[Final Project Case- Study]

Strategic Finance
FIN- 751

To,
Dr. Nasir Sultan

From,
Mukaram Ali
25011720- 010
Majid Zia
25011720- 001

Muhammad Suleman
25011720- 003
 Paradigm Shift from Conventional to Islamic
Banking System: A Case of the Conversion of
Taqwa Islamic Banking in Pakistan

Abstract
O ver the past decade, we have seen a noticeable change in the banking industry
as it moves from traditional methods to the Islamic banking system. Traditional
institutions are increasingly establishing Islamic subsidiaries or transforming their
conventional frameworks into Islamic ones. In 2012, the Bank of Punjab took a
significant step by transforming its first branch into Taqwa Islamic Banking (TIB).
In 2014, the bank undertook a significant transformation by converting 24
conventional branches into Islamic banking. This paper discusses the regulatory
guidelines set by the SBP regarding conversion and examines the procedures
adopted by the Bank of Punjab-TIB. We also discuss the practical challenges and
main issues encountered by BO P-TIB, along with potential solutions. The study will
offer a clear perspective on the conversion and the approach taken by BO PTIB.
The study will help institutions looking to transition their business from a
conventional model to an Islamic model.

Introduction
The Islamic Banking industry in Pakistan has grown rapidly, showcasing the
enthusiastic support from the people for the Islamic banking system. This system
has evolved quickly and gained momentum, resulting in a respected position
within the mainstream financial services industry. In Pakistan, the rapid growth of
the Islamic banking sector can be attributed to various factors, including the deep
religious connection people have and the profitability of Islamic banks (State Bank
of Pakistan, & Department of International Development, (Shahid et al., 2015).
Considering the remarkable success of Islamic banking, the conventional banking
sector has also taken notice. In this context, the State Bank of Pakistan (SBP) has
expressed interest in the Islamic banking system. The SBP has opened doors for
key stakeholders to actively participate in this new system, building on their
existing framework, which has now evolved into fully operational Islamic banks
(Sheikh et al., 2024). The SBP has set up a dedicated Islamic Banking Department
within conventional banks to facilitate the opening of new branches for Islamic
Banking and to transform existing Conventional branches into Islamic ones (Ahmed
et al., 2018). Additionally, the State Bank of Pakistan's shift in approach was met
with great enthusiasm by most conventional banks, leading to the transformation
of the first conventional branch of the Bank of Khyber into an Islamic banking
branch in 2003 (Khan et al., 2017). In 2012, the Bank of Punjab began the process
of converting its conventional branches, while Faysal Bank also sought to transition
its entire system to an Islamic banking framework (Si- djilani & Bouchikhi, 2025).

Regulatory Instructions for Conversion

In June 2010, the SBP introduced a concise set of criteria for converting a
Conventional Bank into an Islamic Bank through IBD Circular No. 2. This circular
specified that banks must secure approval for establishing an Islamic Banking
department from the SBP and must also present sound financial reports before
proceeding with branch conversions. While the SBP has waived the new license
fee for converted branches, it is recommended that the bank submit a branch
conversion plan as part of its annual branch expansion plan to the SBP. This
conversion plan should be thorough, detailing the start and completion dates of
the conversion process, and must be approved by the bank's sharia committee.
The conversion plan will clearly identify the chosen branches and include a
business plan for each one. The plan will also outline how to handle the transfer of
traditional liabilities and customer deposits for those who choose not to adopt the
new Islamic banking system. The SBP might grant preliminary approval to start
the conversion process if they find the submitted plan satisfactory. O nce the
conversion process is complete, the branch will apply for the Islamic banking
license. The bank will accept deposits in accordance with Islamic sharia once it has
secured an Islamic Banking License from the SBP (Ullah et al., 2017). In 2017, the
SBP took steps to enhance the previously established instructions for conversion
by releasing circular #1 of 2017. This circular provides detailed guidelines for
converting a conventional bank into an Islamic bank, ensuring a thorough approach
to the process. The guideline outlines the process of transforming a conventional
bank into a fully- fledged Islamic bank. These guidelines provide a thorough
overview of how the transition from a conventional banking system to an Islamic
banking system takes place, specifically highlighting the case of Taqwa Islamic
Banking in Pakistan. These guidelines are seen as a wonderful step forward for
fostering and nurturing the culture of Islamic Banking in Pakistan. The annual
report from the State Bank of Pakistan has described it as a positive advancement
within the current policy framework (Mahmood et al., 2019).

