“Ownership
Effects of Fractional Reserve Banking
An Islamic Perspective”
This
Paper Is Completed The Final Project For The Course Of Economic And Financial Fiqh Of Islam.
Supervisor
:
Ust Ahmad
Fanani, M.A.
By :
Yuwan Ebit Saputro, NIM :3520140410648
Faculty of Economics and Management Sciences
Islamic Economics Majors
University Of Darussalam
Gontor Ponorogo
2015
PREFACE
In the Name of Allah, The Beneficent, The
Merciful Of Prophet Muhammad Saw
Alhamdulillah, Thank God the task Islamic
Economic Thought History lecture entitled "Ownership Effects of
Fractional Reserve Banking An Islamic Perspective ", can be resolved.
Must not be separated from the contributions of many parties, in particular to
the honorable Ustd Ahmad Fanani, M.A. continue to encourage and
stimulate authors to read books related Economic And Financial Fiqh Of Islam,
also my friends, who are so passionate in discussions , especially associated
with this task.
So with this I say thousands of thank you for
brainstorm, input and criticism in order completion this paper. Hopefully a
good start and hopefully goodness and accomplishments always accompany us all.
December 2015
Yuwan Ebit
Saputro
Contents
Preface.......................................................................................................................
Introduction..............................................................................................................
Understanding The
Origins.....................................................................................
Chapter 1
1.1. Introduction.......................................................................................................
1.1.1 A Problem
Formulation.........................................................................
1.1.2 The Writing
Purpose.............................................................................
Chapter 2
2.1 Ownership
as the Basis of Wealth in Islam..................................................
2.2 Limitations on the Creation and Sources of
Ownership.............................
2.3 Labour
and Effort, the Basis of Ownership...................................................
2.3 Limitations
on Transfer of Ownership.........................................................
2.4 Haram
Means of Ownership..........................................................................
2.5 Money,
Seigniorage and Fractional Reserve Banking (FRB).....................
2.6 Ownership
Effects of FRB..............................................................................
2.7 Other
for FRB Arguments.............................................................................
2.8 Ownership
Effects of Interest Charges in a Fiat Monetary System..........
2.9 Is
Seigniorage of Fiat Money
Riba................................................................
Chapter
3
3.1 Conclusion.......................................................................................................
REFERENCES.........................................................................................................
CHAPTER I
INTRODUCTION
I.I. Baground
Fractional reserve banking (FRB) is the
basis of the present-day monetary systems.
In most countries, Islamic Banking and Finance too operates under this
principle. This article argues that the
FRB has effects on the ownership structure of assets in the economy, and that
this effect violates the Islamic principles of ownership. It argues that money
creation through FRB is creation of purchasing power out of nothing which
brings about unjust ownership transfers of assets in the economy, to the bank
effectively, paid for by the whole economy through inflation[1]. This transfer of ownership is not based on
human effort by taking on legitimate risks and neither with the knowledge nor
the consent of the initial owners. These
violate the ownership principles in Islam and tantamount to theft. It also has the elements of riba.
On the same basis, Islamic governments
should not create fiat money since this is equivalent to taking assets of the
people, rich and poor alike, forcefully without compensation. It is, therefore,
important that Shariah scholars come up with a fatwa on both the fiat money and
the fractional reserve banking system.
Such a fatwa is urgent and pertinent before Islamic banking and finance,
that operate under these systems, takes a course that may prove to be difficult
to reverse later. The Islamic economic
and finance system cannot be founded upon a money system that is fundamentally
equivalent to theft and riba.
Fractional reserve banking (FRB) is the
term given to the banking system practiced in almost all countries today. Indeed, it's a simple system that governs the
working of the present-day monetary system[2]. In most countries, Islamic Banking and
Finance too operates under this principle.
This article argues that the FRB has distributive effects on the
ownership structure of assets in the economy, and that this effect violates the
ownership principle in Islam while inflicting profound injustice on the economy
and society. It shows that FRB creates
ownership out of nothing, without work and taking on legitimate risks; thereby
transfering ownership wrongfully. The
paper also shows that FRB has elements of riba that goes against the maqasid al-Shariah; and therefore can be
termed illegal or haram from Islamic
perspective. If the arguments are valid,
then the paper has profound implications for the validity of FRB from Islamic
perspective, including the operations of Islamic Banking and Finance under the
FRB framework.
1.1.1 A Problem
Formulation
The problem formulation in this paper conclude :
1.
How Ownership as the Basis of Wealth in Islam........................?
2.
What The meaning of FRB and
Negative Effect of FRB............?
3.
How Ownership Effect of
FRB....................................................?
1.1.2
The Writing Purpose
The Writing Purpose in this paper
is to know more than about the problem formulation in this paper.
1.
To more know about Ownership as
the basic of wealth in islam
2.
To more studied The meaning of FRB
and effect it
3.
