Islamic Banking in Pakistan

Islamic banking and finance (IBF) has become a growing force over the past
three decades, with Pakistan, one of the IBF pioneers, converting to an
‘interest-free’ banking system in 1985. However, since independence in 1947,
there has been continual tension over Pakistan’s essential character, between
Islamic Minimalists, who favor a Modernist interpretation of Islam, and
those who favor an Islamic Maximalist interpretation that sees Pakistan as a
model Islamic state.
This book analyzes the push by Islamic revivalists to Islamize Pakistan and
its financial system, from the early 1947 debates in the original Constituent
Assembly to the final 2002 ruling on IBF of the Shariat Appellate Bench of
the Pakistan Supreme Court. It examines the practice and theory behind
contemporary Islamic, ‘Shariah-compliant,’ banking. It offers extensive inter-
views with Pakistani Islamic bankers on the state of their industry and
how they see it developing, and provides analysis on how the Islamic banks’
customers differ from those of conventional banks.
Presenting a critical analysis of Pakistan’s IBF experience and offering a
new insight into Pakistan’s banking industry that illustrates broader political
and social trends in the country, this book will be of interest to specialists on
Islam, South Asia and international economics.

Feisal Khan is Chair of the Economics Department at Hobart and William

Smith Colleges in New York, USA. He has published in academic journals
and edited volumes on economic development and corruption in Pakistan.
Routledge Contemporary South Asia Series

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and Films Shariah-compliant finance
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 Islamic Banking in Pakistan
Shariah-compliant banking and the quest
to make Pakistan more Islamic

Feisal Khan
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First published 2015
by Routledge
2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN
and by Routledge
711 Third Avenue, New York, NY 10017
Routledge is an imprint of the Taylor & Francis Group, an informa business
© 2015 Feisal Khan
The right of Feisal Khan to be identified as author of this work has been
asserted by him in accordance with sections 77 and 78 of the Copyright,
Designs and Patents Act 1988.
All rights reserved. No part of this book may be reprinted or reproduced or
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Trademark notice: Product or corporate names may be trademarks or
registered trademarks, and are used only for identification and explanation
without intent to infringe.
British Library Cataloguing in Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging in Publication Data
Khan, Feisal, author.
Islamic banking in Pakistan: Shariah-compliant finance and the quest to
make Pakistan more Islamic/Feisal Khan.
pages; cm. – (Routledge contemporary South Asia series; 101)
1. Banks and banking–Pakistan. 2. Banks and banking–Religious
aspects–Islam. 3. Banking law (Islamic law)–Pakistan. 4. Interest (Islamic
law)–Pakistan. I. Title. II. Series: Routledge contemporary South Asia series ;
101.
HG3290.5.A6K535 2016
332.1095491–dc23
2015018409

ISBN: 978-0-415-77975-3 (hbk)

ISBN: 978-1-315-67024-9 (ebk)

Typeset in Times New Roman

by Taylor & Francis Books
Contents

List of illustrations xii

Preface: my first exposure to Islamic banking xiii

1 Islamic finance globally and why this book? 1

2 An Islamic Republic or merely a Republic of Muslims? 10
3 The post-Jinnah Islamization of Pakistan 33
4 The debate over riba 50
5 The new orthodoxy of ‘old’ Islamic financial norms 73
6 The nuts and bolts of Islamic banking worldwide 86
7 ‘Rebooting’ Islamic banking in Pakistan to make it more Islamic 117
8 Three decades of the Pakistani experiment 137
9 Quo vadis Islamic banking? 154

Glossary of key terms and abbreviations 164

Bibliography 168
Index 181
List of illustrations

Tables
7.1 Credit extended by Pakistani banks in 2013 by type 131
8.1 Islamic versus conventional bank customers 148

Box
6.1 Major Islamic financing modes 91
Preface: my first exposure to Islamic banking

