Chapter 18 The Legal Framework for Islamic Banking: Pakistan’s Experience
Author: MURVAT SARDAD KHAN
Language:
English
Keywords:
BOOK; bank; central bank; government; SDR; banking organization; state bank; outstanding balance; profit and loss; terms and conditions; ordinary shares; Credit; Loans; Securities; Business enterprises; Cooperative banks
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Abstract

General

Part I

General

1. Islam does not consist of metaphysical beliefs alone: it also provides a system for governing life that deals with all forms of human activity. Thus, it regulates the conduct of man in the individual and collective spheres of life. Like any other such system, it has a legal framework, with foundations, ideals, and principles underlying that framework. This system is clear and simple and it has a definite hold on the mind of every Moslem as he seeks to fashion his life, in its diverse aspects, in accordance with its value system—in letter and spirit. Right from the first day the Islamic System of Governance was introduced in Medina, the Islamic Code has remained in force in all countries ruled by Moslems. None of the absolute monarchs, in their heyday, could dare replace this code. In other words, the Islamic grund norms and social structure have remained intact to a very great extent. The preceding position equally applied to the Indian Subcontinent, over which Moslems ruled for many centuries.

Efforts made by the colonialists to replace the Shariah with their own views, and by the Moslems to establish an Islamic State instead

2. The British, the French, and other colonialists came, at different times, to the Indian Subcontinent as traders and gradually extended their sway. Eventually, the British became the paramount rulers of almost the whole of the Indian Subcontinent. The Moslems lost their political and economic power. The new rulers, in order to perpetuate their own power, made conscious efforts to substitute their own laws and institutions for the laws and institutions of Moslems.1 Despite their subjugation, the Moslems never, for a single moment, became oblivious of their lost position or of their everburning desire to resuscitate and re-establish their social and political institutions and judgment-norms. They waged a ceaseless struggle—at times an armed one, as was seen during the War of Independence in 1857—to regain their liberty. As late as the third decade of the nineteenth century, an Islamic state was carved out in the northwestern part of Pakistan by the Mujahiddin led by Syed Ahmed Delvi and Shah Ismail—the martyrs. In the beginning, Moslems avoided contact with the new rulers, their culture, and the secular educational institutions established by them but run for them by their missionary leaders. Moslems’ long period of isolation, following their defeat in 1857, gradually came to a close through the tireless efforts of Moslem educationists and a new breed of leaders like Sir Syed Ahmad Khan. They took to modern education and, through it, came face to face with modern concepts and means of statecraft. Instead of being assimilated by these concepts, they used these new concepts as tools to attain their cherished goal—namely, the establishment of a modern Islamic state. Their struggle hence changed into a political and intellectual movement, in which every section of Moslem society participated with full vigor, according to its lights and means. Islam no doubt proved to be the moving spirit and the decisive force in their struggle for the establishment of Pakistan. Pakistan Ka Matlab Kia-La-I-La-Ha-Il-Lul-Lah (Pakistan stands for nothing else but the incarnation of Islamic faith and order) became a catchword for the high and the low, the rich and the poor, the lettered and the unlettered Moslem citizenry. This movement was bound to succeed, and succeed it did on August 14, 1947, when Pakistan came into being as an independent and sovereign state.

Part II

  • 3. (a) This struggle continued even after the inception of Pakistan. There was a constant demand on the national level to enforce an Islamic constitution and thereafter to gradually bring the existing laws into conformity with the Holy Quran and the Sunnah. On March 7, 1949, the first Constituent Assembly of Pakistan passed the following resolution:

History of constitntional efforts made (from 1947 to date) to establish Islamic system of governance in Pakistan

“The Objectives Resolution

(In the name of Allah, the most Beneficent, the most Merciful)

Whereas Sovereignty over the entire universe belongs to Allah the Almighty alone and the authority which He has delegated to the State of Pakistan, through its people for being exercised within the limits prescribed by Him, is a sacred trust;

This Constituent Assembly representing the people of Pakistan resolves to frame a Constitution for the sovereign independent State of Pakistan;

Wherein the State shall exercise its powers and authority through the chosen representatives of the people;

Wherein the principles of democracy, freedom, equality, tolerance and social justice as enunciated by Islam shall be fully observed; Wherein the Muslims shall be enabled to order their lives in the individual and collective spheres in accordance wit h the teachings and requirements of Islam as set out in the Holy Qur’an and the Sunnah;

Wherein adequate provision shall be made for the minorities to profess and practice their religion and develop their cultures;

Wherein the territories now included in or in accession with Pakistan and such other territories as may hereafter be included in or accede to Pakistan shall form a Federation wherein the units will be autonomous with such boundaries and limitations on their powers and authority as may be prescribed;

Wherein shall be guaranteed fundamental rights, including equality of status, of opportunity before law, social, economic and political justice and freedom of thought, expression, belief, faith, worship and association, subject to law and public morality;

Wherein adequate provision shall be made to safeguard the legitimate interest of minorities and backward and depressed classes; Wherein the independence of the judiciary shall be fully secured; Wherein the integrity of the territories of the Federation, its independence and all its rights, including its sovereign rights on land, sea and air, shall be safeguarded;

So that the people of Pakistan may prosper and attain their rightful and honoured place amongst the nations of the World and make their full contribution towards international peace and progress and happiness of humanity.”

Establishment of Talimat-i-Islami Board and compilation of 22 points by 31 religious leaders in 1951 for the making of Islamic provisions in the Pakistan Constitution

The Objectives Resolution laid down, so to speak, the ideological foundation of Pakistan and acknowledged that the sovereignty over the entire universe belongs to Allah—The Almighty—and is to be exercised by the people of Pakistan within the limits set by Him as a sacred trust to enable the Moslems of Pakistan to order their lives, individually and collectively, in accordance with the teachings of Islam as set out in the Holy Quran and the Sunnah. The Government of Pakistan established the Talimat-i-Islami Board headed by Syed Sulaiman Nadvi—an eminent scholar of Islam—to make recommendations as to the incorporation of Islamic provisions and other allied matters in the Pakistan Constitution. In addition, in January 1951, 31 learned religious scholars of all shades of opinion unanimously compiled and submitted to the Government 22 points for incorporation in the proposed constitution.2

Islamic provisions of 1956 Pakistan Constitution

  • (b) After a lapse of a few more years, which was marked by tortuous constitutional efforts, the Pakistan Constitution was passed and promulgated on March 23, 1956. It contained the aforesaid Objectives Resolution with slight verbal changes in its preamble. The Constitution established the Islamic Republic of Pakistan.3 Part II of the same document contained fundamental rights such as equality before the law; protection against retrospective offenses or punishment; safeguards as to arrest and detention; freedoms of speech, assembly, and association; the right to hold and dispose of property; freedom of trade, business, or profession; protection against violations of property rights; and the prohibition of slavery and forced labor.4

Voiding of existing laws to the extent of their inconsistency with fundamental rights and barring legislature from making any law curtailing fundamental rights

  • Article 4 provided that existing laws, customs, and usages having the force of law would, insofar as they were inconsistent with the provisions of this part, be void to the extent of that inconsistency; that the state would not make any law which took away or abridged the rights conferred by this part; and that any law in contravention of this clause would, to the extent of such contravention, be void. This part also conferred the right to move the Supreme Court5 by appropriate proceedings for the enforcement of the fundamental rights and, except as provided in the Constitution (i.e., under Part XI,6 which contains emergency provisions), could not be suspended. Part III7 dealt with the Directive Principles of State Policy, which were designed to serve as a guide for the formulation of policies by the state8 but were not to be enforceable in any court. The subject matter of the Directive Principles of State Policy pertained to promotion of Islamic principles, discouragement of parochial and other similar prejudices, principles of social uplift, social and economic well-being of the people, including elimination of riba (the lending of money at interest) as early as possible, and separation of the judiciary and executive branches of government.

  • Article 25, which is important conceptually, is reproduced below:9

“25.__(1) Steps shall be taken to enable the Muslims of Pakistan individually and collectively to order their lives in accordance with the Holy Quran and Sunnah.

(2) The State shall endeavour, as respects the Muslims of Pakistan, _______

  • (a) to provide facilities whereby they may be enabled to understand the meaning of life according to the Holy Quran and Sunnah;

  • (b) to make the teaching of the Holy Quran compulsory;

  • (c) to promote unity and the observance of Islamic moral standards; and

  • (d) to secure the proper organization of zakat, wakfs10 and mosques.”11

Chapter I of Part XII of this Constitution, having a bearing on the subject under discussion, is reproduced below:

“197.__(1) The President shall set up an organization for Islamic research and instruction in advanced studies to assist in the reconstruction of Muslim society on a truly Islamic basis.

(2) Parliament may by Act provide for a special tax to be imposed upon Muslims for defraying expenses of the organization set up under clause (1), and the proceeds of such tax shall not, notwithstanding anything in the Constitution, form part of the Federal Consolidated Fund.

Bar on the making of any lawrepugnant to Islam and procedure for Islamization of existing laws

198.__(1) No law shall be enacted which is repugnant to the Injunctions of Islam as laid down in the Holy Quran and Sunnah, hereinafter referred to as Injunctions of Islam, and existing law shall be brought into conformity with such Injunctions.

(2) Effect shall be given to the provisions of clause (1) only in the manner provided in clause (3).

(3) Within one year of the Constitution Day, the President shall appoint a Commission _______

  • (a) to make recommendations __,

    • (i) as to the measures for bringing existing law into conformity with the Injunctions of Islam, and

    • (ii) as to the stages by which such measures should be brought into effect; and

  • (b) to compile in a suitable form, for the guidance of the National and Provincial Assemblies, such Injunctions of Islam as can be given legislative effect.

The Commission shall submit its final report within five years of its appointment, and may submit any interim report earlier. The report, whether interim or final, shall be laid before the National Assembly within six months of its receipt, and the Assembly after considering the report shall enact laws in respect thereof.

(4) Nothing in this Article shall affect the personal laws of non-Muslim citizens, or their status as citizens, or any provision of the Constitution.

Explanation__In the application of this Article to the personal law of any Muslim sect, the expression ‘Quran and Sunnah’ shall mean the Quran and Sunnah as interpreted by that Sect.”12

Legislature nevertheless competent to pass a law in contravention of Aritcle 198

The overall effect of this Article was that legislature was supreme, inasmuch as a law passed in contravention of the requirement of Article 198 could not be successfully challenged in a court of law nor could a writ of mandamus be used to compel the executive or the legislature to bring existing laws into conformity with the injunctions of Islam.

Lukewarm approach toward enforcement of Article 198

However, one day before the expiry of the one-year period fixed by the Constitution, a chairman of the above-mentioned commission was named by the (then) President of Pakistan, but no member was appointed nor were any concrete steps taken to achieve the objectives of Article 198. In fact, before any beginning could be made in this direction, the Constitution was abrogated by the proclamation made by the (then) President on October 8, 1958.

Salient features of 1962 Constitution

  • (c) The Chief Martial Law Administrator, by virtue of a mandate received by him pursuant to a referendum held on February 15, 1960, promulgated a constitution of his choice on March 1, 1962. It came into force on June 8, 1962, when the first meeting of the National Assembly was held. Subsequently, many amending acts were passed by the National Assembly. The first and second of these amending acts, respectively, restored fundamental rights and the Islamic provisions of the 1956 Constitution. Thus, apart from containing a preamble and fundamental rights on the pattern of the 1956 Constitution, the 1962 Constitution made provisions for the following matters:

Original contribution made for the first time in constitution making in Pakistan

  • (i) (1) right of every citizen and of every other person in Pakistan for the time being was to be dealt with in accordance with law;

  • (2) no action detrimental to the life, liberty, body, reputation, or property of any person was to be taken except in accordance with law;

  • (3) no person was to be prevented from, or be hindered in, doing that which was not prohibited by law; and

  • (4) no person was to be compelled to do that which the law did not require him to do.

  • (ii) loyalty to the republic was the basic duty of every citizen, and obedience to the law was the basic obligation of every citizen, wherever he was, and of every other person who was in Pakistan for the time being;

  • (iii) The Principles of Policy, which were patterned on the 1956 Constitution, included the elimination of “Riba (Usury)” the discouragement of prostitution, gambling, drug-taking, and the consumption of alcohol; and a statement of the legal proposition, contained in Articles 7 and 8, to the effect that it was the responsibility of each organ and authority of the state, and of each person acting on behalf of such organ or authority, to act in accordance with the Principles of Policy and that the responsibility of deciding whether any action was or was not in accordance with these Principles was that of the organ, authority, or person so acting and that no such action could be called into question on the ground that it was in contravention of any Principle of Policy.13 The Principles were hence purely advisory in nature, since they were non-justiciable.14

Principles of policy purely advisory in nature

Hence the Principle that “no law shall be repugnant to the teaching and requirements of Islam as set out in the Holy Quran and Sunnah and all existing laws shall be brought in conformity with the Holy Quran and Sunnah” remained only a pious wish.

  • (iv) the formation of (1) an Advisory Council of Islamic Ideology to make recommendations to the national and provincial governments as to means of enabling and encouraging the Moslems of Pakistan to order their lives in all respects in accordance with the principles and concepts of Islam, to examine all existing laws with a view to bringing them into conformity with the teachings and requirements of Islam as set out in the Holy Quran and Sunnah, and to advise the legislature or the President or a Governor if a proposed law was or was not repugnant to the teachings and requirements of Islam as set out in the Holy Quran and Sunnah and (2) an Islamic Research Institute to undertake Islamic research and instruction in Islam for the purpose of assisting in the reconstruction of Moslem society on a truly Islamic basis.

Position of Islamic provisions in 1973 Constitution

  • (d) In February 1969, martial law was again imposed and the 1962 Constitution was abrogated. Martial law was, however, lifted in 1972 with the promulgation of the Interim Constitution in 1972, followed by the Permanent Constitution in August 1973, which was passed by the collective will of the people as expressed through their chosen representatives. This constitution also contained the preamble, the fundamental rights, the Principles of Policy (including the elimination of riba), and all other matters—including the justi-ciability of the fundamental rights and the non-justiciability of the Principles of Policy—referred to earlier, with this addition: “Islam was declared to be the state religion of Pakistan.” Further, although Chapter IX of the 1973 Constitution did provide for the constitution of the Council of Islamic Ideology with somewhat similar functions (as provided in the 1962 Constitution), it did away with the Islamic Research Institute. Article 227 also stated that all existing laws would be brought into conformity with the injunctions of Islam, as laid down in the Holy Quran and Sunnah, and that no law would be enacted which was repugnant to such injunction. This could, however, be enforced only in the manner laid down in sub-Articles (3) and (4) of Article 230, which are reproduced below:

  • “Article 230 .......................................

  • (3) Where a House, a Provincial Assembly, the President or the Governor, as the case may be, considers that, in the public interest, the making of the proposed law in relation to which the question arose should not be postponed until the advice of the Islamic Council is furnished, the law may be made before the advice is furnished:

  • Provided that, where a law is referred for advice to the Islamic Council and the Council advises that the law is repugnant to the injunctions of Islam, the House or, as the case may be, the Provincial Assembly, the President or the Governor shall reconsider the law so made.

  • (4) The Islamic Council shall submit its final report within seven years of its appointment, and shall submit an annual interim report. The report, whether interim or final, shall be laid for discussion before both Houses and each Provincial Assembly within six months of its receipt, and Majlise-Shoora (Parliament) and the Assembly, after considering the report, shall enact laws in respect thereof within a period of two years of the final report.”

  • Thus, on the lines of earlier constitutions, the Islamicity of existing and future laws remained non-justiciable, with the exception that a time limit of nine years was fixed to give exception that a time limit of nine years was fixed to give legislative effect to the recommendations of the Council of Islamic Ideology, whose mandate was due to expire in August 1982.

Structural changes made in the Constitution to provide for incorporation of Objectives Resolution as a substantive part of the Constitution and establishment of Federal Shariat Court

  • 4. (a) On July 5, 1977, the Constitution of 1973 was suspended. On January 1, 1978, the Chief Martial Law Administrator announced that the Superior Courts of Pakistan would be empowered to declare any law repugnant to the Quran and Sunnah as void. Presidential Order No. 3 of 1979 was promulgated on February 7, 1979. By this Order, Chapter 3-A was included in the Constitution. It provided for constitution of Shariat Benches in each of the four High Courts and one Appellate Shariat Bench in the Supreme Court to declare whether or not any law or provision of law was repugnant to the injunctions of Islam as laid down in the Holy Quran and the Sunnah of the Holy Prophet and stated that if a law were declared to be so repugnant to the Holy Quran and Sunnah, it should cease to have effect on the day on which the decision of the High Court took effect and, in addition, that the President or Governor, as the case might be, was required to take steps to amend the law so as to bring such law or provision into conformity with the injunctions of Islam. Law here did not include “the Constitution, Moslem Personal Law, any law relating to the procedure of any court or tribunal or, until the expiration of three years from the commencement of this Chapter, any fiscal law, or any law relating to the collection of taxes and fees or banking or insurance practice and procedure.” Proceedings pending at the commencement of this chapter or initiated thereafter were not required to be adjourned or stayed by reason of a petition having been made to the High Court for a decision as to whether or not a law or provision of law (relevant to the decision of an issue involved in such proceedings) was repugnant to the injunctions of Islam; such proceedings were to continue, and the point at issue was then to be decided in accordance with the law that was in force for the time being.

Jurisdiction and powers of Federal Shariat Court

  • (b) Effective May 26, 1980, it was substituted by Presidential Order No. 1 of 1980. This chapter underwent several changes. Presently it reads, inter alia, as follows:

  • “Chapter 3-A—Federal Shariat Court

  • 203A. The provisions of this Chapter shall have effect notwithstanding anything contained in the Constitution.

  • 203B. In this Chapter, unless there is anything repugnant in the subject or context, __

    • (a) ‘Chief Justice’ means Chief Justice of the Court;

    • (b) ‘Court’ means the Federal Shariat Court constituted in pursuance of Article 203C;

    • (bb) ‘Judge’ means judge of the Court;

    • (c) ‘Law’ includes any custom or usage having the force of law but does not include the Constitution, Muslim Personal Law, any law relating to the procedure of any court or tribunal or, until the expiration often years from the commencement of this Chapter, any fiscal law or any law relating to the levy and collection of taxes and fees or banking insurance practice and procedure; and

Article 203C .......................................

