Can Pakistan go fully interest-free by 2027?

Pakistan’s ambitious plan to fully transition to an interest-free banking system by 2027 faces skepticism from financial experts, global lenders, and local banking institutions.

The country passed the 26th Constitutional Amendment last year, making the elimination of interest (riba) a constitutional requirement. Following this, the State Bank of Pakistan (SBP) announced that by Dec. 31, 2027, the entire banking sector would operate on an Islamic model.

However, Kamran Khan questioned whether Pakistan’s financial system can realistically achieve this transformation.

Banking sector raises concerns

The Pakistan Banks’ Association (PBA), representing major local and foreign banks, has formally raised concerns with the SBP. The group has sought clarity on how international banks operating in Pakistan would comply, as their global headquarters follow conventional financial practices.

“These institutions cater to multinational companies, international investors, and even the Pakistani government. Will the new Islamic banking framework apply to them as well?” Kamran Khan asked.

PBA also highlighted Pakistan’s reliance on international financial networks for transactions, payments, and foreign exchange settlements. A shift to full Islamic banking could disrupt these ties, raising questions about business continuity.

Foreign investment at risk

Another major challenge is the impact on foreign direct investment (FDI). Many foreign-owned banks in Pakistan are subject to their parent institutions' regulations, which are based on conventional financial models.

Banks such as Habib Bank Limited (HBL), Bank Alfalah, and United Bank Limited (UBL) operate overseas branches that facilitate FDI and foreign currency funding. If forced to switch entirely to Islamic banking, these banks might struggle to maintain foreign partnerships.

“There are serious concerns about how global financial institutions like the International Monetary Fund (IMF) and World Bank will react to this shift,” Kamran Khan said.

Legal and economic challenges

Pakistan’s external debt currently stands at $131 billion, with domestic debt at nearly PKR 50 trillion. The country’s debt obligations include interest-based repayments, raising concerns over how it would transition to a fully Islamic system.

“The 26th amendment mandates interest-free banking, but Pakistan remains legally bound by past agreements under the 1969 Vienna Convention,” Kamran Khan explained. “Changing these agreements unilaterally could result in legal disputes and financial liabilities.”

The Ministry of Law has also weighed in, stating that any modification of international agreements would require bilateral consent. Global financial institutions might not be willing to restructure loans in compliance with Islamic banking principles.

Islamic banking vs. economic reality

A key issue in transitioning to Islamic banking is that Islamic finance requires real assets to back transactions. Unlike conventional banking, where governments can borrow without collateral, Islamic financial instruments—such as Sukuk bonds—must be tied to tangible assets.

Pakistan’s government, however, lacks sufficient assets to back large-scale Islamic financial instruments. Land ownership, for instance, is a provincial matter, making it difficult for the federal government to issue large amounts of Sukuk.

Additionally, SBP itself holds over PKR 6.1 trillion in Pakistan Investment Bonds—traditional interest-based instruments—while its real estate assets are worth only PKR 165 billion.

Key questions remain

Experts also question how Pakistan will replace key financial benchmarks like the Karachi Interbank Offered Rate (KIBOR), which is used to determine lending rates in conventional banking.

“Interest-free banking requires a new framework to replace KIBOR,” Kamran Khan noted. “But even after 20 years of Islamic banking expansion, only 5% of Pakistan’s government debt has been converted to Islamic financial instruments.”

The government has also historically relied on international markets for foreign currency loans, including Panda bonds, Eurobonds, and bilateral loans from allied nations—most of which are structured on conventional interest-based models.

Uncertain path ahead

While Pakistan has made legal commitments to Islamic banking, financial experts believe the transition remains a daunting challenge. The country’s reliance on interest-based global financial institutions, its existing international obligations, and practical economic constraints make a full transition by 2027 unlikely.

“Islamic banking might be an ideal, but the economic system’s dependency on interest-based loans raises serious doubts,” Kamran Khan concluded.