In 1985 Pakistan became one of the first countries in the world to officially
make the full transition from a conventional (interest based) banking system
to an ‘Islamic’ (non-interest based) one. My first employment after graduating
from Stanford University in 1988 was with ANZ Grindlays Bank in Karachi,
Pakistan. Grindlays, alas, is no more, as it was subsumed within the Standard
Chartered behemoth in 2000, but back then Grindlays still retained some-
thing of its old fashioned and ultra-conservative air, quite fitting for a bank
that dated back to 1828 in the UK and had been in South Asia since 1854. As
a consequence, it had the largest branch network, deposit base and manage-
ment training program of all the foreign banks then operating in Pakistan. I
was with Grindlays’ Corporate Banking Division, beginning as a trainee,
from 1988 to 1990. In that time I received very thorough instruction in all
aspects of banking – retail, corporate, and merchant (i.e., investment) bank-
ing and foreign trade operations – in Pakistan, as well as excellent first-hand
corporate banking experience handling some of the biggest domestic and
multinational firms operating in Pakistan. As a trainee I was required to
take – and miraculously passed on my first attempt – the Part I Exam of the
Institute of Bankers Pakistan.1
As part of our preparation for the Part I exam we took evening classes at
the Institute. I was immediately struck by the difference between the theore-
tical version of Islamic banking that we were taught in these classes and the
very different practical version of it that we learnt in our training seminars and
put into practice in our internships in each department of Grindlays. As far as I
could tell, other than the use of some exotic (to me at the time) terms such as
murabaha, modaraba and ijara, the rest of the practical training we received in
the bank was very straightforward, conventional banking. The divide between the
rhetoric of Islamic banking and the practice of it, as I soon realized, held true for all
banks in Pakistan. I found out from my superiors that, for all practical purposes,
nothing had really changed in Pakistani banking after the 1985 mandatory
switchover to an ostensibly Islamic ‘profit and loss sharing’ banking system.
Some years later, during the course of my graduate work in the Economics
department of the University of Southern California, I had the great good
fortune to work with Professor Timur Kuran,2 the King Faisal Chair in Islamic
xiv Preface: my first exposure to Islamic banking
Thought and Culture there, and one of the world’s leading authorities on Islamic
economics and finance. As both his research assistant and PhD student, I bene-
fitted greatly from his encyclopedic knowledge of Islamic economic and financial
institutions, law, norms and practices even though my dissertation had nothing
to do with Islamic economics or finance. It is probably due to this early exposure
that my current research interests are not in the traditional aspects of banking
and finance usually handled by economists (such as return on equity or assets, or
capital adequacy management, or even the causes of financial crises) but on the
political economy side of the issue: what is Islamic economics, how is it now
defined, and why did an Islamic banking system come about in Pakistan? I hope
this book will answer, satisfactorily, these questions.
The genesis of the book lies with Dorothea Schaefter (Senior Editor –
Central, South and Southeast Asia) at Routledge asking me at the South Asia
Conference in Madison, Wisconsin, where I was presenting a paper on Islamic
banking in Pakistan, if I had ever thought of writing a book on the subject.
Unfortunately for her, I thought it was an excellent idea. I am extremely grateful
for the faith in my ability to complete the task that Dorothea and her editorial
team at Routledge, Rebecca Lawrence and Jillian Morrison, have shown since
the project took far, far longer to complete than anyone had originally thought it
would. I am also grateful to the Hobart and William Smith Colleges’ Faculty
Research Funds that gave me the opportunity to travel to Pakistan to do much
of the research that went into the writing of this book.
Parts of the book have appeared in an early form as journal articles and I
would like to thank the publishers of the original papers for giving me per-
mission to use them here. These are parts of Chapter Six: The nuts and bolts
of Islamic banking worldwide (‘How “Islamic” is Islamic banking?’ Journal
of Economic Behavior and Organization, 76: 3, December 2010, pp. 805–820,
© Elsevier Science) and Chapter Seven: ‘Rebooting’ Islamic banking in
Pakistan to make it more Islamic (‘Islamic banking by judiciary: the “back-
door” for Islamism in Pakistan?’ South Asia: Journal of South Asian Studies,
31: 3, December 2008, pp. 535–555, © Taylor & Francis). I am grateful to the
anonymous referees at these journals for their excellent comments on these
papers, as well as to conference participants, friends and colleagues too
numerous to list here with whom I have discussed various aspects of the book
over the years.
However, I would especially like to thank my friend and colleague Dr.
Vikash Yadav, who took time out of his busy schedule to read three very long
chapters and give extensive and useful comments on them that helped clarify
my own thoughts on the issues. I would also like to thank my sister Tehmina,
who took a break from her own graduate research to read several chapters
and give me her extremely helpful comments on them that made me realize
what I thought I was saying was not what it came across as. And my daugh-
ters Melanie and Merrick, who put up with good grace far too many times
with being told, ‘Not this weekend, Abu has to work on his book.’
 Preface: my first exposure to Islamic banking xv
And above all else, I would like to thank my wife Jennifer Tessendorf for
not only putting up with how long this book took to write but with me as
well, and for encouraging me to finish it when I was ready to throw in the
towel, and for reading several drafts of many chapters of the book. She
always gave me detailed and very valuable comments on the chapters that
narrowed and focused my often rambling prose, with several parenthetical
clauses, that while extremely informative and fascinating in and of themselves,
distracted the reader, perhaps by going off on alas irrelevant tangents, from
the essential points being conveyed. The book is by far the better for her
ruthless red pen. However, I did not always take her suggestions and I suspect
that the book is the poorer for that.
I have usually used the standard Pakistani English transliteration of Arabic
and Urdu terms, which is not used by all academics or linguists. For example,
I write murabaha (a cost-plus sale) instead of muraba-ḥa, and sukuk (Islamic
bond) instead of s.uku-k. Not only does the ‘correct’ transliteration disturb the
flow of the sentence and distract the non-specialist (after all, it is Naples in
English and not Napoli or Napule) but Arabized pronunciation and usage in
Pakistan has become a de facto statement of where one’s politico-religious
sympathies lie. Just as I refuse to replace the time-honored South Asian
Khuda Hafiz (May God keep you safe) with Allah Hafiz or use the ‘correct’
Ramadan instead of the traditional Pakistani pronunciation Ramzan, I refuse
to replace murabaha with muraba-ḥa. The continual Arabization of Muslim
culture has reached such ridiculous levels that I was informed, reasonably
politely, that I was not pronouncing my own name correctly. My response to
that was that, yes, my name was of Arab origin but I am not.
Finally, the opinions expressed in this book, except where they are expli-
citly identified as to the source, are my own and no-one else’s. This book is
my opinion and mine alone as to, among other things, whether or not Islamic
banking is needed or even feasible, and what exactly is meant by riba and
what was prohibited for Muslims. I think I am correct, but Allah knows best.

