The Objectives Resolution of 1949 which is now a substantive part as Article 2A of the constitution of the Islamic Republic of Pakistan envisaged that 'the Muslims shall be enabled to order their lives in the individual and collective spheres in accordance with the teaching and requirements of Islam as set out in the Holy Quran and the Sunnah'.  As a consequence of this basic guideline the Article 38(f) of the constitution under Chapter 2 containing the Principles of Policy, provides that the State shall eliminate Riba as early as possible. Article 29 of the constitution also lays down that 'it is the responsibility of each organ and authority of the State, and of each person performing functions on behalf of an organ or authority of the State, to act iit accordance with those Principles in so far as they relate to the functions of the organ or authority'. Elimination of Riba had been a part of the Principles of Policy in the previous constitutions of the country.

On the basis of an official reference about Riba made in March 1963 by the Ministry of Finance, the Council of Islamic Ideology for the first time examined the issue in their meetings held in June and September
1963. The question received from the Ministry and examined by the Council was:

"Whether interest in the form in which it appears in public transactions is in conformity with principles and concepts of Islam?"

The following decision on the issue was taken by the Council in their meeting held on January 13, 1964 at Karachi.

"The Advisory Council of Islamic Ideology agrees that 'Riba' is forbidden but is in disagreement as to whether 'Interest in the form in which it appears in Public transactions which in the opinion of Council includes 'institutional credit' as well would also be covered by 'Riba' specified in the Holy Quran. There is, however, unanimity on the point that for the fulfilment of the Islamic requirement of social justice and concept of human brotherhood, a system of interestless economy should be inaugurated. The Council recognises that any abrupt or sudden change will create numerous difficulties for the country. The Council recommends that efforts in the direction of establishing an economy free from interest should not be unduly delayed".

In its meeting held on December 10, 1966 at Dhaka the Council framed a questionnaire which, beside other information, also sought views on the Quranic definition of Riba and on the point whether the Quranic prohibition of Riba applied to simple interest or not. This questionnaire was not approved until 1976 but the Advisory Council of Islamic Ideology in its meetingheld on December 23, 1969 itself took the historic decision which stated:

a) that under the present banking system any increase received or paid in addition to the principal sum was Riba irrespective of the fact whether the transaction were between the individuals, organisations or the governments

b) The discount allowed on short term loans issued by the Treasury was Riba

c) Interest paid on Savings Certificates was Riba.

d) Prizes paid on prize bonds was Riba.

e) Interest paid on provident fund and postal life insurance was Riba.

f) Interest charged on loans provided to employees of the government and local bodies was Riba.

The Council of Islamic Ideology in its meeting held at Karachi on January 31, 1976 amended its pending questionnaire of December 10, 1966 and finalised the same for general circulation in the newspapers. The questionnaire was specially mailed to well known ulema, universities, research organisations, State Bank of Pakistan, Pakistan Banking Council, nationalised banks and to some reputed organisations in other Muslim countries. In its meetingheld on January 31, 1977 the Council examined the replies received in response to its questionnaire of January 31, 1976. It appears that a very few replies were received and the Council, therefore, decide that it should wait for the opinion of the ulema from other Muslim countries.

It was on September 29, 1977 that the Council of Islamic Ideology was entrusted by the President of Pakistan with the task of preparing a blue print for an interest-free economic system. In view of the technical nature of the task the Council in its meeting held at Islamabad on October 13, 1977 appointed a panel of economists and bankers for compilation of their recommendations. The banker-members of the panel were assigned the job of preparing an interest-free commercial banking framework. This sub-committee completed its report on January 2, 1978. The panel of economists and bankers presented its final report to the Council of Islamic Ideology in February 1980 and with some modifications and substitutions the Council adopted this report on June 15, 1980.

For introducing the system of interest-free banking in the nationalised commercial banks, the Pakistan Banking Council constituted a Superior Task Force for devising the necessary procedures. The Task Force submitted its report on August 4, 1980. Prior to this, in April 1979, six working groups were constituted by State Bank of Pakistan for examining all aspects of eliminating interest from various sectors of the economy. These working groups submitted their reports in November/December of 1979. After the above preparations and necessary changes in the banking laws, the nationalised commercial banks on January 1, 1981 opened for the first time special counters in their 7000 domestic branches for accepting voluntary deposits from their customers on the basis of profit and loss sharing.

