Interview with Mr. Altaf Hussain, a finance expert from Quetta
Pakistan & Gulf Economist had an exclusive conversation with Mr Altaf Hussain about the elimination of interest (Riba) from the financial system in Pakistan. Following are the excerpts of the conversation:
In my perspective, the constitutional mandate to eliminate interest (Riba) from the financial system in Pakistan by January 2028, has both historic opportunity as well as massive implementation challenge. To align the current financial system with the FSC (Federal Sharia Court) decision and revised Article 38(f) shows the State faces complex transition challenges and wants phase wise rather than overnight implementation.
The country’s 26th Constitutional Amendment Article 38(f) clearly states, “Eliminate Riba from the economy as early as possible.” And the timeline was decided on 1st day of January 2028.
The FSC judgement on April 2022, states.” The prevailing financial system in the country is not matching the Sharia Rules.” Furthermore, the deadline decided to make changes in the financial system of the country, is last day of December 2027.
A deep analysis of the financial system of the country reveals a mix of with interest (Riba), interest (Riba) free and charges with the changed name but near to interest structures. Wherever, the interest generating portion is the huge part of the system. The financial institutions claiming interest (Riba) free operations and compliance with Sharia Rules, even those they charge interest (Riba) with the change in name and very less operation may be interest (Riba) free.
On the other hand, we have to consider that our state is indebted to IMF (International Monetary Fund) and also many other countries. The debts are not interest free and the circular debt has turned into enormous amount.
As January 2028, is not so far and there is a lot of deep workings the State has to perform to meet the deadline. The very deep analysis of the financial system currently prevailing, the foreign loans criteria, collection and payment methods, the monetary policy of the SBP (State Bank of Pakistan), the structure and operations commercial banks itself and also with the SBP. And the micro finance financial institutions. The state must also review its financial assistance plans such as, “Asaan Ghar” housing scheme which is not interest (Riba) free.
The state can meet the possible deadline by starting the changes from the very fundamental financial operations and small financial institutions then turns the enormous institutions and their operations according to FSC verdict and Shariah Rules.
The percentage of banking industry covered by the Islamic banking in Pakistan is very encouraging and speculative in future. The 25% coverage shows the trust and willingness of the customers as well as the depositors. It also discloses that following the Sharia Rules in a very competitive uncertain environment, it is possible to gain such a huge share of the industry.
The 25% industry deposits reveals that the sector is huge share of the industry and can impact its financial stability and monetary compliance and any weakness in Shariah governance or risk practices will impact the overall industry not just a segment of the industry.
Looming with the 2028 interest (Riba) free mandate, there are some real caveats which must be targeted to make the sector credible;
i. Form vs Substance risk. As mentioned earlier, many plans are cost plus sale and fixed return sukuk policy which resembles with the conventional interest-bearing policy of the non-Islamic banking policies, even the legal form is different. The growing Islamic banking industry is responsible to provide crystal clear evidences to prove that it is totally risk-sharing or asset-based rather than a re-labelled interest.
ii. As the growth is rapid and huge, it put pressure on the Shariah boards, risk managing teams and compliance system. It is pivotal to consider the growth to invest heavily in sector expertise and system to keep the quality of oversight at the highest.
iii. In the broader perception of the macro policy of the state, the SBP’s monetary policy, the government debt management and liquidity frameworks all must support the Islamic banking system at parity than other conventional banking system as it covers the huge 25% of the sector. Otherwise, it would be difficult for the sector to grow and remain advantageous.
My stand point is that size is directly related with responsibilities. It is the responsibility of the Sharia Board, the sector experts and government to make supportive policies for the sector to perform successful with the oversight to cover the major percentage of the industry which also supports to meet the January 2028 deadline.
The Islamic banking deposits has reached up to 25% of the industry, the sector now covers all the Shariah-Compliant Solutions in the country from personal financing like education, medical, automobiles and home built on sale/lease/partnership structures, to large corporate and government Sukuk backed by real assets and cash flows instead of interest.