203D. (1) The Court may, either on its own motion or on the petition of a citizen of Pakistan or the Federal Government or a Provincial Government, examine and decide the question whether or not any law or provision of law is repugnant to the Injunctions of Islam, as laid down in the Holy Quran and Sunnah of the Holy Prophet, hereinafter referred to as the Injunctions of Islam.

(1A) Where the Court takes up the examination of any law or provision of law under clause (1) and such law or provision of law appears to it to be repugnant to the Injunctions of Islam, the Court shall cause to be given to the Federal Government in the case of a law with respect to a matter in the Federal Legislative List or the Concurrent Legislative List, or to the Provincial Government in the case of a law with respect to a matter not enumerated in either of those Lists, a notice specifying the particular provisions that appear to it to be so repugnant, and afford to such Government adequate opportunity to have its point of view placed before the Court.

(2) If the Court decides that any law or provision of law is repugnant to the Injunctions of Islam, it shall set out in its decision:

  • (a) the reasons for its holding that opinion; and

  • (b) the extent to which such law or provision is so repugnant; and specify the day on which the decision shall take effect

    Provided that no such decision shall be deemed to take effect before the expiration of the period within which an appeal therefrom may be preferred to the Supreme Court or, where an appeal has been so preferred, before the disposal of such appeal.

(3) If any law or provision of law is held by the Court to be repugnant to the Injunctions of Islam,

  • (a) the President in the case of a law with respect to a matter in the Federal Legislative List or the Concurrent Legislative List, or the Governor in the case of a law with respect to a matter not enumerated in either of those Lists, shall take steps to amend the law so as to bring such law or provision into conformity with the Injunctions of Islam; and

  • (b) such law or provision shall, to the extent to which it is held to be so repugnant, cease to have effect on the day on which the decision of the Court takes effect.

203DD ...........................................

203E. (1) For the purposes of the performance of its functions, the Court shall have the powers of a Civil Court trying a suit under the Code of Civil Procedure, 1908 (Act V of 1908), in respect of the following matters, namely:

  • (a) summoning and enforcing the attendance of any person and examining him on oath;

  • (b) requiring the discovery and production of any document;

  • (c) receiving evidence on affidavits; and

  • (d) issuing commissions for the examination of witnesses or documents.

(2) The Court shall have power to conduct its proceedings and regulate its procedure in all respects as it deems fit.

(3) The Court shall have the power of a High Court to punish its own contempt.

(4) A party to any proceedings before the Court under clause (1) of Article 203D may be represented by a legal practitioner who is a Muslim and has been enrolled as an advocate of a High Court for a period of not less than five years or an advocate of the Supreme Court or by a jurisconsult selected by the party from out of a panel of jurisconsults maintained by the Court for the purpose.

(5) For being eligible to have his name borne on the panel of jurisconsults referred to in clause (4), a person shall be an aalim who, in the opinion of the Court, is well-versed in Shariat.

(6) A legal practitioner or jurisconsult representing a party before the Court shall not plead for the party but shall state, expound and interpret the Injunctions of Islam relevant to the proceedings so far as may be known to him and submit to the Court a written statement of his interpretation of such Injunctions of Islam.

(7) The Court may invite any person in Pakistan or abroad whom the Court considers to be well-versed in Islamic law to appear before it and render such assistance as may be required of him.

(8) No Court fee shall be payable in respect of any petition or application made to the Court under Article 203D.

(9) The Court shall have power to review any decision given or order made by it.

203F. (1) Any party to any proceedings before the Court under Article 203D aggrieved by the final decision of the Court in such proceedings may, within sixty days of such decision, prefer an appeal to the Supreme Court:

Provided that an appeal on behalf of the Federation or of a Province may be preferred within six months of such decision.

(2) The provisions of clauses (2) and (3) of Article 203D and clauses (4) to (8) of Article 203E shall apply to and in relation to the Supreme Court as if reference in those provisions to Court were a reference to the Supreme Court.

(2A) ..............................................

(2B) An appeal to the Supreme Court from a judgment, decision, order or sentence of the Federal Shariat Court in a case to which the preceding clauses do not apply shall lie only if the Supreme Court grants leave to appeal.

(3) For the purpose of the exercise of the jurisdiction conferred by this Article, there shall be constituted in the Supreme Court a Bench to be called the Shariat Appellate Bench and consisting of,_______

  • (a) three Muslim Judges of the Supreme Court; and

  • (b) ont more than two ulema to be appointed by the President to attend sittings of the Bench as ad hoc members thereof from amongst the Judges of the Federal Shariat Court or from out of a panel of ulema to be drawn up by the President in consultation with the Chief Justice.

(4) A person appointed under paragraph (b) of clause (3) shall hold office for such period as the President may determine.

(5) Reference in clauses (1) and (2) to ‘Supreme Court’ shall be construed as a reference to the Shariat Appellate Bench.

(6) While attending sittings of the Shariat Appellate Bench, a person appointed under paragraph (b) of clause (3) shall have the same power and jurisdiction, and be entitled to the same privileges, as a Judge of the Supreme Court and be paid such allowances as the President may determine.

203G. Save as provided in Article 203F, no court or tribunal, including the Supreme Court and a High Court, shallentertain any proceedings or exercise any power or jurisdiction in respect of any matter within the power or jurisdiction of the Court.

203GG. Subject to Articles 203D and 203F, any decision of the Court in the exercise of its jurisdiction under this Chapter shall be binding on a High Court and on all courts subordinate to a High Court.

203H. (1) Subject to clause (2) nothing in this Chapter shall be deemed to require any proceedings pending in any court or tribunal immediately before the commencement of this Chapter or initiated after such commencement, to be adjourned or stayed by reason only of a petition having been made to the Court for a decision as to whether or not a law or provision of law relevant to the decision of the point in issue in such proceedings is repugnant to the Injunctions of Islam; and all such proceedings shall continue, and the point in issue therein shall be decided, in accordance with the law for the time being in force.

(2) All proceedings under clause (1) of Article 203B of the Constitution that may be pending before any High Court immediately before the commencement of this Chapter shall stand transferred to the Court and shall be dealt with by the Court from the stage from which they are so transferred.

(3) Neither the Court nor the Supreme Court shall in the exercise of its jurisdiction under this Chapter have power to grant an injunction or make any interim order in relation to any proceedings pending in any other court or tribunal.”

It may be stated that the period of three years mentioned in Article 203B(c) was first replaced by the word “four” by the President’s Order No. 7 of 1983 with effect from (w.e.f.) May 19, 1983, then by the word “five” by the President’s Order No. 2 of 1984 w.e.f. April 26, 1984 and by the word “ten” by the President’s Order No. 14 of 1985 w.e.f. March 2, 1985.

(c) On December 30, 1985, martial law was lifted and the 1973 Constitution was revived by the Revival of the Constitution Order, 1985. In the Constitution so revived, a new Article (viz., Article 2-A below) was inserted by the President’s Order No. 14 of 1985 w.e.f. March 2, 1985: “2-A. The principles and provisions set out in the Objectives Resolution reproduced in the Annex are hereby made substantive part of the Constitution and shall have effect accordingly.”

The Annex reads as follows:

“ANNEX

(Article 2A)

The Objectives Resolution

  • Whereas sovereignty over the entire universe belongs to Allah Almighty alone and the authority which He has delegated to the State of Pakistan, through its people for being exercised within the limits prescribed by Him, is a sacred trust;

  • This Constituent Assembly representing the people of Pakistan resolves to frame a constitution for the sovereign independent state of Pakistan;

Wherein the State shall exercise its powers and authority through the chosen representatives of the people;

Wherein the principles of democracy, freedom, equality, tolerance and social justice as enunciated by Islam shall be fully observed;

Wherein the Muslims shall be enabled to order their lives in the individual and collective spheres in accordance with the teachings and requirements of Islam as set out in the Holy Quran and the Sunnah;

Wherein adequate provision shall be made for the minorities to profess and practise their religions and develop their cultures;

Wherein the territories now included in or in accession with Pakistan and such other territories as may hereafter be included in or accede to Pakistan shall form a Federation wherein the units will be autonomous with such boundaries and limitations on their powers and authority as may be prescribed;

Wherein shall be guaranteed fundamental rights, including equality of status, of opportunity and before law, social, economic and political justice, and freedom of thought, expression, belief, faith, worship and association, subject to law and public morality;

Wherein adequate provision shall be made to safeguard the legitimate interests of minorities and backward and depressed classes;

Wherein the independence of the Judiciary shall be fully secured;

Wherein the integrity of the territories of the Federation, its independence and all its rights including its sovereign rights on land, sea and air shall be safeguarded;

So that the people of Pakistan may prosper and attain their rightful and honoured place amongst the nations of the World and make their full contribution towards international peace and progress and happiness of humanity.”

Before carrying out changes in the Constitution, studies were carried out by different bodies, scholars, etc.

  • (d) General Muhammad Zia-ul-Haq, in search of a true Islamic system of state, assigned the work of the constitutional recommendations to several bodies and committees, viz., the Council of Islamic Ideology, the Majlis-e-Shoora, and his Cabinet Committee. On October 7, 1983, he appointed a Commission to consider the reports of the earlier-mentioned bodies and committees and, after reviewing them, submit to the President its consolidated recommendations. The Commission submitted its report, which was dated August 8, 1983. The President accepted the recommendation of the Commission and made extensive changes in the Constitution by means of President’s Order No. 14 of 1985.15 By those amendments, the Objectives Resolution was made as a substantive part of the Constitution in the form of Article 2-A. Further, Article 270A16 was inserted to validate, notwithstanding any judgment of any court or anything contained in the Constitution, the Proclamation of July 5, 1977, all President’s Orders; Ordinances; Martial Law Regulations; Martial Law Orders; Referendum Order, 1984; the Revival of the Constitution of 1973 Order, 1985; the Constitution (Second Amendment) Order, 1985; and all laws made between July 5, 1977 and December 30, 1985. In a like manner, all orders made, proceedings taken, and acts done by any authority or person between July 5, 1977 and December 30, 1985 in the exercise or purported exercise of powers derived from any Proclamation, President’s Order, Ordinance, Martial Law Regulation, Martial Law Order, enactment, notification, rule, order, by-law, etc. were validated, notwithstanding any judgment of any court, and no suit, prosecution, or other proceedings could lie against any such authority or person. It was further provided that for the preceding purposes, “all orders made, proceedings taken and acts done or purporting to be made, taken or done by any authority or person shall be deemed to have been made, taken or done in good faith and for the purpose intended to be served thereby.”

All laws etc. made between July 5, 1977 and December 30, 1985 were validated by the Constitution (Eighth Amendment) Act, 1985

Council of Islamic Ideology activated

  • (e) In addition to the making of structural changes, as aforesaid, in the Constitution of Pakistan, General Zia-ul-Haq kept the Council of Islamic Ideology busy. That Council not only prepared and submitted Annual Reports for 1974–75, 1975–76, 1977–78, 1978–79, 1980–81, 1982–83, 1983–84, etc. but also many special reports,17 for example, on the Pakistan Code, taxation, fiscal matters, the Islamic judicial system, and insurance. The Federal Shariat Court has so far, over the years, examined the Islamicity of a very large number of18 federal and provincial laws, with its decision subject to appeal, if any, therefrom to the Shariat Appellate Bench of the Supreme Court; the concerned Assembly has made, proposed, or is proposing changes in these laws in the light of decisions of the Federal Shariat Court. The Islamization of laws through the Federal Shariat Court and the Parliament or any Provincial Assembly is an unending job. Apart from the legal and administrative steps described elsewhere, the law-making authority has also taken concrete steps by promulgating the undernoted laws for partial introduction of criminal law of Islam and the collection and disbursement of zakat and usher on a compulsory basis: (1) The Prohibition (Enforcement of Hadd) Order, 1979; (2) The Offences Against Property Enforcement of Hudood) Ordinance, 1979; (3) The Offence of Zina (Enforcement of Hudood) Ordinance, 1979; (4) The Offence of Qazf (Enforcement of Hadd) Ordinance, 1979; and (5) The Zakat and Usher Ordinance, 1980. In view of the preceding position, one can confidently say that the credit for taking constitutional, legislative, and judicial steps for gradual introduction of Shariah rightfully goes to General Muhammad Zia-ul-Haq and his colleagues.

Federal Shariat Court examined the Islamicity of numerous laws

Partial enforcement of criminal law of Islam

Part III

5. Measures to eliminate interest from the financial system of Pakistan were announced, along with other Islamization measures by the President of Pakistan on 12th Rabiul Awal, 1399, which corresponds to February 10, 1979. Under the President’s directive, the Council of Islamic Ideology prepared an interim report in 1979 and a final report in June 1980 containing its recommendations for the elimination of interest from the economy. A high-powered committee, headed by the Federal Finance Minister and consisting of top bankers and experts in finance and the Governor of the State Bank of Pakistan, was set up to initiate an in-depth study on an interest-free banking system and work out its modalities for elimination of interest from the financial system of the country. After the constitution of the committee, the Governor of the State Bank of Pakistan, in consultation with the top bankers and heads of non-bank financial institutions, deliberated upon the subject, and their deliberations culminated in the submission of a report to the Government containing broad recommendations for introduction of interest-free banking in Pakistan. The recommendations contained in all the reports on the subject matter by different committees, along with the suggestions put forth by other research scholars from within the country and abroad, were examined by the Government. Almost all the committees and experts had recommended a step-by-step approach to the problem of eliminating interest from the economy. The Government accepted this recommendation. A number of working groups were set up to work out detailed techniques and procedures, which would be permissible under the Islamic principles, for implementation by the existing institutions.

Constitution of a high-powered committee to study interest-free banking and to suggest its modalities

Decision taken to introduce Islamic banking gradually through existing institutions

Interest eliminated from operations of nonbank financial institutions—mainly through administrative instructions

  • 6.(a) In the first phase, interest was eliminated during 1979 and 1980 from the operations of some of the nonbank financial institutions. For example, the operation of National Investment (Unit) Trust (which mobilizes small savings through the sale of its units and invests the savings in equity shares of companies) was converted into an interest-free organization effective July 1, 1979. All of its interest-bearing securities, held in its investment portfolio, have since been converted into equity shares of companies. It now makes investments in the shape of equity. The Small Business Finance Corporation specializes in extending finances to small firms in trade and industry. For switching over to interest-free basis operations, its Charter was amended effective June 26, 1980 vide Ordinance No. XXX of 1980 to regulate its operations in conformity with Shariah. Subject to Shariah, its was permitted to enter into hire-purchase agreements with hirers or to purchase, to otherwise acquire and sell under a hire-purchase system, or to make outright sales based on a reasonable markup in the price of machinery or other movable or immovable assets in discharge of its business or to provide financial assistance on a profit- and loss-sharing basis. Since June 26, 1980, it has been operating on the basis of hire-purchase, markups in price, and profit- and loss-sharing.

Charter of House Building finance Corporation amended

  • The House Building Finance Corporation, which began operations effective July 1, 1979, finances construction or purchase of houses, or the purchase or development of land, under an agreement of partnership, agreeing to share profits (rental income) and losses (damage to property, etc. owing to calamity) in the ratio of its share in the total investment, on terms and conditions laid down in regulations framed under its charter. Similarly, it was permitted to borrow from, and issue certificates to, banks or institutions entitling those banks or institutions to participate in its profits and losses on the terms and conditions laid down in regulations framed under its charter. For this purpose, its charter was first amended by an ordinance in 1979 and regulations framed by it thereunder. The Investment Corporation of Pakistan not only extends finance for fixed industrial investment but also mobilizes small savings through the flotation of mutual funds. It also extends credit to persons of small means for onward investment in the shares of companies. The Corporation started eliminating its mutual funds holding interest-bearing securities effective July 1, 1979 and gradually disinvested all the interest-bearing securities from its portfolio. As from October 1, 1980, it launched an investors’ scheme on the basis of sharing profits and losses. It no longer extends loans to its investment account holders on the basis of interest. In October 1979, the Government set up the Bankers’ Equity Limited to provide financial assistance for promoting the growth of medium- and large-sized industries in the private sector and to develop the capital market further. It started business effective February 1, 1980. Except for charging interest on foreign-currency loans, it rendered assistance to private sector companies on a non-interest basis during 1980–81. A scheme to provide interest-free production loans to small farmers (subsequently extended effective July 1, 1980 to small fishermen and cooperative societies for water course improvement) through nationalized commercial banks was also introduced with effect from July 1, 1979.

  • (b) Excepting the House Building Finance Corporation and the Small Business Finance Corporation, there was a switchover from interest-based to non-interest operation in nonbank financial institutions.

Part IV

  • 7. (a) The stage is now ripe for a description of the introduction of Islamic banking through legislative instruments and directive powers of the State Bank of Pakistan. The Finance Minister, while presenting the federal budget for 1980–81 on June 26, 1980, announced the decision of the Government to introduce further measures for the extension of interest-free operations to commercial banks. As a first step, separate counters were compulsorily to be opened effective July 1, effective July 1, 1981 by the nationalized banks to accept deposits on a profit- and loss-sharing basis (i.e., PLS deposits). Opening of such counters by foreign banks was optional. One of the foreign banks exercised this option and started accepting PLS deposits. As will be seen from amendments made in the Banking Companies Ordinance of 1962, the PLS deposits were fully earmarked by the banks for interest-free investments. For a variety of reasons, it was not considered feasible to compulsorily introduce Islamic banking at one stroke or to eliminate interest from all financial operations in the economy. Interest-based operations hence continued side by side with interest-free banking. In order to provide a legal cover for these changes and to facilitate the successful implementation of the above-mentioned decision, it was considered necessary to pass new laws or make changes in the existing laws. Accordingly, the following ordinances were promulgated:

Further measures to extend interest-free operations to commercial banks announced

Separate counters for accepting deposits effective January 1, 1981 on profit- and loss-sharing basis announced

Legal cover provided through promulgation of new laws or amendment of existing laws

  • 1. The Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980.

