Islamic Banking in Pakistan

Table of Contents INTRODUCTION ................................................................................................. 1 History of Islamic Banking................................................................................. 4 Purpose of Study ............................................................................................... 5 Objectives of the study ...................................................................................... 5 Hypothesis ......................................................................................................... 6 Delimitations of the study ................................................................................. 6 Review of related Literature .............................................................................. 7 Research Methodology.................................................................................... 11 Population ....................................................................................................... 11 Sample............................................................................................................. 11 Research Instruments ..................................................................................... 12 Analysis of collected data: ............................................................................. 12 Conclusion ....................................................................................................... 15 Bibliography .................................................................................................... 17 ANNEXURES ..................................................................................................... 18

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INTRODUCTION
In any economy banks play very important role. A bank is a reliable financial institution, which has core business of mobilizing the savings of people for investment purposes. It receives the money from one group and lends to other group of people. So bank performs the duty of financial intermediary. Usually there are two types of banks, conventional banks and Islamic banks. In simple words Islamic banks operate in interest free system. Prohibition of interest is designed in Islam in all forms and intent. This Prohibition is strict, absolute and unambiguous. The Holy Qur'an in verse 278 of Surah Al-Baqarah states:"O ye who believe! Fear Allah and give up what remains of your demand for riba, if ye are indeed believers." Verse 2: 279 says: "If you do it not, take notice of war from Allah and His Messenger. But if ye turn back, ye shall have your capital sums. Deal not unjustly and you shall not be dealt with unjustly." Islamic banks appeared on the world scene as active players two decades ago. But many of the principles on which Islamic banking is based have been commonly acceptable all over the world for centuries rather than decades, as it is evident that Islamic finance was practiced mainly in the Muslim world throughout the middle Ages, promoting trade and business activities. It is claimed that many concepts, techniques, and instruments of Islamic finance were later adopted by European financiers and businesspersons." Although the western media frequently suggest that Islamic banking in its present form is a recent phenomenon, in fact, the basic practices and principles date back to the early part of the seventh century" (Islamic Finance: A Euro money Publication, 1997). The main issue here is to know about the differences between operations of a conventional bank and an Islamic bank by focusing on the principles and instruments of Islamic banking. It is difficult to say with accuracy which was the first such company or bank that pioneered this concept of Islamic banking in practice. Some analysts and experts in the field are of the opinion that, Islamic banking and finance,
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first emerged in 1963, when Mit Ghamr Saving Bank began an experimental project offering interest free banking in Egypt. The project was a success and lead to the bank opening four new branches by 1967. Some observers are of the opinion that the concept of an "Islamic bank" was born at the Islamic Summit of Lahore, Pakistan in 1974 which recommended the creation of an Islamic Development Bank. Within few decades, Islamic banking and financial institutions have been quick to establish themselves in all parts of the world in the form of Islamic Commercial Banks, Investment and Holding Companies and Development Banks. The over 150 such institutions that invest money according to Islamic economic principles, are suspended to increase in number over the next few years. Several Muslim countries like Indonesia, Iran, Malaysia, Pakistan, Sudan and Turkey, in recent years have been taking steps to establish an Islamic banking and financial sector. The significant decision of the Pakistani Supreme Court, in Ramadan 1420, to strike down all laws that condone interest and their orders to the Federal government to bring all existing financial organizations in line with Islamic principles is truly path-breaking (www.alrajhibank.com.sa/islamicebanks.htm). Conventional banks have begun to embrace Islamic banking on a moderate scale. Here again the point arises, that, there is some difference between the operations of two banking systems and also there is something which is attracting conventional banks towards Islamic banking system. A significant proportion of the banking system has been Islamized in Pakistan. Recently the State Bank of Pakistan has allowed commercial banks to set up Islamic banking subsidiaries or provide full Islamic banking facilities through dedicated branches (Dawn economic & business review, 2003). Meezan Bank of Pakistan had conducted a research last year on Islamic banking. The main findings of the research were that there is a strong need for a riba-free banking system. People perceive a number of emotional benefits from a product that is based on the belief of Islam. The objective is to lessen the feeling of guilt by following the canon of Islam.