As these PLS deposits had to be invested in interest-free assets, the State Bank of Pakistan authorised the banks to utilise their PLS deposits in the following cleansed-up assets:

(A) As from January 1, 1931. (BCD Circular No. 26 dated 24.12.1980)

1)  Financing of commodity operations of the Federal & Provincial Governments and their agencies.
2)  Export bills purchased/negotiated under letters of credit (other than those under reverse).
3)  Investment in Shares, NIT Units, Participation Term Certificates and PLS based transactions of ICP and BEL.
4)  Provision of finance to House Building Finance Corporation.

(B) As from March 1, 1981. (BCD Circular No. 26 dated 24.12.1980)

1)  Documentary in land bills drawn against letters of credit purchased negotiated.
2)  Financing of trading operations of :-
 a)  Rice Export Corporation of Pakistan
 b)  Cotton Export Corporation
 c)  Trading Corporation of Pakistan
3)  Import bills drawn under letters of credit

(C)  As from July 1 1982 (BCD Circular No. 21 dated 30.6.1982)

1)   Musharika (Profit & Loss sharing)
2)   Leasing
3)   Hire-Purchase

(D)  As from November 2, 1982 (BCD Circular No. 37 dated 2.11.1982)

1)   Investment in Modaraba Certificates

Consequent upon Federal Government's decision, an advanced phase of interest-free banking was introduced in the country by the State Bank of Pakistan in accordance with the instructions contained in their BCD Circular No. 13 of June 20, 1984 which also applied to the branches of foreign banks operating in Pakistan. These instructions were as follows:

a) As from January 1, 1985 all finances provided by a bank to the Federal Government, Provincial Governments, Public sector corporations and public or private joint stock companies shall be only in one of the specified Islamic Modes of Financing and during the period from July 1, 1984 to December 31, 1984 no accommadation for working capita] will be provided or renewed on the basis of interest for a period of more than six months. However, as from July 1, 1984 banks will be free to make finances available on the basis of anyone of the specified Islamic Modes of financing.

b) As from April 1, 1985 all finances provided to all entities including individuals shall be in one of the specified Islamic modes of financing.

c) As from July 1, 1985 no banks shall accept any interest-bearing deposits and as from that date all deposits accepted by a bank shall be on the basis of participation in profit or loss. Deposits in Current Accounts will continue to be accepted as at present and no interest or profit shall be allowed on such deposits.

d) The foregoing instructions of the State Bank of Pakistan shall neither apply to foreign currency deposits in Pakistan nor to on-lending of foreign loans which will continue to be governed by the terms of the loans.

In their BCD Circular No. 13 of June 20, 1984 the following twelve permissible modes of financing, were specified by State Bank of Pakistan:

As from July 1, 1984

(A) Financing by Lending

1)  Loans not carrying any interest on which the bank may recover a service charge not exceeding the proportionate cost of the operation excluding the cost of funds and provisions for bad and doubtful debts. The maximum service charge permissible to each bank will be determined by the State Bank from time to time.

2) 'Qarz-e-Hasna' loans given on compassionate grounds free of any interest or service charge and repayable if and when the borrower is able to pay.

(B) Trade-related Mode, of Financing

3) Purchase of goods by banks and their sale to clients at appropriate mark-up in price on deferred payment basis. In case of default, there should be no mark-up on mark-up.

4) Purchase of trade bills.

5) Purchase of moveable or immoveable property by the bank from their clients with Buy-Back Agreement or otherwise.

6) Leasing

7) Hire-Purchase

8) Financing for development of property on the basis of a development charge.

(C) Investment type Modes of Finance

9)  Musharika or profit £ind loss sharing

10) Equity participation and purchase of shares

11) Purchase of participation term certificates and Modaraba Certificates

12) Rent-sharing

After the issuance of State Bank's BCD Circular No. 13 of June 20, 1984 which laid down a firm time-frame for complete change-over to interest-free banking, the Pakistan Banking Council set-up the following four special committees for the required ground work:

1) Documentation Committee. This committee was assigned the task of drafting the legal documents governing the basis of transactions and the terms of contract between a bank and a consumer.

2) System & Accounting Committee. This committee was assigned the task of devising the new procedures of accounting.

3) Legal Committee. This committee was assigned the task of vetting the legal documents prepared by the Documentation Committee.

4) Training Committee. This committee was assigned the task of developing the training packages and for organising crash training programme through-out the country.

Of all the four committees the most onerous task lay on the shoulders of the Documentation Committee because the Islamicity of the banking transactions depended on the Islamicity of the terms and conditions of the contracts. The surprising aspect of the entire exercise is, that at no point of time, any Shariah advisor was associated while the State Bank of Pakistan had described the permissible modes of financing in utmost general terms. State Bank allowed the banks full freedom to develop their own documents and procedures. In the absence of any Shariah Supervisory Board or Shariah advisors, it was to be expected that mistakes shall be made and liberties taken in the conduct of the proposed Islamic banking. In other parts of the world even small Islamic Banks do not function without the advice of a Shariah Supervisory Board while in Pakistan we were trying to transform the entire banking system on a national level to accord with the principles of Islam without the guidance of any Shariah advisor.