  • 2. The Capital Issues (Continuance of Control) (Amendment) Ordinance, 1980.

  • 3. The Small Business Finance Corporation (Amendment) Ordinance, 1980.

  • 4. The State Bank of Pakistan (Second Amendment) Ordinance, 1980.

  • 5. The Bank (Nationalization) (Amendment) Ordinance, 1980.

  • 6. The Banking Companies (Recovery of Loans) (Amendment) Ordinance, 1980.

  • 7. The Negotiable Instruments (Amendment) Ordinance, 1980.

  • 8. The Banking Companies (Third Amendment) Ordinance, 1980.

  • 9. The Limitation (Amendment) Ordinance, 1980.

  • 10. The Code of Civil Procedure (Amendment) Ordinance, 1980.

  • (b) It will be worthwhile to describe the amendments in each of the above-said laws in some detail so as to permit readers to understand their rationale.

Salient features of law relating to Modaraba and Modaraba Companies

  • (i) The Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980. This ordinance provides for registration of modaraba companies; the flotation, management, and regulation of modaraba; and matters connected therewith or ancillary thereto. It defines modaraba as “a business which a person participates with his money and another with his efforts or skill or both his efforts and skill” and includes “Unit Trusts and Mutual Funds by whatever name called,” and a modaraba company as a company engaged in the business of floating and managing modaraba. No modaraba company is permitted to operate without registration with the Registrar appointed under this ordinance. To be eligible for registration as a modaraba company, every company has to fulfill the following conditions:

  • (1) that it is registered under the Companies Act, 1913 (VII of 1913), or is a corporate body formed under any law in force, and is owned or controlled, whether directly or through a company or corporation, by the federal government or a provincial government;

  • (2) that, being a company solely engaged in the flotation and management of modaraba, it has a paid-up capital of not less than 2½ million rupees;

  • (3) that none of its directors, officers, or employees has been convicted of fraud, breach of trust, or of an offense involving moral turpitude;

  • (4) that none of its directors, officers, or employees has been adjudged an insolvent or has suspended payment to or compounded with his creditors;

  • (5) that its promoters are, in the opinion of the Registrar, persons of means and integrity who have knowledge of matters with which the company may have to deal as a modaraba company; and

  • (6) that, being a company also engaged in businesses other than the flotation and management of modaraba, it has a paid-up capital of such amount and nature as may be prescribed.

A company has to apply for registration to the Registrar on the prescribed Form IX, which is to be accompanied by five copies of its memoranda and articles of association, certificates of incorporation, accepted Treasury Challan in respect to fees paid, five copies of its latest audited accounts (if it is already in business), and a precise description of the business being done other than flotation of modaraba. Subject to his satisfaction about the eligibility of the company and the registration being necessary in the public interest, the Registrar may grant registration on such conditions as he may deem fit. If a modaraba company wants to float a modaraba (which may be either multi-purpose or organized for a specific purpose and organized either for a fixed period or an indefinite period), it has to apply again to the Registrar on Form I, stating the name and type of modaraba; the condition and amounts of modaraba and division thereof into modaraba certificates (i.e., a certificate of definite denomination issued to the subscriber of the modaraba acknowledging receipt of the money subscribed by him); the type of modaraba certificate, along with the registration certificate as a modaraba company; a prospectus duly signed by all of the directors; and a copy of its latest audited balance sheet, profit-and-loss account, etc. “No modaraba shall be a business which is opposed to the injunctions of Islam and a Religious Board constituted under the Ordinance has to certify in writing that the modaraba is not a business opposed to the injunctions of Islam.” After such certification by the Religious Board, the Registrar, on being satisfied that it is in the public interest to do so, may grant a certificate on Form III authorizing the flotation of a modaraba on such conditions as he may deem fit, some of the conditions being that the modaraba shall not undertake any businesses other than those specified in the prospectus and that the modaraba certificate shall be listed for trading on the Stock Exchange. A modaraba shall sue and be sued in its own name through the modaraba company, and its assets and liabilities shall be separate from those of another modaraba, as well as those of the modaraba company. Allotment of modaraba certificates can be made only after approval of prospectus by the Registrar and the raising of the minimum amount stated in the prospectus. Subscriptions of applicants for modaraba certificates have to be kept in a scheduled bank until the allotment of modaraba certificates or until the minimum amount specified in the prospectus is raised by the date specified therein. No modaraba company can engage in any business that is in competition with the business of a modaraba floated by it, nor shall its directors, officers, or their relatives obtain loans, advances, or credits from the funds of the modaraba or on the security of the assets of the modaraba. A modaraba company is permitted to appropriate a fixed percentage, not exceeding 70 percent, of the net amount of the profits of the modaraba as remuneration, in addition to reasonable expenses, each year. Under certain circumstances, which need not be detailed here, the Registrar can, inter alia, cancel the registration of a modaraba company, remove it from the management of modaraba floated by it, appoint an administrator to take over and manage the modaraba in place of the modaraba company, or have an inquiry made into the affairs of a modaraba company or modaraba. The income of a modaraba is exempt from income tax if not less than 90 percent of its profits every year is distributed to the holders of modaraba certificates. It is not permissible for a modaraba to make any loan or contribution to any of the associated undertakings of the modaraba companies, political parties, or other political organizations. The Government is em-powered to constitute an advisory committee to carry out the purposes of the Ordinance. A modaraba can be wound up by the Tribunal, constituted for the purpose by the federal government, on the application of the Registrar under certain circumstances. The Tribunal also has powers to expeditiously decide all claims by a holder of modaraba certificates against the modaraba company or by a modaraba company against any other party with whom it has entered into a business transaction relating to the modaraba fund.

Modarabas have since been successfully floated by many modaraba companies, including the one formed by the National Grindlays Bank Ltd. This is one corporate method of mopping up savings of the people along Islamic lines—that is, using modaraba certificates for investment in such modaraba businesses as are not opposed to the injunctions of Islam. The modaraba certificate is one of the many new financial instruments devised since 1980.

  • (ii) The Capital Issues (Continuance of Control) (Amendment) Ordinance, 1980.

  • The Capital Issues (Continuance of Control) Act, 1947 provides, inter alia, for the continuance of control over issues of capital—that is, over the issuing of any securities for cash or otherwise by a company incorporated in Pakistan or outside Pakistan, except with the consent of the federal government. Similarly, a company, whether incorporated in Pakistan or not, cannot, except with the consent of the federal government, (a) make an issue of capital in Pakistan; (b) make in Pakistan any public offering of securities for sale; (c) renew or postpone the date of maturity or replacement of any security making for payment in Pakistan. The expression “security” meant shares and stock, debentures, other instruments creating a charge or lien on the assets of the company, and instruments acknowledging either a loan to, or the indebtedness of, the company and guaranteed by a third party or entered into jointly with a third party.

New financial instruments existing or devised by the time of the promulgation of the Ordinance, or devised thereafter, included in the definition of the expression “securities”

  • Therefore, to include the new financial instruments existing or devised by the time of the promulgation of the Ordinance, or which could be devised thereafter, it became necessary to extend, through the Promulgation of the Capital Issues (Continuance of Control)(Amendment) Ordinance, 1980, the scope of the expression “securities” to include modaraba certificates; mutual fund certificates and trust units; bonds and participation term certificates; and any other instrument, specified by the federal government in a notification in the Official Gazette, to be a security for the purpose of this Act. In order to maintain synonymity, the State Bank of Pakistan Act, 1956 and the Banking Companies Ordinance, 1962 were also amended in 1980 to insert therein a provision in the definition section to the effect that “securities” included securities as defined in the Capital Issues (Continuance of Control) Act, 1947 (XXIX of 1947).

Need for amendment in the Negotiable Instruments Act, 1881

  • (iii) The Negotiable Instruments (Amendment) Ordinance, 1980.

  • (1) The Negotiable Instruments Act, 1881 defines a promissory note and a bill of exchange in Sections 4 and 5, respectively. The definition includes the elements of an unconditional undertaking or, as the case may be, an unconditional order to pay a certain sum of money to, or the order of, a certain person, or to the bearer of the instrument. Both these sections pertained to interest-based instruments. Because of the switchover, not only did the expression “return in any other form” have to be inserted twice in the third paragraph of Section 5 but also the following had to be necessarily inserted therein as Paragraph 4:

“A promise or order to pay is not ‘conditional’ nor is the sum payable ‘uncertain’ within the meaning of this section or section 4 by reason of the sum payable being subject to adjustment for profit or loss, as the case may be, of the business of the maker.”

  • The definitions of promissory note and bill of exchange, as amended above, were reflected in the definition section of the Limitation Act, 1908 so as to make them also valid for the purposes of that act.

(2) In a nutshell, Sections 79 and 80 provide that when (1) interest at a specified rate is provided in the instrument but no date is fixed for which interest shall be payable from the date of the note or, in the case of a bill, from the date on which the amount becomes payable, until tender or realization of such amount or until the date of institution of a suit to recover such amount; and (2) a promissory note or bill of exchange makes no reference to interest or rate of interest, then interest shall be allowed and calculated at 6 percent per annum from the date of the note or, in the case of a bill, from the date on which the amount becomes payable or, as the case may be, the date at which the same ought to have been paid by the party charged, until tender or realization of the amount due thereon or until the date of institution of a suit to recover such amount. It was, therefore, necessary to add not only the words “or return in any other form” after the word “interest” wherever one wishes to make a consequential amendment but also to insert the following proviso in Section 79:

“Provided that in the case of an amount due on an instrument where the return is on basis other than interest, the return on the amount due, when no rate of return is specified in the instrument, shall be calculated at the following rate:

  • (i) In the case of return on the basis of mark-up in price, lease, hire-purchase or service charges, at the contracted rate of mark-up, rental, hire or service charges, as the case may be; and

  • (ii) In the case of return on the basis of participation in profits and loss at such rate as the Court may consider just and reasonable in the circumstances of the case, keeping in view the profit-sharing agreement entered into between the banking company and the judgment-debtor when the loan was contracted;”

  • “(c) Notwithstanding the provisions of clauses (a) and (b), return on an amount due on an instrument where the return is on basis other than interest shall be allowed from the date it becomes due till the date it is actually paid.”

  • A somewhat similar proviso was added after Section 80. Further, the provisions of the Act, as amended, were made effective notwithstanding anything contained in any other law for the time being in force. A removal-of-difficulty clause was also added in case any difficulty arose in giving effect to any provisions of the said Act as amended. All these changes were effected in the Act through the Negotiable Instrument (Amendment) Ordinance, 1980.

  • (iv) The Code of Civil Procedure (Amendment) Ordinance, 1980.

  • The Code of Civil Procedure, 1908 consolidates and amends the laws relating to the procedure of the courts of civil judicature. Section 34 of the Code authorized the court to order interest in a money decree at such rate as it deemed reasonable on the principal sum adjudged from the date of the suit to the date of the decree, in addition to any interest adjudged on such principal sum for any period prior to the institution of the suit, with further interest at such rate as the court deemed reasonable on the aggregate sum so adjudged, from the date of the decree to the date of payment or such earlier date as the court thought fit. In case the decree was silent with respect to interest, interest was deemed to have been refused and no separate suit therefore could lie. Interest prior to the date of institution of suit was discretionary and, subject to certain conditions, could be awarded under the Interest Act, 1839. Section 34-A was added in 1980. It provided that where the court was of the opinion that a suit was instituted with intent to avoid the payment of public dues (which included the dues of any bank owned or controlled by the federal government) payable by the plaintiff or on his benefit the court might, while dismissing such suit, make an order for payment of interest on public dues at 2 percent above the prevailing bank rate. This was not considered sufficient, and it was, therefore, decided to add the following as Section 34-B to also cover loans given on the basis of markup in price, leases, hire-purchase, service charges, or participation in profit and loss:

Insertion of new Section 34-B wasconsidered necessary

  • “34-B. Interest, etc., on dues of banking company. Where and insofar as a decree is for payment of money due to banking company in repayment of a loan advanced by it, the Court shall, in the decree, provide for interest or return, as the case may be, on the judgment debt from the date of decree till payment:

  • (a) In the case of interest-bearing loans, for interest at the contracted rate or at the rate of 2 percent above the bank rate, whichever is the higher;

  • (b) In the case of loans given on the basis of markup in price, lease, hire-purchase or service charges, for the contracted rate of markup, rental hire or service charges, as the case may be, or at the latest rate of the banking company for similar loans, whichever is the higher; and

  • (c) In the case of loans given on the basis of participation in profit and loss, for return at such rate, not being less than the annual rate of profit for the preceding six months paid by the banking company on term deposits of six months accepted by it on the basis of participation in profit and loss, as the Court may consider just and reasonable in the circumstances of the case, keeping in view the profit-sharing agreement entered into between the banking company and the judgment debtor when the loan was contracted.

  • Explanation._____(1) In this Section in clause (a), ‘bank rate’ has the same meaning as in Section 34-A.”

  • This amending Ordinance had effect notwithstanding anything contained in any other law for the time being in force. It also contained the removal-of-difficulty clause for giving effect to the provisions of the Code as amended by it.

  • (v) The Banking Companies (Recovery of Loans) (Amendment) Ordinance, 1980.

A change was needed in the Banking Companies (Recovery of Loans) Ordinance, 1979

  • The Banking Companies (Recovery of Loans) Ordinance, 1979 provides, inter alia, for the securing and repayment of loans outstanding on the commencement of the Ordinance but becoming time-barred on or after January 1, 1974 and the adjudication of claims by or against a banking company in respect of, or arising out of, a loan, as defined in the Ordinance, through special courts by resorting to a summary procedure as provided in Order XXXVIII in the First Schedule to the Civil Procedure Code. In order to include Islamic modes of finance, the definition of loan as contained in the Ordinance, besides containing other matters, was changed by the amending Order to mean “loans, advances and credit as contained in the Banking Companies Ordinance, 1962.” The Banking Companies (Third Amendment) Ordinance, 1980 had inserted in the Banking Companies Ordinance, 1962 a provision to the effect that “loans, advances and credit included finances provided on the basis of participation in profit and loss, markup in price, lease, hire-purchase or otherwise.” This definition was also adopted for the purpose of the Banks (Nationalization) Act, 1974 by the Banks (Nationalization) (Amendment) Ordinance, 1980. The amending Ordinance also modified subsection (2) of the Act’s Section 8 to read as follows:

  • “(2) The decree shall provide for interest or return, as the case may be, on the judgment-debt from the date of the19 decree till payment _____

    • (a) in the case of interest-bearing loans, for interest at the contracted rate or at the rate of 2 percent above the bank rate whichever is the higher;

    • (b) in the case of loans given on the basis of mark-up in price, lease, hire-purchase or service charges, for the contracted rate of mark-up, rental, hire or service charges, as the case may be, or at the latest rate of the banking company for similar loans, whichever is the higher; or

    • (c) in the case of loans given on the basis of participation in profit and loss, for return at such rate, not being less than the rate of annual profit for the preceding six months paid by the banking company on term deposits of six months accepted by it on the basis of participation in profits and loss, as the Special Court may consider just and reasonable in the circumstances of the case, keeping in view the profit-sharing agreement entered into between the banking company and the judgment-debtor when the loan was contracted.

    • Explanation. In this sub-section, in clause (a), “bank rate” means the bank rate determined and made public under the provisions of the State Bank of Pakistan Act, 1956 (XXXIII of 1956).”

  • Besides, Section 10 was amended to authorize the Special Court to pay to a banking company, out of the fine imposed on a convicted person, compensation for the loss caused by the offense, “including loss of income on a loan given by it on the basis of participation in profit and loss.” It also provided a clause for removing difficulties, if any, arising in giving effect to any provisions of this ordinance by such order made by the federal government as appeared to it to be necessary to remove the difficulty.

  • (vi) The Banking Companies (Amendment) Ordinance, 1980.

Position reflected in the Banking Companies Ordinance, 1962

  • By the Ordinance, apart from enlarging the scope of approved securities for the purpose of the Ordinance (e.g., requirement of minimum paid-up capital and reserves in relation to foreign banks and of maintenance of liquid assets by all banks, the following definitions of “creditor” and “debtor” were inserted to make room for the new modes of receiving deposits or extending financial accommodation:

    • “(dd) ‘Creditor’ includes persons from whom deposits have been received on the basis of participation in profit and loss and a banking company or financial institution from which financial accommodation or facility has been received on the basis of participation in profit and loss, mark-up in price, hire-purchase, lease or otherwise.”

    • “(ee) ‘debtor’ includes a person to whom, or a banking company or financial institution to which, financial accommodation or facility has been provided on the basis of participation in profit and loss, mark-up in price, hire-purchase, lease or otherwise.” Section 7 of the Banking Companies Ordinance, 1962 was also amended to authorize a banking company to act as a modaraba company under The Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980. If a banking company so chose, it could also form a subsidiary company, for which purpose amendment was made to that effect by the amending Ordinance in Section 23 of the Banking Companies (Recovery of Loans) Ordinance 1979. Section 9, which prohibited trading by a banking company, was reconstituted and every banking company was authorized to do trading only to the extent authorized by Section 7—that is, for the “purchase of properties, movable or immovable, exclusively for being leased out or for being sold on hire-purchase basis or on deferred payment basis with mark-up.” The underwriting of modaraba certificates and participation certificates became a permissible activity of banking companies. The State Bank of Pakistan has power to control advances by banking companies under Section 25 of the Banking Companies (Recovery of Loans) Ordinance, 1979. So as to reflect in a way the new modes of financing, subsection (2) of Section 25 was substituted as under:

    • “(2) Without prejudice to the generality of the power conferred by sub-section (1), the State Bank may give directions to banking companies either generally or to any banking company or group of banking companies in particular:

      • (a) as to the credit ceilings to be maintained, credit targets to be achieved for different purposes, sectors and regions, the purposes for which advances may or may not be made, the margins to be maintained in respect of advances, the rates of interest, charges or mark-up to be applied on advances and the maximum or minimum profit sharing ratios; and

      • (b) prohibiting the giving of loans, advances and credit to any borrower or group of borrowers on the basis of interest, either for a specific purpose or for any purpose whatsoever; and each banking company shall be bound to comply with any direction so given.”

