European Journal of Social Sciences – Volume 17, Number 1 (2010)

An Analysis of Functions Performed by Islamic Bank: A Case of

Pakistan

Ashfaq Ahmad
Assistant Professor, Department of Business Administration
University of Sargodha, Sargodha, Pakistan
E-mail: ashfaquos@gmail.com

Asad Afzal Humayoun

PhD Scholar, (FUIEMS) Foundation University, Islamabad, Pakistan

Uzair ul Hassan
Faculty Member, Department of Education, University of Sargodh, Pakistan

Abstract
This study explores the working pattern of Islamic banking by considering its main
functions. Islamic banking proved its success to compete with the deep rooted conventional
banking system in Pakistan. The Islamic bank performs multiple functions to facilitate the
different stakeholder according to their specific needs. Banks pool the funds by accepting
deposits from the savers and provide these funds to entrepreneurs for productive ventures
to generate profits. It provides interest free products to serve the different segments of the
economy according to Shariah principles. The primary function of the Islamic bank is to
promote trade activities as an active interaction with Surplus Units and Deficit Units of the
economy. The secondary function of Islamic bank aims at provision of agency services and
other market compatible products to facilitate its customers. Finally, it also provides
consultancy and Hajj services to compete with the conventional banks. This study gives a
snapshot of functions performed by Islamic banks in Pakistan. This study is an effort to list
out the main functions being performed by the Islamic banks that may guide different
segments of the society to understand the working pattern of the Islamic banks in Pakistan.

Keywords: Functions of Islamic bank, Pakistan, financial intermediation

1. Introduction
Financial intermediaries facilitate the investors to provide finance according to their requirements by
considering the risks and returns attached to different projects. Banks pool the funds by accepting
deposits from the savers and provide these funds to entrepreneurs for productive ventures to generate
profits. An efficient inter-mediation increases the productivity and return of investment for long term
benefits. Islam has provisions for innovative products and practices by using the Ijtihad according to
the holy Quran and Sunnah as the origin for all deeds. Islamic bank works as Mudarib to invest savers’
funds in general investment fund, specific investment fund or accept demand deposits on interest free
basis. It can also perform the function of investment manager (Wakalah) and generate revenue as
service charges. While in conventional banking investors are guaranteed a predetermined rate of
interest and it aims to maximize the return even at the cost of society or other stakeholder. In
conventional banking excessive use of credit and debt financing can lead to financial problems and
promote materialistic attitude that leads to exploitation, which is fatal for society. It is reported that
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Islamic banking is more desirable than conventional banking due to higher level of customer
satisfaction and better service quality (Ahmad, Rehman & Saif, 2010).
Al-Jarhi & Iqbal (2001) defined Islamic bank as a banking institution conducting all known
banking activities including borrowing and lending without interest. It mobilizes funds on the basis of
Mudarbah or Wakalah and may accept demand deposits as interest free loan. It deploys funds on profit
and loss basis or may advances on debt creating basis according to the principles of Sharia’h being an
investment manager. It is evident that Islamic banks are more focused towards just and equitable
distribution of resources as compared to conventional banks (Siddique, 1985). The role of bank is
shown in figure 1.

Figure 1: Role of Financial Intermediaries (Banks)

Savers (Surplus Units)

• Small households or institutions
with smaller amounts
• Risk averse

Financial Intermediation (Banks)

• Financial Markets especially banks
• Reduce Risks
• Pooling small funds to remove
mismatch and exploit opportunities
(Size, Maturity, and Liquidity Preference)

Entrepreneurs (Deficient Units)

