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Islamic Banking:
Islamic banking is defined as banking system which is in consonance with the spirit,
ethos and value system of Islam and governed by the principles laid down by Islamic
Shariah. Interest free banking is a narrow concept denoting a number of banking
instruments or operations which avoid interest. Islamic banking, the more general
term, is based not only to avoid interest-based transactions prohibited in Islamic
Shariah but also to avoid unethical and un-social practices. In practical sense, Islamic
Banking is the transformation of conventional money lending into transactions
based on tangible assets and real services. The model of Islamic banking system
leads towards the achievement of a system which helps achieve economic
Prosperity.
History of Islamic Banking in Pakistan:
Islamic banking in Pakistan has a relatively recent history, starting in the late 1970s
and early 1980s. The establishment of Islamic banks was driven by the country’s
desire to create a financial system that aligns with Islamic principles and offers
Sharia-compliant financial services to its Muslim population. Here’s a brief overview
of the history of Islamic banking in Pakistan:
1. Early Initiatives (Late 1970s – Early 1980s):
The first step towards Islamic banking in Pakistan was taken in 1977 when the
government formed the “Council of Islamic Ideology” to recommend measures for
Islamizing the economy, including the financial sector. In 1979, the government
established the first Islamic bank, “Muslim Commercial Bank” (MCB), as a subsidiary
of the National Investment Trust (NIT). However, MCB initially faced challenges and
struggled to gain momentum.
2. Ordinance for Islamic Banking (1980):
In 1980, the Pakistani government passed the “Interest-Free Banking Ordinance” to
create a legal framework for the establishment and operation of Islamic banks. This
ordinance provided a platform for Islamic banking institutions to function alongside
conventional banks.
3. Establishment of First Full-Fledged Islamic Bank (1983):
The first full-fledged Islamic commercial bank, “Meezan Bank,” was established in
1983. It was a result of the privatization of the Pakistan Kuwait Investment Company
(PKIC) and was subsequently converted into an Islamic bank.
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4. Formation of Islamic Banking Division (1991):
To promote Islamic banking further, the State Bank of Pakistan (the central bank)
established the Islamic Banking Division in 1991. The division was tasked with
overseeing and regulating Islamic banking activities in the country.
5. Growth and Expansion (1990s – Early 2000s):
Throughout the 1990s and early 2000s, Islamic banking gradually gained popularity
in Pakistan. Existing conventional banks also started offering Islamic banking
products through dedicated Islamic banking branches, windows, or subsidiaries. This
expansion helped reach a broader customer base interested in Sharia-compliant
financial services.
6. Legal Framework (2001):
In 2001, the State Bank of Pakistan introduced comprehensive regulations for Islamic
banking, known as the “Prudential Regulations for Islamic Banks.” These regulations
provided a clear framework for Islamic banks to operate, ensuring transparency,
accountability, and adherence to Islamic principles.
7. Continued Growth and Diversification (2000s – Present):
Islamic banking continued to grow steadily in Pakistan, with more Islamic banks
being established and conventional banks expanding their Islamic banking
operations. The government also encouraged the development of Takaful (Islamic
insurance) and Islamic capital markets to complement the Islamic banking sector.
8. Islamic Banking Act (2015):
In 2015, the Pakistani government passed the “Islamic Banking Act” to provide a
legal framework and enhance the regulation of Islamic banking institutions in the
country. This further strengthened the Islamic banking sector and its stability.
Following are the main modes of Islamic banking and finance:
MURABAHA
Literally it means a sale on mutually agreed profit. Technically, it is a contract of sale
in which the seller declares his cost and profit. Islamic banks have adopted this as a
mode of financing. As a financing technique, it involves a request by the client to the
bank to purchase certain goods for him. The bank does that for a definite profit over
the cost, which is stipulated in advance.
IJARAH:
Ijarah is a contract of a known and proposed usufruct against a specified and lawful
return or consideration for the service or return for the benefit proposed to be
taken, or for the effort or work proposed to be expended. In other words, Ijarah or
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leasing is the transfer of usufruct for a consideration which is rent in case of hiring
of assets or things and wage in case of hiring of persons.
IJARAH-WAL-IQTINA
A contract under which an Islamic bank provides equipment, building or other assets
to the client against an agreed rental together with a unilateral undertaking by the
bank or the client that at the end of the lease period, the ownership in the asset
would be transferred to the lessee. The undertaking or the promise does not
become an integral part of the lease contract to make it conditional. The rentals as
well as the purchase price are fixed in such manner that the bank gets back its
principal sum along with profit over the period of lease.
