CHAPTER 1

1. INTRODUCTION

Elimination of Riba from economy is the key issue of the Islamic world. As Riba is
strongly prohibited in Islam. And there are severe warning against this practice given in
Quran and Ah Hadis. The purpose of this dissertation is to give others to focus on
interest free mode of financing as the conventional banking system is based on interest
and there are many people who want to finance in an Islamic way. Due to the frequent
use of interest or we can say that Riba there is injustice to the people and the money is
just hold by a fist of people. As a result of this unbalance economy is created where only
accumulation occurs for the sake of accumulation.

Islamic banking emerged as a response to both religious and economic needs. Islam calls
for avoiding any transaction based on Riba while economic needs ask for diversity in the
role of banking foe promoting investment/ productive activities, facilitating economic
justice and adding stability to the economy. Islamic banking can thus be perceived as an
improved and better-equipped system in different dimensions.

The banking system in an economy works like the blood circulation system of a body. As
only an efficient blood circulation system can ensure a healthy body. Similarly an
efficient and equitable banking system can dispense economic efficiency and justice.
These basic concepts and objectives are common to any banking system whether it be
conventional or Islamic. The difference lies in the methodology adopted to achieve these
objectives through use of interest-based contracts while Islamic banking achieves these
objectives through trade-based contracts. The later is permissible while former is not. The
clear prohibition of interest and permissibility of trade in enunciated in following Quranic
verses
“And Allah has permitted trading, and prohibited Riba”
This similarity of objectives and difference in methodology of conventional and Islamic
finance defines the regulatory framework required for Islamic banking system. Similarity
of objectives implies that a major portion of the regulatory framework would be the same
for both the systems. However, the difference in methodology to achieve the objectives
requires amendments to existing regulatory system according to the Shar’iah principles.
This is more pragmatic approach that helps avoid the tendency of unnecessarily
reinventing the wheel. Moreover,, it gives Islamic banking a great advantage to get
maximum leverage out of already existing and well tested regulatory framework of the
conventional banking.

Islam is not simply one of the greatest monotheistic religions, signifying submission to
the will of Allah, but as system of life in entirety. It prescribes a complete code of
conduct for every day human life in all its spheres and manifestations. It does not confine
itself to a spiritual relationship between man and Allah or describes the Almighty only
with a transcendental reference but also regulates, in right proportions, an interactive
relationship between man and man, and between man and society with moral, political
and economic genesis. As a result, it is a religion lived in every day life and no Muslim is
in any doubt as to exactly how he should carry on the events of his day.

On the other hand, capitalism has not been able to narrow down the gap between the
“haves and “have-nots”. Material affluence, wherever it exists, is marked by a
conspicuous absence of a broad based sharing of fortunes and thus real happiness to a
large number of people is seriously missing. Likewise, socialism advocating collective
ownership of the means of production and control of distribution has failed to provide the
necessary motivation for collective development and personal self-actualization, and thus
retarded the process and rate of economic growth.
Similarly, communism, stressing ownership of property and control of production,
distribution and supply by the whole of classless society, could not get along with the
human potential, dynamism and aspirations, and fell too short to bring about economic
satisfaction or progress, in individual and collective life.

1.1 RIBA AND PROHIBITION OF 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 2:278-9)

“O this who believe; fear Allah and give up what still remains of
the Riba if you are believers. But if you do so, then be warned of
war from Allah and His Messenger. If you repent even now, you
have the right of return of your principal; neither will you do
wrong nor will you be wronged”

1.1.1 Revelation/ verses in Holy Quran regarding Prohibition of Riba

1. First Revelation: In Surah Al-Rum verse 39, dealing in riba has been discouraged in
the following, Allah says;

“That which you give as interest to increase the peoples’ wealth increases not with
God; but that which you give in charity, seeking the goodwill of God, multiplies
manifold’

2. Second Revelation: Muslims have been informed about the practice of taking riba by
Jews in Surah An-Niss:
 “And because of their charging riba while they were prohibited from it”

3. Third Revelation: Riba/ Interest has been abolished in the third verse of surah Al-I’-
Imran.

“O those who believe do not eat up riba doubled and redoubled”

4. Fourth Revelation: In the four revelations, Riba has categorically been prohibited in
all its forms.

1.1.2 Riba in Hadith

1. Jabir ibn ‘Abdallah (R.A), giving a report on the prophit’s Farewell Pilgrimage said:
The Prophet, addressed the people and said, “All of the Riba of Jahiliyyah is annulled.
The first riba that I annul is our riba, that accruing to ‘Abbas ibn ‘Abd al-Muttalib
(the Prophets’s uncle); it is being cancelled completely” (Muslim, Kitab al Hajj, Bab
Hajjati al Nabi may also in Musnad Abmad)

2. From ‘Abdallah ibn Hanzalah: the Prophet (PBUH) said “ A dirham of Riba which a
man receives knowingly is worse than committing adultery thirty-sic times” (Mishkat
al-Masabih, Kitab al-Buyu’, Bab al-Riba on the authority of Ahmad and Daraquntni).
Bayhaqi has also reported the above hadith in Shu’ab al-iman with the addition that
“Hell befits him whose flesh has been nourished by unlawful”

3. From Abu Hurayah : The Prophet (PBUH) said: “ God would be justified in not
allowing four persons to enter paradise or to taste its blessings: he who drinks
habitually, he who takes riba, he who usurps an orphan’s property without right, and
he who undutiful to his parents” (Mustadarak al- Hakim, Kitab al –buyu’).

4. Muslim narrated on the authority of ’Abu Sa‘ıd Al-Khudriy:

Bial visited the Messenger of Allah (PBUH) with some high quality dates, and the
Prophet (PBUH) inquired about their source. Bilal (R.A) explained that he traded two
volumes of lower quality dates for one volume of higher quality. The Messenger of Allah
(PBUH) said: “this is precisely the forbidden Riba! o not do this. Instead, sell the first
type of dates, and use he proceeds to buy the other.”

1.2 KINDS OF RIBA

There are two kinds of Riba:
1. Riba-AN-Nasiyah/Riba-Al-Quran
2. Riba-AL-Fadl

1.2.1 Riba-AN-Nasiyah/Riba-Al-Quran
It is defined as excess, which results from predetermined interest (sood) which a lender
receives over and above the principle.

In the Holy Quran, Allah (SWT) says in Sur Al-Baqarah (2-279):

“……And if you repent, yours is your principal”

It is reported by Harith ibe Abi Usamah in his Musnad that Sayyidna Ali Radi-Allahu
Anhu reportedly referred that the Holy Prophet said:

“Every Loan that derives a benefit (to the lender) is riba”

Example: If Mr. A lends Rs 100 to MR. B (a borrower) with a condition that Mr. B shall
returns him Rs 110 after one month. In this case, the extra amount of Rs 10 is Riba or
Interest.

Explanation
This is the real and primary form of riba. Since the verses of quran has directly renderes
this type of riba as haram, it is called Riba Al Quran. Similarly only this type was
considered Riba in the dark ages; it has earned the name of Riba Al Jahilya. Imam Abu
Bakr Hassas Razi has outlines complete and prohibiting legal definition of Riba Nasiyah
in the following words.
“That kind of loan where specified repayment period and an
amount in excess of capital is predetermined”

One of the ahadith quoted by Ali ibn-e-Talib (RAA) has defined Riba An Nasiyah in
similar words. The holy Prophet (PBUH) said:
“Every loan that draws interest is Riba”

Riba An Nasiyah refer to the addition of the premium which is paid to the lender in return
for his waiting as a condition for the loan and is technically the same as interest. The
prohibition of Riba An Nasiyah is one of those issues that have been confirmed in the
revealed laws of all Prophets (AS). The Quran has also stated the prohibition of Riba in
various verses, has warned those who persist in practicing it of a war which is certain to
be declared on them by Allah Himself and His messenger and has seriously threatened
those engaged as writer, witness and dealer in Riba transaction.

The fact that Riba An Nasiyah is categorically haram has never been disputed in the
Muslim community. In short, the Riba of today which is supposed to be the pivot of
human economy and features in discussion on the problem of interest is nothing but this
Riba, the unlawfulness of which stands proved on the authority of the seven verse of the
Quran, of more than forty ahahdith and the consensus of the muslim community.

Wisdom behind the prohibition of Riba An Nasiyah

There is nothing in the entire world, which has no goodness or utility, but some
commodities have more benefits and less harm so called beneficial and some things have
more harm less benefits so these are called harmful. Even the noble Quran while
declaring liquor and gambling to be haram, proclaimed that they do hold some benefits
for people but the curs of sins they generate is far greater than the benefits they yield.
Same is in the case of Riba An Nasiyah, here the consumer of Riba does have some
casual and transitory profits apparently coming to him, but to sure in this world and in the
hereafter is much too severe as compared to this benefit the Riba consumer suffers such a
spiritual and moral loss that it virtually takes away the great quality of being human from
him. An intelligent person who compares things in terms of their profit and loss, harm
and benefit can hardly include things of casual benefit with an everlasting loss in the list
of useful things. Similarly no sane and just person will say that personal and individual
gain which causes loss to the whole community or group is useful. In theft and robbery
for example, the gain of the gangster and the take of the thief is all too obvious but it is
certainly harmful for the entire community since it ruins its peace and sense of security.
1.2.2 Riba-AL-Fadl
It is defined as excess compensation without any consideration resulting from a sale of
goods. Since the prohibition of this Riba has been established on Sunnah, it is aslso called
Riba AL Hadees. The Prophet (SWW) said,

“Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and
salt for salt; like for like, in equal amounts; and any increase is Riba. However, sell
gold for silver anyways you pleas on the condition it is hand-to-hand (spot) and sell
barley for date anyway you pleas on the condition is hand-to-hand (spot).”

The hadith enumerates six different commodities. An unequal sale or deferred sale of
these commodities will constitute Riba. Majority if Islamic scholar believes that other
commodities should also be included. In order to answer the question, which other
commodities should be included, some fiqhs hold that the characteristics, which are
common amongst these items, can be used as basis (illat) for Riba AL Fadl. An illat is the
attribute of an event that entails a particular divine ruling in all cases possessing that
attribute; it is basis for applying analogy. Ribawi goods are therefore goods that exhibit
one of the efficient causes occasioning application of Riba rules. Various schools define
these causes differently:
Imam Abu Hanifa
Imam Abu Hanifa sees only two common characteristics namely:
1) Weight
2) Volume
Meaning all these six goods are sold by either weight or volume. Therefore all those
commodities, which have weight or volume and are being exchanged, with the same
commodity will fall under the rules of Riba Al Fadl.
Imam Shafi
The two characteristics observed by Imam Shafi are:
1) Medium of Exchange or
2) Eatable
Therefore this law will apply on everything edible or having the natural ability of
becoming a medium of exchange (currency).
Imam Malik
Imam Malik identified the following two characteristics:
1) Eatable
2) Preservable
Imam Ahmad Bin Hanbal
Three citations have been related to him:
i) First citation conforms to the opinion of Imam Abu Hanifa.
ii) Second citation conforms to the opinion of Imam Shafai.
iii) Third citation includes three characteristics at the same time namely edible,
weight and volume.
In short following two transactions are not allowed;
• A deferred sale of goods (A deferred sale is when the goods are
returned /or paid for after some undetermined period).
• A sale of unequal quantities of the same goods.
However, when only one of the two characteristics is present to term the sale as Riba Al
Fadl, then exchange of unequal goods are allowed but deferred sale is not allowed.

Wisdom behind the prohibition of Riba Al Fadl

The prohibition of Riba Al Fadl is intended to ensure justice and remove all forms of
exploitation through unfair exchanges and to close all back-doors to Riba An Nasiyah
because in the Islamic sharia’h, anything that serves as a means to the unlawful is also
unlawful.

1.3 THE BASIC DIFFERENCE BETWEEN CAPITALIST AND ISLAMIC

ECONOMY
Islam does not deny the market forces and market economy. Even the profit motive is
acceptable to a reasonable extent. Private ownership is not totally negated. Yet, the basic
difference between capitalist and Islamic economy is that in secular capitalism, the profit
motive or private ownership are given unbridled power to make economic decisions.
Their liberty is not controlled by any divine injunctions. If there are some restrictions,
they are imposed by human beings and are always subject to change through democratic
legislation, which accepts no authority of any super-human power. This attitude has
allowed a number of practices which cause imbalances in the society. Interest, gambling,
speculative transactions tend to concentrate wealth in the hands of the few. Unhealthy
human instincts are exploited to make money through immoral and injurious products.
Unbridled profit making creates monopolies which paralyze the market forces or, at least,
hinder their natural operation. Thus the capitalist economy, which claims to be based on
market forces, practically stops the natural process of supply and demand, because these
forces can properly work only in an atmosphere of free competition, and not in
monopolies. It is sometimes appreciated in a secular capitalist economy that a certain
economic activity is not in the interest of the society; yet, it is allowed to be continued
because it goes against the interest of some influential circles who dominate the
legislature on the strength of their majority. Since every authority beyond the democratic
rule is totally denied and 'trust in God' (which is affirmed at the face of every U.S. dollar)
has been practically expelled from the socio-economic domain, no divine guidance is
recognized to control the economic activities.

The evils emanating from this attitude can never be curbed unless humanity submits to
the divine authority and obeys its commands by accepting them as absolute truth and
super-human injunctions which should be followed in any case and at any price. This is
exactly what Islam does. After recognizing private ownership, a profit motive and market
force, Islam has put certain divine restrictions on the economic activities. These
restrictions being imposed by Allah Almighty, Whose knowledge has no limits, cannot be
removed by any human authority. The prohibition of riba (usury or interest), gambling,
hoarding, dealing in unlawful goods or services, short sales and speculative transactions
are some examples of these divine restrictions. All these prohibitions combined together
have a cumulative effect of maintaining balance, distributive justice and equality of
opportunities.

1.4 ISLAMIC BANKING

Islamic banking has been defined as banking in consonance with the ethos and value
system of Islam and governed, in addition to the conventional good governance and risk
management rules, by the principles laid down by Islamic Shariah. Interest free banking
is a narrow concept denoting a number of banking instruments or operations, which avoid
interest. Islamic banking, the more general term is expected not only to avoid interest-
based transactions, prohibited in the Islamic Shariah, but also to avoid unethical practices
and participate actively in achieving the goals and objectives of an Islamic economy.

1.4.1Philosophy of Islamic banking and Finance

Islamic Shariah prohibits ‘interest’ but it does not prohibit all gains on capital. It is only
the increase stipulated or sought over the principal of a loan or debt that is prohibited.
Islamic principles simply require that performance of capital should also be considered
while rewarding the capital. The prohibition of a risk free return and permission of
trading, as enshrined in the Verse 2:275 of the Holy Quran, makes the financial activities
in an Islamic set-up real asset-backed with ability to cause ‘value addition’.
Islamic banking system is based on risk-sharing, owning and handling of physical goods,
involvement in the process of trading, leasing and construction contracts using various
Islamic modes of finance. As such, Islamic banks deal with asset management for the
purpose of income generation. They will have to prudently handle the unique risks
involved in management of assets by adherence to best practices of corporate
governance. Once the banks have stable stream of Halal income, depositors will also
receive stable and Halal income.

