Faith or folly? The high-stakes of Pakistan’s push for 100pc Islamic Banking

Pakistan is pushing ahead with its ambitious goal of becoming a 100 percent Islamic banking economy within the next few years, a move in line with the Federal Shariat Court’s ruling to eliminate interest-based banking. While the transition is being hailed by policymakers and religious scholars as a long-overdue step, the shift raises pressing questions for both banks and customers.

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As the sector undergoes this transformation, three concerns dominate the public discourse: how banks are reaching out to customers, what will happen to those who prefer conventional banking, and how savings and returns are being safeguarded? Let’s look at these one by one.

A TRANSITION MARKED BY UNEASE

On paper, Pakistan’s journey towards Islamic banking looks smooth. Islamic banks have expanded their footprint significantly in the past two decades, and the State Bank of Pakistan (SBP) has repeatedly stressed its commitment to a phased but complete transition.

However, the practical rollout has been far from seamless. Banks were asked by the SBP to submit their transition plans with the deadline set around October last year. While those plans remain confidential to individual banks, some of the effects are being seen in Khyber Pakhtunkhwa.

Customers of Habib Bank Limited and Bank of Khyber, in Peshawar, have told HUM News that they were notified at the eleventh hour about their banking branch being converted into Islamic banking. Worse still, those opting to stay with conventional banking were directed to distant branches on the outskirts of the city. Even then, with the overall policy, it seems that the solution is temporary!

Such complaints highlight a key factor – lack of standard operating procedures (SOPs) governing how banks should communicate with customers. Without a clear policy dictating the notice period, the mode of communication, or detailed explanations, many depositors feel blindsided.

THE STRUCTURAL ROADBLOCKS

Lack of transparent SOPs is just tip of the iceberg. Perhaps the biggest challenge in this wholesale move to Islamic banking lies not with the customers but with the government itself.

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In February this year, first Pakistan Banking Summit was held in Karachi, which brought forth multiple such challenges that seemed to have been either completely ignored or deferred as problems for the future. That future, however, has already arrived and the issues can no longer be ignored.

Pakistan Banks’ Association (PBA) Chairman Zafar Masud had pointed out that the government is the single largest borrower in the system, meeting almost 100 per cent of its budget deficit financing through banks. Under the conventional system, this borrowing is carried out without the need for underlying assets. By contrast, in an Islamic framework, every financial transaction must be asset-backed.

This raises a thorny issue: can the government transform its massive domestic debt into Shariah-compliant Sukuk securities? Without a scalable, “asset-light” Sukuk structure, the transition risks stalling at the very foundation of Pakistan’s financial architecture.

The hurdles extend beyond domestic debt. Pakistan’s financial system is deeply embedded in a global network of correspondent banks and international development agencies. Institutions such as the Asian Development Bank, World Bank, and International Finance Corporation routinely provide Pakistan with trade and climate-related funding. But these institutions operate on conventional principles. How will Pakistan maintain access to these facilities once it fully eliminates interest-based banking? Will exemptions be carved out, or will new frameworks be negotiated?

Let’s not touch International Monetary Fund’s programs for now either.

Foreign banks operating inside Pakistan present another layer of complexity. Multinational players are unlikely to abandon conventional banking altogether, and Pakistani banks with significant foreign ownership may also face regulatory dilemmas.

Even the international example offers sobering perspective. Malaysia, widely regarded as a global leader in Islamic finance, has converted only 45 percent of its financial ecosystem into Shariah-compliant operations over half a century, with an ambition of reaching 60 percent in the next 10–15 years. If Malaysia, with its liberal financial environment and supportive global ties, has not achieved full conversion, can Pakistan realistically expect to do so in a fraction of the time?

Beyond banking and debt markets, the entire financial ecosystem will require restructuring. Insurance, equities, derivatives, asset management, and secondary markets all rely on interest-based or speculative instruments that are incompatible with Shariah law. Unless these parallel systems are simultaneously redesigned, Islamic banks will find themselves operating in isolation, unable to function effectively within the broader economy.

NO GOING BACK: THE END OF CONVENTIONAL BANKING

For decades, Pakistan’s banking was dominated by interest-based operations, and customers became accustomed to that model. Now, as the country declares its intent to become a fully Islamic banking economy, what happens to this segment of customers?

The answer from the banking sector is blunt: there will be no option to stick with conventional banking.

Bankers argue that just as customers adapted to conventional banking in the past, they will gradually adapt to Islamic banking. Yet, this raises the second pressing question: For those who choose to remain with conventional banking, what is the way forward?

The truth is, there is no “way forward” in terms of choice. Customers will have to transition, regardless of personal preference. This is not merely a financial shift, but a cultural and behavioural one. While many welcome the move on religious and ethical grounds, others – especially those less familiar with Shariah-compliant products – fear confusion and possible financial disadvantages in the early phases.

LET’S TALK ‘PROFIT’ NOW

A critical concern in this transition is whether Islamic banking products can match the returns customers have been used to in conventional accounts. Traditionally, the profit rates on Islamic savings accounts, mutual funds, and provident funds were 4–5 percent lower than conventional equivalents.

Also read: Sirajul Haq takes Maulana Fazl to task over interest-based system

However, the SBP has recently moved to close this gap. In a major development, the central bank announced that the Minimum Profit Rate (MPR) requirement will no longer apply to deposits of financial institutions, public sector enterprises, and public limited companies. Instead, Islamic Banking Institutions (IBIs) must now pay at least 75 percent of the weighted average gross yield from their investment pools to Pakistani Rupee savings depositors. This shift means that the difference in returns between conventional and Islamic deposits has now narrowed to 0.5–1 percent.

But this leads to the third critical question: If banking customers are not informed in time of the transition, and their returns are affected, what is their recourse?

In theory, the SBP’s revised framework protects customers by ensuring a more transparent and Shariah-compliant distribution of profits. IBIs may even forgo part of their Mudarib share (their profit portion) to meet customer expectations if returns fall below market benchmarks. However, in practice, customers still depend heavily on how well banks communicate these changes. Without adequate notice, many could find themselves caught off-guard by altered profit structures and delayed payouts.

THERE’S MORE!

Even if you would – for the sake of an argument – believe that all the challenges mentioned above can be resolved by 2027, even then the following challenges persist.

Capacity gaps: Not all banks are equally prepared to manage the complexities of Islamic products. Training, Shariah compliance, and pool management require significant investment.

Customer literacy: A large portion of Pakistan’s banking population has limited understanding of how Islamic banking differs from conventional. Without widespread financial literacy campaigns, misunderstandings could deepen.

Geographic inequalities: Urban centres like Karachi, Lahore, and Islamabad may see smoother transitions due to greater availability of Islamic branches, while smaller towns and rural areas are more vulnerable to disruptions.

Operational opacity: Keeping transition plans under wraps might shield banks from criticism, but it also undermines accountability and risks alienating customers.

Pakistan’s transition to a fully Islamic banking system is unprecedented in scale. While policymakers view it as a step towards aligning finance with the country’s Islamic ethos, the process remains riddled with gaps. The lack of transparency on SOPs, the absence of a conventional alternative, and uncertainty over customers’ recourse all point to the need for clearer policies and communication. Unless banks and regulators address customer communication and operational clarity, the risk of alienation will linger.

The central question is not whether Islamic banking can replace conventional but whether the transition will be inclusive, transparent, and smooth enough to bring the public along for the journey.

HUM News English reached out to the SBP with all these concerns and queries. The only response received, after two days of reminders, was that the queries will be answered soon. That response was received over a day prior to the publishing of this story.