Legislative Changes in Islamic Finance

The Islamic system of finance envisages a significantly different basis of contractual arrangements compared to those entailed by the interest-based system. The legal framework governing the financial system was primarily designed from the point of an interest-based system. In order to accommodate the new system a number of changes in the existing legal framework were required. Over the period 1980-84, a variety of new laws and amendments in existing laws were enacted to either give effect to the new measures or to protect them.

The most significant changes in this regard were as follows:

1. Through the insertion of a new Section 26A, in the Banking Companies Ordinance 1963, in Dec. 1980 the banking companies were enabled to raise deposits on the basis of profit and loss sharing basis along with ancillary directions for the use of such deposits;
2. Through the insertion of a new Section 6A, the Partnership Act 1932, in Dec. 1980, the PLS depositors were insulated from the application of the Act which envisaged unlimited liability of the partners in the partnership;
3. Through the insertion of new clauses in Section 5 of the Banking Companies Ordinance 1963, in Dec. 1980, the definitions of creditors and debtors were enlarged to include the arrangements under the PLS accounts and other modes of non-interest financing; in a similar way the definition of loans, advances and credit has been enlarged to include finance provided under the non-interest modes of financing.
4. A change was also effected in the Negotiable Instruments Act 1881 whereby promissory note issued on the basis of adjustable profits were made possible; through further amendments relief under the Act was also made available to notes issued on the basis of mark­up or mark-down in prices;
5. Through an amendment in the Code of Civil Procedure 1908, Courts were allowed to grant mark-up or return, depending on the nature of finance provided, on judgment debt from the date of decree till its discharge;
6. Banking Companies Ordinance 1963 was further amended to provide for newer forms of business (Section 7) in which banking companies can participate such as a Mudaraba Company, to acquire properties for leased out or sold on hire-purchase and deferred payment basis and to invest in mudaraba certificates and participation term certificates;
7. Amendments were also incorporated in the State Bank of Pakistan Act 1956 to enable it to deal with new instruments of financing while undertaking its supervisory and central banking operations.
8. In the Companies Ordinance 1984 new provisions were introduced, relative to the Act of 1913, that dealt with the new concept of redeemable capital and included in its definition non-interest instruments such as PTC, Term Finance Certificate (TFC) or any other instrument not based on interest; they also provided for the allied matters connected with the obligations and rights of parties to such arrangements;
9. Perhaps the most significant legislative change was introduced in the form of a new law, called the Banking Tribunals Ordinance 1984, which established a new judicial machinery in the country, exclusively devoted to the recovery of dues under the non-interest financing arrangements. The jurisdiction of the Tribunals comprised all finances provided by a banking company on the basis other than interest. For this purpose comprehensive definition of finance was provided in the law and same was adopted as such under the Banking Companies Ordinance for defining the scope of business in which the banking companies can engage. A summary procedure was provided for the hearing of recovery cases and extension beyond that period required prior deposit of the claimed amount.

Evidently, a significant amount of legal engineering was undertaken to provide protection to the new system. Although we reserve our comments on these changes for a latter occasion, one cannot help but to note that the entire focus of this exercise had been to accommodate the new system largely within the framework of the old system. Thus we see flagrant inclusion of participative arrangements with in the debtor-creditor relationship.

Source: Experiences in Islamic Banking: A Case Study of Islami Bank Bangladesh, Institute of Policy Studies. Republished with permission.