To more know how ownership Effect
of FRB
CHAPTER II
DISCUTION
2.1. Ownership
as the Basis of Wealth in Islam
The
concept of ownership is an important principle in the Islamic faith. As God created man as the Khalifa
(vicegerent) on Earth, He endowed him with ownership (milikiyyah) rights over
properties (mal) so that he can execute his duties and obligations to himself,
family, society and God in a halal and just way. The object of ownership, i.e. mal, must be
“something of value, permissible and capable of being possessed.” (Qadri,
1973). It can be tangible or intangible
like intellectual property.
Ownership can be private or
public and it refers to a bundle of rights.
Montias defines it as “the word ownership
refers to an amalgam of rights that individuals may have over objects, or claim
on objects or services” and that “these rights may affect an object’s
disposition or its utilization.”[3] Rights include the right to own, to possess,
to utilize, to exclude others, to secure income, to security, to dispose, and
obtain compensation if damaged and so on[4]. Ownership
is based on the following three principles (Abd Mokhtar Yunus):
i.
Allah is
the supreme owner of everything.
“Knowest
Thou not that to Allah belongeth the dominion of the heavens and the earth? and
besides Him ye have neither patron nor helper.” (Al Baqarah, 2:107)
A consequence of this verse is that in Islam
the human effort is the unique basis
for creation of ownership.
ii.
Man as
servant and Khalifa of Allah is endowed with relative and conditional
ownership. Allah created the earth and
universe for the human kind for the purpose of fulfilling the function of Khalifa (vicegerent) and to benefit from
it, as revealed in the following verses.
“It is He who hath created for you all things
that are on earth; Moreover His design comprehended the heavens, for He gave
order and perfection to the seven firmaments; and of all things He hath perfect
knowledge.” (Al Baqarah, 2:29)
“Believe
In Allah and His apostle, and spend (in charity) out of the (substance) whereof
He has made you heirs (mustakhlafina). For, those of you who believe and spend
(in charity), for them is a great reward.” (Al Hadid, 57:7)
Conditional
ownership in the sense that man cannot do whatever he likes with the property
owned. For example, he cannot bequest
more than one third of his property and the Qur’anic injunction that there is a
share of others – the poor and needy in one’s wealth.
iii. An
individual has his own importance and role in the Islamic economic framework.
He is responsible for fulfilling the duty of Khalifa[5]
of Allah on earth and achieving the happiness for himself and for the society.
For this purpose, Allah has gifted humankind with many abilities and rights;
one of them is the right of ownership.
“O ye who
believe ! give of the good things which ye have (honourably) earned” (Al Baqarah,
2:267)
and in another verse,
“ See
they not that it is We who have created for them - among the things which Our
hands have fashioned - cattle, which are under their dominion?”(Yaasin, 36:71)
At the
same time Islam has established limits for the creation, utilization and
transfer of ownership in order to protect the interests of the individual and
the society at the same time. From these, we can deduce that ownership has an
important socioeconomic role.
“And do not eat up your property among
yourselves for vanities, nor use it as bait for the judges, with intent that ye
may eat up wrongfully and knowingly a little of (other) people's property.” (Al
Baqara, 2:188)
The
endeavor of man to satisfy his needs is a necessity that is rooted in his
nature.However, the satisfaction of these needs should not be free of any
limitations or regulations, for the necessities or wants of people are often
conflicting and divers. The absence of any limitations or regulations on
ownership would surely lead to disorder, injustice and concentration of wealth
in the hands of a minority.
There are many definitions of ownership in
Islam. Elkorafi states that the
ownership is a legal statement, from the point of view of Sharia, on something or on its utility[6] that
gives right to whom it is granted to use the owned thing and to get
compensation for it. According to Ibn Ashat, ownership is the ability of
acquiring the legal right to use something and/or its utility by someone or his
representative by proxy. Sadr Alsharia states that ownership is a legal
relation between a person and a thing that gives him right to use it and
prevent others from using it. Ibn Taymia
states that the ownership is “the legal ability to use something”. Khafif defines ownership as the legal ability
that allows someone to exclusively use and benefit from something.
We may summarize the above definitions by
saying that the ownership is a legally defined relation between a person and a
thing and /or it’s utility that one can use only in halal ways and prevent others from using it unless by proxy and the
owner of the thing can get compensations for it. As mentioned earlier, in Islam
the ownership is regulated at all its stages the creation (or sources), the
utilization and the transfer of it. The next section discusses the principles
that govern the creation of ownership.
2.2 Limitations on the Creation and Sources of
Ownership
This
section discusses the sources or causes of ownership from Sharia point of view. Ownership can be divided into three
categories: 1) ownership of the things
that had no previous owner, 2) ownership of things that are already in
existence and had been previously owned by others and 3)
ownership by proxy. The first one
is related to the creation of new ownership, the second is related to the
transfer of ownership which we discuss in the next section. In Islam the halal means of creating new ownership are as follows (Abadi ):
1.