Notes
1 The old Part I and Part II exams, now replaced by a very different system of Junior
Associate, Associate and Fellow, of the IBP were professional qualifications for
Pakistani bankers, as the Certified Financial Analyst Levels I, II and III are in the
USA for financial professionals.
2 Timur Kuran is now Professor of Political Science and Economics and the Gorter
Family Professor of Islamic Studies at Duke University in the USA.
This page intentionally left blank
1 Islamic finance globally and why
this book?

If Islamic banking was confined only to Pakistan or even just to South Asia,
it would be an arcane field interesting only to either Islamic scholars or to
South Asianists. But Islamic banking and finance (IBF) has far outstripped its
relatively humble origins in international finance as an esoteric and obscure
financial issue of as much (or as little) interest to the general public as St.
Thomas Aquinas’ ‘Doctrine of the Just Price.’ That is far from the case.
It is now common knowledge among those dealing with global finance and
related issues that Islamic banking has become a growing force over the past
three decades, with 716 Islamic banks in 61 countries worldwide (UK Trade
& Investment 2013). By 2012 the world’s Islamic financial assets were around
$1.3 trillion, 90 per cent of this in Islamic banks, having grown 150 per cent
since 2006 (Economist 2012) and an absolutely astounding thirteenfold from
2000 when they were a paltry $100 billion (Chin et al. 2008: 1). In 1999 Dow
Jones created ‘Islamic Indexes’ to offer Shariah-compliant investment portfo-
lios to cash-flush pious Muslims. Several major Western banks (e.g., Citibank,
ABN Amro, Bank of America, HSBC, Standard Chartered, and the Union
Bank of Switzerland) either have Islamic Banking subsidiaries or offer Islamic
financial products to their customers. Clearly IBF has transformed itself into
a major factor in global finance.
In the Muslim world the growth rate of Islamic financial assets far exceeds
that of conventional ones. For example, in Bahrain, one of the Muslim
world’s two main money centers, between 1998 to 2005 Islamic bank assets
grew at 111 per cent annually versus only a 6 per cent average annual growth
rate for conventional bank assets (Bahrain Monetary Agency 2006). By 2013
the value of Islamic bank assets in Bahrain had reached $23.3 billion even
though the average annual growth rate for 2005–13 had declined to a ‘mere’
36.4 per cent.1 Predictably, the increase in crude oil prices in the past several
years has increased the growth rate of Islamic bank assets in the Middle East,
and Islamic finance is often seen as an Arab phenomenon or, for the more
knowledgeable, as an Arab and Malaysian phenomenon, as Malaysia is the
other center of Islamic finance. Although still insignificant compared with
conventional banking, e.g., in 2010 the US banking system alone held almost
US$16.5 trillion in assets (Mishkin 2013: 43), the growth of Islamic banks
2 Islamic finance globally and why this book?
demonstrates their importance to, and the growing financial clout of, the
world’s billion-plus Muslims.
What is less well known, even among those otherwise well informed about
Islamic finance, is the importance of Pakistan to Islamic finance globally and
the importance of Islamic finance to Pakistan. Given that South Asian,
especially Pakistani, scholars such as Syed Abul Ala Maududi and Ashraf
Qureishi laid the foundation of current IBF in the 1940s, it is not surprising
that South Asians in general and Pakistanis in particular are ‘over-represented’
among the ranks of IBF theorists and practitioners. This is despite the fact that
South Asia, and certainly Pakistan, has been quite isolated from the mainstream
of global finance for most of the second half of the twentieth century. Pakistan
was a leader in both the development of theoretical Islamic banking and how it
was actually implemented, as Pakistanis and other South Asians are found in
Islamic banks and financial firms throughout the Gulf at all levels, from tellers to
the boardroom. There are also Pakistani and other South Asian analysts and
scholars in major regional think tanks such as the Islamic Research and Training
Institute of the Islamic Development Bank in Saudi Arabia2 and in the central
banks of many Gulf states. Thus there are Pakistanis involved at all levels of
Islamic banking in the Gulf countries, and Pakistan continues to be important in
the future development of Islamic finance even if it does not contribute much to
it monetarily.
Why is IBF and its connection to Pakistan worth studying? Several reasons
come to mind. Islamic banking and finance is a trillion-dollar component of
global finance and one that is still growing rapidly. The original architects of
contemporary IBF were/are disproportionately South Asian and especially
Pakistani, although the Pakistani part of IBF is relatively small and so fairly
insignificant in the global context – even though Pakistan is not an insignif-
icant country for other reasons. More importantly, the fight over Islamic
banking in Pakistan is a microcosm of the battle over what kind of a society
Pakistan is going to be and over the nature of the Pakistani state itself. In
some important aspects, this fight pre-dates the creation of Pakistan itself.
Thus the argument over Islamic banking in Pakistan is important because
it illustrates the battle-lines between Islamic Minimalists who favor a Moder-
nist interpretation of Islam and those who favor an Islamic Maximalist inter-
pretation that sees Pakistan as a model Islamic state. For the latter, Pakistan’s
destiny is to be the ‘New Medina’ that will revive the (mythical) Golden Age
of Islam. The contrast is between these Revivalists and the Modernists who,
however devout they may have been personally, wanted a state that was effec-
tively secular at the functional level, a state that would not make the religious
inclinations and preferences of its people a matter of vital importance and
concern to itself.
This decades-long battle between these two mutually antagonistic forces is
why we see the level of sectarian chauvinism that is the norm for Pakistan
now. And that is why I think this book matters. The book is not meant as a
detailed ‘how to’ guide to Islamic banking in Pakistan or elsewhere, and
 Islamic finance globally and why this book? 3
neither is it meant to be a comprehensive history of Pakistan’s Islamization. I
hope to give the reader enough knowledge of the latter to understand the
former because the two are irreducibly intertwined: Islamic banking would
not exist without societal Islamization.

What is this book about?

