Pakistan's interest-free-banking law is still adjusting to the profit motive

One year after Pakistan's President, Gen. Muhammad Zia ul-Haq, moved to establish the world's first Islamic interest-free banking system in his country, Pakistani bankers and investors are searching for new ways to make money lending money. Islamic banking was established in Pakistan through a series of measures imposed between January and July of last year. Under the new system, interest, or riba, has been abolished from all financial transactions. In outlawing riba, Zia cites passages of the Koran which condemn the exacting of interest payments as a sin of greed.

In December 1984, the Pakistani government called on all five nationalized Pakistani banks and 17 foreign banks operating in the country to submit proposals of more ``godly and brotherly'' ways to make a profit from capital investment.

While seeking the moral approval of Pakistan's 80 million Muslims, more than nine-tenths of the population, Zia also maintains that his plan to ``Islamize'' the nation's banks rests on a logical, if unproven, economic theory. Internal borrowing for domestic development projects has been stifled in recent years as economic growth slowed and entrepreneurs began to worry over the prospect of long-term interest repayments. Zia and his advisers hope the new system will give added incentives to those wanting to start up or expand business in Pakistan.

Pakistan's Islamic banking system has been dubbed Profit and Loss Sharing, or PLS. According to official PLS rules, banks must settle for substantially lower return on their investments if the business borrowing from them suffers misfortune or performs poorly. Conversely, a lending bank will profit more through PLS if its client is also profiting.

The same rules apply to individuals who hold deposit accounts at their local bank. Interest paid on deposits varies according to the fortunes of the bank involved. Thus far, average investors in Pakistan holding relatively small savings accounts have actually earned a little more than they would have under the old fixed-interest system.

A storm of controversy still surrounds the new system, which incorporates the Koranic concept of musharika, or the moral responsibility for partners to share both good and bad business fortunes.

``Nobody is in business to help cover somebody else's losses,'' said one prominent Pakistani banker recently at an interview in his office in Islamabad. ``All they care about is making a profit. It doesn't matter what a holy book said 1,400 years ago.''

Other bankers and economists fear that the shared risks of Islamic banking may make people wary of investing their money in deposit accounts. Pakistan already suffers from one of the lowest savings rates in the world; at 7 percent it is on the same level with far poorer countries like Afghanistan and Nepal.

Ahmed Rashid, a well-known Pakistani economist and contributing editor to Euromoney magazine, has added to the criticism by calling the banking procedures in Pakistan ``a muddle.'' Rashid believes that the introduction of any radically different system will only promote further confusion and mistrust among both banks and big borrowers.

If such assertions prove to be true, it could further damage the already shaky Pakistani economy. Pakistan currently owes a whopping $11 billion in foreign debt. If there is a run on nationalized banks, the government could be hard pressed to keep up its external interest repayment.

The banks themselves are allowed to make profit by imposing a markup on the value of the goods or services they purchase for their borrowers. In theory, the markup system works like this: If a farmer, for example, wants to buy farm machinery to increase his crop output, then the bank will buy the equipment for him and allow him to use it. The bank will later sell this equipment back to him, asking for a price markup for having acted as a retailer of goods.

Just what constitutes a fair markup has not yet been clearly decided. Banks doing business in Pakistan have submitted at least a dozen new markup schemes during the past month. All these proposals are now awaiting official government approval.

Some Pakistanis criticize the new system for not being Islamic enough. Kurshid Ahmad, economist for the fundamentalist Jamaat-e-Islami party, calls the bankers' markup ``a disguised form of interest payment.'' Many of Pakistan's mullahs, or religious leaders, agree.

Zia argues that the markup is not immoral. While bankers are entitled to a markup on the increased value of their investment over time, they cannot charge compound interest on money owed to them. ``A markup is one thing,'' says Zia, ``but there will be no markup on the markup.''

Initially suspicious of the new Islamic banking system and its restrictions, some of the foreign banks in Pakistan have since decided to cooperate. Grindlays, one of the biggest foreign banks with over $90 million invested in Pakistan, began signing musharika agreements with its clients before any of the nationalized Pakistani banks did.