When the IMF approved Pakistan’s latest programme review in May 2026, it quietly highlighted a contradiction that now sits at the centre of Pakistan’s economic model.
The Fund warned that Pakistan’s biggest external vulnerability was its growing dependence on Gulf-linked financing flows, deposits, rollovers, oil facilities, and bilateral support from Saudi Arabia and the UAE, all tied to global liquidity conditions and international pricing benchmarks.
Pakistan’s financial stability, the IMF effectively noted, remained deeply embedded in a conventional global monetary system governed by interest rates, sovereign yields, and dollar funding cycles.
At almost the same moment, Pakistan was moving in the opposite direction domestically. The country is now constitutionally committed to eliminating Riba interest from its financial system by January 1, 2028.
That contradiction captures the central illusion surrounding modern Islamic banking.
For nearly half a century, Pakistan, like Saudi Arabia, Malaysia, and much of the Gulf, has experimented with “Islamic finance” as an alternative to conventional banking.
Yet after decades of institutional evolution, financial innovation, and legal restructuring, the uncomfortable reality has become increasingly difficult to avoid: modern Islamic banking does not function as a fundamentally different economic system. It functions as conventional banking operating through Islamic contractual forms.
The names changed.
The structure did not.
The story begins long before the current court rulings. Pakistan’s first Constitution in 1956 already contained language calling for the elimination of Riba “as early as possible”. But the modern Islamisation drive accelerated under General Zia-ul-Haq after 1977. In 1979, Pakistan began introducing Islamic financial instruments into the banking system, attempting to replace interest-bearing arrangements with profit-and-loss-sharing structures inspired by classical Islamic jurisprudence.
The ambition was enormous. Islamic finance was supposed to create a morally distinct financial order. Instead of lenders earning guaranteed interest, banks would supposedly become partners in productive enterprise, sharing both profits and losses. Finance would remain tied to real economic activity rather than expanding through debt creation and leverage. Risk would be distributed more fairly across society.
The closer Islamic finance moved towards genuine profit-and-loss sharing, the more commercially unstable it became
But almost immediately, the system encountered a practical problem: modern economies require predictability. Depositors want stable returns and capital protection. Governments need liquid debt markets to finance deficits. Banks require reliable cash flows to manage balance sheets. Central banks need benchmark pricing mechanisms to transmit monetary policy. International investors demand standardised risk-return structures compatible with global finance.
The closer Islamic finance moved towards genuine profit-and-loss sharing, the more commercially unstable it became.
The closer it moved towards conventional banking mechanics, the more viable it became.
That tension shaped the industry's entire evolution.
In 1991, Pakistan’s Federal Shariat Court ruled that large parts of the conventional banking system violated Islam. In 1999, the Supreme Court’s Shariat Appellate Bench upheld the ruling and ordered the government to establish an interest-free economy. Yet implementation stalled almost immediately because policymakers realised the implications.
Pakistan’s banking system, sovereign borrowing structure, external financing arrangements, and international obligations were deeply integrated into global finance. Eliminating interest in substance rather than terminology threatened to destabilise the entire system.
By 2002, under General Pervez Musharraf, the legal process was effectively reset, and the issue returned for reconsideration. But the underlying contradiction never disappeared.
It resurfaced dramatically on April 28, 2022, when the Federal Shariat Court again ruled that all forms of interest-based banking were un-Islamic and ordered the state to eliminate Riba from the economy by December 31, 2027. The ruling extended beyond private banking. It directed the government to transform sovereign borrowing, amend banking laws, and even pursue interest-free dealings with international institutions such as the IMF and World Bank.
Then, in October 2024, Parliament entrenched the objective in the constitution through the 26th Amendment, setting January 1, 2028, as the formal deadline for eliminating Riba.
The symbolism was historic. No major modern economy had gone so far in legally committing itself to abolishing interest from the financial system.
Yet the deeper one examines modern Islamic banking, the more difficult it becomes to identify where the supposed economic transformation actually occurred.
Conventional banking works through a relatively straightforward structure. Banks collect deposits, pay depositors a return, lend or invest those funds at higher rates, and earn the spread between funding costs and asset yields.
What no country, not Pakistan, not Saudi Arabia, not Malaysia, has yet demonstrated is how a complex modern economy can function without the underlying economic logic that interest rates perform
Islamic banking performs the same economic function.
