On the other hand in Iran the process of conversion of

traditional banks and financial institutions into Islamic ones

was very rapid.

After this period government has started to wield control on

the banks so that the banks provide interest free loans to
public for housing and for small-scale projects (SME). The
banks have also provided funds for projects in hands of
Government. The six commercial banks and three
specialized banks are mainly engaged in short term
projects and profit sharing agreements are only small
percentage of their activities. Since then Islamic Banks have
steadily been growing. There are thirty-one Islamic
Financial Institutions and interest-free modes of financing
which are practical. Furthermore, more than 48 countries
as well as more than 300 Islamic Banks are working on
these interest-free methods all over the globe.

The international Islamic Financial Institutions are providing a

wide range of services in accordance with the basic
principles of Shariah. The products are Mudaraba,
Murabaha, Musharaka, Ijarah, Istisna and Salam.
Conventional banks operate under the concept of lender-
borrower relationship where interest is considered as the
rental income on capital. The depositors are one of capital
providers. Profits of the banks are distributed at the
prudence of the bank managements. But the Islamic Banks
follow the concept of Mudaraba (profit sharing) based on the
relationship between banks and investor. The profits
generated through this relationship are divided between the
two parties as per agreed ratio.

According to the Institute of Islamic Banking, there

are more than 300 Islamic Financial Institutions in all
over the world. These institutions are working in the
following countries: Bahrain, Bangladesh, British
Virgin Islands, Albania, Algeria, Australia, Bahamas,
Brunei, Canada, Cayman Islands, Cyprus, Djibouti,
Egypt, France, Gambia, Germany, Guinea, Jordan,
Kazakhstan, Kuwait, India, Indonesia, Iran, Iraq, Italy,
Ivory Coast, Lebanon, Luxembourg, Malaysia,
Mauritania, Morocco, The Netherlands, Niger,
Nigeria , Oman, Pakistan, Palestine, Philippines,
Qatar, Russia, Saudi Arabia, Senegal, South Africa, Sri
Lanka, Sudan, Switzerland, Tunisia, Turkey, Trinidad
and Tobago, United Arab Emirates, United Kingdom,
United States, Yemen.

The leading Islamic institutions are located in Bahrain,

Kuwait, Saudi Arabia and Iran. Western banks through their
Islamic units in the Germany, Switzerland, UK Luxembourg
etc. also practiced Islamic Banking. The Islamic Banking
will be increased to 10 percent from 3 per cent in
Pakistan, from 15 to 20 percent in Malaysia, 3 per cent to
10 percent in Indonesia and 60 per cent in the Gulf
Cooperation Council (GCC) countries.

ORIGIN OF ISLAMIC BANKING IN PAKISTAN

The process of islamization the financial system of Pakistan

is agreed with the globally renaissance of Islamic banking in
the late seventies. Pakistan was along with three countries
in the world that has been trying to implement Islamic
banking at national level. This process has started with
presidential order to the local Council of Islamic Ideology (CII)
on September 29, 1977. The council was asked to prepare
the proposal of interest free economic system. The council
included panelists of bankers and economists who submitted
their report in February 1980, highlighting various ways and
sufficient details for remove the interest from the financial
system of Pakistan. This report was a milestone in the efforts
for Islamizing the banking system in Pakistan.

MODES OF FINANCING
Banks adopt different modes of acquiring assets or financing
projects. But they can be widely categorized into three areas:
Trade Finance, Investment and Lending.

TRADE FINANCING

Trade Financing is being done through several ways.

a) Letters of credit where the bank guarantees the import

of an item using its own funds for a client, on the basis of
sharing the profit from the sale of this item or on a mark-up
basis.

