What is a Digital Account? >
A Digital Account is a bank account that can be opened online through the RAQAMI mobile app without visiting a branch. Any eligible individual with a valid CNIC, active email address, registered mobile number, can open a Digital Account. This facility is currently not available for corporate entities, or minor accounts (below 18 years of age)
What are the eligibility criteria for opening a Digital Account? >
To open a Digital Account, the applicant must be a natural person (not a company) and a Pakistani resident holding a valid CNIC. In addition, the mobile number used for registration must be issued under the applicant’s own CNIC is required to complete the onboarding process.
How can I open an RIBDL Account? >
- Download and install the RAQAMI mobile app.
- Enter your CNIC, CNIC issuance date, and registered mobile number.
- Verify the OTP (auto-fetched on your device).
- Set your secure MPIN.
- Complete biometric verification (fingerprint, or fallback to facial/liveness verification if required).
- Confirm your details and accept the Terms & Conditions.
- If all checks are successful, a Level 1 account will be created instantly.
What documents are required to open a RIDBL Account? >
Valid CNIC (mandatory for biometric verification).
For account upgrades to higher levels:
- Proof of Income (e.g., salary slip, employment letter).
- Proof of Profession (employment certificate, business registration).
- CNIC front and back image
What does mobile ownership refer to? >
It ensures that the mobile SIM number used for account opening is registered under your CNIC. This is verified through the PMD CNIC–MSISDN pairing check during onboarding and upgrades.
Are there any limits on Digital Accounts? >
Yes, transaction limits are defined as per account level and SBP regulations:
- Level 1 (Basic Digital Account): Limited transactions and balances.
- Asaan Digital Account: Higher limits designed for specific customer needs.
- Full Digital Account: Offers full transactional limits like a regular account.
Can I open a Digital Account with an expired CNIC? >
No. Your CNIC must be valid. If expired, you will be required to renew your CNIC and restart the onboarding process.
Are overseas Pakistanis eligible for this account? >
Currently, only resident Pakistanis are eligible under current onboarding rules.
Is my Digital Account secure? >
Yes, your Digital Account is secure. Multiple security controls are in place, including OTP verification linked to your registered mobile number and email, a secure MPIN for login and transactions, and biometric verification through NADRA. In addition, all activity on your account is protected by advanced encryption and continuous monitoring to safeguard your information and funds.
Is this service available 24/7? >
Yes. You can open and manage your Digital Account anytime through the RAQAMI mobile app.
Are there any charges for opening a Digital Account? >
No. The Digital Account opening and upgrade process is free of cost.
Is my account opened immediately after submitting the form? >
- Level 1 Account: Created instantly upon successful biometric verification and screening.
- Asaan Digital Account: Opened instantly upon facial/liveness verification and screening.
- Full Digital Account: Activated after document submission and back-office approval.
How can I track the status of my Digital Account application? >
You can view your application status in the RAQAMI mobile app. Push/SMS/email notifications are also sent if further documents or actions are required.
What should I do if I don’t receive the OTP on my mobile or email? >
If you haven’t received the OTP, first check that your mobile number and email address are entered correctly and that your SIM is active to receive SMS. Sometimes delays can occur, so you may try again after a short while. If the problem continues, our customer support team will be happy to assist you.
How can I close my Digital Account? >
You can close your RIDBL Account by first ensuring that your account balance is zero. Once confirmed, simply call our Help Centre to place a closure request. Our support team will guide you through the process and lock your request for account closure.
Can I open a Digital Account if I don’t have access to a smartphone? >
No, a smartphone is required to open and operate a RIDBL Account, as all onboarding and account services are managed through the RIDBL Mobile App.
Can I change my registered mobile number or email later? >
Yes, you can update your registered mobile number or email through the RIDBL Mobile App. For security, you will be required to complete biometric verification during the process, and an OTP will be sent to your new mobile number or email for confirmation
What is Raqami Islamic Digital Bank? >
Raqami Islamic Digital Bank is Pakistan’s first fully digital, Shariah-compliant bank. Our platform is designed to offer seamless, ethical, and accessible financial services that align with Islamic principles. With a customer-centric approach, Raqami aims to empower individuals and businesses by providing a complete range of banking solutions—100% online.
Is Raqami Islamic Digital Bank a bank? >
Yes, Raqami Islamic Digital Bank is a fully licensed digital bank operating under Shariah guidelines. Our banking services are entirely online, making it easy for you to manage your finances anytime, anywhere, without compromising your religious beliefs.
When will the Raqami Islamic Digital Bank App launch? >
The Raqami Islamic Digital Bank app is set to launch soon. In the meantime, you can join our waitlist to be among the first to experience Shariah-compliant digital banking. Sign up now to stay updated!
Which OS will the Raqami Islamic Digital Bank App be available on? >
The Raqami Islamic Digital Bank app will be available for both Android and iOS devices. Whether you’re an Android or iPhone user, you’ll be able to download our app and start banking seamlessly.
How do I sign up for the waitlist? >
Signing up for the waitlist is simple! Just click here to join and be the first to know when our app goes live. You’ll receive early access to the app and exclusive updates on our launch.
What is Raqami Islamic Digital Bank’s Privacy Policy? >
We prioritize your privacy and ensure that your data is protected according to strict industry standards. To learn more about how we handle and protect your information, please review our Privacy Policy.
What is Meant By Riba? >
The word "Riba" means excess, increase or addition, which correctly interpreted according to Shariah terminology, implies any excess compensation without due consideration (consideration does not include time value of money). This definition of Riba is derived from the Quran and is unanimously accepted by all Islamic scholars.
The meaning of Riba has been clarified in the following verses of Quran (Surah Al Baqarah 2:278-279):
“O those who believe; fear Allah and give up what still remains of the Riba if you are believers. But if you do not do so, then be warned of war from Allah and His Messenger. If you repent even now, you have the right of the return of your principal; neither will you do wrong nor will you be wronged.”
What is interest? Is there any difference between interest and Riba? >
The origination of the term “interest” dates back to the 17th century with the emergence of the global banking system. Interest means giving and/or taking of any excess amount in exchange of a loan or on debt. Hence, it carries the same meaning as that of Riba. It is narrated that “the loan that draws interest is Riba.”
There is consensus among Muslim scholars of all schools of thought that interest is Riba in all its forms and manifestations.
What are the different kinds of Riba? >
There are two kinds of Riba:
- Riba-An-Nasiyah / Riba-Al-Quran: In the Holy Quran, Allah (SWT) says in Surah Al-Baqarah (2:279): “And if you repent, yours is your principal.”
The Prophet (peace be upon him) said: “Every loan that derives a benefit (to the lender) is riba.”
Example: If Mr. A lends Rs.100 to Mr. B with a condition that Mr. B shall return Rs.110 after one month, the extra Rs.10 is Riba or Interest.
- Riba-Al-Fadl: Abu Said al-Khudri (RA) narrated that the Prophet (peace be upon him) forbade unequal exchange of commodities such as gold for gold, wheat for wheat, etc., as it could lead to Riba in disguise. This prohibition ensures fairness in trade and prevents exploitation.
What are the revelations/verses in the Holy Quran regarding prohibition of Riba/interest? >
There are four sets of revelations about Riba revealed on different occasions:
- First Revelation: Surah Ar-Rum (30:39) — “And whatever riba you give so that it may increase in the wealth of the people, it does not increase with Allah.”
- Second Revelation: Surah An-Nisaa (4:161) — “And because of their charging riba while they were prohibited from it.”
- Third Revelation: Surah Al-e-Imran (3:130) — “O those who believe, do not eat up riba doubled and redoubled.”
- Fourth Revelation: Surah Al-Baqarah (2:275–281) — “Those who take interest will not stand but as stands whom the demon has driven crazy by his touch... Allah destroys riba and nourishes charities...”
What are the Ahadith about Riba/Interest? >
According to Islamic jurists and scholars, there are around forty Ahadith on the subject of Riba. A few examples include:
- The Prophet (peace be upon him) cursed the receiver and the payer of interest, the one who records it, and the two witnesses to the transaction and said: “They are all alike (in guilt).”
- The Prophet (peace be upon him) said: “A dirham of riba which a man receives knowingly is worse than committing adultery thirty-six times.”
- The Prophet (peace be upon him) said: “Riba has seventy segments, the least serious being equivalent to a man committing adultery with his own mother.”
- The Prophet (peace be upon him) said: “There will come a time when everyone will take riba, and if he does not do so, its dust will reach him.”
Are there any injunctions against Riba/usury in other religious texts? >
Yes. The Old Testament of the Bible also contains injunctions against Riba/usury, such as:
- Deuteronomy 23:19: “Thou shall not lend upon usury to thy brother...”
- Psalms 15:1–5: “He that putteth not out his money to usury, nor taketh reward against the innocent.”