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There is also a belief that Islamic banking will help fight the ills of the economy of the country. Many Western Academic Institutions are introducing Islamic Economy and Banking as Subjects, like Harvard University Center for Middle Eastern Studies (CMES), Durham University, UK, Dow Jones University.etc. These indicators reflect the rising trend of Islamic banking and finance throughout the world. This encourages one to know in detail what Islamic banking is all about, what are its principles and Efforts in different countries for Islamic banking present not only an excellent working examples for those who did not believe in the practicality of the interest free banking but also provide a spade work over which the infrastructure of interest free banking for a country could be built up.

History of Islamic Banking

Haqiqi & Pomeranz in their article Accounting Needs of Islamic Banking gave the history of Islamic banking. They explained that, In Muslim communities, limited banking activity, such as acceptance of deposits, goes back to the time when the Prophet Muhammad was still alive. At that time, people deposited money with the Prophet or with Abu Bakr Sadique, the First Khalifa of Islam. The first modern Islamic bank, established in Egypt in 197, was called Nasser's Social Bank. Islamic accounting, an essential tool for the success of Islamic banks, is said to have been developed contemporaneously at the University of Cairo. The desirability of abolishing fixed interest rates and the Islamization of financial systems were discussed at the first meeting of the Islamic Organization Conference (IOC) in Jeddah in 1973. Subsequently, many Islamic banks were founded under the profit-and- loss sharing system (PLS), which will be discussed below. Islamic banking operations are not limited to Arab soil, or Islamic countries, but are spreading throughout the world. One reason is the "growing trend toward transcending national boundaries, and joining Muslims into a political and economic entity that could have a significant impact on the pattern of world trade. Since Muslims are inclined to follow Islamic traditions, there is a tendency to establish an Islamic economic system in every Islamic nation, And to restore Shariah Law as the basic source for legislation" (Abdel-Magid).
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Further expansion is planned for example; DMI has announced a five-year program to create a network of branches and subsidiaries in more than twenty countries (The Economist, 1982). An American businessman of Iraqi origin plans to establish a U.S. based financial institution to be administered in accordance with Islamic banking practice. When approved by U. S. authorities, the institution will serve several million American Muslims (Barron's 1985).

Purpose of Study
External financing is important almost for every kind of business in an economy and banking industry is the main facilitator in this regard. Islamic banking system plays its role in the banking industry as its minor part. Even though its a minor part it cant be left behind because banks are the bases of the economic growth. So, studying Islamic banking system in detail will not only benefit the researcher but also will be a source of effective information for many classes of bank customers. It will help better understanding Islamic banking system and its salient features. My main purpose of the study of this topic to focus on the growth of Islamic Banking sector in Pakistan, I will highlight the growth in all aspects, growth in Market Share, Investment, Branch network, Depositors and many more factors .

Objectives of the study

Research is a way to help students enhance their knowledge by learning from the practical environment and also to apply the learned theoretical concepts in the practical field. the main objective & purpose of this study is to review the various aspects of Islamic Banking and to identify the factor of growth of Islamic banking in Pakistan and also assess their viability and applicability with respect to individual and corporate consumers. More specifically the objectives will be: To review the History and Development of Islamic Baking in the Pakistan. To focus on the growth of Islamic banking system in Pakistan

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To gauge the differences between interest based banking and Islamic banking. To understand the role of government of Pakistan in the implementation of the proposed system. To study consumer attitude towards Islamic Banking in order to evaluate its success in Pakistan.

Hypothesis
Is Islamic banking becoming popular in Pakistan? Is Islamic banking really a need of the people? How it is different from conventional banking system? Is the religious teachings main reason for growth of Islamic Banking?

Delimitations of the study

The research is conducted within the following limitations: 1) To keep the study manageable, my research is conducted on limited grounds. 2) The study is conducted on small level and only the important aspects are considered. 3) There was a shortage of time thats why limited data is collected. 4) Limited period of time and small sample size in survey questionnaire. 5) Some respondents, who have limited knowledge of Islamic banking or no knowledge about the financial modes of conventional and Islamic banking, also answered the questions hence the replies of some questions may be based on their own imagination or thoughts 6) Although majority of respondents of Islamic banking questionnaire were account holders of Meezan Islamic Bank, however some of respondents had accounts in other Islamic banks too or accounts in Islamic branches of conventional banks, so the results of this study are not fully applicable to Meezan Islamic Bank of Pakistan. 7) Therefore, in this study the results about Islamic banking should be taken only as indicative and perceptive rather than conclusive.