INVESTMENT FINANCING

Banks are doing business in these major products.

a) Musharaka The word came from sharakat (which means

partnership) where a bank may join another entity to set up
a joint venture, both parties participating in the various
aspects of the project in varying degrees. Profit and loss are
shared in a pre-arranged fashion. This is not very different
from the joint venture concept. The venture is an
independent legal entity and the bank may withdraw
gradually after an initial period.

b). Murabaha

Murabaha is particular kind of sale and not a financing in its

origin where the transaction is done on cost plus profit basis.
In this mode of financing the borrower knows the actual price
of assets and profit amount which shall be earned by the
bank. i.e the seller discloses the cost of the product to the
buyer and adds a certain profit to it to arrive on the final
selling price.

c) Bai Salam

In Salam, the seller undertakes to supply specific goods to

the buyer at the future date in exchange of an advanced
price fully paid at spot.Furthermore, the price is paid
immediately in acsh but the suppy of purchased goods is
deffered to a fixed date.

d) Ijarah

One of the four leading mode of financing is Ijarah/Lease

financing under which one party (Lessor) agrees to the
usufruct of a property to another party (lessee) for a
mutually agreed rent as per term and conditions while the
title of leased property remains vested in the Lessor during
the period of rent.

The rule of Ijarah, in the senses of leasing, are very much

analogous to the rule 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 actual property is transferred to
the purchaser, while in case of ijarah, the property remains
in the ownership of the transferor, but only its usufruct.

d) Mudaraba where the bank contributes the finance and

the client provides the expertise, management and labour.
Profits are shared by both the partners in a pre-arranged
proportion, but when a loss occurs the total loss is borne by
the bank.

e) Financing on the basis of an estimated rate of

return. Under this scheme, the bank estimates the expected
rate of return on the specific project it is asked to finance
and provides financing on the understanding that at least
that rate is payable to the bank. (Perhaps this rate is
negotiable.) If the project ends up in a profit more than the
estimated rate the excess goes to the client. If the profit is
less than the estimate the bank will accept the lower rate. In
case a loss is suffered the bank will take a share in it.

LENDING

Main forms of Lending are:

a) Loans with a service charge where the bank lends

money without interest but they cover their expenses by
getting service charge. This charge may be subject to a
maximum set by the authorities.
 b) No-cost loans where each bank is expected to set aside
a part of their funds to grant no-cost loans to needy persons
i.e small farmers, producers, entrepreneurs, etc. and to
needy consumers.

c) Overdrafts also are to be provided, subject to a certain

maximum, free of charge.

INITIATIVES TAKEN IN PAKISTAN

The Islamic banking movement in Pakistan was a
comprehensively nationwide. As it was a huge task, the
switch-over plan was implemented in phases. The process
was started by transforming the operations of specialized FI’s
like Investment Corporation of Pakistan (ICP), National
Investment Trust (NIT), and House Building Finance
Corporation (HBFC) to the system conforming to the Islamic
principles with effect from July 1, 1979. Separate Interest-
free counters started operating in all the nationalized
commercial banks, and one foreign bank from January 1,
1981, to mobilize deposits on profit and loss sharing basis.
As from July 1, 1985, all commercial banking operations were
made ‘interest-free’. From that date, no bank in Pakistan,
including foreign banks, was allowed to accept any interest-
bearing deposits. All existing deposits in banks were treated
to be on the basis of profit and loss sharing. The government
meanwhile also passed Mudarabah Companies Act 1984,
enabled banks/ FI’s or business groups to setup special
Mudaraba Companies in a country.

Islamic Banking and its challenges

Although the concept of Islamic finance was once regarded

was an exotic niche of the financial world, these days it is
growing rapidly, Moreover the sector used to be dominated
by local banks in Middle East but now a growing number of
non Muslim banks are also joining the fray.

Proper Institutional Framework

Every system require institutional framework. Islamic banks are

no other than that, they also require a number of supporting
institutions/ arrangements to Perform various functions.

Islamic banking institutions around the globe try to benefit from

the institutional framework that supports conventional banking.
However, Islamic banks struggling because of the lack of
institutional support specially geared to their requirements.
Structuring a complete institutional set-up is the most serious
challenge for Islamic finance they are facing. To face this
challenge, a "functional approach" is proposed towards
building this set-up.
This function is heavily use in conventional framework that
should be examined and attempts should be made to change the
existing institutions in a way that enables them to provide better
support, or establish some new department according to the need
of the time.
Appropriate Legal Framework and Supportive
Policies

The company laws and commercial banking in most of the

Islamic countries are shaped on the Western model. Those
laws contain necessities that reduce the scope of activities of
Islamic Banking within the area where conventional banking is
in operation. During the business, parties can structure their
agreements according to an Islamic contract, the enforcement of
these agreements in the courts may need extra hard work and it
must costs something. To defeat these conditions, some special
laws and practice must introduce for Islamic banking practice.
Such laws would provide facility to the business of Islamic
banks side by side with conventional banks.