• Organized firms with professional
skills requiring larger funds
• Risk takers

2. Functions of Islamic Bank

Business organization is primarily originated for the sake of profit by performing lawful activities.
Banks are also one of the business organizations that provide a set of products and services to generate
profits. Inception of Islamic banking practices in Pakistan created multiple threats and opportunities to
meet customers' expectations by the provision of quality services. It initiated a healthy competition for
Islamic banks to compete with their peers and conventional banks for greater profits. It was observed
that the banking industry experienced stiff competition with banks and with other financial institutions
to attract potential customers (Hull, 2002).
Islamic bank works as a trading concern and financial intermediary to perform interest-free
activities purely according to principles of Sharia’h. It is a welfare organization that promotes business
and trade activities by pooling the financial resources for the sake of profit and loss for mutual benefit.
It is found that Islamic bank performs activities in the right direction towards human development. It
plays a positive role towards economic development having main focus on human development while
performing its functions (Al-Harran, 1993). It is documented that banks have witnessed more profits on
Murabaha facilities as compared to conventional loans due to profit and loss base of Islamic products
(Ebraim, 1999).
Uzair (1976) suggested the working structure of Islamic bank and explained its functions.
Banking transactions are undertaken among three parties i.e. actual users of the capital or
entrepreneurs; the bank as an intermediary and partial user of funds; the suppliers of funds or
depositors. The study recommended that all the transactions should be based on profit and loss
contracts among the concerned parties and exclusively interest-free. It is also reported that Islamic
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banks could promote savings and investment activities by determination of an equilibrium profit
sharing ratio between depositors and borrowers (Siddiqui, 1979). Islamic banks have a number of
opportunities in Pakistan with a population of more than 96% Muslims. Islamic banks have to face
multiple challenges due to strong reaction from conventional banks because they were deep rooted and
popular among the public to meet their requirements. There are 6 full-fledged Islamic banks with 341
branches offering interest free products in Pakistan (SBP, 2007).
Ahmad et al. (2010) investigated the customer’s satisfaction among Islamic and conventional
banks in Pakistan. A survey of 760 bank customers were undertaken to assess the customers
satisfaction regarding different functions performed by Islamic and conventional banks in Pakistan.
The study concluded that customers of Islamic banks have higher satisfaction as compared to
conventional banks. Islamic banks perform a variety of fund-based and non-fund based functions to
facilitate their customers. Islamic banks play a vital role in the economy to promote productive
activities that enhance economic growth and prosperity. Islamic banks ensure stable economy; fair
distribution of income; reduce injustice; risk sharing, lesser financial crisis; facilitate production and
business activities. Some important functions are displayed in figure 2.

Figure 2: Functions of Islamic Bank

General Specific
Investment Fund Investment Fund

Accepts Deposits
Non-Fund Based Services

Fund Based Services

Agency & Gen. Primary Functions
Utility Functions Islamic Bank

Advance Loans
(Financing Products)

Long Term Medium Term Short Term

Musharika, Ijarah, Murabaha, Salam,
Mudaribah, Ijarah-Wa-Iqtina Muajjal, Istisna
Diminishing etc. etc.
Musharika etc.

Islamic banks perform two types of functions i.e. fund based and non-fund based. Fund based
activities are called primary functions of Islamic bank i.e. acceptance of deposits from savers on profit
& loss basis and lend money to deficient individuals/business units on profit and loss basis. Islamic
Bank accepts deposits against savings and current accounts. It accepts deposits against
investment/savings accounts to generate income under specific investment account or general

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investment account. Islamic Bank invests this amount into different profitable ventures as an agent and
shares the consequences. Bank may receive deposits from people under current account and do not pay
any interest but may charge a fee for its services.
Islamic banks lend money to borrowers for short-term, medium-term and long-term investment
(Musharika, Mudariba, Ijara, Salam, Murabaha etc.) on the basis of profit and loss. In this way
depositor, bank and borrower share risk of loss according to a valid sales contract. It creates a strong
economy on the principles of transparency and accountability. Islamic bank performs some non-fund
based functions like agency services and general utility services. Islamic bank can act as an agent to
provide the different types of services like collection of cheques, collection of dividends, execution of
standing orders, and purchase/sale of securities. It also performs the general utility services e.g. a
collection of utility bills, foreign exchange remittances, providing Hajj services, currency exchanges
and ATM services etc.

3. Sources and Uses of Islamic Bank

Islamic banks are offering a variety of products and services to its customers. They strive to expand
their operations and perform multiple functions to attract the prospective customers for greater profit. It
requires the quality initiatives to retain valued customers by meeting their expectations for better
performance. Islamic bank proved a successful experience in Pakistan and gained popularity among
general public. It is reported that Pakistani banking sector has shown good performance by attracting a
large number of customers due to the provision of quality services (Arby, 2003). There is a sharp
increase in the volume and market share, which is depicted in table 1.

Table 1: Sources & Uses of Funds by Islamic Banks in Pakistan 2003-06 (Million Rs.)