The forms of businesses allowed by Islam at the time the Holy Quran was revealed
included joint ventures based on sharing of risks & profits and provision of services
through trading, both cash and credit, and leasing activities. In the Verse II:275, Allah the
Almighty did not deny the apparent similarity between trade profit in credit sale and Riba
in loaning, but resolutely informed that Allah has permitted trade and prohibited Riba.

Profit has been recognized as ‘reward’ for (use of) capital and Islam permits gainful
deployment of surplus resources for enhancement of their value. However, alongwith the
entitlement of profit, the liability of risk of loss on capital rests with the capital itself; no
other factor can be made to bear the burden of the risk of loss. Financial transactions, in
order to be permissible, should be associated with goods, services or benefits. At macro
level, this feature of Islamic finance can be helpful in creating better discipline in conduct
of fiscal and monetary policies.
Besides trading, Islam allows leasing of assets and getting rentals against the usufruct
taken by the lessee. All such things/assets corpus of which is not consumed with their use
can be leased out against fixed rentals. The ownership in leased assets remains with the
lesser that assumes risks and gets rewards of his ownership.

1.4.2 Objectives of Islamic Banking

Before discussing various objections rose on the present day Islamic banking, we should
first try to understand the objectives of Islamic banking, which are as follows:
 1. To provide Shariah compliant and prudent banking opportunities; hence providing
an opportunity to Muslims to do their banking transactions – a Halal way: In other
words, this is just an effort to avoid Riba and other prohibited elements from
commercial and banking transactions, in order to ensure that we do “Nothing-
Haram”; and
2. Achieving the goals and objectives of an Islamic economic system.
We all can agree that, given the circumstances, the Islamic banking industry is making all
efforts to ensure the first objective, while the second objective, although no-less
important, is not the prime objective of current-day Islamic banking.

1.4.3. History of Islamic Banking

Modern banking system was introduced in Muslim countries at a time when they were
politically and economically slave to the western world. The main banks of the western
world established their branches and subsidiaries in the Muslim countries and territories
to fulfill requirements of foreign business. The Muslim community generally avoided the
foreign banks for religious reasons but with the passage of time, it became more and
more difficult to engage in trade and other activities without making use of commercial
banks. Even then, a large number of Muslims, confined their involvement to transaction
activities such as current account or hundred percent cash margin letter of credits.
Borrowings from commercial banks or placement the access funds and saving accounts
were strictly avoided by practicing Muslims in order to keep away from dealing in
interest which is prohibited by Islam.

With the passage of time, however, due to increase in cross-border transactions and other
socio-economic forces demanding more involvement in national economic and financial
activities, avoiding the interaction with the banks became impossible. Local banks were
established in Muslim countries (including the names like Muslim Commercial Bank) on
the same lines as the interest-based foreign banks and they began to expand within the
country bringing the banking system to more and more people. Governments, businesses
and individuals began to transact business with the banks, with or without liking it. This
state of affairs drew the attention and concern of Muslim intellectuals, which gave
emergence to the contemporary Islamic banking. By the midst of the last century, many
Muslim countries started their efforts to adopt the Islamic economic and banking
systems. Many scholars, economist and experienced bankers came with different
solutions to initiate the Islamic banking. Those experiences paved the route for modern
Islamic banking.

Nowadays Islamic financial institutions (IFIs) are spread all over the world including
European countries and the United States. In particular these have their significant
presence in Pakistan, Saudi Arabia, Bahrain, United Arab Emirates, other GCC countries,
Malaysia, Sudan and Iran.

1.5 ISLAMIC ECONOMIC MODEL

The Islamic economic model is based on the rulings of Sharia or Islamic law – as
revealed in and derived from the Quran. Some of the key features that drive modern
Islamic finance are outlined below:

• Financial products or transactions must be backed by tangible assets to avoid

‘speculation’.
• Sharia strictly and explicitly prohibits Riba, most usually described as usury or
interest. Riba covers not only interest payments as in the conventional banking
system but also the exchanging of any positive, fixed, predetermined rate of return
that is guaranteed regardless of the performance of the underlying investment.
• Instead of fixed payments, Islamic finance adheres to a risk sharing (and profit and
loss sharing) philosophy. In this sense, Islamic transactions can be defined as
equity-based, where the rate of return on assets is not known and not fixed prior to
the undertaking of the transaction.
• The Islamic Law of Contracts dictates that transactions must have contractual
certainty. In this sense, the conventional insurance products and many forms of
financial derivative products had been interpreted as strictly forbidden under
Islamic law.
These central principles have meant that Islamic finance has to be largely asset-backed,
where the payouts are based on the performance of the underlying assets. The easiest
transactions to transform to Sharia compliance were, therefore, secured lending
operations, e.g., to finance the purchase of real estate, vehicles, business equipment, etc.

For example, leased property offers a relatively fixed and periodic cash flow, similar to
bonds or debt instruments that are inaccessible to Islamic investors.

1.6 PROBLEM STATEMENT

We will argue in this study that interest free Islamic modes of finance can replace the
conventional interest based finance with certain added advantages. By synchronizing
entrepreneurial payment obligations and accrual of revenues, sharing based modes of
finance remove a major source of instability from freely functioning markets. Also by
linking financial intermediaries' returns to the actual revenue of the fund users, allocation
of investable funds is redirected to projects expected to produce more value than their
alternatives.

Even though the predominance of non-sharing modes of finance in the current practice of
Islamic banking dilutes these advantages, the Islamic system would score far better than
any system that permits exchange of more money for less money. Part of the reason is the
vast opportunities of exchange that this permission opens bypassing the real economy
that is focused on exchange of goods and services with one another, money serving as a
means of such exchange. Exchange of money for money degenerates into a game of
chance in which people indulge to try their luck, little benefit flowing to the production of
goods and services which exchange is supposed to promote. Prohibition of interest is
directed at restoring money to its essential functions, which certainly do not include a
means for gambling.
Our problem statement is that to find out that Islamic modes of financing are riba/interest
free and is Islamic banking achieving the goal an objective of Islamic economic system.

1.7 RESEARCH OBJECTIVES

The objective of the study is
• To find out that Islamic modes of financing helps in elimination of interest/Riba
from banking sector pr economy.
Sub objectives are;
• To find out different Islamic financing methods.
• To find out the role of Islamic banks in the modern economy
• Compare the difference between conventional banking and Islamic bank
• The study will provide us better understanding of the Islamic permissible mode of
financing.
Our study will be based on the data of Islamic banks working in Pakistan.

1.8 SIGNIFICANCE OF THE STUDY

Islamic finance was practiced predominantly in the Muslim world throughout the middle-
ages, fostering trade and business activities with the development of credit. Islamic
banking, based on the Islamic economic system, is not restricted to Muslims only. The
objective of Islam injunction is welfare of the whole humanity, there are many Islamic
banks working in non-Muslim countries.

Islamic banking an alternate to interest based banking system derives its inspiration and
guidance from the religious edict of Islam and has to conduct its operation strictly, in
accordance with the sharia’h. Islamic financial system works on profit and loss sharing
basis.

The study will provide a broad over view of Islamic financing modes and help personnel
to do riba free investment and get loans in halal way. And this will also provide guidance
to entrepreneurs to maintain a relationship with Islamic financial institutions which is
more ethical and not be involved in business that are prohibited in Islamic laws.

CHAPTER 2
 2. LITERATURE REVIEW

Hussain, Dr. Ishrat (2004) Islam is not a new religion it is the same truth that God
revealed through all His prophets. All religions are the same in essence, whether given,
for example, to Noah, Abraham, Moses, or Jesus, or to the holy Prophet of Islam. For a
fifth of the world’s population, Islam is both a religion and a complete code of life.
Economic growth is the main transmission channel for development. Islam does not
contradict growth; it promotes sustainable development and growth. The ultimate
objectives of an Islamic economic system are achieving development, based on socio-
economic justice, care and compassion for all, in terms of complete human personality.
Tools prescribed to achieve the socio-economic objectives of the Islamic economic
system are the system of Zakat, prohibition of Riba and the Islamic Law of Inheritance.
Prohibition of Riba is the cornerstone of Islamic financial transactions; the basis of
cooperation between capital and enterprise in Islam is sharing of the risks and gains
between the two.

(Khan S. Mohsin & Mirakhor, Abbas 1992) The fundamental sources of Islam – Quran
and the Sunnah (teaching and traditions) of the Holy Prophet Muhammad (Peace Be
Upon Him) – provide guidelines for economic behaviour and a blueprint of how
economic system should be organized.

Siddiqi, Muhammad Nejatullah (1983) In Islam the practice of paying and receiving
interest is prohibited between individuals and the state as much as between one individual
to another.

Those interested in Islamic economics have been endeavoring to develop and crystallize
economic concept and theories, which confirm to the Islamic ideology and postulates.
Kotz (1978) says that the conventional banks and few families who control them have
“Access to other peoples’ capital”. He points out that “the wealthiest and most powerful
capitalists operate through banks” and that these banks are also the major stockholders in
and creditors of the largest non-financial corporations. Mishan (1971:205) observes “… it
would be irrational for the lender to be willing to lend as much to the impecunious as to
the richer members of the society, or to lend the same amounts on the same terms to
each”.

Galbraith (1975:297) rightly points out that “those who least need to borrow and those
who are most favoured are in the planning system. Those who most rely on borrowed
funds, or least favoured are in the market system”.

Schmidt (1974) while expressing his views about the economic problems of that time
said that “The world economy has entered into a phase of extraordinary instability and its
future course is absolutely uncertain”.

Plato and Aristotle had also opposed the concept of interest in the era of before Christ.
Interest was also prohibited in the preliminary teachings of Jews and Christians, and is
also prohibited in the First Testament of the Holy Bible.

Modern economists have also opposed the interest. The famous English economics expert
Lord Keynes, who is globally recognized as an expert of modern economics, has first
time expressed his views on the point that unless the interest is abolished in some un-
vexatious way, unemployment could not be eradicated from the world, rather, he insisted
that the world would not bear the long-run idleness which is connected with the
capitalism.

(Khan and Mirakhor, 1989; Iqbal, 1997), stated that From a theoretical perspective,
Islamic banking is different from conventional banking because interest (riba) is
prohibited in Islam, i.e., banks are not allowed to offer a fixed rate of return on deposits
and are not allowed to charge interest on loans. A unique feature of Islamic banking is its
profit-and-loss sharing (PLS) paradigm, which is predominantly based on the Mudarabah
(profit sharing) and Musharakah (joint venture) concepts of Islamic contracting. Under
the PLS paradigm, the assets and liabilities of Islamic banks are integrated in the sense
that borrowers share profits and losses with the banks, which in turn share profits and
losses with the depositors. Advocates of Islamic banking, thus, argue that Islamic banks
are theoretically better poised than conventional banks to absorb external shocks because
the banks’ financing losses are partially absorbed by the depositors

Muhammad Fahim Khan (2003) We conveniently found Murabahah based financing as a

permissible alternative close to interest based lending by simply utilizing Shariah
permissibility of appointing banks own clients (seeking funds) as its agent to purchase
the goods needed by the client.

M. Nawaz Khan (2008) in his paper in textile today stated that, The state bank of
Pakistan have issued guideline for the development of product in Islamic banking side
divided in three modes participation made, trading mode and debt based mode. But when
reading these instructions the question comes in mind that are the Islamic bank are really
working according to Sharia’h compliance and according to Quarnic on prohibition of
Riba and will these institution eventually lead to elimination of Riba from economy?
There are five issues which should be discus to answer these question first definition of
Riba, second Islamic bank, third implication of Quranic injunction, fourth how to go
about the task in eliminating Riba, fifth are we ready to undertake the task?
Riba can only be defined as real rate of interest as opposed to nominal rate. Real rate
means nominal rate, i.e. the rate actually charged by banks, minus current rate of
inflation. In the old days when gold and silver coins were used the inflation is
compensated as there content is known but in paper money inflation is not compensated
and the lender will suffer a loss if he is paid back the borrowed amount. According to
SBP’s guideline if any financial institution that restricts its operation to sharia’h
compliant mode of banking and finance called the Islamic bank institutions. Let us take
the example of a farmer needing finance for agricultural inputs then the bank buy the
inputs, directly or indirectly sell them to the farmer on deferred payment. In this case a
document are drawn up as if such transaction has taken place when, in actual fact, the
farmer and a banker both know it’s a loan to be repaid with interest. Musharakah and
leasing are the only two financing methods, which are interest free. But we can’t cover
the whole banking activities by these two instruments. If a relationship is defined as
Rubbul mal and Mudarib, then it is not a banking relationship at all. If the banker is
considered to be a trustee of depositor, he cannot use his money for any purpose under
the sharia’h. According to Quran prohibition of Riba means, in essence, that capital alone
cannot be allowed to create additional wealth.
For eliminating Riba we have to create an economy based on equity capital instead of
debt or equity-cum-debt. But if this will be the condition then the entrepreneur will not be
allowed to borrow from the capital market so he will not be able to raise investment
capital. So for this capital market should be reformed to start work on elimination of
Riba. These reforms will affect operation of all the players in the capital market i.e. the
banks, the stock exchange, stockbrokers and private investors. When an entrepreneur
wants to do investment in ay project he first analysis it and then take the project to the
capital market. If the market players are satisfied then they may agree to finance the
project on debt-equity ratio. The banker may be willing to finance half the equity as
bridge loan. A bridge loan is repayable from the sale proceeds of shares. Once the
proposed reforms have been fully established in respect of new projects, all existing
public and private limited companies will be directed to convert their debt into equity.
Export finance and working capital requirement of business and industries can easily be
met by using Musharakah. Credit risk requirement of small business and farmers can be
made thorough Riba free loans. To compensate the inflation banks will be permitted to
take service charges but it is the Islamic state duty to maintain the price stability.
As the entire world economy is working on interest based capitalism so to introduce
equity based system in this situation is like swimming against current, to eliminate Riba
from economy we should be economically strong enough to withstand opposition of the
entire capitalistic world.

Tariq Ahmed Saeedi, (2008) Islamic financial market industry uses KIBOR that follows
conventional financial mechanism as a benchmark to determine its profit. Islamic
financial industry is not in position to develop its own interest mechanism nor has its
sustainable derivative market. Not only Riba is prohibited in Islam but also uncertainty in
profit or speculative investment is also prohibited. Islamic financial institutions as a
whole need proper planning and support of aggressive awareness campaign.

Muhammad El Oorchi (2005), The fact that Islamic laws prohibit paying and receiving
interest does not imply that they frown on making money or encourage reverting to an
all-cash or barter economy. They encourage all parties in a financial transaction to share
the risk and profit or loss of the venture. Depositors in Islamic banking can be compared
to investors or shareholders, who earn dividends when the bank makes a profit or lose
part of their savings if the bank posts a loss. The rationale is to link the return in an
Islamic contract to productivity and the quality of the project, thereby ensuring a more
equitable distribution of wealth.