Introducing the Bank of Punjab and its approach to Islamic

banking
A Shift in Perspective: The Transition from Conventional to Islamic Banking - The
Example of Taqwa Islamic Banking in Pakistan Vol. III, No. The transition from
conventional banking to Islamic banking does take place. These guidelines are
seen as a wonderful step forward for fostering and nurturing the culture of Islamic
Banking in Pakistan. The annual report from the State Bank of Pakistan has
described it as a positive advancement within the current policy framework
(Pasha, 2018). The Bank of Punjab was established in 1989 following the approval
of the Bank of Punjab Act by the Punjab Assembly. In just five years, it achieved
the status of a retail bank. Today, it operates 576 branches nationwide, including
74 that offer Islamic banking services with products and services compliant with
Sharia law (Pasha, 2018). The Bank of Punjab established its Islamic banking
division in 2012- 13 after receiving an Islamic banking license from the State Bank
of Pakistan, branding it as “Taqwa” Islamic banking. They opened their first Islamic
banking branch by transforming the conventional banking branch located in New
Garden Town, Lahore, into an Islamic banking branch. The bank has presented its
conversion plan from 2013 to the State Bank of Pakistan, which has approved the
transition of 24 conventional banking branches to Islamic banking. The bank has
initiated the conversion process, and by the end of that year, all 24 branches have
successfully completed the transition. The Bank of Punjab – TIB – currently
provides a wide array of products on the liability side, including Basic Banking
Accounts, Current Accounts, Profit and Loss Sharing Accounts, Taqwa Rahat
Corporate Account, Taqwa Rahat Account, and Taqwa Certificate. The current
account is provided through Q arz- e- Hasana, while all other profit- generating
accounts are based on Mudaraba. The bank provides a range of financing options,
including Murabha, Ijara, Running Musharaka, and Diminishing Musharaka
products. The income generated from financing is shared with the Mudarba- based
depositors according to a pre- agreed ratio, which is announced on the bank's
website at the beginning of each month. This process is overseen by a respected
Sharia board made up of distinguished scholars, including Mufti Muhammad Zahid
as the chairman, along with Mufti Ijaz Samadani and Mufti Rafay Usmani as board
members (Selim, 2020).

Conversion Procedures of the Bank of Punjab (Taqwa Banking)

Currently, there are three models being utilized for the transition from conventional
banking to Sharia- compliant banking in Pakistan's banking industry:

1st Model
Several financial institutions embraced the transition by placing all investments in
the closest conventional branch, while providing sharia- compliant banking services
at the newly created Islamic Banking Branch. In these situations, there is not any
actual conversion happening at the branch, so account holders need to open new
accounts there. The branch's license has been converted to Islamic. Silk and
Summit Banks Limited Pakistan have successfully put this model into action for
transforming their conventional branches (Ahmed et al., 2018).

2nd Model
The second model outlines the steps for converting liabilities, emphasizing that
bank authorities must obtain consent from the depositor four weeks prior to the
process, in accordance with SBP’s guidelines (Mushtaq et al., 2018). The Bank of
Punjab, Taqwa Islamic Banking embraced this model for the conversion process
(BoK, 2013). If the depositor chooses not to transition from a conventional account
to an Islamic one, their funds will be moved to the nearest conventional bank
account, or they have the option to withdraw their deposit.

3rd Model
The bank needs to transition all its operations from traditional banking to Islamic
banking. The profitable deposits will be transformed into Mudarba- based
deposits, while the current account will be treated as Q arz within the Islamic
Banking System. The financing based on advance or interest will be transformed
into Ijara, which involves a sale and leaseback arrangement. However, the
branches' non- performing loans will not be converted according to SBP directives;
instead, they will be transferred to the conventional branch designated by the
bank (Ullah, 2014). The Bank of Punjab-Taqwa Islamic Banking has chosen to
implement the second model of conversion, focusing solely on transforming the
deposit system.

Advantage of conversion and the model adopted by BOP-Taqwa

Retaining Deposits/Account holders
During the conversion process, the bank takes the chance to keep the branch's
deposits safe and sound while transitioning from a conventional branch to an
Islamic banking branch. When opening a new branch, the bank will need to begin
anew by fostering connections with the local community (Shafii et al., 2016)

Minimum Hindrance and Complications

The bank is taking advantage of its existing, purposefully built premises and the
experienced staff who are already familiar with its internal environment to
kickstart its Islamic operations. This approach simplifies the process for
management compared to opening a new branch (Shafi, Shahimi, & Saaid, 2016).

Acceptability under Sharia

The model embraced by the Bank of Punjab-Taqwa aligns more closely with sharia
guidelines. In this scenario, the previous interest- based relationship between
depositors and the bank concludes on the conversion date, paving the way for a
new sharia- compliant relationship established through a fresh Mudarba
agreement, without the need for any additional agreements. At the end of the
month, the customer receives their fair share of the profits or losses (Fatima, &
Khalid, 2015). In the previous model, where banks convert interest- based advances
into sharia- compliant financing methods, questions about permissibility come up.
Sharia scholars believe that sale and lease back transactions are permissible in
cases of conversion (Fatima, & Khalid, 2015). However, in that scenario, the concern
of reputational risk still remains.