2003 2004 2005 2006

Sources Amount Percentage Amount Percentage Amount Percentage Amount Percentage
Deposits 8397 65 30185 68 49932 70 83740 70
Borrowings 1899 15 6559 15 9006 13 10843 9
Capital & Other Funds 1994 15 5123 12 7811 11 16348 14
Other Liabilities 625 5 2276 5 4745 7 8363 7
Total 12915 100 44143 100 71493 100 119294 100
Uses
Financing 8652 67 27535 62 45786 64 65613 55
Investments 1242 10 2007 5 1854 3 7328 6
Cash/Bank Balance 1978 15 11900 27 19314 27 31358 26
Placements
Other Assets 1042 8 2701 6 4539 6 14996 13
Total 12915 100 44143 100 71493 100 119294 100
Source: SBP, 2007

Khalid (2006) reported that the performance of Pakistani banking sector had improved after
privatization. Islamic banks have shown tremendous growth during the recent years. Similarly, banking
industry in Pakistan has shown an unprecedented growth as the best performing sector having banking
assets of more than $ 60 billions. Almost 81% of banking assets are owned by the private sector while
foreign investors contributed 47% of total paid up capital (Akhtar, 2007). It is found that Islamic
banking practices are getting popularity due to strong and positive relationship between service quality
and customer satisfaction in Pakistan (Ahmad et al. 2010).

4. Summary and Conclusive Remarks

This study explores the working pattern of Islamic banking by considering its main functions. The
Islamic banking practices were started in Pakistan in 2002 as result of untiring efforts of State Bank of
Pakistan to introduce an alternative for interest based conventional banking system. Islamic banking
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European Journal of Social Sciences – Volume 17, Number 1 (2010)

proved its success to compete with the deep rooted conventional banking system in Pakistan. The
Islamic bank performs multiple functions to facilitate the different stakeholder according to their
specific needs. It provides interest free products to serve the different segments of the economy
according to Shariah principles. The primary function of the Islamic bank is to promote trade activities
as an active interaction with Surplus Units and Deficit Units of the economy. The secondary function
of Islamic bank aims at provision of agency services and other market compatible products to facilitate
its customers. Finally, it also provides consultancy and Hajj services to compete with the conventional
banks. This study gives a snapshot of functions performed by Islamic banks in Pakistan. This study is
an effort to list out the main functions being performed by the Islamic banks that may guide different
segments of the society to understand the working pattern of the Islamic banks in Pakistan.

5. References
[1] Ahmad, A., Rehman, K. & Saif, M. I. (2010). Islamic Banking Experience of Pakistan:
Comparison of Islamic and Conventional Banks, International Journal of Business and
Management, 5 (2), 137-144.
[2] Ahmad, A., Rehman, K., Saif, M. I. & Safwan, M.N.(2010). An Empirical Investigation of
Islamic Banking in Pakistan based on Perception of Service Quality, African Journal of
Business Management, 4 (6), 1185-1193.
[3] Akhtar, S. (2007). Pakistan-Banking sector reforms: performance and challenges, Lecture by
Governor of the SBP Pakistan at the Graduate Institute of International Studies, Geneva, 1
February 2007.
[4] Al-Jarhi, A.M., & Iqbal, M. (2001). Islamic Banking: Answers to Some Frequently Asked
Questions, Occasional paper No. 4, Islamic Development Bank, Islamic Research and Training
Institute.
[5] Al-Harren, S.A. (1993). Islamic Finance: Partnership Financing, Pelanduk Publications,
Selangor Darul Ehsan, Malaysia.
[6] Arby, M.F., (2003), Structure and Performance of Commercial Banks in Pakistan, State Bank
of Pakistan.
[7] Ebrahim, M.S. (1999). Integrating Islamic and conventional project finance, Thunderbird
International Business Review, 41 (4/5), 583-609.
[8] Economic Survey of Pakistan, (2007-08), Ministry of Finance, Government of Pakistan:
Islamabad.
[9] Hull, L. (2002). Foreign-Owned Banks: Implications for New Zealand’s Financial Stability,
Discussion Paper Series, DP 2002/05.
[10] Khalid, U. (2006). The Effect of privatization and liberalization on banking sector performance
in Pakistan, SBP Research Bulletin, 2 (2).
[11] State Bank of Pakistan (2007), Islamic Banking Sector Review 2003 to 2007, Islamic Banking
Department, Islamabad.
[12] State Bank of Pakistan (2007), Islamic Banking Bulletin, October - December, 2007.
[13] Siddiqui, M.N. (1979). Banking in an Islamic Framework, Islamic Council of Europe, pp. 101-
111.
[14] Siddiqui, M.N. (1985). Partnership and Profit sharing in Islamic Law, Leicester: The Islamic
Foundation.
[15] Uzair, M. (1976). Some Conceptual and Practical Aspects of Interest-Free Banking, Studies in
Islamic Economics, 37-57.

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