent return on a 100,000 project is not very attractive. It is even less attractive if the profit is to be shared by three participants. But a commercial bank can finance this on the strength of a 20,000 deposit in the investment account, if it had a credit creation factor of 5.So, even if the project made only a two percent profit on the investment of 100,000, the resulting 2000 would still be a 10 percent profit on the original 20,000 deposition a factor of nine it would be a amazing 18 percent. Suppose the three participants — the investor, the bank and the entrepreneur — had originally agreed on an equal share of the profit, the investor would then receive a six-percent return on his investment. Thus an unattractive 2 percent-yield project can be made a very profitable one if financed through a commercial bank.

f) Compensation for inflation
In the last few decades, inflation seems to have become a permanent feature of all 2


h 15

economies, especially of developing economies. This has a shocking effect on those who save money. If they keep it at home as cash, its value is eroded daily by inflation. If a friend borrowed it, its purchasing power is reduced when he returns it. If they deposit their savings with a bank, its value, when they withdraw it after some time, is much reduced. Sometimes the interest rate payable to the depositors lacks so behind the inflation rate that the combined purchasing power of the capital and interest is less than that of the original deposit! On the other hand, the bank’s capital also loses value in the hands of the borrowers. Yet the banking system does not seem to specifically address this problem. For, legally speaking, the problem does not exist — one thousand today of any currency is legally one thousand tomorrow or ten years later, irrespective of any change in its purchasing power. But, admitting the reality, the banks do accommodate a compensation for the loss by adjusting the interest rate. The adjustment, however, is generally always in favour of the bank. This is unfair to both the depositor and the borrower. In the case of a (Muslim) depositor who avoids interest, in rejecting the paid interest he also rejects the little compensation for inflation contained therein. This is as if he is being punished for his religious (or other) conviction, and for his desire to act on it. This is unfair. So Islamic scholars and think tanks have formulated different ways to compensate for inflation.

GROWTH WITNESSED: (SBP ANALYSIS) 2.2 Industry Progress and Market Share
The State Bank of Pakistan has formed a comprehensive regulatory framework aimed at the establishment and promotion of an Islamic banking system in line with best international practices. These measures are primarily demand-driven and provide an option to the customers to choose between the two banking systems in accordance with their preference. As a first step, a three-pronged strategy was laid out for the promotion of Islamic Banking in Pakistan which allows financial institutions, to decide at their discretion, to establish either full-fledged Islamic banks in the private sector; or Islamic Banking subsidiaries or stand alone Islamic Banking branches of the existing commercial banks. This is in significant difference to the earlier attempt, when Islamic Banking was required to be implemented by all banks across the board. As on December 31, 2007 there were six full-fledged licensed Islamic banks having 185 branches. In addition, 12 commercial banks are offering Islamic banking services through 103 branches. The increasing interest of conventional banks in opening Islamic branches and applications for opening full-fledged Islamic banks show the promising future prospects for the growth of Islamic banking in Pakistan.


Source SBP:


Islamic banking services in Pakistan have recorded a noteworthy progress during the quarter under review

Descriptions Total Assets

SepJun- Dec-06 Dec-05Dec-04 Dec-03 07 07159 178 118 72 44 13 3.4% 108 3.1% 90 2.6% 6 13 167 2.9% 83 2.8% 72 2.4% 4 12 150 2.1% 50 1.9% 48 1.8% 2 9 70 1.4% 30 1.2% 30 1.3% 2 7 48 0.5% 8 0.4% 10 0.5% 1 3 17

% Of Banking 3.8% Industry Deposits 124

% Of Banking 3.6% Industry Financing. Invest. & 114

% Of Banking 3.2% Industry Full Fledge 6 Islamic Banks Conventional 12 Banks with Islamic No. Of Branches 207


A Special Reference To Meezan Bank Limited
C om pa ny Inform a tion In 2002 the State Bank of Pakistan issued the first Islamic banking license to Meezan Bank. Societe Generale’, a French commercial bank, operations in Pakistan was acquired by Meezan Bank and concurrently Al Meezan Investment Bank converted itself into a fully fledged Islamic commercial bank. The new bank was renamed Meezan Bank Limited.

Sh a ria h Boa rd • • • • Justice (Retd.) Muhammad Taqi Usmani (Chairman) Dr. Abdul Sattar Abu Ghuddah Sheikh Essam M. Ishaq Dr. Muhammad Imran Usmani ( Shariah Advisor)

To ensure strict Shariah compliance in all the Bank’s operations a dedicated and fully fledged Product Development & Shariah Compliance (PDSC) department was formally setup by the bank in March 2005 for the centralization of Product development activities, new product research, Islamic banking training and Shariah Compliance audit functions. The department works under the guidance & supervision of the Bank’s Shariah Advisor – Dr. Muhammad Imran Usmani and the Shariah Supervisory Board of the Bank. Meezan Bank has a large product menu offering a complete range of Islamic banking products and services, such as: Corporate and Investment Banking, Commercial and SME, Consumer Finance, Treasury & Financial Institutions, and Asset Management. The Asset 19

Management Business is managed through a subsidiary Al Meezan In-vestment Management Limited. The Retail Bank is organized in three Regions across Pakistan, namely South, Central and North Region. In 2005 Meezan Bank launched the Meezan Islamic Institution Deposit Account, a unique product tailored exclusively for Islamic Financial Institutions. The facility was the first of its kind in Pakistan, whereby Islamic Banks (including dedicated, as well as conventional banks’ Islamic branches) got the opportunity to manage excess liquidity by maintaining a checking account with Meezan Bank specifically designed for this purpose.

Meezan Bank

% of Islamic (PKR in Bn) Banking Industry 52 42% 30 64 100 34 % 36 % 35 %

Deposits Financing Total Assets Branch Network

As of Sept 2007, Except Branch Network

All branches of Meezan bank are ‘on-line’ and are supported by state of the art 24/7 Banking services to all its customers, which includes 66 ATM’s, Internet Banking and a Call Centre that operates 24 hours a day seven days a week. The Bank also offers a comprehensive Debit Card that is accepted at over 3,000 outlets across Pakistan. The Bank has a total deposit base of over Rs. 50 billion with more than 150,000 customers. Meezan Bank has established 100 branches spread over 31 major cities in all four provinces across Pakistan within a span of 5 years. The investment in the branch network is driven by the Bank’s vision that is to “establish Islamic Banking as the Banking of First Choice” so as to enable it to reach out to each and every citizen of Pakistan. There are currently six dedicated Islamic Banks operating in Pakistan with a total of 186 branches besides 102 standalone Islamic Banking Branches of Conventional banks.


The rapid growth of the Islamic finance industry is putting pressure on human resources. Institutions report that there are simply not enough qualified personnel to fulfill functions adequately. The situation is particularly acute at the Sharia Board level, where there is a shortage of scholars with the requisite educational and practical knowledge. With so few scholars available, scholars are frequently called on to sit on more than one board, raising conflict of interest issues. . Islamic finance has the potential to continue its rapid progress from the last few years, despite the current economic slowdown. Going forward, Islamic banks will need to go about signing up new customers, developing new products and services, and deploying enhanced capabilities. Problems being faced by Islamic Banking in the world in General Most of the Islamic Banks operate on Bai- Murabaha, Bai- Salam, Istisna, Hire Purchase/ Leasing mode of Investment i.e. Islamic Banks always prefer to run on markup/ guaranteed profit basis having Shariah coverage. For this reason some times the conventional Economists and General people failed to understand the real difference between Islamic Banking and conventional Banking. Mudaraba and Musharaka modes of Investment are ideal but Islamic Banks are not going in these two modes, the reasons for the above are as follows: There is no systemic analysis and research and no real efforts to introduce above mentioned two modes but the practitioners blame the following factors:a) There is lack of committed entrepreneur b) There is lack of committed professional that can create new instruments. c) There is lack of committed sponsors who can pressurize the professionals d) There is shortage of skilled professionals. 2. The problem of forward contact/booking of foreign currency. The value of US Dollars ($), Pound Sterling, Euro and others are not fixed, they are fluctuating from time to time Most of our imports and exports are made in USD and USD being a strong currency always moves upward and the exporters are in better position than the importer in our country. In Bangladesh Forward Booking is required to check the exchange fluctuation for imports of heavy/project Machineries where it take long time say 21