- Proverbs 28:8: “He that by usury and unjust gain increaseth his substance, he shall gather it for him that will pity the poor.”
- Ezekiel 18:8–9: “He that hath not given forth upon usury... he is just. He shall surely live, saith the Lord God.”
These passages reflect that Riba (usury) was also prohibited for previous nations, as mentioned in Surah An-Nisaa (4:161).
Does interest/Riba apply only to consumption loans, or also to commercial loans? >
The prohibition of Riba applies to both consumption and commercial loans. During the Prophet’s time, people borrowed for both personal and business purposes.
- Hazrat Umar (RA) borrowed four thousand dirhams from Abdurrahman ibn Awaf (RA) to send a trade caravan to Syria.
- Hind bint Utbah, wife of Abu Sufyan, borrowed four thousand dirhams from Umar (RA) for trading purposes.
These examples show that Riba includes both personal and business loans.
What is the difference between conventional banking and Islamic banking? >
The following table highlights the key differences between Conventional Banking and Islamic Banking:
| Sr. No. |
Conventional Banking |
Islamic Banking |
| 1 |
Money is treated as a commodity besides medium of exchange and store of value. Therefore, it can be sold at a price higher than its face value and can be rented out. |
Money is not treated as a commodity; it is only a medium of exchange and store of value. Therefore, it cannot be sold above face value or rented out. |
| 2 |
Time value of money is the basis for charging interest on capital. |
Profit on trade or service provision is the basis for earning income. |
| 3 |
Interest is charged even if the borrower suffers losses; there is no profit and loss sharing. |
Islamic banks operate on profit and loss sharing. Losses are shared as per financing mode (Mudarabah, Musharakah). |
| 4 |
Cash or working capital finance is given without any goods/services exchange agreement. |
Islamic financing requires actual goods/services exchange through contracts like Murabaha, Salam, or Istisna. |
| 5 |
Money is used as a commodity, leading to inflation. |
Islamic banking links money with real assets, contributing to genuine economic development. |
What are the basic principles of Islamic banking? >
There are at least six basic principles which are taken into consideration while executing any Islamic banking transaction. These principles differentiate a financial transaction from a Riba/interest based transaction to an Islamic banking transaction.
1. Sanctity of contract: Before executing any Islamic banking transaction, the counter parties have to satisfy whether the transaction is halal (valid) in the eyes of Islamic Shariah. This means that Islamic bank’s transaction must not be invalid or voidable. An invalid contract is a contract, which by virtue of its nature is invalid according to Shariah rulings. Whereas a voidable contract is a contract, which by nature is valid, but some invalid components are inserted in the valid contract. Unless these invalid components are eliminated from the valid contract, the contract will remain voidable.
2. Risk sharing: Islamic jurists have drawn two principles from the saying of prophet Muhammad (SAW). These are “Alkhiraj Biddamaan” and “Alghunun Bilghurum”. Both the principles have similar meanings that no profit can be earned from an asset or a capital unless ownership risks have been taken by the earner of that profit. Thus in every Islamic banking transaction, the Islamic financial institution and/or its deposit holder take(s) the risk of ownership of the tangible asset, real services or capital before earning any profit there from.
3. No Riba/interest: Islamic banks cannot involve in riba/interest related transactions. They cannot lend money to earn additional amount on it. However as stated in point No. 2 above, it earns profit by taking risk of tangible assets, real services or capital and passes on this profit/loss to its deposit holders who also take the risk of their capital.
4. Economic purpose/activity: Every Islamic banking transaction has certain economic purpose/activity. Further, Islamic banking transactions are backed by tangible asset or real service.
5. Fairness: Islamic banking inculcates fairness through its operations. Transactions based on dubious terms and conditions cannot become part of Islamic banking. All the terms and conditions embedded in the transactions are properly disclosed in the contract/agreement.
6. No invalid subject matter: While executing an Islamic banking transaction, it is ensured that no invalid subject matter or activity is financed by the Islamic financial transaction. Some subject matter or activities may be allowed by the law of the land but if the same are not allowed by Shariah, these can not be financed by an Islamic bank.
What is meant by Shariah/Islamic Law? >
Shariah lexically means a way or path. In Islam Shariah refers to the divine guidance and laws given by the Holy Quran, the Hadith (sayings) of the Prophet Muhammad (Peace Be Upon Him) and supplemented by the juristic interpretations by Islamic scholars. Shariah embodies all aspects of the Islamic faith, including beliefs and practices. Islamic Shariah or the divine law of Islam is derived from the following four sources:
1. The Holy Quran
2. The Sunnah of the Holy Prophet (Peace Be Upon Him)
3. Ijma’ (consensus of the Ummah)
4. Qiyas (Anology)
The end result of Islamic Banking and Conventional Banking is the same. Why do they appear similar? >
The validity of a transaction does not depend on the end result but rather the process and activities executed and the sequence thereof in reaching the end. If a transaction is done according to the rules of Islamic Shariah it is halal even if the end result of the product may look similar to conventional banking product.
For example a normal McDonalds burger in USA and Pakistan may look similar, smell similar and taste similar but the former is haram and the later is halal due to its compliance of Islamic guidelines of slaughtering animals.
Similarly, if a person is feeling hungry, he may steal a piece of bread and eat or alternatively buy a piece of bread to eat. The apparent end result would be same but one is permissible in Shariah and the other is not allowed.
The same is also true for Islamic and conventional banking. Therefore, it can be concluded that it is the underlying transaction that makes something “Halal” (allowed) or “Haram” (prohibited) and not the result itself. Apparently, Islamic banks may look similar to conventional banks, however the contracts and product structures used by Islamic banks are quite different from that of the conventional bank. In the verse 2:275 of the Holy Quran, Allah the Almighty has responded to the apparent similarity between trade and interest by resolutely informing that he has permitted trade and prohibited Riba (though they may look similar to someone).
If Islamic banks do not invest in interest based activities then how do they generate profit to pay to their customers? >
The Islamic bank uses its funds in various trade, investment and service related Shariah compliant activities and earns profit thereupon. The profit earned from such activities is passed on to the depositors according to the agreed terms.
Are not Islamic banks just paying interest and dressing it as profit on trade and investments? >
No, Islamic banks accept the deposits either on profit and loss sharing basis or on qard basis. These deposits are deployed in financing, trading or investment activities by using the Shariah compliant modes of finance. The profit so earned by the bank is passed on to the depositors according to the pre-agreed ratio which, therefore, cannot be termed as interest.
Islamic banks use KIBOR i.e. an interest-based benchmark to determine profit sharing ratios. In this context, how these banks can be said to be Islamic when they base conventional benchmark? >
Islamic banks should ideally have their own benchmark system for determination of profit. Since, the industry is in its initial stage of development, it is using the available benchmark for the banking industry. It is expected that once it is grown to a sizable level, it would have its own benchmark. However, using interest based benchmark for determining the profit of any permissible transaction does not render the transaction as invalid or haram. It is the nature/mechanism of the transaction that determines its validity or otherwise.
For example Mr. A and Mr. B are two neighbors. Mr. A sells liquor which is totally prohibited in Islam whereas Mr. B, being a practicing Muslim dislikes the business of Mr. A and starts the business of soft drinks. Mr. A wants his business to earn as much profit as Mr. A earns through trading in liquor. Therefore he decides that he will charge the same rate of profit from his customers as Mr. A charges over the sale of liquor. Thus he has tied up his rate of profit with the rate used by Mr. A in his prohibited business.
One may say that Mr. B uses an undesirable benchmark in determining the rate of profit, but obviously no one can say that the profit charged by him is haram because he has used the rate of profit of the business of liquor only as a benchmark.
The same is true for Islamic banks, it is most desirable and preferable that Islamic banks develop their own benchmark however; in the absence of any such alternative, interest rate related benchmark can be used.
What are the basic principles of Islamic banking?
There are at least six basic principles which are taken into consideration while executing any Islamic banking transaction. These principles differentiate a financial transaction from a Riba/interest based transaction to an Islamic banking transaction.
1. Sanctity of contract: Before executing any Islamic banking transaction, the counter parties have to satisfy whether the transaction is halal (valid) in the eyes of Islamic Shariah. This means that Islamic bank’s transaction must not be invalid or voidable. An invalid contract is a contract, which by virtue of its nature is invalid according to Shariah rulings. Whereas a voidable contract is a contract, which by nature is valid, but some invalid components are inserted in the valid contract. Unless these invalid components are eliminated from the valid contract, the contract will remain voidable.
2. Risk sharing: Islamic jurists have drawn two principles from the saying of prophet Muhammad (SAW). These are “Alkhiraj Biddamaan21” and “Alghunun Bilghurum22”. Both the principles have similar meanings that no profit can be earned from an asset or a capital unless ownership risks have been taken by the earner of that profit. Thus in every Islamic banking transaction, the Islamic financial institution and/or its deposit holder take(s) the risk of ownership of the tangible asset, real services or capital before earning any profit there from.