MUSAWAMAH:
Musawamah is a general and regular kind of sale in which price of the commodity
to be traded is bargained between seller and the buyer without any reference to the
price paid or cost incurred by the former. Thus, it is different from Murabaha in
respect of pricing formula. Unlike Murabaha, seller in Musawamah is not obliged to
reveal his cost. Both the parties negotiate on the price. All other conditions relevant
to Murabaha are valid for Musawamah as well. Musawamah can be used where the
seller is not in a position to ascertain precisely the costs of commodities that he is
offering to sell.
ISTISNA A:
It is a contractual agreement for manufacturing goods and commodities, allowing
cash payment in advance and future delivery or a future payment and future
delivery. Istisna’a can be used for providing the facility of financing the manufacture
or construction of houses, plants, projects and building of bridges, roads and
highways.
BAI MUAJJAL
Literally it means a credit sale. Technically, it is a financing technique adopted by
Islamic banks that takes the form of Murabaha Muajjal. It is a contract in which the
bank earns a profit margin on his purchase price and allows the buyer to pay the
price of the commodity at a future date in a lump sum or in installments. It has to
expressly mention cost of the commodity and the margin of profit is mutually
agreed. The price fixed for the commodity in such a transaction can be the same as
the spot price or higher or lower than the spot price.
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MUDARABAH:
A form of partnership where one party provides the funds while the other provides
expertise and management. The latter is referred to as the Mudarib. Any profits
accrued are shared between the two parties on a pre-agreed basis, while loss is
borne only by the provider of the capital.
MUSHARAKAH:
Musharakah means a relationship established under a contract by the mutual
consent of the parties for sharing of profits and losses in the joint business. It is an
agreement under which the Islamic bank provides funds, which are mixed with the
funds of the business enterprise and others. All providers of capital are entitled to
participate in management, but not necessarily required to do so. The profit is
distributed among the partners in pre-agreed ratios, while the loss is borne by each
partner strictly in proportion to respective capital contributions.
BAI SALAM
Salam means a contract in which advance payment is made for goods to be delivered
later on. The seller undertakes to supply some specific goods to the buyer at a future
date in exchange of an advance price fully paid at the time of contract. It is necessary
that the quality of the commodity intended to be purchased is fully specified leaving
no ambiguity leading to dispute. The objects of this sale are goods and cannot be
gold, silver or currencies. Barring this, Bai? Salam covers almost everything, which is
capable of being definitely described as to quantity, quality and workmanship.
Define Musharakah and also Discuss rules of Musharakah?
Musharakah:
Musharakah is an Islamic financial concept that involves a partnership between two
or more parties to engage in a business venture or investment. In this type of
partnership, the partners contribute capital to the project and share both profits and
losses based on predetermined ratios. It is a form of Islamic finance that promotes
cooperation, risk-sharing, and social responsibility.
Here are some basic rules of Musharakah:
1. Joint Ownership:
All partners in a Musharakah agreement jointly own the capital contributed to the
business venture. Each partner’s ownership share is proportionate to their initial
investment.
2. Sharing of Profits and Losses:
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The partners agree on a ratio for the distribution of profits and losses. This ratio is
applied to the actual profits or losses generated by the venture.
3. Active and Silent Partners:
While one or more partners may actively manage the business (working partners),
others can be silent partners, contributing only capital without participating in the
management.
4. Equal Sharing in Losses:
In principle, partners bear losses in proportion to their capital contributions, but the
Shariah may allow variations based on mutual agreement.
5. Limitation on Liability:
Each partner’s liability is limited to their invested capital, so personal assets are
generally protected from the business’s debts and losses.
6. Scope of the Partnership:
The partnership agreement must specify the scope and duration of the venture,
clearly outlining the purpose and limitations of the partnership.
7. Prohibition of Fixed Interest:
In compliance with Islamic principles, Musharakah does not involve the payment or
acceptance of fixed interest (Riba) on the capital invested.
The Islamic Economic System :
The Islamic economic system is a unique and comprehensive economic framework
based on the principles of Islamic law (Sharia). It emphasizes ethical and moral
considerations, social justice, and the well-being of society as a whole. At its core,
the Islamic economic system seeks to achieve economic prosperity while ensuring
fairness, equitable distribution of wealth, and sustainable development.
Distribution of Profit:
In a Musharakah partnership, profits are distributed among the partnersBased on
the proportion of capital contributed by each partner. ThisMeans that if Partner A
contributes 60% of the capital and Partner BContributes 40%, then the profits will
be divided in the same ratio.For example, if the total profit earned by the
partnership is $100,000,Then Partner A would receive $60,000 (60% of $100,000)
and Partner B Would receive $40,000 (40% of $100,000).