one year or six months to produce the same. But due to the restrictions of Shariah we cannot cover the risk of Exchange fluctuation by forward contract, as Shariah does not permit Forward Booking. As per Shariah, currency, transaction is to be made under certain terms and conditions laid down for “sarf” by Shariah, such as spot possession of both the currencies by both the parties, which is not available in forward Booking. It is also prohibited to deal in the forward money market even if the purpose is hedging to avoid loss of profit on a particular transaction effected in a currency whose value is expected to be declined. This problem requires a solution by Shariah experts. 3. Inland Bill Purchase: This is another problem of Islamic Bank where the exporters immediately after export of the goods approach to the bank for fund before maturity of the bills to meet their daily needs. Here the Bank has to deploy billions each year but how and on what mode of investment? The Bank cannot take anything by providing fund to the exporter except collection fee for collection of the Bill, which is very poor. 4. Unfamiliarity with the Islamic Banking System The first problem is that despite the growth of Islamic banks over the last 30 years, many people in the Muslim and non-Muslim world do not understand what Islamic banking actually is. The basic principle is clear, that it is contrary to Islamic law to make money out of money and that wealth should accumulate from trade and ownership of real assets. . A major issue here is that it is the Shariah Councils or Boards at individual Islamic banks that actually define what is and what is not Islamic banking, and what is and what is not the acceptable way to do business, which in turn can complicate assessment of risk for both the bank and its customer. More generally, the uncertainty over what is, or is not, an Islamic product has so far prevented standardization. This is difficult for regulators, as they like to know exactly what it is they are authorizing. It is also an added burden on the banks that have to educate customers in new markets. 5. Portfolio Management : The behavior of economic agents in any country is determined partly by past experience and present constraints. The Islamic banks are still growing in experience in many countries. Regarding constraints, Islamic banks in different countries do not freely choose arrangements, which best suit, their need. As a result, their activities are not demandoriented and do not react flexibly to structural shifts in the economic setting as well as to changes in preferences It is known to the bank management that a certain portion of the short-term fund is normally not withdrawn at maturity; these funds are used for medium or long-term financing. However, a precondition for this maturity transformation is that the bank be able to obtain liquidity from external sources in case or unexpected withdrawals. Islamic banks, without having an interest-free Islamic money and capital 22

market, have no adequate instruments to meet this pre-condition for effective maturity transformation. On the other hand, Islamic banks can enhance term transformation if there is an interest-free bond market or a secondary market for Islamic financial papers. Adequate financial mechanism still has to be developed, without which financial intermediation, especially the risk and maturity transformation, is not performed properly. 6. The Regulatory environment The relationship between Islamic banks and monetary authorities is a delicate one. The central bank exercises authority over Islamic banks under laws and regulations engineered to control and supervise both traditional banks. Whatever the goals and functions are, Islamic banks came into existence in an environment where the laws, institutions training and attitude are set to serve an economy based on the principles of interest. The operations of Islamic banks are on a profit and loss share basis, which actually do not come fully under the jurisdiction of the existing civil laws. If there are disputes to be handled, civil courts are not sufficiently acquainted with the rationale of the operations of Islamic Banking. Regarding the protection of depositors, Islamic Banks are required to let the authorities know the difference between money paid into current accounts and money paid into investment accounts. In non-Muslim counties the central banks are very stringent in granting licenses for Islamic banks to operate. In order to be established in those countries Islamic banks must also meet the additional requirements of other government and non-government authorities. So, apart from legal constraints there are economic measures that result operations of Islamic banks in the non-Muslim world difficult. In Muslim countries also they face economic restrictions. Besides funding, acceptable investment outlets is a major challenge for Islamic financial institutions. 7. Absence of Liquidity Instruments Many Islamic banks lack liquidity instruments such as treasury bills and other marketable securities, which could be utilized either to cover liquidity shortages or to manage excess liquidity. This problem is forced since many Islamic banks work under operational procedures different from those of the central banks; the resulting non-compatibility prevents the central banks from controlling or giving support to Islamic banks if a liquidity gap should occur. So the issue of liquidity management must come under active discussion by the authorities involved is Islamic banking. 8. Use of Advanced Technology and Media Many Islamic banks do not have the variety of products essential to satisfy the growing need of their clients. The importance of using proper advanced technology in upgrading the acceptability of a product and diversifying its application cannot be over emphasized. Islamic banks must have to come to terms with rapid changes in technology, and redesign the management and decision-making structures and, above, all introduce modern 23

technology in its operations. Many Islamic banks also lack the necessary expertise and institutional capacity for Research and Development that is not only necessary for the realization of their full potential. 9. Need for Professional Bankers The need for professional bankers or managers for Islamic banks cannot be over emphasized. Some banks are currently run by direct involvement or by managers who have not had much exposure to Islamic banking activities. As a result, many Islamic banks are not able to face challenges and stiff competition. There is a need to institute professionalism in banking practice to enhance management capacity by competent bankers committed to their profession. Because, the professionals working in Islamic banking system have to face bigger challenge, as they must have a better understanding of industry, technology and the management of the business venture they entrust to their clients. There is also a need for banking professionals to be properly trained in Islamic banking and finance. 10. Blending of Approach of Islamic Scholars with the Approach of the Conventional Bankers Bankers, due to the nature of their jobs have to be pragmatic or application-oriented. There is and will be tendency in the bankers practicing in Islamic banks to mould or modify the Islamic principles to suit the requirement for transactions at hand. Being immersed in the operations of day-to-day banking, they find little time to do any research, which can make any substantial contribution to the Islamic banking. Islamic Scholars active in researching Islamic Banking and finance. A very few of them are knowledgeable about banking or the needs of the customers.

3.1 Problems of Islamic Banks
After a rapid expansion in the seventies and early eighties, Islamic banks experienced a setback. The exaggerated optimism of the early years made way for a more realistic view. Success was not only lacking in professional and financial matters. The ideological compromises that were made in practice worsened the picture. PLS financing is only incorporated in the banks’ operations on a small scale. The stagnation is mainly caused by the following four problems:

a) PLS financing is unpopular with both Islamic banks and clients.
For the banks, there are too few attractive projects with an acceptable level of risk. Clients, on the other hand, are unwilling to share too much information and profit with the banks. As a result, PLS-financing attracts many high-risk/low-reward projects, and uncooperative, or even fraudulent, entrepreneurs.


b) PLS is not suitable for short-term financing or for the non-profit sector.
Companies often need finance for short-term liquidity. The administrative procedure of PLS is too lengthy to answer such urgent needs. Furthermore, it is difficult to determine the return on financing liquidity. The same applies to financing the non-profit sector: what is the return of an investment in schools, or in a new highway?

c) Lack of developed Islamic financial products, Institutions and markets.
Owing to a lack of suitable financial instruments, Islamic banks still experience difficulties in optimizing their risk, return and liquidity. Furthermore, the network of Islamic banks is still underdeveloped and too small. Finally, there are no developed Islamic money and capital markets. In cases of liquidity shortages, Islamic banks cannot call upon central banks, because they provide interest-based financing. Recently, Malaysia opened an Islamic inter-bank money market. Initiatives of this kind, more research, and new Islamic financial instruments may cure the ‘childhood diseases’ of the system.

d) Islamic banking in non-Islamic countries is still difficult.
Western banking legislation requires banks to guarantee the capital of depositors, and ensure them a fixed return. This is directly opposed to the PLS-principle. Furthermore, the valuation of Islamic banks’ investment is a difficult and cumbersome task, for which no adequate procedures have yet been developed. As a result, Islamic banks fail to satisfy central banks’ strict liquidity and capital adequacy requirements, and have great difficulty in obtaining full banking permission in the West. It is clear that the problems are mainly concentrated in the field of financing. With respect to deposits, Islamisation has succeeded. If the problem of financing could be overcome, Islamic banking should be able to make a decisive breakthrough.