Reviving
a dead land that is not owned by anyone, by working it.
2. Discovering
a treasure.
3. Producing
something (agriculture, industrial, scientific, intellectual adn so on.)
4. If a
person owns an animal that gives birth to another animal, the latter becomes
the property of the owner of the former. In other words, any product of an
owned thing is owned by the owner of that thing (like fruits of an owned tree,
produce of a slave etc.)
5.
Own
something as a result of hunting or fishing.
6. Return
on investment profit from trade, product of employees, etc.
7. Agriculture
is regarded by many scholars as the most halal
[7]
way that can be used to create ownership, for in agricultural the principles of
Tawakkul[8]
and Ikhlas[9]
are stronger.
2.3 Labour
and Effort, the Basis of Ownership
As discussed earlier, Qur’anic injunctions
reveal the human effort as the basis for creation of ownership in Islam. The traditions of the Prophet also attest to
this. The Prophet (p.b.u.h.) is reported
to have said,“Nobody has eaten better food than the food that resulted from his
efforts; the prophet Daud a.s. used to eat from the work of his own hands.” (
Sahih Al Bukhari )
and in
another hadith,
“Whoever revives a dead land he has a reward (adjr)
for it. ” ( Musnad Imam Ahmad )
It is clear that the underlying principle of
these sources of creation of ownership is the
human effort (physical or intellectual). Thus, human effort is the
principal halal way for creating
ownership in Islam. Allah has, in the
Qur’an, exerted people to work:
“And when the prayer is finished, then may ye
disperse through the land, and seek of the bounty of Allah. and celebrate the
praises of Allah often (and without stint): that ye may prosper.” (Al
Jumu’a, 62:10)
“..others traveling through the land, seeking
of Allah’s bounty; yet others fighting in Allah’s Cause.” (Al
Muzzammil, 73:20)
The
Prophet was once asked, what was the best and most preferred means of
ownership. He responded by saying that
it is the work of a man by his own hands and any licit trade. (Atarghib wa
Atarhib).Also, in
a well-known hadith, the Prophet
said: “A worker should be given his reward before his
sweat dries.”The
above traditions show clearly the importance given in Islam to human efforts
and also the importance of a just distribution of wealth in society.
Prominent Muslim scholars of the past have also
emphasized the importance of human effort in creating ownership. Al Ghazzali said “Allah has ordered us to
fulfill our needs and the needs of our family, this is possible only by
creating ownership through work; what is necessary to complete a duty (wajib) is also a duty (wajib)”.
This shows that work is wajib in
order to create halal ownership of
things that we consume. Even things that
are eaten and fed to one’s family must be owned first according to Shariah
legal means, otherwise it can tantamount to consuming haram[10]
things.
Therefore, ownership for oneself and the family
is one of the most important duties (wajibat),
for it is rooted in man and it keeps oneself away from harming others by taking
the wealth of others wrongfully.
2.4 Limitations
on Transfer of Ownership
Transfer
is the most common way of acquiring ownership and Shariah[11] gives
great importance to the willingness and consent of the owner in the transfer of
ownership. There are two basic Shariah principles in the transfer of ownership.
The first one says that it is not possible to force one to own something
without one’s agreement or prior acceptance, while the second says that it is
not possible to take possession of something that belongs to another without
his agreement or prior consent (Abadi).
Among
the most important halal ways of ownership
through transfer are as follows (Abadi):
1.
Trade, exchange
2.
Compensation
salary, commission etc.
3.
Inheritance
4.
Zakat
and Sadaqa
5.
Hiba or
gift
6.
Mahr or
dowry
7.
Wakaf
8.
Dia for
death
9.
Khal’a
10. Ghanima
– war booty
Transfers
can be classified into the following categories:
a.
Transfer
of something from an owner to an owner with compensation (like in trade) – that
is mutual exchange of ownership.
b. Transfer
of something from an owner to an owner without compensation (like heritage and hiba).
c.
Transfer
of something from an owner to a non-owner with compensation (like debt).
d. Transfer
of something from an owner to a non-owner without compensation (like slave
delivery, sadaqua).
e. Transfer of something that is not owned to a
non-owner (like reviving a dead land without owner).
It is to
be noted that any transfer where the ownership of one of the parties or both is
not halal, is not valid from Shariah
point of view (Abadi).
2.5 Haram Means of Ownership
The principal haram ways of ownership in Islam are as follows (Abadi):
1.
Hoarding
(storing goods until price rises)
2.
Overpricing
3.
Riba
4.
Corruption
5. Theft
(taking possession of assets of people secretly without their permission or
agreement.)
6.
Cheating
on the quality of a product
7.
Gambling
8.
Some
trade practices like Bay Al Gharar
9. Forced
and unfair possession of the assets of people without their permission and/or
agreement
10.
