Reconstruction of banking in Islam – II

I.A. Farooq

Application of funds


Maintenance of cash balances is not against the principles of shariah.

Balances maintained with central bank and commercial banks are in accordance with the principles of shariah as long as they are maintained as current accounts (no accruals to be paid).

The short term balances may be kept in securities of riba-free institutions, (like real leases and lease-based securities). The arrangements can be made with the Central Bank for sale and purchase of the securities to meet immediate requirements of cash shortages. The exercise requires existence of active secondary market. The central bank has already taken measures to create a secondary market that can be developed on a priority basis once the theme of the interest-free banking system is supported.


a) Government debt:

The major investment of banking companies at present is in government debt. The transformation of the existing debt into an interest-free investment is a subject that can be sorted out by transforming all debt into bank deposits and then borrowing as loan (under service charges), which is an agreed mode of business covered by shariah.

b) The remaining investments are already in the corporate securities that have been accepted by scholars with or without changes.

Loans and advances: This is the most important area of operations of a bank. However, in the recent prudential regulations the Central Bank has introduced a regulation requiring every borrower to submit accounts and there is a borrowing ceiling on this. This can be enlarged (declared equity) to encompass all borrowers. Any lending to its clients will be through the following modes:

i) Qarz-e-Hasna (approved by shariah), ii) Financing by lending (service charges may be recovered; being in accordance with the shariah), iii) Musharika (this is in accordance with the shariah, iv) Investment in the equity of borrowers (for this purpose the borrowers should be transformed into Corporate entities as far as possible. In the interim period lending will be through musharika agreements based on the equity ratio even with fluctuating balance)

A system of calculation of equity and facilities for sharing profit and loss on a daily balance basis can be developed to accommodate existing business counts, running finance, overdrafts, and other fluctuating balance accounts. This system will involve a major role by service sectors and will thus also open avenues of employment. The system will make the account ruled income calculation transparent and, thus, convenient for the authorities. It is also proposed that these accounts may be accepted by the authorities like other accounts presented to them by accountants for their corporate customers. The reconstructed system is indicative of a major role by the Stock Exchange and Secondary market. These should be (and can be) developed/strengthened on immediate basis.

Lending (contra of borrowing): This will he on the same lines as explained under the head borrowing under resources.

Lending (Borrowing – international Market)

As dealt under the head Resources.

Alternate – B

All application of funds will be contribution to equity on rolling basis. Profits and losses will be shared on products on annual daily summations.


The system takes care of the objections raised by religious circles and Islamic society regarding interest component in the banking system. The system will run on takeover, merger, liquidation, and privatisation basis.

Every bank will be guided by a Religious Board.

State bank published my article, “Reconstruction of Banking Thought in Islam” in its issue of mid January, 2000. As feedback, I received a number of queries from readers and other persons on certain aspects of the article that were explained to them in person. I also received a letter from Mr. N. M. Hashmi (an ex-Executive of the bank now residing in Canada) who was of the view that the subject of “Government debt” and “International borrowing” needed more research. By the grace of Allah, the full text of the Supreme Court (SC) judgment has become available by now. I would request the readers to read the SC judgment and contents of my article again. I hope a synthesis or a combined view of the SC judgment and suggestions made in my article would provide answers to most of the mind-boggling questions.

Following is a chart-from presentations of transformation processes of economy if the judgment of the SC is implemented. The footnote indicates the steps required to be taken by the legal system. The net effect displays the restructured shape of the economy.

Formal economy – Properly documented

a) Cash – Ultimately gold and silver coins

b) Credit – Ultimately bank notes of dinar and dirham

(only asset based)

Business loans where no write-offs, recovery to be followed and to be adjusted from proceeds of estate on death of the borrower, shortfall to be met by Central Bank. Profit and loss to be shared on the basis of daily product summations.

Personal loans – service charges – voluntary recovery – shortfall to be met by central bank.

Grants – to be met by central bank

Legal information Economy



Illegal informal Economy

a) Cash

c) Credit

Debt – to be converted into bank deposit.

Note: a) Informal Economy to be eliminated through demonetisation via bank accounts.

b) Non Banking institutions to be upgraded as unit banks and will follow local as well as central laws.

c) Central Bank will ultimately be Bait-ul-Mal.

d) One vote will be equivalent of Nisab.

Liabilities (Resources)

1) Capital – No change

2) Deposits

a) In account form

b) Supported by promissory note and not deposit receipt (if required)

c) Others – all in account form.

Assets (Utilisation)

1) Cash – No change

2) Government Securities – Change to bank deposits

3) Loans and Advances

a) Account form with management sharing (right for declaration of profit or loss)

b) Business loan

c) Personal loan

d) Grants

e) Any other mode allowed by shariah

4) Others – in account from

Note: Government to be provided facilities that will be assets-based. However, ulema or SC may decide on the following points:

Sharia-based form of currency/bank note (Matter, material, design and denomination etc.

D.P. Note – model based on Quran and Sunnah.

Definition of assets and their list according to Quran and Sunnah so as to reshape Balance Sheet (s).

A declaration that banking function and present book-keeping and vouching system are in accordance with Quran and Sunnah.

I am thankful to all those readers who showed keen interest in the contents and raised a number of questions. These queries were explained on merit. However, two of the important questions raised were:

a) Legal system:

How the existing system will be transformed in view of the constitutional constraint and very large number of laws (and practice).

b) By trading houses:

That requires explanation about loan documentation in terms of restructured banking practices, and not the banking laws alone.

Consequently, the commercial law, practice, and other complementary laws were studied again, especially from above as also following angles:

Banks themselves are Muslim institutions in their body format except riba. However, their constituents follow trade practices in line with their respective tradition.

The cross border transactions between Muslim countries following different tradition will be very difficult to conclude in line with commercial law prevalent in different Muslim countries.

The SC judgment lays down to transform inland banking system before or by June 30, 2001, while leaving the cross border decision open-ended.

Transactions between Muslim and non –Muslim countries can only mature on the basis of a Single Uniform Accounting Practice. Deviation from this will lead to riba-based transactions in disguise form in the first stage (through barter and completely in the second, as happened in the past.)

The management of resources currently, directly, or indirectly, is in the hands of non-Muslim pole of the Economic World. However, in their own wisdom, despite prohibition in their religion (s); they continue to practise riba obviously failing to derive an alternative from their code of ethics as the original text has been lost in history.

The above points need elaborate discussion. However, it will be easy to understand them if the following functions are accepted to be derived from Quran and Sunnah by Muslim stalwarts in the historic process after continuing careful and coherent consideration and deep thought and, above all, by blessings of Allah who has been so submitted in the earlier part of my articles. These functions are:


Promissory note.



Commercial law

Juridical person

(to be continued)

The writer is an ex-Advisor Banking State Bank of Pakistan

Source: The Post, 9th September, 2008


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