Ratio of profit:
The ratio of profit for each partner must be determined in proportion to the actual
profit accrued to the business, and not in proportion to theCapital invested by him.
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It is not allowed to fix a lump sum amount forAny one of the partners, or any rate of
profit tied up with his investment.Therefore, if A and B enter into a partnership and
it is agreed betweenThem that A shall be given Rs 10,000/- per month as his share
in theProfit, and the rest will go to B, the partnership is invalid. Similarly, if it isAgreed
between them that A will get 15% of his investment, the contractIs not valid.
Sharing of loss:
In the case of loss in Musharakah financing, all the Muslim jurists areUnanimous on
the point that each partner shall suffer the loss exactlyAccording to the ratio of his
investment. Therefore, if a partner hasInvested 40% of the capital, he must suffer
40% of the loss, not more,Not less, and any condition to the contrary shall render
the contractInvalid. There is a complete consensus of jurists on this principle.
What is Islamic banking and conventional Banking and it’s
differences?
Islamic Banking:
Islamic banking is defined as banking system which is in consonance with the spirit,
ethos and value system of Islam and governed by the principles laid down by Islamic
Shariah. Interest free banking is a narrow concept denoting a number of banking
instruments or operations which avoid interest. Islamic banking, the more general
term, is based not only to avoid interest-based transactions prohibited in Islamic
Shariah but also to avoid unethical and un-social practices.
Conventional Banking:
Conventional banking, also known as traditional banking or commercial banking,
refers to the standard banking system that operates in most countries worldwide. It
is the typical banking model that predates the development of Islamic banking and
other specialized banking systems.
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Define Shirkat-ul-Milk,Shirkat-ul-Aqd, Shirkat-ul-wujooh and

Shirkat-ul-A,Mal?
1. Shirkat-ul-Milk:
Shirkat-ul-Milk, also known as “Joint Ownership” or “Partnership of Ownership,” is
an Islamic financial concept that refers to shared ownership of an asset or property
between two or more individuals. In this form of partnership, each partner owns a
specific share of the asset or property based on their contribution. The primary
characteristic of Shirkat-ul-Milk is the co-ownership of the asset, where all partners
have a proportionate ownership stake.
2. Shirkat-ul-Aqd:
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Shirkat-ul-Aqd, also known as “Partnership of Contract,” is another type of
partnership in Islamic finance. It involves a contractual partnership where two or
more parties come together to engage in a specific business or economic activity.
Unlike Shirkat-ul-Milk, where the focus is on joint ownership, Shirkat-ul-Aqd
emphasizes the partnership’s contractual agreement, roles, and responsibilities in a
business venture.
3. Shirkat-ul-Wujooh:
Shirkat-ul-Wujooh, also known as “Partnership of Presence,” is an Islamic financial
concept that involves a partnership where two or more parties provide their
presence or expertise in a business venture, rather than contributing capital or
funds. In this type of partnership, partners may offer their skills, knowledge, labor,
or services to the venture, and the profits or losses are shared based on the agreed
terms.
4. Shirkat-ul-Amlak:
Shirkat-ul-Amlak, also known as “Partnership of Property,” is a specific type of
partnership where two or more individuals jointly invest in real estate or immovable
property. Each partner’s ownership share in the property is determined by their
respective contributions, and they share the rental income, profits, or losses in
proportion to their ownership stakes.
Q no 1: Write a comprehensive essay on Mudarabah as one the
major mods of Islamic finance?
Mudarabah: One of the Major Modes of Islamic Finance
Introduction to Islamic Finance:
Islamic finance is a rapidly growing global industry that operates in accordance with
Islamic principles, which are derived from the Quran, the Sunnah (sayings and
actions of the Prophet Muhammad), and the teachings of Islamic scholars. It is based
on the prohibition of interest (riba) and promotes ethical and equitable financial
practices. Islamic finance provides alternatives to conventional financial systems and
aims to create a just and socially responsible economic environment.
Among the various modes of Islamic finance, mudarabah holds a prominent
position. Mudarabah is an essential financial contract that facilitates the partnership
between capital providers (rab al-maal) and entrepreneurs or fund managers
(mudarib) to engage in profit-sharing ventures. This essay will explore the concept,
principles, and applications of mudarabah, as well as its significance in Islamic
finance.
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1. Definition and Principles of Mudarabah:

Mudarabah is a form of Islamic finance that operates on the principle of profit-
sharing between the capital provider and the entrepreneur. In this contract, the
capital provider (rab al-maal) provides the funds, while the entrepreneur (mudarib)
contributes expertise, skill, and effort to manage the business project. The profits
generated from the venture are shared between the parties based on a pre-agreed
ratio, while the losses, if any, are solely borne by the capital provider.
