P L d 2000 s c 225 (Riba prohibition stayed)

 

The transaction of a sale of Murabaha based on mark-up, even after fulfilling its necessary conditions is not an ideal mode for the extensive use of Islamic Banks. Still, the banks will have to resort to this transaction in certain cases, especially in the initial phase of transformation. It is therefore, more necessary to strike down section 9 as it stands at present, instead of striking down the transaction of `mark-up’ totally, because provisions of section 9 are an obstacle in the way of a true Islamic Banking. These not only invalidate the transaction of Murabaha or Bai’ Mu’ajjal according to Shariah, but also hamper the natural function of leasing hire-purchase Musharaka or Mudaraba transactions. Section 9 was, in fact, designed in the context of interest-based banking in which the banks deal in money and papers only, while a true Islamic financing is always backed by real assets, and this is the basic distinctive feature of Islamic Banking which can rid the economy from many evils of the interest-based banking. The concept of Islamic Banking cannot be translated into reality unless it is realized that the banks are not meant only to deal in money and papers, but their financing is based on and firmly related with real business activities. The elimination of interest can neither be effective nor feasible without lifting the bar imposed on the banks by section 9 of the Banking Ordinance. The correct, just and practicable decision about the concept of mark-up provided in section 25 is not possible unless the bar imposed by section 9 is relaxed.

 

Where a proper and just settlement of the issues involved in a law under challenge is not possible without striking another provision of the same law, the Court has the jurisdiction to hit that provision also.

 

A just decision about the `mark-up’ envisaged in section 25 of the Banking Ordinance is not possible without striking down section 9. Therefore, the word `mark-up’ in section 25 may be retained, however, section 9 of the same Ordinance is repugnant to the Injunctions of Islam in so far as it prohibits banks from purchase and sale of goods and other trading activities necessary for adopting the Islamic modes of financing like Bai’ Mu’ajjaI and Murabaha based on mark-up, leasing, hire-purchase and Musharaka in their true and genuine forms. Section 9 shall be substituted to accommodate all the Islamic modes of financing with their necessary requirements.

 

Province of the Punjab v. Amin Jan Naeem and 4 others PLD 1994 SC 141 and Qazilbash Waqf v. The Land Commissioner, Punjab PLD 1990 SC 99 ref.

 

(q) Banking Companies Rules, 1963---

 

----R. 9(2)(3)---Constitution of Pakistan (1973), Art.203-F---Repugnancy to Injunctions of Islam---Provisions of R.9(2)(3), Banking Companies Rules, 1963 in so far these pertain to interest, are repugnant to the Injunctions of Islam ---Shairat Appellate Bench of Supreme Court directed that the law shall cease to have effect from 30-6-2001.

 

Sub-rule (2) of Rule 9, Banking Companies Rules, 1963 provides for crediting of interest on foreign approved securities on realization while sub-rule (3) relates to crediting of interest realized on rupee securities. Sub-rules (2) and (3) of Rule 9, in so far as they pertain to interest, are repugnant to the Injunctions of Islam as laid down in the Holy Qur’an and Sunnah of the Holy Prophet (p.b.u.h.). The retention of interest on foreign approved securities already realized need not be refused. The amount so received is to be credited to Baitul Mal and can be used for discharging the foreign debt and meeting out the other liabilities. Such a transitory and provisional course of action is allowed by Shariah. Same way, the interest received on rupee securities already issued and held can be similarly dealt with. However, in future such transactions which involve interest shall not be permitted.

 

(r) Banks (Nationalization) Payment of Compensation Rules, 1974--

 

----R. 9---Constitution of Pakistan (1973), Art.203-F---Repugnancy to Injunctions of Islam---Rule 9, Banks (Nationalization) Payment of Compensation Rules, 1974, which provides for reckoning of interest from the date of acquisition of the shares and its annual payment and the procedure of payment of interest and provisions referring to interest, are repugnant to Injunctions of Islam----Shariat Appellate Bench of the Supreme Court directed that instead of merely deleting the word “interest” from the various clauses of R.9, a new Rule should be framed on the lines indicated by the Court ensuring effective enforcement of prohibition of interest in future---Return of the profit relatable to the shares to be managed through Shariah compliant modes ---Shairat Appellate Bench of Supreme Court directed that the law shall cease to have effect from 30-6-2001.

 

Rule 9, Banks (Nationalisation) Payment of Compensation Rules, 1974 which provides for reckoning of interest from the date of acquisition of the shares and its annual payment and the procedure of payment of interest and these provisions referring to interest are repugnant to the Injunctions of Islam. Instead of merely deleting the word “interest” from the various clauses of Rule 9, a new rule should be framed on the lines indicated in the judgment ensuring effective enforcement of prohibition of interest in future. However, the return or the profit relatable to the shares shall be managed through Shariah compliant modes.

