Theory-Practice Convergence of Islamic Banking in Pakistan: An Empirical Analysis

Abstract

Islamic banking was launched with the hopes that it would provide an alternative banking system that would be free of injustices inherent in conventional banking system. Given that bank interest was deemed impermissible by majority of the Muslim jurists, the alternative was proposed in the form of Profit-and-Loss Sharing (PLS) banking system. Muslim economists sought to replace fixed-return debt financing model of banking with that of equity financing on the basis of Profit-and-Loss Sharing. On the basis of this celebrated theory of Islamic banking, Siddique and Iqbal (2015) developed some empirically verifiable hypotheses for tracing the convergence between theory and practice of Islamic banking. This paper develops empirical methodologies and tools to test those observable hypotheses. Applying these methodologies, the study investigates the extent to which Islamic banking practice has converged to its theory in Pakistan. The results indicate that the Islamic banking industry of Pakistan is yet to achieve its stated objectives.