PROJECT DATA

ISLAMIC MODE OF FINANCING

Islamic Modes of Financing in Pakistan: A Legal Perspective

Pakistan's legal landscape accommodates various Islamic modes of financing, drawing

principles from both Islamic jurisprudence and conventional law. Here's a breakdown
from a legal standpoint:

The Constitutional Framework for Islamic Finance in Pakistan:

The Constitution of Pakistan provides the bedrock for the legal framework of
Islamic finance in the country. Here's a detailed breakdown of its key aspects:

1. Islam as the State Religion:

Article 2A declares Islam as the state religion of Pakistan. This signifies

the state's commitment to upholding Islamic principles in all aspects,
including the financial system.

2. Objectives Resolution:

This resolution, now included in the Constitution, outlines the Islamic

values aimed for in Pakistani society. It emphasizes the establishment
of a "just and equitable order" and the elimination of exploitation. These
principles indirectly guide the development of a fair and ethical financial
system based on Islamic principles.

3. Article 38(f):

This article specifically mandates the state to "eliminate riba (interest) as

early as possible." This provision directly influences the development of
Islamic finance, which offers alternatives to conventional interest-based
financing.
 4. Federal Sharia Court:

Established under the Federal Sharia Court Act, 1979, this court has the
authority to review and declare laws inconsistent with Islamic principles.
Its rulings have been instrumental in shaping the legal landscape for
Islamic finance, clarifying Sharia compliance of certain modes and
principles.

5. State's Responsibility:

The Constitution, through various articles, outlines the state's

responsibility to promote social and economic welfare. This provides
grounds for justifying Islamic finance as a means to achieve financial
inclusion and equitable development, aligning with Islamic values of
fairness and shared prosperity.

6. Judicial Interpretation:

Over time, Pakistani courts have interpreted the Constitution and other
legal provisions in ways that support the development of Islamic
finance. This ongoing judicial engagement provides further legitimacy
and stability to the sector.

Challenges and Opportunities:

While the Constitution provides a strong foundation, challenges remain in fully

aligning the legal framework with Islamic principles. Ongoing debates and
interpretations highlight the need for continuous efforts to refine policies and
regulations to optimally integrate Islamic finance with the broader financial
system.

Overall, the Pakistani Constitution plays a crucial role in legitimizing and

guiding the development of Islamic finance. Its principles of Islamic values,
social justice, and equitable economic development create a supportive
environment for this unique financial system to flourish and contribute to the
well-being of the Pakistani society.
Exploring the Legal Landscape of Islamic Finance in Pakistan: Specific Laws

Pakistan has built a robust legal framework to foster its thriving Islamic finance industry.
Let's delve into the specific laws that play a key role:

1. The Islamic Banking Act, 1985: This cornerstone act established the legal
infrastructure for Islamic banking institutions and authorized them to operate using
innovative Sharia-compliant modes of financing. These include:

 Murabaha

It is the most frequently exercised mode of Islamic financing which is Practically implemented in financial
institutions and in other financial Transactions.

It is defined as:

“Murabaha is particular kind of sale where the seller expressly Mentions the cost of the sold commodity
he has incurred, and sells it To another person by adding some profit”

For financial transactions by using Murabaha, it is very important that All conditions of sale defined by
the Islamic jurists should be fulfilled.

For example:

I) Before sale, the commodity of sale has to be in the possession of Vendor.

II) If the sale is attributed to a future date or event, it will be Regarded as void and if parties
want to effect sale, a fresh sale Contract is required.
III) Price should be certain for the validity of the sale
IV) The delivery of the commodities must be certain etc.

Now we can explain financial transactions by using Murabaha in

Following points

1: On the time of sale the cost of goods sold is expressed in Mudaraba and sells the commodity by
adding profit with the Mutual consent of both parties

2: Cost include all expenses like carrying charges and other taxes Etc, but the administrative expenses
like salaries of staff and rent Are not included.

3: The validity of Murabaha depends on the fact that parties should Know about the exact cost
otherwise Musawama is used.

4:Most preffered way is that the financier himself purchase Commodity but due to non applicability of
the concept, they can Also higher agent for purchasing commodity on their behalf.

5: Commodity should be purchased from the third party

6: Payment can be made on deffered basis with the mutual consent Of both parties.
So, we can conclude by saying that this Islamic instrument is not a Loan that bears interest but it
practiced as a sale of commodity by adding Some agreed profit whose payment can be made in some
future date.