The unique characteristics of Islamic banking give rise to a set of challenges that have to be addressed by Islamic banks. These include: • Establishing appropriate risk and liquidity management techniques • Achieving consistent sharia supervision • Managing the talent pool • Addressing legal and tax restrictions


a) Establishing appropriate risk and liquidity management techniques
The risk of Islamic financial institutions differs from those of their conventional counterparts because of some of the Islamic financing techniques. For example, in an auto murabahah transaction, there is a risk that the customer will not purchase the vehicle from the bank even though he committed to do so. The less standardized the goods financed through murabahah, the greater the risk .As a result, Islamic banks need to evaluate their risk management techniques and deploy appropriate capabilities to mitigate risks. Conventional risk management techniques and instruments are not fully sufficient for all Islamic banks. A major challenge facing Islamic banks is the absence of short-term liquidity management and long term refinancing instruments. As a result, asset liability management is becoming a real problem. On the short-term side, sharia-compliant money market instruments are in short supply..A similar problem exists on the long-term financing side, where the issuance of sukuk is the only option available but requires an underlying asset on which to base the financing. Islamic banks need to foster the development of appropriate sharia-compliant liquidity management and funding instruments to ensure that short- and long-term funding requirements are met. The short-term funding need is particularly acute because customers increasingly shift funds from non interest- bearing current accounts to off-balance-sheet investment accounts. Long-term funding can be achieved through the issuance of sukuk, as this market is already well developed.

b) Achieving consistent sharia Supervision
The market for Islamic finance faces a major problem: The absence of universal standards, geographic differences exist, and even within one country, different sharia boards may deliver different interpretations. Unless standardization of the regulatory framework of Islamic banking is significantly improved, sharia arbitrage will continue to exist and grow. Sharia approval will be obtained by banks in a manner that best suits customers’ needs and the circumstances of individual products or transactions. The absence of universal standards, and the lack of transparency regarding the application of sharia, places a huge burden on the marketing of Islamic financial services.

c) Managing the talent pool
The Islamic banking industry has experienced rapid growth over the past few years, and this growth is expected to continue for the foreseeable future. A major impediment, however, to realizing the future potential of Islamic banking is the limited available talent pool, especially for senior positions. At present, there are simply not enough people with the required skills available in the marketplace. This situation exists at all levels in financial services institutions, but is particularly prevalent at the sharia board level. It takes many years of education and practical experience to become a sharia scholar. As a 26

consequence, there are few scholars available and many of them sit on multiple boards, raising the inevitable issue of conflict of interest. However, in the short term, the lack of skilled resources will likely persist and limit the development of the industry.

d) Addressing legal and tax restrictions
In many non-Muslim countries, Islamic and conventional banks are not on a level playing field, as there are numerous legal and tax restrictions that make it difficult for Islamic banks to compete. For example, in many jurisdictions, Islamic real estate financing through the diminishing musharaka technique leads to a double taxation, with conveyance duty on the acquisition of the real estate. Some countries, such as the U.K., have taken the lead in abolishing legislation that places Islamic finance at a disadvantage. However, until other countries follow a similar path, the development of this form of finance will be limited.

Islamic banking has established its identity. Alhumdulillah it is here to stay, grow and develop into a competitive alternative to interest-based financial architecture. Central banks of several Muslim countries have jointed hands in order to give it an international standard. Some issues are identified here that may help consolidation and growth of Islamic banking.

a) Standardization
Standardization is urgently needed in the following respects: (1) vocabulary of Islamic financing, (2) financial instruments and their documentation and (3) pricing formulas for Islamic financial products. 1.1 Vocabulary of Islamic Banking: There is no universally followed terminology for Islamic financing. One finds inter-bank differences in the use of terms. For example, while majority of Islamic banks use the nomenclature Murabahah to stand for financing via sale on deferred payment, some label it Bai’ Thaman bil Ajil. —Quite interestingly, these latter institutions also offer Murabahah financing products. In addition to the above, selective interpretation of Arabic terms creates confusion among the bank clients and the public. For example, istisna’ originally means manufacturing and delivery of something against advance payment. But in Islamic banking quarters, istisna’ financing signifies payment by an Islamic bank to the manufacturer of a thing for its delivery to the bank’s client with whom the bank has saleon-deferred-payment relationship.This and some other terms are likely to be a hurdle in communication among Shari’ah scholars. And, this may also hinder popularization of Islamic banking.



Financial Instruments and Their Documentation:

It is difficult to think of “identical” documentation for all Islamic financial institutions in lieu of a given Islamic financial instrument. This is because practical concerns may vary from institution to institution, practical needs may not always be the same, and, last but not least, door for financial innovation in emergent situations will always remain open. Nevertheless, there has to be some measure of standardization in financial instruments for speedy migration to Islamic financial system in the Muslim world. This is almost a must for regulatory purposes. 1.3 Pricing Formulas for Islamic Financial Products:

Any financing operation by an Islamic bank will involve accommodation of interests of the bank’s principals, the bank staff and the fund-seekers. These concerns are addressed mainly through “pricing” of the financial products. —Of course, security for financing also matters. Standard pricing formulas, in the light of Shari’ah principles, are needed for those on the front desk for efficient working of the Islamic financing model. Their development will also help promotion of Islamic financing in academic and professional circles.

b) Public Awareness
Islamic financial model is feasible. In fact, with the availability of more financing modes than those recognized at present, it is bound to be more versatile and efficient.3 But it faces problem of general acceptability. This is mainly due to unfamiliarity with the various Islamic modes of financing. This problem is likely to be solved over time. But pace of development of Islamic banking can be expedited through the following: (1) public education campaigns, (2) inclusion of Islamic banking concepts in school curriculum, (3) making Islamic financing course a part of business administration programs and (4) offering fully fledged degree programs in Islamic financing.

c) Training of Banking Professionals
Lack of qualified manpower is one of the biggest hurdles in the advancement of Islamic banking. Pioneers in Islamic banking developed their financial instruments and painstakingly trained their staff. There is no training institute to meet manpower needs of existing and future Islamic banks. Some of the reasons for this lacuna are understandable. For example, lack of consensus on form and details of Islamic financial instruments and nonexistence of Islamic reporting and accounting procedures. Some work has been done. But a lot more is still needed, especially on the fundamentals. Nevertheless, there is enough material to offer short training courses in Islamic banking. It is pertinent to note here that bank staff shall need a different orientation in the Islamic framework. The need for aggressive marketing of Islamic financial products and the follow-up considerations will add a new dimension to training programs for Islamic bankers. 28

d) Emphasis on Shari’ah Audit instead of Reliance on Shari’ah Supervision
In the early phase of Islamic banking, professional bankers took the lead. But they were not well versed in the Shari’ah. Therefore, Islamic banking model emerged as “banking under Shari’ah supervision”. Practically this was done through delegating authority for the Shari’ah matters to the respective Shari’ah Boards, absolving Islamic bankers of their responsibility in Shari’ah violations. Of course, in principle, Shari’ah Boards have the authority to impose their viewpoint. But logistic considerations do not permit timely vetting and/or monitoring of all banking operations. In view of the above, it will be more fruitful if the following approach is adopted: 1. The Islamic financial instruments should be properly and fully developed, accommodating all relevant factors. 2. Principals of Islamic banks should set economic and Shari’ah parameters for providing bank financing. 3. Bank officials at the branch level should be given full freedom for making routine financing decisions, of course, in the light of the abovementioned parameters. 4. There should be both random and regular, either biannual or annual, Shari’ah audit of all financing operations. 5. The prospects of Shari’ah compliance should be ehanced through introduction of penalties for the bank staff and Shari’ah-rating of the bank.

e) Institutionalization of Recovery of Debt
Timely recovery of debt is critical for the success of Islamic financing. In general, debt is created with actualization of obligations of a client. Payment defaults, whether in lieu of some installment or the principal, can adversely affect business plans of Islamic banks, their working and, above all, settlement with different groups of depositors. The Shari’ah bars creditors from charging for payment delays. Measures available to Islamic banks may include careful evaluation of financing requests, proper pricing of Islamic financial products, effective covering contracts and efficient machinery for enforcement of contracts. There is also need for redefinition of legal rights of the creditors. For example, debts may be recognized as first charge on the assets of the debtors as soon as they become due. Of course, a margin may be given for Shari’ahrecognized basic personal needs of the debtors.

f) Risk Management
Nature of Islamic financial instruments implies that Islamic banks face not only the traditional commercial credit risk of their clients but also other risks associated with the 29

instruments. For example, market risk for salam financing or potentially damaging claims due to ownership of assets in lease financing. Islamic banks can reduce it through the following action: 1. Innovative collateral arrangements, third-party guarantees and credit rating of clients by specialized institutions 2. Choice of an appropriate financial instrument available in the Islamic setup 3. Pricing of Islamic financial products

g) Accounting
Accounting represents by far the biggest challenge in the implementation of the Islamic financial paradigm. The Shari’ah is about rights and responsibilities. When question of property rights comes, parameters are exogenously given in the Qur’an and Sunnah. Some implications of this point for accounting purposes are as follows: a) Income is not realized when it accrues but when it is materialized. In the case of murabahah financing, therefore, there is need to bring in new steps whereby banks acquire claims of the parting depositors to the funds tied in financing. A parallel step will be needed to accommodate new depositors in the bank’s future income from the investments tied in murabahah financing. b) The Shari’ah is relevant for the cost side also. When depositors offer funds to the banks on partnership basis, they are dealing with the legal person “bank” that is personified by infrastructure of the bank, its staff, etc. This legal person is supposedly responsible for providing investment services to the said depositors. With this being the case, Islamic banks cannot charge their establishment costs to operating expenses for deposits raised on the basis of musharakah or modarabah. c) In the Shari’ah, costs are associated with acquisition of property rights. If this understanding is correct, then costs should normally be payments to third parties in lieu of acquisition of ownership of some thing or exclusive rights to some service. This places question mark on treating depreciation charges on fully owned durable assets for a business venture as costs. These examples can be multiplied. No doubt, the concerned parties might have genuine concerns. But fresh thinking is necessary to ascertain how these and similar other issues can be resolved in Shari’ah-compliant and beneficial ways.