Any
means that harm the individual or society
2.6. Money, Seigniorage and Fractional Reserve
Banking (FRB)
In most of human history,commodities played the
role of money in facilitating exchange in the economy. Mankind used all kinds
of things as money; from beads, shells, salt etc. as money but the dominant
were gold and silver. Nevertheless, following the demise of Bretton Woods in
1971, money today is predominantly takes the form of paper notes, coins (known
as state money) and accounting records (created by banks as money through
fractional reserve banking). Unlike in the gold standard or Bretton Woods,
‘modern’ money is not backed by or redeemable for gold and hence the term fiat
money.
This brings the issue of seigniorage, which is
the benefit one gets from the first use of fiat money, i.e. the free purchasing
power which new money, not backed by gold or anything with intrinsic value,
carries with[12]. Indeed, it’s the seigniorage that is at the
centre of the discussion of this paper relative to the Islamic concept of
ownership. Seigniorage is inherent in currency notes and coins, money created
through fractional reserve banking and interest charges; and this paper
discusses the ownership effects embedded in these.
Let us now revert our discussion to the concept
of FRB.
As mentioned earlier, banking systems in almost all countries operate
under the fractional reserve system.
Fractional reserve banking simply means that a commercial bank needs to
keep a fraction of the deposits of its customers as reserve, while the rest can
be lent out. As simple as it sounds, within the fiat monetary system, it
incredibly has profound implications for the economy and society. This fraction is determined by the central
bank and is known as the statutory reserve requirement (SRR). In Malaysia, as
of October 1, 2006 the SRR ratio as set by the Bank Negara Malaysia was 4
percent of deposits. The reserve requirement is the proportion of deposits
which the banking sector must keep as reserves to fulfill withdrawal
needs. Nevertheless, under this system,
an original deposit of RM1,000 for example, enables the banking sector to
increase deposits to a maximum amount of RM25,000 (which is RM 1,000 divided by
the reserve requirement of 0.04).
This new money creation is achieved through
credit creation that is purely an
accounting semantic that does not involve any 'real' money[13]. Notice that for the original RM1,000 deposit,
an additional RM24,000 deposit (credit money) is created by means of loans[14]. When a loan is extended, it does not reduce
the deposit of any of the depositors at all, because it is new money created
into the economy. As a result of this
new money creation, the original RM1,000 deposit is now equivalent to 4 percent
of the current total deposits of RM25,000, i.e. the required reserve ratio.
Therefore,
the basic money supply in a nation consists of currencies and coins, normally
termed as M0, and credit money which is also called bank money. The total of
these two is termed as M1. Therefore,
central banks use the SRR to control the money supply in their respective
economies. During the 1997 economic crisis, for example, the Bank Negara of
Malaysia[15]
reduced the SRR from about 13 percent to 4 percent in order to increase the
money supply in accordance to its expansionary monetary policy. Nonetheless, as
innocent as the system may seem, it has profound distributional effects in the
economy.
2.7. Ownership Effects of FRB
The ownership effects of FRB can be expounded
as follows. Consider a businessman approaching the bank with a business plan,
seeking a business loan - to buy land, building, machinery etc. Approved, the
bank creates new money through fractional reserve banking and loans it out to
the businessman at interest. The Islamic bank would use the newly created money
to buy the assets from the economy and resell it to the customer at
profit. The implications are as
follows. The businessman uses the loaned
money to buy the land, building and machinery that he wanted. He now owns these assets[16].
Now the question is: Initially, neither the bank nor the
businessman owned the assets. The bank
did not even have the money then. But
the businessman/bank became the owner of the assets after creating money out of
nothing, through the FRB process. From the real economy perspective, every such
transfer of asset, which is not a gift, inheritance or likewise, must be
compensated for. If so, who then paid
for the assets ? Diagram 1 explains
this.
Diagram 1
Of real things. Now bank creates Y amount of
new money and loans to the businessman, who uses it to acquire ownership of
some of the real things. Now there is more money in the economy (X + Y) but
same amount of real things, W. Therefore
this causes inflation in the system. Those holding the initial X money would
find their purchasing power fall. The total of the purchasing power lost equals
the wealth transferred to the businessman.
Note that the introduction of new money had
transferred ownership of assets. But there is now more money in the economic
system than before. Ceteris paribus, this
is inflationary[17].
Those holding money would have to forego some purchasing power of their money. They
can now only claim less real things in the economy. Indeed, the total of the real purchasing
power lost by the economy as a whole equals the total value of assets transferred
to the businessman/bank. In other
words, all subjects in the economy paid for the transfer of wealth through
inflation, through increased
price levels. Table 1 gives the growth in the monetary aggregate M1, which is
the total of currency in circulation and demand deposits, for thirty two
selected countries for the period 1993 to 2004.
