Modes of Financing: Islamic Banking

The State Bank of Pakistan had prescribed 12 modes of financing to be used by the banking companies for providing finance to their clients. These modes were circulated through State Bank’s circular No 13 dated June 20, 1984. Details are given below:

a. Financing by Lending

1. Loans not carrying any interest on which the bank 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.
2. Qard-e-hasan loans given on compassionate grounds free of any interest or service charge and repayable if and when the borrower is able to pay.

b.Trade-related Modes

1. 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.
2. Purchase of trade bills.
3. Purchase of movable or immovable property by the banks from their clients with buy-back agreement or otherwise.
4. Leasing.
5. Hire-purchase.
6. Financing for development of property on the basis of a development charge.
7. Investment type Modes
8. Musharakah or profit-and-loss sharing.
9. Equity participation and purchase of shares.
10. Purchase of participation term certificates and mudarba certificates.
11. Rent-sharing.

Keeping in view the past experience, there is need to make changes in the prescribed modes. The following existing modes of financing need to be deleted:

1. Purchase of property under buy-back agreement. Widely misused by banks.
2. Purchase of trade bills. According to Shari'ah principle banks should purchase goods represented by the said bills, and not the trade bills without any rcspon sibility for the goods themselves.
3. Finance-leasing. Practically used by financial institutions as a money loan for purcha.se of durable goods making the lessee responsible for all liabilities relating to the leased assets.
4. Financing on the basis of development charges. Sufficient evidence is not available in support of its being Islamically acceptable.

The following new modes of financing need to be added to the list of the approved modes of finance:

1. Bai’ salam, i.e. purchase of goods and commodities by banks from their clients on the basis of immediate payment of price but on deferred delivery of goods and commodities. This mode can eliminate one difficulty being faced by the manufacturing sector, i.e. while raw material can be purchased by banks and sold to their clients on deferred payment basis, no provision exists for meeting the cost of overheads and other administrative expenses. Financing through bai' salam can take care of the value-added portion of the product. However, the banks will have to use this mode with care and caution lest they should be stuck up with unsold goods.
2. Financing on the basis of profit-sharing under mudar- ba arrangement. At present, banks can provide finance to clients on the basis of musharakah but not on the basis of mudarba. What is presently permitted is that banks can purchase mudarba certificates issued by companies registered as mudarba companies for purpose of floatation of mudarbas. As such banks are not permitted to provide finance to a technically qualified person who has the skills but is in need of finance. Also, there is need to make changes in the terminology used in banking transactions. For example, it is suggested that terms like bai’ mu'ajjal certificate be used for TFC (term finance certificate) and musharakah certificate be used for PTC (participation term certificate). Word ‘bai' mu‘ajjal' be used

Source: Elimination of Riba, Khurshid Ahmad, Khalid Rahman and Zahed A. Valie. Republished with permission.