In addition, the following new Section 26-A (which hardly needs any explanation) was added:

  • “26-A, Deposits. (1) Deposits of money may be accepted by a banking company on the following basis:

  • (i) on participation in profit and loss of the banking company;

  • (ii) free of interest or return in any form; and

  • (iii) until20 such time as the Federal Government determines and notifies, by publication in the Official Gazette, that the domestic operations of the banking companies have become free of interest, on interest.

(2) Every banking company receiving deposits on the basis of participation in profit and loss shall maintain separate accounts in respect thereof as also of investment made, finance provided out of the amount of such deposits, cash reserves and liquid assets maintained there against and all income and expenditure relating thereto.

(3) Deposits received on the basis of participation in profit and loss shall be invested or employed, at the absolute discretion of the banking company, only in transactions or business the return on which does not accrue to the banking company by way of interest.

(4) A person depositing money with a banking company on the basis of participation in profit and loss shall be entitled, subject to such general directions as the State Bank may give from time to time in the interest of monetary stability, to receive periodically such share of the profit of the banking company arising out of suchtransactions as may be determined by it and, in the event of loss incurred by the banking company, shall be liable to bear proportionate loss.”

Section 29 was also amended to provide that in computing the amount of liquid assets to be maintained on the close of every day by a banking company, among others, any balances maintained in Pakistan by a banking company in current account with the State Bank or its agent, or both, or “in profit and loss sharing term deposit account with the State Bank” will be counted as cash. In the like manner, Section 31, which deals with unclaimed deposits, was amended to provide that as soon as an unclaimed amount is paid by a banking company to the State Bank it shall cease to bear interest “or rank for a share of profit or loss.” Subsection 6 of Section 83 makes provisions for imposition of a penalty, at the rate indicated therein, on a banking company in respect of every day of default on its part in maintaining the statutory requirement of maintenance of liquid assets. A proviso was addred to this sub-section to the effect that “in the case of default relating to liabilities assumed on the basis of participation in profit and loss, the penalty shall be as determined by the State Bank from time to time.” Apart from making consequent amendments in Section 91-A, the following was added as Section 91-B:

  • “91-B. Removal of difficulties. If any difficulty arises in giving effect to any of the provisions of this Ordinance, the Federal Government may make such order as may appear to it to be necessary the purpose of removing the difficulty.”

State Bank of Pakistan Act, 1956 had to be amended to enable the State Bank to make loans on a profit- and loss-sharing basis and to provide for certain other allied matters

  • (vii) The State Bank of Pakistan (Amendment) Ordinance, 1980.

  • Effective July 1, 1979, the State Bank was authorized by Ordinance No. XLVII of 1979 to provide “finances to scheduled banks or financial institutions on the basis of participation in profits and loss on such other terms and conditions as the Central Board may decide from time to time.” By means of the above amending ordinance, apart from insertion of definition of “securities” stated elsewhere, the following definitions were also inserted to introduce the new modes of financing and to avoid having to amend other sections of State Bank of Pakistan Act, 1956 wherever these expressions were used:

    • (i) “(ff) ‘debentures’ includes Participation Term Certificates”;

    • (ii) “‘loans and advances’ includes finances provided on the basis of participation in profit and loss, mark-up in price, leasing, hire-purchase or otherwise”; and “(o) ‘Shares’ includes Modaraba Certificates.”

Consequently, the purchase, sale, and rediscount of participation term certificates became permissible under Section 17(2)(c). Similarly, loans and advances can be given to banks on the basis of participation in profit and loss, markup in price, leasing, hire purchase, or otherwise. Subclause (d) of clause (4) of Section 17 of the State Bank of Pakistan Act, 1956 was also amended by the ordinance to give loans and advances on demand or on the expiry of a fixed period not exceeding 180 days to local authorities, scheduled banks, or cooperative societies, inter alia, on the security of promissory notes supported by “such Modaraba Certificates or Participation Term Certificates” as were acceptable to the Bank. Clause (13) of Section 17 of the State Bank of Pakistan Act, 1956 authorizes the Bank to act as an agent to the federal government, any provincial government, or any local authority in the several matters mentioned therein. Partly to reflect the new changes, subclause (c) was amended to read as follows: “(c) the collection of the proceeds, whether principal or interest, profit, dividend or other return, on any securities.” Section 20 of the Act prohibits the State Bank from allowing interest on deposits on current account. The prohibition was extended by the amending ordinance to “return in any other form” on deposits on current account. Section 22, which deals with the Bank rate, was amended by this ordinance to provide that “in respect of finance provided by the Bank on basis other than interest it may determine, from time to time, the terms and conditions either generally or specifically.” Section 36 deals with the cash reserve required to be kept with the State Bank by the scheduled banks. It also provides for imposition of a penalty in case the balance held on any day with the Bank is below the minimum fixed under Subsection (1) or Subsection (2). This had to be amended, as shown below, to provide for imposition of penalty in the case of liabilities assumed on the basis of profit and loss sharing:

“(b) in the case of its liabilities assumed on the basis of profit and loss sharing, in respect of such day a penalty at a rate that may be prescribed by the Bank from time to time on the amount by which the balance with the Bank falls short of the fixed minimum, and if on the day on which the next return is due such balance is still below the fixed minimum as disclosed by this return, the penalty may be increased by 25 percent in respect of that day and each subsequent day on which the balance held at the Bank at the close of business on the day is below the fixed minimum.”

As usual, it was also provided that “this Act shall have effect notwithstanding anything contained in any other law for the time being in force or any agreement, contract or articles of association.” Similarly, a removal-of-difficulties clause was also inserted for the purpose of removing any difficulty that might arise in giving effect to any of the provisions of the Act.

Part V

  • 8. (a) In exercise of the powers vested in it under Section 25(2) of the Banking Companies Ordinance, 1962, the State Bank directed, vide BCD (Banking Control Division) Circular No. 26, dated December 24, 1980, that on and from the dates mentioned below (i) no banking company shall provide financial accommodation in any form for the purposes mentioned below on the basis of interest; and (ii) financial accommodation for these purposes by a banking company shall be only on the basis indicated against each and on no other basis:

Directive exercised powers conferred under Section 25 of the Banking Companies Ordinance, 1962

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In the context of (vii) above, it may be noted that the LIM (loan against imported merchandise) facility will continue to be on the existing basis of interest.

“2. The financing of the entire trading operations of Rice Export Corporation of Pakistan, Cotton Export Corporation and Trading Corporation of Pakistan will stand changed to mark-up basis and shall cease to have any element of interest as from 1st March, 1981. All advances outstanding against them on the 28th February, 1981 shall be deemed to have been repaid to the banks with interest accrued thereon on the 1st March, 1981 and thereafter re-lent by them the same day on mark-up basis. Stocks against which the advances had been made will be deemed to have been purchased by the banks for the outstanding amount and then sold on marked-up price to these corporations on deferred payment of 90 days.

3. As a result of the above, financing of Cotton Export Corporation under Part I of the Export Finance Scheme of the State Bank will also stand changed to mark-up basis and shall cease to have any element of interest as from 1st March, 1981. Financing of other parties under the said Scheme will, however, continue on the existing basis of interest.”

  • (b) Viz., Circular No. 30, dated December 12, 1980, the State Bank directed that as from March 1, 1981:

    • “(i) in the case of finances, other than export finance under the Export Finance Scheme of the State Bank and for commodity operations against counter-finance limits sanctioned by the State Bank, provided to the Rice Export Corporation of Pakistan, Cotton Export Corporation and Trading Corporation of Pakistan, no banking company shall apply mark-up in prices of more than 3.5% for 90 days; and

    • (ii) in the case of finance provided to the Cotton Export Corporation under the Export Finance Scheme, no banking company shall apply mark-up in price of more than 0.75% for 90 days.”

The State Bank, in supersession of previous Circular No. 30, dated October 26, 1987, prescribed charges for different modes to be charged by banks (under BCD Circular No. 31, dated December 24, 1980) and by the State Bank. (BCD Circular No. 32, dated December 24, 1980) on different modes of financing.

  • (c) By another directive (viz., BCD Circular No. 26, dated November 9, 1981), the State Bank directed that “with effect from the 16th November, 1981, no banking company shall provide financial accommodation in any form to the Utility Stores Corporation for financing its trading operations on the basis of interest. As from that date financial accommodations to the Corporation for its trading operations shall be provided on the basis of mark-up in price and no banking company shall apply mark-up in price of more than 3.5% for 90 days.

  • 2. All advances outstanding against the Corporation on the 15th November, 1981 shall be deemed to have been repaid to the banks with interest accrued thereon on the 16th November, 1981 and thereafter re-lent by them the same day on mark-up basis. Stocks against which the advances had been made will be deemed to have been purchased by the banks for the outstanding amount and then sold on marked-up price to the Corporation on deferred payment of 90 days.”

  • (d) By yet another Circular (No. 21, dated June 30, 1982), it was decided to enlarge the area of interest-free banking from July 1, 1982 as shown below:

    • “i) FINANCING OF WORKING CAPITAL NEEDS OF SELECTED CUSTOMERS IN TRADE AND INDUSTRY ON THE BASIS OF PROFIT AND LOSS SHARING (i.e. ‘MUSHARIKA’).

Banks will be free to provide finance for working capital needs of customers in trade and industry on a selective basis on the basis of sharing of profit and loss (‘MUSHARIKA’). Both the bank and the client will have the option either to extend/avail of finance on PLS basis or on the basis of interest.

A certain proportion of profit in a venture will be payable to the client as management fee. The remaining profit will be distributable between the bank and the client on the basis of their respective funds employed in the venture, calculated on daily product basis. It has been decided to allow complete flexibility, for the time being, to the banks to negotiate with their clients the proportion of the management fee, the sharing ratio of the remaining profit and the weightage, where necessary to be given to the bank’s or the client’s funds employed in the venture. However, the sharing ratio of the remaining profit (viz. profit left after payment of management fee) once determined in relation to a venture, will not be alterable.

The proportion of profit payable to the client as management fee (subject to achievement by the client of profit at the projected level) as well as the sharing ratio of the remaining profit between the bank and the client and the weight-age to be given to the funds of the client or those of the bank will be mutually determined on the basis of profit projection given by the client. If the actual profit turns out to be more than that projected, the bank may, at its discretion, enhance the management fee and vice versa. However, the sharing ratio of the remaining profit and the weightage, where necessary given to the client’s or the bank’s funds as originally determined shall remain unalterable.

In case of loss, the loss will be borne by the bank and client strictly in the ratio of their respective funds employed in the venture, calculated on daily product basis.

  • ii) FINANCING OF FIXED CAPITAL INVESTMENT NEEDS OF SELECTED INDUSTRIAL CUSTOMERS ON THE BASIS OF LEASING.

Banks will be free to provide finance for fixed capital investment needs to their industrial customers on a selective basis on the basis of leasing. Both the bank and the client will have the option whether to extend/avail of finance on the basis of leasing or on interest basis.

The banks will, for the time being, have complete flexibility in negotiating terms of leasing with their clients.

  • iii) FINANCING OF SELECTED CUSTOMERS IN TRADE AND INDUSTRY ON THE BASIS OF HIRE-PURCHASE.

Banks will be free to provide finance for purchase of machinery/equipment/vehicles etc. to their clients in trade and industry on selective basis on the basis of hire-purchase. They will have complete flexibility, for the time being, to negotiate terms of hire-purchase with their clients.”

(e) Circular No. 13, dated June 20, 1984, provided as under:

  • “(i) As from the 1st July, 1984, all banking companies will be free to make finances available in any of the under-noted modes. However, as transitional arrangement they will also be free to lend on the basis of interest, provided that no accommodation for working capital will be provided or renewed on interest basis for a period of more than six months.

  • PERMISSIBLE MODES OF FINANCING

(A) Financing by lending:

  • i) Loans not carrying any interest on which the banks may recover a service charge not exceeding the proportionate cost of the operation, excluding the cost of funds and provision for bad and doubtful debts. The maximum service charge permissible to each bank will be determined by the State Bank from time to time.

  • ii) Qard-e-Hasana loans given on compassionate ground free of any interest or service charge and repayable if and when the borrower is able to pay.

  • (B) Trade-related modes of financing including the following:

    • i) Purchase of goods by banks and their sale to clients at appropriate mark-up in price on deferred payment basis. In case of default, there should be no mark-up on mark-up.

    • ii) Purchase of trade bills.

    • iii) Purchase of movable or immovable property by the banks from their clients with Buy-Back Agreement or otherwise.

    • iv) Leasing.

    • v) Hire-purchase.

    • vi) Financing for development of property on the basis of a development charge.

The maximum and the minimum rates of return to be derived by the banks from these modes of financing will be as may be determined by the State Bank from time to time.

  • (C) Investment type modes of financing. These modes include the following:

    • i) Musharika or profit and loss sharing.

    • ii) Equity Participation and purchase of shares.

    • iii) Purchase of participation term certificates and Mudaraba certificates.

    • iv) Rent-sharing.

The maximum and minimum rates of profit to be derived by the banks from such transactions will be as may be prescribed by the State Bank from time to time. However, should any losses occur, they will have to be proportionately shared among all the financiers.”

  • “(ii) As from the 1st January, 1985, all finances provided by a banking company to the Federal Government, Provincial Governments, public sector corporations and public or private joint stock companies shall be only in any one of the modes indicated hereinbefore.

  • (iii) As from the 1st April, 1985, all finances provided by a banking company to all entities, including individuals, shall be on the same basis as mentioned in (ii) above.

  • (iv) The appropriate mode of financing to be adopted in any particular case will be settled by agreement between the banking company and the client. Some possible modes of financing for various transactions have been shown below.

POSSIBLE MODES OF FINANCING FOR VARIOUS TRANSACTIONS

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  • VI. (1) As from the 1st July, 1985, no banking company shall accept any interest-bearing deposits. As from that date, all deposits accepted by a banking company shall be on the basis of participation in profit and loss of the banking company, except deposits received in Current Account on which no interest or profit shall be given by the banking company.

  • (2) The instructions contained in items (i), (ii), and (iii) above shall, however, not apply to on-lending of foreign loans which will continue to be governed by the terms of the loans. Likewise, the instructions contained in item (v) above shall not apply to foreign currency deposits.”

  • VII. BCD Circular No. 26, dated November 26, 1984, detailed the formula for calculation of service charges on loans other than “Qard-e-Hasana” during an accounting year. Vide Circular No. 32, dated November 26, 1984, banks were directed that effective January 1, 1985, interest, whenever charged by a banking company in any of the items of bank charges, would be replaced by a non-interest mode considered appropriate by it and that overdue/penal interest or markup would not be charged by a banking company as from that date. Instead, it might take legal steps for recovery of the overdue finance.

  • VIII. Vide BCD Circular No. 33, dated November 26, 1984, all banks and development financial institutions were advised that effective January 1, 1985, finance for meeting temporary liquidity, including discounting facilities (hitherto extended on interest), will be provided by the State Bank, on a profit-and loss-sharing basis, in accordance with the formula laid down therein. Again, in terms of BCD Circular No. 34, dated November 26, 1984, all banks and development financial institutions receiving PLS deposits were required to declare half-yearly rates of profit on various types of its PLS deposits after prior clearance from the State Bank. The formula for working out rates of profit was indicated in this circular. With effect from January 1, 1985, the minimum and maximum range of the annual rate of profits earned by a bank/development financial institution in respect of trade-related modes of financing and investment modes of financing were to be within the limits respectively indicated in BCD Circular No. 37, dated December 10, 1984, read with BCD Circular No. 23, dated May 25, 1983, and BCD Circular No. 38, dated December 10, 1984, read with BCD Circular No. 24, dated May 25, 1985. All banks and development financial institutions were required by BCD Circular No. 39, dated December 10, 1984, to provide finance only on the basis of any one of the non-interest modes of financing considered appropriate by them. The State Bank was to provide refinance to them under Part I (Local Sales) of the scheme on a profit-and loss-sharing basis. The share of the State Bank was to be 75 percent, and any loss was to be met first out of the reserves and credit balance in the profit-and-loss account of the banks/development financing institutions, and if any loss remained, it would be shared by all financiers in proportion to the respective amounts provided by them. As for Part II (Export Sales) of the scheme, the State Bank would continue to provide refinance by way of loans without interest or service charge. Finance provided under the Export Scheme was com-pulsorily to be made, effective January 1, 1985, on the basis of any one of the non-interest modes of financing considered appropriate by the banks and development financing institutions. All savings accounts, regardless of the date of their opening, were required to be on the basis of participation in profit and loss of the banking company in terms of BCD Circular No. 29, dated June 12, 1985. I will not further burden this paper with the contents of other circulars on the subject issued by the Banking Control Department of the State Bank.

Part VI

  • 9. (a) Pursuant to the announcement of Pakistan’s Finance Minister in his budget speech for 1984–85, steps towards complete transformation of domestic banking operations were taken in 1985. Some of the steps taken by the State Bank have already been stated in the preceding paragraphs. The complete switchover to non-interest-based financing, which became effective on July 1, 1985, required more changes in laws. Accordingly, the President was pleased to promulgate The Banking and Financial Services (Amendment of Laws) Ordinance, 1984 and The Banking Tribunals Ordinance, 1984. Each of the provinces also passed ordinances whereby changes were made in The Cooperative Societies Act, 1925; The Stamp Act, 1899; The Cooperative Societies and Cooperative Banks (Repayment of Loans) Ordinance, 1966; and the West Pakistan Finance Act, 1963. Brief mention of the salient features of the above laws is given in the next sub-paragraph.

Second and third phase of amendments in existing laws for complete switchover to non-interest-based banking

Relaxation mregistration fee and stamp duty pro-vided to avoid burdening banks and borrowers with additional cost

Agreement for sharing of profit and loss between a banking company and borrowers exempted from the Partnership Act, 1932

  • (b) The Banking and Financial Services (Amendment of Laws) Ordinance, 1984.