 

(s) Banking Companies (Recovery of Loans) Ordinance (XIX of 1979)---

 

----S.8(2)(a)(b)---Constitution of Pakistan (1973), Art. 203-F---Repugnancy to Injunctions of Islam---Provision of whole of S.8(2)(a) relating to interest and S.8(2)(b) of Banking Companies (Recovery of Loans) Ordinance, 1979 relating to mark-up are repugnant to Injunctions of Islam---shariat Appellate Bench ‘of Supreme Court directed that said provisions be suitably amended keeping in view the observations recorded in the judgment ---Shariat Appellate Bench declared that the provision will cease to have effect from 30th June, 2001.

 

(t) Islamic Jurisprudence---

 

---- Banking and economic system in Islam---Infrastructure and legal framework to successfully practise Islamic Banking and economic system--Elimination of Gharar, deceit and fraud is necessary by providing effective and necessary legal framework in order to ensure success of any economic system ---Gharar can be eliminated by bringing as much transparency, fairplay as possible in all public dealings---Effort to eliminate only Riba. in isolation from banking system, would be more harmful than helpful due to intricate interdependence of different vital economic sectors, and efficient v: course will be to first identify and strengthen the existing critical economic sectors falling under Shariah, thus, isolating Riba-based system for its proper treatment ---Shariat Appellate Bench of Supreme Court gave  guidelines and laid down measures needed to be taken to provide  infrastructure and legal framework to successfully practise Islamic economic system.

 

The framing of the laws and economic and monetary policies is the function of concerned organs and institutions of the State and not of Supreme Court but as the Government in the present case has insisted in its application that guidelines be provided in respect of the issues raised and as the economists, religious scholars etc. have expressed their. opinion with respect to these issues and with respect to the infrastructure needed to successfully practise Islamic economic system, Supreme Court has recorded guidelines for the consideration of the concerned quarters

 

The scholars, economists ‘and auditors are unanimous that elimination of Gharar, deceit and fraud is necessary by providing effective and necessary legal framework in order to ensure success of any economic system. The small investors who invested either in the stock markets or in bank deposits have been losers for the reasons that their savings have been eroded partially or fully because of presence of Gharar and speculative characteristics of stock markets. A reduction of nearly Rs. 300 billion in the market capitalization has gone unheeded. Similarly, defaults on bank loans amounting to approximately Rs.300 billion restricted these institutions to offer a reasonable return on deposits of small investors. Loopholes in the economic system allow defaulters to get away without any resistance and as such stringent measures/regulations are required to check speculative activities in the stock markets as also by formulating and administering monetary policy by an independent body which is competent and powerful enough to seek compliance of the monetary policy including borrowing activity prescribed under the laws/regulations to be framed and enacted in terms of the Constitutional mandate of Article 79 of the Constitution.

 

The laws in Pakistan on the subjects of good governance, fair dealings and transparency do exist but these need to be made comprehensive and also to the implemented in true spirit. Effort to eliminate only Riba. in isolation, from banking system would be more harmful than helpful due to intricate interdependence of different vital economic sectors, and that the efficient course will be to first identify and strengthen the existing critical economic sectors falling under Shariah, thus. isolating Riba-based system for its proper treatment.

 

Four major engines of economy identified by the economists which fueled the West’s economic growth are following:--

 

(i) Banking/Financial Sector;

 

(ii) Share market;

 

(iii) Debt/Bond Market; and

 

(iv) Government Borrowing/Lending.

 

Creation of large middle class is also a touchstone of Islamic Financial model to fight for concentration of wealth in few hands.

 

The other pertinent thing to be noted is that the total value of capital market is much bigger than the GDP. So, even if we, in Pakistan, are successful in creating an Islamic based judicious regulations, at least for capital markets, we can hope for a quick change for the better as these reforms would be effective to check corruption in all the sectors. The disintermediation will also trigger competition within our banking sector towards promoting Islamic products. The regulatory framework to control unlawful conduct including Gharar is designed to maximize justice and fairplay at all levels of investors’ interaction. Gharar can be eliminated by bringing as much transparency/ fairplay as possible in all public dealings. The disclosure requirements are so elaborate that speculative activities are minimized. This is achieved, inter alia. through the following measures:---

 

(1) Individual’s Credit History

 

No individual is allowed to get utilities connections, open any bank account, or obtain a loan unless his credit report received from a credit bureau is clean. These bureaus are non-Government entities and by paying a nominal fee any organization can access the databases for requisite information.

