Elimination of riba from the economy and islamic


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Elimination of riba from the economy and islamic

  1. 1. Elimination of Riba from theeconomy and islamic modes offinancingAdnan Sattar KhanAdnan AhmedMuhmmad HassaunHammad Hamid
  2. 2. Sequence of events Started when President Zia-ul-haq in September 1977 asked the Council of Islamic Ideology to prepared a blueprint of interest free Islamic economy. The council appointed a panel of economist and bankers in November 1977. A report submitted in February 1980. An amended report was adopted in June 1980.
  3. 3. Commercial Bankinga) Financing Operations 1. Industry 2. Agriculture 3. Commerce sector 4. Construction 5. Transport 6. Other sectors 7. Personal loansb) Depositsc) Miscellaneous Transactions
  4. 4. Industry Fixed Capital Investment Working Capital Investment
  5. 5. Industry – Fixed Capital InvestmentCurrent System Proposed System Term loans 1. Firm which maintain accounts audtied by Debentures Chartered Accountants ◦ Profit & Loss Participation in 2. Firms which maintain underwriting accounts but are not Bridge financing audited by Chartered Accountants All include interest ◦ Hire-purchase, Bai Muajjal & Leasing 3. Smaller firms who do not maintain proper accounts ◦ Normal rate or return, Bai Muajjal & Hire-purchase
  6. 6. Industry – Fixed CapitalInvestment For the proposed system to be successful, monitoring by the banks of the actual performance of the concern is required. Should be able to inspect the projects and call for any information and books of accounts. My also appoint a director on the Board.
  7. 7. Industry – Working CapitalCurrent System Proposed System Grant of demand loans 1. Firm which maintain accounts audited by Cash credit Chartered Accountants Overdraft ◦ Profit & Loss sharing on Opening of import LCs daily product basis. Discounting of bills 2. Firms which maintain accounts but are not All include interest audited by Chartered Accountants ◦ Bai Muajjal & Normal rate of return.
  8. 8. Commercial Bankinga) Financing Operations 1. Industry 2. Agriculture 3. Commerce sector 4. Construction 5. Transport 6. Other sectors 7. Personal loansb) Depositsc) Miscellaneous Transactions
  9. 9. AgricultureCurrent System Proposed System Minimal involvement by 1. Short term commercial banks. Upto subsistence level State Bank fixes every ◦ Financing under Special year mandatory targets Loans Facility. Repay only for commercial banks for principal. agri loans. Exceeding subsistence level State Bank shares with ◦ Financing under Bai commercial banks 50/50 Muajjal & Bai Salam losses on these loans. All loans were interest bearing until recently.
  10. 10. AgricultureCurrent System Proposed System Minimal involvement by 1. Medium and Long term commercial banks. ◦ Plough Cattle State Bank fixes every ◦ Dairy and Poultry farming year mandatory targets ◦ Land improvement and for commercial banks for development agri loans. ◦ Purchase of tractors, State Bank shares with installation of tubewells, commercial banks 50/50 digging of Karezes, and losses on these loans. construction of storage All loans were interest facilities. bearing until recently.
  11. 11. Commercial Bankinga) Financing Operations 1. Industry 2. Agriculture 3. Commerce sector 4. Construction 5. Transport 6. Other sectors 7. Personal loansb) Depositsc) Miscellaneous Transactions
  12. 12. Commerce SectorCurrent System Proposed System Demand loans 1. Retailers who do not Cash Credit maintain book of accounts Over-draft facility ◦ Financing under Bai Opening of import LCs Muajjal & Special Loans Bill discounting Facility All include interest 2. Retailers who maintain book of accounts ◦ Same as working capital requirements for Industry.
  13. 13. Construction Proposed System Financing of construction companies, both fixed capital investment and working capital may strictly be on PLS basis.
  14. 14. Transportation Proposed System Financing under hire- purchase or Bai Muajjal arrangements.
  15. 15. Other Sectors Proposed System Financing under PLS for other sectors. Finance under Bai Muajjal or investment Auctioning for purchase of capital good & machinery.
