Pakistan: legal challenges to Islamic banking |
Islamic banking has emerged as a significant segment of Pakistan’s financial system, serving both faith based and commercial objectives by mobilising substantial domestic capital.
Since its formal introduction in Pakistan in 1979, the industry has grown to claim a meaningful share of the banking sector, with assets and deposits running into trillions of rupees and a gradually expanding institutional footprint.
Despite this scale of evolution, it is yet in a struggling phase because of the structural, regulatory and specifically, the legal challenges, which require consideration of the legislation.
The said consideration is required for strengthening the subject legal framework as well as to address the transitioning of the conventional banking into Islamic banking, in accordance with the judgement of the Federal Shariat Court, passed in the year 2022, cited as PLD 2023 — Federal Shariat Court 47. The judgment has directed the government to transition Pakistan to a completely interest-free economic system within five years.
The judgment has reaffirmed that interest (Riba) in banking is prohibited (haram) under Islamic law (Sharia) and expressly directed the government to move towards an interest-free economy.
The review of the Pakistan legal framework shows that banking in Pakistan is governed mainly under the Banking Companies Ordinance, 1962 (the “Ordinance”), which serves as the principal law to regulate this sector, including defining the “banking” / “banking business” and the business that the banks can conduct. Interestingly, the Ordinance did not have a dedicated framework for Islamic banking until the enactment of the Banking Companies (Amendment) Act, 2024, through which Parliament introduced an exclusive Part (Part II-A) on Islamic banking, marking the first formal legislative basis for Islamic banking, although the State Bank is reportedly reviewing numerous existing laws to formalize this mandate.
Prior to the enactment of the Banking Companies (Amendment) Act, 2024, Islamic banking was regulated primarily through guidelines, circulars, and administrative directions issued by the State Bank of Pakistan.
The newly inserted Part II-A introduces a formal framework for Islamic banking; however, its scope remains limited, as it sets out only foundational principles and largely relies on earlier provisions of the Ordinance. For example, the newly introduced Part II-A has though provided that what could be the permissible business activities of Islamic banks; however, it did not provide a distinct and comprehensive statutory framework on the subject but simply provides that the businesses should be consistent with the Sharia Principles as specified by the State Bank and the Ordinance.
This deficient framework for Islamic banking is causing legal adaptability of the banking products offered by Islamic banks.
The legal framework provides minimal statutory definitions for Islamic banking........