Understanding the Interest-Free System

Introduction 

It has been years that different terms and policies have been applied to overcome Riba (interest) to make Pakistan an interest-free bank according to Islamic guidelines. All these endeavours were in vain when the other party started pleading, for their benefits. Around 34 hearings were conducted to resolve this issue. Many arguments were made in the Court but the matter is still undecided”. It can be said a longstanding matter is still pending and the consensuses are not established by either party. Before looking at how courts address this issue of Riba, knowing what Riba is, how Islam communicates this to others and in what way can we remove it from this system is the big issue. 

What is Riba?

Riba is an Islamic term that means to “increase” or to “exceed”. This refers to the unequal exchange of money, which makes one lose and another benefit from it. Riba can be referred to as ‘charged interest for unreasonable purposes’. Mostly it is used in banking, where one who pays back the loan also has to pay Riba.

According to the Sharia law engaging in practices of Riba (interest) is strictly prohibited for numerous reasons, primarily because it involves earning money through unfair means. Islam encourages acts of charity, symbolizing kindness and discouraging self-interest. Conferring to Sharia law, it is prohibited for many reasons. Mainly, people are making money in an illegal way. In contrast, Islam promotes charity which gives the sign of kindness and removes the selfishness which can lead to social bitterness.  In Islam it has been told 8 times in the Quran to stay away from Riba, a total of 12 verses in the Quran deal with Riba.

[2:275]; “Those who consume interest cannot stand [on the Day of Resurrection] except as one stand who is being beaten by Satan into insanity.” [2:276]; “Allah destroys interest and gives increase for charities.”  [3:130]; “Believers! Do not swallow interest, doubled and redoubled, and be mindful of Allah so that you may attain true success”.

Whereas in Hadiths; There are about 70, 72, or 73 varieties of Interest, From Jabir: The Prophet, may curse the receiver and the payer of interest, the one who records it, and the two witnesses to the transaction and say: “They are all alike [in guilt].’’ Anas ibn Malik: The Prophet, said: “If a man extends a loan to someone he should not accept a gift.”

Riba is not only used in banks but also used in contracts. In contrast, two types of riba are explained in the holy Quran. One is used as Riba in loan contracts and is known as Riba al-Nasiyah. It can be seen when a lender asks for more money from the borrower because the borrower is late in repaying a loan, this extra charge of money only applies to loans and not to credit purchases. If by default he can’t pay back the loan and its increased it from its original amount, the Riba steps in. Hence, “Any pre-determined or pre-agreed increase or any extra amount over the original loan amount charged by the lender is considered as Riba”.

Over here we can also talk about giving an optional gift to anyone, however, while giving it the borrower should not agree on it and the lender should not stipulate in his way. As told by Jabir bin Abdullah: “I went to the Prophet while he was in the Mosque. After the Prophet told me to pray two Rakat, he repaid me the debt he owed me and gave me an extra amount.” [Sahih Bukhari].  This is a clear example of how we can gift in repayment. The other type of contract is Riba in sale or exchange contract (Riba al-Fadl).  If two people exchange the same commodity but in unequal amounts, the extra would be Riba. This type of Riba is also called Riba al-Hadith in the literature of scholars because it is not directly mentioned in the Quran. The Prophet (ﷺ) has classified it as Riba in the following hadith:

“Gold for gold, silver for silver, wheat for wheat, barley for barley, the date for date, salt for salt, must be equal on both sides and hand to hand, whoever pays more or demands more (on either side) indulges in Riba” [Sahih Muslim].

According to this hadith, two main criteria qualify a sale as having Riba: one Delay in time or deferment of the exchange of commodities, and second Difference in quality in exchange for similar commodities. This type of Riba is only applied to possessions like rice, oil wheat, etc. This happens in the sale and transaction of something that is on commodities.

Precedents 

On April 12, 2022, a hearing was held at the Federal Shariat Court (FSC)(Islamabad) on Riba, where it came out as; “The full bench of the Court comprising of Justice Muhammad Noor Meskanzai Chief Justice, Justice Dr. Syed Muhammad Anwar, and Justice Khadim Hussain M. Shaikh, in the exercise of power under Article 203-D of the Constitution of Islamic Republic of Pakistan continued hearing of the Riba case and reserved it. Although countless laws have been established to address this issue, there are cases where enforcement is overlooked or not thoroughly applied.  Riba not only affects the economic system but also makes one selfish and hard-heartedness which can easily kill humanity for its purposes. This is disastrous to society morally and economically. More or less we are still working on Riba so we can provide any alternative solution to the system.

The amendment in the Contract Act 1974 clearly says; “the provision relating to interest contained in the sections of the Act and the word “interest” wherever appearing in the meaning of riba in the contract Act 1974 and section 74 of contract Act 1974 be deleted and paragraphs reorganised and substituted appropriately”. All this aside first we should know how this interest works. what are the processes by which banks provide loans? A small example can be; If a person asks for a loan of 10,000 and the required time within he has to pay back his loan is in 1 year and the bank interest rate is 7 percent. Ultimately, in the end, he has to pay 10,700 which is 700 times more than the actual amount. This clearly shows how one can be in loss and another one in benefit.