Dr. S. Alam (2009) stated that, Riba means increase or any addition amount over the
principle amount it includes all like usury and interest. Riba is of two kinds (a) Riba An-
Nasiah i.e. interest on lent money. (b) Riba Al-fadl, i.e. taking a superior thing of the
same kind of goods of inferior quality. Riba is strongly prohibited in the Holy Quran and
Holy Prophet Hazrat Muhammad Peace be upon Him has also described on many
occasions and strictly prohibited taking riba in any form, from any source. Allah does not
love those sinners who, in spite of the divine favors of admonition and riches continue to
receive usury and consider to legally valid. That reflects rank ingratitude plus
contumacious sinfulness on their part. Usury and interest is totally banned item and
earning it from banks or any other institution is an illegal money and useless for everyone
and anyone who is doing usury transaction and is not good on his part. Attacking with
several diseases and calamities are due to taking interest /Riba/usury.

Aziz Tayyebi in his discussion paper discussed that, Islamic finance is any finance that
comply principles of Islamic law(sharia’h) Islamic law explain all ethical concept of
money and capital, relationship b/w risk & profit and social responsibility of financial
institutions. The important feature of Islamic financial system is the prohibition of paying
and receiving of interest on capital, i.e. guaranteed fix predetermined rate tied to maturity
called riba, while the profit on capital comes from sharing is encouraged this increase the
wealth through entrepreneurship.
Islamic principles related to Islamic financial system are; advocating risk sharing,
promotion of entrepreneurship, discovering speculative behavior, preservation of
property rights. The nature of capital as solely being a medium of exchange is central to
the prohibition of interest.
The important principle of Islamic finance includes the prohibition of contractual risk,
advocating of sharing of risk and return, Asset backed finance.
For Financing Working capital and liquidity Management:
Murabaha: This instrument is used for trade and asset finance allowing deferred
payment by customers. In this the bank purchases the requested commodity and sells it to
the customer at the agreed mark up price rather than just lending money.
Istisna’a: Instruement for lomg term construction projects. It allows sale of a commodity
prior to it coming into existence, frequently use to finance construction of real estate
developments and large assets such as ships.
Asset Finance:
Ijara: equivalent to leasing used to finance reallestate and equipments.
Diminishing Musharakah: Nowadays, moving away from ijara to diminishing
Musharakah as a mode of financing Islamic mortgages. It is a hybrid financing technique
of both ijara and Musharakah as it is based on sharing risk so it appeals many Islamic
investors.
Equity like instruments:
Musharakah: It is similar to joint venture arrangement through equity participation.
Ownership distributed according to each partner share in the financing and profit and loss
both are shred by partners. It is used for large project finance and private equity funds.
Mudarabah: it is an investment where one party provides the entire capital and the other
party provides the management. Profit sharing is agreed up-front, although the loss is
born by the provider of the fund alone.
Fixed income investment:
Sukuke: It is an Islamic bond it is asset backed the return from asset is passed to sukuk
holders. Asset includes real estate. It is used for many governments to raise fund for
infrastructure and account for the largest portion of Islamic finance.

The institutions that regulates IF are accounting and auditing organization for IF
(AAOIFI) was founded in Bahrain, Malaysia Accounting Standard Board (MASB), and
Islamic Financial Standard Board (IFSB), based in Malaysia.
To take a greater share and to expand Islamic finance need to focus on number of key
issues like product development, standardization, and human capital.
According to congressional Research service report on IF in July 2008 notes: “Some also
view the integration of ethics and values into finance as a positive development with
investors reportedly considering SCF (sharia’h compliance finance) to be more reliable
than conventional financing, given the recent global credit crises and fears of economic
recession.

Shamim Ahmed Siddiqui (2005) stated that, Elimination of riba is an important in Islamic
World Bank interest is called Riba. There are many issues related to debt like Islamic
mode of financing which can be replaced by using profit & loss sharing banking system.
Usury & bank interest both comes under the definition of riba. In conventional banking
there is very injustice with depositor as they are paid off relatively very small amount
from the income generated by their funds and is very unfair during inflationary period.
Therefore to stop this injustice inflicted on debtor or creditor riba is prohibited.
Profit and loss sharing not only generate a better income distribution pattern but also
leads to produce more reasonable and justifiable attitude individually and among each
other. Ulema condemn interest based transaction but there is no Muslim country that
developed a workable alternative banking and financial system so ordinary Muslim
which do not have much knowledge get confused when they observed that transaction in
so called Islamic banks are not much different from the practice of interest so they left
issue of riba on government and ulema and carry out there day to day business on interest
based.
Many banks are shifted to Islamic bank but in most cases it is the change in the name and
interest was given the name of mark up.
The objection on conventional insurance is that premium are kept in interest bearing
instrument which is replaced by Takaful in Islamic banking which was according to
teaching of Islam. In order to promote brotherhood Islam encourage giving Qard Hasana
but objection in this assertion could exist of inflation. To fulfill basic need of human like
housing and small loans for business Islamic society should establish financial institution
that give loan for genuine need without interest the cost of such institution should be
borne by the government.
Musharakah and Mudarabah technique of finance has the potential to enhance investment
and could also generate a more equitable desirable income distribution pattern.
In Islamic technique of finance compared to debt system, a greater profit is allocated to
provider of fund when economy is going well; the rate may be low and in extreme cases
may get a negative return in bad condition of economy. This has the stabilizing effect on
economy.

Noor Ahmed Memon (2007) Islam accepts basic concomitants of market economy like
the right of innate ownership, freedom of enterprise and competitive environment of
business and industry. The Holy Prophet (Peace be upon him) is reported to have allowed
competitive price mechanism to balance the demand and supply of goods for dispensation
of economic justice, ultimate best benefit of society and efficient allocation of resources.
The limitations only take care of some moral, religious and cultural perceptions as well as
to suit the aspirations that emphasize the significant role of the state in inculcation of the
desired norms. These limitations are necessary for fulfillment of overall objectives of
Islamic Shariah.

M. Siddiq. Noorozoy (1982) The basis of the injunction against riba on consumption
loans is that those who borrow are assumed to be in need of such loans for purposes of
maintaining some minimum standard of living. To make a loan to another without riba,
then, is an act of charity. Thus, those with higher incomes and, therefore, higher savings
(surplus funds) are asked to make loans to those with lower incomes who are in need
without having to exact riba from them. Achieving equity among different levels of
income and wealth is a fundamental aspect of the Islamic value system. Islamic taxation
in the form of zakat is directed toward this end. The prohibition of riba on consumption
loans is clearly also aimed at the redistribution of purchasing power from the rich to the
poor.

CHAPTER 3
3. RESEARCH PROCESS

The mission of any religion is to reformulate or to reconstruct all aspects of human

behavior in accordance with its teaching and axioms of faith. One of these aspects is the
economic and financial behavior of the faiths adherents. Nowadays, it is reasonably
understood by Muslims and non-Muslims alike that Islam is not merely a relation
between humans and God but total way of life whose worldview is founded on four basic
pillars. Thus, for a Muslim Islam is way of life: divine, final and comprehensive. The
need for Islamic finance arises from the desire of many Muslims to regulate their finances
in accordance with the requirements of their faith.

3.1 THEORETICAL FRAMEWORK

As Islam has given guidance in every way of the life so our research process will move
around the Islamic financing methods as conventional banking base on interest, which is
strongly prohibited in Islam while Islamic financing methods are based on partnership.
So our variable is Riba, which is dependent on Islamic financing methods, which the
 Islamic banks are using nowadays. Our study focus on the methods which are adopted
mainly by Pakistani Banks as we work on secondary data in our study which was
available in books and state bank of Pakistan’s literature. So our dependent variable is
Schematic
Elimination of Riba (y) and Independent variable is Islamic mode s of financing (x),
Diagram
Elimination of riba from banking sector and economy depend on Islamic mode of
Islamic Modes
financing offered by different Islamicofbank and institutions working in any country.
Financing

Elimination of Islamic Mode

Riba Depend on of financing

Dependent
Musharakah
Mudara Murabaha Ijara Independent Istisna’a
Salam
Variable bah Variable

1.Participat 1.Selling 1.Contract 1.Contract 1.Contract

1.Participator
ory mode agreement for for supply for supply of
y mode
2.Profit is 2.Seller financing of goods at commodities
2.Profit and
shared and disclose Equipment/ future date at future date
loss sharing
loss is bear actual building on advance on advance
by the amount of and other payment. payment.
owner commodity facility. 2.Mainly 2.Financing
& add 2.Rental for facility for
some profit and agriculture. the
purchase manufacture.
price is
fixed

Implementation of
these methods by
Islamic Institutions

Cause

Elimination Of Riba
from banking and
Economy
There is a direct relationship between the two variable if the Islamic financing method
follows Shariah principle i.e. if they work according to Islamic laws then they are
beneficial in helping riba from the banking sector as well as from the economy.

Conventional

Money

Bank Client

Money+ Money (Interest)

Islamic

Goods & Services

Bank Client

Money
In the preceding chapters we will see that either these Islamic financing methods are
helping in elimination of riba or not. And how the Islamic institutions are adopting these
methods

3.2 HYPOTHESIS

Our study hypothesis is Prove that elimination of Riba/interest is possible by using

permissible Islamic financing methods or not.

Ho: {Elimination of riba is observed by using Islamic financing methods.}

H1: {Elimination of riba is not possible by using Islamic financing methods.}

CHAPTER 4
4. RESEARCH DESIGN

Our study is descriptive as we first describe the different Islamic financing methods and
how the banks are using them and the data we are collected is from secondary sources.

4.1 SOURCES OF DATA

The data is collected from secondary data resources, such as literature review, Journals
Newspapers, web browsing, articles and books related to the topic/ Islamic Banking. The
data is collected from state bank of Pakistan’s books. Our main focus is the Islamic banks
working in Pakistan using different Islamic methods that are really interest free and not
just merely change of name that the conventional banks are using for financing.

4.2 METHODS OF DATA COLLECTION/ SAMPLING

Sampling or data collection is always a difficult and the most important step to do any
study as our study is based on the out come of that data. Here we are using the data
present in the SBP’s Published books which are very reliable and authentic and we will
see how many Islamic banks are working in Pakistan and how many permissible Islamic
financing methods they are using.

CHAPTER 5
5. PERMISSIBLE ISLAMIC MODE OF FINANCING

Most types of trade (buying and selling) are permitted in Islam, where prohibition is the
notable exception. Yusuf 'Ali (1991) translated the meaning of [2:275] thus:

Those who devour usury (riba) will not stand except as stands one whom the Evil One by
his touch hath driven to madness. That is because they say: 'trade is like usury', but Allah
hath permitted trade and forbidden usury. Thus, "Allah has permitted trade" (bay') is the
general rule, with Riba sales being a strictly forbidden exception.

Therefore, any financing conducted through valid trading by mutual consent is

permissible. However, since most Muslims lack sufficient knowledge regarding the
various conditions for a sale to be valid, contemporary jurists and financial practitioners
have limited Islamic banking and finance to a few "named" contracts. Those are contracts
that have been studied extensively by jurists over the centuries, and whose validity is well
established through the Prophet's (pbuh) own actions (Sunnah), or consensus of the early
Muslim communities and jurists ('ijma'). To further add credibility to the industry, the
Arabic names for those contracts are often used instead of their English counterparts (e.g.
the term 'ijarah is often used instead of its English counterpart "lease").

Following are the major mode of Islamic financing;

I) Participatory mode of Finance
a) Mudarabah
b) Musharakah
II) Non Participatory mode of finance
a) Murabaha
b) Musawamah
c) Salam
d) Istisna
e) Ijarah
f) Ijarah wa iqtina

5.1 PARTICIPATORY MODE OF FINANCE

Various forms of partnership can be direct financing methods. In the early days of
Islamic banking and finance, those forms were commonly grouped under the banner
"profit and loss sharing", to be contrasted with the debt-based forms of financing. It was
assumed by some that the profit and loss sharing methods were somehow more ideal
from an Islamic point of view. The fact that most Islamic banking practice concentrated
on credit sales and leases was thus often lamented as re-labeling of the forbidden interest.

There are two participatory modes;

1. Musharakah
2. Mudarabah

We will discus both in detail

5.1.1 Musharakah
Hadees-e-Qudsi:
Allah Subhan-o-Tallah has declared that He will become partner
in a business between two Mushariks until they indulge in
cheating or breach of trust. (Khayanah)

Musharakah’ is a word of Arabic origin which literally means sharing. In the context of
business and trade it means a joint enterprise in which all the partners share the profit or
loss of the joint venture. It is an ideal alternative for the interest-based financing with far
reaching effects on both production and distribution. In the modern capitalist economy,
interest is the sole instrument indiscriminately used in financing of every type. Since
Islam has prohibited interest, this instrument cannot be used for providing funds of any
kind. Therefore, musharakah can play a vital role in an economy based on Islamic
principles.

5.1.1.1 The Concept of Musharakah

“Musharakah” is a term frequently referred to in the context of Islamic modes of
financing. The connotation of this term is a little limited than the term “Shirkah” more
commonly used in the Islamic jurisprudence. For the purpose of clarity in the basic
concepts, it will be pertinent at the outset to explain the meaning of each term, as
distinguished from the other. “Shirkah” means “Sharing” and in the terminology of
Islamic Fiqh, it has been divided into two kinds:
1. Shirkat-ul-milk: It means joint ownership of two or more persons in a particular
property. This kind of “Shirkah” may come into existence in two different ways: \
sometimes it comes into operation at the option of the parties. For example, if two or
more persons purchase equipment, it will be owned jointly by both of them and the
relationship between them with regard to that property is called “Shirkat-ulmilk”.
Here this relationship has come into existence at their own option, as they themselves
elected to purchase the equipment jointly.
But there are cases where this kind of “Shirkah” comes to operate automatically without
any action taken by the parties. For example, after the death of a person, all his heirs
inherit his property, which comes into their joint ownership as an automatic consequence
of the death of that person.
2. Shirkat-ul-‘aqd: This is the second type of Shirkah which means “a partnership
effected by a mutual contract”. For the purpose of brevity it may also be translated as
“joint commercial enterprise”.

Shirkat-ul-‘aqd is further divided into three kinds:

• Shirkat-ul-amwal where all the partners invest some capital into a commercial
enterprise.
• Shirkat-ul-A’mal where all the partners jointly undertake to render some services
for their customers, and the fee charged from them is distributed among them
according to an agreed ratio. For example, if two persons agree to undertake
tailoring services for their customers on the condition that the wages so earned will
go to a joint pool which shall be distributed between them irrespective of the size of
the work each partner has actually done, this partnership will be a shirkatul-a’mal
which is also called Shirkat-ul-taqabbul or Shirkat-ul-sana’i’ or Shirkatul-abdaan.
• The third kind of Shirkat-ul-‘aqd is Shirkat-ul-wujooh. Here the partners have no
investment at all. All they do is that they purchase the commodities on a deferred
price and sell them at spot. The profit so earned is distributed between them at an
agreed ratio.
All these modes of “Sharing” or partnership are termed as “Shirkah” in the terminology
of Islamic Fiqh, while the term “Musharakah” is not found in the books of Fiqh. This
term (i.e. Musharakah) has been introduced recently by those who have written on the
subject of Islamic modes of financing and it is normally restricted to a particular type of
“Shirkah”, that is, the Shirkat-ul-amwal, where two or more persons invest some of their
capital in a joint commercial venture. However, sometimes it includes Shirkat-ul-a’mal
also where part also where partnership takes place in the business of services.

