Elimination of riba from the economy and islamic

Elimination of Riba from the
economy and islamic modes of
financing
Adnan Sattar Khan
Adnan Ahmed
Muhmmad Hassaun
Hammad Hamid

Sequence of events
 Started when President Zia-ul-haq in
September 1977 asked the Council of
Islamic Ideology to prepared a
blueprint of interest free Islamic
economy.
 The council appointed a panel of
economist and bankers in November
1977.
 A report submitted in February 1980.
 An amended report was adopted in
June 1980.

Commercial Banking
a) Financing Operations
1. Industry
2. Agriculture
3. Commerce sector
4. Construction
5. Transport
6. Other sectors
7. Personal loans
b) Deposits
c) Miscellaneous Transactions

Industry
 Fixed Capital Investment

 Working Capital Investment

Industry – Fixed Capital
Investment
Current System Proposed System

 Term loans 1. Firm which maintain
accounts audtied by
 Debentures Chartered Accountants
◦ Profit & Loss
 Participation in
2. Firms which maintain
underwriting accounts but are not
 Bridge financing audited by Chartered
Accountants
 All include interest ◦ Hire-purchase, Bai Muajjal
& Leasing
3. Smaller firms who do not
maintain proper accounts
◦ Normal rate or return, Bai
Muajjal & Hire-purchase

Industry – Fixed Capital
Investment
 For the proposed system to be
successful, monitoring by the banks of
the actual performance of the concern
is required.
 Should be able to inspect the projects
and call for any information and books
of accounts.
 My also appoint a director on the
Board.

Industry – Working Capital


 Grant of demand loans 1. Firm which maintain
accounts audited by
 Cash credit
Chartered Accountants
 Overdraft ◦ Profit & Loss sharing on
 Opening of import LCs daily product basis.

 Discounting of bills 2. Firms which maintain
accounts but are not
 All include interest audited by Chartered
Accountants
◦ Bai Muajjal & Normal rate
of return.

Agriculture


 Minimal involvement by 1. Short term
commercial banks. Upto subsistence level
 State Bank fixes every ◦ Financing under Special
year mandatory targets Loans Facility. Repay only
for commercial banks for principal.
agri loans. Exceeding subsistence level
 State Bank shares with ◦ Financing under Bai
commercial banks 50/50 Muajjal & Bai Salam
losses on these loans.
 All loans were interest
bearing until recently.

Agriculture


 Minimal involvement by 1. Medium and Long term
commercial banks. ◦ Plough Cattle
 State Bank fixes every ◦ Dairy and Poultry farming
year mandatory targets ◦ Land improvement and
for commercial banks for development
agri loans.
◦ Purchase of tractors,
 State Bank shares with installation of tubewells,
commercial banks 50/50 digging of Karezes, and
losses on these loans. construction of storage
 All loans were interest facilities.
bearing until recently.

Commerce Sector


 Demand loans 1. Retailers who do not
 Cash Credit maintain book of
accounts
 Over-draft facility
◦ Financing under Bai
 Opening of import LCs Muajjal & Special Loans
 Bill discounting Facility

 All include interest 2. Retailers who maintain
book of accounts
◦ Same as working capital
requirements for Industry.

Construction

Proposed System

 Financing of construction
companies, both fixed capital
investment and working
capital may strictly be on PLS
basis.

Transportation

Proposed System

 Financing under hire-
purchase or Bai Muajjal
arrangements.

Other Sectors

Proposed System

 Financing under PLS for
other sectors.
 Finance under Bai Muajjal or
investment Auctioning for
purchase of capital good &
machinery.

Personal Loans
 Under Islamic system a needy may
not be expected to borrow because it
is the state‟s duty to assist them.

Personal Loans


 All personal loans are 1. Interest free loans for
interest bearing. students.
2. Financing under Bai
Muajjal and Hire
purchase for consumer
durables.
3. Financing under
Federal Zakat Fund for
calamity-stricken areas.

Deposits
 Switch over should be gradual
 Deposits may be accepted by the
bank under the existing system for a
transitional period to avoid adverse
effect on depositor‟s confidence.

Deposits


 Uniform and fixed return 1. Fixed return on savings
& time deposits be
replaced by variable
return.
2. In order to provide with
uniform returns, profits
of all banks be pooled
for distribution to
depositors.

Miscellaneous Transactions
1. Inter-bank transactions
2. Financial assistance from State Bank
3. Foreign transactions of banks
involving interest.

Inter-bank transactions &
Financial assistance from State
Bank

 All transactions are 1. Transactions under PLS
interest bearing. arrangements are
recommended on the
basis of daily products.

Foreign transactions of banks involving
interest.

 Foreign branches of Pakistani banks
would have to conduct business on
interest basis.
 Foreign deposits on local banks
would also continue to earn interest.

Foreign transactions of banks involving
interest.

 In order to avoid merger of interest
income with non-interest income, the
administration of foreign branches of
Pakistani banks and foreign currency
deposits held with local banks be
entrusted to a separate Corporation.

Chapter III

Specialized Financial Institutions

1 )Pakistan Industrial Credit and
Investment Corporation ( PICIC)
 PICIC was established in October, 1957
 PICIC provide finance to the private industrial
sector
◦ Long term loans
◦ medium term loans
 Public limited company with paid up capital of Rs.
79.68 Million
◦ 65% held by private investors and financial
institutions of Pakistan
◦ 35 % held by foreign investor

 Interest

Assets Liabilities
Debenture purchased Debentures Issued
Loans in foreign and local Long term rupee borrowing
currency
Deposits held with bank Line of credit in foreign currency

Borrowings from banks
Borrowings from SBP

 The council recommended the elimination of
interest from PICIC‟s operations
◦ Portion of share capital held by foreign
investor
◦ Interest based debentures was replaced by
participation term certificates
◦ PICIC can only hold its time deposits with
bank on PLS basis
◦ Underwriting arrangements was replaced by
„Firm commitment‟ underwriting which is
compatible with sharia.

