A CRITICAL ANALYSIS OF THEORY AND PRACTICE OF ISLAMIC FINANCIAL INSTRUMENTS, WITH SPECIAL REFERENCE TO THEIR USE IN PAKISTAN DURING 1980-1995

The advancement of technology greatly increased the demand for money. Vast monetization as well as ever-rising demand for money necessitated the use of credit instruments. Under the western economic system credit inevitably entailed fixed rate of return for the use of borrowed money. So long as the European empires dominated over the states where Muslims had lost their sovereignty, the conventional economic system continued to prevail. However, the resurgence of Islamic thought inspired the Muslims to reorganize their financial system.\ud \ud The injunction on “Riba� in Islam re-awakened the Muslims. The commencement of Islamic finance movement paved the way for transforming the conventional system of economics into an Islamic one which could ensure an exploitation free financial system. The efforts ultimately fructified. First, the establishment of The Islamic Development Bank in 1975 and then the formation of Oar-ul-Mall AI-Islami in 1981 inspired the Muslims to adopt their own system of finance, which ensures “Riba� free transaction. Like all other Muslim countries Pakistan also embarked upon the scheme of Islamisation in 1979 and introduced several non-interest based financial instruments. In the process of change many critics observed that the instruments employed in Pakistan did not meet the criteria postulated by jurists on Islamic Fiqah. With a view to analysing and finding out the nature, scope and implications of each instrument, this study was undertaken to suggest practical alternative to the prevailing interest-based financial instruments.\ud \ud While analysing Pakistan's experiences in introducing Non-Interest modes of financing, it was observed that the instruments which conformed to Islamic Sharia like Musharika could not be continued with because of uncertainty of profit rate and also manipulation of accounts by the partner companies which often resulted in lower rate of return. Therefore, the Non-Interest modes applied in banking could not command public acceptability. Financing on the basis of “Mark up� was therefore, adopted mostly for providing working capital requirements of business & industry. Under this mode notional transaction of sale/purchase of goods formed the basis which can not get authenticity from the law of Sharia\ud \ud In order to make a detailed study for identifying the complexities involved and implications of each financial instrument like Musharika, Modaraba, Ijara, Bai Muajjal, Bai Salam etc the original works of renowned jurists as well as that of modern scholars have been consulted. Finally the following conclusions have been drawn with regard to the Non-Interest Based Modes employed in Pakistan:\ud \ud 1. The mode of modaraba was implemented by Modaraba companies instead of individual modaribs. The activities of modaraba companies remained restricted, mostly, to stock trading instead of distribution process.\ud \ud 2. The instrument of musharika did not receive much acceptability because of the attitude of the risk averters on the one hand and the availability of alternate modes of financing on the other.\ud \ud 3. Arbitrary weightage to bank's investment under rent sharing mode has no legitimacy as it awards undue edge to bank's investment to the detriment of partner customer.\ud \ud 4. The buy-back agreement transactions remained confined to stock and other marketable securities which restricted its scope as well as utility. The transactions entered into with regard to real estate and other fixed assets did not prove the criteria under the law of Sharia because neither the possession changed nor benefits accruing from the assets were derived by the buyers i.e. financing bank.\ud \ud 5. Both the modes of hire-purchase and leasing are settled at a predetermined rate of rent instead of working out actual net rent on case to case basis. Again, the activities of leasing companies relating to loan advancing on the basis of markup do not find approval under the law of Islamic Sharia.\ud \ud 6. Bill discounting procedure under the new modes in no way differs from the bill purchase under the conventional system. By renaming “Interest� into “Mark Down� does not legitimise the transaction under the law of Sharia. Similarly financing on the basis of “Mark Up� under the garb of sale-purchase transaction can not derive approval from the Islamic jurisprudence. The financing under sale/purchase of goods on the basis of “Mark Up� on deferred payment basis is a notional transaction and carries interest in disguise.\ud \ud Suggestions have, therefore, been made wherever felt feasible keeping in view the socio-economic viability of each instrument. At the end an “Alternative� to present “Mark-Up� based mode has been suggested which will operate without involving the element of interest. Under these “Alternative�, a banker will, after having satisfied himself about the credit worthiness of the customer and security offered, sanction a finance limit of a certain amount for a pal1icular customer. Therefore, the customer will be allowed to purchase Trader’s Credit Cheques against the already approved limit. These Trader's Credit Cheques will be encashable at all branches of the issuing bank. The customer will pay a commission/fee at the time of purchase of T.C.C. of required denomination. On presentment of the T.C.C. the issuing bank will make payment to the debit of customer’s account. The customer will adjust his liabilities within 90 days for which period, the customer will not pay any charges. However, in case of his failure to liquidate the liability within 90 days, he will be issued monthly notice for adjustment of account and incase of his failure to positively respond the bank or finance giving agency will exercise the right against securities as envisaged in banks finances recoveries ordinance 2001. The instrument will provide the customer a finance facility without involving the element of interest. The operational mechanism has already been elaborated in Part-III