It is evident from this discussion that the term “Shirkah” has a much wider sense than the
term “Musharakah” as is being used today. The latter is limited to the “Shirkat-ulamwal”
only, while the former includes all types of joint ownership and those of the partnership.

Since “Musharakah” is more relevant for the purpose of our discussion, and it is almost
analogous to “shirkat-ul-amwal”, we shall now dwell upon it, explaining at the first
instance, the traditional concept of this type of Shirkah, then giving the brief account of
it’s application to the concept of financing in the modern context.

5.1.1.2 The Basic Rules of Musharakah

Musharakah or Shirkat-ul-amwal is a relationship established by the parties through a
mutual contract. Therefore, it goes without saying that all the necessary ingredients of a
valid contract must be present here also. For example, the parties should be capable of
entering into a contract; the contract must take place with free consent of the parties
without any duress, fraud or misrepresentation; etc., etc.
But there are certain ingredients, which are peculiar to the contract of “Musharakah”.
They are summarized here:
1. Distribution of Profit
The proportion of profit to be distributed between the partners must be agreed upon at the
time of affecting the contract. If no such proportion has been determined, the contract is
not valid in Shar’iah.

The ratio of the profit for each of the partners must be determined in proportion to the
actual profit accrued to the business, and not in proportion to the capital invested by him.
It is not allowed to fix a lump sum amount for any one of the partners, or any rate of
profit tied up with his investment.

Therefore if A and 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. Similarly, if it is agreed between them that A will get 15% of his
investment, the contract is not valid. The correct basis for distribution would be an agreed
percentage of the actual profit accrued to the business.

If a lump sum amount or a certain percentage of the investment has been agreed for any
one of the partners, it must be expressly mentioned in the agreement that it will be subject
to the final settlement at the end of the term, meaning thereby that any amount so drawn
by any partner shall be treated as ‘on account payment’ and will be adjusted to the actual
profit he may deserve at the end of the term. But if no profit is actually earned or is less
than anticipated, the amount drawn by the partner shall have to be returned.
2. Ratio of Profit
Is it necessary that the ratio of the profit of each partner confirm to the ratio of the capital
invested by him? There is a difference of opinion among the Muslim jurists about this
question.

In the view of Imam Malik and Imam Shafi’i, it is necessary for the validity of
Musharakah that each partner gets the profit exactly in the proportion of his investment.
Therefore, if A has invested 40% of the total capital, he must get 40% of the profit. Any
agreement to the contrary which makes him entitled to get more or less than 40% will
render the Musharakah invalid in Shari’ah.

On the contrary, the view of Imam Ahmed is that the ratio of profit may differ from the
ratio of investment if it is agreed between the partners with their free consent. Therefore,
it is permissible that a partner with 40% of investment gets 60% or 70% of the profit,
while the other partner with 60% of the investment gets only 40% or 30%.

The third view is presented by Imam Abu Hanifah which can be taken as a via media
between the two opinions mentioned above. He says that the ratio of profit may differ
from the ratio of investment in normal conditions. However, if a partner has put an
express condition in the agreement that he will never work for the Musharakah and will
remain a sleeping partner throughout the term of Musharakah, then this share of profit
cannot be more than a ratio of his investment.

3. Sharing of Loss
But in the case of loss, all the Muslim jurists are unanimous on the point that each partner
shall suffer the loss exactly according to the ratio of his investment. Therefore, if a
partner has invested 40% of the capital, he must suffer 40% of the loss, not more, not
less, and any condition to the contrary shall render the contract invalid. There is a
complete consensus of the jurists on this principle. Therefore, according to Imam Shafi’i,
the ratio of the share of a partner in profit and loss both must conform to the ratio of his
investment. But according to the Imam Abu Hanifa and Imam Ahmad, the ratio of the
profit may differ from the ratio of investment according to the agreement of the partners,
but the loss must be divided between them exactly in accordance with the ratio of capital
invested by each one of them. It is this principle that has been mentioned in the famous
maxim:

“Profit is based on the agreement of the parties, but loss is always

subject to the ratio of investment.”
5.1.1.3 The Nature of the Capital

Most of the Muslim jurists are of the opinion that the capital invested by each partner
must be in liquid form. It means that the contract of Musharakah can be based only on
money, and not on commodities. In other words, the share capital of a joint venture must
be in monetary form. No part of it can be contributed in kind. However, there are no
different views in this respect.

5.1.1.4 Management of the Musharakah

The normal principle of the Musharakah is that every partner has a right to take part in its
management and to work for it. However the partners may agree upon a condition that
the management shall be carried out by one of them and no other partner shall work for
the Musharakah. But in this case the sleeping partner should be entitled to the profit only
to the extent of his investment, and the ratio of the profit allocated to him should not
exceed the ratio of his investment as discussed earlier. However, if all the other parties
agree to work for the joint venture, each of them shall be treated as the agent of the other
in all the matters of the business and any work done by one of them in the normal course
of business shall be deemed to be authorized by all the partners.

5.1.1.5 Termination of Musharakah

Musharakah is deemed to be terminated in anyone of the following events:

1. Every partner has a right to terminate the Musharakah at anytime after giving his
partner a notice to this effect, whereby the Musharakah will come to an end. In this case,
if the assets of the Musharakah are in cash form, all of them will be distributed pro rata
between the partners. But if the assets are not liquidated, the partners may agree either on
the liquidation of the assets, or on their distribution or partition between the partners as
they are. If there is a dispute between the partners in this matter i.e. that if partner seeks
liquidation while the other wants the partition or distribution of the non-liquid assets
themselves, the latter shall be preferred, because after the termination of Musharakah, all
the assets are in joint ownership of the partners, and a co-owner has a right to seek
partition or separation, and no one can compel him on liquidation. However, if the assets
are such that they cannot be separated or partitioned, such as machinery, then they shall
be sold and the sale proceeds shall be distributed.
2. If any one of the partners dies during the currency of Musharakah, the contract of
Musharakah with him stands terminated. His heirs in this case, will have the option either
to draw the share of the deceased from the business, or to continue with the contract of
the Musharakah.

3. If any one of the partners becomes insane or otherwise becomes incapable of effecting
commercial transactions, the Musharakah stands terminated.

5.1.1.6 Termination of Musharakah without closing the business

If one of the partners wants termination of the Musharakah, while the other partner or
partners like to continue with the business, this purpose can be achieved by mutual
agreement. The partners who want to run the business may purchase the share of the
partner who wants to terminate his partnership, because the termination of the
Musharakah with one partner does not imply its termination between the other partners.

However, in this case, the price of the share of the leaving partner must be determined by
mutual consent, and if there is a dispute about the valuation of the share and the partners
do not arrive at an agreed price, the leaving partner may compel other partners on the
liquidation or the distribution of the assets themselves. The question arises whether the
partners can agree, while entering into the contract of the Musharakah, on a condition
that the liquidation or separation of the business shall not be effected unless all the
partners, or the majority of them wants to do so, and that a single partner who wants to
come out of the partnership shall have to sell his share to the other partners and shall not
force them on liquidation or separation.
5.1.1.7 The difference between interest base financing and Musharakah

S# Interest based financing Musharakah

A fixed rate of return on a loan Musharakah does not envisage a fixed
advanced by the financer is rate of return. The return is based on
1
predetermined irrespective of the profit the actual profit earned by the joint
earned or loss suffered by the debtor ventures
The financer can suffer loss, if the joint
2. The financer cannot suffer loss
ventures fail to produce fruits
The returns of the creditor are tied up
Results in injustice either to the creditor
with the actual profits accrued through
or the debtor. If the debtor suffer a loss,
the enterprise. The greater the profits of
it in unjust on the part of the creditor to
the enterprise, the higher the rate of
claim a fixed rate of profit. Also if the
3. return to the creditor. If the enterprise
debtor earns a very high rate of profit, it
earns enormous profits, all of it cannot
is injustice to the creditor to give him
be secured by the debtor exclusively
only small portion of the profit leaving
but will be shared by common people
the rest for the debtor.
e.g. Depositors in the bank
5.1.2 MUDARABAH

“Mudarabah” is a special kind of partnership where one partner gives money to another
for investing it in a commercial enterprise. The investment comes from the first partner
who is called “rabb-ul-mal”, while the management and work is an exclusive
responsibility of the other, who is called “mudarib”.

5.1.2.1 Types of Mudarabah

There are two of Mudarabah namely:

1. Al Mudarabah Al Muqayyadah
 Rub-ul-maal may specify a particular business or a particular business or a particular
place for the mudarib, in which case he shall invest the money in that particular business
or place. This is called Al Mudarabah Al Muqayyadah (restricted Mudarabah).
2. Al Mudarabah Al Mutlaqah
However if Rab-ul-maal gives full freedom to Mudarib to undertake whatever business
he deems fit, this is called Al Mudarabah Al Mutlaqah (unrestricted Mudarabah).
However mudarib cannot, without the consent of Rab-ul-Maal, lend money to anyone.
Mudarib is authorized to do anything, which is normally done in the corse of business.
However if they want to have an extraordinary work, which is beyond the normal routine
of the traders, he cannot do so without express permission from Rab-ul-Maal. He is also
not authorized to:

a) Keep another Mudarib or a partner

b) Mix his own investment in that particular Modarahab without the consent of Rab-
ul- Maal.

5.1.2.2 Investments
In Mudarabah, Rab-ul-Maal provides the investment and Mudarib the management
therefore the Rab-ul-Maal should hand over the agreed investment to Mudarib and leaves
everything to Mudarib with no interface from his side but he has the authority to:
a) Oversee the mudarib’s activities and
b) Work with Mudarib if the mudarib consents

The basic principle is that the capital in Mudarabah is valid just the way as it is in Shirkah
which according to Hanafi fiqah should be in liquid form but according to other acholars
equipment, land etc can also be included as capital. However all agree on the following:
Assets other than cash can be used as an intermediate step, meaning:
This is subject to the determination of exact amount of the assets before it is used for
Mudarabah. If the assets are not correctly evaluated, the Mudarabah is not valid.

5.1.2.3 Distribution of the Profit:

It is necessary for the validity of Mudarabah that the parties agree, right at the beginning,
on a definite proportion of the actual profit to which each of them is entitled. No
particular proportion has been prescribed by the Shar’iah; rather, it has been left to their
mutual consent. They can share the profit in equal proportions, and they can also allocate
different proportions for the rubb-ul-mal and the mudarib. However, they cannot allocate
a lump sum amount of profit for any party, nor can they determine the share of any party
at a specific rate tied up with the capital. For example, if the capital is Rs.100000/- they
cannot agree on a condition that Rs.10000/- out of the profit shall be the share of the
mudarib, nor can they say that 20% of the capital shall be given to rabb-ul-mal.
However, they can agree on that 40% of the actual profit shall go to the mudarib and 60%
to the rabb-ul-mal or vice versa.

It is also allowed that different proportions are agreed in different situations. For example
the rubb-ul-mal may say to the mudarib, “If you trade in wheat, you will get 50% of the
profit and if you trade in flour, you will have 33% of the profit ”. Similarly, he can say
“If you do the business in your town, you will be entitled to 30% of the profit, and if you
do it in another town, your share will be 50% of the profit.”
Apart from the agreed proportion of the profit, as determined in the above manner, the
mudarib cannot claim any periodical salary or a fee or remuneration for the work done
for him by the Mudarabah. All the schools of the Islamic Fiqh are unanimous on this
point. However, Imam Ahmad has allowed for the mudarib drawing his daily expenses of
food only from the Mudarabah account.

The Hanafi jurists restrict this right of the mudarib only to a situation where he is on a
business trip outside his own city. In this case he can claim his personal expenses,
accommodation, food etc., but he is not entitled to get anything as daily allowances when
he is in his own city.

If the business has incurred loss in some transactions and has gained profit in some
others, the profit shall be used to offset the loss at the first instance, then the remainder, if
any, shall be distributed between the parties according to the agreed ratio.

5.1.2.4 Termination of Mudarabah

The contract of the Mudarabah can be terminated at any time by either of the two parties.
The only condition is to give a notice to the other party. If all assets of the Mudarabah
are in cash form at the time of termination, and some profit has been earned on the
principle amount, it shall be distributed between the parties according to the agreed ratio.
However, if the assets of the Mudarabah are not in the cash form, the mudarib shall be
given an opportunity to sell or liquidate them, so that the actual profit may be determined.

There is a difference of opinion among the Muslim jurists about the question whether the
contract of Mudarabah can be effected for a specified period after which it terminates
automatically. The Hanafi and Hanbali schools are of view that the Mudarabah can be
restricted to a particular term, like one year, six months, etc, after which it will come to
an end without a notice. On the contrary, Shafi’i and Maliki schools are of the opinion
that the Mudarabah cannot be restricted to a particular time.

However, this difference of opinion relates only to the maximum time limit of the
Mudarabah. Can a minimum time limit also be fixed by the parties before which
Mudarabah cannot be terminated? No express answer to this question is found in the
books of the Islamic Fiqh, but it appears from the general principles enumerated therein
that no such limit can be fixed, and each party is at liberty to terminate the contract
whenever he wishes. This unlimited power of the parties to terminate the Mudarabah at
their pleasure may create some difficulties in the context of the present circumstances,
because most of the commercial enterprises today need time to bring fruits. They also
demand constant and complex efforts. Therefore, it may be disastrous to the project, if
the rabb-ul-mal terminates the Mudarabah right in the beginning of the enterprise.
Specially, it may bring a severe set back to a mudarib who will earn nothing despite all
his efforts. Therefore, if the parties agree, when entering into the Mudarabah, that no
party shall terminate it during a specified period, except in specified circumstances it
does not seem to violate any principle of Shar’iah, particularly in the light of the famous
hadith, already quoted which says:

“All the conditions agreed upon by the Muslims are upheld, except a
condition which allows what is prohibited or prohibits what is lawful.”