  • The Ordinance amended the Registration Act, 1908; The Partnership Act, 1932; The Banking Companies Ordinance, 1962; The Wealth Tax Act, 1963; The Establishment of the Federal Bank for Cooperatives and Regulation of Cooperative Banking Act, 1977; The Income Tax Ordinance, 1979; and the Companies Ordinance, 1984.

    • (i) Amendments in The Registration Act, 1908 and The Stamp Act, 1899.

    • Section 78 of the Act provides for preparation of a table of fees payable for registration of documents, searches of documents, and certain other matters described in this section. Similarly, The Stamp Act, 1899 provides for stamp duty payable on execution of several documents mentioned therein. Since financing in the new modes entailed additional documentation and cost, in order to save banks and borrowers from the additional expenses, Section 78 of the Registration Act, 1908 and The Stamp Act, 1899 were amended to authorize the federal government or, as the case might be, the provincial governments to exempt, by notification in the Official Gazette, from payment of fees or stamp duty, either in whole or in part, any instrument executed by, or in favor of, a banking company (as defined in the Banking Tribunals Ordinance, 1984) in the normal course of its banking business. In due course, these notifications21 were issued by the federal government and provincial governments.

    • (ii) Amendment of the Partnership Act, 1932.

    • This act defines partnership “as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.” A partner’s liability is unlimited, and the liabilities of a partnership can be recovered from all or any of the partners. Further, every partner has a right to participate in the conduct of business. The Act also contains provisions about many matters — for example, the relation of partners to third parties, incoming and outgoing partners, dissolution of a firm, mutual rights and liabilities of partners, consequences arising from not registering a firm with the Registrar of Firms. Thus, if a depositor is made a partner, not only could his liability far exceed the amount of his deposit but also the partnership itself might be illegal if the number of partners exceeded 20 persons. In the latter event, beside violating Section 14 of the Companies Ordinance, 1984, every such partner would be personally liable for all the liabilities incurred in the business that was illegally carried on by the firm. Therefore, with a view to avoiding any difficulties that might be created by the above and other such technicalities, and to protecting depositors, it was considered necessary to amend the Partnership Act, 1932 by inserting Section 6A therein to the effect that “nothing contained in this Act shall apply to a relationship created by any agreement between a banking company and a person or group of persons providing for sharing of profits and losses arising from or relating to the provisions by the banking company of finance to such person or group of persons. Explanation: For the purposes of this Section, a ‘banking company’ and ‘finance’ would have the same meaning as in the Banking Tribunals Ordinance, 1984.”

Banking Companies Ordinance, 1962 further amended

Banker-customer relationship retained

  • (iii) Amendment in the Banking Companies Ordinance, 1962.

  • According to Islamic law, the relationship in the several Islamic modes of financing—such as modaraba, musharika, murabaha, ijara—between the financier and the financed is different from that of creditor and debtor. To avoid distortion, as far as possible, the definition of debtor, earlier inserted by Ordinance No. 58 of 1980, was changed by the amending ordinance to include “a person to whom, or a banking company or financial institution to which, finance as defined in the Banking Companies Ordinance, 1984 has been provided.” Similarly, the definition of “loans, advances and credits” was modified so that it “included ‘finance’ as provided in the Banking Tribunals Ordinance, 1984.” Thus, the banker-customer relationship under the non-interest-based banking system was not disturbed. The expression “finance” has been exhaustively defined in the Banking Tribunals Ordinance, 1984, as follows:

Finance defined

  • “(e) ‘finance’ includes an accommodation or facility under a system which is not based on interest but provided on the basis of participation in profit and loss, mark-up or mark-down in price, hire-purchase, lease, rent-sharing, licensing, charge or fee of any kind, purchase and sale of any property, including commodities, patents, designs, trade marks and copyrights, bills of exchange, promissory notes or other instruments with or without buy-back arrangement by a seller, participation term certificate, mus-harika certificate, modaraba certificate, term finance certificate or any other mode other than an accommodation or facility based on interest and also includes guarantees, indemnities and any other obligation, whether fund based or non-fund based, and any accommodation or facility the real beneficiary whereof is a person other than the person to whom or in whose name it was provided;” Section 7 of the Ordinance lists the various forms of business in which a banking company may engage. Since new financial instruments were evolved, clause (a) of a subsection of this section was amended in three places to include therein “participation term certificates, term finance certificates, musharika certificates, modaraba certificates and such other instruments as may be approved by the State Bank.” Subclause (aa) was also added to authorize every banking company to provide finance as described above. Existing clause (ee) was also replaced by the following, thereby enlarging its scope: “(ee) ‘debtor’ includes a person to whom, or a banking company or financial institution to which, finance as defined in the Banking Tribunals Ordinance, 1984, has been provided;” Section 10 deals with disposal of non-banking assets by every bank. Of necessity it had to be amended to exempt from its purview the holding of immovable property required for its own use or “as may be permitted by the State Bank from time to time.” Thus, to some extent, the State Bank has retained control over the holding of immovable property by the banks. By means of an amendment to Section 23, every bank was also permitted to form any subsidiary for the conduct of any form of business permitted by Section 7. In order to give blanket protection to banks, their officers, and their employees; to exempt banks from requirements of license or permit of any description; and to keep intact charges created to secure any interest-based facility even if it were subsequently converted into, or replaced by, any facility not based on interest, etc., the following self-explanatory sections were added to the Ordinance:

  • “93A. Exemption of Officers, etc. from Liability_______.

  • A banking company and its officers and employees shall be exempted from criminal or civil liability of every description provided for in any law in respect of any property, movable or immovable, owned by the banking company, exclusively or jointly with another person or persons so long as the property remains in the custody, power and control of such person or persons on account of license, lease, hire-purchase, forward sale, rent-sharing agreement or in any other arrangement within the purview of clauses (ee) and (gg) of Section 5.

  • 93B. Exemption from requirement of license._______

  • Any requirement of a license or permit to import or export any commodity or article or its purchase or sale shall not apply to a banking company undertaking such transaction in the normal course of its banking business.

  • Explanation. _______In this section, a transaction undertaken by a banking company shall be deemed to be in the normal course of its banking business, only if it is based on an agreement for sale or purchase, lease, or hire-purchase of the said commodity or article by the banking company with its customer to whom finance is provided by it and who is in possession of a valid license or has otherwise complied with the requirements of law governing the import or export or sale or purchase of such commodity or article.

  • 93C. Exchange of information. _______

  • (1) Banking Companies may exchange on confidential basis amongst themselves, either directly or through the Pakistan Banking Council, information about their respective clients.

  • (2) No suit or other legal proceeding shall lie against the Pakistan Banking Council or any banking company or any officer of the Pakistan Banking Council or banking company for anything which is in good faith done in pursuance of this section or for any damage caused or likely to be caused by anything done or intended to be done as aforesaid.

  • 93D. Continuance of charge and priority._______

  • Where a charge over any property has been or is created by any person in favour of a banking company to secure any interest-based facility extended by the banking company to such person and such facility is at any time converted into or substituted by any facility not based on interest, such charge shall continue to remain valid and shall maintain its priority in favour of the banking company against all charges created by such person in favour of any other person subsequent to the original date of registration of such charge.

  • Explanation. _______ For the purposes of sections 93A, 93B, 93C and 93D, ‘banking company’ shall have the same meaning as in the Banking Tribunal Ordinance, 1984.”

Provisions on the pattern of Section 93A were made in the Charter of Federal Bank for Cooperatives by Ordinance No. LVII of 1984 and on the pattern of Section 93B and 93D by Act No. XX of 1985. Similarly, the Agricultural Development Bank Ordinance, 1961 was amended by Act No. XXI of 1985 to make provisions therein on the above lines.

Charters of Federal Bank for Coopera-tives and Agricultural Development Bank of Pakistan further amended

  • (iv) Amendments in the charters of Federal Bank for Cooperatives and the Agricultural Development Bank Ordinance, 1961.

  • The changes brought in the provisions of the Banking Companies Ordinance, 1962 and the Banking Tribunals Ordinance, 1984 were reflected in the charter of the Federal Bank for Cooperatives by Ordinance No. LVII of 1984 and that of Agricultural Development Bank by Act XXI of 1981. For example, “loans, advances and credit” was to include “finance,” as defined in the Banking Tribunals Ordinance, 1984 and all cognate expressions were “to be construed accordingly.” The pertinent section in both laws authorizing the concerned bank to transact the several kinds of business described therein was amended as well to include therein, inter alia, the following:

    • (1) “obtain or raise funds on the basis of participation in profit and loss, mark-up and mark-down in price, hire-purchase, lease, rent-sharing, licensing, charge or fee of any description, participation term certificates, modaraba certificates and such other instruments as may be approved by the State Bank, purchase or sale of any property, including commodities, patents, designs, trade marks and copyright, with or without buy-back arrangements with the seller or on condition of payment of its price in one or more installments of a stated future date or dates or any other mode not based on interest”;

    • (2) “the subscribing to the debenture or participation term certificates or term certificates or modaraba certificates or musharika certificates, and such other instruments as may be approved by the State Bank, of any body corporate concerned with agriculture or the financing of agriculture or the financing of cottage industries in rural areas which are repayable within a period not exceeding ten years”;

    • (3) “the purchasing or otherwise acquiring in the normal course of its banking business of any residential or commercial property, movable or immovable, including commodities, patents, designs, trade marks and copyrights, with or without buy-back arrangements by the seller, or for outright sale or sale in the form of hire-purchase or on deferred payment basis with mark-up or for leasing or licensing or for rent-sharing or for any other mode of financing other than one based on interest and, until so disposed of, dealing with and maintaining the same.”

Consequential amendments were made in another clause dealing with the selling and realizing of all property, whether movable or immovable property, “commercial or residential, including commodities, patents, designs, trade marks and copyrights,” which may in any way come into the possession of the Federal Bank for Cooperatives in satisfaction, etc. of any of its claims, and the acquisition and the holding of, and generally the dealing with, any right, title or interest in any property, movable or immovable, “commercial or residential, including commodities, patents, designs, trade marks and copyrights.” Section 30 of the Agriculture Development Bank of Pakistan Ordinance, 1961 was also amended and the Government was authorized to provide, in the rules, for “the manner, conditions and terms of issue and redemption of bonds, debentures, participation term certificates, term finance certificates, modaraba certificates, musharika certificates and such other instruments as may be approved by the State Bank.”

In addition to the foregoing, the following amendments were also made in the charter of the Federal Bank for Cooperatives:

  • (4) Section 19 had provided for borrowing and raising finances through the issue and sale of bonds and debentures carrying interest. In keeping with the new requirements, it was replaced with the following:

  • “19. Power to borrow or obtain finance:

    • (1) The Bank may, for the purpose of its business, borrow or obtain finance from all or any of the persons and in the manner mentioned in clause (ii) or clause (iiia) of sub-section (2) of Section 17 and raise funds by issue and sale of bonds, debentures, modaraba certificates, participation term certificates, musharika certificates, term finance certificates and such other instruments as may be approved by the State Bank:

    • Provided that the aggregate of the sums due on such bonds, debentures, modaraba certificates, participation term certificates, mus-harika certificates, term finance certificates and such other instruments as aforesaid issued and outstanding and the contingent liabilities of the Bank in respect of guarantees shall not, at any time, exceed ten times the aggregate of the amount of the paid-up share capital and reserves of the Bank.

    • (2) The bonds, debentures, modaraba certificates, participation term certificates, mush-arika certificates, term finance certificates and such other instruments as aforesaid may be guaranteed by the Federal Government as to repayment of the principal and return, if any having regard to the terms thereof.”

  • (5) Section 28, which gives power to the Federal Bank for Cooperatives to lay down guidelines and give directives, was also amended to authorize that Bank to give directives to provincial cooperative banks as to “charges or mark-up to be applied on advances or the maximum and minimum profit-sharing ratios to be derived therefrom, and return to be given on deposits.”

  • (6) Section 40 was amended to exempt from compulsory registration “bond, debenture, participation term certificate, term finance certificate, Musharika certificate, Modaraba certificate or such other instrument as may be approved by the State Bank” issued by that bank and not creating, declaring, assigning, limiting, or extinguishing any right, title, or interest to or in any immovable property except insofar as it entitled the holder to the security afforded by a registered instrument whereby the Bank had mortgaged, conveyed, or otherwise transferred the whole or part of its immovable property or any interest therein to trustees upon trust for the benefit of the holders of such instruments.

  • (7) The Federal Bank for Cooperatives regulates and supervises the provincial cooperative banks. Section 29 deals with the maintenance of liquid assets by every provincial cooperative bank. Any default in this regard, besides amounting to an offense, also attracts the imposition of a penalty at the rate given in Section 43(8), on the pattern of Section 83(6) of the Banking Companies Ordinance, 1962. The following proviso was added to reflect the new thinking:

  • “Provided that _______

  • (1) in the case of default in complying with the requirement of Section 29 relating to liabilities assumed on the basis of participation in profit and loss, the penalty shall be as determined by the Bank from time to time; and

  • (2) in the case of default in complying with the requirement of sub-section (3) of Section 42, the penalty shall be as determined by the Bank from time to time.”

  • (v) Amendment of the Wealth Tax Act, 1963 and the Income Tax Ordinance, 1979.

    • (1) Section 45 of the Wealth Tax Act, 1963, inter alia, exempts banking companies from the Act. Apart from banking companies, so far about 13 development financing institutions have been included in the definition of banking company for the purposes of the Banking Tribunals Ordinance, 1984. By virtue of addition of the words “as defined in the Banking Tribunals Ordinance, 1984” after the words “banking company,” these development financing institutions have also been exempted from the Wealth Tax Act, 1963.

    • (2) The Income Tax Ordinance, 1979.

    • Section 23 provides that in computing the income under the head “income from business or profession,” it will be permissible for the assessee to make the allowances and deductions listed out therein. This list was extended to include the following matters:

    • “(vii-aa) any sum paid to a modaraba or to a Participation Term Certificate holder for any funds borrowed for the purposes of the business or profession;

    • (vii-b) any sum paid or credited to any person maintaining a profit and loss sharing account or deposit with a scheduled bank by way of distribution of profits by the said bank in respect of the said account or deposit;

    • (vii-c) any sum paid by the House Building Finance Corporation constituted under the House Building Finance Corporation Act, 1952 (XVIII of 1952), to the State Bank of Pakistan (hereinafter referred to as the ‘Bank’) as the share of the Bank in the profits earned by the said Corporation on its investment in the property made under a scheme of investment in property on partnership in profit and loss, where such investment is provided by the Bank under the House Building Finance Corporation (Issue and Redemption of Certificates) Regulations, 1982;

    • (vii-cc) any sum paid by the National Development Leasing Corporation Limited to the State Bank of Pakistan (hereinafter referred to as the ‘Bank’) as the share of the Bank in the profit earned by the said Corporation on its leasing operations financed out of a credit line provided by the Bank on a profit and loss sharing basis;”

      • “(xix) any transfer to a participatory reserve created by a company under Section 120 of the Companies Ordinance, 1984 (XLVII of 1984), in accordance with an agreement relating to particularly redeemable capital entered into between the company and a banking company as defined in the Banking Tribunals Ordinance, 1984: Provided that, out of the amount so transferred in any income year, not more than five per cent of the value of participatory redeemable capital shall qualify for deduction under this subsection:

      • Provided further that no deduction shall be allowed if the amount of the tax-exempted accumulation in the participatory reserve exceeds ten per cent of the amount of participatory redeemable capital.”

      • The above amendments were respectively added by the Finance Ordinance, 1980; the Finance Ordinance, 1981; the Finance Ordinance, 1982; and Ordinance No. LVII of 1984. The last-mentioned ordinance also added the following as clause (d) to Section 25 by way of consequential amendment to Section 23 (there is no need to state the rationale for insertion of this self-explanatory clause):

“(d) where any amount accumulated in the participatory reserve of a company which has been allowed as a deduction under clause (xix) of subsection (1) of Section 23 is applied by the company towards any purpose other than payment of share of profit on the participatory redeemable capital or towards any purpose not allowable for deduction or exemption under this Ordinance, the amount so applied shall be added to the income of the company in the income year during which it is so applied.”

  • (vi) Amendment in the Companies Ordinance, 1984.

  • A new concept of redeemable capital, which follows, was introduced in this ordinance, by Ordinance No. LVII of 1984, as clause (30A) in Section 2:

    • “(30A) ‘redeemable capital’ includes finance obtained on the basis of participation term certificate (PTC), musharika certificate, term finance certificate (TFC), or any other security or obligation not based on interest, other than an ordinary share of a company, representing an instrument or a certificate of specified denomination, called the face value or nominal value, evidencing investment of the holder in the capital of the company on terms and conditions of the agreement for the issue of such instrument or certificate or such other certificate or instrument as the Federal Government may, by notification in the Official Gazette, specify for the purpose.”

    • Accordingly, participatory redeemable capital was defined to mean “such redeemable capital as is entitled to participate in the profit and loss of a company.” Similarly, “debenture” included debenture stock, bonds, participation term finance certificates, and any other certificates, other than a share, of a company, whether constituting a charge on the assets of the company or not. Security was defined to mean “any share, script, debenture, participation term certificate, modaraba certificate, musharika certificate, term finance certificate, bond, pre-organization certificate or such other instrument as the Federal Government may, by notification in the Official Gazette, specify for the business.” This paper would remain incomplete if the definition of “financial institution” inserted therein were not reproduced below:

“ ‘financial institution’ means a financial institution set up and controlled by the Federal Government or a Provincial Government, whether directly or through a company or corporation set up or controlled by such Government, and includes such other institutions or companies the Federal Government may, by notification in the Official Gazette, specify for the purpose.”

  • One of the problems was that the memoranda of many companies as on the commencement of the Companies Ordinance, 1984 did not include the power to enter into any arrangement for contracting loans, advances, and credits as is now defined in the Banking Companies Ordinance, 1962. The procedure for alteration of a memorandum of a company is cumbersome, and by the time it was altered in accordance with the law the company could not have taken such loans. This problem was overcome by inserting the following in Section 19 of the Income Tax Ordinance, 1979:

    • “(2) Notwithstanding anything contained in this Ordinance or in any other law for the time being in force or the memorandum and articles, the memorandum and articles of a company shall be deemed to include, and always to have included, the power to enter into any arrangement for obtaining loans, advances or credit, as defined in the Banking Companies Ordinance, 1962 (LVII of 1962), and to issue other securities not based on interest for raising resources from a scheduled bank or a financial institution.”

