THE government’s approach towards Islamic banking has undergone a radical change. Pakistan has worked with two models of Islamic banking, one introduced by General Zia and the other inducted by the present government.

It may be mentioned at the outset that it is a misnomer to call them, or for that matter any other model any where, Islamic. They are, at best, interest-free banks and do not, by any means, qualify to be termed Islamic. They do not abide by the basic Islamic values and injunctions but, in fact, blatantly dare defy them.

They are not supposed to finance economic activities, which are prohibited by Islam, but they would not care. Islam has sanctified debt and there are very strict detailed instructions to repay the debt. The debt owed by an affluent person in particular must be recovered, even if harsh means have to be employed.

The way the banks in Pakistan are merrily writing off, without going through any due legal process of bankruptcy, their loans to the rich with a lot of clout in government or outside, is totally un-Islamic. It is not the banks’ own money (equity), which is lost but that of the public, hence a serious breach of trust.

This demands that banks keep balance between the interests of depositors and borrowers, mainly in terms of return, to ensure justice in its true spirit.

In sharp contrast to this principle, banks in Pakistan serve as an active and effective mechanism for exploitation of depositors to benefit the big borrowers and also to fatten themselves, all at the expense of the depositor who often is a small saver. This has been well known but now has been publicly conceded by none other than the State Bank Governor.

At a recent annual meeting of the Institute of Bankers Pakistan, he has bemoaned the miserable plight of the depositors. Inflation at 9.3 per cent during FY05, weighted average rates of advances at 8.41 per cent and deposits at 1.85 per cent and the spread between the two rates, benefiting the banks, at 6.56 per cent speak volumes of the plight of depositors.

Small deposit-holders fare much worse as the banks have individually prescribed minimum balance, often quite high for a poor country, below which no return is given, instead a service charge is imposed.

It very interesting and significant that in the huge literature on Islamic banking there is no discussion, worth the name, of the status of bank depositors. Islamic banking has been primarily pushed by the well-organized and influential lobby of borrowers, who expect cheap, if not free credit. This largely explains the nebulous position of the depositor.

Taking the case close at home, bank depositors maintain profit and loss sharing accounts. Whose profit and loss do they share? Banks or their borrowers? It is neither and depositors are at the mercy of banks, who dole out practically nothing in real terms, if at all they do so.

What is the status of bank visa-a-vie the depositor? Is the bank a trustee or a borrower or a partner? There are many more questions awaiting answer. Islamic scholars and bankers have been pre-occupied with the assets side of the banking. It is time they also focus their attention on the equally important liabilities side of banks to provide a just treatment to depositors, most of whom are small men.

The government of Pakistan has decided to introduce Islamic banking in Pakistan in a pragmatic manner, as a parallel banking system, comparable and compatible with the conventional banking.

In the long term, the government assumes that the people of the country will ‘vote through their wallet.’ The choice and responsibility is then of the people of Pakistan.”

“The major issue in implementing Islamic banking in or legal issue. However, experience has shown that this approach has always met with failure or at best with very limited success.”

“In the current model, the State Bank of Pakistan (SBP) took two significant key decisions. First, it decided to commit itself to promoting Islamic banking in Pakistan. Second, to change the approach.

Now, it looks at Islamic banking as a change management issue which needs to be implemented in gradual manner keeping in mind the parameters of change management, which are very different than the parameters of managing a religious or a legal issue.

Another important consequence of the change in the approach is that SBP is focused on making sure that implementation of Islamic banking is market driven. To ensure this, regulations that have been promulgated are also market driven and reflect the needs of the key stakeholders of this sector.”

“The five pillars of the Islamic banking model are: A flexible entry to the industry that allows banks to choose the structure that suits them the most in terms of their business strategy, their current structure and their cost structure. It also allows a bank to upgrade its position by moving from the simplest option to a more comprehensive solution.