  16. 16. Personal Loans Under Islamic system a needy may not be expected to borrow because it is the state‟s duty to assist them.
  17. 17. Personal LoansCurrent System Proposed System All personal loans are 1. Interest free loans for interest bearing. students. 2. Financing under Bai Muajjal and Hire purchase for consumer durables. 3. Financing under Federal Zakat Fund for calamity-stricken areas.
  18. 18. Commercial Bankinga) Financing Operations 1. Industry 2. Agriculture 3. Commerce sector 4. Construction 5. Transport 6. Other sectors 7. Personal loansb) Depositsc) Miscellaneous Transactions
  19. 19. Deposits Switch over should be gradual Deposits may be accepted by the bank under the existing system for a transitional period to avoid adverse effect on depositor‟s confidence.
  20. 20. DepositsCurrent System Proposed System Uniform and fixed return 1. Fixed return on savings & time deposits be replaced by variable return. 2. In order to provide with uniform returns, profits of all banks be pooled for distribution to depositors.
  21. 21. Miscellaneous Transactions1. Inter-bank transactions2. Financial assistance from State Bank3. Foreign transactions of banks involving interest.
  22. 22. Inter-bank transactions &Financial assistance from State BankCurrent System Proposed System All transactions are 1. Transactions under PLS interest bearing. arrangements are recommended on the basis of daily products.
  23. 23. Miscellaneous TransactionsForeign transactions of banks involving interest. Foreign branches of Pakistani banks would have to conduct business on interest basis. Foreign deposits on local banks would also continue to earn interest.
  24. 24. Miscellaneous TransactionsForeign transactions of banks involving interest. In order to avoid merger of interest income with non-interest income, the administration of foreign branches of Pakistani banks and foreign currency deposits held with local banks be entrusted to a separate Corporation.
  25. 25. Chapter IIISpecialized Financial Institutions
  26. 26. 1 )Pakistan Industrial Credit andInvestment Corporation ( PICIC) PICIC was established in October, 1957 PICIC provide finance to the private industrial sector ◦ Long term loans ◦ medium term loans Public limited company with paid up capital of Rs. 79.68 Million ◦ 65% held by private investors and financial institutions of Pakistan ◦ 35 % held by foreign investor
  27. 27.  InterestAssets LiabilitiesDebenture purchased Debentures IssuedLoans in foreign and local Long term rupee borrowingcurrencyDeposits held with bank Line of credit in foreign currency Borrowings from banks Borrowings from SBP
  28. 28.  The council recommended the elimination of interest from PICIC‟s operations ◦ Portion of share capital held by foreign investor ◦ Interest based debentures was replaced by participation term certificates ◦ PICIC can only hold its time deposits with bank on PLS basis ◦ Underwriting arrangements was replaced by „Firm commitment‟ underwriting which is compatible with sharia.
  29. 29.  Governtment loans should be converted into Government investment on PLS basis or replaced by PTC‟s to be issued by PICIC to the Government alternative for the loans from World bank, Asian development bank and other agencies conforming with sharia.
  30. 30. Industrial Development Bank of Paksitan(IDBP) Established in august 1961 Provide long term and short term loans. ◦ For acquiring fixed assets ◦ Working capital requirement Bank had a paid up capital of 50 million held entirely by Federal Govt. Apart from share capital other bank resources consist of: ◦ Deposits from the public ◦ Borrowings from SBP, Federal Govt. and world bank The nature of business is similar to PICIC so changes required would be similar to PICIC. For deposits and working capital changes required
  31. 31. National Development Finance Corporations (NDFC) Established in 1973 to provide financial and technical assistance. ◦ Establishment of new enterprises ◦ Expansion of existing enterprises Functions of corporation includes: ◦ Provision of medium and long term loans in foreign and local currencies. ◦ Provision of loans for working capital requirement. ◦ Equity participation ◦ Purchase of debenture ◦ Underwriting ◦ Issue of guarantee for local and foreign currency loan ◦ Participation in loan syndication.