h) Regulation and Control of Islamic Financial Institutions
We restrict our observations to regulation and control of Islamic banks. Regulation and control of Islamic banks would be necessary to ensure that they remain “financial institutions”. 30

Islamic banks may be required to maintain reserves in lieu of their obligations to depositors who keep funds with them for safekeeping. But as deposits mobilized on partnership basis, no similar restrictions may be imposed on profit-sharing ratio. This is because Islam permits the competent authority to regulate entry into marketplace. But the matter of terms of contracts is left to willing consent of the contracting parties. In the larger interest of the economy, sectoral targets might be prescribed for Islamic banks. That is, the banks may be called upon to utilize some of their expertise and resources to finance priority sectors in the economy. Such a requirement would be akin to a parameter for entering into and remaining in banking activities. The equivalents of existing open market operations by central banks can take place in the Islamic money market. But their nature and scope would depend on two things. First, the central banking authority should remain neutral among the existing Islamic banks when it comes to offering fresh liquidity. Second, the authority ought to use Shari’ah-compliant financial certificates and securities of government, corporate sector and Islamic banks.

i) Migration from Riba-Based to Riba-Free Banking
Some Muslim countries have adopted a dual banking system in the hope of gradually shifting to riba-free banking. The Pakistani model allows for establishment of full-fledged Islamic banks, Islamic subsidiaries by conventional banks and Islamic banking branches by conventional banks. This process need to be carefully handled so that the interests of those opting for Islamic investments of their funds, are protected, both against mismanagement by Islamic banks and mixing with interest-based operations of the conventional banks.

j) Legal Framework
At present Islamic banks are working in many Muslim countries without proper legal cover. Of course, Iran, Sudan and Malaysia are exceptions. In general, legislative needs for legislating the Shari’ah principles and the Shari’ah restrictions for contracts can minimize Islamic banking. Nevertheless, attention will also have to be paid to the following and similar other points. Murabahah financing means purchase and resale, i.e. two trading transactions. This need not be seen as such for sales tax purposes because Islamic banks do not buy things under financing for their personal needs. Registration requirements associated agreements need to be simplified as the associated costs may hinder lease financing. There is also need for special legal cover in order to facilitate and implement musharakah agreements by Islamic banks. Adjudication of recovery of bank receivables is presently interest-based. Its alternatives need to be developed and provided for in the law. One issue that will continue to be relevant in the foreseeable future is prospect of Islamic banks working in the prevalent interest-based framework. It is obvious that Islamic financial instruments and their documentation and accounting requirement would be different. Therefore, the room for putting Islamic financial norms into practice in the existing framework would be limited. This, in turn, implies that Muslim countries should 31

consider providing separate legal cover for Islamic financing.

k) Shortage of Supportive and Link Institutions
It has to depend on a number of link institutions and so is the case with Islamic banking. For identifying suitable projects, Islamic banking can profitably draw the services of economists, lawyers, insurance companies, management consultants, auditors and so on. They also need research and training forums in order to prompting entrepreneurship amongst their clients. Such support services properly oriented towards Islamic banking are yet to be developed in Pakistan

l) Organizing Relationship with Foreign Banks
Another important issue facing Islamic banks in Bangladesh is how to organise their relationships with foreign banks, and more generally, how to conduct international operations. This is, of course, an issue closely related to the creation of financial instruments, which would be simultaneously consistent with Islamic principles and acceptable to interest-based banks, including foreign banks.

m) Long-term Financing
Islamic Banks stick very closely to the pricing policies of the government. They cannot benefit from hidden costs and inputs. On the other hand, Islamic banks as financial institutions are even more directly affected by the failure of the projects they finance. This is because the built in security for getting back their funds, together with their profits, is in the success of the project. Islamic ally, it is not lawful to obtain security from the partner against dishonesty or negligence, both of which are very difficult if not impossible to prove.

n) Human resource for Sharia'h compliance
Users of Islamic financial services assign primary importance to Sharia'h compliance of the services they use. It is understandable that Sharia'h noncompliance entails a serious operational risk and can result in withdrawal of funds from and instability of an Islamic bank, irrespective of its initial financial soundness. Sharia'h compliance is hence a serious matter for an Islamic bank, in addition to its compliance with other regulatory requirements.

o) Unresolved Fiqh Issues
Lack of standard financial contracts and products can be a cause of ambiguity and a source of dispute and cost. In addition, without a common understanding of certain basic foundations, further development of banking products is hindered.


Islamic banking and financing has established itself both nationally in Muslim countries and internationally in the financial world. Regular degree programs are also being offered at the university level in both the East and the West. Now Islamic banking industry faces issues of a different sort. That is, how to (1) consolidate the gains made so far and sustain it, (2) prepare against any meltdown and (3) grow. These issues determine the scope for our research discussion. Our research involves some futurology. Its nature requires interactive dialogue. We propose the following list of questions for thought: • • • • • Will Islamic banking survive or not? What shape might the Islamic banking industry take in the future? What, or what type of, challenges might Islamic banking face in the coming years? What changes might Islamic financing bring about in the way people live, businesses work and governments run public affairs? How might development of Islamic financing affect the disciplines of Fiqh, Accounting, Business Administration (in particular, Finance and Marketing and Business Management), Economics and Public Policy?

1. Survival of Islamic Banking & Finance
Survival of Islamic banking depends on the following: (1) its economic viability, (2) its stability, (3) its response to challenges to its identity, and (4) confidence of depositors and savers. We discuss these four things in turn.

1.1 Economic Viability:
Economic viability of Islamic banking/financing is not an issue for two reasons: • • Islamic banking is just another way of banking. Islamic banking offers a better financial architecture, on economic grounds.

Note that financial tag for Islamic financial instruments need not be an issue because numbers can always be worked out to show that cost of Islamic financing remains the same as that associated with interest-based financing. It is also important that Islamic financing has direct linkage between financial flows and 33

real flows in the economy. That is, funds will flow from Islamic banks only against real economic activity. Thus, investors will approach Islamic banks only when they have genuine needs. End in dichotomy between financing and the use of funds will lead to integration of real and financial sectors in the economy. In this sense, Islamic financial architecture will be superior to the existing interest-based financing architecture.

1.2 Stability:
According to Dr. Mohsin Khan, in his 1985 article in IMF Working Papers, when there is downswing in an interest-based economy depositors’ existing claims remain a liability of the banking system. This forces the banks into debt management. That is, creation of new and more costly debt against the banks in the form of new deposits and borrowings from other sources—in order to retire existing debt to the depositors. This action increases the process of downswing, and slows the recovery in the economy. As against this, Islamic banking has advantage that bank obligations to depositors automatically adjust, both in downswing and recovery phases, due to the principle of profit-and-loss sharing. More recently, in an article on the web Dr Tariqullah Khan of the IDB has stated the same point as follows. “A banking system would be unstable if it concentrates asset risks on bank capital. Since Islamic banking principle is based on risk sharing and it spreads risks between bank depositors and bank capital, it is inherently more stable. If this inherent quality is coupled with prudential regulations and supervision and with implementation of internationally acceptable standards of risk management, transparency and corporate governance, Islamic banking can practically become an ideal alternative to the traditional banking system in achieving equity, stability and efficiency”. It is also well known in traditional finance literature that interest-based debt finance is an important source of economic instability, as compared with equity finance.