 

(2) Industries’ Rating

 

Four rating agencies namely, (i) Standard and Poor’s, (ii) Moody’s, (iii) DCR, and (iv) Fitch. IBCA are referred to by the financial institutions and lending institutions for reporting about credit ratings of the borrowers before extending loans, whether the borrower is a corporate body or other institution. The Security Exchange Commission, USA grants them licence and monitors their quality of work. In Pakistan, to regulate the business of credit rating companies, the Credit Rating Companies Rules, 1995 were framed by the Federal Government under section 33 of the Securities and Exchange Ordinance, 1969, but these Rules have not been usefully applied whereas in USA, individuals, corporations, banks and financial institutions and even the municipalities are all rated by the credit companies and their credit rating is relied upon by the investors before investing into the bonds or other instruments floated or offered for investment to the public. These ratings are instituted on the philosophy of right to know.

 

Even in England various statutes provide for prudential regulations and disclosure of necessary information. The Financial Services Act, 1986 and the regulations framed thereunder provide protection for the investors, with the “securitisation” of the investment industry in order to provide a system intended to make effective and to enhance London’s position as a financial centre. The Serious Fraud Office (S.F.O.) was established as an integral part of the criminal justice system. The S.F.O. is responsible for investigation and prosecution of some of the biggest cases of fraud in British .history. The S.F.O. is an independent Government Agency headed by Director who exercises his powers under the superintendence of the Attorney-General, maintains liaison with Government departments and regulatory bodies such as the Department of Trade and Industries, Bank of England. International Stuck Exchange, Securities and Investment Board, etc, These and other organizations report to the S.F.O. allegations of serious and complex abuses and misuse of powers and white-collar crimes.

 

The distinctive feature of the S.F.O.’s approach to investigations is the use of multidisciplinary teams, a team of Lawyers, Accountants, Police Officers, etc. appointed in each case, headed by a lawyer, who acts as a case controller being responsible for ensuring expeditious investigation and effective prosecution. It is through such measures that the West has effectively adopted Islamic teachings of justice, fairplay and proper disclosure to minimize Gharar. These measures are to be adopted by providing proper legal framework so as to bring about fundamental changes in the fabric of our society as transparency will put the economy on the right track quickly. It is due to absence of this regulatory legal framework and transparency and prudential measures that the investors in Pakistan were deprived of billions in the shape of Taj Company and Cooperatives scams. There has been a quick growth of companies at Stock Exchange as the corporate managers are least bothered to take investors into confidence by sharing company information and do not feel any moral obligation to share profits with investors. All this is due to absence of strict regulations, third party ratings and risk assessment. A comparison between the size of the economy and number of listed companies can be a guide to the loose regulatory framework that encourages rogues to fleece investors and creditors in the disguise of “Limited Liability” Laws. The number of companies at Karachi Stock Exchange Market arc 750 while the number of listed companies at New York Stock Exchange is five times larger whereas economy of USA is more than 100 times bigger than Pakistan’s economy. Unlike western countries there are no laws in Pakistan against insider trading (trading in Shares by owners) by major shareholders, which is conflict of interest, a crime in West.

 

The market indexes in the west like DOW JONES (USA), FTSE (UK), and Nikkei (Japan) were developed by third parties. In Pakistan tile KSE (Karachi Stock Exchange) 100 index is maintained by the stock market itself and has come under adverse comments from Ministry of Finance due to its speculative characteristics. It is said that this index serves the purpose of few players in the market by luring innocent investors into investment, thus, cyclically depriving them of their hard-earned money. This also requires transmission by introducing independent transparency.

 

(3) Debt Markets in Pakistan

 

We have an inactive debt market and its savings have been repeatedly wiped out as unlike western markets during melting clown of stocks. debt markets are not in a position to provide the necessary “hedge” to the investors. The result of this under-developed debt market is the promotion of Riba through savings being channeled into banking system as industries want long-term finance. they have to resort to the banking system which in turn results in promoting Riba transactions. It’ the concept of Islamic debt through Musharaka certificates is adopted on urgent basis. lot of equity/funds can be made available through developed debt markets and in that way reliance on banks can be reduced. Infrastructure can he provided by advising provinces/municipalities/corporate bodies to connote Qirad certificates/diminishing Musharaka certificates. thus, reducing reliance on foreign exchange borrowings and this is how local funds can he generated.

 

(4) Establishment of Data Collection Firms

 

The financial institutions should encourage experts, lawyers and others to establish firms for keeping track of the clients, individuals. corporations who commit default so that they could be brought before the competent Courts by facilitating service of the process of the Courts on them and also trace their properties and assets whether standing in their names or benami to facilitate recovery through execution of decrees.

 

(5) Recovery System

 

The laws pertaining to recovery of the defaulted loans are to be streamlined alongwith establishment of requisite number of Courts presided over by competent judges of unquestioned integrity. These judges should not be over burdened and only such number of cases should he assigned to them which can be disposed of within a period of three months. The tendency to institute recovery proceedings only when the borrowing company or the individual have almost squandered away their assets requires to be curbed and defaulters must be brought to book by instituting proper proceedings within reasonable time of default when the borrower as well as his assets are still traceable and realizable.