My aim here is to examine how Pakistan came to be one of the first countries
of the world to institute a fully ‘Islamic’ banking system. This was done by
military diktat in 1985. That is the short answer.
The long answer is of course a much more complicated and convoluted
one. To fully understand why the orders for a conversion were issued requires
some knowledge of how and why Pakistan came into being and its complex
relationship with Islam. The former requires some understanding of the basis
and extent of Hindu–Muslim political antagonism in the British Indian
Empire that led to the partitioning of British India into two separate
Dominions, India and Pakistan, in August 1947. The latter requires an under-
standing of the overtly religious basis of both the Indian National Congress’s
and the Muslim League’s mass following and the process by which the religion
genie emerged onto the Indian nationalist scene. Without the salience of reli-
gion, both the Congress and the League lacked a mass following and the ability
to mobilize at the grassroots. Before Mohandas Karamchand Gandhi, 1869–
1948, began the transformation of the Congress Party after his return to India in
1915, it was little more than a glorified debating society for India’s Anglicized
native elite who sought ‘Home Rule’ from the British colonial rulers. Similarly,
the Muslim League was little more than a lobbying association for some of
India’s Muslim grandees before the President of the Muslim League Moham-
med Ali Jinnah, 1876–1984, and Pakistan’s leader after independence in 1947,
turned it into a real political party with mass appeal. In both cases the appeal of
the respective parties to India’s masses (to Hindus in the case of Congress and to
Muslims in the case of the League) had an undeniable religious aspect to it.
While the religious nature of the appeal may well have been stronger for the
League than for Congress, it was vital to the success of both.
In the case of India, the Hindu genie could be more or less successfully
stuffed back in the bottle by Jawaharlal Nehru, 1889–1964, India’s first prime
minister, because it had been discredited by the murder of Mahatma Gandhi
by Hindu fanatics in 1948 and then further weakened by the death of Nehru’s
Deputy Prime Minister (the new regime’s strongman) Sardar Vallabhai Patel,
1875–1950, relatively soon after independence. While certainly not as secular
as Nehru, Patel was not a Hindu zealot like the extremists who killed Gandhi;
he was, however, much closer to the extremely conservative (both religiously
and politically) Hindu businessmen who funded both Congress and some of
the Hindu chauvinist groups. Had these two events not taken place, it is
highly likely that India’s much vaunted secularism, a product of Nehru’s per-
sonal beliefs and his virtually unopposed supremacy in Indian politics for a
4 Islamic finance globally and why this book?
decade and a half after independence, would have been greatly weakened and
challenged well before the Bharatiya Janata Party’s Hindutva (i.e., Hinduness,
an assertive brand of Hindu chauvinism) revival of the late 1980s. Pakistan
was not as fortunate as India in being able to stave off the Islamists for as
long as India could the Hindutva movement.
For Pakistan, the Islamic genie, once out, refused to go back in the bottle.
Mohammed Ali Jinnah was personally secular and areligious but many of
those who followed him had done so precisely because he was articulating a
Muslim nationalism that was, for them at least, irrevocably linked to Islamic
revivalism. Pakistan ka matlab kya? La illaha il lallah! (‘What does Pakistan
mean? There is no God but Allah!’) was the extremely potent rallying cry in the
Punjab during the 1946 elections that catapulted the League into power there.
Some of those such as Syed Abul Ala Maududi, 1903–79, who had vigorously
opposed Jinnah precisely because he had no use for religion in public or poli-
tical life, went to Pakistan after independence to save the Muslim homeland
from people like Jinnah who thought in modern (secular) terms that did not
place Islam center stage. Maududi was, along with Imam Khomeini of Iran and
Syed Qutb of Egypt, one of the three greatest theoreticians of political Islam in
the twentieth century, and he and other Islamists opposed Jinnah’s Muslim
nationalism precisely because it would have an Islamic modernist, territorial
basis and not a religious one.
This confusing and contradictory mix of circumstances – those who wanted
a Muslim homeland were not in favor of an Islamic state, and those who most
vociferously advocated for an overtly Islamic Pakistan were not originally in
favor of a Muslim homeland – helps make this such a difficult and compli-
cated case study. The importance of Islam here goes back directly to the only
real tool the Muslim League had at its disposal to create a mass following for
itself: mobilize the masses on an overtly religious basis to counter Gandhi’s
religion-tinged appeal to the Hindu masses.3
This was a real quandary for many of the Muslim League’s leaders, who
were mostly educated at the Oxbridge-patterned Aligarh Muslim University
founded by the first major Indian Islamic modernist, Sir Syed Ahmad Khan,
1817–98. Theirs was a modernist interpretation of Islam that saw little con-
flict between modernity and religion even though most of them were at least
