Rethinking Pakistan’s economic model—III, Banking, debt & Illusion of Reform

Part I and Part II of this series have attempted to establish that Pakistan’s recurrent economic crises are structural, not cyclical—poverty persists because the system produces it; and that reform has failed because it does not confront anti-people power structures. The exploitative financial system lies at the heart of this structure. Without reconfiguring how money is created, allocated and rewarded, no meaningful transformation is possible.

The challenge of transformation is now legally mandated after amendment in Article 38(f) of the Constitution of Islamic Republic of Pakistan [“the Constitution”] by the Constitution (Twenty-sixth Amendment) Act, 2024. It obligates the State to completely eliminate riba [Quranic term for prohibitive amount charged/claimed on debts without putting any effort] before the first day of January 2028. The constitutional command is neither ornamental nor optional. It is binding on all organs of state. This is explained in some details in Who will draft riba prohibition law? [Minute Mirror, April 7, 2028].

Pakistan’s banking system is often presented as stable, profitable and resilient. In reality, these very characteristics reveal its fundamental flaw. Stability has been achieved not through efficient intermediation but through risk-free earnings derived from the state itself. Banks prefer lending to government because sovereign borrowing offers guaranteed returns. This has created a financial architecture in which the state borrows to survive, banks earn without productive risk, and the real economy is starved of capital. This is not financial intermediation; it is institutionalised rent extraction.

The consequences are visible across sectors. Small and medium enterprises struggle to access credit. Agriculture remains under-financed despite its share in employment. Innovation is constrained by lack of venture capital. Meanwhile, financial profits remain high, not because banks are supporting growth, but because they are insulated from it.

The intellectual justification for this system lies in the conventional model of finance, which treats money as a commodity capable of generating returns independent of production. This assumption has been widely challenged, yet it continues to dominate policy. As Dr. Asad Zaman has argued in his critique of modern economics: “Interest-based finance creates a system in which money begets money without engaging in real economic activity. This leads to concentration of wealth and disconnects finance from production.”

This critique aligns with empirical realities. When returns are fixed in advance, capital seeks safety rather than productivity. Lending shifts toward low-risk borrowers—primarily the state and large corporations—while sectors requiring innovation and risk-taking are excluded. The result is an economy that stagnates despite financial expansion.

Pakistan’s attempt to address this through “Islamic banking” has not altered the structure. The terminology has changed—profit on debt instead of interest, mark-up instead of lending rate—but the underlying mechanism remains intact. Returns are predetermined, risk is transferred and financial institutions continue to operate as claimants rather than participants.

This is why the distinction between conventional and so-called Islamic banking in Pakistan is largely formal, not substantive. Both operate on fixed-return structures that detach finance from production. The system remains extractive, regardless of nomenclature.

It is well elaborated by Dr. Shahid Hassan Siddiqui in Islami bankari: ghair sudi ya sudi-o-istehsali [Islamic Banking: Interest-free or interest-exploitative], and  Muhammad Munir Ahmed in  Usury, Banking & Madina Economics and Breaking the Trap of Debt, Inflation, Interest & Poverty, by Qanit Khalil Ullah and Sohaib Umar. The problem of transformation, therefore, is not the absence of alternatives but the refusal to adopt them. Dr. Asad Zaman’s work for transformation is seminal, but real challenge of drafting laws for implementation still remains unattended.

At a theoretical level, the critique of fixed-return finance converges with emerging global thought. Stephanie Kelton, in The Deficit Myth, demonstrates that money creation is a sovereign function and that financial constraints are often self-imposed. However, her framework also implicitly assumes that financial systems channel resources toward productive use. In Pakistan, this assumption does not hold. Money creation and allocation are captured by institutional structures that prioritise stability of returns over expansion of production.

A deeper reconstruction requires moving beyond debt altogether as the dominant financial instrument. The alternative is not utopian. It is grounded in well-established economic principles and historical experience. Finance must be reoriented from fixed claims to participatory engagement. Capital should earn returns only when value is created. This requires institutionalising profit-and-loss sharing arrangements, equity-based financing and cooperative ownership structures.

The conceptual foundation for such a system is clearly articulated in the framework of a sustenance-based economy, as outlined in the work of many scholars, including Dr. Asad Zaman. When interpreted in economic terms, this framework rejects both scarcity-driven capitalism and command-based socialism. It proposes a system in which resources are organised collectively to ensure continuous development of human potential. Material needs are met as part of a broader objective: the creation of a society where individuals can participate fully without fear of deprivation. Translating this into policy requires specific steps including legal framework—this aspect is missing in entire contemporary Muslim literature.

First, Pakistan must establish a parallel financial architecture. Existing commercial banks are structurally incapable of transformation due to their balance sheet dependence on fixed returns. New institutions—public development banks, cooperative financial networks and equity funds—must be created to provide participatory finance to productive sectors.

Second, regulatory frameworks must be redesigned to discourage risk-free lending. Capital adequacy rules, liquidity requirements and incentives currently favour government securities. These must be recalibrated to reward productive investment.

Third, the legal system must support risk-sharing arrangements. Contract enforcement, dispute resolution and bankruptcy laws must be aligned with participatory finance rather than debt recovery alone.

Fourth, public finance must lead by example. Government investment in infrastructure, industry and technology should adopt equity participation models where feasible, aligning returns with outcomes rather than guaranteeing payments irrespective of performance.

Fifth, financial literacy and institutional capacity must be developed to support this transition. Participatory finance requires different skills, risk assessment methods and governance structures compared to traditional lending.

These reforms are complex, but the alternative is continued stagnation. The deeper issue is philosophical. Modern financial systems are built on the assumption that capital is entitled to a return irrespective of outcome. This assumption has produced unprecedented inequality and recurring crises. A human-centred economic model rejects this premise. It asserts that returns must be linked to contribution, not entitlement.

This shift has profound implications. It transforms the relationship between capital and labour from adversarial to cooperative. It aligns incentives with productivity. It reduces systemic risk by distributing it rather than concentrating it.

Pakistan’s current financial system does the opposite. It concentrates risk on borrowers, guarantees returns to lenders and channels resources toward non-productive uses. This is why growth remains low despite financial expansion. Reforming this system is not optional. It is essential for any meaningful economic transformation.

The objective is not to abolish finance but to redefine it. Finance must serve production, not dominate it. It must enable participation, not enforce dependency. It must distribute opportunity, not concentrate wealth.

This brings the series to its logical conclusion. The critique of extractive capitalism, the exposure of elite capture, the analysis of fiscal dysfunction and the reconstruction of financial architecture all converge on a single point: economic systems must be designed around human wellbeing, not material accumulation.

A society in which individuals remain trapped in cycles of debt, insecurity and limited opportunity cannot achieve sustainable progress. The measure of success must therefore change. Economic policy must aim to eliminate structural sources of fear—fear of unemployment, fear of indebtedness, fear of exclusion—and replace them with systems that ensure dignity, participation and stability.

The moment has thus arrived where the choice is no longer between reform and status quo, but between perpetuating an extractive order that survives on debt and exclusion, and reconstructing—within the constitutional mandate—a people-centred economy in which finance serves production, wealth circulates, and no individual is left to live under the shadow of fear or despair.

The existing hybrid plus setup, lacking legitimacy, is keen to mutilate the Constitution for self-perpetuation. It, thus, lacks the very foundation to undertake any pro-people structural transformation [To be concluded].