1.3 Challenges to Identity:
Most of the murabahah financing work as follows: 1) There is a promise/agreement between a bank and its client. This binds the client to purchase thing(s) in question from the bank, creates a financing facility in the name of the client, and authorizes the client to directly purchase from the suppliers (though at the will of the bank). 2) The client makes necessary purchase(s), and payment advices are sent to the bank that the bank honors. 3) The client directly takes delivery of the good(s) from the supplier. 4) Once the thing(s) is (are) with the client, a sale-purchase agreement is made between the bank and the client as follows. The client offers to buy (what is already with him) and the bank agrees to sell the same thing! 5) The client discharges his payment obligations to the bank. 34

6) The above process is materially no different from that associated with Supplier’s Credit currently in trend in interest-based banking. As per the existing approaches as understood by us, there is little difference between hire purchase practiced by Islamic banks and financial lease condemned by the fuqaha as a transaction of riba. Similar points may be raised about some other financial instruments adopted by Islamic banks. The line of distinction between Islamic financing and interestbased financing must always be above criticism in order to avoid identity crisis for Islamic banking.

1.4 Confidence of Depositors and Savers:
Dr. Tariqullah Khan recently raised this issue as follows. “A bank licensed as an Islamic bank may be running on a very sound financial footing. However, if the depositors came to know that the bank has violated its Shari’ah mandate, the depositors will lose confidence and the finding will cause deposit withdrawal and probably collapse of the bank. This can lead to financial instability threatening economic development”. Caution is, therefore, necessary against any thing that creates doubts about the Shari’ah credentials of Islamic banks’ transactions, especially on the financing side.

2. Likely Shape of Islamic Banking & Finance in Future
2.1 Islamic Banks as Pure Financial Institutions:
Islamic banks will become pure financial institutions that fill financial gaps standing in the way of real economic transactions at the grassroots level. The following economic factors will lead to this development. Practitioners of Islamic banking will recognize that efficiency and gains lie in specialization. They will, therefore, delegate to third parties responsibility for field operations for a financing transaction, of course, in return for a charge. In some cases, such as taking physical possession of a thing in trade- or lease-based financing, this third party may be the bank’s client himself. This is likely to happen because economies of scales enjoyed by third-party specialized institutions will reduce operational costs for the banks. In the end, one expects Islamic banks institutions to touch the economic landscape only on the financial Plane, i.e., become pure financial institutions—while acting as economic agents. Apart of the above our research says that, regulators also need to recognize the following danger. Islamic banks, as already seen, will provide financing by coming in the picture as traders, lessors or partners. This factor along with their ability to gather sizeable funds can have potentially damaging effects. For example, if there are no checks on the scope of trading operations of Islamic banks, mega traders will emerge as the expense of small traders and businesses. This monopoly problem can be addressed through limiting the role of Islamic banks to financing matters only. 35

That is, for example, they may be permitted to enter into a transaction as trader in order to facilitate a sale-and-purchase transaction at the grassroots level, they should not be allowed to buy and sell things for themselves.

2.2 Islamic Banks will primarily be Economic Institutions:
Islamic banking will be ethical banking, among others, for the following reasons: 1) Islamic banks will stay away from financing Shari’ah-prohibited activities— producing alcohol or financing speculative activities, for example. 2) There will be transparency in their transactions with the clients— depositors as well as fund-seekers—due to compliance with the Shari’ah Ahkam on gharar. Islamic banks will also contribute to social welfare of the economy to the extent Ahkam on zakah would apply to them. But ahead of this, generally they shall be pure economic institutions established by their owners for profit earning. Of course, individually some Islamic banks may specialize in participatory modes of financing modes due to some religious convictions of their owners. But there is no Shari’ah compulsion for this. Islam allows banks to exploit all halal ways to their advantage, of course, subject to willing consent of the all concerned in a given transaction. As for Islamic banks doing charity, the thinking needs to clear. A bank’s money (deposits plus bank capital) belongs to its depositors and shareholders. Prior permission of the ultimate owners is a must for any charity.The same principle applies to profits earned through financing operations in which capital stakes of depositors, and may be the bank’s shareholders, are involved. Technically speaking, bank management should have some carefulness for charity with prior permission of the shareholders and the depositors. But getting such a mandate is practically not possible because both the group of bank shareholders and that of bank depositors continuously keep on changing.

2.3 Standardization of Islamic Financial Products:
Standardization is necessary, and it is clear to happen. This is because the world is a global village. Consumers’ consciousness and competition among Islamic banks will lead to standardization of Islamic financial products. Ultimately, without exceptional circumstances when large and long-term fund commitments and/or a lot of financial engineering is involved, only price competition will rule in the Islamic banking industry. In passing, one may note that in the long run standardization in the financial instruments will require consensus of fundamental Shari’ah principles for designing financial contracts. Unless this happens, Islamic banking may become a clash of belief.


3. Future Challenges for Islamic Banking & Finance
Our forecasted some of these challenges are noted below.

3.1 Financial Innovation in Critical Areas:
Progress of Islamic banking will depend on its ability to innovate in the following areas: • • • • Financial instruments yielding stable income flows for orphans, widows, pensioners and other weaker segments of the society Financial instruments for meeting government’s financing needs Cover or security for financing, in particular Shari’ah-compliant alternatives for penalty on payment default. Formulas for pricing of Islamic financial products

3.2 Competition:
We have anticipated Islamic banks should be ready to face not only intra-industry competition but also inter-industry competition from interest-based banks. The latter are already offering Islamic financial products. The competition is likely to grow.

3.3 Misuse of Islamic Banking
Our research suggests unless there are effective checks and monitoring, some factors may use Islamic banking. For example, in the existing murabahah financing banks do not directly come into the picture as buyers from the would-be suppliers. This gives dishonest borrowers a window for getting credit from the bank through untruthful purchases. Moreover, without effective checks and monitoring, some bankers under financial pressures may be approached to provide funds through fake transactions.


4. Effect of Islamic Banking on Economy and Economic Life
We anticipate the following effects: • • The real and financial sectors in the economy will be better integrated, as compared to what one finds in interest-based economies. Both what the governments do and the way, in which they work, will change. This will mainly come from the fact that without tax revenues, governments may address only those needs for which an economic transaction—other than pure loan transaction—can be defined between the government and the financiers. Economic considerations will in the long run lead to development of “Fiqh for Government” that would regulate economic activity at the government level. Inter-bank money market and central banking will take new form. New environment of Shari’ah-compliant divisible and tradable financial instruments and the Shari’ah parameters for contracts will give shape to this development. Accounting and financial management may experience major changes. This would happen because Islam has different position on ownership, rules for transactions and the financial instruments. Islamic banking will lead to better business ethics because banks will entertain only economically viable financing requests. Note that the said transformation shall take place even without earlier moral uplift of the society for Islamic banking. Careful design of Islamic financial instruments will discourage dishonest behavior by fund-seekers.

5. Effect of Islamic Banking on Various Disciplines
Fiqh: A change is already taking place. Instead of thinking within the narrow scenarios of Hanafi, Maliki, Shafie, Hanbali and Ja’fari fiqhi schools, contemporary fuqaha are joining hands and looking for common ground that best suits contemporary needs. OIC Fiqh Academy and AAOIFI provide formal international platforms. Individual Islamic banks have either international representation on their Shari’ah Boards or they are open to international influences. Accounting, Financial Management, Marketing and Bank Management: When full significance of the Shari’ah is recognized, these areas will change. The force will come from, among other factors, Islamic concept of “rights” (based on Islamic view of ownership) and permissible forms of transactions. Economics: New economics will emerge for the new economic setup. Changes will 38

be more noticeable in the areas of macro and monetary economics. Public Policy: A shift will take place due to changes in what governments may do and the ways in which they would work.

6. Some Other Relevant Points
6.1 With Islamic banking gaining ground, new challenges are already emerging for changing the rules for international trade and accommodating Shari’ahcompliant foreign trade financing. A good deal of work has been done, but a lot more is needed. If Islamic financing is adopted at the state level, inter-governmental financial flows will change, in both form and size. 6.2 Forces of the status quo will always resist change. Hence, every now and then issues would be raised about what riba is or what it is not. 6.3 Government finances will remain a problem in the way of Islamic banking until sufficient new financing tools are developed and a consensus develops on the economic and social role of government. 6.4 While the thrust of the present efforts in Islamic banking is on the financing side, matters related to liability side of Islamic banks will become an issue in future. The way in which Islamic banks look after interests of various groups of depositors and what they actually do, both are likely to become an issue.