3. No Riba/interest: Islamic banks cannot involve in riba/interest related transactions. They cannot lend money to earn additional amount on it. However as stated in point No. 2 above, it earns profit by taking risk of tangible assets, real services or capital and passes on this profit/loss to its deposit holders who also take the risk of their capital.
4. Economic purpose/activity: Every Islamic banking transaction has certain economic purpose/activity. Further, Islamic banking transactions are backed by tangible asset or real service.
5. Fairness: Islamic banking inculcates fairness through its operations. Transactions based on dubious terms and conditions cannot become part of Islamic banking. All the terms and conditions embedded in the transactions are properly disclosed in the contract/agreement.
6. No invalid subject matter: While executing an Islamic banking transaction, it is ensured that no invalid subject matter or activity is financed by the Islamic financial transaction. Some subject matter or activities may be allowed by the law of the land but if the same are not allowed by Shariah, these can not be financed by an Islamic bank.
What is meant by Shariah/Islamic Law?
Shariah lexically means a way or path. In Islam Shariah refers to the divine guidance and laws given by the Holy Quran, the Hadith (sayings) of the Prophet Muhammad (Peace Be Upon Him) and supplemented by the juristic interpretations by Islamic scholars. Shariah embodies all aspects of the Islamic faith, including beliefs and practices. Islamic Shariah or the divine law of Islam is derived from the following four sources:
1. The Holy Quran
2. The Sunnah of the Holy Prophet (Peace Be Upon Him)
3. Ijma’ (consensus of the Ummah)
4. Qiyas (Anology)
The end result of Islamic Banking and Conventional Banking is the same. Why do they appear similar?
The validity of a transaction does not depend on the end result but rather the process and activities executed and the sequence thereof in reaching the end. If a transaction is done according to the rules of Islamic Shariah it is halal even if the end result of the product may look similar to conventional banking product.
For example a normal McDonalds burger in USA and Pakistan may look similar, smell similar and taste similar but the former is haram and the later is halal due to its compliance of Islamic guidelines of slaughtering animals.
Similarly, if a person is feeling hungry, he may steal a piece of bread and eat or alternatively buy a piece of bread to eat. The apparent end result would be same but one is permissible in Shariah and the other is not allowed.
The same is also true for Islamic and conventional banking. Therefore, it can be concluded that it is the underlying transaction that makes something “Halal” (allowed) or “Haram” (prohibited) and not the result itself. Apparently, Islamic banks may look similar to conventional banks, however the contracts and product structures used by Islamic banks are quite different from that of the conventional bank. In the verse 2:275 of the Holy Quran, Allah the Almighty has responded to the apparent similarity between trade and interest by resolutely informing that he has permitted trade and prohibited Riba (though they may look similar to someone).
If Islamic banks do not invest in interest based activities then how do they generate profit to pay to their customers? >
The Islamic bank uses its funds in various trade, investment and service related Shariah compliant activities and earns profit thereupon. The profit earned from such activities is passed on to the depositors according to the agreed terms.
Are not Islamic banks just paying interest and dressing it as profit on trade and investments? >
No, Islamic banks accept the deposits either on profit and loss sharing basis or on qard basis. These deposits are deployed in financing, trading or investment activities by using the Shariah compliant modes of finance. The profit so earned by the bank is passed on to the depositors according to the pre-agreed ratio which, therefore, cannot be termed as interest.
Islamic banks use KIBOR i.e. an interest-based benchmark to determine profit sharing ratios. In this context, how these banks can be said to be Islamic when they base conventional benchmark? >
Islamic banks should ideally have their own benchmark system for determination of profit. Since, the industry is in its initial stage of development, it is using the available benchmark for the banking industry. It is expected that once it is grown to a sizable level, it would have its own benchmark. However, using interest based benchmark for determining the profit of any permissible transaction does not render the transaction as invalid or haram. It is the nature/mechanism of the transaction that determines its validity or otherwise.
For example Mr. A and Mr. B are two neighbors. Mr. A sells liquor which is totally prohibited in Islam whereas Mr. B, being a practicing Muslim dislikes the business of Mr. A and starts the business of soft drinks. Mr. A wants his business to earn as much profit as Mr. A earns through trading in liquor. Therefore he decides that he will charge the same rate of profit from his customers as Mr. A charges over the sale of liquor. Thus he has tied up his rate of profit with the rate used by Mr. A in his prohibited business.
One may say that Mr. B uses an undesirable benchmark in determining the rate of profit, but obviously no one can say that the profit charged by him is haram because he has used the rate of profit of the business of liquor only as a benchmark.
The same is true for Islamic banks, it is most desirable and preferable that Islamic banks develop their own benchmark however; in the absence of any such alternative, interest rate related benchmark can be used.
Is Islamic banking meant only for Muslims? >
The teachings of Islam are not confined to Muslims, rather these equally address the non-Muslims due to their universal nature. The basis of Islamic banks is laid down on ethical values and socially responsible system. The values like justice, mutual help, free consent and honesty on the part of the parties to a contract, avoiding fraud, misrepresentation and misstatement of facts and negation of injustice or exploitation form the basic principles of Islamic banking. Therefore, the principles of Islamic banking lead the economic system to achieve the common good and economic prosperity. On this premise, Islamic banking becomes a viable option for everyone irrespective of their religion.
What are the major modes of Islamic banking and finance? >
The following are the modes of finance which are or three categories:
1) Participatory modes of Finance
a) Mudarabah
b) Musharakah
2) Non Participatory modes of Finance
a) Murabaha
b) Musawamah
c) Salam
d) Istisna
e) Ijarah
f) Ijarah wa Iqtina (Ijarah Muntahiyyah Bittamleek)
3) Sub contracts
a) Wakalah
b) Kafalah
c) Rahn
What is Mudarabah? >
A form of partnership where one party provides the funds while the other party provides expertise. The people who bring in money are called "Rab-ul-Maal" while the management and work is an exclusive responsibility of the "Mudarib". The profit sharing ratio is determined at the time of entering into the Mudarabah agreement whereas in case of loss it is borne by the Rab-ul-Maal only. In case of Islamic banks, the depositors are called Rabb-ul-Maal and the bank is called Mudarib.
There are two types of Mudarabah:
1. Al-Mudarabah Al-Muqayyada: In case of Islamic banks, Rab-ul-Maal is the depositor who gives specifies instructions to the Mudaraib (Islamic bank) regarding the investment of his deposit/funds in a particular business. This is called Al-Mudarabah Al-Muqayyadah (restricted Mudarabah).
2. Al-Mudarabah Al-Mutlaqah: In case where Rab-ul-Maal (depositor) gives full freedom to the Mudarib (bank) to undertake whatever business he deems fit, this is called Al-Mudarabah Al-Mutlaqah (unrestricted Mudarabah).
It is necessary for the validity of Mudarabah that the parties agree on a certain formula of sharing the actual profit right at the beginning of the contract. The Shariah has prescribed no particular proportion of profit sharing rather it has been left to the mutual consent of the parties.
For the deposit management, Islamic banks create different pools of investment keeping in view the risk and maturity profile of the depositors. The deposits of the customers are placed in these pools and profit therefrom is distributed between the bank and the depositors as per weightages assigned at the time of agreement.
Mudarabah agreement cannot allow a lump sum amount of profit for any party nor can it determine the share of any party at a specific rate tied up with the capital. For example, if the capital is Rs.100,000/-, parties cannot agree on a condition that Rs.10,000 out of the profit shall be the share of the Mudarib nor can they say that profit equivalent to 20% of the capital shall be given to Rab-ul-Maal. However they can agree that 40% of the actual profit shall go to the Mudarib and 60% to the Rab-ul-Maal or vice versa.
What is Musharakah? >
Musharakah means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business. Under Islamic banking, it is an agreement under which the Islamic bank provides funds which are mixed with the funds of the business enterprise and others. All providers of capital are entitled to participate in management but not necessarily required to do so. The profit is distributed among the partners in pre-agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital contributions. The following are the rules with regard to profit and loss sharing in Musharakah:
1. The profit sharing ratio for each partner must be determined in proportion to the actual profit accrued to the business and not in proportion to the capital invested by him. For example, if it is agreed between them that 'A' will get 10% of his investment, the contract is not valid.
2. It is not allowed to fix a lump sum amount for anyone of the partners or any rate of profit tied up with his investment. Therefore if 'A' & 'B' enter into a partnership and it is agreed between them that 'A' shall be given Rs.10,000/- per month as his share in the profit and the rest will go to 'B', the partnership is invalid.
3. If both partners agree that each will get percentage of profit based on his capital percentage, whether both work or not, it is allowed.
