Islamic Banking and the Conversion of Conventional Banking to Islamic Banking in Pakistan

Abstract

In 1979, by the order of the president of Pakistan, conventional banking was converted to Islamic banking. At that time Pakistani economy was based on interest based banking. Government of Pakistan established a council in 1962 called Council of Islamic Ideology, and its main objective was to study the Islamic economic system and giving the guidelines to convert the existing banking system to Islamic banking system. The phase of transition started in two main phases. In first phase, the basic infrastructure was changed to Islamic banking system so that strategies could be developed to introduce full fledge Islamic system. The process of Islamisation from conversion of three specialized credit financial institutions The House Building Corporation, The Investment Corporation of Pakistan and The National Investment trust. State bank of Pakistan ordered all commercial banks to convert their operations according to Islamic modes of financing. After successful implementation of first phase, Second phase was to introduce new instruments for financing and investment under Islamic modes and eliminate all sorts of conventional banking from the economy. Presently Islamic modes of financing are in practice in all banks of Pakistan. Major modes of financing are Mudarabah, Musharakah, Murabaha, hire purchase, Leasing, Diminishing Musharakah, Mark-up, Mark down, investment in equity capital, rent sharing and profit and loss sharing. State bank of Pakistan is the apex in the monetary system in Pakistan and responsible for efficient working of money markets and capital markets. To control the economy, State Bank sets minimum and maximum rates of returns on investments and financing. Banks and borrower mutually choose a rate of return between these limits. In order to safeguard interest of depositors/investors, state bank is continuously making and implementing polices. These are mainly concerned with cash reserve requirements, credit allocation to each industry according to annual development plan and changes in margin requirements. At present all banking system in Pakistan is according to Islamic modes of financing and banks are competing with each other to give the best rate of return to their depositors. Banking Tribunal ordinance is working to resolve disputes between the financier and borrower. Time to time state bank of Pakistan is making recommendations to ensure that all requirements of Islamic financing are being met.