Restricted Monitoring
BO P-Taqwa's conversion model offers the benefit of minimal sharia monitoring at
a lower cost compared to other models that demand extensive oversight. In this
approach, the sharia department is responsible for reviewing the premises,
advertisements, stationery, branch income and expenses, obtaining consent from
depositors, and training staff. In the alternative model, the sharia department is
responsible for overseeing all asset cases, along with letters of guarantee, letters
of credit, and all advance agreements (Fatima, & Khalid, 2015). We will also work
on developing the right conversion product for every situation. Additionally, we will
keep an eye on the implementation of the agreements that have been approved
for each product tailored to specific customers. This makes the conversion more
challenging.

Analysis of Conversion of BOP-TIB Methodology of the Study

The process of conversion and the related documents, along with the conversion
plan, were explored during visits to the bank's head office. The documents and
procedures have been carefully examined, and there have been multiple visits to
observe the transition from conventional banking to Islamic banking.

BOP Taqwa is submitting the Conversion Plan to SBP

In 2013, the banking policy and regulations division of SBP received a request from
Bank of Punjab – Taqwa Islamic Banking, accompanied by a detailed and duly
approved shari’ah advisory board, seeking in- principle approval from SBP. This
plan includes the following details (Fatima & Khalid, 2015): the specifications of
the particular branch of the conventional bank; a solid rationale for converting the
conventional branch to an Islamic one, along with the identified business
opportunities in the bank's service area. A comprehensive business plan spanning
a minimum of three years, outlining the anticipated assumptions. fourth An
effective advertisement and information hub to keep all customers updated about
the bank's transition to an Islamic branch. An authentic process will be guaranteed
by obtaining written consent from the customer. vi. The process of moving current
assets and liabilities to the closest traditional arrangement. seven. Enhancing staff
skills to support the successful implementation of the Islamic banking system; viii.
To further ensure that the Shari’ah advisory board is compliant with the respective
banks
Examination of the actions undertaken by BOP Taqwa for
transformation
During the review of the documents and visits to the branches transitioned by the
Bank of Punjab-Taqwa Islamic Bank, the following step- by- step process was
noted as being utilized by the bank:

Handing Over the License of Conational Banking to the SBP

During the review of the correspondence with the SBP, it was noted that the
original Conventional Banking License, along with the branch survey report, was
sent to IBD SBP by the Islamic banking department of the Bank of Punjab-Taqwa
Islamic Banking.

Details about the general public

The bank has taken steps to follow the guidance from SBP IBD about conversion.
They have made sure to inform the community by putting up banners outside the
branch, clearly stating the transition to Islamic Banking in a visible location.
Additionally, prominent notices were placed within the branch premises, including
at the entrance door, cash counters, and on the notice board (Ahmed & Khan,
2017).

Announcement of conversion notice in the newspaper

As outlined in SBP Circular No. 2 of 2010, bank management is responsible for
informing customers and the public about the closure of conventional banking
branches. This information must be shared through newspapers at least four
weeks prior to the conversion date. The News and daily Jang were chosen by BO P-
TIB for publishing these conversion notices, which were indeed printed in these
newspapers (Ullah, 2010).

Agreement Letters / Terms of Service

The bank makes sure that branch staff take the time to inform and explain to
customers about the conversion. They also gather written consent from all existing
customers for switching to Islamic Banking Products and Services using a ‘Consent
Letter’ in the bank’s specified format. In addition to consent letters, we also
gather Islamic terms and conditions for account opening forms from our
customers, which are kept at the branch. A sample of these can be found on the
BO P-TIB website (BoK, 2013). We also sent out the letters of consent via courier,
clearly stating the date of conversion and including the ‘Islamic Terms and
Conditions’ for all our branch customers. We keep track of this activity by using the
following method: a. A separate dispatch register is kept to track the sending of
consent letters. b. The courier receipt numbers are listed next to each customer's
name, and the corresponding courier receipts are attached to the relevant pages
of the register. c. Every returned mail is noted in the dispatch register next to the
corresponding customer name.

Managing Dormant and Foreign Currency Accounts

During the review of the dormant (IDLE) accounts and foreign currency accounts of
IBD-TIB, it was observed that the dormant accounts were brought back to life by
reaching out to the account holders. The customer has provided a re- activation
request, along with all necessary formalities, including a consent letter and
acceptance of the Islamic terms and conditions. It has been observed that Taqwa
Islamic Banking did not provide profit and loss products for foreign currency. The
accounts were not transitioned to Islamic banking, but current account holders of
foreign currency accounts were given the option to convert their accounts, and
some chose to switch to an Islamic banking current account.

