Pakistan plans phased shift to Riba-free financial system after 2027

Pakistan government has prepared a post-2027 financial sector strategy to move the country towards a Riba-free financial system through a phased transition, while ensuring that existing domestic and international financial commitments continue to be honoured.

The strategy paper, titled Post-2027 Financial System in Pakistan, has been prepared in light of the Federal Shariat Court judgment of April 28, 2022, and the 26th Constitutional Amendment, which set a timeline to eliminate Riba before January 1, 2028.

The document says the transition to a Riba-free financial system is likely to be gradual to avoid disruption to the financial sector and the wider economy. It states that the government is committed to creating an enabling legal, regulatory and business environment for financial institutions while maintaining financial stability.

The strategy covers banks, Development Finance Institutions, Microfinance Banks, Non-banking Finance Companies, insurance companies, mutual funds, real estate investment trusts, Modarabas and other financial intermediaries.

Pakistan’s financial system currently operates with both conventional and Islamic institutions. Islamic banking institutions account for 28% of banking deposits, 38% of financing and 23% of banking sector assets.

As of end-December 2025, the Islamic Banking Industry comprised seven full-fledged Islamic banks and 16 conventional banks offering Shariah-compliant services through Islamic banking branches. Total assets of the Islamic banking industry stood at Rs14.467 trillion, while deposits were recorded at Rs11.037 trillion.

The strategy says that, subject to the availability of an enabling policy, regulatory and liquidity management framework, the majority of financial institutions are expected to transform into Islamic banks or institutions in line with the constitutional requirement. However, transition by banks and financial institutions with majority foreign shareholding will be voluntary and based on their own plans and strategies.

A key assurance in the strategy is that existing commitments and obligations towards domestic and international counterparties will continue to be honoured according to contract terms during and after the transition. Conventional financing will be replaced with Shariah-compliant financing on respective maturities to preserve contractual sanctity and investor confidence.

Post-2027, the government is expected to explore options to ensure that all fresh domestic funding is raised through Shariah-compliant modes and instruments. Since the government is expected to mostly issue Shariah-compliant securities after 2027, conventional banks will also be allowed to use these securities for liquidity management. Existing conventional securities will also continue to qualify for liquidity management.

The government plans to ensure availability of Sukuk across different tenors, including short-term instruments of three, six and 12 months, to help financial institutions manage liquidity.

For external financing, the government will try to secure fresh foreign funding through Shariah-compliant modes after 2027, subject to the availability of reasonable options in global capital markets. It also plans to strengthen arrangements with multilateral and bilateral partners, including structured co-financing mechanisms with Islamic financial institutions, while maintaining debt sustainability.

The strategy says conventional public debt outstanding as of December 2027 will be replaced with Shariah-compliant financing on respective maturities. Conventional debt maturing after 2027 will continue to be serviced as per contractual commitments.

The development of a Shariah-compliant public finance system has been identified as the most critical milestone for the transition. The strategy calls for a range of short-, medium- and long-term Shariah-compliant instruments, a Shariah-compliant money market, effective SBP open market operations for liquidity injection and absorption, and an interbank market for placement of surplus liquidity.

The government, in collaboration with the State Bank of Pakistan and leading Islamic banking institutions, has developed a hybrid Sukuk structure based on Ijarah-cum-Murabaha and secured approval from the SBP Shariah Advisory Committee. The structure will allow the government to issue Sukuk almost twice the value of underlying assets. The first hybrid Sukuk of Rs109 billion, with maturities of one year and 10 years, was issued on April 17, 2026.

Another major initiative is the development of an Assets Register of all non-current assets owned by the federal government and its entities. The register will be managed by the Assets Registry Company, a fully federal government-owned entity to be housed in the Finance Division. The mechanism is intended to create a pool of assets to support regular Sukuk issuance.

The strategy says assets assigned to the Assets Registry Company will remain available to the federal government or its entities for normal use and will continue to appear in their financial statements, with disclosure that the asset has been assigned for Sukuk issuance. The government will seek cabinet approval for establishment of the company and assignment of assets for regular Sukuk issuance.

The State Bank of Pakistan will formulate and implement monetary policy on Shariah principles while pursuing its core mandate of price stability. The central bank has already introduced Shariah-compliant open market operations for liquidity injection, and a Shariah-compliant standing facility is also operational. Liquidity absorption and placement facilities will be operationalised once sufficient Shariah-compliant government securities are available.

The review of SBP’s monetary policy framework is in progress and is expected to be completed by December 2027. The strategy says the framework is largely Shariah-compliant based on initial assessment.

The transition will also cover capital markets, insurance and non-bank financial services. The strategy says a large portion of the equity market, pension schemes, Modarabas and NBFCs is already Shariah-compliant, indicating institutional readiness. Conventional contracts executed by December 2027 in the capital market will be honoured and serviced according to their contractual terms.

Legislative changes are also planned. The review of all banking-related laws in light of the Federal Shariat Court judgment has largely been completed, while the review of remaining laws is expected to be completed during CY26 and legislated during CY27. The strategy says amendments identified in banking laws are minor in nature and will be placed before Parliament after review.

SBP and SECP have also reviewed the regulatory framework to assess conformity with Shariah principles. The strategy says most of the framework is already aligned, while draft amendments needed for full alignment will be notified after consultations and before December 2027.

On financial safety nets, the document says a Shariah-compliant lender of last resort facility is already available for Islamic banks, while a Shariah-compliant deposit protection scheme is operational for eligible deposits of Islamic banking institutions. The resolution and recovery framework for failed financial institutions will also be updated in line with the post-2027 system.

The treatment of retained earnings has been identified as a key issue for conventional banks seeking transformation. SBP formed a workstream comprising its representatives, senior Shariah scholars and industry experts, including chief financial officers of leading banks. The workstream has recommended Shariah-compliant options that would allow banks and financial institutions to retain earnings on their balance sheets after conversion.

The strategy says IT transition is not expected to create major obstacles, as most conventional banks already operate Islamic banking windows and have relevant systems for Islamic banking products, pool management and profit calculation. A Working Group on Information Technology Ecosystem has worked with banks to assess system requirements and gaps.

Capacity building has also been included as part of the transition plan. A Capacity Building Strategy has been rolled out for training banks, board members, senior management, branch staff, academia, Shariah scholars, parliamentarians, government officials, journalists, company directors, external auditors and professional institutions.

The strategy identifies conversion of existing public debt into Shariah-compliant debt as the most critical challenge. It says the establishment of the Assets Registry Company, assignment of federal assets for Sukuk issuance, regular Sukuk issuance mechanisms and an annual Sukuk calendar will be essential for implementation.

The document concludes that the transition will be gradual and should not create major disruption, provided the government, SBP, SECP and other stakeholders complete legislative, regulatory, public finance, monetary policy, foreign financing, safety-net and capacity-building reforms by December 2027.