The foreign banks appeared more earnest in pursuing the Islamic principles in their transactions and some of them even deputed their senior officers to visit the Islamic banks operating in other Muslim countries. But as time passed by, the foreign banks preferred to copy the practices adopted by the nationalised banks. Before the issuance of State Bank's BCD Circular No. 13 of June 20, 1984 the nationalised banks were concentrating on financing on the basis of musharika, leasing and hire-purchase and true commercial Islamic banking could be conducted on these modes of financing. After the issuance of BCD Circular No. 13 of June 20, 1984 which permitted the banks to finance on the basis of markup, all other modes of financing went in the background. As far as the nationalised commercial banks are concerned they are controlled and guided by the Pakistan Banking Council and have to transact their business in accordance with the contract documents which have been provided by the legal committee appointed by the Council.

A study of the legal documents IB- 1 to IB- 32 (which are different from the documents drafted by the Documentation Committee) reveals that the said documents (except IB-7& IB-32) are based on a single mode of financing that is mark-up with a buy-back agreement. As such almost the entire interest-free banking in Pakistan is being conducted on the basis of mark-up with a buy-back agreement. The mark-up financing can be provided by banks under two modes of financing which appear at serial No. 3 and 5 in the list given above. The mark-up mode of financing
mentioned at serial No. 3 reads as under:

"Purchase of goods by banks and their sale to clients at appropriate mark-up in price on deferred payment basis. In case of default their should be no mark-up on mark-up."

This mode of financing is similar to Murabaha financing adopted by Islamic banks in other countries under the guidance of their Shariah Supervisory Boards. In this mode of financing there are three parties and the transaction takes place in the following manner:

1) The client approaches the bank with the request to purchase for him certain specified goods from a specified source or otherwise.

2) The bank purchases the goods and pays for them in cash.

3) The bank thereafter sells those goods to  the client on deferred payment basis at a price which includes cost plus a known amount of the profit.

4) The purchasing client pays the price of the goods to the bank according to the agreement and the transaction comes to an end.

In Murabaha sales the Shariah principles followed is, that no one can sell such goods which he does not own. For this reason, when a client approaches the bank he only signs a promise to purchase which is different from the contract of sale. The client and the bank conclude a contract of sale when the goods have been purchased and owned by the bank. As regards the agreement or promise to purchase, some banks consider that the promise to purchase is not binding on the client but binding on the bank while some other Islamic banks consider that the promise is binding both on the bank and the client. The bank is however considered responsible in all cases for any defects in the goods which risk is treated to be the real consideration for earning the specified gain over the cost. The mode of financing involving three parties is being used in Pakistan only for the financing of the agricultural inputs.

The most common mo ie of mark-up financing being used by banks in Pakistan is the one mentioned at serial No. 5 which reads as under :

"Purchase of moveable or immoveable property by the banks from their clients with Buy-Back Agreement or otherwise."

The practice followed is that a client sells his goods to the bank for cash simultaneously buys-back the same goods from the bank at a higher price (marked-up price) payable at a future date either in lumpsum or in instalments. This mode of financing is not accepted as Islamically permissible form of Murabaha and has been looked upon with great disfavour by the ulema and the Islamic bankers in other parts of the world. An acceptable form of a Buy Back transactions according to Shariah is likely to be as follows:

A 1s in need of money. He sells his goods to B for cash with an agreement that A will repurchase his goods from B before an agreed date but at the same price. If A fails to repurchase the goods by the agreed date the sale becomes final. It will, therefore, be seen that the transaction is in the nature of an interest-free loan secured by the goods sold which can be repurchased by the original seller under an agreement. On the other hand an owner (A) can sell his goods or property to purchaser (B) at a mutually agreed price without any buy-back agreement. Later, when A has sufficient funds he may offer to buy the same goods or property from (B) at a mutually agreed price which may be higher, or lower than the previous purchase price. The mode of mark-up financing with Buy Back Agreement used by banks in Pakistan also provides that a specified amount shall be paid by the bank to the client by way of prompt payment. rebate if the client pays the agreed price to the bank on or before the due date.