7. Future Strategy and Outlook (Pakistan Specific)
Our research has a special focus on the future outlook of Islamic banking in Pakistan .we have therefore carried out significant efforts to get the forecast and also the strategy suggested by us. While the number and operations of Islamic banks are fast expanding, this segment of the market is still small relative to the desire for Islamic finance. Pakistan, in light of its past experience, is launching a gradual and steady approach to Islamic banking. Despite rapid expansion in industry, the share of Islamic banking in the total banking system is a modest 3.2%. Moreover, it only caters for around 23,000 borrowers through around 170 branches relative to the countrywide 5 million borrowers (or 4.8 million excluding microfinance borrowers) used through 7,700 branches by conventional banks. Financing and investment levels of Islamic banks barely range around Rs77 billion, which is below 3% of the total banking system’s advances6. On the product side, Islamic banks so far offer about 75% of products currently available in conventional banking while clean lending for consumer financing products, like personal loans and credit cards, still pose a challenge. Islamic banks operate exclusively in large cities with some now venturing into secondary cities but they are absent from rural areas where there is great potential for business growth. Global interest in Islamic finance industry and Pakistan’s success in laying basic foundation and middle infrastructure of Islamic financial system lends confidence that the 39

country has good potential and prospects to further exploit this industry. Going forward, however, it is important that Pakistan adopts a more standardize and coordinated approach and strategy for the development of Islamic finance industry. In designing this strategy, Pakistan will conform to the standards being promoted by the Islamic Financial Services Board (IFSB) – the sixteen member Council of Governors of Central banks with several associate and affiliate members – whose chairpersonship in Pakistan assumes effective January 2008. The goal and objectives of the forward-looking strategy should be to offer an alternative avenue of financial intermediation, which is competitive and promotes efficient allocation of resources in an equitable manner. Strategy should aim to increase conventional banking industry’s efforts to broaden and deepen the process of financial intermediation and financial penetration. Islamic banking can serve as a key vehicle to improve and strength the access to development finance by bringing in financial innovation that can cater adequately to diverse demands of the population as well as corporate sector’s and country’s infrastructure financing requirements, while ensuring that it take cares of faith based system of financing consistent with the Shariah principles. Major elements of this strategy would require both industry and SBP to closely work together on multiple fronts. Some of the key areas of focus include: 7.1 Aggressive deposit mobilization to augment domestic financial savings of the country. Islamic banks have phenomenal potential to exploit resource mobilization. Islamic banks, besides catering to the needs of small depositors through profit and loss sharing basic accounts with no charges, need to use high net worth investors. Fast adjustment of these practices by the Islamic finance industry will be helpful in competing more effectively with conventional banks in raising deposits. Resource mobilization is critical for Islamic finance industry to grow effectively and meet the alternative requirements of economy and society. 7.2 Diversification and innovation of financial structures. This would involve either applying innovative Islamic products on a separate basis or applying a combination of Islamic instruments to suit project finance needs. In attempting the latter, it needs to be ensured that Islamic products such as Murabaha, Ijara and diminishing Musharaka etc. are implemented with their necessary requirement, consistent with Shariah principles. At the same time, it requires financial engineering, flexibility in the evolving Sahriah system and alliance both among domestic and with the bigger global players (such as Standard Chartered, HSBC, UBS, Citibank etc.) to diversify Islamic financial structured products to support project finance in addition to associated real estate, shipping, trade, and aircraft financing. Islamic financing products/structures are now quite common in Middle East and Saudi Arabia and have gained ground in non-Muslim countries too. In designing structures there has to be more tolerance among participants to: 40

• •

Integrate Islamic and conventional funds to allow co-financed projects with different players; Accept ownership risks (since in all Islamic transactions, lender is at some stage the owner of financed goods) but with comfort of clarity of legal issues surrounding ownership; Ensure proper tax treatment of the proposed Islamic financing structures, avoiding Adverse treatment relative to conventional borrowing, e.g. often profit participating payments are subject to tax while interest payments on loans are tax deductible; Ensure flexibility in selection of assets for Islamic tranche; Understand issues surrounding asset risks; and Provide for payment of insurance and maintenance expenses for Islamic financed assets etc.

• • •

7.3 Extend the outreach of financial services with focus on underserved regions and poor and vulnerable groups Islamic banks will be allowed to pursue their plans for branch expansion as long as Islamic banks, like conventional banks, open at least 20% of new bank branches in rural areas. Conventional banks will have the option to seek partial or full conversion to Islamic banks. Microfinance banks are to be allowed to set up special windows or dedicated branches for Islamic Microfinance operations and licenses will be given to dedicated Islamic Microfinance banks. Guidelines have been already issued to promote Islamic Microfinance industry. Similar initiatives will be launched to issue guidelines for promoting SME, Agriculture and Infrastructure financing. 7.4 Promote financial industry diversification

This requires that, there is adequate development in Islamic capital markets, which so far has lagged behind the banking sector. 7.5 Enhance understanding and capacities of Islamic Banking Risk Management. Risk increases in Islamic banking, considering that banks and customers operate on profit and loss sharing mechanism. Because of this participatory risk relationship, the financial institution may not be exposed to traditional credit risk associated with conventional banking but more to risks associated with assets financed and off-balance sheet risk linked with the transfer of assets and its management as well as any volatility in the values of underlying assets. In structuring new products, there is need for institutions to factor in appropriate risks of real commodities, properties and equipment being financed with proper risk mitigation management and techniques. The strategy has to recognize the risk associated with Islamic banking and as such it has to include suitable steps. 41

7.6 Promote international Islamic Industry.






Aside from standard application of conventional banking regulations and guidelines, Islamic banks will be encouraged to adopt IFSB and AAOIFI (Accounting and Auditing of Islamic Financial Institutions) standards to suit domestic requirements. SBP is an active member of these international bodies and has provided input into the technical design and formulation of these standards. 7.7 Promote good corporate governance in Islamic banking.

Our research suggests Islamic banks must exhibit unique fiduciary responsibilities towards investment account holders, ensure Shariah compliance and select investments that are Shariah compliant (avoiding products/businesses that are haram) as well as implement sound internal risk management. As such, they will be required to follow a distinct corporate governance framework in line with the IFSB’s Guiding Principles on Corporate Governance. 7.8 Launch joint capacity building efforts for Islamic finance industry. We believe SBP and the industry will promote capacity building for greater understanding of Shariah principles, asset and liability management, and features of product structure. In addition, specialized training will be needed to promote smooth and effective implementation of IFSB and AAOIFI standards.


Theoretical framework
In this research we have for hypothesis 1 success of Islamic banking is the dependent variable and volume of deposits, customer satisfaction and products innovation are its independent variable. For hypothesis 2 volumes of deposits are dependent variable that is affected by number of Islamic branches. For hypothesis 3volume of deposits is a dependent variable and profit sharing rate is an independent variable.

5.1 Inventory of Variables
Hypotheses 1

Dependent Variable
• • • • • Hypothesis 2 Success of Islamic banking

Independent Variables
Volume of deposits Lack of awareness Customer of satisfaction Product innovation

Dependent Variable
• • Hypothesis 3 Volume of deposits

Independent Variables
Number of Islamic banks branches

Dependent Variable
• • Volume of deposits

Independent Variables
Profit share rate


5.2 Mode Of Observations
We have selected structured in-depth interviews for banking officials and questionnaire as our observational tools to gather primary data in the form of feedback from general public or account holders. Secondary data has been collected from SBP and different sources that are manipulated later. The logic for using this questionnaire is to insight into the growth potential and future prospects of Islamic banking through identifying the perception of general public regarding Islamic banking.

5.3 Field Data Collection
The data was collected from general public of different Islamic and conventional banks and from different Islamic baking officials. The questionnaire was distributed, was filled out and was received on same day. The during the process when they were filling the questionnaire we stayed there in order to over come any difficulty faced by the respondent in filling out questionnaire.

5.4 Hypothesis
1. Null Hypothesis (H0): Islamic banking is not a successful story in Pakistan. Alternate Hypothesis (H1): Islamic banking is a successful story in Pakistan 2. Null Hypothesis (H0): volume of deposited is not dependent on no. of Islamic bank branches. Alternate Hypothesis (H1): volume of deposit is dependent on no. of Islamic bank branches. 3. Null Hypothesis (H0): volume of deposit is not related to profit sharing rate. Alternate Hypothesis (H1): volume of deposit is related to profit sharing rate.


5.5 Sampling Design
TARGET POPULATION SIZE: The total population size for questionnaire is 150 customers from the general public SAMPLE SIZE: The sample size for this study would be 120.