certainly ceremonial deists when it came to the role of religion in public life.4
Their call for Muslim nationalism had an ethnic basis. It was ‘the Muslims
are a separate nation and that is why they deserve their own state’ and not
‘the Muslims are a separate religion and that is why they deserve their own
state.’ Yet to succeed in their aim they had to utilize religion to mobilize the
masses.
There were few ulema (Muslim religious scholars) of any standing who
supported the Muslim League’s call for a separate Muslim homeland. The
most important among them was Maulana Shabbir Ahmad Usmani, 1886–
1949, who was indispensable to Jinnah and the League both for countering
Congress’s conservative (mainly ultra-orthodox) Muslim allies who charged
 Islamic finance globally and why this book? 5
that the League’s leaders were pro-British, irreligious and indeed well nigh
non-Muslims for all practical purposes; and for mobilizing the Muslim
masses in a way that the grandees who formed the Muslim League leadership
never could. But Usmani did so not for Jinnah or the League, but for the
opportunity to create a model Islamic state and society, an opportunity that
would be denied to him in a secular, much less a Hindu-led, India. This was
essentially the same reason why Maududi left India for Pakistan.
There is thus a continual tension in Pakistan from the first day over those
who favor what the contemporary Iranian philosopher Abdul Karim Soroush
has termed Maximalist Islam (where everything in a modern state has to be
explicitly derived from well established Islamic principles – what is commonly
but somewhat inaccurately termed Shariah 5) and Minimalist Islam (where
only broad conceptual outlines need be in conformity with Islam) (Fremont
2000). Most, but certainly not all, of the higher-level leadership of the Muslim
League, the army and the civil service in the new state favored Islamic Minim-
alism (usually expressed as lip service to Islamic norms or other such perfunctory
invocations of religion publicly): ceremonial deism.
This tension played out in several arenas in Pakistan, as seen in, for
example, the early demand that the Pakistani education system include man-
datory classes in Islamiat (the study of Islam)6 or Maulana Usmani’s demand
that the government appoint a supra-parliamentary Shaikh ul Islam (Chief of the
Muslim Clergy) who would have the right to oversee all public officials.7 The
particular manifestation that I am going to examine in depth here is how it
affected the Pakistani financial system.
I shall examine in detail how it came about that Pakistan rather than, say,
Saudi Arabia or a Persian Gulf country came to have one of the world’s first
Islamic banking systems. I shall also look in detail at both what Islamic
finance is supposed to be, and what it actually is. That is, does Islamic finance
as it is actually practiced differ from how its advocates envisaged it in theory?
How, if at all, does Pakistani IBF differ from that practiced elsewhere in the
world? And what is its likely future evolution?
Pakistan has received a great deal of notoriety and world attention for the
past two decades, whether because of its nuclear weapons, or nuclear pro-
liferation to other Muslim countries, or its ongoing brutal Islamist insurgency
and terrorist campaign against the state, or its support of the ultra-Islamist
Afghan Taliban, or Muslim terrorist attacks on India originating in Pakistan.
Much of this attention has been openly scurrilous and in the extreme verging
on outright scaremongering and sensationalism, and not just in the yellow
press. For example, Bruce Riedel, the former US Central Intelligence Agency
career officer, Special Assistant to the President of the United States and chair
of the advisory group to President Barack Obama on South Asia, epitomizes
the type of sensationalism used to sell books–he is the author of several books
on Pakistan, Afghanistan and South Asia in general. Riedel personally
briefed then US President-elect Barack Obama that ‘Pakistan, the birthplace
of global Islamic jihad and now its epicenter, had become a crucible of terror
6 Islamic finance globally and why this book?
and was the most dangerous country in the world’ (Riedel 2012: 2, emphasis
added).
That being said, there are certainly more than ample grounds for much of
the world to be concerned about what is happening in Pakistan and to try to
make sense of it and why it has occurred. While Pakistan is not actually ‘the
most dangerous country in the world,’ it certainly is a country that cannot be
ignored by the rest of the world. The common denominator in most of what
concerns security analysts in the outside world seems to be ‘Islam’ and how
‘Islam’ seems to be involved in everything that happens in Pakistan. Why is
this so?
To work backwards then, using the particular issue that this book focuses
on, for Pakistan, the demand for an Islamic financial system was irrevocably
linked to the demand for an Islamic state. The underlying strength of this
demand was because religion was the basis of the creation of Pakistan, and
Muslim ethnic mobilization was not possible without their religious mobiliza-
tion. And this meant that every Pakistani constitution had to be appropriately
Islamic, culminating in the 1980 orders issued by Gen. Zia ul Haq, 1924–88, for
Pakistan’s banks to convert to an Islamic banking system.

