Pakistan’s banking landscape is on the verge of an incredibly dramatic transformation. In 2022, the Federal Shariat Court (FSC) declared that interest must be phased out of the economy by December 2027, turning an old debate into a deadline. Soon after, the 26th Constitutional Amendment reinforced this mandate by requiring the state to eradicate interest from the economy by January 1, 2028.

Together, these decisions have turned what was once an aspirational debate into a constitutional obligation. Pakistan is no longer merely considering whether to Islamise its financial system; it is bound by both the judiciary and the Constitution to do so.

The stakes could not be higher. On one hand, Islamic banking in Pakistan has displayed robust growth with assets now exceeding Rs11.5 trillion, nearly a quarter of the banking sector. Yet with this progress, the financial system still remains heavily reliant on interest-based laws, debt instruments, and institutional frameworks. Without urgent reforms, Pakistan risks missing its constitutional deadline, facing legal uncertainty, and losing international investor confidence.

The dual banking framework introduced in the early 2000s allowed Islamic and conventional banks to coexist. This provided choice and market development, but also created a halfway system. Two decades later, most financial statutes — including the Banking Companies Ordinance (1962), Public Debt Act, Financial Institutions (Recovery of Finances) Ordinance, 2001 and the State Bank of Pakistan Act — still assume interest-based contracts.

Comprehensive Islamic financial laws to consolidate provisions, and ensure enforceability in courts are necessary if the state hopes to switch to Shariah-compliancy

This legal ambiguity hampers dispute resolution, increases risk, and undermines investor confidence. Without decisive action, legislators risk weakening both policy clarity and their own credibility.

Islamic finance is not conventional finance minus interest; it is an entirely different system of contractual relationships based on trade, partnership and rental arrangement backed by risk sharing and real economic transactions. For example, a Murabaha sale is not a loan and a Mudarabah based deposit is not a liability but a form of equity. These differences must be recognised in statutory law with clarity.

Countries like Malaysia and Brunei have embedded Islamic contracts into their legislation and empowered centralised Shariah boards to give binding rulings. Pakistan must follow suit by enacting a comprehensive Islamic financial services and banking law to consolidate provisions, clarify rights and obligations, and ensure enforceability in courts.

A glaring contradiction lies at the heart of Pakistan’s financial management: while courts and the Constitution mandate elimination of interest, the government continues to rely heavily on Treasury Bills and Pakistan Investment Bonds — both conventional instruments.

Although in recent years, the Ministry of Finance has geared up a 10-year Sukuk issuance plan to raise close to Rs6tr, the issuance is still insufficient keeping in the view the public debt volume. A legal framework must mandate Sukuk as the primary tool for deficit and budget financing, with diverse structures like istisna‘a for infrastructure, salam for agriculture, and wakalah for pooled investments.

While 2027-2028 may seem distant, legislative processes are slow and drafting, debating, and passing financial reform bills can take years

Embedding these structures into law would broaden participation by pension funds, retail investors, and foreign Islamic funds — deepening the capital market and reducing reliance on interest-based borrowing.

Legal reforms are meaningless without effective enforcement. Today, most financial disputes are handled by courts or tribunals where judges often lack expertise in Islamic finance jurisprudence. This leads to inconsistent rulings and prolonged litigation.

Pakistan needs Specialised Shariah Finance Tribunals (SFTs) with judges trained in both modern commercial law and Islamic jurisprudence.

A legislatively empowered Centralised Shariah Supervisory Board (CSSB) is urgently needed. Binding rulings would harmonise practices across the industry, standardise contracts, and will guide government, central bank and judiciary while protecting consumer confidence.

The FSC ruling and the 26th Amendment have placed lawmakers at the centre of this transition. Yet, awareness in Parliament about the technical, legal, and economic implications of eliminating interest remains limited.

Timely, well-informed legislative action is essential to avoid last-minute improvisation that could destabilise the economy. Lawmakers should therefore prioritise hearings, consultations, and debates to build consensus around the required reforms.

While 2027-2028 may seem distant, legislative processes are slow. Drafting, debating, and passing financial reform bills takes years. Waiting until the last moment risks rushed reforms that could cause liquidity shortages, legal disputes, and investor flight. A phased legal transition over the next two to three years is the only sustainable path.

To meet its constitutional and judicial obligations, Pakistan must, first, enact an Islamic Financial Services Act to consolidate provisions and ensure enforceability. Second, Mandate Sukuk for government borrowing. Third, establish a CSSB with binding authority. Fourth, set up SFTs for swift and consistent dispute resolution.

This transformation to Islamic finance could also position Pakistan as a global hub in a $5tr Islamic finance industry. With legal certainty, investor protection, and competitive products, Pakistan can attract substantial domestic and foreign investment.

The 26th Amendment and FSC ruling are historic opportunities. The question is not whether Pakistan will transition to Islamic finance — but whether it will do so proactively, with foresight and confidence, or reluctantly, under crisis and pressure.

With political will and legislative vision, Pakistan can meet its constitutional mandate and emerge as a leader in Islamic finance. But delay risks leaving the nation stranded halfway across the bridge. The time for lawmakers to act — and to act boldly — is now.

Ahmed Ali Siddiqui if the Founding Director of IBA CEIF and can reached at (aasiddqui@iba.edu.pk)

Dr Maqbool Hassan is an Industry Fellow at Meezan Bank and Assistant Professor Bahria University

Published in Dawn, The Business and Finance Weekly, October 6th, 2025