Explanation: How will the transition to interest-free banking take place? – Newspaper

The easy part is over. The banking regulator withdraws its legal challenge from the decision of the Federal Shariah Court (FSC) to abolish interest-based banking by the end of 2027.

Now begins the most difficult part. Making banking operations interest-free in five years seems like a task of herculean proportions. So let’s break it down into three specific questions.

First, the very idea of ​​interest-free banking. To the uninitiated, this may sound like an oxymoron: after all, why would a bank lend money to a customer if they won’t receive any interest on the principal?

Second, how will the bank become 100% Islamic in just five years, given that the share of Sharia-compliant bank assets is currently less than 20%, even after more than two decades of government support?

Third, what are the likely steps the government will take to achieve the 100pc conversion target by the end of 2027?

Trade, not interest

Interest-free banking does not mean that the bank operates on a no-profit-no-loss basis.

Unlike a conventional bank, which acts only as a creditor and makes a gain on a loan (read: interest), the bank-customer relationship in Islamic banking changes depending on the mode of financing and the nature of the facility.

Read also : Is it possible for Pakistan to switch to an interest-free banking system?

Islamic banking is essentially asset-backed. Instead of giving money to a customer to buy a car, an Islamic bank buys the car itself and leases it to the customer and gradually transfers ownership of the asset over a period of time. In other words, the bank becomes the “lessor” and the customer becomes the “lessee”.

The way the transaction is structured can potentially generate exactly the same return for conventional and Islamic banks. But the roundabout way of letting a customer own a car makes the whole process Islamic, experts say.

“Islam forbids interest, not trade. The banking process is important. Islamic banks do not lend money. They operate as trading and investment houses,” Meezan Bank Ltd Senior Executive Vice President Ahmed Ali Siddiqui said. Dawn Thursday.

Realistic timeline

Former Governor of the State Bank of Pakistan, Dr Ishrat Husain, publicly expressed his disappointment with the Islamic banking sector last year, saying it was “below expectations”.

In a telephone interview on Thursday, Dr Husain reiterated his view that the banking industry should have achieved a “30-40% conversion” in the 21 years since he granted the first banking license in the country. Sharia to Meezan Bank Ltd in 2001.

“With the latest developments, I believe the pace of conversion will accelerate. Conventional banks are only five years old. Faysal Bank Ltd has already converted and other banks will now be under pressure to make the transition” , did he declare.

Faysal Bank will become a full Islamic lender by the end of 2022 after isolating its residual portfolio of conventional loans. It is in the process of abandoning its conventional banking mandate and becoming the sixth Islamic bank in the country. In addition to the five existing players, no less than 17 conventional banks are currently operating their Islamic banking branches in Pakistan.

According to Faysal Bank’s Chief Financial Officer, Syed Majid Ali, there has never been a conversion from a conventional bank to an Islamic bank on such a “massive scale”. Faysal Bank’s balance sheet size was 997 billion rupees at the end of June. The conventional lender took five years to fully make his 100pc business Shariah-compliant.

course correction

The first step the government should take to bring the banking sector in line with Islamic principles is the transition of its own ministries and institutions to Islamic banking.

“The government should announce the plan to convert the National Bank of Pakistan into a Sharia-compliant entity,” Siddiqui said, referring to the state-owned bank which had until recently opposed the transition. by challenging the FSC’s decision in court. .

Large entities like Pakistan State Oil Company Ltd and Oil and Gas Development Company Ltd, as well as cash-rich government branches like the Ministry of Finance, should be legally required to place their excess cash in Islamic banks, he said. he declares.

More importantly, the government should sell Sukuk or Islamic bonds and use the funds generated to repay old debts incurred through conventional instruments such as treasury bills and investment bonds.

“All new borrowing must be interest free going forward,” he said.

Posted in Dawn, November 11, 2022