 

(6) Training of Officers and Staff

 

The education of the officers and staff of the financial institutions so as to make them aware of the rudimentary or essential principles of Islamic economy is imperative. They should have necessary knowledge of the modes and the products to be used by them. These training institutions should include courses in accounting and audit procedures suited and conforming to the principles of Shariah. Such an education will be objective oriented and should inculcate commitment with the objectives of Shariah.

 

(7) Audit and Accounts

 

The development of audit and accounts system and procedures conforming to the principles/ Injunctions of Islam and capable of achieving objectives of Shariah is also essential. Such standards and procedures have been laid down in detail in the book titled “Accounting and Auditing Standards for Islamic Financial Institutions” published by Accounting and Auditing Organization for Islamic Financial Institutions P.O.Box 1176, Manama, Bahrain Institute of Chartered Accountants and Auditors with the assistance of the representatives of the State Bank of Pakistan and Finance Division should study these standards, procedures for introducing any modification, change, alteration, if any required to suit the requirements and the needs of Financial Institutions and Banks in Pakistan.

 

Measures needed to be taken, the infrastructure and legal framework to be provided may be summarized as under:---

 

(1) Strict austerity measures to drastically curtail the Government expenditure should be adopted and implemented and deficit financing should he controlled as therein lies the solution to economic revival.

 

(2) An Act to regulate the Federal Consolidated Fund and Public Account, Provincial Consolidated Fund and Public Account requires to be enacted by the Parliament and the Provincial Assemblies respectively. This law will have to take care of borrowing powers, purpose and the scope of borrowing, its utilization, regulation and monitoring process including all ancillary matters.

 

(3) Law providing for necessary prudential measures ensuring transparency be enacted. These laws may include laws like Freedom of Information Act, the Privacy Act and Ethics Regulations of United States, Financial Services Act of Britain.

 

(4) Establishment of institution like Serious Fraud Office to control white collar and economic crimes.

 

(5) Establishment of credit rating agencies in the public sector.

 

(6) Establishment of evaluators for scrutiny of feasibility, reports.

 

(7) Establishment of special departments within the State Bank -

 

(a) Shariah Board for scrutiny and evaluation of Board’s procedures and products and for providing guidance for successfully managing the Islamic economics.

 

(b) A Board for arranging exchange of information, financial institutions about feasibility of projects, evaluation thereof and credit rating of institutions, corporations and other entities.,

 

(c) A Board for providing technical assistance to the financial institutions/banks with regard to the anomalies emerging in the practical operation of the financial institutions or difficulties arising during operation of financial products, transactions or arrangements between the financial institutions and the consumers/clients. This may also take the shape of Islamic Financial Service Institution. Such institutions will also work in the field of shares and investment certificates underwriting promotion and market making to help in activation of primary and secondary markets. The rise of such institutions, whose functions include the promotion of financial instruments and to work as their catalysts in the financial market, would be of great help and support to Islamic Banking. Among the factors which would help the creation and spreading of such institutions is the extension of tax incentives to their operation as well as to Islamic Banks to benefit from their services.

 

The establishment of aforenoted infrastructure is considered necessary by the economists for operation of the Islamic banking system with success.

 

Keeping all these aspects in view, Shariat Appellate Bench of Supreme Court appointed different dates for different phases of the transformation and directed that:

 

(1) The Federal Government shall, within one month from the announcement of this judgment, constitute in the State Bank of Pakistan a high-level Commission fully empowered to carry out, control and supervise the process of transformation of the existing financial system to the one conforming to Shariah. It shall comprise Shariah Scholars, committed economists, bankers and chartered accountants.

 

(2) Within two months from the date- of its constitution, the Commission shall chalk out the strategy to evaluate, scrutinize and implement the reports of the Commission for Islamization of the economy as well as the report of Raja Zafarul Haq Commission after circulating it among the leading banks, religious scholars, economists and the State Bank and Finance Division, inviting their comments and further suggestions. The strategic plan so finalized shall be sent to the Ministries of Law, Finance and Commerce, all the banks and financial institutions to take steps to implement it.

 

(3) Within one month from the announcement of this judgment, the Ministry of Law and Parliamentary Affairs shall form a task-force, comprising its officials and two Sharjah Scholars from the Council of Islamic Ideology or from the Commission of the Islamization of Economy, to:

 

(a) Draft a new law for the prohibition of Riba and other laws as proposed in the guidelines above.

 

(b) To review the existing financial and other laws to bring them into conformity with the requirements of the new financial system,