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Review of related Literature

a)What are Islamic Banks Islamic bankers do not expect to advance money and receive a predetermined sum on a fixed date in the future. Under the Shariah, the base of the Islamic faith, they are instead responsible for ensuring that money is invested in viable projects, with reliable borrowers. If the project succeeds the banker shares in the profit. If it fails he suffers the losses. Islamic financial techniques have been employed successfully in a growing number of major projects in the West. Al Rajhi Bank has completed deals for the financing of ships and aircraft (using the Ijara lease financing technique), and many industrial projects including the building of power stations, a refinery and schools, and the expansion of an aluminium smelter in Bahrain (using the Istisna - deferred financing technique). Given the huge potential for development in the Islamic world and the increasing amount of funds being invested according to the Shariah, it seems perfectly reasonable to suppose that the recent growth in Islamic banking will continue at an accelerated pace (Colin Willis). b) Knowledge about Islamic Bank The sources of knowledge are mainly newspapers and magazines, television and radio, and family members. Many of the Muslim respondents visit the banks branch and seek information about the bank services and operations on their own initiative. For non-Muslims, about 75% of the respondents know of the existence of the Islamic bank from information derived mainly from newspapers and magazines. c) Principles of Islamic Banking For millions of Muslims, banks are institutions to be avoided. Islam is a religion which keeps Believers from the teller's window. Their Islamic beliefs prevent them from dealings that involve usury or interest (Riba) Yet Muslims
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need banking services as much as anyone and for many purposes: to finance new business ventures, to buy a house, to buy a car, to facilitate capital investment, to undertake trading activities, and to offer a safe place for savings. For Muslims are not averse to legitimate profit as Islam encourages people to use money in Islamic ways, not just to keep their funds idle (Nida'ul Islam, 1995). Islamic banking is based on the Quran that teaches prohibition of charging interest. Islamic banking is widely regarded as the fastest growing sector in the Middle Eastern financial services market. The best known feature of Islamic banking is the prohibition on interest. The Quran forbids the charging of Riba on money lent. The rules regarding Islamic finance are quite simple and can be summed up as follows: a) Any predetermined payment over and above the actual amount of principal is prohibited. b) The lender must share in the profits or losses arising out of the enterprise
for which the money was lent. c) Making money from money is not acceptable by Islam.

d) Uncertainty, Risk or Speculation is also prohibited. e) Investments should only support practices or products that are not forbidden in Islam. d) Growth of ISLAMIC BANKING in Pakistan Islam was the basis of creation of an independent state within the undivided Indo-Pak Sub- Continent. All Constitutions of Pakistan have incorporated, within the principles of policy, the elimination of Riba as an important objective of the State policy. Quaid-e-Azam in his speech at the occasion of the inauguration of State Bank of Pakistan, had expressed the desire for evolving an Islamic system of banking. In Pakistan Islamic banking emerged as a response to both religious and economic needs. Efforts for economy wide elimination of Riba started during 1970s and most of the significant and practical steps were taken in early 1980s. It was a very bold and comprehensive exercise. Pakistan was among the three countries in the world that had been trying to implement interest free banking at national level. Numerous measures were taken to introduce interest free banking in Pakistan. Banking and other relevant laws viz. SBP Act, Companies
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Ordinance, recovery laws, negotiable instruments act, etc. were amended to facilitate interest free banking system and the industry was given a specific timeline to convert to the Islamic banking system. State Bank Pakistan also gave the industry the products which it was allowed to use without any change or exception. New r eg u l a ti o ns w e r e prepared prescribing the modes of financing, profit distribution mechanism for deposits, financing facilities by SBP, etc. which constituted ground work for Islamization of financial system. The efforts and practical steps undertaken in the 1980s to Islamize the economy at national level are considered as pioneering work in the Muslim world as this became important reference material for other countries which undertook the path towards introduction and establishment of an Islamic banking system. In early 90s the whole exercise was challenged in the Federal Shariah Court and the procedure adopted by banks in Pakistan since July 1, 1985 was declared un-Islamic by the Federal Shariah Court (FSC) in November 1991. The system was based largely on mark-up technique with or without buy-back arrangement. The FSC declared that various provisions of the laws held repugnant to the injunctions of Islam in its Judgment dated November 14, 1991 would cease to have effect as from July 1, 1992. In a meeting held on September 4, 2001 under the Chairmanship of the President of Pakistan, attended by officials of the Ministries of Finance and Law, Governor State Bank of Pakistan, Chairman and some members of the Council of Islamic Ideology and the Chairmen, and the two Task Forces it was decided that the shift to interest free economy would be made in a gradual and phased manner and without causing any disruptions. It was also agreed that State Bank of Pakistan would offer three institutional options: 1) Setting up subsidiaries by the commercial banks for the purpose of conducting Shariah compliant transactions; 2) Specifying branches by the commercial banks exclusively dealing in Islamic products with all safeguards to ensure integrity and purity of Islamic banking operations,