4. It is also allowed that if an investor is working, his profit share could be higher than his capital contribution irrespective of whether the other partner is working or not. For instance, if 'A' & 'B' have invested Rs.1,000/- each in a business and it is agreed that only 'A' will work and will get two third of the profit while 'B' will get one third. Similarly if the condition of work is also imposed on 'B' in the agreement, then also the proportion of profit for 'A' can be more than his investment.
5. If a partner has put an express condition in the agreement that he will not work for the Musharakah and will remain a sleeping partner throughout the term of Musharakah, then his share of profit cannot be more than the ratio of his investment.
6. It is allowed that if a partner is not working, his share of profit can be established at a rate lower than his capital share.
7. If both are working partners, the share of profit can differ from the ratio of investment. For example, Mr. A and Mr. B both have invested Rs.1,000/- each. However, Mr. A gets one third of the total profit and Mr. B will get two third, this is allowed.
8. If only a few partners are active and others are only sleeping partners, then the share in the profit of the active partner could be fixed at higher than his ratio of investment e.g. 'A' & 'B' put in Rs.100 each and it is agreed that only 'A' will work, then 'A' can take more than 50% of the profit as his share. The excess he receives over his investment will be compensation for his services.
The following are the Basic rules of distribution of loss in case of Musharakah:
All scholars are unanimous on the principle of loss sharing in Shariah based on the saying of Syedna Ali ibn Talib that is as follows:
"Loss is distributed exactly according to the ratio of investment and the profit is divided according to the agreement of the partners."
Therefore the loss is always subject to the ratio of investment. For example, if Mr. A has invested 40% of the capital and Mr. B has invested 60%, they must suffer the loss in the same ratio, not more, not less. Any condition contrary to this principle shall render the contract invalid.
What is Murabaha? >
Murabaha is one of the most common modes used by Islamic Banks. It refers to a sale where the seller discloses the cost of the commodity and amount of profit charged. Therefore, Murabaha is not a loan given on interest rather it is a sale of a commodity at profit.
The mechanism of Murabaha is that the bank purchases the commodity as per requisition of the client and sells him on cost-plus-profit basis. Under this arrangement, the bank is bound to disclose cost and profit margin to the client. Therefore, the bank, rather than advancing money to a borrower, buys the goods from a third party and sells those goods to the customer on profit.
A question may be raised that selling goods on profit (under Murabaha) and charging interest on the loan (as per the practice of conventional banks) appears to be one of the same things and also produces the same results. The answer to this query is that there is a clear difference between the mechanism/structure of the product. The basic difference lies in the contract being used. Murabaha is a sale contract whereas the conventional finance overdraft facility is an interest based lending agreement and transaction. In case of Murabaha, the bank sells an asset and charges profit which is a trade activity declared halal (valid) in the Islamic Shariah. Whereas giving loan and charging interest thereupon is pure interest-based transaction declared haram (prohibited) by Islamic Shariah.
What are the basic rules of a valid Murabaha transaction? >
The following are the rules governing a Murabaha transaction:
1. The subject matter of sale must exist at the time of the sale. Thus anything that may not exist at the time of sale cannot be sold and its non-existence makes the contract void.
2. The subject matter should be in the ownership, either actual or constructive, of the seller at the time of sale. If he sells something that he has not acquired himself then the sale becomes void.
3. The subject matter of sale must be in physical or constructive possession of the seller when he sells it to another person. Constructive possession means a situation where the possessor has not taken physical delivery of the commodity yet it has come into his control and all rights and liabilities of the commodity are passed on to him including the risk of its destruction.
4. The sale must be instant and absolute. Thus a sale attributed to a future date or a sale contingent on a future event is void. For example, 'A' tells 'B' on 1st January 2008 that he will sell his car on 1st February 2008 to 'B', the sale is void because it is attributed to a future date.
5. The subject matter should be a property having value. Thus goods having no value cannot be sold or purchased.
6. The subject matter of sale should not be a thing used for an un-Islamic purpose.
7. The subject matter of sale must be specifically known and identified to the buyer. For Example, 'A' owner of an apartment says to 'B' that he will sell an apartment to 'B'. Now the sale is void because the apartment to be sold is not specifically mentioned or identified to the buyer.
8. The delivery of the sold commodity to the buyer must be certain and should not depend on a contingency or chance.
9. The certainty of price is a necessary condition for the validity of the sale. If the price is uncertain, the sale is void.
10. The sale must be unconditional. A conditional sale is invalid unless the condition is recognized as a part of the transaction according to the usage of trade.
What is Murabaha used for in Islamic banks? >
Murabaha is typically used to facilitate the short-term financing requirements of the customer. The following are the uses of Murabaha:
1. Purchase of raw material, goods and merchandise of all kinds and description
2. Purchase of equipments
3. Import of goods and merchandise
4. Export financing (pre-shipment)
5. Other financing of working capital nature
Presently, the majority of financing extended by Islamic banks is based upon Murabaha.
What is Bai Muajjal? >
Bai' Muajjal is the Arabic equivalent of "sale on deferred payment basis". The deferred payment becomes a debt payable by the buyer in lump sum or in installments as may be agreed between the two parties. In Bai' Muajjal, all those items can be sold on deferred payment basis which come under the definition of tangible goods where quality does not make a difference but the intrinsic value does. Those assets do not come under definition of capital where quality can be compensated for by the price and Shariah scholars have an 'ijmah' (consensus) that demanding a high price in deferred payment in such a case is permissible. The following are the conditions of a valid Bai’ Muajjal:
1. The price to be paid must be agreed and fixed at the time of the deal. It may include any amount of profit agreed between the parties.
2. Complete/total possession of the object in question must be given to the buyer, while the deferred price is to be treated as a debt due from him.
3. Once the price is fixed, it cannot be decreased in case of earlier payment nor can it be increased in case of default.
4. In order to secure the payment of price, the seller may ask the buyer to furnish a security either in the form of mortgage or in the form of any other item.
5. If the commodity is sold on installments, the seller may put a condition on the buyer that if he fails to pay any installment on its due date, the remaining installments will become due immediately.
What is Musawamah? >
Musawamah is a general and regular kind of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former. Thus, it is different from Murabaha in respect of pricing formula. Unlike Murabaha, seller in Musawamah is not obliged to reveal his cost. Both the parties negotiate on the price. All other conditions relevant to Murabaha are valid for Musawamah as well. Musawamah can be used where the seller is not in a position to ascertain precisely the costs of commodities that he is offering to sell.
What is Ijarah? >
Ijarah refers to transferring the usufruct of an asset but not its ownership. Under Islamic banking, the bank transfers the usufruct to another person for an agreed period at an agreed consideration. The asset under Ijarah should be valuable, non-perishable, non-consumable, identified and quantified. All those things which do not maintain their corpus during their use cannot become the subject matter of Ijarah, for instance money, wheet etc.
What are the salient features of Ijarah transaction? >
The customer approaches the bank and expresses his desire for a particular asset/property. The bank acquires that asset as per undertaking of the customer to acquire the said asset on Ijarah basis. The bank leases (transfers the use of the asset) it to the customer for an agreed period of time and against an agreed amount of rentals. An Ijarah agreement, signed between the bank and the customer, stipulates all the relevant conditions with regard to the transaction. According to this agreement the bank is Lessor and the customer is Lessee. During the Ijarah period, the corpus of the leased property remains in the ownership of the bank and only its usufruct is transferred to the lessee. The following main points are considered in the Ijarah transaction:
1. As the corpus of the leased asset remains in the ownership of the Islamic bank, all the liabilities emerging from the ownership shall be borne by the bank. It is necessary for a valid lease that the leased asset is fully identified by the parties.
2. The lessee (customer) cannot use the leased asset for any purpose other than the purpose specified in the lease agreement. However, if no such purpose is specified in the agreement, the lessee can use it for whatever legitimate purpose it is used in the normal course.
3. The lessee is liable to compensate the lessor (bank) for any harm to the leased asset caused by any misuse or willful negligence. The leased asset shall remain in the risk of the bank throughout the lease period in the sense that any harm or loss caused by the factors beyond the control of the lessee shall be borne by the lessor.
4. A property jointly owned by two or more persons can be leased out and the rental shall be distributed between all joint owners according to the proportion of their respective shares in the property. A joint owner of a property can lease his proportionate share only to his co-sharer and not to any other person.
5. The rental must be determined at the time of contract for the whole period of lease. It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of executing a lease. If the rent for a subsequent phase of the lease period has not been determined or has been left at the option of the lessor, the lease is not valid.
6. The determination of rental with regard to the aggregate cost incurred in the purchase of the asset by the lessor, as normally done in financial leases, is not against the rules of Shariah, if both parties agree to it, provided that all other conditions of a valid lease prescribed by the Shariah are fully adhered to.