On May 1st, 2022, the Federal Shariat Court (FSC) issued a much-anticipated verdict on the interest-free economy. While the specific details were not provided in the text, the result is described as setting a positive direction and addressing reservations. This development is seen as opening new possibilities for realizing an interest-free economy and should be considered a stepping stone for further actions by the government and stakeholders. 

It is said that the State Bank of Pakistan also wants to eliminate Riba from the country with every possible object. Still, the question arises as to why this process is always hanging. It’s been years since we have been working on it, or maybe it’s because banks don’t want to eliminate this, as they get more profit from it.  

Whereas article 38 of the constitution read as (f); “The state shall eliminate Riba as early as possible’’. The article wants to eliminate it as soon as possible but the judgment came out after 20 years stating that;

 “We are of the view that a five-year period is reasonably enough time for the implementation of our decision completely i.e., convert the economy of Pakistan into, an equitable, asset-based, risk-sharing, and interest-free economy,” read a 298-page judgment authored by Justice Dr Syed Muhammad Answer and endorsed by two other judges. “Therefore, we would specify the 31st day of December 2027 on which the decision shall take effect by way of the complete elimination of Riba from Pakistan,” it added. As previously said many amendments were introduced to overcome with Riba and another article which also gives us the view that we should not use this as we are an Islamic country and our laws are made according to Quran and Sunnah. This is a prohibited act in all Muslim countries.

As referred to by Article 227 says; “(1) all existing laws shall be brought in conformity with the injunction of Islam as laid down in the Holy Quran and sunnah, in this part referred to as the injunction Islam, and no law shall be enacted which is repugnant to such Injunctions.’ Moreover, it is not only used within the countries it can also be borrowed money from foreign countries as well. Hence, the loan taken from the bank is riba whether it is taken for personal use, commercial use, or industrial use it’s still prohibited for us. Apart from it and keeping the recent hearing in view, the bank has not provided any solution to the courts probably because they think that they will be at a big loss. In my view the alternative solution for this can be; that there should not be any fixed price for this, the current rate of interest is 22% rather than working on it we are encouraging it to be like this, it can be said that the bank is reluctant to change its process, and wants to promote the system of the interest. 

In viewing the Saudi Arab Islamic banking system, it is not a conventional banking system but rather an Islamic banking system. A satisfying line is drawn between conventional banking and Islamic banking.  Conventional banking is a man-made principle; secondly, it has an interest in investment and in borrowing as well; thirdly it maximizes profits with only legislative restrictions; lastly, the money that is deposited is in an un-Islamic way. On the other hand, if the Islamic Banking System is implemented, then there will be no interest, so the economic system gradually gets better as well as the society, it maximizes profits with legislative and shariah restrictions. Lastly, money that is deposited in the bank can be used as what is allowed under the Shariah Law.

Assuming that we do make laws and different amendments to overcome it but still, a system cannot survive one way. It can be said that it is always a two-way thing if courts cannot come to a particular discussion or are still hanging up there then banks who give loans with Riba should step in and give any other alternative solution to courts so that we can be an interest-free country as soon as possible. There are several options available to change Pakistan towards an interest-free banking system such as; Islamic banking: Islamic banking is a financial system based on the principles of Shariah law, which prohibits charging or paying interest (Riba). Instead, Islamic banks use profit and loss sharing (PLS) and other non-interest-based financing methods to provide financial services to customers. You can consider switching to an Islamic bank that offers services based on Shariah principles. 

Ethical banking: Some conventional banks offer ethical banking services that focus on socially responsible investments and avoid financing activities that are considered harmful or unethical. You can research ethical banks in your area and switch to a bank that aligns with your values. 

Credit unions: Credit unions are not-for-profit financial cooperatives that are owned by their members. They offer similar services as banks but operate on a different business model. Since credit unions are owned by their members, they prioritize the needs of their members over profit. You can consider joining a credit union that aligns with your values and beliefs. Cash-based transactions: You can also choose to conduct cash-based transactions and avoid using banks altogether. However, this may not be a feasible option for everyone and may require significant changes to your financial habits It’s important to see that each point has its pros and cons, and the bank should opt for the one which suits them. Additionally, if courts look up to this matter very seriously they might work on this. 

Besides that, there have been several studies and proposals for creating interest-free banking in Pakistan. Here are some references that may be useful:  “Interest-Free Banking in Pakistan: A Critical Analysis” by S. M. Aamir Shahzad and Raza Ali Khan, published in the International Journal of Management, Accounting, and Economics in January 2020, critically assesses Pakistan’s existing Islamic banking system and suggests a framework for interest-free banking based on Islamic principles. He underlines the importance of interest-free banking in Islamic economics and the growing demand for such services in Pakistan.

