Debts in the economy, reserve requirements and credit creation : fractional reserve system : [2]

Fatawa Question

Walaikum As salaam Wa Rahmatullah Wa Barakatuh, I am sorry if my question was not clear. In Sha Allah all is well with you. In the past few weeks I have been working a bit more intensely on my research and I am almost set on the exact direction of my paper along with an outline. In getting my paper set up I came across a recent article on BBC titled How Shari’ah-compliant is Islamic Banking ? (http://news.bbc.co.uk/2/hi/business/8401421.stm) The article starts off with the following quote : "The question's pertinence was raised in March last year, when Sheikh Muhammad Taqi Usmani, of the accounting and auditing organization for Islamic Finance Institutions (AAOIFI), a Bahrain-based regulatory institution that sets standards for the global industry, said that 85 % of Sukuk, or Islamic bonds, were un-Islamic."This caught my attention especially as I have been reading different works on different types of financial instruments / contracts found within modern day Islamic banking and the claim that Islamic bankers and economists have tended to modify the conventional, fractional reserve banking model to non-interest operations. I'm assuming that because many Islamic finance institutions are simply trying to "Islamize" conventional, profit-based banking, Mufti Usmani believes that 85 % of Sukuk (let alone other aspects of Islamic banking) are un-Islamic. With this in mind, in a hypothetical situation where we have an ideal Islamic state and Islamic economic system would we actually have any of these aspects of Islamic banking we find today, such as Musharakah, sukuk, etc. ? as well in our ideal system wouldn't it be smarter to have the government set up a central bank that was there primarily to serve the people, unlike private banking (whether Islamic or not) which is driven by profit margins ? I was debating a few things over in my mind after having read Dr. M Umer Chapra's article on the authenticity of Islamic Banking. As well, I understand that we are allowed to adopt principles from non-Muslims as is seen in the use of the ditch during the battle of al-khandaq by the Prophet Muhammad Alayhi as Salaat wasalaam when Salman al Farisi (ra) recommended it. And if we do not have this example, does it mean that we cannot take anything from others ? At the time I was just wondering if whether or not we would be better off without banks. 1-As a follow up, I had a few questions on the issue of fractional reserve banking, where banks issue out credit (a cheque with no value that is not backed by any real asset) to borrowers. Within the framework of an Islamic economy would this be allowed or must any loan that is given out actually be redeemable for the asset that backs the currency ? 2-Further, now everything is electronic. Is the balance sheet well balanced electronically, I. e., suppose there is no paper currency at all. 3-As well, in terms of backing the currency by the asset many people claim we should return to a gold / silver currency. Islamically, we must have the currency backed by a real asset (not necessarily gold / silver though) correct ? 4-This being the case, if the currency is backed by a real asset like gold / silver wouldn’t the money supply be finite ? How would this be dealt with as the population continues to grow ? 5-I have learned from my research that in terms of the credit creation, banks have the ability to create money out of debt. For example, under the fractional reserve banking system a depositor comes into the bank and deposits $ 100. If the government sets the reserve requirement at 10 % the bank must take $ 10 and put in reserves. The other $ 90 it can lend out. But while lending out that $ 90 it still guarantees the depositor his $ 100. So, despite depositing only $ 100, there is now $ 190 in the money supply. This extra $ 90 was created by lending, and that creation is possible because the money is not backed by any asset. Since the borrower must pay back $ 90 plus the interest, he will eventually have to take out more loans since the bank only created the principle (the $ 90) but not the interest. Playing out this example on a larger scale, it can have disastrous consequences on a society. Over 90 % of money in circulation today is credit created by this process, and it merely exists as numbers on a computer. If all money had to be backed by an asset wouldn't it help solve this problem ? Looking forward to hearing from you. I cannot emphasize how much help your responses are. Osama

Fatwa

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Publication Date

2010-01-15

Main Subjects

Financial and Accounting Sciences
Islamic Studies

Topics

• Islamic jurisprudence
• Financial institutions
• Management
• Derivative securities
• Banking services
• Islamic Banks
• Deeds

No. of Pages

4

Data Type

Fatawa

Language

English

Record ID

BIM-730793

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