Credit Accounts or Accounts of Advances

As previously noted, Taqwa Islamic Bank has chosen to convert only deposits,
while the advances and accounts linked to interest- based advances are moved to
the nearest conventional branch. However, there were instances where some
branch employees were not transferred to the conventional branch in a timely
manner. Although it was moved at a later stage.

Promotional Materials and Stationery for Islamic and

Conventional Banking
The State Bank of Pakistan is working on separating the Islamic and conventional
banking systems. In line with this, the Bank of Punjab Taqwa Islamic Banking has
notified its branches about the conversion process. They have instructed that the
Islamic Banking Division should submit a request for Islamic Banking stationery to
the Stationery Department at least 30 days prior to the conversion date, clearly
stating that date. It was noted that in certain branches, conventional stationary
was being used, which goes against the recommendations of the State Bank of
Pakistan (BoK, 2018). The Bank plans to ensure that its branches are well-
prepared by prioritizing the availability of Islamic Banking stationery and
promotional materials ahead of the conversion. We will also be removing branch
stamps, visiting cards, and traditional advertising materials to refresh the Branch's
appearance completely. To achieve this, it would be beneficial to display Islamic
verses about Halal Business and the prohibition of Riba on the walls of the branch,
creating an environment that embodies the Islamic business vision. The overall
atmosphere and appearance of the branch did not quite convey an Islamic feel,
making it less impressive in that regard. The bank plans to consider this matter
regarding the conversion as well.

Employee Development
According to the BO P-TIB Manual of Conversion, staff will receive the Islamic
Banking O perations Manual to help them become more familiar with the system.
The Training Department will make sure that branch staff receive the right level of
training well ahead of the conversion. This way, they will be prepared to address
any questions from both existing and potential customers. The training will last for
a minimum of five days. The credit staff will receive training on Islamic banking
products and how they operate. The SBP also conveys this message (Islamic
Banking Department, SBP, 2017).

Essential Challenges and How to Address Them

The transition of BO P-Taqwa Branches from conventional banking to Islamic
Banking is a positive step for the community, particularly in the context of the
Islamic Republic of Pakistan. It offers locals the chance to access Islamic Banking
services conveniently and right at their doorstep. This also provides a chance for
those looking to steer clear of interest- based banking to find an alternative within
the banking sector. In a similar vein, the conversion model embraced by BO P-TIB
proves advantageous for the banks, as they leverage their existing staff and
facilities for new operations while drawing in new customers seeking Islamic
services. However, after a thorough analysis of the entire process at BO P-TIB, it is
suggested that certain aspects of this conversion model could benefit from
greater focus in the future.

Staff Training
In these branches, it is common for current staff to have the chance to serve, but
those from conventional branches who are new to Islamic banking have only
received five days of training. As a result, they may lack familiarity with the
products and services, as well as the foundational concepts behind what Islamic
banking offers. In our conversations with the branch employees, we noticed that
they seem to be missing training in Islamic banking. It is essential for the branch
manager and operations team to receive thorough training in Islamic Banking. This
will help them better serve the local community and address any misconceptions
or doubts surrounding Islamic Banking. Besides these two office holders, a five-
day training for the other Branch staff should be adequate.

Awareness of local community and its Ulamas

The local community seems to be unaware of the new Islamic banking branch
opening nearby, and many lack knowledge about its products and the benefits
that Islamic banking can offer. The bank did not make any significant efforts to
engage the local community or the nearby sharia scholars to help them
understand the products or services provided by Taqwa Islamic Banking. Before
opening or converting a conventional branch, it is advisable to invite local elders,
businesspeople, imams from mosques, and local muftis to the branch. They should
be given a briefing about the products and services of Islamic banking and how it
differs from the conventional banking system.

Transforming the Financing Portfolio

Given the limited availability of financing for conversion and the complexities
involved in its execution, it would be beneficial for the product development
department of Islamic Banks, the Islamic Banking Department of The State Bank
of Pakistan, and industry Sharia scholars to collaborate. Together, they can design
and recommend additional Sharia- compliant products to enhance the conversion
of the advance’s portfolio.

Advancements in IT
The use of electronic data processing and advanced IT systems plays a crucial role
in modern banking practices. Without a reliable IT system in place for every aspect
of today's banking, the conversion process can be quite challenging. It is advisable
for banks to develop advanced IT systems that address conversion- related issues
before embarking on the conversion process to prevent any difficulties.

Proper Implementation of the Plan Presented to SBP

Executing a solid plan is crucial for conversion. While the plan submitted to SBP
might look great on paper, how it is carried out is what truly matters. Every
department involved in the conversion process, including I.T, Audit, Compliance,
Sharia, Media, Treasury, and the Islamic Banking Department, needs to be
thoroughly prepared. It is important that the roles of each department are clearly
defined to prevent any mishandling, which could result in penalties from
regulators or damage to our reputation.

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