Clearly for all countries the monetary
aggregate grew at a higher rate than the real economy itself, measured by the
growth in real GDP. Comparing the growth in money and the real economy, the
third column gives the implied inflation.
Therefore, in all these countries transfers of ownership of assets have
been taking place financed through inflation. The worst of these countries is
Turkey and Brazil, with implied annual inflation rates of 66.66 percent and
39.73 percent respectively. Hence when inflation is a monetary phenomenon, i.e.
due to increase in money supply, it therefore is a 'tax' on the economy a
hidden tax on the rich and the poor alike that, indeed, transfers wealth.
Accordingly, when inflation is a monetary
phenomenon, not all market participants are losers. It's a zero-sum game that
actually redistributes wealth and ownership of assets in the economy, where the
loss to one is a gain to another. It basically transfers ownership of
assets from the economy as a whole to those who create fiat money a one-way
transfer similar to gift, inheritance, tax etc. but here with the absence of
knowledge and consent. Contrarily, when inflation is due to real phenomenon,
for example due to a fall in the real output, then the whole economy bears the
reduction and therefore is not a zero-sum game. In effect, when a bank creates
money through FRB and lends it out, in the real economy, it actually takes
possession of assets of others by force, neither with their knowledge nor
consent[18],
and lends them out to others, for a return.
Table 1
Monetary Aggregates for Selected Countries
(1993 – 2004)
|
|
Money
|
GDP
|
Implied
|
|
|
|
Growth
|
Growth
|
Inflation
|
|
|
1
|
ARGENTINA
|
10.58
|
1.51
|
8.93
|
|
2
|
BAHRAIN
|
7.72
|
4.17
|
3.40
|
|
3
|
BANGLADESH
|
13.28
|
4.54
|
8.36
|
|
4
|
BRAZIL
|
43.32
|
2.57
|
39.73
|
|
5
|
CHILE
|
9.65
|
4.75
|
4.68
|
|
6
|
CHINA,P.R.:
MAINLAND
|
19.64
|
9.20
|
9.57
|
|
7
|
ETHIOPIA
|
12.92
|
3.84
|
8.74
|
|
8
|
GHANA
|
37.57
|
1.44
|
35.61
|
|
9
|
INDIA
|
16.25
|
5.62
|
10.06
|
|
10
|
INDONESIA
|
19.62
|
6.81
|
11.99
|
|
11
|
IRAN, I.R. OF
|
27.64
|
2.48
|
24.55
|
|
12
|
ISRAEL
|
13.27
|
3.66
|
9.27
|
|
13
|
JORDAN
|
7.99
|
3.60
|
4.24
|
|
14
|
KENYA
|
13.49
|
2.67
|
10.54
|
|
15
|
KUWAIT
|
5.61
|
2.62
|
2.91
|
|
16
|
MALAYSIA
|
11.80
|
5.41
|
6.06
|
|
17
|
MALDIVES
|
17.37
|
7.56
|
9.12
|
|
18
|
MAURITIUS
|
12.51
|
4.62
|
7.54
|
|
19
|
MEXICO
|
17.81
|
2.84
|
14.55
|
|
21
|
NIGERIA
|
24.77
|
2.83
|
21.33
|
|
22
|
PAKISTAN
|
14.62
|
3.68
|
10.55
|
|
23
|
PHILIPPINES
|
14.11
|
4.15
|
9.57
|
|
24
|
SAUDI ARABIA
|
7.16
|
2.46
|
4.59
|
|
25
|
SINGAPORE
|
11.77
|
5.63
|
5.82
|
|
26
|
SOUTH AFRICA
|
14.83
|
2.43
|
12.11
|
|
27
|
SRI LANKA
|
16.53
|
4.53
|
11.48
|
|
28
|
SYRIAN ARAB
REPUBLIC
|
13.15
|
3.96
|
8.84
|
|
29
|
THAILAND
|
8.42
|
3.66
|
4.59
|
|
30
|
TUNISIA
|
10.43
|
4.70
|
5.48
|
|
31
|
TURKEY
|
71.82
|
3.10
|
66.66
|
|
32
|
VENEZUELA, REP.
BOL.
|
36.12
|
0.67
|
35.22
|
Source:
Computed from International Financial Statistics Yearbook 2005
From
Islamic perspective, is it justified that the bank takes possession of assets
of people and lend them to others for productive or consumption purposes,
whenever someone shows the need for these assets? For example, when one needs a
house, the bank creates new money and uses it to take possession of the house
from the developer and loan it to the participant at some interest or sell it
at profit as in the case of Islamic financing?
We
contend that this clearly violates the ownership principles in Islam. This is indeed equivalent to theft, i.e. taking possession of assets belonging to
others without their knowledge and permission.