5.6 Data Collection Methods
Data collected from the following sources:  from prior articles and journals  from “HRM Books”  by “Questionnaires”  by “In-depth Interviews”



Analysis of Questionnaire for Consumers
1) You have account in

Frequency Islamic bank Conventional Bank Both None 42 48 24 6

Percentage 35% 40% 20% 5%

45 40 35 30 25 20 15 10 5 0 Islamic bank Conventional bank Both None 5 20 35 40

Interpretations: The graph shows that 35% of the public has the account in Islamic banks; where as 40% of them are holding accounts in conventional banks. Only 20% of the respondents have accounts in both banks and 5% of them are holding accounts in none of the banks.


2) Have you used Islamic banking products and services? If yes please mention.

Frequency Yes No 67 53

Percentage 56% 44%


60 50 40 30 20 10 0 No 44




The result shows that 56% of respondents have used Islamic banking products and services but in terms of Islamic deposit account, Mudarbah and online line transfer payments and Ijara financing, where as 44% have not used their products and services.


3) Are you aware of Islamic banking products and services?

Frequency All of them Most of them None 12 90 18

Percentage 10% 75% 15%

80 70 60 50 40 30 20 10 0 All of them Most of them None 10 15 75


The picture predicts that only 75% of the respondents are aware of most of the products of Islamic banking and only 10% are having knowledge regarding all the products of Islamic banking. 15% of respondents say that they have no idea about Islamic banking products and services.


4) Are you satisfied with Islamic banking products and services?

Frequency Yes No Don’t know 54 12 54

Percentage 45% 10 % 45%

50 45 40 35 30 25 20 15 10 5 0 Yes No Don't know 10 45 45


Here we can see that the satisfaction level of respondents regarding their products and services is 45% i.e. not up to the mark. 45% of them say that


5) Islamic banks take guidance from Quran and Hadith source to market their products?

Frequency Agree Neutral Disagree 72 24 24

Percentage 60% 20% 20%

70 60 50 40 30 20 10 0 Agree Neutral Disagree 20 20 60


The graph depicts that 60% of the respondents agree to the statement that Islamic banks take the support from Quran and Hadith to market their products, where as 20% says that they don’t know about marketing strategies of Ibs and same 20% are not agreed with this statement.


6) Staff members are often not well informed about Islamic products?

Frequency Agree Neutral Disagree 60 48 12

Percentage 65% 25% 10%

70 60 50 40 30 20 10 0 Agree Neutral Disagree 10 25 65


According to 65% of respondents the staff embers are not fully informed regarding their products. 25% says that they have no idea about their knowledge, and 10% of them do not agree with this statement. This shows that there is need to improve their HR quality of Islamic banks



The objective of Islamic banks is to only increase profits?

Frequency Yes No Don’t know 12 66 42

Percentage 10% 55% 35%

60 50 40 30 20 10 0 Yes No Don't know 10 35 55


55% of respondents denied the statement that core objective of Islamic banking is to make profits. Only 10% of them agree to it. And 35% of respondents are neutral about this statement


8) Do Islamic banks value their customers needs better than their conventional competitors?

Frequency Always Most of the time Never 24 90 6

Percentage 20% 75% 5%

80 70 60 50 40 30 20 10 0 Always Most of the time Never 20 5 75

Intrepretations: Graphically it shows that 75% of the respondents agree that islamic banks value their customers most of the time. Where as 20% have admitted that islamic banks always value their customers and 5% are against this statement.


9) Islamic products more costly as compared to interest bearing products?

Frequency Yes No Don’t know 24 54 42

Percentage 20% 45% 35%

50 45 40 35 30 25 20 15 10 5 0 Yes No Don't know 20 45 35

Interpretations: Here you can see that about 35% of respondents have no idea about pricing formula of Islamic banks as majority of them are not using their products and services.20% are agreed to this statement that their products are costly as compared to conventional banks. And 45% have disqualified this statement.


10) Islamic banks witnessed growth in terms of volume of deposits and the number of branches it owns?

Frequency Yes No No idea 84 36

Percentage 70% 30%

80 70 60 50 40 30 20 10 0 Yes 0 No No idea 30 70

Interpretations: It looks good to see that about 70% of respondents have agree to the statement that Islamic banking have achieved great progress in terms of terms of volume of deposits and the number of branches it owns.


11)Are the products innovative and improved then conventional banks? Frequency Yes No No idea 36 44 40 Percentage 30% 37% 33%

40 35 30 25 20 15 10 5 0 Yes No No idea 30 37 33


Graph shows that 37%of respondents are not satisfied with the improved quality of Islamic products. 30% are satisfied with it, where as 33% of respondents have no idea about their products improved level. 56

12)Marketing campaigns have been streamlined?

Frequency Agree Neutral Disagree 30 12 78

Percentage 25% 10% 65%

70 60 50 40 30 20 10 0 Agree Disagree Neutral 10 25 65


The picture shows that about 65% of respondents say that marketing campaigns of Islamic banking are not up to that level.25% are satisfied with this statement up to some level, where as 10% are neutral about it.


13)Are the customers getting more facilities and incentives?

Frequency Yes No No idea 20 82 18

Percentage 17% 68% 15%

80 70 60 50 40 30 20 10 0 Yes No No idea 17 15 68


Here according to graph we can say that 68% of respondents are not satisfied with the facilities of Islamic banking, 17% of them are fully satisfied with the customer facilities and incentives where as 15% have no idea about their facilities and incentives offered.


14)Islamic banks have attained great progress when it comes to Professional approach?

Frequency Agree Neutral Disagree 78 18 24

Percentage 65% 15% 20%

70 60 50 40 30 20 10 0 Agree Disagree Neutral 20 15 65


Graphs depicts that 65% of respondents have agreed that Islamic banks have attained great progress in term professional approach. Where as 20% of them are not satisfied with this statement and 15% are neutral about it.


15)Is profit maximization your top priority while going for Islamic bank investments?

Frequency Yes No Neutral 62 30 24

Percentage 52% 25% 23%



It is seen that 52% of respondents give their prime priority to Islamic banking profit because their sole importance seems to be profit maximization not merely the ethical compliance. Where as 25% are not satisfied with this statement and 23% of them are 60

neutral about it.

Analysis of Questionnaire for Officials
1) Is Islamic banking viable? According to different officials Islamic banking is viable and feasible in all respects beyond any shadow of doubt. It offers a much better financial infrastructure on all grounds be it economical, social, religious or any other sphere. The question is quite broad in its scope. Talking about economic feasibility they says that the cost of carrying out operations if not less it is at least equal to that of conventional banking. Now coming towards the religious and ethical feasibility. According to them as there are a lot of people out there who only believes in Islamic laws, for them it is something very obvious. The main motive behind the establishment of Islamic banking is to get rid of riba or any other practices prohibited by Islam so it complies with those principles. 2) What changes Islamic financing brings about in the way people live, business works, and government public affairs? As per the interview official’s said that Islamic banking would bring about very positive and long lasting changes in the daily lives of people, business goings on and the govt. public affairs. They says that Islamic banking will bring: • • • • • Riba free economic environment Just wealth distribution Halal profits Economic transaction backed by underlying assets Promotion of legitimate trade

They says that People will think broadly about the common grounds instead of fighting on narrow scenarios like hanfi, hanbli etc in business riba free businesses would take place. Islamic concept of ownership rights will take place and transactions that are being allowed by Islam would be in practice. 3) Are Islamic banks as efficient as other financial institutions in responding to the needs of their clients and earning good return for their depositors? According to some senior officials there are different types of efficiencies that evaluate the overall efficiency of the banks. These includes productive efficiency, operational efficiency, allocative efficieny, distributive efficiency and stabilization efficiency etc when it comes to the needs and requirements of the clients it is very well taken care of by the Islamic banks like shariah compliance needs, financial innovation needs, services and 61