 Governtment loans should be converted into
Government investment on PLS basis or
replaced by PTC‟s to be issued by PICIC to the
Government
 alternative for the loans from World bank,
Asian development bank and other agencies
conforming with sharia.

Industrial Development Bank of Paksitan
(IDBP)
 Established in august 1961
 Provide long term and short term loans.
◦ For acquiring fixed assets
◦ Working capital requirement
 Bank had a paid up capital of 50 million held entirely
by Federal Govt.
 Apart from share capital other bank resources
consist of:
◦ Deposits from the public
◦ Borrowings from SBP, Federal Govt. and world bank
 The nature of business is similar to PICIC so
changes required would be similar to PICIC.
 For deposits and working capital changes required

National Development Finance Corporations
(NDFC)
 Established in 1973 to provide financial and
technical assistance.
◦ Establishment of new enterprises
◦ Expansion of existing enterprises
 Functions of corporation includes:
◦ Provision of medium and long term loans in foreign and
local currencies.
◦ Provision of loans for working capital requirement.
◦ Equity participation
◦ Purchase of debenture
◦ Underwriting
◦ Issue of guarantee for local and foreign currency loan
◦ Participation in loan syndication.

 Share capital 120 million
 Held entirely by Government of Pakistan
 Other resources
◦ SBP
◦ Deposits of fixed maturities
 Interest
Assets Liabilities
Loans advanced Borrowings
Debenture purchased Deposits accepted
Deposits held with commercial
banks
 Operations same as PICIC and Commercial banks
so changes should be similar to those.

 Other recommendations
◦ Cash credit from SBP on PLS basis.
◦ The new deposits should be accepted on PLS
basis where as previous deposits continues on
previous terms.

Agriculture Development Bank of Pakistan
(ADBP)
 Established in 1961 by merging the agriculture
Development finance corporation (ADFC) and
Agriculture bank of Pakistan (ADP).
 Provide loans to individuals and corporate bodies
engaged in Agriculture and for development of
agriculture
 Bank provides short, medium and long term loans.
 The banks financial resources consist of its capital
and reserves, different type of deposits and
borrowings from domestic as well as foreign
resources

 ADBP interest payments are on deposits,
borrowings from SBP and loans from international
institutions.
 After elimination of Interest:
◦ Rules for accepting deposits should be same as those for
commercial banks.
◦ Loans accepted from SBP should be on PLS basis

Small business finance corporation (SBFC)

 Previously known as the people finance
corporation (PFC).
 Established in 1972 to provide financial assistance
to persons of small means.
 Its provide finance on interest basis to all type of
small businesses.
 The firm was authorized to provide loans upto a
maximum limit of Rs.50000 to individuals and firms
 150000 Rs of loan to cottage and small industries.
 The paid up capital of the firm was 70 million:
◦ Federal Govt. 30 m
◦ SBP 9.6 m
◦ Nationalized commercial bank 30.40 m

 It was suggested that corporation provide finance
on hire purchase “bai mujjal”.
 Other interest bearing transactions of the firm was
◦ Deposits with banks
◦ Borrowings
 Rules similar to commercial banks should be
applied.

Equity Participation Fund

 Established in 1970 with special legislation.
 To promote the small and medium industries of
less developed areas
 The fund was administered by the IDBP and
empowered to provide equity support
 50 million paid up capital
◦ Federal Govt. 20 m
◦ 10 m each by SBP, provincial Govt and
institutional investors.
 Firm Should adopt the “firm commitment”
underwriting to avoid the Bridge financing on
interest bearing.

Insurance Companies

 Council said the existing system of insurance, is
not only involved the interest but also the element
of gambling.
 Council suggested that
◦ Both life and general insurance should be organized on co-
operative lines.
◦ Income from premium should be invested in profitable
business
◦ Annual profit so earned should be reserved for the
distribution among the members.
◦ At the time of maturity the insured should be entitled of
principal along with the profit to his credit if any

Central Bank and Monitory
Policy Cash Reserve Requirement
• Minimum
• State Bank Penalize banks through provision not involving
interest rate.
• Liquidity Ratio Requirement
• Overall Ceiling on the Landing and Investment
Operation of Bank
• Fine Should Related to the Quantum of Excess over Credit
Ceiling Instead of Interest
• Mandatory Targets for Providing Finance to Priority
Sectors
• Selective Credit Control
• Profit and Loss Sharing Basis
• Contribution of Parties

• Issue of Direction
 Interest Margins Replace by Profit & Loss Margins
• Moral Suasion
• Bank Rate
 Distributable Profits
 Apply weight to the investments
 Calculate Profit Ratios and distribute profit
• Open Market Operation
 State Bank Issue Securities Based on Profit and Loss
Sharing
 Provides Loan to Federal and Provincial Government on
Interest free basis
• State Bank as Bank of Issue
 Dealing with international financial institution
 Miscellaneous domestic transction

1. Internal Borrowings of the Federal and
Provisional Governments.
 Market loans
 Treasury bills
 Loans and advances by State Bank to Government
 Inter-Government Loans.

2. Government borrowings from external
sources.
3. Provident funds.
4. Taccavi loans.
5. Loans to government employees.
6. Charge of penal interest rates.

Summary and conclusion
 The elimination of interest occupies a key
position in the establishment of the Islamic
order.
 Next step for the government is to set up
various working groups.
 Country is poised for the introduction of
the interest-free banking system.

 The real alternatives to interest under an
Islamic economic system are profit/loss
sharing or qard-i-hasan.

Elimination of riba from the economy and islamic

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