7. The lessor cannot increase the rent unilaterally, and any agreement to this effect is void.
8. The lease period shall commence from the date on which the leased asset has been delivered to the lessee.
9. If the leased asset has totally lost the function for which it was leased, the contract will stand terminated.
10. The rentals can be used on or benchmarked with some index as well. In this case the ceiling and floor rentals would specifically be mentioned in the agreement for validity of lease.
11. At the end of the lease period, the ownership of the property may be transferred to the lessee against a nominal price through a separate sale deed to be executed after the expiry of the lease.
What is the difference between conventional mortgage financing and Islamic Mortgage financing? >
There are several key differences between conventional mortgage finance and Islamic mortgage finance.
Under conventional mortgage, in order to purchase a property the customer borrows money and repays it with an additional amount over a period of time. The additional amount is the amount of interest which is against the Shariah rulings of Islam. Under Islamic mortgage finance facility, Islamic bank shares with the customer in purchasing his desired property. Accordingly, the customer and the bank become the joint owners of the property in proportion to their share in purchasing the property. In order to own and use the entire property, the customer purchases the share of bank’s property over a period of time and also pays the rent for using the bank’s share of the property. Over a period of time, the customer manages to purchase the entire share of bank in the property. Ultimately, the customer becomes the sole owner.
Further, in case of Islamic mortgage finance, the rent will be charged after the lessee has taken delivery of the property and it is in workable/usable condition. Rent cannot be charged from the day the price was paid to acquire the property/asset. If the supplier has delayed the delivery after receiving the full price, the lessee should not be liable for the rent of the period of delay. In case of conventional mortgage finance, normally the lease rentals starts from the date the bank make payment for purchasing the property/asset.
The rental amount under Ijarah transaction is normally linked to interest based benchmark like LIBOR or KIBOR. Is not it an interest based financing? >
The difference between an interest based financing and a valid lease does not lie in the amount to be paid to the lessor. The basic difference is that in the case of lslamic Ijarah, the ownership and title in the asset/property rest with the lessor who assumes the full risk of the corpus of the leased asset. If the asset is destroyed during the lease period, the lessor will suffer the loss. Similarly, if the leased asset looses its usufruct without any misuse or negligence on the part of the lessee, the lessor cannot claim the rent, while in the case of an interest-based financing, the financier is entitled to receive interest, even if the debtor did not at all benefit from the money borrowed. So far as this basic difference is maintained, (i.e. the lessor assumes the risk of the leased asset) the transaction cannot be categorized as an interest-bearing transaction, even though the amount of rent claimed from the lessee may be equal to the rate of interest.
Therefore, the use of the rate of interest merely as a benchmark does not render the Ijarah contract invalid as an interest-based transaction. It is, however, advisable at all times to avoid using interest-based benchmark so that an Islamic transaction is totally distinguished from an un-Islamic one, having no resemblance of interest whatsoever.
Interest rates are subject to unknown variations and linking the amount of rent with interest rate will create uncertainty (Gharar) impermissible in Shariah. How would the Ijarah contract remain valid under this scenario? >
It is one of the basic requirements of Shariah that the parties to the contract must exactly know its considerations. Under Ijarah agreement, amount of rent is one of the prime considerations of the agreement. So far as the parties are agreed with mutual consent upon a well-defined benchmark which would serve as a criterion for determining the rent, and whatever amount is determined, based on such benchmark, will be acceptable to both parties, therefore, there should not be any dispute.
However, in order to save the parties from unforeseen losses due to the either way movement in the interest rate, the scholars have advised that there should be a floor and cap for the amount of rentals stipulated in the contract in case variable benchmarks is taken to determine the rental amount.
What is Ijarah-wa-Iqtina? >
It is allowed in Shariah that the lessor signs a separate promise, (but not an agreement or contract) to gift the leased asset to the lessee at the end of the lease period, subject to his payment of all amounts of rent. There can also be a unilateral promise by the lessee to purchase the asset at the end of the Ijarah period. Alternatively, there may be an undertaking by the bank to sell the asset to the lessee at the end of the Ijarah period. However, Ijarah agreement should not be dependent either on the promise by the lessee (to purchase) or the undertaking by the bank (to sell). This arrangement is called “Ijarah wa iqtina” and it has been allowed by a vast majority of contemporary scholars and is widely used by the Islamic banks.
However, the validity of this arrangement is subject to two basic conditions:
1. The agreement of Ijarah should not have the clause regarding the lessor’s promise to gift or sell the leased property to the lessee at the end of the Ijarah period. Therefore, there should be a separate document stipulating this promise by the lessor.
2. The promise should be unilateral and binding on the promisor only. It should not be a bilateral promise binding on both parties because in this case it will be a full contract becoming effective on a future date, which is not allowed in the case of sale or gift.
What is Bai Salam? >
Salam means a contract in which advance payment is made for goods to be delivered at a future date. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. Bai Salam covers almost everything which is capable of being definitely described as to quantity, quality and workmanship. For Islamic banks, this product is ideal for agriculture financing, however, this can also be used to finance the working capital needs of the customers. The permissibility of Salam is an exception to the general rule that prohibits forward sale. Bai-Salam has been permitted by the Holy Prophet (PBUH) himself, without any difference of opinion among the early or the contemporary jurists, notwithstanding the general principle of Shariah that the sale of a commodity which is not in the possession of the seller is not permitted.
Upon migration from Makkah, the Prophet (PBUH) came to Madinah, where the people used to pay in advance the price of fruit or dates to be delivered over one, two or three years. However, such sale was carried out without specifying the quality, measure or weight of the commodity or the time of delivery. The holy Prophet (PBUH) ordained: “Whoever pays money in advance for fruit to be delivered later should pay it for a known quality, specified measure and weight (of dates or fruit) of course along with the price and time of delivery.”
The Salam transaction is subject to the strict conditions as follows:
1. It is necessary for the validity of Salam that the buyer pays the price in full to the seller at the time of affecting the sale. In the absence of full payment, it will be tantamount to sale of a debt against a debt, which is expressly prohibited by the Holy Prophet (PBUH). Moreover the basic rationale for allowing Salam is to facilitate the "instant need" of the seller. If it is not paid in full, the basic purpose will not be achieved.
2. Only those goods can be sold through a Salam contract in which the quantity and quality can be exactly specified e.g. precious stones cannot be sold on the basis of Salam because each stone differ in quality, size, weight and their exact specification is not possible.
3. Salam cannot be affected on a particular commodity or on a product of a particular field or farm e.g. Supply of wheat of a particular field or the fruit of a particular tree since there is a possibility that the crop is destroyed before delivery and given such possibility, the delivery remains uncertain.
4. All details in respect to quality of goods sold must be expressly specified leaving no ambiguity, which may lead to a dispute.
5. It is necessary that the quantity of the commodity is agreed upon in absolute terms. It should be measured or weighed in its usual measure only, meaning what is normally weighed cannot be quantified and vice versa.
6. The exact date and place of delivery must be specified in the contract.
7. Salam cannot be affected in respect of things, which must be delivered at spot.
What is Istisna? >
It is a specific kind of a Bai (sale) where the sale of the commodity is transacted before the commodity comes into existence. The legality of Istisna is accepted by the Shariah scholars because it does not contain any prohibition. As far as the financing mode, it has been legalized on the basis of the principles of Istihsan (public interest).
Istisna is an agreement culminating in a sale at an agreed price whereby the purchaser places an order to manufacture, assemble or construct (or cause so to do) anything to be delivered at a future date. It becomes an obligation of the manufacturer or the builder (as the case may be) to deliver the asset of agreed specifications at the agreed period of time. As the sale is executed at the time of entering into the Istisna contract, the contracting parties need not renew an exchange of offer and acceptance after the subject matter is prepared.
Istisna can be used for providing the facility of financing the manufacture or construction of houses, plants, projects and building of bridges, roads and highways etc. After giving prior notice, either party can cancel the contract before the manufacturing party has begun its work. Once the work starts, the contract cannot be cancelled unilaterally.
What is the difference between Istisna and Ijarah? >
Under Istisna, the manufacturer either uses his own material or he arranges for the material himself whereas under Ijarah the material is provided by the customer and the manufacturer uses only his labour and skill meaning that his services will be hired for a specified fee paid to him.
Further, under Istisna the purchaser has the right to reject the goods after inspection if these are not according to the specifications agreed at the time of contract whereas under Ijarah this right of inspection does not exist.
What is the difference between Istisna and Salam? >
The following are the main differences between Istisna' and Salam:
1. In case of Istisna, the subject on which the transaction of Istisna' is based is always a thing which needs manufacturing/assembling/processing etc., whereas in case of Salam, the subject matter can be a thing that does not necessarily need manufacturing etc.
2. The price in Istisna' does not necessarily need to be paid in full in advance. It is not even necessary to pay the full price at delivery. It can be deferred to any time according to the agreement of the parties. The payment may also be made in installments. In case of Salam, the price has to be paid in full in advance.