 Ijara:

“It is also a term used in Islamic Fiqh, which means to give some Thing on rent”

Ijara has two different types:

1:If a person provide services and wage is given as compensation, In this sense employee is called
Mustajir and the employee is Called Ajir.

2: Other type is regarding the usufruct of assets and properties. So Ijara means “to transfer the usufruct
of a particular property to Another person in exchange for rent claimed from him”.

For this concept the term Leasing is used in English, lessor is called Mujir and the lessee is called Mustajir
and the rent payable is called Ujrah.

Now we briefly explain some basic Islamic rules for second type of

Ijara

1: For valid lease contract property must be in the possession of Lessor.

2: The liabilities rising from owner ship of property shall be born By lessor.

3: Lease asset is only used for purpose mentioned in lease contract.

4: Damage to the leased asset by misuse or negligence must be Born by lessee.

5: Properties of two or more persons can be leased out and the Leasing amount is dispersed according to
the respective share in the property.

6: Rent amount must be fixed, but it is permitted that for different Phase, different rent is fixed.

7:If the rent is not paid on agreed time the lessee can be Accountable to pay price calculated in approved
rate.

So these concepts are used for financing of this type.

Salam:

As it is known very well, according to the jurisprudence of Islam it Is compulsory for the validity of
contract that the physical ownership is Necessary for the seller. But it has two exceptions based on some
Defined conditions we will discuss both separately.

Salam:

“A sale where by the seller undertakes to supply some specific Goods to the buyer at a future date in
exchange of an advanced price Fully paid at spot”.

 Istisn’a:
Istisna is a mode of finance it is defined as:

“Kind of sale where a commodity is transacted before it comes into Existence”.

We can say in current era of global business a party orders to Manufacture a product and for this some
time he/she have to pay Advance payment.

The important point in the case of Istasna that the manufacturer uses Its own material for production
otherwise the contract will be of Ijara Rather than Istisna.

Also it is important to fix the price with the approval of concerned People and specification of product
should also be settled.

There are some differences between Istisna and Salam:

1) In Istisna manufacturing of commodity is necessary

2) In salam full price is paid in advance but in Istisna there is no such Condition
3) Delivery time is important time of Salam and not of Istisna.

Musharakah:

The term of Musharkah is used in Islamic mode of financing it comes From word Sharikah, that means
sharing. It can be separated into two Kinds.

1) Sharikat ul Milk:

It refers to combined ownership of the property by two or more Parties; it has two ways.

1. At the option of parties, such as jointly purchase of

Equipment.

2. It comes automatically for example heir’s ownership of Property after the death of concerned
person.
2) Sharikat ul Aqd:

It means partnership by mutual contract It has further three sub divisions:

1. Sharikat-ul-amaal
2. Sharikat-ul-amwaal
3. Sharikat-ul-wajooh.

We can explain some rules of Musharakah on over all basis as under.

• All the valid conditions of sale should be present in the Musharkah for its validity.

• Investment comes from all parties

• Percentage of profit should be determined when contract is made

• Lumpsum amount is not allowed in Musharakah

• Ratio of profit distribution is a contradictory point in Musharakah.

• According to Imam Malik and Shafi profit is shared according to the Percentage of investment.
According to Imam Ahmad profit sharing Ration can be different from investment. Imam Abu Hanifah
make a Coordination between the both point of views. According to him if

The partner will remain sleeping through out the contract the profit Should not exceed from its
investment.

• On the point of loss all the Islamic jurists are given one view that Loss will be distributed according to
the share of investment.

• Any partner can exercise its right for the termination of contract.

• If the partner dies or insane then the contract is automatically Terminated.

 Mudaraba:

Mudaraba is a special kind of partnership, where one partner gives money to another for investing it in a
commercial interprise. The investment comes from the first partner who is called Rabul Mall and
management is Exclusively done by Mudarib.

I) Rabul Mall may specify a specific business and Mudarib have to do that business.
II) Rabul Mall can contract with more than one person
III) Islam has not specify the percentage of profit it depends upon the Parties mutual
consent, but it is prohibited strictly to allocate lump sum amount to any party.
IV) Any party can terminate the contract only condition is a notice to other party .