Shariah scholars do not recognise this type of sale transaction as a permissible form of Murabaha. Such transaction have been termed as 'Heela' by many while others have named it as 'Bai-Einah'. The practice of Murabaha financing is accepted with reservations as the same is not based on any explicit text of the original sources of Shariah i.e. the Holy Quran and the Sunnah. Murabaha is based on Ijtehad and opinion often quoted in its support is of Imam Al-Shafie appearing in his book Al-Umm. Murabaha financing mentioned at serial No. 3 has, however, been cleared by the Shariah Supervisory Boards of almost all the Islamic banks subject to certain conditions as this mode of transaction specifically pertained to the trading practices but it is now being adopted by the Islamic banks as a tool of financing. The three party Murabaha was cleared by the Council of Islamic Ideology in Pakistan with great reservations only to be used in special circumstances. The present position is that the Buy-Back form of 'Murabaha' is being used in Pakistan as the prime mode of financing. For this obvious reason the Islamic banking system as practiced in Pakistan appears to have lost its credibility. There is no doubt that the most plausible Islamic alternative to the interest-based banking will gravitate towards a trade-based model of banking which will have to be developed accordingto principles of Shariah and the changing needs of the economy. Such a model shall be based on the following three modes of financing:

1) Lending without interest (Qard-e-Hasna)

2) Sale and trade

3) Profit and loss sharing (Musharika & Modaraba)

At present, banks are authorised to purchase Modaraba certificates floated by Modaraba companies which are, in fact, joint stock companies registered as a Modaraba company with the Registrar of Modarabas. If a bank desires to finance cm the basis modaraba, a client not registered as a Modaraba Company, the bank can not do so as this is not authorised by State Bank of Pakistan. This is a very serious deficiency which needs to be rectified. For example, a technically qualified engineer who has no capital of own, needs banks financing for establishing his own business, he cannot be financed on the basis of Modaraba though the bank can provide him finance by way of Qard-e-Hasna.

We will also have to give up our orientation and prejudices which we drawfrom the norms of conventional interest-based banking. Some of the major inherited prejudices are as follows:

1) Banks can not trade on their own document. This prejudice can not coexist with Islamic banking as even in a Murabaha transaction the bank has to purchase and sell the goods on its own account.

2) Banks deal in documents and not in goods. This prejudice also cannot coexist with Islamic banking as the banks when they purchase and sell the goods on their own account, must accept the responsibility for the defects in the goods.

Without going into the finer points relating to Shariah principles pertaining to Murabaha transactions, be it a three party deal with Buy-Back Agreement, the financing on the basis of mark-up in price (Murabaha) has no significant economic merit over the interest-based system except for that genuine financing cannot be provided even under mark-up deals if there are no goods to be transacted. For instance, the fiscal deficit of the government can not be financed on the basis of markup in price in the absence of the goods. The same holds for the individuals in case of their personal needs.

In my opinion the cost of credit, in bank financing on the basis of murabaha or mark-up in price, is the same as in the case of financing on the basis of simple interest except that in Murabaha financing the price agreed remains the same even if the payment is not made on the due date. It might, therefore, be said that the present system of Islamic banking in Pakistan is nearer to the Shariah position as it stood in the third or fourth year of the Hijra when verse 130 of Surah Ale-Imran prohibited the doubling and quadrupling (i.e. compounding) of interest.

Before concluding I must reiterate that a system of true Islamic banking will have to be based on the following four basic principles:

1) Riba (as defined in the Holy Quran) must be eliminated from all the banking transaction mechanically as the horse was replaced by the motor power in the earliest model of a car though its force is still measured in terms of horse power.

2) Financing must be provided by banks only for the Halal activities which will be naturally socially and economically desirable.

3) The choice of the mode of financing must be based on their economic merit. For example, wherever possible, musharika and Modaraba financing must be preferred over the Murabaha financing.

4) The objectives of the banking system must be related to the economic ideals of Islam.

It must also be remembered that a banking system is an adjunct to the economic system in which it operates. A banking system based on Islamic principles shall suffer from severe limitations if it has to operate in an environment which does not show consideration for the other principles of Islam. For better implementation of the Islamic banking steps are urgently called for:

1) A legal definition of Riba is needed. In the absence of a legal definition of Riba it has been noticed that even senior people in authority have been voicing their personal opinion as to what constitutes Riba. They show no respect for the decision given by legally constituted bodies such as tine Council of Islamic Ideology.

2) A Shariah Supervisory & Technical Board is required at the national level to which problems may be referred by the banks and guidance sought. The said Board may also periodically conduct a critique of the system.

3) A Shariah Audit Department be established at State Bank's level with suitable administrative powers.

It is only the beginning of the process and it will continuously demand a refining and redefining of the various components of the system.

-------------------

The author is Executive Vice President & Head of Islamic Banking Division,United Bank Limited, Head Office, Karachi. The views expressed in this paper are, however, his own.