3. The time of delivery does not have to be necessarily fixed in Istisna' whereas in case of Salam the time of delivery is an essential part of the sale.
4. Istisna contract can be cancelled before the manufacturer starts the work. Salam contract cannot be cancelled unilaterally.
Is it permissible for an Islamic bank to impose penalty in case receivables are delayed? >
In Islamic law it is permissible to penalize a debtor who is financially sound but willfully delays payment of debt without any genuine reason. Such act of the debtor is unjust as the Prophet (PBUH) has said:
“A rich debtor who delays payment of debt commits Zulm.”
A heavy non-performing portfolio and default on the part of clients is a serious problem confronting the financial institutions all over the world including Pakistan. This problem may be a threat to the success of Islamic banking system if not properly addressed. If clients do not honour their commitments in respect of timely payment of a debt created in installment sale, Murabaha, leasing or do not pay banks’ share of profit in participatory modes or do not deliver goods at stipulated time in Salam and Istisna, it could cause irreparable loss to the system.
The jurists allow punishment (T´azir) to such willful defaulters in the form of fine. In view of the severity of the problem, Islamic Fiqh Academy of the OIC and Shariat Appellate Bench of the Supreme Court of Pakistan have approved the provision of penalty clause in the contractual agreements. This would also help in maintaining a credit discipline in the banking and act as a deterrent against debts becoming bad or unrealizable.
However, the penalty proceeds would be used for charity as penalty cannot become source of income for the bank in any manner.
Can Islamic banks claim compensation or liquidated damages on account of late payment/default by the clients? >
The contemporary Shariah scholars have evolved a consensus that banks are authorized to impose late fees on the delinquent. However, the proceeds of such penalty are to be used for charity purposes. It is the court or any recognized alternative independent dispute resolution body which can allocate any part of the penalty as liquidated damages/solatium for the banks.
Liquidated damages can be given to banks in case of default on the part of banks’ clients provided it is based on actual financial loss. The court or a recognized adjudicating forum may reasonably adjust the amount of compensation. The actual financial loss cannot be the loss in terms of conventional opportunity cost. It has to be proved by the bankers themselves to the satisfaction of the court or any arbitrator.
Islamic bank’s financing is sometime costlier than that of the conventional banking. Why is it so? >
Islamic banking is in its early stage and is in the process of strengthening its base in the economies having conventional banking rooted deeply in the current interest-dominated system. The volume of business captured by the conventional banking system gives it an edge over Islamic banking in terms of cost due to its ability of having achieved economies of scale.
The conventional banks can avail the economies of scale due to their wide network and huge volume of business which the Islamic banking, in its nascent stage cannot avail given the present volume of their business. Further, Islamic banking has to maintain some additional documentation which adds to the cost of its operations.
While Islamic banking may appear to be marginally costlier at this stage, the incremental cost is not prohibitive in relation to the benefits.
Does discounting of bills is allowed under Islamic Shariah? >
A promissory note or a bill of exchange represents a debt payable by the debtor to the holder. This debt cannot be transferred to anybody except at its face value. Discounting of bill or a Note or a Cheque, therefore, involves interest. In an Islamic financial market, the papers representing money or debt cannot be traded (except at face value). However, the papers representing holder’s ownership in tangible assets, like shares, lease certificates, Musharakah certificates, etc. can be traded due to the underlying assets they represent.
Islamic banks have various modes of finance through which the business needs of the customer can be satisfied without discounting the bill.
A majority of Islamic Shariah scholars do not allow Salam in gold, silver, currencies or monetary units, although a few jurists have allowed it. As such, a few Islamic banks have been using Salam in currencies as an alternative to bill discounting.
If the Islamic banks do not lend money on interest then what modes of financing can be used for the following? >
As a matter of principle, all the financial transactions between the parties are lawful in the eyes of Islamic Shariah as long as they do not violate Islamic principles. Islamic Shariah provides several interest-free modes of finance that can be used to satisfy various business needs of the customer. These modes can be clubbed into two broad categories:
The first category may include modes of advancing funds on a profit-and-loss-sharing basis. Examples of profit and loss sharing category are Mudarabah, Musharakah and participation in the equity capital of companies. The second category may include the modes of finance which are used for the purchase/hire of goods (including assets) and services on a fixed return basis. Examples of this type are Murabaha, Istisna, Salam and Ijarah.
Therefore, the financial needs can easily be met through interest-free legitimate modes of finance. These can be used to finance the trade, industry or a budget deficit through domestic or foreign sources. The following would further elaborate in detail.
A) Modes for financing trade and industry:
Murabaha, Musawamah, Ijarah and Salam are particularly suitable for trade while Istisna is especially suitable for manufacturing or construction industry. Further, the trade and industry need financing for the purchase of raw materials, inventories (stock in trade) and fixed assets as well as to meet some working capital requirements.
Murabaha can be used for the financing of all purchases of raw materials and inventory. For the procurement of fixed assets including plant and machinery, buildings etc., either Diminishing Musharakah or Ijarah can be more feasible. Funds for continuing/recurrent expenses can be obtained by the advance sale of final products of the company using Salam or Istisna and even Musharakah in appropriate circumstances.
B) Modes for financing a budget deficit:
It is noted that in an Islamic state, all the efforts should be made to avoid the budget deficit. However, in case of unavoidable circumstances, the budget deficit may be kept to the possible minimum limit. Sometimes the budget deficits are seen as a result of either extravagant (and/or unproductive) expenditure or insufficient and/or inefficient effort to generate tax revenue due to political, economical reasons or otherwise.
There is a need to win public confidence about these needs and to create transparency in government expenditure. There is also a need to prevent the leakage of revenue generating streams for the Government. This can serve better in keeping budget deficits to a minimum level. In case of unavoidable deficits, government-owned enterprises can obtain finance by way of Mudarabah, Musharakah or Sukuk certificates, just like private companies do.
C) An alternative to foreign loans:
Seeking Islamic solution to foreign borrowing, arrangements could be made to attract foreign as well as domestic funds through the following two ways:
i. The issue of Musharakah (partnership) or Ijarah certificates can be used to finance the projects of the Government. Such certificates can be denominated in foreign as well as domestic currencies and they would carry a predetermined basis for sharing the profits earned through the respective projects. The certificates issued can be restricted to a particular project or earmarked to a group of projects.
ii. The establishment of funds to finance the economic activities of public and private enterprises on equity, partnership, and Ijarah basis. These funds can attract resources through the issue of shares and certificates of various values and maturities and in domestic as well as foreign currencies. These can be established either to finance a certain sector (for example agriculture, industry, and infrastructure), a particular industry (for example textiles, household durables, etc.), or a conglomerate of projects.
If banking were to be based on interest-free transactions, how would it work in practice? >
Islamic bank, like other banks, is an institution whose main business is to mobilize funds from savers and use these funds to finance the economic activities of businessmen and entrepreneurs. While a conventional bank uses the rate of interest for both obtaining funds from savers and lending these funds to businessmen, an Islamic bank performs these functions using various financial modes which are compatible with the Shariah.
For mobilizing resources, it uses either the contract of Mudarabah or Wakalah with the fund owners. Under the first contract, the net income of the bank is shared between the fund user (Mudarib) and fund providers (Rab-ul-Maal) according to a predetermined profit sharing formula. In the case of loss, the same is shared by fund providers in proportion to the capital contributions. As far as the nature of investment deposits are concerned, these could be either general investment deposits or specific investment accounts in which deposits are made for investment in particular projects. In addition, there are current accounts that are in the nature of an interest-free loan to the bank. The bank guarantees the principal in case of current accounts but pays no profit on such accounts.
Under the Wakalah contract, clients give funds to the bank that serves as their investment manager. The bank charges a predetermined fee for its managerial services. The profit or loss is passed on to the fund providers after deducting such a fee.
On the assets side, the bank uses a number of financial instruments none of which involves interest. A wide variety of such modes of financing is available as discussed before.
Do we really need Islamic banking? >
The question may be divided into following two parts for proper understanding:
1. Do we need bank?
2. If yes, why it should be on the basis of Islamic Shariah.
i. Do we need bank?
In order to assess the need of the bank, we need to look at the functions it performs. In any society, be it a secular or Islamic one, the main function of the bank is to mobilize funds from the surplus units and allocate these to the shortfall units or to the units having budget constraints. This function is performed through the process of financial intermediation in the financial markets where banks are the most important operators. Financial intermediation enhances the efficiency of the saving/investment process by eliminating the mismatches inherent in the requirements and availability of financial resources of savers and entrepreneurs in an economy.
Normally the surplus units/savers are small households or individuals who save relatively small amounts whereas the entrepreneurs are firms which often need relatively large amounts of funds. Financial intermediation removes this size mismatch by collecting small savings and packaging them to suit the needs of entrepreneurs. In addition, entrepreneurs may require funds for periods relatively longer than would suit individual savers. Intermediaries resolve this mismatch of maturity and liquidity preferences again by pooling small funds.