Laws are compulsory to allow Islamic financial institutions to

operate their business according to Islamic rules and to give
better chances to Islamic financial markets for Islamic financial
transactions. In this situation, the legal framework of Islamic
banking and finance might include the following items:

Islamic Banking Laws

These laws will relates with the supervision,

establishment, and functioning of Islamic banking with in the
country. In different Muslim countries they have such laws which
provide a legal framework for the working of various Islamic
banks.
Laws Concerned with Financial Institutions

Islamic non-banking financial institutions can do their

business with reasonably within the legal framework in
many Islamic countries. In some others, some alterations are
required to broaden the range of operations to cover Islamic
financial operations.

Supervisory Framework

Supervision of Islamic banks is as necessary as the

conventional banks. Currently, lack of efficient supervisory
framework is one of the major weaknesses of the existing
system and it this must deserves serious attention. The roles
of the shari'ah advisory boards and the Central banks both must
to be strengthened and streamlined.
The reasons for the importance of regulation and supervision of banking
industry is to increase the information which are easily available to
investors & to make sure the soundness of the financial system. In case of
Islamic banking, there are some additional elements of supervision. This
makes relationship of shari'ah supervision of their activities.

As the information to the customer, currently this situation of Islamic banks

have many drawbacks. In many cases the major part of information of
calculating the share of profits of different types of deposit which is not
declare to the deposit holders. Similarly, details where the funds are sues
by the banks are not declared. The regulatory bodies must necessitate
the banks to disclose these kind of information to the investors and
increase the competency of financial markets.

In countries Islamic banks are working under the supervision of central bank
of their respective country and treated same as the conventional banks.
Some countries issue unique and special Islamic banking Act to run the
operations of Islamic banks and their relationship with the central bank.
Some countries issue laws that set general rules for the operations of
Islamic banks side by side with conventional banks16. Central banks
treated Islamic banks to the same conditions, controls and regulations
that they apply to the conventional banks. There are lots of factor to treat
Islamic banks other than conventional banks, some of these factors are the
following:

A. Central banks usually keep some of the deposits of both Islamic

banks and conventional bank and pay interest on this deposit which
Islamic bank cannot accept. An alternative is required to ensure that
Islamic banks get a profit or loss on their deposits with the central banks.
B. In those countries where the central bank conducts open market
operations, Islamic banks are not able to participate in these operations
because the securities bought and sold on interest based nature.
C. Lack of proper understanding of the exact nature of Islamic financings
may also be responsible for unsuitable policies of the central banks
towards Islamic banks. This is particularly true of mudarabah and
musharakah . This may have significant implications for reporting as well
as control and regulation of Islamic banks by the central banks.
Accounting Standards

Conventional banks have same accounting standards in almost every

countries. Central banks issue the aggregated balance sheets of the banks
and supervise regularly and with no difficulty, In contrast, dissimilarity of
accounting practices among Islamic banks go to the degree that any
meaningful comparison between their balance sheets or profit and loss
accounts becomes a very hard task if not altogether impossible.
Furthermore, the concepts used in the balance sheets or profit and loss
statements are not thoroughly defined.

However, during the last few years some development has been made to
overcome this problem, In order to establish standardization in the
accounting practices of Islamic financial institutions, some Islamic banks,
under the guidance of the Islamic Development Bank, have established an
organization called, Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI). The organization, is now doing its
operation and based in Bahrain, is composed of a supervisory committee
and a Financial Accounting Standards Board liable for preparing,
issuing and amendment the accounting standard for the Islamic
banks and Islamic financial institution who are agree to apply the
standard set by the board.