5.1.2.5 Difference between Musharakah and Mudarabah

S# Musharakah Mudarabah
1 All partner invest Only Rab-ul-Maal invest
All partners participate in the Rab-ul-Maal has no right to participate in the
2 management of the business and management which is carried out by the
work for it. Mudarib only.
The loss, if any, is suffered by the rabb-ul-
All the partners share the loss to the mal only, because the mudarib does not
3 extent of the ratio of their invest anything. However this is subjected to
Investmen a condition that the mudarib has worked with
due diligence.
4 The liability of the partners in The liability of rabb-ul-mal is limited to his
musharakah is normally unlimited. investment, unless he has permitted the
Therefore, if the liabilities of the mudarib to incur debts on his behalf.
business exceed it’s assets and the
business goes in liquidation, all the
exceeding liabilities shall be borne
pro rata by all the partners.
However, if all the partners have
agreed that no partner shall incur
any debt during the course of
business, then the exceeding
liabilities shall be borne by the
partner alone who has incurred a
 debt on the business in violation of
the aforesaid condition.
As soon as the partners mix up their
capital in a joint pool, all the assets The goods purchased by the mudarib are
of the musharakah become jointly solely owned by the rabb-ul-mal, and the
owned by all of them according to mudarib can earn his share in the profit only
5 the proportion of their respective in case he sells the goods profitably.
investment. Therefore, each of them Therefore, he is not entitled to claim his
can benefit from the appreciation in share in the assets themselves, even if their
the value of the assets, even if the value has increased
profit has not accrued through sales.
Muzara’ah is a partnership on crops between a land-owner and a farmer. Here the gross
revenue, not the net profit, is distributed according to agreement and land is due back to
its owner at the end of the contract. The essential two features of muzara’ah are: 1)
distribution of gross profit; and 2) the return of the fixed asset to its owner as is. These
two features serve as a basis for creating a contemporary Islamic financing contract
outside agriculture. An example of such a gross revenue-sharing contract is financing is
financing the ownership of infrastructure such as a toll bridge, an airport or a railroad
project on the basis of a percentage of its gross revenues.

5.1.3 Diminishing Musharakah

Another form of Musharakah, developed in the near past, is ‘diminishing Musharakah’.
According to this concept, a financier and his client participate either in the joint
ownership of a property or an equipment, or in a joint commercial enterprise. The share
of the financier is further divided into a number of units and it is understood that the
client will purchase the units of the share of the financier one by one periodically, thus
increasing his own share till all the units of the financier are purchased by him so as to
make him the sole owner of the property, or the commercial enterprise, as the case may
be.

The diminishing Musharakah based on the above concept has taken different shapes in
different transactions. Some examples are given below:

1. House financing on the basis of Diminishing Musharakah

It has been used mostly in house financing. The client wants to purchase a house for
which he does not have adequate funds. He approaches the financier who agrees to
participate with him in purchasing the required house. 20% of the price is paid by the
client and 80% of the price by the financier. Thus the financier owns 80% of the house
while the client owns 20%. After purchasing the property jointly, the client uses the
house for his residential requirement and pays rent to the financier for using his share in
the property. At the same time the share of financier is further divided in eight equal
units, each unit representing 10% ownership of the house. The client promises to the
financier that he will purchase one unit after three months. Accordingly, after the first
term of three months he purchases one unit of the share of the financier by paying 1/10th
of the price of the house. It reduces the share of the financier from 80% to 70%. Hence,
the rent payable to the financier is also reduced to that extent. At the end of the second
term, he purchases another unit increasing his share in the property to 40% and reducing
the share of the financier to 60% and consequentially reducing the rent to that proportion.
This process goes on in the same fashion until after the end of two years, the client
purchases the whole share of the financier reducing the share of the financier to ‘zero’
and increasing his own share to 100%. This arrangement allows the financier to claim
rent according to his proportion of ownership in the property and at the same time allows
him periodical return of a part of his principal through purchases of the units of his share.

2. Diminishing Musharakah for business of services

‘A’ wants to purchase a taxi to use it for offering transport services to passengers and to
earn income through fares recovered from them, but he is short of funds. ‘B’ agrees to
participate in the purchase of the taxi; therefore, both of them purchase a taxi jointly.
80% of the price is paid by ‘B’ and 20% is paid by ‘A’. After the taxi is purchased, it is
employed to provide transport to the passengers whereby the net income of Rs. 1000/- is
earned on daily basis. Since ‘B’ has 80% share in the taxi it is agreed that 80% of the fare
will be given to him and the rest of 20% will be retained by ‘A’ who has a 20% share in
the taxi. It means that Rs. 800/- is earned by ‘B’ and Rs. 200/- by ‘A’ on daily basis. At
the same time the share of ‘B’ is further divided into eight units. After three months ‘A’
purchases one unit from the share of ‘B’. Consequently the share of ‘B’ is reduced to
70% and share of ‘A’ is increased to 30% meaning thereby that as from that date ‘A’ will
be entitled to Rs. 300/- from the daily income of the taxi and ‘B’ will earn Rs. 700/-. This
process will go on until after the expiry of two years, the whole taxi will be owned by ‘A’
and ‘B’ will take back his original investment along with income distributed to him as
aforesaid.

3. Diminishing Musharakah for Trade

‘A’ wishes to start the business of ready-made garments but lacks the required funds for
that business. ‘B’ agrees to participate with him for a specified period, say two years.
40% of the investment is contributed by ‘A’ and 60% by ‘B’. Both start the business on
the basis of Musharakah. The proportion of profit allocated for each one of them is
expressly agreed upon. But at the same time ‘B’s share in the business is divided to six
equal units and ‘A’ keeps purchasing these units on gradual basis until after the end of
two years ‘B’ comes out of the business, leaving its exclusive ownership to ‘A’. Apart
from periodical profits earned by ‘B’, he gains the price of the units of his share which, in
practical terms, tend to repay to him the original amount invested by him. Analyzed from
the Shar’iah point of view this arrangement is composed of different transactions which
come to play their role at different stages. Therefore, each one of the foregoing three
forms of diminishing Musharakah is discussed below in the light of the Islamic
principles:

5.2 NON-PARTICIPATORY MODE OF FINANCE

There are three major sale-based financing contracts that are discussed in the classical
literature on shariah: deferred or installment payment sale, forward sale with immediate
payment, and manufacturing sale
a) Murabaha
b) Musawamah
c) Salam
d) Istisna
e) Ijarah
f) Ijarah wa iqtina
5.2.1 Murabaha (Cost plus sale)
In this sale, the buyer knows the price at which the seller obtained the object to be
financed, and agrees to pay a premium over that initial price. It was narrated that 'Ibn
Mas'ud (mAbpwh) ruled that there was no harm in declared lump-sum or percentage
profit margins. Thus, one may approach an Islamic financial institution and say "purchase
this item on my behalf at this price, and I shall give you a pro.t ('urbihuka) margin of
$10", or "purchase this item on my behalf at this price, and I shall give you a profit
('urbihuka) margin of 10%". The fact that the latter statement may be perceived to make
explicit a percentage payment should not be of concern, since it is not Riba if the sale
satisfies the conditions of murabaha. Notice that in this contract, the Islamic bank or
financial institution must own the item at the time the customer buys it from them with
the specified profit margin.

Murabaha is, in fact, a term of Islamic Fiqh and it refers to a particular kind of sale
having nothing to do with financing in its original sense. If a seller agrees with his
purchaser to provide him a specific commodity on a certain profit added to his cost, it is
called a murabahah transaction. The basic ingredient of murabahah is that the seller
discloses the actual cost he has incurred in acquiring the commodity, and then adds some
profit thereon. This profit may be in lump sum or may be based on a percentage.

The Bai’ Murabahah involve purchase of a commodity by a bank on behalf of a client

and its resale to the letter on cost-plus-profit basis. Under this arrangement the bank
discloses its cost and profit margin to the client. In other words rather than advancing
money to a borrower, which is how the system would work in a conventional banking
agreement, the bank will buy goods from a third party and sell those goods on to the
customer for a pre-agreed price.

Murahabahah is a mode of financing as old as Musharakah. Today in Islamic banks

world-over 66% of all investment transactions are through Murabahah.
5.2.1.1 Difference between Murabaha and sale
A simple sale in Arabic is called Musawamah-a bargaining sale without disclosing or
referring to what the cost price is. However when the cost price is disclosed to the client
it is called Murabahah. A simple Murabahah is one where there is cash payment and
Murabahah and Murabahah Muajjal is one on deferred payment basis.

5.2.1.2 Basic rules for Murabahah

1. The subject of sale must be existing at the time of sale. Thus, a thing which has
not yet come into existence cannot be sold. If a non-existent thing has been sold,
though by mutual consent, the sale is void according to Shari‘ah.

2. The subject of sale must be in the ownership of the seller at the time of sale. Thus,
what is not owned by the seller cannot be sold. If he sells something before
acquiring its ownership, the sale is void.

3. The subject of sale must be in the 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 the physical delivery of the commodity, yet the
commodity has come into his control, and all the rights and liabilities of the
commodity are passed on to him, including the risk of its destruction. The sale
must be instant and absolute.
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. If the parties wish to effect a valid sale,
they will have to effect it afresh when the future date comes or the contingency
actually occurs.
5. The subject of sale must be a property of value. Thus, a thing having no value
according to the usage of trade cannot be sold or purchased.
6. The subject of sale should not be a thing, which is not, used except for a haram
purpose, like pork, wine etc.
7. The subject of sale must be specifically known and 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 a 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.

5.2.1.3 Basic mistakes in Murabahah financing

Some basic mistakes that can be made in practical implications of the concept are as
follows:

1. The most common mistake is to assume that Murabahah can be used fir all types
of transaction and financing. This mode can only be used when a commodity is to
be purchased by the customer. If funds are required for some other purpose
Murabahah cannot be used
2. The document is signed for obtaining funds for a specific commodity and
therefore it is important to study the subject matter of the Murabahah.
3. In some cases, the sale of commodity to the client is affected before the
commodity is acquired from the supplier.
4. It is observed in some financial institutions that Murabahah is applied on already
purchased commodities, which is not allowed in Shar’iah and can be affected on
not yet purchased commodities.

5.2.1.4 Arguments against Murabahah

An argument that arises in Murabahah is that profit or interest both are the same and
Murabahah financing is the same as conventional banking. Islamic scholars however
argue that in several respects a Murabahah financing structure is quite different to an
overdraft organized along conventional lines and the former offers several benefits to the
bank and the customers. Depositors are made to share in profits of the bank as a result of
this financing. The basic difference is however the Aqd or the contract which covers the
Islamic conditions. If the contract has interest element then it will be void.
5.2.1.5 The use of interest -rate as Benchmark

Many institutions financing by way of Murabaha determine their profit or mark-up on the
basis of the current interest rate, mostly using LIBOR (Inter-bank offered rate in London)
as the criterion. For example, if LIBOR is 6%, they determine their mark-up on
Murabaha equal to LIBOR or some percentage above LIBOR. This practice is often
criticized on the ground that profit based on a rate of interest should be as prohibited as
interest itself.

No doubt, the use of the rate of interest for determining a halal profit cannot be
considered desirable. It certainly makes the transaction resemble an interest-based
financing, at least in appearance, and keeping in view the severity of prohibition of
interest, even this apparent resemblance should be avoided as far a possible. But one
should not ignore the fact that the most important requirement for validity of Murabaha is
that it is a genuine sale with all its ingredients and necessary consequences. If a
Murabaha transaction fulfils all the conditions enumerated in this chapter, merely using
the interest rate as a benchmark for determining the profit of Murabaha does not render
the transaction as invalid, haram or prohibited, because the deal itself does not contain
interest. The rate of interest has been used only as an indicator or as a benchmark.

5.2.1.6 Uses of Murabahah

Murabahah can be used in following conditions:
Short / Medium / Long term financing for:
• Raw material
• Inventory
• Equipment
• Asset financing
• Import financing
• Export financing
• Consumer good financing
• House financing
 • Vehicle financing
• Shop financing
• PC financing
• Tour package financing
• Education package financing
• All other services that can be sold in the form of package
• Securitization of Murabahah agreement (certificate) is allowed at par value only

5.2.2 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

5.2.3 SALAM
Salam is a sale whereby the seller undertakes to supply some specific goods to the buyer
at a future date in exchange of an advanced price fully paid at spot. Here the price is cash,
but the supply of the purchased goods is deferred. The buyer is called “rabb-us-salam”,
the seller is “muslam ilaih”, the cash price is “ra’s-ul-mal” and the purchased commodity
is termed as “muslam fih”, but for the purpose of simplicity, I shall use the English
synonyms of these terms.

Salam was allowed by the Holy Prophet (PBUH) subject to certain conditions. The basic
purpose of this sale was to meet the needs of the small farmers who needed money to
grow their crops and to feed their family upto the time of harvest. After the prohibition of
riba they could not take usurious loans. Therefore, it was allowed for them to sell the
agricultural products in advance.

5.2.3.1 Purpose of Use

To meet the need of small farmers who need money to grow their crops and to feed their
family up to the time of harvest. When Allah declared Riba haram, the farmers could not
take usurious loans. Therefore Holy Prophet (PBUH) allowed them to sell their
agricultural products in advance.

To meet the need of traders for import and export business; Under Salam, it is allowed
for them export sell the goods in advance so that after receiving their cash price, they can
easily undertake the aforesaid business. Salam is beneficial to the seller because he
received the price in advance and it was beneficial to the buyer also because normally the
price in Salam is lower than the price in spot sales.

5.2.3.2 Condition of Salam

1. First of all, 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. It is necessary because in the
absence of full payment by the buyer, it will be tantamount to sale of a debt
against a debt, which is expressly prohibited by the Holy Prophet (PBUH).
Moreover, the basic wisdom behind the permissibility of Salam is to fulfill the
instant needs of the seller.

2. Salam can be affected in those commodities only the quality and quantity of
which can be specified exactly. The things whose quality or quantity is not
determined by specification cannot be sold through the contract of Salam. For
example, precious stones cannot be sold on the basis of Salam, because every
piece of precious stones is normally different from the other either in its quality or
in its size or weight and their exact specification is not generally possible.
 3. Salam cannot be affected on a particular commodity or on a product of a
particular field or farm. For example, if the seller undertakes to supply the wheat
of a particular field, or the fruit of a particular tree, the Salam will not be valid,
because there is a possibility that the crop of that particular field or the fruit of
that tree is destroyed before delivery, and, given such possibility, the delivery
remains uncertain.

4. It is necessary that the quality of the commodity (intended to be purchased

through Salam) is fully specified leaving no ambiguity which may lead to a
dispute. All the possible details in this respect must be expressly mentioned.

5. It is also necessary that the quantity of the commodity is agreed upon in

unequivocal terms. If the commodity is quantified in weights according to the
usage of its traders, its weight must be determined, and if it is quantified through
measures, its exact measure should be known. What is normally weighed cannot
be quantified in measures 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.

The most famous hadith in this context is the one in which the Holy Prophet (PBUH) has
said:
“Whoever wishes to enter into a contract of Salam, he must affect the
Salam according to the specified measure and the specified weight and
the specified date of delivery.”

5.2.3.3 Benefits of Salam

There are two ways of benefiting from the contract of Salam:
 1. After purchasing a commodity by way of Salam, the financial institution can sell
it through a parallel contract of Salam for the same date of delivery. The period of
Salam in the second parallel contract is shorter and the price is higher than the
first contact. The difference between the two prices shall be the profit earned by
the institution. The shorter the period of Salam, the higher the price and the
greater the profit. In this way institution can manage their short term financing
portfolios.
2. The institution can obtain a promise to purchase from a third party. This promise
should be unilateral from the expected buyer. The buyer does not have to pay the
price in advance. When the institution receives the commodity, it can sell it a pre-
determined price to a third party according to the term of the promise.

