A SHARIAH-COMPLIANT ALTERNATIVE TO RUNNING FINANCE FOR PAKISTAN’S UNDOCUMENTED SECTOR: FOCUSING ON THE AGRI INDUSTRY

Abstract

Around sixty-four percent of Pakistan’s economic activity functions within the undocumented and informal sector, with agriculture constituting its largest component. Despite the presence of several Islamic financial instruments such as Ijarah, DM, and Salam, there remains no active Shariah-compliant substitute for the conventional Running Finance facility within the undocumented and informal sector. Following the Federal Shariat Court’s revolutionary judgment of April 28, 2022, which declared interest-based banking inconsistent with Islamic injunctions, and the State Bank of Pakistan’s consequent directive (IFPD Circular No. 03 of 2024) to transition toward full Islamic banking, financial institutions now face the noteworthy challenge of transforming existing Running Finance portfolios into Shariah compliant arrangements.

This study examines the structural incompatibility of Running Musharakah, the most commonly used Islamic alternative, with Pakistan’s undocumented and informal sector, particularly within agriculture. The analysis highlights that Running Musharakah requires financial transparency and audited accounts, conditions absent in most informal enterprises, thus limiting its Shariah applicability. To address this gap, the study recommends a hybrid model merging Sale and Lease Back (Ijarah) with Mudarabah or Wakalah bi al-Istithmar arrangements. The structure introduces two parallel accounts: a financing account based on Ijarah for liquidity provision, and a deposit account under Mudarabah or Wakalah for surplus management and profit allocation. Supporting mechanisms such as a Profit Equalization Reserve (PER), Hiba (voluntary gift), and Musharakah participation by the bank ensure rate stabilization and equitable returns while maintaining contractual independence.

The anticipated framework shortens documentation, ensures transparency, and provides operational flexibility suitable to the undocumented sector. It further inserts robust risk management tools through asset ownership, collateralization, and Takaful coverage. Conceptually, the model presents a viable Shariah-compliant alternative to conventional Running Finance, aligning with the liquidity and working capital needs of Pakistan’s agriculture and informal enterprises. Its adoption can contribute meaningfully to enhancing financial inclusion, supporting the Islamic banking transformation process, and promoting sustainable economic participation in compliance with Islamic commercial law.