Islamic banking the challenges ahead.

WILL our economic and financial system be able to eliminate riba (interest) by December 2027, as ordained by the Federal Shariat Court? If the past is any guide, this time frame is almost impossible to adhere to. What are the challenges in transforming our economy into a riba-free system? How quick, or slow, has been the Islamisation of banks in Pakistan so far? To answer the latter question first, the first serious attempt to Islamise the banking system started in 2002, with the establishment of the Meezan Bank. Islamic banking assets then started to grow rapidly, but the share of Islamic assets in commercial banking grew very slowly. From zero per cent in 2002, to 8.2pc in 2012, to 19.5pc in June 2022 - the share has risen at an average speed of close to 1pc annum. If this share continues to rise at this pace, Islamic banking assets will surpass interest-based banking assets around 2052, when half our banking system would have been Islamised.

The actual speed of Islamisation will, of course, depend on how soon or otherwise we overcome the challenges. The primary challenge does not relate to interest-based banks becoming Sharia-compliant, but to the transformation of government, domestic and external debt to Sharia-compliant securities like sukuk. It is after such transformation that the banking and financial sector will find it simpler to move towards a riba-free system. This is easier said than done. The outstanding value of the federal government debt - domestic and external but excluding IMF debt and State Bank foreign exchange liabilities - was Rs47.8 trillion at end-June 2022. It has already crossed Rs50tr since then. Without the transformation of domestic debt, banking and financial institutions can't become Sharia-compliant.

Though the transformation is not impossible, it is extremely difficult to achieve by 2027. Why? Because government borrowing from banks does not require any real assets from the federal government under the interest-based financial system. A riba-free system requires real assets against which the borrower can get Sharia-compliant financing from an Islamic bank. All financial activities, under the Islamic financial system, must be asset-backed. This is also one of the main differences between Sharia-compliant and interest-based activity. Linking the latter to a real asset is a direct, and not remote, exercise. Since financial activities, whether interest-based or Sharia-compliant, look similar, it confuses...

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