It can even be termed as being worse than theft because in a theft, the
thief takes the risk of being caught and punished. However, under fractional reserve banking the
theft takes place within the legal provisions and hence FRB may be termed as
‘legalized theft”. It also has elements
of riba for it is purchasing power created out of nothing, neither with work
nor assuming any risk. All these clearly
contradicts the Qur’anic verse Al Baqarah 188
that commands Muslims not to eat up the properties of others in
conceit.
2.8. Other for FRB Arguments
Other arguments generally put forward in
support of FRB are :
a. The
money multiplier brought about through FRB increases liquidity in the market.
More money may bring about more liquidity
but can this be justified by transferring wealth unjustly and
indiscriminatingly among the subjects in the economy especially if the argument
that FRB is similar to theft is true ?
The priorities of the Islamic economic
system which is based on the maqasid al Shariah must be always kept in
view when solutions of any kind are sought.
In this
case, therefore, liquidity cannot be justified when the means of achieving it
does not protect the wealth of people.
b. Money
supply increased through FRB stimulates the economy through increased demand
and thereby increases the real output.
Some
scholars argue that, when the money supply is increased, and if the real output
were to increase too (due to a rise in productivity) then the price levels may
not increase, i.e. non-inflationary. This is true, but then the moral question
comes up again, i.e. On what moral or legal grounds should the bank take
ownership of any productivity increase in the economy ? The benefit should go
to those who are responsible for the productivity increase the firms and
workers[19].
c.
Some
quarters propose that if that is the case, then, why not rest the money
creating and lending power with the government alone, for example, by
nationalizing banks[20].
In this way everyone including the poor would technically own the loans and
money created in the system. Also in this way the government could use the
newly created money in a ‘shuratic’ way in areas most beneficial to all like
building infrastructure, schools, hospitals, social welfare etc.
While nationalizing banks may accrue the
benefits of new money to the government that supposedly represents the people,
the question remains: Can the government take ownership of assets of its
subjects forcefully, without their knowledge and consent and lend/sell them to others
at interest or profit . In other words, is it justified for governments to
impose a 'hidden tax' on the poor and the rich alike through inflation and take
possession of assets[21] Indeed in Islam, even the government is
subjected to its rules of ownership.
It cannot take possession of assets of the
people wrongfully. Its income from zakat
and other levies are meticulously calculated and carefully implemented. In zakat, for example, only those with
wealth equal or beyond the nisab are
required to pay. The poor are exempted from such levies. The system ensures
that not a single soul is wronged. Fiqh
Muamalat[22]
governs and ensures a just exchange of ownership in trade and business
activities. Faraid go very meticulous
on how transfer of wealth should take place in the case of inheritance.
Zakat and sadaqat are encouraged as transfers of
ownership from the rich to the poor. The poor is never forced and burdened in
the Islamic system but the FRB does tax the poor too. Meera (2002, 2004)
contend that the seigniorage of fiat money including that created by FRB is
responsible for significant global socio-economic problems.
d.
Controlling
the money supply by regulating the statutory reserve ratio provides monetary
policy flexibility.
This
may sound like a valid reason but we contend that this characteristic is
necessary in the current monetary framework because of the fiat nature of all
national currencies. The kind of automatic adjustment process that existed
under the gold standard is absent in the current global monetary system[23].
Indeed, even in the present monetary system most developing nations monetary
policies have become subjected to the decisions by the developed nations,
thereby enjoying neither flexibility nor independence of monetary policies.
e.
Some
quarters argue that nations issue money based on gold and foreign currencies
reserves they have, like those placed with the IMF. Therefore, money is not
created out of nothing but rather is backed by those reserves.
The fallacy of the above argument is that when
we say money is backed by gold or anything, it is redeemable for that thing. when
the dollar was redeemable for 1/35 ounce of gold in the Bretton Woods system. When
there is no specific per unit redemption then there is no backing[24].
f.
FRB
allows the managing of the international competitiveness of a nation’s
exports. By increasing or decreasing the
money supply, wages and the price levels can be affected accordingly.
Its is true that monetary policy can be used to
improve competitiveness of exports.But the question is at whose expense ? If
competitiveness is achieved by reducing wages, then the increased exports is
achieved at the expense of the workers.
This again has distributional effects.
Additionally, just how much export
competitiveness is enjoyed by developing nations visa the developed nations in
the current set up ? The frequent
failures of WTO talks and mass demonstrations during its meetings are the
result of dissatisfaction among the mostly disadvantaged developing nations in
international trade negotiations.
2.9. Ownership
Effects of Interest Charges in a Fiat Monetary System
The ownership effects of interest charges are
quite straight forward and easy to see.An interest charge basically imposes on
the borrower a payment of additional ‘free’ purchasing power over and above the
principal amount loaned. It’s ‘free’
because the interest is charged without regard to and independent from the
risks borne by the borrower. In a fiat monetary system, loans are not repayable
in the aggregate because the interest portion that need to be paid does not
exist in the form of money.