profitability needs etc. For this if you see the Profit-income Ratio I-e percentage share of Islamic banks income distributed to the depositors as profit of different Islamic banks like Al Baraka, Meezan etc it will speak for itself that the depositors are getting handsome returns and their satisfaction level is also high. That shows high efficiency level in return. Yes, Ibs are efficient as they are using most advance software to bring best customer solutions; especially deposit management tagging of assets is the most specialized features of Ibs. 4) What challenges will Pakistan face in implementation of Islamic banking and how it is emerging in Pakistan? Officials say that Liquidity Management and acceptance level of Islamic banking products in population at large will be the core challenges. In the future while its implementation in the true sense. These problems will relate to macro and micro operations some of Ibs are worth mention are problems related to liquidity and capital, financial stability, lack of capital market and interest free instruments, severe competition in the financial sector, Absence of Infrastructure for International Islamic Trade Financing, Increased Cost of Information, Lack of Intention of the Management to be strict with Shariah Guidelines. 5) Are you satisfied with present HR quality in Islamic banking? HR quality is going average if not impressive but there is still a lot to be done in this regard. Hr needs to be train in the basic knowledge of Islamic banking and its products. 6) How much potential is there for Islamic banking in overall banking industry? According to officials at present Islamic banking share in totals banking business in Pakistan is about 4%, which will further accelerated to 12% by 2012. Some says that Islamic banks will need to grow at least by 40-50% annually to be able to raise its share from 3.5% to about 15% of the total banking system. 7) What are the factors that will be important in the future of Islamic banking? Factors that are very important in the future of Islamic banking like the need to reorganize the whole financial system. Ibs should keep them selves away from negative marketing and should penetrate in rural sector for wider acceptability. Islamic banks should be promoted, as PLS banks, and they should Re-affirm their commitments to establish a just society free of exploitation. Islamic banks will have to function in line with modern business practices, through improvement and expansion of their products range. 8) What do you think is the best solution/campaign for public awareness? According to some officials Consumer education and awareness program needs to be developed to enhance public awareness of Islamic banking products and services. This can be done through large-scale marketing and promotional campaigns by the banks, 62

customer orientation programmes, seminars, media presentation, workshops etc and all other means that govt. and banks could channelize to create public awareness.

9) What are the threats Islamic banking is facing in our economy? The threats Islamic banks includes the severe competition they are facing in our economy from the banking giants like standard chartered, citigroup etc who have already jumped into this. Apprehension of public at large about transaction of Ibs that they are not Islamic is one of the major threats. 10) Is the volume of deposits dependent on number of Islamic branches? The volume of deposits is greatly influenced and affected by the number of branches if Islamic banks and the profit sharing rate as well. I can suggest that, if the Islamic commercial banks would like to collect more funds, a competitive profit sharing rate (with regard to conventional bank’s interest rate) should be offered, and more branch offices are built.


In conclusion, the market for Islamic banking shows a rich potential. However as the competitive intensity increases. The winning players will be those that are able to deploy differentiated capabilities and address the existing challenges unique to Islamic banking. The rapid growth of the Islamic finance industry is putting pressure on human resources. Institutions report that there are simply not enough qualified personnel to fulfill functions adequately. The situation is particularly acute at the Sharia Board level, where there is a shortage of scholars with the requisite educational and practical knowledge. With so few scholars available, scholars are frequently called on to sit on more than one board, raising conflict of interest issues. This paper has attempted to investigate the influence of number of branch offices and profit sharing rate on the volume of deposits. From the estimation, it may be concluded that there have been a long run relationship between the volume of deposits and profit sharing rate and number of branch offices of Islamic commercial banks. It can be said that, aside from religious considerations, in the long run, depositors are indeed influenced by welfare maximization principle, and accessibility of the Islamic commercial banks. It can be suggested that, if the Islamic commercial banks would like to collect more funds, a competitive profit sharing rate (with regard to conventional bank’s interest rate) should be exercised, and more branch offices or outlets are built. Islamic finance has the potential to continue its rapid progress from the last few years, despite the current economic slowdown. Going forward, Islamic banks will need to go about signing up new customers, developing new products and services, and deploying enhanced capabilities


To increase the pool of bankers and tactful operators who are knowledgeable and competent, efforts will be directed to promote human capital development to support the envisaged growth of the industry via: Establishing an industry owned institution on Islamic banking and finance dedicated to train and supply a sufficient pool of Islamic bankers and tactful operators as required by the industry; and requiring Islamic banking institutes and operators to commit adequate budget allocation for skill development to enhance knowledge and expertise in the field of Islamic banking and tactful. Complementary measures will also be taken to create and increase awareness amongst the public on the concept and advantages of Islamic banking as well as customer education on misperceptions. This can be achieved by: Encourage Islamic banking institutions to embark a regular promotional program on Islamic banking. Islamic banking institutions should be encouraged to form strategic alliance with institutions of higher learning to enhance knowledge on Islamic banking

To build capable and innovative management teams committed to Islamic banking, the employment of experienced and qualified staff, including expatriates to facilitate transfer of knowledge and expertise should be encouraged. The recruitment of expatriates should be compliment the efforts made to build the skills of the domestic industry players

Strategic steps should be taken to prepare the Islamic banking and tactful industry players to be among the best-managed institutions, capable of capitalizing on the unique features of Islamic banking and be tactful to achieve significant competitive edge. The recommendations involve measures to ensure that the scarcities of skilled manpower in Islamic banking are adequately addressed. The development of management teams and the continuous application of bench marking to elevate the performance level will be given due importance.

The impetus for future growth has to originate from a separate regulatory platform in order from the industry to break away from its infancy stage and focus on its own set of banking principles


New licenses should be issued to qualified domestic industry players to stimulate increased competition among Islamic banking and conventional banks having Islamic branches Issuance of Islamic banking licenses to qualifies foreign Islamic banking players, which would drive improved performance, leading to enhanced efficiency and financial innovation in the industry. Measures should be directed to ensure the development of a comprehensive and effective infrastructure to support the financial operations of Islamic banking.

Benchmarking is essential for Islamic banking to be at par with international best practices. Hence a benchmarking program should be introduced to facilitate Islamic banking institutes in evaluating their relative efficiency, identifying the performance gaps and formulating strategies to improve and deliver best results.


I. “Islamic Banking & Finance Another Approach” By A.L.M. Abdul Gafoor II. III. “Article on Islamic Banking, Finance & Economics” by Maryam Ayaz Manager Business Development, Apvision (Private) Limited IV. Current Issues in the Practice of Islamic Banking by Sayyid Tahir* V. “The evolution of the Islamic financial system” by Professor Rodney Wilson, University of Durham, Institute for Middle Eastern and Islamic Studies VI. “The role of Islamic Banks in Non Muslim Countries” by M. UMER CHAPRA from THE JOURNAL OF MUSLIM MINORITY AFFAIRS JULY 1992. VOLUME 13: NO. 2 VII. “Islamic Banking A Performance Analysis” by M. RAQUIBUZ ZAMAN, HORMOZ MOVASSAGHI, Ithaca College VIII. Source: The Journal of Global Business, Volume 12, No. 22, Spring 2001, pp. 3138. IX. X. XI. XII.



Questionnaire for consumers
We are the students of MBA, University of Central Punjab Lahore and working on subject research topic. Information provided by you will be kept confidential and will be used only for academic purposes. We are grateful for your cooperation and guidance. Thank you.

First Name: Occupation:

________________ _________________



Organization: __________________

Qualification: ________________

1) You have account in Islamic bank None Conventional bank Both

2) Have you used Islamic banking products and services? If yes please mention. __________________ __________________ 3) Are you aware of Islamic banking products and services? All of them Most of them None

4) Are you satisfied with Islamic banking products and services? Yes No 68 Don’t know


Islamic banks take guidance from Quran and Hadith source to market their products? Agree Neutral Disagree

6) Staff members are often not well informed about Islamic products? Agree Neutral Disagree

7) The objective of Islamic banks is to only increase profits? Yes No Don’t know

8) Do Islamic banks value their customers needs better than their conventional competitors? Always Most of the time Never

9) Islamic products more costly as compared to interest bearing products? Yes No Don’t know

10) Islamic banks witnessed growth in terms of volume of deposits and the number of branches it owns? Yes No No idea

11) Are the products innovative and improved then conventional banks? Yes No No idea

12) Marketing campaigns have been streamlined? Agree Disagree Neutral

13) Are the customers getting more facilities and incentives? Yes No No idea

14) Islamic banks have attained great progress when it comes to Professional approach? Agree Disagree Neutral



Questionnaire for Officials
I. Is Islamic banking viable? II. What changes Islamic financing brings about in the way people live, business works, and government public affairs? III. Are Islamic banks as efficient as other financial institutions in responding to the needs of their clients and earning good return for their depositors? IV. What challenges will Pakistan face in implementation of Islamic banking and how it is emerging in Pakistan? V. Are you satisfied with present HR quality in Islamic banking? VI. How much potential is there for Islamic banking in overall banking industry? VII. What are the factors that will be important in the future of Islamic banking? VIII. What do you think is the best solution/campaign for public awareness? IX. What are the threats Islamic banking is facing in our economy? X. Is the volume of deposits dependent on number of Islamic branches?


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