    • Section 61 provides that where a company agrees to allot its shares or debentures with a view to these shares or debentures being offered for sale to the public, any document by which the offer for sale to the public is made shall, for all purposes, be deemed to be a prospectus issued by the company, and all enactments and rules of law as to the contents, filing, and registration of a prospectus and as to the liability for statements in, and omissions from, the prospectus shall apply with the modifications spelled out in the section. Likewise, according to Section 62, a person holding more than 10 percent of the shares or debentures of a company can offer for sale to the public such shares or debentures with the approval of the Corporate Law Authority, with the stipulation that any document by which such offer is made to the public shall for all purposes be deemed to be a prospectus, with all the attendant conditions and circumstances as previously stated herein. The banks and financial institutions were made entitled, under Section 79, to the issue of ordinary shares of a loanee company matching the outstanding balance of loans, advances, and credit or non-interest-bearing securities and obligations outstanding, etc. Similarly, they could acquire shares or other securities of a company in the ordinary course of business. To make such banks and financial institutions subject to the rigor of Sections 61 and 62 would have unnecessarily subjected them to restraints, thus leading to the unpopularity of Islamic modes of finance. It was, therefore, provided in Section 62 that “a notice, circular, advertisement or other document soliciting bids, offers, proposals or tenders for sale of shares or other securities acquired in the course of normal business or for negotiating sale thereof or expressing an intention to disinvest such shares or other securities issued by a scheduled bank or a financial institution shall not be deemed to be a prospectus or an offer for sale to the public for the purpose of Sections 61 and 62.”

    • Again, Section 73 requires every company having a share capital and making allotment of its shares to file a return within 30 days with the registrar containing the information and take certain other steps detailed in this section. If default is made in complying with the requirements of this section, the company and every officer of the company who is knowingly a party to the default is liable to a fine not exceeding five hundred rupees for every day of default. This section was made applicable, mutatis mutandis, “to shares which are allotted or issued or deemed to have been issued to a scheduled bank or a financial institution in pursuance of any obligation of a company to issue shares to such scheduled bank or financial institution:

    • Provided that where default is made by a company in filing a return of allotment in respect of the shares referred to in this sub-section, the scheduled bank or the financial institution to whom shares have been allotted or issued or deemed to have been issued may file a return of allotment in respect of such shares with the registrar together with such documents as may be specified by the Authority in this behalf, and such return of allotment shall be deemed to have been filed by the company itself and the scheduled bank and the financial institution shall be entitled to recover from the company the amount of any fee properly paid by it to the registrar in respect of the return.”

  • Reference has already been made to the issue of shares in lieu of the outstanding balance of a loan, etc. In order to facilitate better understanding, Section 87 was changed by Ordinance LVII of 1984 to read as follows:

    • “87. Issue of shares in lieu of outstanding balance on any loans, etc. _______ Notwithstanding anything contained in section 86 or the memorandum and articles, a company may issue ordinary shares or grant option to convert into ordinary shares the outstanding balance of any loans, advances or credit, as denned in the Banking Companies Ordinance, 1962 (LVII of 1962), or other non-interest bearing securities and obligations outstanding or having a term of not less than three years in the manner provided in any contract with any scheduled bank or a financial institution to the extent of twenty per cent of such balance:

    • Provided that such shares shall not be issued or option to convert the outstanding balance exercised unless in any two of the preceding three years after expiry of two years from the date of commencement of commercial production, the return on such non-interest bearing securities, obligations, loans, advances or credit has fallen below the minimum rate of return laid down by the State Bank of Pakistan for the said years.”

    • Section 92 provides companies limited by shares with the power to alter voluntarily its share capital. As a direct consequence of Section 87, it was necessary to amend Section 92 to provide that “notwithstanding anything contained in this Ordinance or any other law for the time being in force or the memorandum and articles where the authorized capital of a company is fully subscribed, or the unsubscribed capital is insufficient, the same shall be deemed to have been increased to the extent necessary for the issue of shares to a schedule bank or financial institution in pursuance of any obligation of the company to issue shares to such scheduled bank or financial institution.”

  • Section 94 was also consequently amended to provide that notice of every such automatic increase in share capital, as referred to in Section 92, will also be filed by the company with the registrar, and where default is made by the company in this behalf, the scheduled bank or the financial institution may itself file notice of such increase with the registrar; such notice shall be deemed to have been filed by the company itself and the scheduled bank or financial institution shall be entitled to recover from the company the amount of any fee properly paid by it to the registrar in respect of such increases. Another very important provision in this ordinance, which was designed to protect the interests of scheduled banks and financial institutions, was included in an amended Section 120, which reads as follows:

  • “120. Issue of securities and redeemable capital not based on interest. _______

  • (1) Notwithstanding anything contained in this Ordinance or any other law or the memorandum or articles or any agreement, resolution or other document, a company may, upon terms and conditions contained in an agreement in writing, issue to one or more scheduled banks, financial institutions or such other persons as are specified for the purpose by the Federal Government by notification in the Official Gazette, either severally, jointly or through their syndicate, any instrument in the nature of redeemable capital in any of several forms in consideration of any funds, moneys or accommodations received or to be received by the company, whether in cash or in specie or against any promise, guarantee, under-taking or indemnity issued to or in favour of or for the benefit of the company.

  • (2) In particular and without prejudice to the generality of the foregoing provisions, the agreement referred to in sub-section (1) for redeemable capital may provide for, adopt or include, in addition to others, all or any of the following matters, namely:

  • (a) mode and basis of repayment by the company of the amount invested in redeemable capital within a certain period of time;

  • (b) arrangement for sharing of profit and loss;

  • (c) creation of a special reserve called the ‘participation reserve’ by the company in the manner provided in the agreement for the issue of participatory redeemable capital in which all providers of such capital shall participate for interim and final adjustment on the maturity date in accordance with the terms and conditions of such agreements; and

  • (d) in case of net loss on participatory redeemable capital on the date of maturity, the right of holders to convert the outstanding balance of such capital or part thereof as provided in the agreement into ordinary shares of the company at the break-up price calculated in the prescribed manner.

  • (3) The terms and conditions for the issue of instruments or certificates of redeemable capital and the rights of their holders shall not be challenged or questioned by the company or any of its shareholders as repugnant to any provision of this Ordinance or any other law or the memorandum or articles or any resolution of the general meeting or directors of the company or any other document.

  • (4) The provisions of this Ordinance or the Capital Issues (Continuance of Control) Act, 1947 (XXIX of 1947), relating to the creation, issue, increase or decrease of the capital shall not apply to the redeemable capital.”

  • Mortgage or charge or other interest based on agreement for the issue of any instrument in the nature of redeemable capital could be created under Section 121 only after the filing of the prescribed particulars of the mortgage or charge, together with a copy of the instrument, with the registrar for registration within 21 days of its creation. The directors of the company were enabled to issue debentures or any instrument in the nature of redeemable capital by the amendment of Section 196. The other amendments, being of only minor importance, need not be adverted to here.

  • (vii) Promulgation of the Banking Tribunals Ordinance, 1984.

    • To ensure the success of non-interest-based banking, it was considered necessary to establish separate tribunals and to provide a somewhat expedited procedure for adjudicating the claims of banks for recovery of finance that were described earlier. Hence the need to promulgate this ordinance. The salient features of this ordinance are given below:

    • (1) Apart from foreign and local banks, development financing institutions are included in the definition of bank. By notification in the Official Gazette, the federal government is empowered to add to, or omit from, the list of development financing institutions mentioned in the schedule to this ordinance. Thirteen development financing institutions have been put on the list so far.

    • (2) The provisions of the Limitation Act, 1908 do not apply to any suit, application, or other proceedings filed by a banking company. Consequently, the provisions of the Limitation Act do not apply to banking companies for recovery of the finance given by them to their customers (i.e., persons who have obtained finance from a banking company or are the real beneficiaries of such finance) and includes the surety and an indemnifier. No such concession has, however, been extended to the customers of the banking companies. Consequently, the Limitation Act, 1908 will apply to suits, applications, or other proceedings filed by a customer against a banking company.

    • (3) The provisions of the Ordinance are in addition to, and not, save as otherwise expressly provided in the Ordinance, in derogation of, any other law for the time being in force. Thus, the banking tribunals established under it have all the powers vested in a civil court under the Code of Civil Procedure, 1908. Further, a banking tribunal has to follow, in all matters with respect to which procedure has not been provided in the Ordinance, the procedure laid down in the Code of Civil Procedure, 1908. Apart from civil jurisdiction, a banking tribunal has the power to try offenses punishable under this ordinance, and for that purpose it has the same powers as are vested in the Court of Session under the Code of Criminal Procedure, 1898.

    • (4) A banking tribunal is to consist of a person who either is or has been, or is qualified for appointment as, a Judge of High Court, a District Judge, or an Additional District Judge, and who will be the chairman, and two additional members, who are to be appointed by the federal government. So far, one banking tribunal has been established for each province. The members appointed by the federal government have mostly been senior cadre officers of banks. They have the necessary experience of practical and theoretical banking, and their association was considered advisable to ensure a proper appreciation of banking matters by the banking tribunals. The Ordinance provides for (1) sittings of the banking tribunal; (2) its decision to be taken in terms of theopinion of its members, including the chairman, or if the case is to be decided by the chairman and only one of the other members and there is a difference of opinion between them, then in accord with opinion of the chairman; (3) not recalling or rehearing a witness who has given evidence merely by reason of a change in the composition of the tribunal or of the absence of any member from any sitting; and (4) any act or proceeding of the banking tribunal to be valid despite the existence of a vacancy in, or a defect in the constitution of, the banking tribunal.

    • (5) No court other than a banking tribunal will have or exercise any jurisdiction with respect to any matter to which the jurisdiction of a banking tribunal extends under the Ordinance, including a decision as to the existence or otherwise of finance and the execution of a decree passed by a banking tribunal, provided that nothing herein shall be deemed to affect:

    • (a) the right of a banking company to seek remedy before any court or otherwise that may be available under the law by which the banking company may have been established or under that law as amended from time to time; or

    • (b) the power or jurisdiction of the banking company or any court, as is referred to in (a) above, or to require the transfer to a banking tribunal of any proceeding pending before the banking company or any such court immediately before the commencement of this ordinance.

  • This provision was considered necessary to preserve intact the right of certain banking companies, conferred on them by their charters, to recover their dues (1) as an arrears of land revenue or (2) through the decision of a District Court for attachment and sale of property of a debtor or for the transfer of the management of an industrial concern.

  • (6) A banking tribunal has power to adjudicate the claims of a banking company against a customer and not those of a customer against a banking company. Any plaint filed by a banking company has to be verified on oath by an official of certain designation of that bank. The banking tribunal has to issue a notice requiring the defendant to show cause, within 10 days of the service of such notice, as to why the decree as prayed for in the plaint should not be passed against him. If the defendant fails to file a reply within the aforesaid period, or if he files a reply and the same is rejected by the banking tribunal, the banking tribunal shall pass a decree in favor of the banking company as prayed for in the plaint; provided always that if a decree is passed upon the failure of the defendant to give reply within the stipulated period, the tribunal may set aside the same upon the application of the defendant made within 30 days of the passing of the decree if the tribunal is satisfied that there was sufficient cause for the defendant not to file the reply within the specified period. If a suit is not disposed of within 90 days of the filing of the plaint, the defendant has to deposit in cash or to furnish a security, acceptable to the tribunal, equal in value to the claim in the suit; and, on the failure of the defendant so to make deposit or furnish the security, the tribunal is required to pass a decree in favor of the banking company, except that the requirement of deposit in cash or furnishing of a security may be dispensed with if, in the opinion of the tribunal, the delay is not attributable to the conduct of the defendant. The banking company is permitted to withdraw the amount deposited upon an undertaking to refund the same to the tribunal, if so ordered, at any time. The object of this provision for the withdrawal of such deposits is to ensure that pending adjudication and execution of the decree, the banking company need not stand deprived of the use of the amount deposited. It will be remembered that in the case of an interest-based loan, the court not only passes decree for the principal amount but also for interest, at the contracted rate, up to the date of the filing of suit, and at a certain other rate from the date of the suit until the date of the decree and thereafter until realization of the decretal amount. The present position also avoids the charging of interest in any form. Another indirect remedy provided in this regard specifies that if a convicted person is fined, the whole or part of the fine may be applied in or toward payment (i) of the cost of all or any of the proceedings under the Ordinance, and (ii) to a banking company as compensation for any loss occasioned by the offense, including loss of income. Appeal against the judgment of a tribunal lies to the High Court within 30 days of the decree or the order of the tribunal, provided that no such appeal filed by the defendant against a decree can be entertained unless he has deposited with the tribunal the amount claimed in the suit and required to be deposited by him, as previously mentioned herein, if the suit remains pending after the expiry of 90 days from the filing of suit owing to delaying tactics on his part, or, as the case may be, the decretal amount. Every such appeal shall be heard by a bench of not less than two judges of the High Court. No court or authority, excepting the High Court on appeal from the order or decree, is authorized to call, or permit to be called, into question any proceeding, order, or judgment of the banking tribunal. Every such decree is to be executed forthwith on the written application of the decree-holder, and the banking tribunal has no power to allow the decretal amount to be paid in installments without the consent of the decree-holder. Where a banking company holds any property belonging to the judgment debtor as security it may sell, subject to compliance with certain conditions mentioned in the Ordinance, the same, without the intervention of court, either by public auction or private treaty, to any person and appropriate the proceeds thereof, according to law, toward total or partial satisfaction of the decree. There is one other important provision from the bank’s point of view. If a decree remains unsatisfied beyond a period of 30 days from the date of the decree, the banking tribunal has the power to impose, on the application of the decree-holder, a penalty on the judgment debtor of such amount as the tribunal may deem fit; the amount of such penalty is to be recovered from the judgment debtor as a fine under the Code of Criminal Procedure, and the recovery so made is to be made over to the banking company as liquidated damages for failure of the judgment debtor to satisfy the decree. Imposition of a penalty at one time shall not be a bar to imposition of a further penalty if the failure to pay the decretal amount continues. Being a fine, this provision is not considered to be against the injunctions of Islam.

  • (7) The Ordinance also provides that:

    • “Whoever intentionally destroys, or removes, or reduces the value of the property on the security of which finance was provided to him, or, without the prior approval in writing of the banking company which provided finance, transfers such property or any part thereof otherwise than in accordance with the terms of approval shall, without prejudice to any other action which may be taken against him under this Ordinance or any other law for the time being in force, be punishable with imprisonment of either description for a term which may extend to five years, and shall also be liable to fine, and shall be ordered by the Banking Tribunal trying the offense to deliver up or refund, within a time to be fixed by the Banking Tribunal, the property or the value of the property so destroyed, removed or reduced in value or transferred as the case may be.”

  • (viii) Amendment in provincial laws:

    • Mention has already been made of amendments made in The Stamp Act, 1899 by each of the four provinces to ease the additional burden of stamp duty arising on account of additional documentation, etc., required because of Islamic modes of financing. In addition to these amendments, each of the provinces made amendments in other laws men-tioned herein after.

    • (1) The West Pakistan Finance Act, 1963, as in force in each province.

    • Section 16 of this Act levied a capital-gains tax on any profits or gains arising from the voluntary sale, exchange, or transfer of immovable property, excluding, inter alia, transfers of movable property under a deed on gift, bequest, or will or transfers on irrevocable trust effected after June 30, 1963 within urban areas specified by the provincial government under the West Pakistan Urban Immovable Property Tax Act, 1958. Since the new modes of financing involved transfer, re-transfer, assignment, etc., of immovable property more than once, it was felt necessary to save the banks and customers from the additional tax leviable on this account.22 Accordingly, each of the provinces amended the Act by adding the following provisions to Section 16:

      • “Provided further that the tax shall not be levied on any profits or gains arising from assignment, re-assignment, sale or transfer of any immovable property assigned, re-assigned, sold or transferred to, or by, a banking company by, or as the case may be, to its customer on account, or in consequence, of finance provided by the banking company to its customer:

      • Provided further that in a case of forced sale by a banking company on default by the customer the exemption contained herein shall not apply to the customer.

      • Explanation I._______For the purpose of this section the expressions ‘banking company,’ ‘customer’ and ‘finance’ shall have the same meanings as have been assigned to them in the Banking Tribunals Ordinance, 1984.

      • Explanation II._______A certificate issued by the banking company certifying the transaction referred to in this section shall be presumed to be correct.”

  • (2) The West Pakistan Cooperative Banks and Co-operative Societies (Repayment of Loans) Ordinance, 1966.

  • This Ordinance related to the special procedure provided in the Banking Tribunals Ordinance, 1984 for recovery of interest-based loans taken from a cooperative bank or cooperative society. It was amended23 by each of the provinces to include in the definition of loan “finance as provided in the Banking Tribunals Ordinance, 1984 and all cognate expressions shall be construed accordingly.”

  • (3) The Cooperative Societies Act, 1925.

  • This law was amended24 by each of the provincial governments to enable the provincial cooperative banks to give loans, inter alia, on the basis of finance as provided in the Banking Tribunals Ordinance, 1984 (all cognate expressions to be construed accordingly); to exempt from compulsory registration under the Registration Act, 1908 “Participation Term Certificate, Term Finance Certificate, Musharika Certificate, Modaraba Certificate and such other instruments as may be approved by the State Bank of Pakistan” or any endorsement upon or transfer of the aforesaid instruments, including debentures, to add the words “or return” after the word “interest” wherever the latter occurs in the Act and to authorize the provincial government to make rules to regulate the manner in which the funds may be raised, inter alia, by means of “Participation Term Certificates, Term Finance Certificates, Musharika Certificates, Modaraba Certificates and such other instruments as may be approved by the State Bank of Pakistan.”