Moreover, the risk appetite of savers and entrepreneurs are also different. It is often considered that small savers are risk averse and prefer safer placements whereas entrepreneurs may wish to deploy funds even in risky projects. The role of the intermediary again becomes crucial. They can substantially reduce their own risks through different techniques of proper risk assessment and risk management. Furthermore, small savers cannot efficiently gather information about opportunities to place their funds. Financial intermediaries are in a much better position to collect such information which is crucial for making a successful placement of funds.
The role and functions of banks outlined above are indeed highly useful and socially desirable. Hence, we reach to the point where the banks become the need of any economy.
ii. Why the bank should be on the basis of Islamic Shariah?
Commercial banks normally operate on a lending basis. They may not be much bothered about the use of funds as long as the borrower pays back the loan regularly. This does not ensure that the amount advanced to the borrower was used for the productive or unproductive purpose. Thus, the impact of commercial banking on economic development may remain below potential.
Whereas, Islamic bank provides finance which has a greater focus on productive use. Islamic banks’ financing targets both the equity as well as the working capital needs of enterprises. It is expected that its impact on economic development will be more pronounced. The avoidance of interest by Islamic banking is an additional plus. Allocating financial resources on a productive basis is more efficient than their allocation on a purely lending basis. It has also been argued that the whole banking system would be more stable and less liable to suffer from financial crises. A monetary system based on riba is also unjust as it allows savers and banks to get away with guaranteed fixed returns on their loans without bearing a fair part of the risks faced by entrepreneurs.
Is Islamic banking viable? >
Islamic banking is still in the stage of evolution. No one disputes that there is a definite desire amongst Muslim savers to invest their savings in the venues which are permitted by the Shariah. Nevertheless, they must be provided with halal returns on their investments. Islamic scholars and practical bankers took up this challenge and have made commendable progress in the last few decades in providing a number of such instruments.
However, the concepts of Islamic banking and finance are still in their early stages of development and Islamic banking is an evolving reality for continuously testing and refining those concepts. Islamic banking and financial institutions have now spread across several Muslim countries as well as non-Muslim countries. Various components of the Islamic financial system are now available in different parts of the world in varying depth and quality. A detailed and integrated system of Islamic banking and finance is gradually evolving.
Theoretical arguments and models developed by Islamic economists and the successful practice of hundreds of institutions in heterogeneous conditions both testify to the viability of Islamic banking. The Islamic banking model provides a complete banking solution to all the business needs of the customers while remaining within the boundaries of Shariah.
The average growth rate of assets in Islamic banks over the past twenty years has been around fifteen percent per annum. Islamic banking institutions have come of age now and are realizing a high degree of success in respect of market penetration. This is considered remarkable in view of the fact that the markets in which these Islamic banks were established already had highly developed and well-established commercial banks as competitors.
Another manifestation of the success of Islamic banking is the fact that many conventional banks have also started using Islamic banking techniques in their business operations, particularly in dealing with Muslim clients or in predominantly Muslim regions.
How does Islamic banking fare vis-à-vis conventional banking? >
The approach of Islamic banking to satisfy the business needs of customers is entirely different from that of conventional banking. Basically, Islamic banking satisfies the business needs of the entrepreneurs by the following two modes:
1. Profit and Loss sharing modes
2. Debt creating modes (financing the purchase of commodities on credit with a mark-up)
On the other hand, conventional banking satisfies the business needs of entrepreneurs by charging fixed interest which raises several questions. Although the results of operations of an enterprise in which such loans are to be invested are by no means certain, yet guaranteeing in advance a fixed return on a loan without taking into consideration the actual results of operations puts all business risks on the entrepreneur/borrower.
The Islamic banking philosophy is not based on interest because according to Islam, interest (riba) is haram and a curse in society. Islamic banking focuses on the common good, encourages high ethical standards such as universal brotherhood, collective welfare and prosperity, social welfare, and justice. On the other hand, the interest-based system accumulates money around a handful of people and inevitably creates monopolies, greed, injustice, and oppression.
Furthermore, the allocation of financial resources on the basis of profit-and-loss sharing gives maximum weight to the profitability of the investment whereas an interest-based allocation gives it to creditworthiness. It is expected that allocation made on the basis of profitability would be more efficient than that made on the basis of interest. Moreover, a system based on profit sharing would be more stable compared to one based on a fixed interest rate on capital.
In an interest-based system, the bank is obliged to pay a fixed return on its obligations regardless of their performance, whereas in a profit-sharing system, the return paid depends directly on the returns of its portfolio of assets. Consequently, the cost of capital adjusts automatically to suit changes in production and business conditions. This flexibility prevents the failure of enterprises and ensures harmony between a firm’s cash flow and its repayment obligations.
Since bank assets are created in response to investment opportunities in the real sector, the real factors related to production of goods and services become the prime movers of the rates of return to the financial sector. Transforming an interest-based system into a profit-sharing system helps achieve economic growth, increases the supply of venture capital, and encourages new entrepreneurs to participate in productive activities.
How can Islamic banking institutions avoid money laundering and such kind of other illegal/illegitimate activities? >
In the post–9/11 global scenario, anti–money laundering measures by regulatory authorities of banking and finance have gained extraordinary importance. It is pertinent to indicate in this regard that Islamic banks, by their nature, are less likely to engage in money laundering and other illegal activities. They cannot undertake activities which are detrimental to society, because to ensure the adherence of moral values, every transaction has to go through an exhaustive test of Shariah compliance.
Islamic banks are not allowed to invest in narcotics, casinos, nightclubs, alcoholic drinks, etc. This requires that the clients of Islamic banking must have businesses which are socially beneficial, creating real wealth and adding value to the economy rather than making paper transactions. Therefore, a more stringent ‘Know Your Customer’ (KYC) policy is an in-built requirement for an Islamic bank.
Islamic modes of financing and deposit-taking discourage questionable or undisclosed means of wealth which form the basis of money-laundering operations. Islamic financing modes are used to finance specific physical assets like machinery, inventory, and equipment. Further, the role of Islamic banks is not limited to a passive financier concerned only with timely interest payments and loan recovery. Islamic banks act as partners in trade and must concern themselves with the nature of business and profitability position of their clients.
To avoid loss and reputational risk, Islamic banks must be extra vigilant about their clientele. As such, Islamic banks are less likely to engage in illegal activities such as money laundering and financing of terrorism than conventional banks.
However, the existence of rogue elements cannot be ruled out in any type of organization. Keeping this in view, Pakistan has adopted a strategy by following uniform international standards to ensure fair play by all kinds of banks and financial institutions including Islamic banks. It has also put in place stringent regulations to effectively curb money laundering. The ‘Know Your Customer’ (KYC) regulation has been sharpened to provide more detailed guidelines to banks and DFIs for due diligence in respect of customers. All banks are required to properly investigate transactions which are out of character with the normal operation of the account, particularly those involving heavy deposits, withdrawals, or transfers.
Can a Muslim country transform its economy according to the principles of Islamic finance in a successful manner? What are the prerequisites for success? >
The conventional banking system still holds sway over the overwhelming part of banking operations internationally. However, over the last thirty years, several Muslim countries have started Islamic banking systems which are running parallel to the conventional banking system. Islamic banking is yielding reasonable success, as evident from its consistent growth rate of around 15% annually.
The current success of Islamic banking and finance has been accomplished despite the unavailability of an ideal legal and institutional setup which is imperative to support the operation of these banks. There is no doubt that once an appropriate institutional infrastructure is completed, their degree of success will be even greater.
The provision of an enabling framework is a prerequisite for the success of an Islamic financial system. This framework should include:
– Compatible national and banking laws
– Supportive rules and regulations
– A fair tax regime
– An accounting system consistent with Islamic principles
– Transparent financial disclosures
When these prerequisites are fulfilled, a Muslim country can successfully transform its economy according to the principles of Islamic finance and ensure long-term financial stability and socio-economic justice.
In case all interest-based transactions are abolished from the economy, what would be the economic implications on national and international level? >
In case all interest-based transactions are abolished from the economy, the implications at the national and international levels may be visualized as follows:
A) Implications at the National Level
i. Adopting the operating method of Islamic banking:
The economic consequences of eliminating interest at the national level can be anticipated from the operational nature of Islamic banks. Islamic banks can undertake financing through both partnership modes and sales-based modes involving fixed returns. This allows them a wider operational scope where they can closely monitor and follow up on the activities and performance of the enterprises they finance. They may even participate on company boards to gain insights as partners with a stake in the enterprise.