  32. 32.  Share capital 120 million Held entirely by Government of Pakistan Other resources ◦ SBP ◦ Deposits of fixed maturities InterestAssets LiabilitiesLoans advanced BorrowingsDebenture purchased Deposits acceptedDeposits held with commercialbanks Operations same as PICIC and Commercial banks so changes should be similar to those.
  33. 33.  Other recommendations ◦ Cash credit from SBP on PLS basis. ◦ The new deposits should be accepted on PLS basis where as previous deposits continues on previous terms.
  34. 34. Agriculture Development Bank of Pakistan (ADBP) Established in 1961 by merging the agriculture Development finance corporation (ADFC) and Agriculture bank of Pakistan (ADP). Provide loans to individuals and corporate bodies engaged in Agriculture and for development of agriculture Bank provides short, medium and long term loans. The banks financial resources consist of its capital and reserves, different type of deposits and borrowings from domestic as well as foreign resources
  35. 35.  ADBP interest payments are on deposits, borrowings from SBP and loans from international institutions. After elimination of Interest: ◦ Rules for accepting deposits should be same as those for commercial banks. ◦ Loans accepted from SBP should be on PLS basis
  36. 36. Small business finance corporation (SBFC) Previously known as the people finance corporation (PFC). Established in 1972 to provide financial assistance to persons of small means. Its provide finance on interest basis to all type of small businesses. The firm was authorized to provide loans upto a maximum limit of Rs.50000 to individuals and firms 150000 Rs of loan to cottage and small industries. The paid up capital of the firm was 70 million: ◦ Federal Govt. 30 m ◦ SBP 9.6 m ◦ Nationalized commercial bank 30.40 m
  37. 37.  It was suggested that corporation provide finance on hire purchase “bai mujjal”. Other interest bearing transactions of the firm was ◦ Deposits with banks ◦ Borrowings Rules similar to commercial banks should be applied.
  38. 38. Equity Participation Fund Established in 1970 with special legislation. To promote the small and medium industries of less developed areas The fund was administered by the IDBP and empowered to provide equity support 50 million paid up capital ◦ Federal Govt. 20 m ◦ 10 m each by SBP, provincial Govt and institutional investors. Firm Should adopt the “firm commitment” underwriting to avoid the Bridge financing on interest bearing.
  39. 39. Insurance Companies Council said the existing system of insurance, is not only involved the interest but also the element of gambling. Council suggested that ◦ Both life and general insurance should be organized on co- operative lines. ◦ Income from premium should be invested in profitable business ◦ Annual profit so earned should be reserved for the distribution among the members. ◦ At the time of maturity the insured should be entitled of principal along with the profit to his credit if any
  40. 40. Central Bank and MonitoryPolicy Cash Reserve Requirement • Minimum • State Bank Penalize banks through provision not involving interest rate. • Liquidity Ratio Requirement • Overall Ceiling on the Landing and Investment Operation of Bank • Fine Should Related to the Quantum of Excess over Credit Ceiling Instead of Interest • Mandatory Targets for Providing Finance to Priority Sectors • Selective Credit Control • Profit and Loss Sharing Basis • Contribution of Parties
  41. 41. • Issue of Direction  Interest Margins Replace by Profit & Loss Margins• Moral Suasion• Bank Rate  Distributable Profits  Apply weight to the investments  Calculate Profit Ratios and distribute profit• Open Market Operation  State Bank Issue Securities Based on Profit and Loss Sharing  Provides Loan to Federal and Provincial Government on Interest free basis• State Bank as Bank of Issue  Dealing with international financial institution  Miscellaneous domestic transction
  42. 42. Government Transaction
  43. 43. 1. Internal Borrowings of the Federal and Provisional Governments. Market loans Treasury bills Loans and advances by State Bank to Government Inter-Government Loans.
  44. 44. 2. Government borrowings from external sources.3. Provident funds.4. Taccavi loans.5. Loans to government employees.6. Charge of penal interest rates.
  45. 45. Summary and conclusion The elimination of interest occupies a key position in the establishment of the Islamic order. Next step for the government is to set up various working groups. Country is poised for the introduction of the interest-free banking system.
  46. 46.  The real alternatives to interest under an Islamic economic system are profit/loss sharing or qard-i-hasan.