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Business Administration QUESTION #9581
Question 1
Pakistan's Islamic Economic System initiatives include the Mudarabah Companies Ordinance 1980 and the introduction of Profit and Loss Sharing (PLS) accounts. Which fundamental principle distinguishes Islamic finance from conventional banking, and what structural challenge has limited its full implementation in Pakistan?
  • Prohibition of gharar (uncertainty) — conventional banks hedge uncertainty through derivatives which Islamic banks cannot use, limiting risk management capacity
  • Prohibition of riba (interest) — replacing fixed interest with profit/loss sharing requires banks to act as equity partners rather than creditors, creating asset-liability mismatches and requiring sophisticated project appraisal capacities that many Pakistani banks lack✔️
  • Mandatory zakat deduction — the obligation to distribute 2.5% of assets annually reduces the capital available for Islamic banks to deploy as financing
  • Prohibition of haram industries — screening out non-compliant sectors restricts the investable universe and reduces portfolio diversification
Correct Answer Explanation
Riba prohibition is the central distinguishing principle. The shift from interest to PLS fundamentally changes bank economics — banks become risk-sharing equity partners whose returns depend on project performance rather than contractual interest. This demands sophisticated credit appraisal, creates asset-liability duration mismatches, and requires legal/accounting frameworks that Pakistan's system has only partially developed, explaining the incomplete transition.