They identify challenges, including legal and regulatory issues, lack of awareness, and competition. The proposed framework relies on principles like mudarabah, musharakah, and ijara to create Islamic-compatible financial products that provide various customer needs. Moreover, he also discusses the role of the State Bank of Pakistan (SBP) in promoting interest-free banking and recommends measures such as regulatory support, public awareness, and a level playing field for Islamic and conventional banks.

Certain articles inspect challenges and solutions for implementing interest-free banking in Pakistan. It discusses the growth of Islamic finance, challenges like legal and regulatory issues, and competition. His Project solutions include public awareness, regulatory support, human resources development, and levelling the playing field for Islamic and conventional banks. Interest-free banking in Pakistan has the potential to boost financial inclusion, economic growth, and the Islamic finance industry.

‘The article “Creating Interest-Free Banking in Pakistan” by Abdul Quddus Suhaib and Abdul Sattar Abbasi, published in the Journal of Economic Cooperation and Development in 2013, outlines a framework and roadmap for establishing interest-free banking in Pakistan. It underlines the importance of interest-free banking in Islam, its possibility for financial presence and economic development, and categorizes challenges, including legal and regulatory issues, lack of awareness, and competition. The proposes a complete framework based on mudarabah, musharakah, and ijara principles to create Islamic financial products. They also give a roadmap for operation, including legal and regulatory development, public awareness, human resource improvement, and creating a level playing field for Islamic and conventional banks.’

‘In the research article “Interest-Free Banking in Pakistan: A Study of Customers’ Perception and Attitude” by Muhammad Azeem Qureshi, published in the Pakistan Journal of Commerce and Social Sciences in 2013, the author examines how customers in Pakistan perceive interest-free banking. The paper digs into the increasing demand for such services and the problems faced, including legal and controlling issues, a lack of awareness and education, and inflexible market competition. Moreover, it highlights the opportunities allied with interest-free banking, like financial inclusion, economic growth, and Islamic finance industry development. Furthermore, the author also gives solutions such as establishing a legal and regulatory framework, raising public awareness, improving human resources and infrastructure, and fostering collaboration among policymakers, regulators, and stakeholders to advance interest-free banking and Islamic finance in Pakistan’

These references provide valuable insights into the challenges and opportunities of creating interest-free banking in Pakistan. However, it’s important to note that implementing interest-free banking requires significant regulations it may take time to establish an inclusive system. Based on the views expressed in the above-mentioned research articles, interest-free banking can be seen as a viable alternative to conventional banking, especially for those who prefer to conduct financial transactions by Islamic principles. The articles also highlight the challenges and opportunities of implementing interest-free banking in Pakistan, including legal and regulatory issues, lack of awareness and education, and market competition. It is important to address these challenges to ensure the successful implementation and growth of interest-free banking in Pakistan. This can be achieved through collaboration and cooperation between policymakers, regulators, and stakeholders in promoting interest-free banking and Islamic finance in Pakistan.

The introduction of interest banking, in Pakistan is believed to bring potential advantages to the country’s economy and society. Firstly, it can foster inclusion by granting access to banking services for individuals who are either unable or unwilling to utilize traditional banking services. This in turn can encourage progress and alleviate poverty by empowering people to save, invest and actively participate in activities. Secondly, interest-free banking has the potential to attract investments from foreign investors who are seeking Shariah financial products and services. This influx of funds can enhance the availability of capital for businesses, and stimulate growth. Thirdly interest-free banking holds the promise of promoting socially responsible finance by aligning transactions with Islamic principles. These principles involve abstaining from interest-based transactions promoting risk sharing and investing in projects. Lastly fostering the expansion of interest banking can contribute significantly to the advancement of Pakistan’s finance industry. This growth will not generate employment opportunities. Also support related sectors such, as Islamic insurance (takaful) and Islamic capital markets. Overall, the implementation of interest-free banking in Pakistan can have significant economic and social benefits, including financial inclusion, increased investments, ethical and socially responsible finance, and the development of the Islamic finance industry. However, it is important to address the challenges and ensure the effective implementation and growth of interest-free banking in Pakistan. Lastly, a more effective solution can be using interest banking for business purposes, to using interest-based loans to finance business projects or funds that have the potential to generate higher returns than the cost of borrowing. This can allow businesses to influence the use of debt to grow their operations and increase profitability. For instance, when a business decides to borrow money from a bank at an interest rate of 8% to fund a project. This project is projected to produce a return of 12%, per year. In such a situation the interest paid on the loan would be balanced out by the return on the investment eventually resulting in a net return, for the business.

However, it is critical for businesses to thoroughly measure the risks and benefits associated with applying for interest-based loans. They should ensure that the cost of borrowing does not outweigh the returns on their investments, furthermore, businesses should also explore sources of financing like equity financing or revenue-sharing agreements these options do not involve interest-based transactions. 

Bibliography

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