Why an Islamic Pakistan with an Islamic banking system?

As the first modern state founded expressly because of the religion of its
inhabitants, Islam has always been at the forefront of what makes Pakistan
what it is and what it might become. But Islam and Pakistan have always had
a curiously ambivalent relationship. As discussed above, many of the original
leaders of the Muslim League, the army and the civil service inherited from
the departing British colonial rulers were personally quite secular in their
lives. They viewed Islam’s role in Pakistan along lines similar to that of the
role of Christianity in the United States in much of the twentieth century:
nominally Christian and certainly ceremonially deist, but not a country where
faith played a role in governing or legislating. Others though, notably Islamists
such as Syed Abul Ala Maududi and the political party that he founded, the
Jamaat e Islami (Party of Islam), saw Pakistan very differently. For Maududi
and other Islamists like him, Pakistan’s existence could only be justified if it were to
serve Islam by being the world’s first truly Islamic state. Although Maududi died in
1979, the Jamaat and its highly disciplined Islamist cadres are still a potent
Islamist force in Pakistan, India and Bangladesh and are among the most
vocal advocates of political Islam in South Asia.
Maududi and the other Islamist parties in Pakistan saw the Islamization
of the financial sector in Pakistan not as an end in itself but merely as one
aspect of the total Islamization of the nation, government, laws, culture and
people. That is why no study of economic and financial Islam in Pakistan,
and why Pakistan became a pioneer in Islamic finance, is possible without
analyzing the role political Islam played in both the creation of Pakistan and its
later history. For all Islamists and not just Maududi, Islam is not an à la carte
 Islamic finance globally and why this book? 7
menu that one can pick and choose from: it is all or it is nothing. Maududi
wrote extensively not only on what made for an ‘Islamic’ state or an
‘Islamic’ form of government but also on what made an economic or financial
system ‘Islamic.’
But why does there have to be an ‘Islamic’ economic or financial system?
The current conventional answer is that Islam prohibits charging or receiving
interest, but this is far too simplistic a view and one, as I shall demonstrate,
that was far from the uniform perception of all Muslims in the past.
In 1979 the military ruler of Pakistan, Gen. Zia ul Haq (ruled 1977–88), fully
backed by the Jamaat e Islami and other Sunni Islamic political parties, announced
that Pakistan would soon become the first country in the world to move to a wholly
Islamic banking system. By 1985 all banks in Pakistan were ordered to offer only
Islamic banking and financial services, although in practice there was no sig-
nificant change in actual banking practices. However, the ultra-orthodox were
not appeased by nominal changes to the system and sought legal redress which,
given the explicit wording of the 1973 Constitution and Gen. Zia’s changes to
the Pakistani legal structure, they obtained.
Two court rulings (1991 by the Federal Shariat Court, an Islamic appellate
court, and 1999 by the Supreme Court’s Shariat Appellate Bench) declared
that the financial Islamization decreed by Gen. Zia was inadequate and
mandated a wholesale revision of the existing system to make it more Islamic.
This would require shifting the emphasis from lending to direct equity parti-
cipation as the sole permissible financing instrument. In 2002 the Supreme
Court’s Shariat Appellate Bench reversed its 1999 ruling and ordered the
Federal Shariat Court restudy the issue before ruling on it afresh. Later in
2002 also, responding to the widespread criticism that the Pakistani banking
system was not Islamic in any meaningful way, the country’s central bank,
the State Bank of Pakistan, decided to rename the hitherto Islamic banking
system as ‘conventional banking’ and established a parallel – now truly Islamic
and ostensibly fully Shariah-compliant – banking system while it studied how
conventional banking could be overhauled.
Have things really changed since the ‘reboot’ of Islamic banking in Pakistan
in 2002? What does current Islamic banking in Pakistan really look like? And