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3) Setting up a new full-fledged commercial bank to carry out exclusively banking business based on proposed Islamic products. As a result of these efforts, in 2001, an Islamic Banking Division was established in the Banking Policy Department at SBP. This time around, concerted efforts were made by SBP to undertake Islamic Banking in its true spirit and also keeping in view the lessons learnt from the experience of Bahrain, Malaysia and Saudi Arabia etc. in this area. Accordingly, steps have been taken to set up a parallel banking system, so that an enabling environment is ensured for the sector, avoiding any serious repercussions of entire transformation of financial sector. Current Industry Review 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. Currently there are 6 full fledged licensed Islamic banks (IBs) and 12 conventional banks have licenses to operate dedicated Islamic banking branches (IBBs). All of the five big banks in Pakistan are providing Islamic banking services. The total assets of the Islamic banking industry are over Rs. 313 billion which accounts for a market share of 5.1% of total banking industry assets. The market share of deposits stands at 5.2%. Total branch network of the industry comprises of more than 528 branches with presence in over 50 cities & towns covering all the four provinces of the country. SBP has over the years attempted to develop a supportive Regulatory and Supervisory Framework having special emphasis on Shariah Compliance that is in line with the best international practices. Pakistan h a s adopted a three tiered, Shariah Compliance Mechanism and process to ensure a deeper and extensive Shariah compliance supervision on an on-going basis. The financing activities of Islamic banks have revived besides substantially higher assets and deposits growth. The profitability indicators have also shown marked improvement as compared to the preceding quarter. The financing and investment portfolio of Islamic banks reached Rs 195.0 billion compared with Rs 185 billion in March 2009, depicting an increase of 5.1 percent during the last quarter. In terms of market share, total assets, financing & investment and deposits reached 5.1 percent and 4.2 percent and 5.2 percent, respectively. The branch network of 6 full-fledged Islamic banks and 12 conventional banks increased to 528 branches in June 2009.
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The growing depositors confidence is well reflected, which shows an increase of 15.5 percent in the deposits. The deposit base of Islamic banks stood at Rs 238 billion. Total liabilities of Islamic banks have increased by 13.3 percent to Rs 274 billion from Rs 242 billion. While the net assets and equity increased by around 7 percent each. There is an increase of 6 percent in the reserves to one billion rupees and then appropriated profits increased by 79 percent to Rs 900 million in last quarter. Islamic Finance has made commendable progress in the last few years. The growth rate remained consistently higher than the conventional finance industry, culminating in continuously rising share of Islamic finance in the local and global financial markets. The SBP is leading the way in Pakistan and has envisioned to achieve a share of 12 percent by 2012 in its Islamic banking strategy plan.

Research Methodology
This study is basically descriptive in nature, and this would explore & review the research done on Islamic banking by different researchers and scholars. This research work is from the data collected directly from the financial Statements of the banks, both Islamic and conventional and also from the reports of State Bank of Pakistan, another source is direct from the customer of the banks. The primary data collection applied obtaining the information from peoples through filling of questionnaires, observation, and interview methods in Lahore. My university friends have also helped me for this work. 30 persons at Meezan Islamic bank and 30 at conventional banks in Lahore were asked to express their views during this study.

Population
Population for this research is customers at Meezan Islamic bank and other conventional bank (NIB Bank).