Therefore, in aggregate, the interest portion
must and can only be paid in real terms. in the form of goods and services. To
illustrate this, say a central bank pushes 1 billion of its currency into the
economy with an interest charge of 20 percent per annum. This 1 billion would
exchange hands in the economy, creating value and wealth in the form of goods
and services. This would show-up in the form of increased assets amount in the
balance sheets of individuals and businesses.
But the total amount of money in the system would still be 1 billion
while the system is required pay back 1.2 billion. Since the 0.2 billion does not exist, at the
end of the year, the system as a whole will default and the interest portion
can only be paid, therefore, in the form of real assets and services (that can
come from both the previously owned assets and the newly created ones).
Therefore, in the current fiat money system,
interest transfers ownership of assets by the mere design of the system someone
simply got to default on the loans and repayment made in the form of real
things. This is the reason why collaterals and guarantors are important for
banks. When loans are repaid by means of instalments, the default is somewhat
camouflaged. For instance, in the above example if the borrowers are allowed to
repay the 1.2 billion in monthly instalments of 0.1 billion, the banking system
could spend back monthly the 0.1 billion received thereby acquiring goods and
services. This money can later be used to pay again to the bank. The system would appear as though not
defaulting but in the process goods and services would have transferred to the
bank, just like in the earlier example when goods and services got transferred
after an obvious default.
It is therefore clear that interest transfers
ownership of wealth by the mere design of the system, while refusing to take
any risks involved in the process of creating value and wealth. That interest is riba is therefore quite
obvious. What is not so obvious is
whether the creation of fiat money itself is also riba.
2.10 Is
Seigniorage of Fiat Money Riba
Having discussed the effects of FRB, can the
seigniorage of fiat money be considered as riba? We assert that it is.
Consider Diagram 2 below:
forced tax on the people.” Is this a reasonable argument ?
Diagram 2
Seigniorage of Fiat Money and Riba
0 APR
=10 % 1
$1000
$1100
If a
bank lends out say $1,000 at an APR of 10 percent, the borrower must repay $1,100
at the end of the year. The additional $100 is regarded as riba because it is
additional purchasing power acquired without assuming any risk. But what if the
original principal amount of $1,000 is created out of nothing, as in FRB and
currency notes and coins ? It gives free purchasing power that is ten times the
interest charge, and is assumed immediately, unlike the interest money that is
received only a year later[25].
This free purchasing power that is many times more than the interest itself and
acquired without assuming any legitimate risk is indeed riba. It is pertinent and urgent in current times
therefore, that scholars of Shariah deliberate on this and come up with a fatwa
on fiat money and fractional reserve banking.
Since Islamic banking and finance operate under these systems, such fatwa
is urgent and pertinent before Islamic banking and finance takes a course that
could prove difficult to reverse later.
CHAPTER III
Conclusion
This paper looked at the fractional reserve
banking system from the perspective of Islamic principles of ownership. It
argued that money creation through FRB is creation of purchasing power out of
nothing. In the real economy, this brings about ownership transfers of real
goods and services from the economy to the bank effectively, paid for by the
whole economy through inflation.
This
creation of ownership or transfer of ownership does not take place with the
knowledge and consent of each and every initial owner; and the transfer takes
place without assuming any legitimate risk. The transfer is also not based on
human effort or product of labour. These violate the ownership principles in
Islam and tantamount to theft. It also
has the elements of riba that is even worse than interest charges. Scholars
have identified this as a source of significant socio-economic problems
including unjust distribution of wealth and poverty.
On the
same basis, we can deduce that, not only the creation of money by FRB is not halal but the process of creating fiat
money itself is not halal as
well. Indeed, a bank note of USD100, for
example, has a purchasing power of 100 USD but the cost of its creation might
not exceed say 80 cents, so the difference, 100-0.80=99.20 USD, i.e. the
seigniorage, is a purchasing power
created out of noting without any human effort.
On the
same basis, we can say that even the government should not create money out of
nothing because it is equivalent to taking assets of people without
compensation. In Islam, the ownership is protected even against the government.
The government can take the assets of people in only very specified, prescribed
ways like the zakat, and in other
cases it has to give compensation.
Therefore,
fiat money and FRB are anti-thesis to Islamic economics and finance. Accordingly, this paper asserts that Islamic
banking and finance operating under fiat money and fractional reserve banking
is unacceptable or even could be termed haram
since it violates the principles of ownership while having the elements of
theft and riba.
One may
argue that the modern financial system has made the economy more efficient. But
the price humanity had to pay for this efficiency in terms of loss of
ownerships, unjust distribution of wealth and damage to the environment
probably outweigh any efficiency gained. It is not easy, of course, to point
finger at established systems like the fractional banking system. But
established systems have floundered and collapsed in the past for example, like
socialism in Russia. Now capitalism is, indeed, showing similar signs of faltering,
with long established firms and banks showing sign of distress and even
collapsing. Analysts normally attribute this to firm-specific factors, but from
earlier arguments, we do assert here that the financial structure in the
economy, in particular the fractional reserve banking system has a lot to do
with it.