Islamic Scholars have consensus that Sharikah and Mudarabah are the real modes of Islamic finance.
Murabaha, Ijarah, Salam and Istisna were Adopted modes of finance temporarily for interim periods.
When Sharikah and Mudarabah are established, others will be withdrawn. But it can not be made
possible up till now. Ijarah and Murabaha are the major modes of Islamic finance which are being used.
Main cause of not using Sharikha and Mudarabah as mode of finance in our financial institutions is that
the Partner and Mudariba in Sharikah and Mudarabah are “Ameen” not Dhamin of investment (Capital)
according to the Shariah. Most of the investors are not investing their capital in Sharikah and Mudarabah
based instruments and products in financial institutions because they do not trust others about their
investments. They want to ensure the security of their capital. without implementing teachings and
injunctions of Islam in our individual and collective life, we cannot have the true results from any system
which is Presented in Shariah to solve our problems. Untill we do not adopt Sharikah and Mudarabah as
major modes of finance, we shall not be able to change prevailing economic system into Riba free Islamic
economic system in its true senses.

3. The Federal Sharia Court Act, 1979:

This act established the Federal Sharia Court (FSC) with the authority to review and
declare laws inconsistent with Islamic principles. The FSC has played a crucial role in
guiding the development of Islamic finance by:

 Reviewing contracts and issuing rulings on their Sharia compliance.

  Providing interpretations of Islamic legal principles applicable to financial transactions.
 Advising the government on legal reforms related to Islamic finance.

4. National Sharia Standards Framework:

This framework, developed by the Securities and Exchange Commission of Pakistan

(SECP), aims to standardize Sharia interpretations and practices within the Islamic
finance industry. This initiative promotes consistency, transparency, and investor
confidence in the sector.

5. Other Relevant Laws:

Several other laws indirectly contribute to the legal framework for Islamic finance, such
as:

 The Companies Act, 2016: governs the formation and operation of

companies, including Islamic banking institutions and Takaful companies.
 The Banking Ordinance, 1959: provides the general framework for the banking
sector, with specific provisions for Islamic banking activities.
 The Securities Act, 2015: regulates the capital markets and includes provisions for
Sukuk issuance and trading.

These laws, combined with ongoing legal discourse and regulatory adjustments, provide
a dynamic and evolving legal landscape for Islamic finance in Pakistan. This fosters a
fertile ground for innovation and the continued development of Sharia-compliant
financial products and services, catering to the needs of a diverse and growing Islamic
finance market.

Judicial Recognition: A Pillar of Islamic Finance in Pakistan

The Pakistani judiciary has played a crucial role in solidifying the legal foundations of
Islamic finance within the country. Here’s a deeper look at this crucial pillar:

Landmark Cases:

Meezan Bank Limited vs. Irfan Iqbal Shami (2005): This landmark case established the
validity of Ijara contracts in Pakistan, paving the way for the widespread adoption of this
popular Islamic financing mode. The court affirmed the Sharia compliance of Ijara and
its enforceability under Pakistani law.
  Bank Al Baraka Pakistan vs. Fazal-ur-Rehman (2014): This case tackled the
issue of profit distribution in Mudarabah agreements. The court clarified the rights
and obligations of both parties, providing greater certainty and transparency for
Mudarabah contracts.
 First Habib Modarba Management Company Ltd. Vs. Muhammad Farooq
(2019): This case dealt with the termination of Mudarabah contracts. The court
established principles for equitable termination, protecting the interests of both
parties and promoting investor confidence.

Impact of Judicial Recognition:

 Legitimacy and Stability: Court rulings have reinforced the legal validity of
Islamic financial contracts, offering stability and predictability for market
participants.
 Clarification of Sharia Compliance: Judges’ interpretations of Sharia principles
have provided guidance on the permissibility and implementation of specific
Islamic financing modes
 Consumer Protection: Judgments have established legal precedents that
protect the rights and interests of customers engaging in Islamic financial
transactions.
 Dispute Resolution: Courts offer avenues for resolving disputes arising from
Islamic financial contracts, promoting fair and efficient settlements.

Challenges and Future Trajectory:

Standardization of Judicial Interpretations: Divergent rulings on certain Sharia-

related issues can create ambiguities. Efforts are underway to harmonize judicial
interpretations through initiatives like the National Sharia Standards Framework.

Awareness and Education: Continuous education for judges and legal professionals
on Islamic finance principles is crucial to ensure consistent and informed judgments.

Looking Ahead:

The Pakistani judiciary’s consistent recognition of Islamic finance has been instrumental
in its growth and success. Moving forward, continued collaboration between the
judiciary, regulatory bodies, and industry experts will be vital in addressing challenges,
refining legal frameworks, and further strengthening the foundation of Islamic finance in
Pakistan