Sample
As I have limited time that is why to make the research size manageable in time I have selected a sample of 30 people from each type of bank (Meezan bank & NIB).
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Research Instruments
I used Questionnaires & direct interviews to get the replies of Customers at bank and also few personnel of banks.

Analysis of collected data:

The data collected is summarized according to the numerical order of the questionnaire and analyzed according to the importance and need of the study. Some of the questions are analyzed in details and some of are not due to the requirement of the study. Questions and Responses:
1. What is your age?

18-30 31-40 41-50 51-60 Above 60

Answers showed that Islamic Baking is more popular in young and middle age peoples of the society, while the conventional banks are popular in old or senior citizens of the country
2. Gender?

Male Female Respondents in both kind of banks were Male. During our whole stay, at different place of the projected sites, we could not meet any female respondent or account holder at Islamic Bank. While there were some female coming in conventional Banks. This analysis shows that Islamic banks have to make the females as their target customer, so that the Islamic banking services can disburse in a balanced way.
3. Educational Qualification?

Matric Intermediate
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Graduate Masters Above masters Islamic banking is more popular in highly educated class of the society as compared to conventional banks. University graduates respondents of Islamic banks represent 64.3 percent as compare to the 34 percent of conventional banks respondents. While, high school graduate respondents at conventional banks are 38.67% as compare to 5.33% in Islamic Banks. Private employees and businessmen are more in numbers in Islamic banks as compare to conventional banks. While t h e n u m b e r s o f s t u d e n t s a n d government employees are more in the conventional banks.
4. Your Monthly Income? Rs. 7000-10,000 Rs. 10,001- 20,000 Rs. 20,001- 25,000 Above Rs. 25,000

The result of this question shows that Islamic banks are more popular in highlevel income groups of the society, while conventional banks are more popular in low-level income groups.
5. For which purpose you use this bank?

Investment/ Savings Borrowings Other The distribution of account holders in both types of banks is symmetric. Although the purposes distribution is not very clear, yet conventional bank have more numbers of respondents at their services section.
6. Do you understand the key concepts of Islamic banking?

Yes No There was unexpectedly high percentage of the conventional bank account holders or visitors who were well aware of the Islamic banking concepts. On
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the other hand, as oppose to our expectations 11 of the Islamic bank respondents were not aware of the concepts of the Islamic banking. This result shows that Islamic banks did not explained well the concepts of Islamic banking to their customers. And this result was of opposite to expectations, that Islamic banks enhance the awareness and education both in economic as well as religious matters and support the religious resurgence for the community
7. If you have an opportunity to open an account with Islamic bank, would you transfer your account to Islamic bank?

Yes No No reply I got very supportive response for transfer of their financial activities from conventional bank Islamic bank.
8. Would you please tell us the reason for the transfer of your account?

RIBA Higher profit Other Peoples want to transfer their bank dealings from conventional banks to Islamic banks because of religious background as well as higher profits as shown by the annual financial reports of both kinds of banks.
9. Would you continue to deal with Islamic bank even if its services charges are higher than the conventional banks?

Yes No No reply This question also shows an affectionate attachment of the people for Islamic baking. Even in the case of higher bank charges peoples are willing to continue their dealings with Islamic bank.
10. Islamic Banks can contribute more to the societal balance, human prosperity and welfare. Do you agree?

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Agree Disagree Dont know The replies of above question show that peoples in Pakistan expect that Islamic banks are more helpful for economic development, societal balance and human prosperity. It is also verdict from the injunction of Shariah rules that Islamic financial institutions are obliged to participate in the equal distribution of wealth, human prosperity and equal economic development This research study is result of a pioneer fieldwork conducted so far on Islamic Banking in Pakistan. Therefore, the results should be taken only as indicative and perceptive rather than conclusive. It is hoped that further empirical or theoretical studies will be done to draw more definitive realities.