Part VII

10. As stated elsewhere, the immunity accorded to fiscal laws or laws relating to the levy and collection of taxes and fees or banking, or insurance practice and procedure from the jurisdiction of the Federal Shariat Court was intended to expire sometime in 1990. Therefore, unless the period often years mentioned in Article 203-B(c) of the Constitution is further extended beyond 1990,25 the banks will have to meet the challenge. For this purpose, preparation, it is believed, is already afoot, and different committees are carrying out studies and collecting materials on different subjects in consultation with religious scholars, both within the country and abroad. For example, recently the Federal Shariat Court has suo moto raised issues regarding the Islamicity of legal personality of a company and the limited liability of a shareholder. A group has been formed to study this problem. The Court has not yet given any judgment.

Part VIII

11. Despite the constitutional immunity given to banking practice and procedure, one of the judges of the Sind High Court has, in a series of judgments,26 determined in suits on the original side and not the extraordinary jurisdiction on the constitutional side, not allowed interest though it was allowed in laws (e.g., by Sections 79 and 80 of the Negotiable Instruments Act and by the Interest Act), as it was found to be against the express injunctions of the Holy Quran and Sunnah. The argument, in a nutshell, is that Article 2-A is in the nature of a paramount clause and a supra-constitutional one and also covers Article 189, so that law declared by the Supreme Court before the insertion of Article 2-A or without considering the said article is subservient to the provisions of Article 2-A. Further, the High Court is a court of general jurisdiction and is empowered to enforce an existing law and construe the same with all such adaptations as are necessary to bring it into accord with the provisions of the Constitution in terms of Sub-Articles (1) and (6) of Article 268 read with Article 2-A, subject to the exception provided in Article 203-GG to the effect that the decision of the Federal Shariat Court, subject to the decision of appeal, if any, by the Shariat Appellate Bench, regarding the Islamicity of any law will be binding on the High Court and all courts subordinate to the High Court. According to these judgments, the Federal Shariat Court has the power only to examine the Islamicity of a law; it can neither legislate nor frame a new law as substitute for the law found to be repugnant to the injunctions of Islam, nor can it give relief in a given case. Additionally speaking, though the principles of policy are not justiciable, no such exception has been made for Article 2-A, which is in the substantive part of the Constitution. Although the Sind High Court also considered the view27 of Mr. Justice Gul Mohammad Khan (formerly Chief Justice of the Federal Shariat Court) about the scope of Article 2-A, etc. to the effect that even the other provisions of the Constitution and other excluded laws (e.g., those concerning banking practice and procedure) were justiciable by the High Court, it was of the opinion that the competency of courts is relatable to the power given to them by the Constitution or by or under any law and not by the Islamic system and that consequently the High Court can enforce any existing law in the light of Article 2-A, even in a civil suit.

These judgments have been described by Mr. Justice Dr. Nasim Hassan Shah28 as a very “valiant effort” on the part of the concerned judge. Dr. Shah has not, however, given his own opinion on the subject. Another judge of the same High Court has given a contrary ruling in Suit No. 429/1983. According to this ruling, a High Court cannot strike down any Article of Chapter 3-A of the Constitution (e.g., Article 203-D) on the basis of Article 2-A. In this respect, reference has been made to the following observation of the full bench in Muhammad Bachal Memon’s case:29

“17. Thirdly, Article 2-A on the basis of which also validity of Article 270-A is sought to be questioned was inserted by the President’s Order No. 14 of 1985 promulgated on February 3, 1985, by the President of Pakistan. I do not find any valid reason nor has any been advanced by any counsel to test the validity of an amendment made in the Constitution by the Parliament by Constitution (Eighth Amendment) Act, 1985, on the touchstone of a provision which was initially not an enforceable part of the Constitution and which was made enforceable by the President’s Order No. 14 of 1985. In my opinion both the amendments have the same force and the validity of one cannot be tested on the touchstone of the other.” It will also be profitable to reproduce the following remarks from the judgment of full bench in the case30 of Mr. Ghulam Mustafa Khar:

“75. So far as seeking of aid of Objectives Resolution for the purpose of interpretation of the Constitution is concerned, the submission is not without merit. It is a cardinal rule of interpretation of Statutes that each part of the enactment must expound the other. The Court is entitled rather than bound to examine if other parts of the Statute throw some light or render help in construing its particular provision. We have not been unmindful of this principle in the course of this judgment. But we are unable to agree with Mr. Shahid Hussain Kadri. It is to be noticed that behind every constitutional document there are certain values adopted by the makers of the Constitution. In our Constitution, some of these values are enshrined in the Objectives Resolution which represents the aspiration of the nation, and offers a moral and historical intuition, for understanding the Constitution. While interpreting the Constitution, the Objectives Resolution must be present to the mind of the Judge and where the language of the Constitutional provision permits exercise of choice the Court must choose that interpretation which is guided by the principles embodied therein. But that does not mean that the Objectives Resolution is to be given a status higher than that of other provisions and used to defeat such provisions. One provision of the Constitution cannot be struck down on the basis of another provision. To the same effect is the decision of the High Court Karachi, in Muhammad Bachal Memon’s case with which we respectfully agree. The language of Article 270-A(1) does not admit of any doubt and leaves no choice for the Court. We have already held that the validation of the legal measures cabined in Article 270-A(1) is well within the competence of the Parliament. In construing Article 270-A(1), therefore, Article 2-A does not hold out any interpretative constraint.”

Be that as it may, these cases are under appeal, and a definite position will emerge only when they are finally decided by the Supreme Court.

Addendum on Recent Developments

AKHTAR HAMID

I. Introduction

1. This addendum to the late Mr. Sardad Khan Murvat’s paper (hereinafter referred to as the main paper) attempts to bring it up to date by including a discussion of the more important developments in Islamic banking in Pakistan which have occurred since May 1988. It picks up where the main paper leaves off—that is, with the discussion of the constitutional question which was before the courts in the 1987 series of cases1 that mooted the question of interest under the Shariah in a meaningful manner in a judicial environment for the first time. Readers should bear in mind that, since this addendum is a continuation of the main paper, any references which are not explained herein are explained in the main paper.

II. Further Developments Concerning the Objectives Resolution

2. The constitutional question under consideration in the cases cited above was whether or not the Objectives Resolution, as incorporated in Pakistan’s Constitution by Article 2-A, was to be given a supra-constitutional status. According to Justice Tanzil-ur-Rahman, who rendered the decisions in the first three of these cases,2 each of which called into question the legality of interest-based transactions, there was no doubt that the Objectives Resolution had become a substantive part of the Constitution. Accordingly, all laws subservient to the Constitution, such as the Negotiable Instruments Act, 1881, the Code of Civil Procedure, 1908, and the Interest Act, 1839—to the extent that these allowed interest to be paid or awarded—could and should be tested on the “touchstone” of the Objectives Resolution. The judge, however, was reluctant to accord the Objectives Resolution any higher status than that. When it came to the test, he felt bound to give effect to the interest-related provisions of yet another law which he had been asked to review, namely, the Banking Companies (Recovery of Loans) Ordinance, 1979, on the grounds that those provisions stood protected under the Constitution.3 That one provision of the Constitution could not claim ascendancy over another provision of the Constitution clearly formed the guiding principle of the judge who subsequently differed with Justice Tanzil-ur-Rahman in one of the 1987 cases on matters related to payment of interest.4 The powerful Full Bench decision in Khar’s casec,5 which followed, seemed to have placed this issue beyond doubt.

3. It may be noted that the three decisions in question were rendered by the same single judge6 of the Sind High Court acting in the exercise of his original civil jurisdiction, and did not at that time represent any consensus of judicial opinion. The decisions were subject to appeal, and, in fact, an appeal was filed in the Habib Bank case7 and admitted for a regular hearing by a Division Bench of the Sind High Court. The judgment and order of the single judge were stayed in their entirety and the federal government was made a party to the appeal, since it involved substantial questions of interpretation of constitutional law.8 For example, there was nothing in either Article 2-A itself or elsewhere in the Constitution providing for, or otherwise justifying, the elevation of Article 2-A, and—through it—the Objectives Resolution, to a supra-constitutional position.9 That being so, the provisions of Article 2-A and the Objectives Resolution must, at best, be read and construed harmoniously with the other provisions of the Constitution and not so that every other provision of the Constitution is subservient to, and required to be tested against, the provisions of the Objectives Resolution. The appeal is still pending, and the higher court has, therefore, not had an opportunity so far to consider these arguments.

4. This is not to say, however, that these or similar arguments have not been presented in any court since Justice Tanzil-ur-Rahman first expounded his views. Early in 1989, two other single judges of the Sind High Court, also acting on the original side, handed down decisions which seemed to prolong the judicial controversy started in 1987. In the first10 of these two cases, the judge, as Justice Tanzil-ur-Rahman was in some of the earlier cases, was called upon to pronounce on the validity of the Code of Civil Procedure, 1908, the Negotiable Instruments Act, 1881, and the Interest Act, 1839, which, insofar as they pertained to interest, he duly pronounced as “… no longer good law and Courts in Pakistan [being] precluded from decreeing interest in any form whatever.”11 But the judge was not, unlike Justice Tanzil-ur-Rahman in the earlier cases, called upon to consider the validity of the Banking Companies (Recovery of Loans) Ordinance, 1979 or any other law protected by the Constitution. That, however, did not deter him from pronouncing on the nature of the constitutional protection and, in the process, stating in effect that Justice Tanzil-ur-Rahman had been wrong in the Habib Bank case in considering himself bound by Bachal Memon’s case and in deciding, in the light of the decision in that case, that he could not test the validity of the constitutional provisions in question12 by reference to the Objectives Resolution. The judge was of the view that

.... every law in force in Pakistan, whether it be covered by a constitutional or a sub-constitutional instrument, is available for being tested in consonance with other Constitutional Provisions some of which are of a higher status .... and one amongst them is of the highest order namely the Sovereignty of Allah as recognized, declared and enjoined in the Objectives Resolution, giving rise to another norm namely the ascendancy of the Laws of Quran and the Sunnah .... 13

5. The learned judge in the other14 of the two cases referred to in the previous paragraph seemed to take a diametrically opposed view of the matter. This case was more in point, since it involved questions relating to the enforceability of the interest-related provisions of the Banking Companies (Recovery of Loans) Ordinance, 1979, which, it may be recalled, had been held by Justice Tanzil-ur-Rahman to be protected by the Constitution.15 Relying on Khar’s case,16 which had, itself, supported the views stated in Bachal Memon’s case,17 the judge refused either to accord the Objectives Resolution a status higher than that of the other provisions of the Constitution or to use it to defeat such provisions. In fact, he went further and cast serious doubts on the nature of the Objectives Resolution as an enforceable provision of the Constitution. On this point, he stated in unequivocal terms that “Unless Article 2-A is construed as a supra-constitutional provision, no law can be tested on the touchstone of the Objectives Resolution or Article 2-A ....”18 In other words, the Objectives Resolution was not only not a basis for defeating other provisions of the Constitution but also not a basis for defeating the provisions of any other law, whether that law was coextensive with or subservient to the Constitution. In the result, the judge had no hesitation in deciding that, notwithstanding the argument that “charging of interest is prohibited by Islam”19: “… still the laws in force in Pakistan permitting the plaintiff to charge interest on the principal amount due against the defendant must be given effect to.”20 The judge took the view that the Objectives Resolution did not constitute a “self-executing” provision of the Constitution.21 It merely indicated “a line of policy or principles, without supplying the means by which such policy or principles are to be carried into effect.”22 There was nothing in the Objectives Resolution itself which empowered the courts to strike down legislation on the grounds that it was “inconsistent with or repugnant to the tenets of Islam....”23 The Objectives Resolution was of limited, albeit important, use to the courts, which “can always seek guidance from [it] to expound the Constitution and to understand its true meaning.”24 As for the Islamization of laws in the country, this function under the Constitution25 was conferred on the Council of Islamic Ideology or the Federal Shariat Court. Applying the rule of “harmonious construction,”26 and considering that a supra-constitutional status could not be given to Article 2-A, the provision of the Constitution dealing with the Council of Islamic Ideology and the Federal Shariat Court could not be considered to have been overridden by Article 2-A of the Constitution. In other words, the ordinary courts could not usurp the powers of the Federal Shariat Court to pronounce a law or the provisions of a law as repugnant to the injunctions of Islam.

6. From the point of view of banking law and practice, of all the cases so far considered in this paper, only two were really directly in point—the Habib Bank case of 1987 and the Habib Bank case of 1989—since these alone dealt with the question of the enforceability of the interest-related provisions of the Banking Companies (Recovery of Loans) Ordinance, 1979. It may be recalled that in both cases, interest was allowed, with the decision turning on the constitutional point as to whether or not the interest-related provisions of the 1979 Ordinance stood protected under the Constitution. That being so, in neither case was the judge called upon to decide whether or not interest was prohibited by the Quran and Sun-nah. Nevertheless, in the first case, the judge could not be prevented from expressing his view obiter that that was, indeed, the case.27 In the other case, however, the judge very correctly refrained from considering the question at all.28 Neither case is, therefore, authoritative on the point as to whether interest is prohibited by the Quran and Sunnah, and the Banking Companies (Recovery of Loans) Ordinance, 1979 is still good law. Nor is this position likely to be directly affected by the appeal in the 1987 Habib Bank case,29 when that is finally taken up and disposed of, for the decision in that appeal, as suggested earlier, would probably turn merely on whether Article 2-A of the Constitution, and—through it—the Objectives Resolution, is to be accorded a supra-constitutional status, and whether or not the courts have the power to strike down a law, whether that law is coextensive with or subservient to the Constitution, which fails the test of the Objectives Resolution. Nevertheless, as a result of views expressed in these and the other cases, a good deal of uncertainty has been introduced in the law as to whether or not the courts would be prepared in the future to enforce interest-based transactions.

III. The Enforcement of Shariah Act, 1991

7. Since the 1989 decisions, two other legal developments have occurred which have an important bearing on the future of financial and economic, including banking, transactions in the country. The first was the passage of the Enforcement of Shariah Act in June 1991.30 The Act deals with many and diverse aspects of life31 and enables the state to take measures to regulate these in the light of the Shariah, which is defined as “… the injunctions of Islam as laid down in the Holy Quran and Sunnah.”32 The Shariah has been stated in the Act to be “the supreme law of Pakistan,”33 and the courts have been obligated to interpret laws in the light of the Shariah in the following manner:

  • (a) While interpreting the Statute law, if more than one interpretation is possible, the one consistent with the Islamic principles and jurisprudence shall be adopted by the court; and

  • (b) where two or more interpretations are equally possible, the interpretation which advances the Principles of Policy and Islamic provisions in the Constitution shall be adopted by the Court.34

8. All Muslim citizens of Pakistan are duty-bound, under the Shariah Act, “to observe Shariah and act accordingly.”35 And some of the measures that the state is called upon to take pursuant to the Act include “… steps to ensure that the economic system of Pakistan is constructed on the basis of Islamic economic objectives, principles and priorities.”36 To that end, the federal government was required to appoint a commission consisting of economists, bankers, jurists, ulema,37 elected representatives, and other persons deemed fit for appointment.38 It would be part of the functions of this commission to recommend “the ways, means and strategy” to change the existing economic system,39 as well as the “measures and steps, including suitable alternatives,”40 that would need to be taken to establish “the economic system enunciated by Islam”41 and to “monitor progress”42 in that direction by “identifying lapses and bottlenecks if any and suggesting alternatives to remove any difficulty.”43 Of particular interest in the present context is the authority to be given to the commission:

… to undertake the examination of any fiscal law or any law relating to the levy and collection of taxes and fees or banking or insurance law or practice and procedure to determine whether or not these are repugnant to the Shariah and to make recommendations to bring such laws, practices and procedures in conformity with the Shariah.44

One of the specific tasks to be assigned to the commission is to

… oversee the process of elimination of riba45 from every sphere of economic activity in the shortest possible time and also recommend such measures to the Government as would ensure the total elimination of riba from the economy.46

The reports of the commission are to be placed before Parliament through the federal government “on a regular basis and at suitable intervals.”47

9. Just so that there is no doubt about the matter, the Shariah Act specifically protects all international financial transactions, apparently both existing and future ones, with the obligations under such transactions remaining “valid, binding and operative,”48 “notwithstanding anything contained in this Act,”49 until “an alternative economic system is introduced.”50 Also similarly protected under the Act are other existing obligations.51

10. Thus, under the Shariah Act, the Shariah is to be observed by the state, as represented by the three branches of government—namely, the legislature, the executive, and the judiciary—as well as by each individual Moslem citizen, in his or her own way, as specified or generally indicated in the Act. In relation to the economic field, what the relevant provisions of the Act seem to boil down to is this. If any changes in fiscal, banking, and other relevant laws are needed to bring them into conformity with the injunctions of Islam (the Shariah), these are to be recommended by the commission appointed by the Government for this purpose and enacted by the legislature. It is not for the courts, either on their own initiative or on the application of a Moslem citizen, to recommend such changes, and it is still less appropriate for them to strike down any laws on the grounds that they are repugnant to the Shariah. The courts are there to adjudicate and, in that process, to “interpret” the laws and nothing more. Under the scheme of the Act, it is quite clear that the Islamization of the economy is intended to be a gradual process; even though riba is expected to be eliminated from the economy “in the shortest possible time,”52 this phrase has not been defined, and all existing obligations which are based on interest have been protected until a new riba-free system has been instituted. If there are difficulties experienced in the course of transition to the new system, these are to be resolved through “alternatives” rather than ignored.

