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Truth About Islamic Banking and Takaful

By Shah Nawaz Khan

 Several thousand books and articles about Islamic Banking and quite a few about ‘Takaful’ (Islamic form of Insurance) have been published during past 30 years. Prior to that the discussion used to center around legitimacy of banking Interest for Muslims. Whereas the number of books on Islamic Banking and Insurance is impressive, the quality of contents is not. Quantity, not quality, is the defining feature of writings on Islamic economics, and more particularly on Islamic banking and Islamic Insurance.

 The concept of Islamic economic system as some zealots of Islamization of economics talk about, appears to be more like Utopian philosophy inasmuch as they regard alleviation of poverty by fair and equitable distribution of wealth as an objective of Islamic system! Although there is great emphasis on charity and helping the needy and payment of Zakat and distribution of war booty, there are no specific provisions in Holy Scriptures for distributing of wealth on socialist pattern. The objects mentioned in Holy Quran for taking care of poor and needy could be and often achieved by taxes like wealth tax, income tax import duty etc. over and above Zakat. Much better social security benefits are provided to people in the capitalistic countries than most of the Islamic or Socialist countries. The fact is that during the glorious period of Islamic history, the economic system followed by Muslims was capitalistic.

The research and experiments in Islamic Banking have been going on since the last five or six decades but Islamic Banking in practical shape is working since the last 4 decades or so thriving on misconceptions of Muslims about modern banking and insurance.

Two things that separate Islamic banking from conventional banking are that:

Interest cannot be employed but the lender can share in the profit and loss of the venture undertaken by the borrower in proportion to the money lent. The borrower pays rent under lease agreement. Or the lender purchases the property or goods for borrower and sells to him at much higher price usually payable in instlments or in lump sum at expiry of agreed term.

All operations and investments by the management must be according Islamic ethical standards.

But among the proponents of Islamic Banking there appears to be no consensus about defining the role of Central Reserves Bank and the regulations for the commercial banks, mortgages, gold bonds, advent of plastic and paper money under fiat currency system and dealings with inflation and International Banking. The efforts to evolve the standard sets of principles, terminology, procedures, laws and regulations and to educate people are disjointed. Arabic terminology is used to describe the products and practices. Talk about formation of Islamic Monetary Fund confines to academic discussion.

During the last century many companies were established in different Islamic countries for Interest Free Banking. They would neither pay interest nor earn interest but charge fixed service fee. They introduced products for sharing profit and losses on investment that bank made in different business ventures permissible according to Islamic ideals for doing business. They tried to earn profits on partnerships and profit-sharing (mudaraba) with businessmen.

In some countries the Islamic banks entered into business directly, buying and selling commodities, land or real estate.After different methods were tried Murahaba emerged, which is currently the predominant form of Islamic finance in many countries. In this mode of finance the bank buys something on the specific request of a client and sells it to that client at a price higher than the purchase price, to be paid after a period of time.More often than not that happens to be more expensive than paying the conventional interest. Leasing and prepaid orders (salam / istisna) have also been introduced as profitable employment of the pool of deposits. In way such practices tantamount to renaming the interest as rent, installments of purchase price etc.

Sharing Profit and Loss 

For business ventures banks grants loan on some collateral security and agrees to share profit and loss on agreed ratios redeeming loan in lump sum or in installments. Terms of sharing loss depend on type of security or guarantee given. 

Exploitation in the name of Interest Free Financial Operations and Products

Installment Plans: There are number of shops from where you can buy electric appliances and variety of other items even vehicles on installments. Some leasing companies are also doing this kind of business. Usually the thing you could buy in RS. 12, 000 cash would be made available to you for RS.1000 per month payable in 20 monthly installments. That means installments would accumulate to RS. 20, 000/- without interest.

These businessmen say that they are not charging any interest and doing the business in legitimate Islamic way. We are not prohibited to sell an item of RS. 12, 000 for RS. 20, 000/ - and we fix the monthly installments to cater for our profit and expenses.

Rent on House Building Loans: Similarly the House Building Finance Corporation has Islamized interest as 'rent' and now acquisition of loan has become more expensive and wide differences in rent charges exist from place to place and city to city.

If people in USA and most other countries get loans for purchases of cars, houses, appliances etc. hardly at 9 % why we Pakistanis have to pay such heavy rent or exorbitant interest or service charge as high as 20 % and even 52% pa on credit card purchases. Is this not consumer exploitation?

State bank of Pakistan is regulating the Islamic banking operations in a haphazard manner through various regulatory instruments of law which includes circulars, etc, Tax advisors and experts opine that alignment with other laws is required for a good framework for the correct interpretation of Shariah compliant products, which must be consistent in harmony with other related laws.

Lack of Control on Inflation: The role of Finance Ministry and State Bank of Pakistan in controlling Inflation has been dismal. In theory, the paper money can have a stable value but, in practice, paper money has always resulted in inflation.

Printing of currency notes without any commodity backing or beyond the reserves required maintaining its stability, causes fall in purchasing power of the money and we have seen the demise of gold and silver dollar as well as India's silver Rupee and other coins in the subcontinent such as paisa, annas, chowanni etc. and now the Rupee is worth less than an Anna of yester years. On the other hand in the old days where there were metal coins the worth of money used to appreciate against consumable items. Now the printing of one Rupee note costs more than its face value and it has been abolished and the RS. 5 note has also gone.

See article Ravages of Paper Money.

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Shah Nawaz Khan has vast experience in marketing and supervising life insurance sales force besides underwriting and advertising and computer operations.  He retired as Executive Director of State Life Insurance Corporation of Pakistan after serving the insurance industry for 40 years. He is now moderating two Internet discussion forums.

Related article - Money, Interest and Riba


Founding Father of Pakistane Muhammad Ali Jinnah laying foundation of State Bank of Pakistan in 1948, emphasized upon adopting Islamic Moral Vlues not only in economic field but all affairs of life.

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