Here, firstly I want to explain the Shariah-Compliant products. In Islamic finance, the key shift is from lending money on interest to sharing in assets, trades or ventures.
i. Returns come from profit, rent, or mark-up on real goods/services, not from a fixed interest charge on money.
ii. Contracts and flows are structured so that risk and ownership are real, and not just nominal.
The Shariah-Compliant personal financing products in Pakistan offered by the Islamic banking are as follows;
1. Murabah: It is the cost-plus sale method of financing and mostly used for buying goods or cash needs.
2. Tawarruq: in this method the personal loan for health, education, travel is secured against any asset and the transaction is structured in co-ownership in asset.
3. Musharaka: In this method a joint house is purchased and the person pays the bank share of ownership in the form of monthly rentals.
4. Ijarah: In this method the bank owns the automobile and leases it to the customer with the genuine shared ownership of the asset on the monthly lease rental payment term.
For the businesses the Shariah-Compliant solutions extend the same concepts of the personal solution concepts.
1. Musharaka: under this method of financing the bank and the business share capital to the venture, the profit and loss is shared according to the capital contribution of the each.
2. Mudarabah: Under this method of financing the bank provides the capital and the business provides the management/services. The profit is shared as per agreement and the losses are borne by the capital provider unless any visible negligence of the management or services provider.
When it comes to the capital market end, the Sukuk is the Shariah-Compliant alternative to the conventional interest-bearing bonds.
Following are the types of Sukuk which I want to explain briefly;
1. Ijarah Sukuk; it is a leasing backed financing method. This method includes the following steps;
i. A physical asset (Roads, building, aircraft, airport etc) is identified and sold to a SPV (Special purpose vehicle)
ii. The SPV issues Sukuk Certificates to the investors.
iii. The SPV leases back the asset to the government or company.
iv. The investors receive lease rental income instead of interest during the lease term.
v. When the lease term matures, the asset is bought back and the investor receive his principal amount.
2. Musharaka Sukuk; under this financing system, the investors become the owner of the business and share the profit and loss as per their share of business.
3. Muharaba Sukuk; this is the cost-plus sale system of financing. The same methodology is followed as for the personal Muharaba system of financing.
4. Istisna Sukuk; this method of financing is usually used in construction or manufacturing. The investor pays the amount of the building an asset and receive returns when it is leased, sold or delivered.
The framework for integrating Islamic economic principles into Pakistan’ economy is not just a framework rather it is a reform in the prevailing economic system.
As the Islam is a religion of social justice, clarity and purity, risk sharing, ethical conduct, charity and equilibrium in wealth distribution so the framework must consider all these fundamental principles and concepts of Islam. The framework must not be only removal of interest from its financial activities. The core concept must not be only Islamic banking rather in broader perception it must consider the trade, import and export, finance, economic activities, fairness, true and fair audit reports and implementation of rule of law in all aspects.
Following measures are pivotal for the framework to get successful,
1. Financing activities like Musharakah, Ijarah, Mudarabah, Sukuk and hariah- Compliant Islamic banking must be expanded and implementation with simple and easy procedures so every person and business can avail the opportunities.
2. Social financing activities like Zakat, Waqf and Charitable institutions must be strengthened so the poor also can participate in the financing activities.
3. The banking system, corporate sector, taxation laws and capital markets all must be aligned according to the Shariah-compliant laws and the compliance of the laws must be measurably implemented in all aspects.
4. The financing activities must cover in real means the housing, agriculture, trade and productive assets.
5. The key role of good governance is the main factor for the all activities to be successful. The controls for controlling corruption must be translated well and strong enough. there must be transparency in system and the enforcement of Islamic principles must be clearly visible in the system it just not remains only in the papers.
To put it in nut shell, the state’s policy is towards the Islamic financing system since the past and also the society is supportive to this way of financing. The only biggest challenge is to form a mature, simple framework and its implementation with its true letter and spirit.