how do its practitioners and customers feel about it? I shall also examine these
and other issues and hope to be able to convey a full picture of Pakistani Islamic
banking to the reader.

The organization of the book

The book is organized as follows:
Chapter One: Islamic finance globally and why this book?
Chapter Two: An Islamic Republic or merely a Republic of Muslims?
The importance of religion (both Hinduism and Islam) in Indian national-
ism; the beginning of Muslim mass mobilization around religious symbols;
8 Islamic finance globally and why this book?
the resulting central role of Islam in the creation of Pakistan and the creation
of an overtly Islamic Muslim political identity.
Chapter Three: The post-Jinnah Islamization of Pakistan
The Islamization of Pakistan, from the 1949 Objectives Resolution to Gen-
eral Zia’s (1980s) amendments to the constitution creating the Federal Shariat
Court and the Shariat Appellate Bench of the Supreme Court of Pakistan to
attempts by democratically elected governments to expand the scope of
Islamization.
Chapter Four: The debate over riba
The Koran’s categorical prohibition of riba and different interpretations of
what exactly is being prohibited; the arguments of Islamic Modernist/Islamic
Minimalist scholars (such as Sir Syed Ahmad Khan, Fazlur Rahman, and
others) and the perspective of Islamic Maximalists (such as Syed Abul Alal
Maudoodi and Anwar Iqbal Qureishi); Islamic banking’s role in strengthen-
ing and preserving a strong ‘Muslim’ identity and the prevention of the creation
of ‘partial Muslims.’
Chapter Five: The new orthodoxy of ‘old’ Islamic financial norms
The position of contemporary Islamic economists regarding the permissi-
bility of charging interest on financial transactions; the time value of money in
Islam; an alternate theory as to why Islam and other pre-modern societies pro-
hibited the charging of interest on loans; the 1980 Council of Islamic Ideology
report that formed the basis of the 1985 conversion from a conventional to an
Islamic banking system and how it compares to historical financial practices in
Muslim societies.
Chapter Six: The nuts and bolts of Islamic banking worldwide
The ideal form IBF is supposed to take and how current IBF is actually
implemented in Pakistan and elsewhere; range and type of products offered;
where and how they differ from conventional counterparts; how IBF institu-
tions handle information asymmetry issues and the resulting problems of
adverse selection and moral hazard; legal issues in offering IBF products in
non-Islamic legal environments (USA, Western Europe); more ‘liberal’ Malay-
sian (Shaafi madhab) interpretation of Islamic banking rules versus more
‘restrictive’ Gulf/South-Asian (Hanafi/Hanbali madhab); how far IBF institu-
tions have successfully offered alternatives to conventional financial products
and whether IBF lives up to its claims.
Chapter Seven ‘Rebooting’ Islamic banking in Pakistan to make it more Islamic
The 1991 and 1999 Pakistani legal decisions invalidating the existing financial
system on grounds it is unIslamic and hence unconstitutional; the possible impact
on the economy of direct-equity participation as sole financing model; the 2002
Supreme Court Shariat Appellate Bench reversal of its 1999 ruling; the likelihood
that the 2002 reversal will stay the law in the future; how Pakistani Islamic banking
post-2002 differs from the version instituted by Gen. Zia in 1985.
Chapter Eight: Three decades of the Pakistani experiment
The main changes to Islamic banking in Pakistan post-2002; the size and
scope of Pakistan’s Islamic banking sector and how, if at all, it differs from
 Islamic finance globally and why this book? 9
the picture of Islamic banking presented in Chapter Six; the views of Pakis-
tani Islamic and conventional bankers and others involved in the Pakistani
financial sector; the behavior of the Pakistani retail and corporate clientele of
both Islamic and conventional Pakistani banks; the differences between those
that use Islamic versus those that use conventional banks.
Chapter Nine: Quo vadis, Islamic banking?
A reiteration of the main points of the book; the likely path Islamic bank-
ing in Pakistan will take in the future; an alternative vision of Islamic banking
offered by some critics of its current form.

