Islamic banking in Pakistan has witnessed remarkable growth over the past two decades, emerging as a major pillar of the financial system and offering Shariah-compliant alternatives to conventional banking. Rooted in the prohibition of riba (interest), the system promotes profit-and-loss sharing, transparency, and asset-backed financing. Today, Islamic banking accounts for over 20% of Pakistan’s banking industry assets and continues to expand steadily.
However, beyond this growth, critical questions remain: Are Islamic banks truly fulfilling their ethical and social responsibilities, or are they largely replicating conventional banking under a different label?
Shariah Governance and Investment Models
The State Bank of Pakistan (SBP) regulates Islamic banking through a comprehensive Shariah Governance Framework (SGF). Revised in 2024 and effective from January 1, 2025, this framework requires every Islamic Banking Institution (IBI) to establish an independent Shariah Supervisory Board (SSB) comprising qualified scholars.
These boards play a crucial role by:
Certifying Shariah compliance of financial products.
Reviewing and auditing banking transactions.
Supervising disposal of income deemed non-compliant.
Guiding zakah calculations and issuing fatwas on complex matters.
Islamic banks operate primarily through established Shariah-compliant contracts such as:
Murabaha – cost-plus sale.
Ijarah – leasing arrangements.
Mudarabah – profit-sharing partnership.
Musharakah – joint venture financing.
Sukuk – asset-backed investment certificates.
Unlike conventional lending, these models ensure that profit generation remains tied to tangible assets, trade, and services, thereby discouraging speculative practices.
KIBOR: A Persistent Dilemma
Despite the prohibition of interest, Islamic banks in Pakistan widely use the Karachi Interbank Offered Rate (KIBOR) as a benchmark for determining profit rates on financing and deposits. This practice ensures consistency with the wider financial system but has attracted criticism.
Scholars and practitioners argue that reliance on KIBOR undermines the spirit of Islamic finance and exposes it to accusations of “window-dressing.” A truly Islamic alternative benchmark remains elusive, though efforts are underway to develop distinct mechanisms based on profitability indices, commodity prices, or real sector performance.
Regulatory Fines and Compliance Challenges
While Shariah compliance is strictly monitored, Islamic banks face similar regulatory challenges as their conventional counterparts. SBP has frequently imposed fines for lapses in anti-money laundering (AML), Know Your Customer (KYC), customer due diligence, and forex compliance:
2024: Eight banks (including Meezan Bank and MCB Islamic) fined over Rs. 775 million.
2022: Six banks, including one Islamic bank, fined Rs. 290 million.
2020: Fifteen banks fined Rs. 1.68 billion.
2019: Ten banks (including Dubai Islamic Bank) fined Rs. 805 million.
Notably, these fines are unrelated to Shariah violations but highlight weaknesses in governance and operational discipline—raising concerns about institutional rigor.
Investments in Sukuk and Stock Markets
Islamic banks in Pakistan have limited investment avenues since interest-bearing instruments such as treasury bills and bonds are prohibited. Consequently, they concentrate heavily on:
Government Sukuk: Asset-backed securities that offer high, relatively safe yields.
Shariah-Compliant Equities: Stocks of companies screened under Islamic criteria.
While profitable, this concentration exposes Islamic banks to market volatility. The dependency on sukuk and stock markets has sparked debates about whether banks are prioritizing profitability over social impact, as grassroots financing and micro-level development receive far less attention.
Poverty Alleviation and Qarz-e-Hasna
Perhaps the sharpest criticism of Islamic banking in Pakistan lies in its limited role in poverty alleviation. Shariah encourages Qarz-e-Hasna (benevolent, interest-free loans) to support vulnerable groups. Yet, very few Islamic banks offer this service at scale.
Reasons include:
High operational costs and branch overheads.
Lack of profitability in Qarz-e-Hasna.
Absence of regulatory incentives for expansion.
As a result, the gap between the moral ideals of Islamic finance and the practical operations of banks continues to widen.