Depositors still place funds with banks expecting capital safety and stable returns. Banks still deploy those funds into financing structures designed to generate predictable cash flows. Banks still earn spreads between liabilities and assets. Governments still borrow from banks. Central banks still influence liquidity conditions. Financial markets still price risk and time.
The language differs. The economic architecture remains strikingly familiar.
Take Murabaha, the dominant Islamic financing instrument globally. Instead of lending money directly and charging interest, the bank technically purchases an asset and resells it to the customer at a marked-up price payable over time. Legally, this is framed as trade rather than lending.
Economically, however, the transaction behaves almost identically to a conventional loan. The repayment schedule is fixed. The return is predetermined. The bank bears minimal ongoing commercial risk. The pricing is calibrated against prevailing market benchmarks.
The same convergence appears in Islamic mortgages structured through diminishing musharakah arrangements. Customers gradually purchase the bank’s ownership share while paying rent on the remaining portion. Yet the monthly payment structure closely resembles a conventional mortgage instalment and fluctuates with prevailing financing conditions.
Most revealing of all is the industry’s overwhelming dependence on conventional interest-rate benchmarks. Islamic banks across Pakistan, Saudi Arabia, and Malaysia routinely price products using KIBOR, SAIBOR, SOFR-linked benchmarks, or historically LIBOR. This dependence is not a technical side issue. It is the core admission that modern Islamic banking still requires conventional pricing mechanisms to function.
The rise of Meezan Bank illustrates the point. Meezan has become Pakistan’s most profitable banking success story not because it escaped the conventional financial system, but because it mastered operating within it under Islamic contractual forms.
A significant portion of its earnings comes from sovereign sukuk, government-linked financing, and benchmark-linked instruments whose pricing moves with the same interest-rate cycle driving conventional banking profitability.
During periods of high policy rates, Islamic banks such as Meezan often see profits surge for the same reason conventional banks do: asset yields reprice upwards while deposit costs adjust more slowly. The economic engine remains the spread between funding costs and financing returns — the foundational logic of conventional banking itself.
If Islamic finance were genuinely independent of conventional finance, it would not need conventional benchmarks to price capital.
But it does.
Pakistan itself offers repeated examples. Islamic sovereign sukuk are priced according to market yield expectations shaped by the same monetary conditions driving treasury bills and government bonds. In 2025, Pakistan arranged a massive Islamic financing facility for power-sector circular debt that Reuters reported was explicitly linked to three-month KIBOR pricing.
This pattern extends far beyond Pakistan.
Saudi Arabia, often presented as proof that Islamic finance can operate at scale, runs one of the most globally integrated financial systems in the world. Saudi sovereign sukuk trade alongside conventional bonds and are priced against international yield conditions. Saudi banks manage liquidity, profitability, and risk using structures economically indistinguishable from conventional global banking.
Malaysia, widely regarded as the world’s most sophisticated Islamic finance hub, reveals the same reality even more clearly. The country successfully developed deep Islamic capital markets and advanced Shariah governance frameworks. Yet Islamic banks operate within the same monetary system as conventional banks, benchmark products against conventional rates, and depend on standard central bank liquidity operations. Malaysia did not build an alternative to modern finance. It built a hybrid system designed to integrate Islamic legal structures into conventional global markets.
That is ultimately what modern Islamic finance became across the Muslim world: not a replacement for conventional finance, but a parallel legal architecture layered on top of it.
The reason is structural rather than ideological. Modern financial systems require a mechanism to price time, liquidity, inflation, and risk. Interest rates perform that function. Islamic finance has never discovered a scalable alternative mechanism capable of replacing it entirely. Instead, it adapted conventional economic relationships into Shariah-compliant contractual forms while preserving most underlying financial functions.
This is precisely why the IMF’s latest warning about Pakistan matters so much. Pakistan’s reserves, refinancing ability, and economic stability remain tied to Gulf deposits, international lenders, and global capital markets operating entirely through conventional pricing systems. When global interest rates rise, Pakistan’s borrowing costs rise. When dollar liquidity tightens, Pakistan’s refinancing pressures intensify. When Gulf liquidity shifts, Pakistan’s reserves come under pressure.
None of these realities disappears because the contractual language changes.
Pakistan may ultimately succeed in eliminating the word “interest” from laws and banking terminology.
What no country, not Pakistan, not Saudi Arabia, not Malaysia, has yet demonstrated is how a complex modern economy can function without the underlying economic logic that interest rates perform.