The essential principles of mudarabah include:
a. Profit and Loss Sharing:
The fundamental characteristic of mudarabah is the equitable distribution of profits
and losses between the capital provider and the entrepreneur. This encourages both
parties to work diligently and responsibly to ensure the success of the project.

b. Limited Liability:
The liability of the capital provider is restricted to the capital they invested in the
mudarabah. On the other hand, the entrepreneur’s liability is generally limited to
their time and effort, except in cases of gross negligence or violation of the agreed
terms.
c. Transparent Communication:
Open and honest communication is crucial in mudarabah contracts. Both parties
must be aware of the business details and risks involved to make informed decisions.
d. Permissible Ventures:
Mudarabah is generally used for ethical and Sharia-compliant business activities.
Investments in industries such as alcohol, gambling, or other unlawful activities are
strictly prohibited
2. Application of Mudarabah:
Mudarabah finds applications in various financial transactions and Islamic banking
products. Some of the common applications include:
a. Islamic Banking:
Islamic banks use mudarabah contracts to engage with their clients. Customers can
deposit their money into mudarabah accounts, allowing the bank to use the funds
for Sharia-compliant investments. Profits earned from these investments are shared
between the bank and the depositors according to a pre-agreed ratio.
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b. Venture Capital:
Mudarabah can be utilized in venture capital financing, where investors provide
funds to entrepreneurs to support their business ideas. In case of success, both
parties share the profits; otherwise, the investor bears the loss.
c. Islamic Investment Funds:
Mudarabah contracts form the basis for some Islamic investment funds. Investors
pool their funds, and fund managers (mudarib) invest in various Sharia-compliant
assets, distributing profits to the investors based on a predetermined ratio.
d. Trade Financing:
Mudarabah can also be employed for trade financing. Investors provide capital to
traders for purchasing goods, and the profit generated from the sale of these goods
is shared between the two parties.
3. Significance of Mudarabah in Islamic Finance:
Mudarabah plays a crucial role in the Islamic finance system for several reasons:
a. Alignment with Islamic Principles:
Mudarabah adheres to the principles of Islamic finance, emphasizing ethical
conduct, risk-sharing, and social responsibility. It promotes economic justice by
encouraging equitable distribution of wealth.
b. Encouragement of Entrepreneurship:
Mudarabah encourages entrepreneurship and investment in productive ventures. It
enables entrepreneurs to access capital without resorting to interest-based
financing, thereby promoting a fair and sustainable economic system.
c. Risk Management:
The risk-sharing aspect of mudarabah helps distribute risk between the capital
provider and the entrepreneur. This reduces the burden of losses on a single party
and encourages prudent decision-making.
d. Islamic Banking Growth:
The application of mudarabah in Islamic banking products contributes to the growth
of Islamic banking and finance globally. It allows Muslims to engage in banking
activities without compromising their religious beliefs.
Conclusion:
Mudarabah stands as a significant mode of Islamic finance that exemplifies the
principles of fairness, risk-sharing, and ethical conduct. Its application spans various
financial transactions, fostering entrepreneurship and investment in Sharia-
compliant ventures. As Islamic finance continues to gain momentum worldwide,
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mudarabah plays a pivotal role in shaping an economic landscape that promotes
social justice, transparency, and sustainable growth while upholding Islamic values
and principles.
Q no 2: What is Diminishing Musharakah? Highlight various uses
of Diminishing Musharakah.
Diminishing Musharakah is a concept used in Islamic finance, particularly in home
financing and business partnerships. It is a partnership-based arrangement where
two or more parties jointly own an asset or engage in a business venture. Over time,
one partner gradually buys out the ownership share of the other until complete
ownership is transferred to a single partner. This financial product aligns with Islamic
principles by avoiding interest-based transactions and promoting shared risk and
profit sharing.
The process of Diminishing Musharakah Involves the following steps:
1. Initial Joint Ownership:
The bank or financier and the customer enter into a partnership where both parties
contribute to the purchase of an asset or engage in a business venture. The
ownership is shared based on their respective contributions.
2. Periodic Buyout:
The customer commits to buying out the bank’s ownership share gradually over
time. With each payment, the customer’s ownership share increases, while the
bank’s ownership decreases.
3. Rental Payments:
The customer also pays rent for the portion of the asset or business owned by the
bank. The rental amount decreases with each buyout payment, reflecting the
reduction in the bank’s ownership share.
4. Full Ownership Transfer:
Once the customer has made all the necessary buyout payments, they become the
sole owner of the asset or business.
