KARACHI:

Prior to 1985, there were no Islamic banks in Pakistan. Fast forward to today and there are six full-fledged Islamic banks (IBs) and 16 Islamic Banking Branch Networks (IBBs). These are Islamic divisions or subsidiaries of conventional banks. Islamic banking now accounts for nearly a quarter of all banking assets in Pakistan and continues to grow faster than the conventional sector.

So, what were the factors that led to the introduction of Islamic banking in Pakistan, and to what extent are these banks truly Islamic? The story begins in 1985, when then president Ziaul Haq, during the latter stage of his Islamisation programme, sought to introduce Islamic banking in Pakistan. To this end, he constituted two committees.

The first was a committee of religious scholars. Its purpose was to examine whether Islamic banking could be implemented within Pakistan’s existing financial and legal framework.

The second was a technical committee led by the then finance minister, Ghulam Ishaq Khan, whose members included economists, bankers and financial experts. Its purpose was to assess the technical and economic feasibility of transitioning to an Islamic financial system.

Both committees were tasked with advising Ziaul Haq on whether Pakistan could realistically move towards an interest-free banking system while remaining tied to the global financial order.

The technical committee was unambiguous in concluding that a comprehensive transformation of the economic structure in Pakistan would be required to establish a genuinely Islamic economic system. This would include changes from the production to the consumption of wealth, alignment of economic procedures with Islamic principles, and institutional independence from global financial bodies such as the IMF and the World Bank. The committee argued that without such systemic changes, converting only the banking sector to an Islamic model would be inconsistent and technically unviable.

The committee of religious scholars did not disappoint the rulers. Its members acknowledged that full implementation of an Islamic economic system was not feasible under existing conditions. However, they proposed incremental steps through the use of legal mechanisms (hiyal) such as Murabaha, Mudaraba, Ijara and Bay Mu’ajjal. These mechanisms were intended to approximate Islamic financial principles within the constraints of the prevailing economic environment.

When the recommendations reached policymakers, the technical committee’s report was set aside and the system based on hiyal was adopted. Though some of the scholars on the committee later expressed reservations about the resulting framework, the hybrid model was adopted, continues to operate and is commonly presented as Islamic banking.

This led to the creation of an Islamic-looking system layered on top of a conventional economic structure. The broader argument is that both Islamic and conventional banking in Pakistan remain embedded within the global, debt-based economic system. As a result, labelling the system “Islamic” without undertaking structural reforms risks creating conceptual confusion and misleading the public.

The rapid growth in Islamic banking in Pakistan can, in part, be explained by the public’s belief that there exists a truly Islamic system of banking in the country. Labelling a bank as Islamic opens the door to a flood of faithful depositors who are loath to deal with conventional banks.

This is cheap money for the banks, since it is held primarily in current accounts that do not pay interest. In banking terms, the cost of funds for Islamic banks is zero. This enables them to produce outstanding financial results. And this is why 16 conventional banks have jumped into the fray by forming Islamic banking subsidiaries – IBBs, as they are called.

If proof is needed of the profitability of Islamic banking, consider that the leading Islamic bank in Pakistan, Meezan Bank, earned a net profit in 2024 of Rs101 billion, with a return on equity (ROE) of about 30%. Compare these results for the same year with Pakistan’s largest bank, Habib Bank Limited (HBL), which earned a net profit of Rs59 billion and an ROE of approximately 15%, despite HBL’s asset base being twice the size of Meezan’s.

Islamic banking has given rise to so-called Shariah boards populated by prominent Islamic scholars. These boards are retained by banks to advise them on whether their Islamic banking products and investments are compatible with Shariah. Since these boards earn income from the banks, there is a natural incentive to tell the banks what they want to hear.

There is no dispute among Muslims that Islam does not allow Riba, or interest, on the lending or borrowing of money. So, the question is: do legal mechanisms, complex machinations in the structure of Islamic products, and clever semantics such as calling interest “profit” render banking Islamic? Given that this is a matter of faith and that a great deal of money is involved, it is not likely that this question will obtain an unequivocal answer.

THE WRITER IS CHAIRMAN OF MUSTAQBIL PAKISTAN. HE HOLDS AN MBA FROM HARVARD BUSINESS SCHOOL