LEGAL issues confuse profit in Islamic banks with the concept of interest in conventional banks, charity and computational methods.

Generally, Pakistan Banking Courts (PBCs) ensure fair and just treatment in Islamic banks’ disputes. In most of the recovery suits, Islamic banks are entitled to only principal amounts due from a defaulting customer. However, inconsistencies occur, particularly with regards to treatment of profits.

In some cases, the courts have recognised the distinct nature of Islamic financing structures and entitled Islamic banks to profits accruing from the principal amount. For instance in one of the recovery suits, an Islamic bank filed a suit for recovery of Rs 8.7m against the defendant firm.


Generally, Pakistan Banking Courts ensure fair and just treatment in Islamic banks’ disputes. However, inconsistencies occur, particularly with regard to the treatment of profit


The defendants failed to fulfill their contractual obligations under the Master Murabaha facility agreement and the suit amount was payable by them as per complaint.

The defendant challenged the authority of the plaintiff to file the suit, legality of the documents forming part of the plaint and delayed disbursement of the amount by plaintiff. The court found that the defendants could not prove their allegations in law and through facts supported by appropriate evidence.

The court, therefore, issued a decree in favour of the plaintiff for the recovery of Rs8.9m principal account and Rs0.6m as profit outstanding, adding to a total amounting to Rs8.7m.

Nevertheless, there are instances when courts did not recognise profit as a distinct feature of Islamic banks. Instead, the profit was treated as interest in the court. It seems the judges did not appreciate the distinct structure of the Islamic banking transaction.

Profits which the Islamic bank charged could not be distinguished from the interest/markup that the conventional banks charge. Thus, the courts allowed Islamic banks to recover the principal amount whereas profits were denied.

The Islamic bank filed a suit for recovery of around Rs4.8m to be recovered from defendants. The dispute involved Master Murabaha facility for purchase of auto parts. Plaintiff alleged that the defendants failed to discharge their duty in terms of Master Murabaha and sub-Murabaha agreements.

The allegations made by the defendant are as follows:

Defendant challenged the enforceability and admissibility of the documents annexed with plaint. They accused the bank with the charge of forgery.

Defendant claimed that the bank committed fraud upon defendants, as all the documents including sanction advices, finance agreement, letters of guarantee and mortgages did not bear the defendant’s signature.

Defendant also challenged the authority of the plaintiff’s representative counsel to file the suit.

It was also alleged that the statement of accounts annexed with the plaint was neither verified nor signed as required under Section 2(8) of the Banker’s Book Evidence Act 1891.

Finally, the defendant claimed that the Murabaha roll over transaction was not permissible under Islamic mode of financing. They further claimed that interest could not be charged on Murabaha transaction but the plaintiff included interest in its claim.

The court found that defendant could not prove their allegations with appropriate evidence except for the last one. The court entitled the plaintiff a decree for the recovery of around Rs4.1m. This included the principal amount, cost of funds and cost of suit.

However, this amount did not include the profits i.e. around Rs0.7m claimed by the plaintiff. The court confused the plaintiff’s claim relating to profits with markup after due date of default.

In Islamic banks, charity is payable by defaulting party to prevent frequent and willful defaults. The Islamic bank ensures the charity is disbursed to the deserving third party. The courts are reluctant to allow Islamic banks recover the charity amount from their customers.

There is some confusion as to the interpretation of the charity clause in the agreement as well as charity being considered non-Islamic by the courts. The issues related to charity needs to be effectively addressed.

Additionally, Islamic banking facilitates transactions based on distinct financial structures. These structures are not generally known to judges, who compute recovery amount based on conventional banking transactional structures.

In their computation, the judges eliminate profits and charity, which results in financial losses and increases the credit risk for Islamic banks.

Finally, issues arise from the violation of the State Bank of Pakistan’s regulatory guidelines. When some judges deny the Islamic banks’ use of KIBOR as a benchmark rate.

To resolve these legal and regulatory issues, following recommendations are made.

It is essential to create consistency in courts’ treatment of Islamic banks’ profits. The issue of profit being confused with markup and markup after due date can be overcome through appropriate training of all stakeholders in the court of law. These include legal advisors of Islamic banks, lawyers and judges.

The concept of charity and charity clause in Murabaha transactions and other modes of financing need clarifications. It is essential that courts appreciate the concept and purpose of charity in Islamic banking transactions.

At the same time, Islamic banks also need to ensure that the charity clause in their agreements is unambiguous and easy to understand.

The Federal Judicial Academy needs to ensure the administrators of justice are well equipped with appropriate skills and knowledge on Islamic banking transactional structures.

Ahmed Ali Siddiqui is a director at Centre for Excellence in Islamic Finance, IBA. aasiddiqui@iba.edu.pk

Dr Faiza Ismail is a research consultant at CEIF. fismail@iba.edu.pk

Published in Dawn, Business & Finance weekly, October 17th, 2016

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