Notes
1 Calculated from ‘Table 27: Aggregated balance sheet of the Islamic banks: retail
banks and wholesale banks’ of the Central Bank of Bahrain’s (2014) Statistical Bulletin.
2 M. Umer Chapra, one of the world’s most prominent Islamic economists and former
advisor to the Saudi Arabian Monetary Agency (the Saudi central bank), is originally
from Pakistan and was granted Saudi citizenship by the King, an honor so rare as to
be almost unheard of.
3 Gandhi was also the leader of the Khilafat Movement 1919–24 to restore the Sunni
Muslim Turkish Caliph. However, his unilateral decision to call off both his part of
the Movement (and, incidentally, the Congress campaign to oust the British from
India) led to great bitterness on the part of the Movement’s Muslim leadership, who
persisted for two years after his decision. The Movement fizzled out by 1924 when
Mustafa Kemal Ataturk abolished the Caliphate and even Indian Muslims gave up
the cause.
4 Ceremonial deism was the legal term coined in 1962 by Eugene Rostow, Dean of
the Yale Law School, to describe the purely nominal and often perfunctory use of
religion in public life in the United States, e.g., the invocation of God in the Pledge
of Allegiance or on US currency. The United States Supreme Court affirmed the
constitutionality of such usage in 1984. See Epstein 1996 for more details.
5 A necessary distinction should be made between fiqh (Islamic jurisprudence) and
Shariah (literally ‘path,’ but here the Divine Path or Law that all Muslims must
follow). While the two terms are often used interchangeably, what is usually termed
Shariah is better called fiqh. Fiqh is simply the result of (fallible) human attempts to
interpret Shariah and should not be viewed as immutable; only Shariah is immutable.
There are currently four main Sunni (Hanafi, Shafi, Hanbali, and Maliki) and one
main Shia (fiqh e Jafaria aka Ithna Ashari or Twelver Shia) schools of thought
(madhab) regarding fiqh; in the past there were others that are now extinct. It is usual to
characterize Hanafi as the most ‘moderate/progressive’ and Hanbali (of which Saudi
Wahhabism is a direct outgrowth) as the most ‘conservative’ although no school is uni-
formly more ‘progressive’ or ‘conservative’ in all areas. The Sunni schools of thought are
not exclusive and there is substantial overlap among them; similarly, the main Shia
madhab has many commonalities with the Sunni ones. There are also fringe Sunni (e.g.,
the Ahmadia) and Shia (e.g., Ismaili) schools that differ greatly from the main five mad-
habs and some of these no longer call themselves Muslims (e.g., Druze or Baha’i); these
groups are often persecuted by both mainstream Shias and Sunnis.
6 This was implemented at the primary school level in the early 1950s and massively
expanded under General Zia ul Haq’s military dictatorship (ruled 1977–88) until
compulsory Islamiat classes and examinations were required through the first two
years of the college curriculum.
7 See Chapter Two for more details on this.
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