- Federal Shariah Court declares interest-based practices incompatible as Islamic banking assets grown dramatically
Islamic finance, founded on Shariah principles, began to take shape in the modern era roughly eight to nine decades ago. Its global prominence surged after the oil boom of the 1970s in the Middle East, when newly accumulated wealth sought financial systems aligned with Islamic values. One of the earliest modern experiments was the Mit Ghamr Savings Bank in Egypt, established in 1963, often regarded as the first practical model of contemporary Islamic banking.
In Pakistan, early discussions on interest-free finance date back to the 1950s, but structured efforts gained momentum during the 1970s. The country’s 1973 Constitution further strengthened this direction by mandating the elimination of Riba (interest) from the economy. A major turning point came in 1991, when the Federal Shariah Court delivered its landmark judgment declaring interest-based practices incompatible with Islamic injunctions. This position was reaffirmed in a historic 2022 decision, which declared interest in all forms to be Riba and set a transition period until December 2027 for moving toward a fully interest-free system, with January 1, 2028, as the target date for implementation.
At its core, Islamic finance differs from conventional finance in several fundamental ways. It prohibits interest, discourages investment in harmful or unethical activities, promotes risk-sharing between parties, and links financial transactions to real economic assets. These principles stem from Shariah-divine guidance derived primarily from the Holy Qur’an and the Sunnah of the Prophet Muhammad (peace be upon him). Transactions must also avoid key prohibitions such as Riba (interest), Gharar (excessive uncertainty), Maysir (gambling), Rishwah (bribery), and Jahl (ignorance). The emphasis is not only on outcomes but also on ethical processes, determining whether an activity is permissible (halal) or prohibited (haram).
Full-fledged financial system
Over time, Islamic finance has developed into a full-fledged financial system that combines traditional and modern approaches. It offers classical instruments such as Salam and Istisna, which have been used for centuries, alongside contemporary Shariah-compliant alternatives to conventional banking and investment products. This evolution has enabled it to cater to a wide range of financial needs while adhering strictly to ethical and religious principles. Today, Islamic finance in Pakistan and globally covers four major sectors: Islamic banking, Islamic capital markets, Takaful (Islamic insurance), and Islamic social finance. Each sector addresses specific economic activities, from personal banking and investments to risk management and social development initiatives, reflecting the versatility and growing relevance of this financial model.
Islamic banking is the most dominant segment. Over the past 15 years, assets have grown dramatically, with market share now approaching one-quarter to one-third of the banking industry. Supported by the State Bank of Pakistan, Islamic banks are playing a central role in the country’s transition toward interest-free finance.
The complete conversion of Faysal Bank into a full-fledged Islamic bank marked a significant milestone, bringing the total number of dedicated Islamic banks to six. Institutions such as Meezan Bank — the country’s largest Islamic bank — have also invested heavily in awareness and capacity building through partnerships with universities and the establishment of academic centers dedicated to Islamic finance.
One such example is the Center of Islamic Finance established at the Institute of Business Management Sciences, University of Agriculture, Faisalabad, supported by a PKR 2.5 million grant from Meezan Bank. The primary objective of the Center is to educate and develop technical skills and expertise in Islamic banking and finance for students, academia, industry professionals, and other stakeholders. In addition to academic programs, the Center is aimed at contributing to the growth of the industry through applied research, development of case studies, and enhancement of human capital. By fostering collaboration between educational institutions and the financial sector, it aims to bridge the gap between theory and practice, equipping participants with the knowledge and skills needed to advance Islamic finance in Pakistan.
Islamic capital markets have developed in parallel, offering Shariah-compliant investment avenues. The introduction of Islamic stock indices at the Pakistan Stock Exchange has enabled investors to participate in equities that meet defined Shariah screening criteria. In addition, Sukuk asset-backed Islamic bonds — have emerged as a vital financing tool for both government and corporate sectors, funding infrastructure, energy projects, and development initiatives without resorting to interest-based borrowing.
Fastest growing sector
Takaful, the Islamic alternative to conventional insurance, is one of the fastest-growing sectors within Islamic finance. Unlike traditional insurance, it operates on the principles of mutual cooperation, shared responsibility, and risk-sharing among participants. Policyholders contribute to a collective fund, which is used to support members in times of need, ensuring compliance with Shariah principles. Over the past few years, Takaful has steadily gained market acceptance in Pakistan, offering both family and general coverage options. Its growth is driven by increasing awareness of ethical finance, rising demand for Shariah-compliant solutions, and supportive regulatory frameworks. Analysts expect this sector to continue expanding, potentially capturing a significantly larger share of the overall insurance market in the near future.
Perhaps the most socially transformative component is Islamic social finance, which integrates traditional charitable mechanisms with modern financial practices to address poverty and inequality. Instruments such as Zakat, Waqf, and interest-free microfinance play a crucial role in supporting vulnerable communities. Organizations like Akhuwat Foundation have demonstrated the power of this model by providing millions of interest-free loans, while programs such as National Rural Support Programme extend Shariah-compliant financing to rural households and small enterprises. Increasingly, these efforts are being aligned with global development agendas, including the UN Sustainable Development Goals.
Despite remarkable progress, the journey toward a fully Islamic financial system is far from complete. Experts emphasize the need for coordinated regulatory action by institutions such as the State Bank of Pakistan and the Securities and Exchange Commission of Pakistan, accelerated conversion of conventional banks, expansion of Sukuk markets, wider adoption of Takaful, and stronger institutionalization of social finance tools. Equally important is investment in human capital, research, and digital innovation to ensure accessibility and transparency.
Islamic finance in Pakistan can grow beyond mere compliance into a strong and inclusive economic model. Strengthening institutions, expanding Shariah-compliant banking and capital markets, and promoting tools like Takaful and Sukuk are key steps. This approach can reduce reliance on interest-based systems while fostering ethical investment and wealth creation. It can also enhance financial inclusion by supporting small businesses, rural communities, and social welfare programs. Islamic social finance tools such as microfinance, Zakat, and Waqf can further contribute to poverty alleviation and sustainable development. Ultimately, these efforts could position Pakistan as a globally competitive hub for ethical and Shariah-compliant finance.
Authors’ Information
Dr. Sahar Munir (sahar.munir@uaf.edu.pk) is a Lecturer, and Dr. Hammad Badar (hammad.badar@uaf.edu.pk) is an Associate Professor at the Institute of Business Management Sciences, University of Agriculture, Faisalabad.