5.2.4 ISTISNA’A
It is a contractual agreement for manufacturing goods and commodities, allowing cash
payment in advance and future delivery or a future payment and future delivery. Istisna’a
can be used for providing the facility of financing the manufacture or construction of
houses, plants, projects and building of bridges, roads and highways.
‘Istisna’a’’ is the second kind of sale where a commodity is transacted before it comes
into existence. It means to order a manufacturer to manufacture a specific commodity for
the purchaser. If the manufacturer undertakes to manufacture the goods for him with
material from the manufacturer, the transaction of Istisna’a’ comes into existence. But it
is necessary for the validity of Istisna’a’ that the price is fixed with the consent of the
parties and that necessary specification of the commodity (intended to be manufactured)
is fully settled between them.
The contract of Istisna’a’ creates a moral obligation on the manufacturer to manufacture
the goods, but before he starts the work, any one of the parties may cancel the contract
after giving a notice to the other. However after the manufacturer has started the work,
the contract cannot be cancelled unilaterally.
5.2.4.1 Difference between Istisna’a’ and Salam
Keeping in view this nature of Istisna’a there are several points of difference between
Istisna’ and Salam which are summarized below:

(a). The subject of Istisna’a’ is always a thing which needs manufacturing, while
Salam can be affected on any thing, no matter whether it needs manufacturing or
not.
(b).It is necessary for Salam that the price is paid in full in advance, while it is not
necessary in Istisna’.
(c). The contract of Salam, once effected, cannot be cancelled unilaterally, while the
contract of Istisna’ can be cancelled before the manufacturer starts the work.
(d).The time of delivery is an essential part of the sale in Salam while it is not
necessary in Istisna’ that the time of delivery is fixed.

5.2.4.2 Istisna’a’ as a mode of financing

Istisna’ may be used to provide financing for house financing if the client owns a land
and seeks financing for the construction of a house, the financier may undertake to
construct the house on the basis of an Istisna’. If the client does not own the land and
wants to purchase that too, the financier can provide him with a constructed house on a
specified piece of land. The financier does not have to construct the house himself. He
can either enter into a parallel Istisna’ with a third party or hire the services of a
contractor. He must calculate his cost and fix the price of Istisna’ with his client that
allows him to make a reasonable profit over his cost. The payment of installments by the
client may start right from the say when the contract of Istisna’ is signed by the parties.

Istisna’ may be used for similar projects like installations of an air conditioner plant in
the client/s factory, building a bridge or a highway.

5.2.4.3 Uses Of Istisna’

• House financing
• Financing of plant/ factory/ building
 • Booking of apartments
• BOT (buy, operate and transfer) arrangements
• Construction of buildings and plants

5.2.5 Ijarah
“Ijarah” is a term of Islamic fiqh. Lexically, it means ‘to give something on rent’. In the
Islamic jurisprudence, the term ‘ijarah’ is used for two different situations. In the first
place, it means ‘to employ the services of a person on wages given to him as a
consideration for his hired services.’ The employer is called musta’jir while the employee
is called ajir.
The rule of ijarah, in the sense of leasing, is very much analogous to the rules of sale,
because in both cases something is transferred to another person for a valuable
consideration. The only difference between ijarah and sale is that in the latter case the
corpus of the property is transferred to the purchaser, while in the case of ijarah, the
corpus of the property remains in the ownership of the transferor, but only its usufruct i.e.
the right to use it, is transferred to the lessee.

5.2.5.1 Lease as a Mode of Financing

Like Murabahah, lease is not originally a mode of financing. It is simply a transaction
meant to transfer the usufruct of a property from one person to another for an agreed
period against an agreed consideration. However, certain financial institutions have
adopted leasing as a mode of financing instead of long term lending on the basis of
interest. This kind of lease is generally known as the ‘financial lease’ as distinguished
from the ‘operating lease’ and many basic features of actual leasing transaction have been
dispensed with therein.

When interest-free financial institutions were established in the near past, they found that
leasing is a recognized mode of finance throughout the world. On the other hand, they
realized that leasing is a lawful transaction according to Shari‘ah and it can be used as an
interest-free mode of financing. Therefore, leasing has been adopted by the Islamic
financial institutions, but very few of them paid attention to the fact that the ‘financial
lease’ has a number of characteristics more similar to interest than to the actual lease
transaction. That is why they started using the same model agreements of leasing as were
in vogue among the conventional financial institutions without any modification, while a
number of their provisions were not in conformity with Shar’iah.

5.2.6 Ijarah Wa Iqtina

In Islamic Shariah, it is allowed that instead of sale, the lessor signs a separate promise to
gift the leased asset to the lessee at the end of the lease period, subject to his payment of
all amounts of rent. This arrangement is called Ijarah wa Iqtina. It has been allowed by a
large number of contemporary scholars and is widely acted upon by the Islamic banks
and financial institutions. The walidity of this arrangement is subjected to two basic
conditions.

a) The agreement of Ijarah itself should not be subjected to signing this promise of
sale or gift but the promise should be recorded in a separate document,
b) 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 affected to a future date, which is not allowed in the case of sale or gift.
CHAPTER 6
6. DATA ANALYSIS AND DISCUSSION

As described earlier section that data was collected from secondary source here I will
give the data taken from State bank of Pakistan’s hand book showing how many Islamic
financial institutions are working in Pakistan and which financial instruments these banks
are using for financing which are helping in elimination of Riba. As well as these data
also show the growth of Islamic banks till Sep, 2009.

Islam was the basis of creation of an independent state within the undivided Indo-Pak
Sub-Continent. Since its creation, the people of Pakistan have held the demand for
elimination of Riba from the financial system of Pakistan on the basis of Islamic
precepts. All Constitutions of Pakistan have incorporated, within the principles of policy,
the elimination of Riba as an important objective of the State policy.

Since Pakistan started with an approach to convert the whole system into Islamic one, a
number of amendments in relevant laws were introduced providing legal cover for
Islamic financial products and services. Similarly, some new laws were introduced to
allow new financial institutions or facilitate the existing ones. The legal and
regulatory infrastructure developed during that era has proved to be invaluable asset as
we keep on charting the present landscape of the industry today on the same. Islamic
Banking Industry of Pakistan continued its progress during the year 2008. They have
increased their share of assets in the overall banking system to 4.9% up to December
2008. The growth is also reflected in increased share of deposits and financing &
investment that stood at 4.8% and 4.4% respectively at the end of Dec 2008.

Description Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08

Total Assets 13 44 72 118 276 276

%age of Banking 0.5% 1.4% 2.1% 2.9% 4.2% 4.9%

Industry
Deposit 8 30 50 83 202 202
%age of Banking 0.4% 1.2% 1.9% 2.8% 4.1% 4.8%
Industry
Financing& Investment 10 30 48 72 186 187

%age of Banking 0.5% 1.3% 1.8% 2.4% 3.6% 4.4%

Industry
Conventional bank with 3 7 9 12 12 12
Islamic bank branches
No. of branches (including 17 48 70 150 289 514
sub branches)

Currently, there are 6 full-fledge banks and 12 conventional Banks are offering Islamic
Banking products through their Islamic Banking Branches. Hence, branch network of
IBIs comprises of around 514 branches as on Dec 31, 2008.

Industry Progress and market share

Rupees in billion & industry share
in percent in percent
Sep Jun Dec.0 Dec. Dec. Dec. Dec.04 Dec.03
09* 09* 8 07 06 05
13
Total Assets 323 313 276 206 119 72 44

Share in industry 0.5

5.3 5.1 4.9 4.0 2.8 2.0 1.5
8
Deposits 245 238 202 147 84 50 30

Share in industry 5.5

5.2 4.8 3.8 2.6 1.8 1.3 0.4
Net Financing & 198 194 186 138 73 48 30 10
Investment
 4.2
4.2 4.3 3.5 2.3 1.7 1.3 0.5
Share in industry
Total Islamic
Banking
19 18 18 18 16 11 11 4
Institutions

Total No. Of
Branches** 551 528 515 289 150 70 48 17

*Source: Annual Accounts except for June and Sept 09, data for which is based on Un-audited
Quarterly Accounts
6.1 ISLAMIC BANKING BRANCH NETWORK AS ON SEP’30, 2009
Type Bank Name No. of Branches

Full Fledge Albaraka Islamic Bank B.S.C. 30

Islamic Banks (E.C.)
BankIslami Pakistan Limited 70
Dawood Islamic Bank Limited 25
Dubai Islamic Bank Pakistan 24
Limited
Emirates Global Islamic Bank 42
Limited
Meezan Bank Limited 140
Sub-total 331

Askari Bank Limited 22

Bank AL Habib Limited 6
Bank Alfalah Limited 48
Habib Bank Limited 1
Islamic Bank Habib Metropolitan Bank Limited 4
Branches of MCB Bank Limited 11
Conventional National Bank of Pakistan 8
Banks Soneri Bank Limited 6
Standard Chartered
Bank(Pakistan) 11
The Bank of Khyber 16
The Royal Bank of Scotland 3
United Bank Limited 5
Faysal Bank Limited 1

Sub-Total 142

Askari Bank Limited 2

BankIslami Pakistan Limited 32
Dawood Islamic Bank Limited 6
Sub Branches Dubai Islamic Bank Pakistan 2
Limited
Meezan Bank Limited 35
Emirates Global Islamic Bank Ltd 1

Sub Branches Total 78

Grand Total 551

6.2 PRODUCTS/SERVICES RANGE

These banks are offering wide range of Shariah compliant products & services on Asset
& Liability sides. Not all banks offering wide range of products but some are offering
wide range and some are offering some products that are compatible to sharia’h laws.
The products range includes working capital finance through Murabaha for importers and
exporters, Sharia’h compliant substitute for conventional foreign and local bills
discounting. Running Finance Musharakah (based on Shirkat-ul-Aqd) is offered as
substitute for conventional banking running finance facility. Services Ijarah is used to
finance services based trade & industries.
These Islamic banks are using Consumer Car Ijarah as Shariah compliant substitute for
conventional auto finance and Diminishing Musharakah Housing Finance as Shariah
compliant substitute for conventional mortgaged financing. The bank also presents a
variety of deposit schemes such as (a) Current accounts ,(b) Saving accounts based on
Mudarbah, (c) Term Deposit Receipts for different maturities based on Islamic mode and
(d) Investment Banking services for structuring and transaction documentation for
syndicated financing and Investment Sukuk, etc.

6.3 FINANCING MIX

Financing Mix
Rupees in billion

Jun 09 Sep 09 %Change

Murabaha 58.0 50.6 -12.8

Ijarah 26.2 29.8 13.5

Musharaka 3.7 3.6 -2.8

Mudaraba 0.9 0.5 -48.1

Diminishing Musharaka 45.3 38.0 -15.0

Salam 2.9 1.7 -41.7

Istisna 4.8 6.1 26.2

Others 2.3 7.9 242.4

Total 144.3 138.7 -3.9

Amount of Non-Performing Financing 7.3 8.9 23.3

Provision against Non-Performing Financing 4 4.9 24.6

Net Non-Performing Financing 3.3 4 21.7

Net Financing 140.3 133.7 -4.7

6.4 PRODUCT OFFERED BY FULL FLEDGE ISLAMIC BANKS

1. MEEZAN BANK LIMITED

Asset Side Products
 Easy Home
Underlying Islamic Mode Diminishing Musharaka
Type of Product Easy Buyer, Easy Builder, Easy Renovate, Easy
Replace
Basis for Pricing KIBOR(90 days average of 12-month KIBOR)
Minimum Financing Limit In case of Buyer, Builder, Replacement
Rs.300,000 In case of Renovation Rs.150,000
Maximum Financing Limit In case of Buyer, Builder, Replacement Rs.40
million, In case of Renovation Rs.1 million
Minimum Tenors In case of Buyer, Builder, Replacement 3
Car Ijara
Years In case of Renovation 2 Years
Underlying
Maximum Islamic Mode
Tenors InIjara
case of Buyer, Builder, Replacement 20
Type of Product Consumer
Years In case of Renovation 7 Years
Target
BasisCustomers
for Pricing Salaried Individuals,
Fixed rate Self-employed
for different tenures
Minimum Financing Limit Professionals,
Used Rs. 250 KBusiness Individuals
Security/Collateral
Maximum Financing Required
Limit owner
Usedoccupied residential
Rs. 1.5 million, Semi property,
Commercial upto 1
Land for home building.
million, New upto Rs 2 million, Imported upto 4
million
Minimum Tenors 3 Years
Maximum Tenors 5 Years
Target Customers Salaried Individuals, Self-employed
Professionals, Business Individuals
Security/Collateral Required Exclusive ownership of the asset, post dated
cheques

Short term Financing

Underlying Islamic Mode Murabaha
Type of Product Corporate/SME
Basis for Pricing KIBOR Based/Risk Rating/Bank's Liquidity
Position
Minimum Financing Limit No
Maximum Financing Limit As per SBP Prudential Regulations(PRs)
Minimum Tenors 7 days
Maximum Tenors 1 Year
Target Customers Corporate
Underlying Islamic Mode Cash / MOTD /Letter of
Security/Collateral Required Hypothecation/Pledge

Islamic Export Refinance Scheme (IERS)

Underlying Islamic Mode Murabaha
Type of Product Corporate/SME
Basis for Pricing SBP Rate
Minimum Financing Limit No
Maximum Financing Limit As per SBP PRs
Minimum Tenors 30 days
Maximum Tenors 180 days
Target Customers Corporate
Security/Collateral Required Cash/MOTD/Letter of Hypothecation/Pledge

Long Term Financing

Underlying Islamic Mode Ijara / Diminishing Musharaka
Type of Product Corporate/SME
Basis for Pricing KIBOR Based/Risk Rating/Bank's Liquidity
Position
Minimum Financing Limit No
Maximum Financing Limit As per SBP PRs
Minimum Tenors 1 Year
Maximum Tenors 5 Years
Target Customers Corporate
Security/Collateral Required Cash/MOTD/Letter of Hypothecation/Pledge

Bill Purchase (Usance)

Underlying Islamic Mode Murabaha
Type of Product Corporate/SME
Basis for Pricing Prevailing Market Rate
Minimum Financing Limit No
Maximum Financing Limit As per SBP PRs
Minimum Tenors 15Days
Maximum Tenors 180 Days

Bill Purchase (Sight)

Underlying Islamic Mode Salam
Type of Product Corporate/SME
Basis for Pricing Prevailing Market Rate
Minimum Financing Limit No
Maximum Financing Limit As per SBP PRs
Minimum Tenors 2 Days
Maximum Tenors 30 Days
Target Customers Corporate
Security/Collateral Required Cash/MOTD/Letter of Hypothecation/Pledge

There are many liability side products of Meezan bank like Current Account, Saving
Account, Karobari Munafa Account, Fcy Account, FCY Saving Account and it issue
many certificates also these products base on Qard, Mudarabah and Musharakah. But as I
had focus in my study the financing mode of Islamic banking so I mentioned here only
Asset side products for short term and long term Financing.