IV. Lifting of the Constitutional Bar on the Federal Shariat Court’s Jurisdiction

11. The other legal development of 1990–91 which has a bearing on banking law and practice in Pakistan was the removal of the constitutional bar on the jurisdiction of the Federal Shariat Court (FSC) in respect of banking, fiscal, and other economic laws. It may be recalled that in conferring authority on the FSC to decide whether or not any law or provision of law was repugnant to the injunctions of Islam, the Constitution had provided, through a provision inserted by an amendment of 1980, that “law” for this purpose “… does not include … until the expiration of [ten] years … any fiscal law or any law relating to the levy and collection of taxes and fees or banking or insurance practice and procedure ....”53 The ten years were stated to run from the date of the constitutional amendment.54 This period expired on June 25, 1990, with the result that the FSC’s jurisdiction in banking and fiscal matters was restored as of June 26, 1990. Beginning soon thereafter, several petitions were filed in the FSC on behalf of individuals, including certain members of the bar, challenging the interest-related provisions of a number of fiscal and banking laws. The FSC consolidated these petitions and disposed of them all in one voluminous judgment, which was delivered in mid-November 1991.55

12. The FSC’s judgment was written by Dr. Tanzil-ur-Rahman, who, it may be recalled, had, while a judge of the Sind High Court, in 198756 initiated the judicial dialogue on the subject of the validity, from the point of view of the Shariah, of laws providing for payment of interest, and who had since become the Chief Justice of the FSC. It held that the interest-related provisions of some twenty fiscal or related laws—including the Interest Act, 1839, the Negotiable Instruments Act, 1881, the Code of Civil Procedure, 1908, the State Bank of Pakistan Act, 1956, the Agricultural Development Bank Rules, 1961, the Banking Companies Ordinance, 1962, and the Banking Companies (Recovery of Loans) Ordinance, 1979—were repugnant to the injunctions of Islam and directed both federal and provincial governments to take steps to bring said laws into conformity with these injunctions by June 30, 1992. As was made amply clear in the judgment, such steps were to include the deletion of all references to “interest” from those laws.

13. In the FSC’s view—which it arrived at after reviewing relevant passages from the Quran, the traditions of the Prophet (Hadith), and the available body of juristic and theological consensus (Ijma)—riba, in the Shariah, means “an addition, however slight, over and above the principal.” This means that the concept covers both usury and interest; that it is not restricted to doubled and redoubled interest; that it applies to all forms of interest, whether large or small, simple or compound, doubled or redoubled; and that the Islamic injunction is not only against exorbitant or excessive, but also against minimal, rates of interest. Rejecting an argument based on the concept of al-riba, meaning usury as practiced at the time of the Quranic revelations, which would have restricted the Islamic injunction to loans other than commercial loans for productive purposes, the FSC observed that there was authority for stating that commercial loans were, in fact, prevalent in pre-Islamic times. Accordingly, in the FSC’s view, the Quranic prohibition applied equally to commercial loans for productive purposes and to personal loans for consumptive purposes; it also applied to interest charged by banks or other institutions and individuals in modern times just as it had to interest charged by the institutions and individuals in the business of making commercial loans at the time of the Quranic revelations. This is the concept of riba-al-nasiah—interest charged on money lent or any addition over and above the principal sum advanced on loan. The FSC was, however, careful to distinguish riba from profit, which is an “increase” in a bai’, or sale. In Shariah, riba is not an increase simpliciter but rather a special kind of increase.

14. Once it had endorsed the position that, in the Shariah, any increase, no matter how small, over and above the principal advanced by way of a loan, is riba, it was but a short step for the FSC to strike at certain practices, which have sprung up in recent years, of allowing such an increase but without calling it “interest.” One such practice, which was the focus of the FSC’s attention, involves the concept of “indexation,” under which the lender would be allowed an increase over the principal amount loaned out by indexing that amount to, say, changes in the price level of commodities in order to hedge against inflation. Judicial approval of this concept had been given earlier by the Sind High Court in one of the two 1989 cases discussed in this paper; in that case, the judge, Justice Wajihuddin, while agreeing with the decision delivered by (then) Justice Tanzil-ur-Rahman of the same court in a previous case57 and disallowing interest, had gone on to hold that in “inflationary” conditions, the borrower should be required to return at least “the equivalent of the real worth of the currency loaned out to him.”58 The same judge again endorsed this view at the next opportunity, which arose in 1990, when he allowed a lender an additional amount based on indexation.59 In the FSC, Chief Justice Tanzil-ur-Rahman, however, delivered a strong dissent from the views of Justice Wajihuddin and an equally strong endorsement of his own views as expressed in the 1987 trilogy of cases.60 In his view, based on a convergence of juristic opinion, in the Shariah, money transactions are on a par with commodities transactions as far as lending and borrowing are concerned. The basic principle is that the quantity (units) returned should be the same as the quantity borrowed, even though the price of the commodity may have changed in the meantime. If, therefore, a loan in a certain currency is taken for a period of time, it should be repaid in the same quantity—in terms of the currency in which it was borrowed—irrespective of any decrease or increase in its value in terms of that currency, provided the same currency is legal tender at the time of repayment and has not been discontinued by the government. Accordingly, to allow any increase on the basis of indexation is riba and is prohibited. “Equivalency” is limited to a situation of “demonetization”—that is to say, if the currency in which the loan was made has ceased to be legal tender and has been replaced by another currency before repayment is made, then repayment would be made in the number of units of the new currency equivalent to the number of units borrowed in the original currency of the loan.

15. The other practice which was castigated by the FSC was allowing a “markup” to the lender on the principal of the amount loaned out by him. A markup is a form of bai’mu’ajjal, or a sale in which the margin of profit or markup to the seller is mutually agreed upon in advance between the buyer and the seller. The payment of the sale price is on a deferred basis and may be made either as a lump sum or in installments. Under this financing technique, the lender buys the commodity involved and then sells it to the borrower at a markup. It may be recalled that markup was one of the non-interest-based modes of financing which were instituted under the 1984 Islamization reforms of the banking system.61 The FSC’s objection to markup flows primarily from the consideration that the concept is appropriate for trade but not for banking, since banks are not trading organizations. It had, therefore, been permitted in banking as a temporary measure only, on the understanding that it would be used sparingly during the transition period.62 It had, however, become the mainstay of the “interest-free” banking system and served as a “back-door for interest to creep in.” The FSC therefore directed the government to also delete references to markup from legislation.63 Somewhat similar views were expressed by the FSC about leasing, another non-interest-based mode of financing then in use, although in this case the Court stopped short of directing the deletion of legislative references. In the Court’s view, the best modes of financing in accordance with the Shariah were those based on profit- and loss-sharing, namely, modaraba and mus-harika, while markup and leasing were but poor and transient substitutes.

16. Insofar as the FSC was required to examine Pakistani banking laws, its decision had implications primarily for banking law and practice in Pakistan. The FSC, however, also used the opportunity to comment, albeit briefly and without taking all considerations into account, on aspects of international banking practices insofar as these touched Pakistan. In the Court’s view, there is a need for borrowing and lending to stop in Pakistan and for the banking system to change over completely to a profit- and loss-sharing basis. There is also a need, in the FSC’s view, to stop all borrowing and lending at interest by all levels of government from foreign governments, international financial institutions, and foreign commercial banks. Instead, fresh ideas should be explored to arrange funding for economically profitable projects (as opposed to current (administrative) expenditures) on a profit- and loss-sharing basis. It should not be too difficult to arrange such funding, since there is a growing international acceptance of Islamic financing options. Since the easy availability of foreign credit on an interest basis has compounded indebtedness, closing the door to such credit in the future should promote fiscal and economic discipline in Pakistan.

V. Summary and Conclusions

17. A controversy is thus raging in the courts, as elsewhere in the country, as to whether modern banking law and practice, based as it is on the charging of interest, is repugnant to the injunctions of Islam and, if so, what should replace it. In order to address this issue, the courts have had to get over the constitutional hurdle, which goes to their authority to consider the issue at all; and judging from the cases decided in the Sind High Court before the FSC’s 1991 intervention, it is far from clear that they have succeeded in doing so. Until the constitutional question is resolved by the highest court in the land (the Supreme Court), which binds all other courts subordinate to it, the Sind decisions cannot be taken as authoritative, one way or the other, for stating whether interest charged by contemporary banks is riba and, therefore, repugnant to the Shariah.

18. The FSC’s 1991 decision, however, may have rendered some of these questions moot. The FSC’s jurisdiction under the Constitution is clear, or at least clearer than that of Pakistan’s other courts: to examine laws, including banking and fiscal laws, in the light of the Shariah and, if these are found wanting when viewed in that light, to direct their repeal or amendment. Following the Court’s 1991 decision, the question that remains is whether the decision that the payment of interest as practiced today is riba, is correct in law. Under the Constitution, the forum where this question can be mooted is the Shariat Appellate Bench of the Supreme Court, to which the Government can appeal within six months of the FSC’s decision.64 Whether the Government will file such an appeal remains to be seen.

19. Even if it is accepted that bank interest is riba, it would take a while for it to be eliminated from the country’s financial system. The FSC believes that the Government and the banks have already been given sufficient time to change to a non-interest-based system. The Report of the Council of Islamic Ideology on the Elimination of Interest came out as long ago as 1980. The measures which were taken pursuant to that report, as part of the 1984 reforms, were less than adequate and could only be considered as transitory. Nevertheless, nothing further has been done since then to complete the transition. In the FSC’s view, the appointment of the new commission under the Shariat Enforcement Act of 1991 does not make any difference, nor should the commission be allowed to stand in the way of the FSC’s decisions.

20. If the FSC’s decision is permitted to take effect as of June 30,1992—either through the Government’s unwillingness to pursue an appeal or, if it does appeal, through confirmation of the decision by the Shariat Appellate Bench—all references to “interest” in the laws under examination by the FSC would stand deleted.65 For the banks, this would mean that they would not be able to claim interest on overdue loans, in instances where they have filed suit to obtain payment, from the date of filing of a suit to the date of payment. As for making loans in the first instance, it should be borne in mind that banks have done so on the basis of non-interest-based modes of financing since 1984. In this connection, the one serious implication of the FSC decision for banks would be that they would no longer be able to resort to either markup or leasing, except in a very limited fashion. This would be likely to leave a very large void in the system which, again, the banks would need to close with alternative modes of financing evolved on the basis of musharika and modaraba. This is what the FSC would consider to be completion of the transition to a riba-free banking system. But, in order to complete the process without causing widespread disruption, the banks would need more time—something which the Government might be willing to grant but which the FSC would not. The rationale for the Shariah Enforcement Act, 1991 seems to have been swept away by the FSC’s 1991 decision. Islamization of the banking system is now for the FSC to order, and is no longer for the executive branch of the Government of Pakistan to recommend, after due deliberation, or for the national legislature to legislate. It is thus becoming increasingly difficult for the Government to stand by its commitment to a gradual process of change. An attempt to make an overnight change could disrupt domestic banking, and if—as seems to be the wish (though not yet the order) of the FSC—the Government stops borrowing at interest from foreign governments, international financial institutions, and commercial banks, the disruption could affect international banking insofar as it touches Pakistan.

COMMENT

ZUBAIR IQBAL and ABBAS MIRAKHOR

Mr. Murvat’s paper* provides a very comprehensive and useful review of the evolutionary process through which changes were introduced in Pakistan’s legal system in order to introduce the Islamic banking law. Pakistan chose to follow a gradualist approach to the transformation of the banking system. The evolution began, as Mr. Murvat says, in 1947. It became more formalized in the latter part of the 1970s and was generalized in the middle of 1985. The gradualist approach has allowed the law to catch up with the requirements of the time. Of course, problems have emerged, and we will address those shortly. What we will attempt to do is to provide a bridge between the legal and the economic aspects of Islamic banking, and briefly review Pakistan’s experience.

A rigorous legal framework is very central to Islamic banking, at the core of which are the issues of contracts and property rights which underlie the prohibition of predetermined interest. Islamic law provides freedom of contract, assuming that the terms of the contracts are not in violation of the precepts of the Shariah: in particular, it permits any arrangement based on the consent of the parties involved, so long as the shares of each are contingent upon uncertain gain and are a function of tangible transformation of resources. This aspect of the arrangement is crucial, since the Shariah condemns even a guarantee by the working partner to restore the value of invested capital, not only because it removes the element of uncertainty needed to legitimize the agreed distribution of the possible profits but also because the lender would not be remunerated to the extent of the productivity of his financial capital in the resulting profit. Islam recognizes two types of individual claim to property: (1) property that is a result of the combination of an individual’s creative labor and natural resources, and (2) property whose title has been transferred by its owner as a result of exchange, remittance of the rights of others in the owner’s property, other benefits, grants by the owner to those in need, and—finally—inheritance.

Money represents the monetized claims of its owner to property rights created. Lending money, in effect, is a transfer of this right, and all that can be claimed in return is its equivalent and no more. Funds are used either productively, in that their expenditure leads to the creation of additional wealth, or unproductively, in that their expenditure does not lead to the creation of incremental wealth, by the borrower. In the first case, when funds are used in combination with the creative labor of the entrepreneur to create additional wealth, the lender may ask for a portion of this incremental wealth but may not ask for a fixed return, irrespective of the outcome of the enterprise. In the second case, since no additional wealth, property, or asset is created by the borrower, the money lent, even if it is legitimately acquired, cannot claim any additional property rights, since none are created.

On the basis of the above, economists have developed theoretical models of Islamic banking. These models imply no reduction in the effectiveness of monetary policy or of the role of central banks in the performance of their traditional function, including monetary policy. With the exception of the discount rate, all traditional tools of monetary policy would be available to the central bank. These models propose that manipulation of the ratios that determine profit sharing between banks and depositors, as well as between banks and agent entrepreneurs, be used as an additional monetary policy tool. They also foresee that in an Islamic banking system, the central bank would invest directly in the real sector and, so long as securities do not have par-value features and represent real assets, the central bank would have the ability to buy and sell securities—that is, to engage in open-market operations.

The Islamic banking system is, in principle, compatible with the close correspondence between financial and real rates of return, and, consequently, with an efficient allocation of resources. This is the most central element of the system. Theoretically, Islamic banking would allow for a perfect match between real rates of return and financial rates of return. Moreover, it could be adopted without weakening the effectiveness of official supervision of financial intermediation. It is, however, recognized that the efficient working of such a financial system requires properly organized primary and secondary capital financial markets.

Since the new law has been in operation for only three years, it is much too soon to comprehend its full impact on the operation of the banking system, the economy, or the effectiveness of monetary policy. While some problems have emerged, by and large, Pakistan’s experience has been favorable. Some deepening of the financial market has taken place through the creation of instruments, and mobilization of savings has continued unabated. There has been a movement away from fixed returns and toward (lending and borrowing based on) variable returns. In the process, there has been a movement toward equalizing financial rates of return and real rates of return. But a lot remains to be done.

Problems that have been encountered relate basically to difficulties in moving away from traditional short-term financial operations and toward medium-term and long-term equity operations involving profit and loss sharing. Owing to legal and institutional constraints, banks have continued to concentrate, as in the past, on short-term financing and the provision of working capital on a markup or installment basis. The persistence of these practices would end up generating a permanent bias in the balance sheets of the banks, which might not be conducive to their stability. Financing of government deficits continues to be on an interest basis, with serious implications for the transformation of the system, because payments by the Pakistani Government on these borrowings are fixed and are not related to the returns from its investments or expenditures. Continued government borrowing on a fixed-rate basis would inevitably index bank charges at this rate rather than at the actual rates of profit of borrowing entities. In addition, certain problems are peculiar to banks. The effective implementation of the new system has also been constrained, particularly by the legal and economic environment. The absence of precise legal definitions of various modes of financing is likely to constrain their future evolution. Moreover, the new system was introduced without fundamental changes in the laws governing contracts and mortgages.

As Mr. Murvat points out, the legal system has been adjusting, and eventually adjustments will take place to accommodate the new requirements. In particular, it is important to note that the dispute-settlement procedure has become operational through the establishment of tribunals. This is something that has to be watched very carefully and closely. How effective this procedure is will determine whether the system will progress toward handling more complex operations and modes of finance. The formula for determining profit-sharing ratios is arbitrary and could not only destabilize the movement of deposits between banks but also bias profit shares in favor of shareholders and against depositors. In principle, the shareholders and the depositors should be treated even handedly. So far, the differential treatment has been prompted by the banks’ perceived need to accord higher returns to those who have supposedly taken greater risks by tying up their resources for longer periods. This concept of relating returns to time creates a problem under the Islamic system. There is a need to develop new instruments to accommodate the diverse needs of the private sector, particularly in consumer finance. An effective implementation of the new system will also require reforms in other areas of the economy and economic policy. In particular, the existing income-tax system is viewed as iniquitous. Therefore, business owners have attempted to conceal genuine profits. Moreover, business attitudes would have to change, since without such change, entrepreneurs are unlikely to enter into profit-and-loss-sharing operations.

There are three basic sources of these problems. First, as Mr. Murvat points out, the legal framework is still evolving, and there is ambiguity with regard to the limitations of property rights and of contracts under the Islamic banking system. Second, difficulties have been encountered in devising non-interest-based sources of financing for the Government. Third, and finally, the existing financial infrastructure is inadequate: there are too few people with sufficient knowledge of the Shariah and a dearth of the expertise needed to determine costs and benefits, as well as profits and losses, under Islamic banking. At the same time, there is a need for well-developed and open secondary and primary capital markets that can provide liquidity to depositors and to ensure the marketability of assets. Without such markets, the banking system will not be able to move from short-term, trade-oriented operations to profit-and-loss-sharing ones.

Solutions to these problems will have to be found if the banking system is to continue to develop. Some steps have been taken, and experiments with new modes of financing have been undertaken. As Mr. Murvat points out, participatory certificates and other credit certificates have been introduced to increase financing options. (Modaraba operations with longer-term maturities have, however, been few, and these would need to be developed to bring the system to maturity.) Nonetheless, it should be kept in mind that the Islamic banking system will succeed only if steps are taken toward equating the real rate of return with the financial rates of return, since that would improve resource allocation and allow for more efficiency and growth.

*

The views expressed in this paper are the author’s and do not reflect the official views of the State Bank of Pakistan.

*

This comment addresses Mr. Murvat’s paper but not the addendum to it prepared by Mr. Hamid.

Within Same Series

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Cover Current Legal Issues Affecting Central Banks, Volume I
Current Legal Issues Affecting Central Banks, Volume I
Editor: Mr. Robert C. Effros
ISBN:
9781557751423
Publication Date:
15 Jun 1992
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557751423.071
Pages:
660