The three levels of entry are a. Full fledged Islamic bank, b. Islamic banking subsidiary of a conventional bank. c. Stand alone Islamic banking branches of a conventional bank.

A Shariah compliant framework consists of the following components (a) A central Shariah Board for the country at SBP that advises SBP on the Shariah ruling or Shariah disputes referred to it by SBP. The Shariah ruling that SBP adopts will become binding on all banks. (b) Appointment of Shariah Advisory Board in Islamic banks\Islamic banking branches for ensuring Shariah compliance in product development,policies and procedures and periodic internal Shariah review.

Basic structures and essentials of Islamic modes of financing approved by the Shariah Board of SBP. These guidelines\essentials will be promulgated as Prudential Regulations in due course of time. SBP is currently in the process of inviting the views and suggestions from all stakeholders, particularly the Shariah scholars, academics, bankers and the business community. These essentials do not preclude the possibility of developing new modes or instruments of financing, modification or variants of the modes by financial institution provided these are Shariah compliant.

Model agreements for major Islamic modes with dual objectives of facilitating the existing Islamic banking sector and the potential market players to develop Islamic banking products in particular and to create awareness about Islamic banking products in general.

Model agreements for following modes have been provided by SBP: Murabaha facility agreements, Musamwah facility investment agreement, lease agreement, salam agreement, musharaka investment agreement, istisna agreement, agreement for interest-free loan, Mudaraba financing agreement, and syndication Mudaraba agreement.

These model agreements can be modified according to the products designed by the banks conducting Islamic banking business, with the approval of their Shariah Adviser. The SBP Shariah Board continues to review more model agreements, which will be made available to the banks for use. These model agreements will also ensure harmony in documentation of Islamic banks.

Shariah Compliance Audit of SBP: Another major step for ensuring Shariah compliance of Islamic banking operations is the Shariah compliance audit by SBP on a yearly basis as part of on-site inspection of Islamic banks.

A supporting system has been put in place for the Islamic banking model, which includes setting up of Islamic banking department in SBP, in place of Islamic Economics Section in its Research Department, as part of an effort to change taxation laws, introduction of accounting standards and integration of the model with the global economy.

For product diversification, it is mentioned, “Many banks do not have the diversity of products essential to satisfy the growing needs of their clients such as structured instruments for financing trade, leasing and money market instruments. Many of them also need to develop the necessary expertise and institutional capacity for research and development, which would allow them to develop the needed products.

“Now the banks are taking the lead by developing new deposit and financing schemes. However, more work needs to be done especially for short-term liquidity management by these banks. A Modaraba based inter-bank money market product is under development, which can be used once there is a significant number of Islamic financial institutions in the market.”

By way of summing up, it is said, “as this industry is in its very initial stages, its share in the banking sector is currently negligible. Nevertheless, keeping in view the trends, it has a promising future.”

One cannot avoid the strong immediate impression that the new model of Islamic banking has been designed, rather blindly copied, for the country where the conventional interest-based banks are operating and the public is to be given a choice of Islamic banking. This ignores the ground reality in Pakistan where, with complete Islamization of financial system in 1985, the conventional banks are not supposed to exist.

One thought can be that, may be, General Zia’s model of Islamic banking is taken as nothing more than conventional banking. Yet another idea can be that, may be, conventional interest-based bank may be allowed to be set up to provide a parallel banking giving the choice to the public. In any case, the situation is ambiguous and quite confusing.

The SBP would be rendering a great service to the public if it publishes complete data pertaining to the operations of the banks and financial institutions set up or converting to General Musharraf’s model. SBP has never given the break up of bank advances by the approved 12 modes of financing.

As regards the new products to be introduced, the situation is already extremely tricky. The SBP has been compelled to issue warning to financial institutions not to deceive the public through the clauses of the new schemes written in “very fine print” at some odd inconspicuous place in the contract. The State Bank Governor, at the IBP meeting mentioned above, has warned the banks of dazzling temptations.