2. AL-BARAKA ISLAMIC BANK

Asset Side Products

Ijara Financing (Commercial Vehicles, office equipment, Ijarah for Plant and
machinery, Office Equipment- Consumer, Ijara for Vehicle- domestic)
Underlying Islamic Mode Ijara
Type of Product Corporate, SME
Basis for Pricing KIBOR based fixed and variable rates
Minimum Financing Limit As per PRs and subject to bank's internal
assessment for allocation of limit
Maximum Financing Limit As per PRs and subject to bank's internal
assessment for allocation of limit
Minimum Tenors 3 Years
Maximum Tenors 5 Years
Target Customers All customers falling under corporate, SME
sector
Security/Collateral Required Title of the leased asset on bank's name, Security
deposit and or any other security as per PRs

Murabaha Finance
Underlying Islamic Mode Murabaha
Type of Product Corporate, SME,
Basis for Pricing KIBOR based fixed rates for each transaction.
Minimum Financing Limit As per PRs and subject to bank's internal
assessment for allocation of limit
Maximum Financing Limit As per PRs and subject to bank's internal
assessment for allocation of limit
Minimum Tenors 90 days
Maximum Tenors 1 Year
Target Customers All customers falling under corporate, SME
sector
Security/Collateral Required Cash, Collateral, Pledge, Mortgage or
hypothecation of asset or as per PRs or bank's
 requirement.

Export Murabaha & Murabaha Finance FE-25/ Import Murabaha &

Murabaha Finance FE 25 Import
Underlying Islamic Mode Murabaha
Type of Product Corporate, SME,
Basis for Pricing Current interbank foreign currency rate for export
Murabaha: LIBOR based current rates for
Murabaha Finance
Minimum Financing Limit As per PRs and subject to bank's internal
assessment for allocation of limit
Maximum Financing Limit As per PRs and subject to bank's internal
assessment for allocation of limit
Minimum Tenors 90 days
Maximum Tenors 180 days
Target Customers All customers falling under corporate, SME
sector
Security/Collateral Required Cash, Collateral, Pledge, Mortgage or
hypothecation of asset or as per PRs or bank's
requirement.

Islamic Export Refinance Scheme

Underlying Islamic Mode Murabaha, Istisna, Musawama, Musharaka
Type of Product Corporate, SME,
Basis for Pricing As per SBP refinance rate.
Minimum Financing Limit As per PRs and subject to bank's internal
assessment for allocation of limit
Maximum Financing Limit As per PRs and subject to bank's internal
assessment for allocation of limit
Minimum Tenors As per PRs
Maximum Tenors 180 Year
Target Customers All customers falling under corporate, SME
sector
Security/Collateral Required Cash, Collateral, Pledge, Mortgage or
hypothecation of asset or as per PRs or bank's
requirement.

Housing Musharaka-Consumer
Underlying Islamic Mode Diminishing Musharaka
Type of Product Consumer
Basis for Pricing KIBOR
Minimum Financing Limit Rs.300,000
Maximum Financing Limit Rs.20 million
Minimum Tenors 3 Years
Maximum Tenors 20 Years
Target Customers Customers falling under salaried, self
employed and businessmen categories
Security/Collateral Required Properties are mortgaged in bank's favor, personal
Guarantee or any other collateral.

Commercial Construction and Purchase

Underlying Islamic Mode Diminishing Musharaka
Type of Product Corporate, SME
Basis for Pricing KIBOR
Minimum Financing Limit As per PRs and subject to bank's internal
assessment for allocation of limit
Maximum Financing Limit As per PRs and subject to bank's internal
assessment for allocation of limit
Minimum Tenors No
Maximum Tenors 5 Years
Target Customers All customers falling under corporate, SME
sector
Security/Collateral Required Properties are mortgaged in bank's favor, personal
Guarantee or any other collateral.

Personal Murabaha-Consumer
Underlying Islamic Mode Murabaha
Type of Product Consumer
Basis for Pricing Market based fixed rate
Minimum Financing Limit Rs.25,000
Maximum Financing Limit Rs.500,00
Minimum Tenors 6 months
Maximum Tenors 2 Years
Target Customers Customers falling under salaried, self
employed and businessmen categories for
consumer financing
Security/Collateral Required Murabaha shall be secured by way of
hypothecation of items to the bank

Export Musharaka
Underlying Islamic Mode Musharaka
Type of Product Corporate
Basis for Pricing KIBOR plus spread (pre-agreed ratio)
Minimum Financing Limit As per PRs and to bank's internal assessment
Maximum Financing Limit As per PRs and bank's internal assessment
Minimum Tenors As per PRs and bank's internal assessment
Maximum Tenors 180 days
Target Customers All customers falling under corporate, SME
sector
Security/Collateral Required Pledge, Mortgage or hypothecation of asset.

Al-Barakah Islamic bank also has liability side products working on Qard and Mudaraba.

3. BANK ISLAMI PAKISTAN LIMITED

Asset Side Product

Murabaha
Underlying Islamic Mode Murabaha
Type of Product Corporate, SME
Basis for Pricing KIBOR
Minimum Financing Limit As approved by bank's credit committed
Maximum Financing Limit Rs.900 million (linked with bank's equity)
Minimum Tenors 15 days
Maximum Tenors 180 days
Target Customers Corporate, SME
Security/Collateral Required Cash margin, Equitable/registered mortgaged, pledge
of stocks/shares, Hypothecation charge on current
assets

Ijara (corporate)
Underlying Islamic Mode Ijara
Type of Product Corporate, SME
Basis for Pricing KIBOR
Minimum Financing Limit As approved by bank's credit committed
Maximum Financing Limit Rs.900 million (linked with bank's equity)
Minimum Tenors 3 Years
Maximum Tenors 5 Years
Target Customers Corporate, SME
Security/Collateral Required ownership of the leased asset, security margin, PGs

Diminishing Musharaka
Underlying Islamic Mode Combination of Shirkat-ul-milk and Ijara
Type of Product Corporate, SME
Basis for Pricing KIBOR
Minimum Financing Limit As approved by bank's credit committed
Maximum Financing Limit Rs.900 million (linked with bank's equity)
Minimum Tenors 3 Years
Maximum Tenors 5 Years
Target Customers Corporate, SME
Security/Collateral Required ownership of the leased asset, security margin, PGs

Islamic Export Refinance Scheme

Underlying Islamic Mode Musharaka and Murabaha
Type of Product Corporate, SME
Basis for Pricing SBP IERS rate plus bank's spread
Minimum Financing Limit As approved by bank's credit committed
Maximum Financing Limit Rs.900 million (linked with bank's equity)
Minimum Tenors 180 Days
Maximum Tenors 180 Days
Target Customers Corporate, SME
Security/Collateral Required Cash Margin, Equitable or registered mortgage,
Pledge of Stocks etc

Istisna
Underlying Islamic Mode Istisna
Type of Product Corporate, SME
Basis for Pricing KIBOR
Minimum Financing Limit As approved by bank's credit committed
Maximum Financing Limit As approved by bank's credit committed
Minimum Tenors 30 Days
Maximum Tenors 180 Days
Target Customers Corporate, SME
Security/Collateral Required Cash Margin, Equitable or registered mortgage,
Pledge of Stocks etc

Usance Bill Purchase

Underlying Islamic Mode
Type of Product
Basis for Pricing
Minimum Financing Limit
Maximum Financing Limit
Murabaha for purchase of fresh raw material
Corporate, SME
based on Treasury ready ruling rates
Depends on the kind of exposure limit as
advanced by the Treasury Department
Depends on the kind of exposure limit as
advanced by the Treasury Department
Minimum Tenors 30 Days
Maximum Tenors 180 Days
Target Customers Corporate, SME
Security/Collateral Required Lien on Sight LC/Bill document, Cash Margin,
Equitable/registered mortgage, Hypothecation
charge on fixed asset/on current assets, PGs

Auto Ijarah
Underlying Islamic Mode Ijarah
Type of Product Consumer
Basis for Pricing Faced rack rates as decided by Management
Minimum Financing Limit Rs.250000
Maximum Financing Limit Rs. 1,500,000
Minimum Tenors 3 Years
Maximum Tenors 5 Years
Target Customers Salaried Individual /Businessmen &
Corporate /SME at present.
Security/Collateral Required Ownership of leased vehicle; Security Margin;
Personal Guarantee

Muskun Housing Finance

Underlying Islamic Mode Diminishing Musharaka & Ijarah
Type of Product Consumer
Basis for Pricing KIBOR based
Minimum Financing Limit Rs.200,000
Maximum Financing Limit RS.50,000,000
Minimum Tenors 2 Years
Maximum Tenors 20Years
Target Customers Salaried Individual/Businessmen & Corporate /SME
at present.
Security/Collateral Required Equitable /Registered Mortgage on Property

Islamic bank has four liability side products three are account and one is certificate all
product work on Mudarabah.

4. EMIRATES GLOBAL ISLAMIC BANK LIMITED

Assets Side Products

Auto Ijara
Underlying Islamic Mode Ijara MBT
Type of Product Consumer
Basis for Pricing Fixed for initial 1 year, repricing will be possible
with mutual consent thereafter
Minimum Financing Limit Rs.0.2 million
Maximum Financing Limit Rs.2.5 million
Minimum Tenors New Vehicle 36 months, Used 24 months
Maximum Tenors New Vehicle60 months, Used 36months
Target Customers Salaried, Self employed, businessmen
Security/Collateral Required Security deposit, post dated cheques and
comprehensive takaful /insurance

Finance against Imported Merchandise and Finance against Trust Receipt

Underlying Islamic Mode Murabaha
Type of Product Corporate, SME and Investment Banking depend on
the credit worthiness of the client
Basis for Pricing Fixed for initial 1 year, repricing will be possible
with mutual consent thereafter
Minimum Financing Limit No
Maximum Financing Limit As per PRs
Minimum Tenors No
Maximum Tenors 1 Year
Target Customers SME, Local Corporate and Blue Chip Co.
Security/Collateral Required Pledge of commodity finance inclusive of margin,
Hypothecation, Mortgage, Personal guarantee, Cash
margin, Lien, etc.

Murabaha Finance Local

Underlying Islamic Mode Murabaha
Type of Product Corporate, SME and Investment Banking depend on
the credit worthiness of the client
Basis for Pricing Fixed for initial 1 year, repricing will be possible
with mutual consent thereafter
Minimum Financing Limit No
Maximum Financing Limit As per PRs
Minimum Tenors No
Maximum Tenors 3 Year
Target Customers SME, Local Corporate and Blue Chip Co.
Security/Collateral Required Pledge of commodity finance inclusive of margin,
Hypothecation, Mortgage, Personal guarantee, Cash
margin, Lien, etc.

Export Murabaha Financing (Pre-Shipment)

Underlying Islamic Mode Murabaha Financing
Type of Product Corporate, SME and Investment Banking
Basis for Pricing Depends on the credit Worthiness of respective
customer.
Minimum Financing Limit No
Maximum Financing Limit As per PRs
Minimum Tenors No
Maximum Tenors 6 months (180 days)
Target Customers SME, Local Corporate and Blue Chip Co.
Security/Collateral Required Pledge of commodity finance inclusive of margin,
Hypothecation, Mortgage, Personal guarantee, Cash
margin, Lien, etc.

Direct Ijara financing and Sale & Lease Back Ijara Financing
Underlying Islamic Mode Ijara
Type of Product Corporate, SME and Investment Banking
Basis for Pricing Depends on the credit Worthiness of
respective customer.
Minimum Financing Limit No
Maximum Financing Limit As per PRs
Minimum Tenors 2 years
Maximum Tenors 5 years
Target Customers SME, Local Corporate and Blue Chip Co.
Security/Collateral Required Ownership of the Ijara assets financed,
Hypothecation, Mortgage Cash Margin,
Lien, etc

Al-Bait Home Finance

Underlying Islamic Mode Diminishing Musharakah (Shirkat-ul- Milk)
Type of Product Consumer Finance
Basis for Pricing 1Year Kibor = (Floor:2.00%)(Ceiling: 7.00%)
Minimum Financing Limit As per PRs
Maximum Financing Limit As per PRS
Minimum Tenors 3 years
Maximum Tenors 20 Years
Target Customers Age: 21-60, Net disposable monthly
income:Min.Rs.20,000/-, Pakistani,
Salaried or Self-Employed/Business,
Relationship: Deposit Account with any bank
in Pakistan, should not be in the default list.
Security/Collateral Required Equitable/ Registered Mortgage, MODTD, Post
dated cheques.

It have liability side product depends on Mudarabah and Qard

5. DUBAI ISLAMIC BANK LIMITED
Asset Side Products

Murbaha for Purchase Order (local)

Underlying Islamic Mode Murabaha
Type of Product Corporate, Commercial and SME
Basis for Pricing Cost plus mutually agreed profit.
Minimum Financing Limit As per prudential regulations
Maximum Financing Limit As per prudential regulations
Minimum Tenors NA
Maximum Tenors 1 year
Target Customers Manufacturing industries, Construction
Industries, Traders and Individuals
Security/Collateral Required Hypothecation of assets, Charge on
current & fixed assets or any other
security deem necessary by the bank

Financial Ijarah/Ijarah MBT

Underlying Islamic Mode Ijarah
Type of Product Corporate, Commercial and SME
Basis for Pricing Floating Rate based on KIBOR
Minimum Financing Limit As per prudential regulations
Maximum Financing Limit As per prudential regulations
Minimum Tenors 90 days
Maximum Tenors 5 year
Target Customers Manufacturing industries, Construction
Industries, Transportation Industries
Security/Collateral Required Hypothecation of assets, Charge on
current & fixed assets or any other
security deem necessary by the bank

Shirkatul Milk
Underlying Islamic Mode Musharaka / Co ownership cum Ijara
Type of Product Corporate, Commercial and SME
Basis for Pricing Floating Rate based on KIBOR
Minimum Financing Limit As per prudential regulations
Maximum Financing Limit As per prudential regulations
Minimum Tenors 180 days
Maximum Tenors 5 year
Target Customers Manufacturing industries,
Security/Collateral Required Irrevocable power of Attorney,
Memorandum of Deposit of Title Deeds, Title
Agency Declaration, Charge on
Current and Fixed Assets

Diminishing Musharaka (Shirkatul Melk)

