KARACHI: A cement company makes cement — plainly a permissible business. Yet it may be excluded from Pakistan's Islamic indices, while a competitor making the same cement is admitted. The difference is rarely the product; it is a handful of ratios computed from the balance sheet and income statement. Shariah screening is the process that turns a theological principle — avoid interest, avoid prohibited businesses — into arithmetic that an index can apply to hundreds of listed companies consistently. Behind the KMI All Share and KMI-30 indices on the Pakistan Stock Exchange sits a published set of tests: what the company does, how much interest-bearing debt it carries, how liquid its assets are, how much of its income comes from non-compliant sources, and whether its shares are genuinely traded. This guide explains each test, why the thresholds take the values they do, and what an investor should — and should not — conclude from a company passing.
Step one: the business activity screen
Screening begins before any ratio, with the company's core business. A company whose main activity is itself prohibited cannot enter the index at any leverage level: conventional banking and insurance built on interest and conventional underwriting, alcohol, gambling, pork-related production and similar activities fail at this gate. Most PSX companies pass it easily — cement, textiles, fertiliser, pharmaceuticals, technology and energy are all real-economy businesses — but the gate is subtler than it looks for conglomerates and holding companies, whose income may arrive from a tangle of subsidiaries. Screeners look through to the underlying activities and their contribution, which is why a group with a large conventional financial subsidiary can face questions an operating company never meets. Our earlier guide to Shariah screening on the PSX introduces this landscape; here we go into the numbers themselves.
The debt test: interest-bearing borrowing against assets
The first ratio asks how much of the company is financed by interest-bearing debt. In the screening criteria applied for Pakistan's KMI indices — adopted with the involvement of Shariah scholars associated with the index's development and published by the exchange — interest-based debt must remain below a threshold expressed against total assets, conventionally 37 per cent. The logic is tolerance, not approval: a modern listed company operating in a conventional financial system will almost inevitably carry some borrowing, and scholars setting practical standards for minority shareholding fixed a ceiling beyond which the company is, in substance, too financed by riba for its shares to be traded as compliant.
Two practical points matter for investors. The numerator counts interest-bearing obligations, not every liability — trade payables and other non-interest-bearing items are treated differently, and definitions are set out in the published criteria. And the test is applied to reported financial statements, so a company can drift in or out of compliance as it borrows for an expansion or repays debt at year-end. Index reviews therefore rebalance: names enter and leave the KMI universe as their audited numbers change, a churn that Islamic funds must follow by selling departures — sometimes into a falling price, one of the hidden costs of screened investing.
The illiquid-assets test: why the share must stand for something real
The second balance-sheet test is the least intuitive and the most classical. Screening requires that illiquid assets — plant, property, inventory and other tangible assets — form at least a stated proportion of total assets, conventionally 25 per cent in the KMI criteria. The reasoning reaches back to rules about trading shares as ownership of a business rather than as bundles of cash and receivables: if a company's assets were almost entirely money and debts owed to it, trading its shares at a premium or discount would resemble exchanging money for money on deferred terms, which raises riba concerns. Requiring a solid core of real assets keeps the share anchored to an operating enterprise.
For investors this test has a visible fingerprint: cash-rich, asset-light companies — some technology, services and trading names — can fail or hover near the boundary despite spotless income, while asset-heavy industrials pass comfortably. It also interacts with events: a company that sells a major plant, or raises a large cash pile in an offering, changes its own screening arithmetic, and an investor tracking compliance needs the latest balance sheet, not last year's index list.
The income test: non-compliant income below five per cent
The third ratio moves to the income statement. Almost every operating company earns some incidental income that is not Shariah-compliant — interest on bank deposits and surplus cash is the universal example. The screen tolerates a small amount: non-compliant income must remain below 5 per cent of total revenue (expressed against the company's income as defined in the criteria). Above that ceiling, whatever the business, the shares leave the compliant universe.
Passing below the ceiling does not end the matter — it creates the obligation of purification. The non-compliant portion attributable to each share is calculated and published for compliant companies, and the observant investor donates that amount to charity, without counting it as zakat, to cleanse the dividend and return received. The arithmetic of that process is worked through in our guide to Shariah purification calculations, and its interaction with obligatory giving is covered in our guide to zakat on shares. High interest rates make this test bite harder than newcomers expect: when treasury returns are rich, a lazy cash balance can push a company's non-compliant income toward the ceiling and swell the purification figure on every dividend.
Why 37 per cent, and why five per cent? These numbers are not in the Quran or the classical manuals — they cannot be, since joint-stock companies did not exist to be screened. They are the product of ijtihad, scholarly reasoning for a new situation: contemporary scholars, working through bodies such as the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and national Shariah boards, reasoned that a minority shareholder does not control a company's borrowing, that some tolerance is unavoidable if Muslims are to invest in listed markets at all, and that the ceiling should sit well below half so that compliant capital and real activity remain dominant. Different standard-setters landed at different points — some global standards express the debt test against market capitalisation with a ceiling around a third, others against assets — which is why the same company can pass one provider's screen and fail another's. The thresholds are therefore best understood as principled conventions: serious, reasoned and openly published, but conventions nonetheless, which a stricter investor is free to tighten privately by screening a personal portfolio more severely than the index does.
