Rethinking banking?

The Federal Shariat Court’s (FSC) ruling that the country’s current interest-based financial system be replaced with an interest-free one within five years has triggered a how-to-reinvent-banking debate in a country whose crippled economy is already walking on the crutches of capital borrowed from world lenders at high markups. There is a growing demand for Islamic banking in Pakistan as confidence in the sector increases, and consumers continue to search for products and services that are Shariah-compliant. But the only question that needs to be answered right now is whether this is an appropriate time to address these structural and radical shifts. The court has decreed that all mention of interest or riba under the law of the land be struck down/modified and further measures be introduced to make the economy free of riba in absolute terms. As a result, banking/financial institutions, investors and individuals may only engage in Islamic financing.

The verdict has long-term consequences and will affect almost all standing domestic and international obligations of the country. This development has raised questions about the future of investments in the country. If the country were to go interest-free, then all investment would have to undergo various conditions of Islamic financing. This would be a gargantuan undertaking, given the scale of economic transactions. Per some observations, the key distinguishing feature of Islamic financing is that it requires investors to directly participate in the underlying risk of the transaction, such that there exists a direct link between investors and the assets backing the transactions. This translates into investors needing to contribute their personal income to cover possible losses. The underlying asset sales could therefore be perceived as unsecured loans during bankruptcy proceedings, potentially voiding the sale itself – thus compromising investor confidence and protection.

The country’s Islamic banking industry includes five full-fledged Islamic banks and 17 conventional banks offering Shariah-compliant financial products. The industry now accounts for 19.4 per cent of the country’s overall banking system in terms of assets while in terms of deposits the share is 20 per cent (as of March 31, 2022). The development of principles and regulations that apply to every part of the Shariah-based economic system will enable a smooth transition to a system without set rates of interest on loans or returns on savings. Religious scholars and economists should work together to produce these rules. However, it would be better to mandate that all banks use Shariah-based banking practices alongside their interest-based transactions. The government has welcomed the FSC decision. But any attempts to align our entire banking system with Islamic laws that ban interest payment would have to be worked out with much caution and without haste. There are very few Muslim countries that have adopted fully Shariah-compliant financial systems. In fact, Iran is the only country that has shifted completely; Libya has plans to do so while Sudan is rethinking its commitment to a fully Shariah-compliant system. An unplanned, hasty shift could lead to global isolation – which is why a Saudi-like hybrid system where Islamic products coexist with conventional banking would be a far better route to take for Pakistan.