Conclusion
In a system based on profit and loss sharing, it is to the advantage of banks and financial institutions to invest in those projects where higher rates of profits are anticipated. The Islamic banking system, therefore, induces savings and capital formation and lead to optimum allocation of resources. Islamic banking is a part of over-all value system of Islam. It is, therefore, imperative that simultaneously genuine efforts are made to ensure that the people are imbued with honesty of purpose and their actions conform to Islamic values. The basic values that Islam seeks to establish are: (a) Freedom (b) Brotherhood (c) Equality (d) Justice (e) Trust i.e. treating the God given capabilities and resources as trust. (f) Honest Consciousness i.e. sense of responsibility and care for ones obligations. It emerges from all this that Islamic banking has following distinguishing features: (a) Islamic banks deal with money and do not deal in money, (b) it is interest- free, (c) 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, (d) it is multi-purpose and not purely commercial, (e) it is strongly equity-oriented, and (f) Value erosion of capital due to inflation is compensated. Islamic have to develop the new modes of finance. That included a lot of work to formulate new contractual arrangements on both their asset and liability sides. They can participate and make use of such new and innovative techniques that would help them better serve their customers.
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Islamic banks like all other modern conventional banks under interestbased system have to remain competitive and tailor their services and products according to the needs and requirements of their clients, ensuring that the products designed by them remain within the framework of Shariah.

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Bibliography
Author. (November-December ,1995). Principle of Islamic Banking. Nida'ul Islam Magazine, 10th issue. Mishkin, S. Fredevic (1995). The Economic of Money, Banking and Financial Markets. Khan, Abdul Wadood. (1999). Interest Free Banking:Lahore. Khawaja, Abdul Haleem . (1994). Economic Theory Lahore: Naveed Publications. Siddiqi, Najatullah, M. (1983). Banking without Interest. Leiscester: the Islamic founded on, UK. Khan, Ikram, M. (1992). Islamic Banking in Pakistan: Lahore Taqi Usmani, M .(1998). An Introduction to Islamic Finance. Idaratul Ma'arif: Karachi, Pakistan Uzair, M. (2001). Interest Free Banking : Royal Book Company Karachi. State Bank of Pakistan (2009) Quarterly Report on Islamic Banking Dawn economic & business review, 2003. Electronic sources: http://www.islamic-banking.com/ibanking/whatib.php www.alrajhibank.com.sa/islamicebanks.html http://www.islamicconferences.com http://www.islamicbanking-finance.com http://www.islamic-finance.net http://www.albaraka.com/islamicinfo/islamicbooks/instruments/table.ht http://www.worldbank.org/fandd/english/0697/articles/0140697.htm http://www.islamic-economics.com http://www. riba-free-economy.com http://www.interest-free commercial banking.com http://www.gdrc.org/icm/islamic-banking.html

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ANNEXURES
YEAR WISE ENTRY OF ISLAMIC BANKS 2003 1. Meezan Bank 2. Bank of Khyber 3. MCB Bank 4. Bank Al-Falah 2004 1. Albaraka Islamic Bank 2. Habib Bank AG Zurich 3. Standard Chartered 4. Metropolitan Bank 5. Soneri Bank 2005 1. Habib Bank 2. Bank Al Habib 2006 1. Dubai Islamic Bank 2. Bank Islami Pakistan 3. ABN Amro N.V. (Now RBS Bank) 4. Askari Bank Ltd. 5. National Bank 6. United Bank Ltd. 2007 1. Emirates Global Islamic
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2. Dawood Islamic Bank Questionnaire

1. What is your age? 18-30 31-40 41-50 51-60 Above 60 2. Gender? Male Female 3. Educational Qualification? Matric Intermediate Graduate Masters Above masters 4. Your Monthly Income? Rs. 7000-10,000 Rs. 10,001- 20,000 Rs. 20,001- 25,000 Above Rs. 25,000

5. For which purpose you use this bank? Investment/ Savings Borrowings Other 6. Do you understand the key concepts of Islamic banking? Yes No 7. If you have an opportunity to open an account with Islamic bank, would you transfer your account to Islamic bank? Yes
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No No reply 8. Would you please tell us the reason for the transfer of your account? RIBA Higher profit Other 9. Would you continue to deal with Islamic bank even if its services charges are higher than the conventional banks? 10. Yes No No reply Islamic Banks can contribute more to the societal

balance, human prosperity and welfare. Do you agree? Agree Disagree Dont know

Name:____________________________ Cell #:_____________________________ Occupation:______________________ Comments:_______________________ ___________________________________

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