Corporate Social Responsibility (CSR) and Research Gaps
Although Islamic banks promote their ethical foundation, their performance in CSR and research remains modest:
Between 2003–2017, CSR disclosure in Islamic banks averaged only 31%, later improving but still falling short of expectations.
Socially impactful spending is limited compared to the significant profits generated annually.
Investment in Research & Development (R&D)—particularly in poverty-focused financial products—remains minimal.
This undermines the claim that Islamic banks operate with higher ethical standards than conventional banks.
Comparison with Conventional Banks
Key Differences
Interest vs. Shariah Compliance: Conventional banks thrive on interest-based lending; Islamic banks avoid it.
Risk Sharing: Islamic finance promotes shared risk, while conventional banks transfer risk almost entirely to borrowers.
Asset-Backed Financing: Financing must be tied to tangible assets in Islamic banking.
Key Similarities
Both are regulated by SBP.
Both provide deposits, financing, and investment services.
Both pursue profitability and sustainability as core objectives.
Impact of Government Policies
The government of Pakistan has taken bold steps to promote Islamic banking. Notably, a constitutional amendment mandates the elimination of interest (riba) by January 1, 2028, aiming to transition the economy toward Shariah compliance.
Meanwhile, SBP’s revised Shariah Governance Framework strengthens monitoring, standardization, and compliance. Dedicated policy support, tax incentives for sukuk, and Shariah-compliant refinancing facilities are also being introduced to accelerate growth.
Global Context: Lessons from Other Countries
Pakistan’s Islamic banking industry can draw lessons from successful global models:
Malaysia: Widely recognized as the global leader in Islamic finance, Malaysia has built a robust infrastructure, regulatory framework, and product diversity.
United Kingdom: With five fully Islamic banks and a supportive regulatory environment, the UK has become a non-Muslim-majority hub for Islamic finance, attracting both Muslim and non-Muslim investors.
These examples highlight the importance of regulatory clarity, innovation, and inclusivity in ensuring long-term success.
The Role of International Institutions
Although institutions like the IMF, World Bank, and ADB do not directly promote Islamic banking, their influence on Pakistan’s financial system is significant. Through policy advice, lending programs, and emphasis on strong regulatory frameworks, they indirectly shape the environment in which Islamic banking operates. For instance, IMF’s push for robust compliance frameworks strengthens risk management across both conventional and Islamic banking.
National Vision: Toward a Riba-Free Economy
Pakistan aspires to become a global hub for Islamic finance, leveraging its large Muslim population and demand for Shariah-compliant products. The national strategy focuses on:
Strengthening Shariah Governance: Ensuring consistency, credibility, and transparency.
Promoting Islamic Finance Education: Building a skilled workforce and enhancing public awareness.
Fostering Innovation: Developing new financial instruments aligned with Shariah.
Financial Inclusion: Expanding outreach to underbanked and low-income populations.
The ultimate goal is a riba-free economy, ensuring justice, fairness, and equity in financial dealings. However, achieving this requires not just regulatory changes but also a cultural shift within banking institutions and society at large.
Conclusion: Beyond Form to Spirit
Islamic banking in Pakistan represents a historic attempt to align finance with faith and ethics. Its rapid expansion, regulatory backing, and public demand demonstrate that a system free from interest is both possible and viable.
Yet, significant challenges persist:
Overreliance on sukuk and stock markets instead of grassroots financing.
Limited poverty alleviation programs through Qarz-e-Hasna.
High service charges that restrict accessibility for low-income groups.
Weak CSR performance and negligible investment in socially impactful R&D.
For Islamic banks to “do it right,” they must move beyond formal compliance and profitability. They must demonstrate that they are not only Islamic in structure but also in spirit—committed to justice, inclusion, and the upliftment of society.
Only then can Pakistan’s Islamic banking truly embody its promise as an ethical alternative and a global model for faith-driven finance.