Various Uses of Diminishing Musharakah:
1. Home Financing(Diminishing Musharakah for Home Purchase):
• Diminishing Musharakah is widely used in Islamic home financing, allowing
individuals to buy homes without resorting to conventional interest-based
mortgages.
• The bank and the customer jointly purchase the property, with the customer
committing to buy out the bank’s share over time.
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• The customer makes periodic payments, which include both the principal
buyout amount and the rent for the bank’s share.
2. Business Financing:
• Diminishing Musharakah can be used to finance new business ventures or
expand existing ones in compliance with Islamic principles.
• The financier and the entrepreneur become partners, with the entrepreneur
gradually buying out the financier’s share in the business.
• As the entrepreneur’s ownership share increases, the rent paid to the
financier decreases.
3. Project Financing:
• In large-scale projects such as infrastructure development or real estate
development, Diminishing Musharakah can be utilized to raise capital
without resorting to interest-based loans.
• Investors and project developers enter into a partnership, and the developer
gradually buys out the investors’ shares as the project generates revenue.
4. Islamic Investment Funds:
• Diminishing Musharakah is used in some Islamic investment funds, where
investors pool their funds, and the fund manager invests in various projects
or assets.
• Investors’ ownership shares in the fund decrease as the investments mature
or are sold, and they receive periodic payouts or dividends.
5. Trade Finance:
• Diminishing Musharakah can be applied in trade finance to facilitate
transactions without interest.
• In a joint venture arrangement, the financier and the trader jointly purchase
goods, and the trader gradually buys out the financier’s share using the profits
earned from sales.
Q no 3: Explain in detail the performance of Islamic Banks in
present Capitalist Economy.
The performance of Islamic banks in a present capitalist economy can be evaluated
based on several key aspects:
1. Financial Performance:
Islamic banks have generally shown positive financial performance in recent years.
They have recorded strong growth in assets, deposits, and profitability. For example,
according to the Islamic Financial Services Board (IFSB), the total assets of Islamic
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banks globally reached $2.44 trillion in 2019, an increase of 8.2% from the previous
year. This growth indicates that Islamic banks are able to compete with conventional
banks and attract a significant customer base.
2. Compliance with Sharia Principles:
Islamic banks operate based on Sharia principles, which prohibit interest (riba),
speculation (gharar), and unethical investment activities. Instead, they engage in
profit-sharing (mudarabah), partnership (Musharakah), and trade-based
transactions. The performance of Islamic banks is heavily dependent on their ability
to comply with these principles. Regulatory bodies, such as the Accounting and
Auditing Organization for Islamic Financial Institutions (AAOIFI), set standards and
guidelines to ensure the implementation of Sharia-compliant practices.
3. Risk Management:
Islamic banks employ unique risk management practices compared to conventional
banks. They focus on minimizing Islamic finance-specific risks, such as compliance
risks and asset quality risks. Islamic banks also emphasize risk-sharing between the
bank and its customers, as opposed to transferring risk entirely to borrowers. While
these risk management practices can enhance stability, they also pose challenges,
as Islamic banks must deal with additional complexities in evaluating the risk profile
of their clients and assets.
4. Customer Base and Market Penetration:
Islamic banks cater to a specific target market that prefers Sharia-compliant financial
products. The performance of Islamic banks depends on their ability to attract and
retain customers who seek ethical banking services. Islamic banks have been
successful in tapping into the large Muslim populations in predominantly Muslim
countries. However, in non-Muslim-majority countries, their market penetration can
be limited.
5. Regulatory Environment:
The regulatory environment plays a crucial role in shaping the performance of
Islamic banks. Governments and regulatory authorities in many countries have
established frameworks to facilitate the growth of Islamic finance and ensure a level
playing field. However, challenges exist, such as differing interpretations of Sharia
principles and the lack of standardized regulations globally. These challenges can
impact the performance of Islamic banks and inhibit their growth potential.
6. Innovation and Product Development:
Islamic banks have been increasingly innovative in developing new products and
services to meet the evolving needs of their customers. These innovations include
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Islamic microfinance, Islamic bonds (sukuk), and Islamic insurance (takaful). By
offering a wider array of products, Islamic banks can attract a broader customer base
and enhance their performance in the capitalist economy.
In conclusion, the performance of Islamic banks in a present capitalist economy
showcases positive financial growth, compliance with Sharia principles, effective risk
management, market penetration challenges, the influence of the regulatory
environment, and innovation in product development. As Islamic banking continues
to evolve, addressing these factors will shape the future performance and
competitiveness of Islamic banks within the capitalist framework.