After a
series of corporate financial distresses, particularly during the 1997 East
Asian financial crisis, corporate governance has become an in-thing in this
part of the world, with the determination to instill transparency and check
corporate scandals and frauds. But are we bold enough to recognize fractional
reserve banking as profound fraud[26].
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[1] Deterioration of the value of money because a
lot of money in circulation as a result the price of goods to rise
[2] Nonetheless, we find that
the FRB is not understood by many, or perhaps is not much of a concern to,
including even those who are trained in the areas like Economics and Finance.
[3] Montias, The Structure of
Economic Systems, p.116
[4]
Mustafa Omar Mohamed, Foundation of Islamic Economics course notes, Faculty
of Economics and Management
[5] Khalifah Is an Arabic word
literally meaning “ One who replaces someone else sh left or died” (The Khalifa
is a Fard Kifaya on the Ummah).
[6] Utility
is taken to be correlation to desire or want. It has been already argued that
desires cannot be measured directly, but only indirectly, by the outward phenomenato
which economics is chiefly concerned the measure is found in the price which a
person is willing to pay for the fulfillment or satisfaction of his desire.
(Marshall, Alfred (1920). Principles of Economics. An Indroductory Volume (8
th). London : Macmillan.)
[7]
Halal is (Arabic Language is alal) the means “Lawful, Permissible.
[8] Tawakkul (Arabic: تَوَكُّل) in the Arabic
language, is the word for the Islamic concept of reliance on God or
"trusting in God's plan". It is seen as "perfect trust in God
and reliance on Him alone.
[9] Ikhlas towards Allah means
that by his worship, a person intends to draw closer to Allah, the Most
Glorified, the Most High, and to gain access to the Abode of His Generosity
(i.e. Paradise)
[11] The shari'ah is a
complete way of life; no aspect of human life is outside its domain. Islam
expects a Muslim to follow its laws in every aspect of life: personal and
familial, religious and social, moral and political, economic and business,
etc. After all, "Muslim" means one who submits to God
[12] We have dealt extensively
with the concept of seigniorage elsewhere and do not intend to discuss it
further here. Please see Meera (2004),
Meera and Larbani (2006a and 2006b).
[13] Not even paper currency
or coins. When a loan is extended, the borrower
is recorded a double entry, one debit and one credit. The debit denotes him as a debtor to the bank
for the loan taken, while the credit entry denotes him as a depositor, to the
amount extended to him. These are simply
accounting entries that do not involve the movement of any physical currency
notes.
[14] This is how banks create
money out of thin air. Money is created when banks extend loans. Hence money in
most part is only accounting entries in the books, electronic or otherwise.
[15] Malaysia’s central bank.
[16] The real owner of these
assets is, indeed, the bank for if the businessman fails to pay back the loan
then the bank can take possession of those assets.
[17]
Quantity theory of money says that money supply is directly proportional
to price times real output, i.e. M ∝ PY. When money supply, M is increased, when
the real output, Y stays constant, the price level, P, rises, i.e.
inflationary. Price levels can also rise when
real output, Y falls. For example, due to a fall in output as a result of
natural disasters like flood or due to fall in the productivity levels.
[18] Since FRB is a legalized institution, even if
one knows one’s wealth is being taken by force and that one does not consent
it, one indeed can do nothing about it, i.e. cannot demand compensation or
anything like that.
[19] This like someone saying,
“Please give me the right to bring forth money out of nothing. With it I can have purchasing power to demand
the goods and service that you produce.
With that, the economy as a whole would have more goods and
services. Isn’t that good?”
[20] Meera (2004) suggests the
nationalization of banks as an intermediary step towards a total 100 percent
reserve requirement system based on real money.
[21] Some individuals and
organizations, like the Christian Council for Monetary Justice, Britain,
suggest that the government use this inflation 'tax' of new money and push this
new purchasing power through the poorer sections of the economy - like funding
orphanages, homes for the elderly, hospitals etc.
[22] Fiqh literally means
understanding of rulings and precepts, whilst muamalat, in this particular
facet, refers to economic transactions and activities such as ba'i, ijarah,
istisna'a, salam, murabaha, mudaraba.
[23] See Duncan (2003) for a
discussion on this.
[24] This is like a government
saying, “I have some gold therefore I have the right to issue fiat money and
impose.
[25] According to the
principle of time value of money, in today’s terms, the value of the $100
interest received at the year-end is less than that amount with regard to its
purchasing power today.
[26] After teaching and
advising state leaders on economics for over 70 years, the late Harvard
professor John Kenneth Galbraith wrote his last book titled, The Economics of Innocent Fraud. We recommend it for wisdoms into the workings
of present-day economic and financial systems.
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