Economists believe Islamic banks face fewer risks than purely commercial ones, regardless of whether the economy is in a period of expansion or recession. The greater their ability to monitor financed activities, the less vulnerable they are to moral hazards — giving Islamic banks an edge in profitability and stability. By using an effective mix of partnership and fixed-return modes, they can enhance monitoring efficiency and profitability, leading to overall national economic growth.
ii. Resource allocation on production bases:
The most important feature of Islamic financing at the macroeconomic level is its unique method of financial resource allocation. In a conventional economy, lending decisions revolve around interest rates and creditworthiness. In contrast, an Islamic economy allocates financial resources based on production and commercial criteria. The key determinant of financing is the profitability and productive results of the enterprise, with creditworthiness being secondary.
Under Islamic finance, debt accumulation problems are minimized because debts arise only from real transactions — purchases of goods or assets — and are non-tradable except at face value. Mark-up (profit) is fixed and non-compounding. Thus, Islamic economies avoid excessive leveraging and speculative debt trading. Moreover, public sector borrowing through Islamic modes like Sukuk replaces conventional interest-bearing bonds, ensuring that debt volumes stay aligned with real economic activity. Consequently, the Islamic economy remains shielded from debt-driven crises.
iii. Relative stability of the banking system:
Conventional banks face instability during economic downturns because their assets (loans) are riskier than their liabilities (deposits). When returns on loans drop below interest obligations, banks can fail. In contrast, Islamic banks guarantee only demand deposits and share risks with investment depositors. When returns fall, payouts to depositors also adjust downward, maintaining equilibrium. Hence, Islamic banking offers greater resilience and stability to the financial system, leading to a more stable domestic economy.
B) Advantages of Islamic Financing at the International Level
In the age of globalization, enhanced transparency and open capital flows expose economies to international shocks. In conventional systems, short-term, interest-based capital flows create vulnerability — foreign banks lend to local banks, which then lend to businesses. If confidence wanes, loans are recalled rapidly, triggering financial crises as seen in East Asia.
An Islamic financial system avoids this instability. External capital inflows must follow Shariah-compliant modes — either partnership-based or mark-up based — which are contractual, non-tradable, and non-recallable on demand. Capital providers must wait until maturity or honor partnership terms. Consequently, Islamic economies are far less prone to speculative capital flight or sudden liquidity crunches. This results in a more stable and crisis-resistant international financial position for economies operating under Islamic finance principles.
A large number of Muslim countries depend heavily on foreign loans from other countries as well as from international financial institutions like the World Bank and the IMF. If interest is totally abolished from the economy of a Muslim country, how can it deal with foreign countries and foreign financial institutions? >
This question has three parts as follows:
a) How to deal with current debts
b) Economic effects of borrowing
c) Alternatives to borrowing
a) Dealing with current debts
The shift to an Islamic economic system does not mean that outstanding debts contracted under the conventional system will not be settled. It is a basic principle of the Shariah that Muslims must honour their contracts and promises. Therefore, both the principal and interest portions of past debts should be settled, whether these obligations are with domestic or foreign parties.
If a country faces liquidity constraints in repaying all its debts, several courses of action may be considered:
• Outstanding debts of developing countries are often traded in secondary markets at discounted prices. The indebted country may negotiate with creditors to swap debt for equity participation, thereby achieving partial relief.
• Governments can privatize portions of the public sector as part of a broader structural adjustment program. The proceeds from privatization can be used to buy back foreign debt at a discount, or debt can be swapped for equity in national enterprises, while maintaining majority ownership in key sectors.
b) The harmful effects of borrowing
Once existing debts are settled, Muslim governments should strictly avoid future interest-based borrowing. The global debt crises — beginning in 1982 and recurring in 1997 during the Asian financial crisis — revealed the dangers of excessive debt and dependency on foreign creditors. Economists observed that many developing economies fell victim both to creditor opportunism and their own unsound fiscal policies.
Heavily leveraged economies face the “open economy dilemma,” whereby they cannot simultaneously maintain fixed exchange rates, free capital flows, and independent monetary policy. In such economies, borrowers face high risks during downturns since debts must be repaid regardless of business conditions, leading to bankruptcies. Moreover, pessimism in one debt segment quickly spreads to others because conventional debts are tradable, leading to systemic contagion. Short-term external debt further magnifies this instability, as seen in the Asian crisis. Hence, it is prudent for Muslim countries to minimize borrowing and rely on Islamic modes of financing instead.
c) Alternatives to foreign borrowing
Muslim countries can still attract foreign financial resources through Shariah-compliant mechanisms. This requires innovative use of financial markets and dialogue with international institutions to promote understanding of Islamic finance principles.
Islamic financing channels funds directly into real assets and productive activities — unlike conventional loans, which may fuel bureaucratic inefficiency or speculative investments. The use of Islamic modes enhances efficiency, ties finance to real economic output, and promotes sustainable development.
The following methods can be adopted to attract foreign capital:
• Issuing Islamic financial instruments (such as Sukuk) denominated in foreign currencies.
• Establishing specialized funds for targeted sectors or projects, such as:
– Infrastructure funds (roads, ports, power projects, etc.)
– Ijarah (leasing) funds
– Trade financing funds
– Agricultural investment funds
– Industrial investment funds
– Housing finance funds
– Project-specific investment funds
d) When is it permissible to borrow?
Borrowing per se is not prohibited in Islam, provided the debtor has the means to repay. Even debt-based Islamic financing is permissible as long as it remains tied to tangible assets. However, the question arises: if a state cannot meet essential needs without resorting to interest-based borrowing, what then?
Islamic jurisprudence provides the doctrine of darurah (necessity), which states that “necessity renders permissible what is ordinarily impermissible.” This doctrine allows temporary suspension of the normal rule in dire circumstances — but under strict conditions. It must first be determined, by competent Shariah scholars and economic experts, that the situation truly qualifies as a necessity. Even then, borrowing should be limited to the extent required, and the borrower must maintain the intent to return to normal Shariah compliance as soon as possible.
Thus, interest-based borrowing may be temporarily permissible in cases of genuine and compelling necessity — for example, to fund essential development projects — but only after feasibility studies confirm that repayment will be possible from the project’s proceeds. This principle ensures that emergency exceptions do not become a routine policy and that the sanctity of Shariah remains upheld.
Can Islamic banks play any role in economic development of the country? >
While functioning within the Shariah framework, Islamic banks can perform a crucial task of resource mobilization and efficient allocation using either profit sharing (Musharakah and Mudarabah) or trading and Ijarah-based categories of Islamic modes of financing. Profit sharing modes can be utilized for short, medium and long-term project financing, import financing, pre-shipment export financing and working capital financing. To ensure the maximum contribution of Islamic finance to economic development, it is essential to create an environment that encourages financiers to allocate more funds for Musharakah and Mudarabah-based financing.
The non-profit-and-loss-sharing (non-PLS) techniques permitted under Islamic Shariah complement the PLS modes by providing flexibility to meet diverse sectoral needs based on varying risk profiles. Trade-based modes such as Murabaha, which carry lower risk and offer better liquidity, have certain advantages, though they may not contribute as effectively to reducing income inequality or promoting capital goods production as participatory techniques. Ijarah-based financing requires Islamic banks to purchase, maintain, and later dispose of assets in accordance with Shariah principles—engaging them in real economic activities beyond simple financial intermediation.
Salam financing also offers vast potential for supporting productive activities, particularly in agriculture, agro-based industries, and the rural economy. It provides strong incentives for production, since the seller must deliver the goods agreed upon after receiving the advance payment. Salam can stabilize commodities markets, especially for seasonal goods, helping balance supply and demand and reduce price volatility. It enables savers to invest their surplus funds in productive ventures instead of idle saving or unnecessary consumption, contributing to steady economic growth.
Based on the above, it can be concluded that the supply and demand of capital will continue to function effectively in an interest-free economy—enhanced by a greater supply of risk-based capital, more efficient resource allocation, and an active role of banks in asset-based financing. Islamic banks not only can survive without interest, but can also actively promote development with distributive justice by increasing the supply of risk capital, encouraging capital formation, and facilitating the growth of fixed assets and real-sector businesses.
Banks can also participate in fund and portfolio management through asset management, Ijarah, and trading companies. Such entities—either standalone or as subsidiaries—can manage investors’ schemes to mobilize resources on Mudarabah or agency basis, and deploy funds through Murabaha, Ijarah, or equity participation. Subsidiaries may focus on specific sectors, entering into genuine trade and leasing transactions. Low-risk funds based on short-term Murabaha and Ijarah operations (in local or foreign currencies) are suitable for risk-averse savers. Meanwhile, equity-based funds allow investors to share in the profits of specific enterprises, with the bank charging a management fee for overseeing the investments.
Furthermore, the small and medium enterprise (SME) sector has immense potential to enhance production capacity and generate self-employment opportunities. Strengthening Islamic financial participation in SME development can significantly reduce unemployment and increase exports.
In light of the above, it can be safely concluded that Islamic banking possesses great potential to play a highly effective and transformative role in the economic development of the country.
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