The price test: market price against net liquid assets
A further classical check links the share's market price to its net liquid assets per share — in essence, the price should not fall below the value of the company's liquid net assets in a way that would make the transaction problematic under the rules the scholars apply. In practice this test rarely binds for ordinary operating companies trading normally, but it can matter for distressed, shell-like or deeply discounted names, and it is part of why screening lists are reviewed rather than assumed. Investors should treat it as the screen's safety valve: a reminder that compliance is assessed on current data, not on a company's reputation or its presence in last year's brochure.
How the KMI indices use the screens
The screens feed two flagship benchmarks maintained on the PSX: the KMI All Share, which gathers the compliant universe, and the KMI-30, a narrower index of thirty large, liquid compliant companies, developed with scholarly input from Meezan Bank's Shariah scholars when Islamic indexing was formalised in Pakistan. Index construction layers ordinary index discipline over the religious one: after the screens, liquidity and size decide membership of the thirty, reviews occur on a cycle, and buffers soften turnover at the margin. The result is the benchmark against which Pakistan's Islamic mutual funds and the Shariah-compliant PSX ETFs are measured, and the reference list most brokers mean when they say a stock "is in the KMI".
Investors should understand what index membership does and does not certify. It certifies that, on the data and criteria applied at review, the company passed published tests set with scholarly oversight — a serious, standardised process. It does not certify that every scholar agrees with the thresholds: standards differ internationally, with global screening providers and other national standards using different debt denominators (some measure against market capitalisation rather than assets) and different ceilings, so a stock compliant in Karachi may fail a stricter Gulf or Malaysian screen, and vice versa. Nor does membership bless the investment: a compliant company can still be overpriced, badly governed or heading for losses, which is why screening sits alongside, never instead of, ordinary analysis of the kind in our guide to valuing a PSX stock.
Screening also shapes behaviour inside companies, in ways investors rarely notice. A chief financial officer of a company that values its Islamic fund shareholder base — and in Pakistan, Shariah-compliant funds are a large and growing pool of institutional money — has a live incentive to keep interest-bearing debt visibly below the ceiling, to sweep idle cash out of interest-bearing deposits toward compliant placements, and to time borrowings with reporting dates in mind. Losing KMI status is not a mere label change: compliant funds must exit, broker research flags the removal, and the stock's natural buyer base shrinks overnight. Conversely, a heavily indebted company that deleverages into compliance can be rewarded with an entirely new class of holders. The ratios, in short, are not passive measurements. Published, monitored and tied to real money flows, they have become one of the quiet disciplines on corporate balance sheets in Pakistan's market — an effect the screen's designers would count among its purposes.
One more distinction protects investors from a common misunderstanding: screening is not the same as an Islamic company's own compliance. A screened share is a conventional company whose numbers fall within tolerances for minority investors; an Islamic financial institution — a Meezan Bank, an Islamic mutual fund, a takaful operator — is held to a stricter standard in which its own contracts, funding and investments must themselves be compliant, supervised by its own Shariah board and, for banks, by the State Bank's Shariah governance framework. Confusing the two leads to odd expectations, such as demanding that a cement company run its treasury Islamically. The cement company is merely investable-with-conditions; the Islamic bank is the institution actually obliged to be Islamic. Both judgments matter, but they are different judgments, and annual reports disclose different evidence for each: ratios and other-income detail for the first, Shariah board reports and pool disclosures for the second.
Compliance is also dynamic within the year, not only at review dates, and the events that move it are the ordinary events of corporate life. A rights issue that parks a large cash balance on the balance sheet dilutes the illiquid-assets ratio and swells interest income until the money is deployed; a leveraged acquisition can carry a compliant company through the debt ceiling in a single transaction; a sharp fall in the share price changes nothing under an asset-based debt test but can matter greatly under market-capitalisation-based standards applied abroad. Islamic fund managers therefore track candidate breaches between index reviews, and a company that announces transformational borrowing is, for the observant investor, a screening event as much as a credit event. The published data trail — quarterly accounts, the exchange's compliant-company lists, and companies' own Shariah compliance statements in their annual reports — makes that tracking possible for any investor willing to do it.
Using the screens yourself
The published criteria let any investor replicate the spirit of the tests from an annual report: identify the core business, sum interest-bearing debt against total assets, estimate the tangible share of the asset base, and divide non-compliant income — disclosed in the accounts, often as other income with interest identified — by revenue. Compare your arithmetic with the exchange's compliant list and with the purification figures companies publish, and where they differ, trust the process but ask why: timing of statements and definitional detail explain most gaps. Treat borderline companies — debt near the ceiling, income near five per cent — as what they are: names whose status can flip at the next review, with forced selling by Islamic funds as a real, if modest, price risk. This article is educational content, not financial advice.
Key takeaway: KMI screening applies published arithmetic to principle — a permitted core business, interest-bearing debt below the asset threshold, a real core of illiquid assets, non-compliant income under five per cent — and passing starts purification duties rather than ending the investor's homework.