Underlying Islamic Mode Musharaka / Co ownership cum Ijara
Type of Product Corporate, Commercial and SME
Basis for Pricing
Minimum Financing Limit
Maximum Financing Limit
Minimum Tenors
Maximum Tenors
Target Customers
Security/Collateral Required
Underlying Islamic Mode
Type of Product
Basis for Pricing
Minimum Financing Limit
Maximum Financing Limit
Minimum Tenors
Maximum Tenors
Target Customers
Security/Collateral Required
Underlying Islamic Mode
Type of Product
Basis for Pricing
Minimum Financing Limit
Maximum Financing Limit
Minimum Tenors
Maximum Tenors
Target Customers
Security/Collateral Required
Floating Rate based on KIBOR
As per prudential regulations
As per prudential regulations
NA
More than one Year
Manufacturing industries
Hypothecation of assets, Charge on current & fixed
assets or any other security deem necessary by the bank
Murabaha(Import) (Funded)
Murabaha Cum Wakala
Corporate, Commercial and SME
the purchase of the goods; the pre agreed profit either in
lump sum or as a percentage of the cost (flat or a
benchmark) to be calculated and finalized at the time of
entering into the Murabaha contract; Any other expenses
directly related to the purchase of the goods subject of the
Murabaha such as the cost of shipment, insurance,
transportation etc
As per prudential regulations
As per prudential regulations
15 days
360 days
Import oriented industries
Hypothecation of assets, Charge on current & fixed
assets or any other security deem necessary by the bank
Export Finance
Wakala
Corporate, Commercial and SME
The Wakala Capital may be calculated as an amount net of the
cushion for meeting the foreign bank charges and the bank's profit
from the transaction on the basis of the number of days that the
facility is being availed.
PKR 500,000 within the per party limit as defined under
Prudential Regulations
PKR 500,000 within the per party limit as defined under
Prudential Regulations
15 days
360 days
Export oriented industries
Hypothecation of assets, Charge on current & fixed
assets or any other security deem necessary by the bank
 Dubain Islamic Auto Finance
Underlying Islamic Mode Musharaka cum Ijara
Type of Product Consumer Financing
Basis for Pricing Floating Rate based on KIBOR
Minimum Financing Limit Rs.100, 000 for New, used and
reconditioned cars
Maximum Financing Limit Rs.3,000,000 for New, used and
reconditioned cars
Minimum Tenors 1 year New, used/reconditioned cars and light
commercial vehicle
Maximum Tenors new car 7 years used/reconditioned car 5 years Light
Commercial Vehicle 6 years
Target Customers Salaried, Self Employed Businessmen
and self employed professionals
Security/Collateral Required The vehicle itself which will be registered in the name of
the customer but hypothecated in favor of the bank

Dubai Islamic Home Finance

Underlying Islamic Mode Musharaka and Ijara

Type of Product Consumer Financing
Basis for Pricing Floating Rate based on KIBOR
Minimum Financing Limit Rs.0.50 million for Home Purchase, Home
Renovation, Purchase of undivided share of property
mortgaged at other bank
Maximum Financing Limit Rs.30 million for Home Purchase,Rs.10 million for
Home Renovation and Rs. 30 million for Purchase of
undivided share of property mortgaged at other bank
Minimum Tenors 3 years for Home Purchase, Home Renovation and
Purchase of undivided share of property mortgaged at
other bank
Maximum Tenors 20 years for Home Purchase, Home Renovation and
Purchase of undivided share of property mortgaged at
other bank
Target Customers Salaried, Self Employed Businessmen and self
employed professionals
Security/Collateral Required Residential property located in the bank's approved
list of areas

Istisna’s cum Wakala and Commodity Murabaha are two more Asset side products.Dubai
islami bank have five lliability side products out of which four base on Mudaraba and one
base on wadiah.
 5. DAWOOD ISLAMIC BANK LIMITED

Asset Side Products

Financing Against Procurement of Local and Imported Goods

Underlying Islamic Mode Murabaha
Type of Product Corporate, SME, Commercial
Basis for Pricing KIBOR plus Margin
Minimum Financing Limit As per PRs
Maximum Financing Limit As per PRs
Minimum Tenors No
Maximum Tenors 3 Year
Target Customers Trading, Manufacturing and Services Concerns
Security/Collateral Required Pledge, Hypothecation, Mortgage

House Finance/ Financing for Machinery and Equipment

Underlying Islamic Mode Dimisnishing Musharaka
Type of Product Individual consumers, Corporate, Commercial, SME
Basis for Pricing KIBOR plus Margin
Minimum Financing Limit As per PRs
Maximum Financing Limit As per PRs
Minimum Tenors (for House financing) 1 year
(for Machinery and Equipment) 3 years
Maximum Tenors (for House financing) 20 years
(for Machinery and Equipment) 7 years
Target Customers Salaried Persons, Self employed professionals and
businessmen
Security/Collateral Required Mortgage of Property, PGs, BGs, Charge Fixed
assets

Car Ijarah/ other assets Ijara / Financing for services

Underlying Islamic Mode Ijarah
Type of Product Individual consumers
Basis for Pricing KIBOR plus Margin
Minimum Financing Limit As per PRs
Maximum Financing Limit As per PRs
Minimum Tenors (for Car Ijarah and for 3 years
other Assets)
(for Financing Services) 1 month
Maximum Tenors (for Car Ijarah, other 5 years,7 years and 3 years respectively
Assets and for Financing Services)
Target Customers Salaried Persons, Self employeed professionals and
businessmen
Security/Collateral Required (for Car ownership of the vehicle ownership of the leased
Ijarah) assets/lien on
(other Assets and for Financing Services) cash & marketable Securities/PGs/BGs

Islamic Export Refinance Scheme

Underlying Islamic Mode Murabaha, Istisna and Mudaraba
Type of Product Corporate, Commercial, SME
Basis for Pricing As announced by SBP from time to time
Minimum Financing Limit As per limits prescibed by IERS
Maximum Financing Limit As per limits prescibed by IERS
Minimum Tenors No
Maximum Tenors 180 days
Target Customers Trading, Manufacturing Concerns
Security/Collateral Required Pledge, Hypothecation, Mortgage, Lien
on Cash and Marketable securities

Pre-Shipment Export Finance / Post-Shipment Export Finance / Local Bill

Discounting
Underlying Islamic Mode (Pre-Shipment Export Mudaraba-cum-Istisna and Mudaraba
Export Finance )
(Post-Shipment Export Finance& Local Bill Export Murabaha-cum-Mudaraba
Discounting )
Type of Product Corporate, Commercial, SME
Basis for Pricing KIBOR plus Bank's spread
Minimum Financing Limit As per PRs
Maximum Financing Limit As per PRs
Minimum Tenors (Pre-Shipment Export 30 Days
Finance & Local Bill Discounting )
(Post-Shipment Export Finance) 15 days
Maximum Tenors 180 Days
Target Customers Manufacturing and Trading Concerns
Security/Collateral Required Pledge, Hypothecation, Mortgage, Lien
on Cash and Marketable securities, PGs,
BGs, Lien on Export Document, Bill of
Exchange

On the liability side Dawood Islamic bank offer four sharia’h compliant deposite scheme
that are available for customers to invest their funds. One product work on Qard mode
and remaining three work on Mudaraba.
 6.5 PRODUCTS OFFERED BY ISLAMIC BANKING BRANCHES (IBBS) OF
CONVENTIONAL BANKING
Asset side Product

1. Bank Alfalah Limited

Bank Product offer Underlying Islamic

mode
Alfalah Murabaha Finance (Local, Import and Murabaha
Export)
Alfalah Murabaha Finance (Import ) Murabaha
Alfalah Murabaha Finance (Export) Murabaha
Bank Alfalah Alfalah Car Ijarah Ijara Muntahee
Limited Bttamleek
Ijarah Finance Ijara
Alfalah Musharaka Homes Diminishing
Musharakah
Alfalah Salam Finance Salam

Bank Alfalah offer three liability side product i.e. Riba Free saving account work o
Mudaraba Islamic mode, Riba Free Current Account work on Qard, and Riba Free
Alfalah Musharaka term Deposite wich work on Musharaka Islamic mode.

2. Habib Metropolitan Bank Limited

Bank Product offer Underlying Islamic

(Asset side Product) mode
Habib Murabaha Finance Murabaha
Ijara Ijara MBT
Metropolitan Diminishing Musharakah Diminishing
Bank Limited Musharakah
It offer three liability side product which work on Qard and Musharakah.

3. Bank of Khyber

Bank Product offer Underlying Islamic

(Asset Side Product) mode
Murabaha Murabaha
Chief Minister NWFP Agriculture Scheme Murabaha
Ijarah Munahia Bitamleek Ijara Muntahia
Bitmleek
Khyber Motor Cycle Ijarah Scheme Ijara Muntahee
Bank of Khyber Bttamleek
Musharaka Musharaka
Diminshing Musharaka Diminishing
Musharakah
Mudaraba Finacing Mudaraba Finacing
Forign Currency under Islamic Banking Qarz-e-Hasana

Their liability side products are current and saving account and one Riba free Certificate
which work on Qard and Musharakah respectively

4. Royal Bank of Scotland

Bank Product offer Underlying Islamic

(Asset Side Product) mode
Islamic Home Finance Diminishing
Musharakah
Royal Bank of Murabaha working Capital Finance Murabaha
Scotland Islamic & Long term Financing Facility for Diminishing
Corporate &SME Customers Musharakah
Sight letter of Credit and Usane letter of credit Murabaha
It offers five-liability side product one product work on Qard-e-Hasna, Hybrid of
Mudarabah and Musharakah.

5. Standard Chartered Bank (Pakistan)

Bank Product offer Underlying Islamic

(Asset Side Product) mode
Islamic Murabaha Facility Murabaha
Islamic Term Deposite Diminishing
Musharakah
Islamic Import Finance Murabaha
Standard Islamic auto financing Diminishing
Musharakah
Chartered Bank
Islamic Over draft Musharaka
(Pakistan) Islamic Export Bills Finance( under LC) Musawamah
Islamic Invoice Finance ( For import & export Murabaha for import/
transaction on open account basis) Musawamah for
export
LC Confirmation Kafalah

It have five liability side products out of which two work on Qard and remaining
underlying Islamic mode is Mudaraba.

6. Habib Bank Limited

Bank Product offer Underlying Islamic

(Asset Side Product) mode
Habib Bank Ijarah/ Leasing Ijarah
Habib Bank Habib Bank Murabaha Facility Murabaha
Limited Diminishing Musharakah Diminishing
Musharakah

Habib bank offer only one liability side product work on underlying Islamic mode Qard.
 7. Soneri Bank Limited

Bank Product offer Underlying Islamic

(Asset Side Product) mode
Soneri Bank Murabaha Murabaha
Salam Salam
Limited Ijarah Ijarah MBT

Soneri bank offer three liability side product on underlying Islamic mode Qard and
Musharakah.

8. Bank Alhabib Limited

Bank Product offer Underlying Islamic

(Asset Side Product) mode
Murabaha Murabaha
Bank Alhabib Ijarah Ijarah
Limited Diminishing Musharakah( Immovable and Diminishing
Movable Property) Musharakah

Bank Alfalah offer three liability side product i.e, Current Account, PLS saving deposit
and term deposit and underlying Islamic mode are Qard and Mudarabah respectively.

9. Askari Commercial Bank

Bank Product offer Underlying Islamic

(Asset Side Product) mode
Askari Murabaha Murabaha
Diminishing Musharakah for commercial Diminishing
Commercial property Musharakah
Bank Diminishing Musharakah for plant and Diminishing
machinery Musharakah
Musharaka Musharakah
Ijara for machinery and equipment Ijarah
Istisna/ Parallel Istisna Istisna/ Parallel Istisna
Salam/ Parallel Salam Salam/ Parallel Salam
Askari Ijara Bis Sayyarah Ijarah
 Askari Home Musharakah Diminishing
Musharakah

Askari commercial bank offer fifteen liability side product work on three different
underlying Islamic modes i.e., Qard, Mudarabah and Waqala.

10. National Bank of Pakistan

Bank Product offer Underlying Islamic

(Asset Side Product) mode
National Bank of NBP Ijarah Ijara
NBP Murabaha Murabaha
Pakistan Istisna/ Parallel Istisna Istisna/ Parallel Istisna

It offers only three liability side products work on Qard, Mudarabah and Musharakah.

11. United Bank Limited

Bank Product offer Underlying Islamic

(Asset Side Product) mode
Ameen Auto Ijarah Ijarah
Ameen Commercial Ijarah Diminishing
United Bank Musharakah
Limited Ameen Murabaha Murabaha
Ameen commercial Diminishing Musharakah Diminishing
Musharakah

It offers three liability side products work on Qarz and Mudarabah.

12. MCB Bank Limited

Bank Product offer Underlying Islamic

(Asset Side Product) mode
Al-Makhraj Car Ijarah Ijarah Wa Iqtina
 Al- Makhraj Equipment Ijarah Ijarah Wa Iqtina
Al- Makhraj Diminishing Musharakah Musharakah
MCB Bank Equipment Financing
Limited Murabaha Financing Murabaha
Islamic Finance Against Foreign Bills (IFAFB) Murabaha/Musawama
Islamic Export Refining Scheme (IERS) Murabaha/Musawama

MCB offers three liability side products on underlying Islamic mode Musharakah and Al-
wadiya.

CHAPTER 7
7. CONCLUSION

Islamic finance can meet all the transaction needs of the market it does so more
efficiently than conventional finance as it focus on productivity of the project rather than
credit worthiness of the borrower. By synchronizing entrepreneur’s payment obligation
with revenue accrual, Islamic finance reduces instability in the financial market. In
Islamic economy man seems to care for others along with focusing on self-interest. It has
been demonstrated that all market activities can be finance by using various Islamic
modes Islamic banks can perform a crucial task of resource mobilization and efficient
allocation using either profit sharing (Musharakah and Mudarabah) or trading & Ijarah
based categories of Islamic mode of financing. Profit sharing modes can be used for
short, medium and long term project financing, import financing, pre-shipment export
financing and working capital financing transaction. On order to ensure maximum role of
Islamic finance in the development of economy it would be necessary to create an
environment which may induce financiers to choose Musharakah/ Mudarabah based
financing.

The Islamic financing system replaces the concept of riba with profit and loss sharing.
There are many arguments that say that Islamic banking is not Islamic it is just merely
change of name to attract people who want to live their life in Islamic way and afraid of
riba, but as I studied different Islamic modes of financing I came to a conclusion that
these methods follows Islamic principles and are riba free only the problem is that they
follow the KIBOR and LIBOR as a benchmarks which needed to be replace by some
Islamic benchmark, but only because of the use of these benchmarks we cant say these
methods are not Islamic methods. These methods are introduced after many investigation
by a shariah board and complies Islamic modes by adopting these methods by Islamic
banks riba can be eliminated from the banking sector and consequently from the
economy only there is a need of public awareness and from government sector to
establish Islamic institutions that offer Islamic products all over the Muslim countries.

7.1 RECOMMENDATIONS

Following are some of my recommendations on the basis of this study:

• There is a need to educate people about Islamic financing methods especially the
bankers.
• Banks in Pakistan use KIBOR & LIBOR as benchmark for the determination of
their rate of return, that needs to be replace by Islamic index.
• There should be continued dialogue b/w Islamic banks, Islamic economists,
shariah scholars and those working in the conventional bank with an open mind.
• Shariah scholars must find out solution to conventional hedging, sale of deeds and
securitization.
CHAPTER 8
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