MBF707: Monetary and Fiscal Framework in Islamic Finance

1. MBF707: Monetary and Fiscal Framework in Islamic Finance COMSATS Institute of Information Technology (Virtual Campus)

2. Lecture 16Islamic Approach to Money, Banking and Monetary Policy - A Review(Continued)

3. Review of the Last Lecture

4. Topics of Discussion in Two Lectures • Introduction • Money • Interest Free Banking • Monetary Policy • International Banking • Conclusions

5. Issues Need Attention • The supply of short-term interest-free loans. • Discounting of bills of exchange • Supply of credit to consumers • Financing of the public sector

6. 1. Short- Term Loans Loanable funds at the micro level would be performed by the individual banks on the following criteria: • Specific credit needs of a firm. • Social priority attaching to the enterprise. • Nature of the security offered against loan. • Whether the credit seeker has also obtained long term advances from the bank for the same enterprise. • Annual, monthly or weekly average of the applicant's balance in current account with the same bank.

7. 2. Bills of Exchange Bills of exchange pose a special problem for interest-free banking. Extending an interest-free loan against the bill or advancing cash to the buyer (who would have written the bill) on the basis of Mudarabah, claiming a share in the profits from sale of the merchandise involved.

8. 3. Credit for the Consumer • Should be organised as part of a comprehensive social security programme. • Banks could grant interest-free loans to their depositors as overdrafts. • Commercial banks should finance the supply side and share profits with sellers.

9. 4. Finance for the Government and the Public Sector • One of the major evils of the interest-based system, has been the phenomenal growth in public debt. • A switch over to an interest-free system will curtail this growth. • Costs of administration, defence and other 'non-productive' services of the state will have to be met through fiscal measures including compulsory borrowing from owners of large surpluses. • Public sector projects may be financed through issue of 'shares' promising part of the profits to shareholders. • Funds could flow into the public sector projects on the basis of Mudarabah or Shirkah directly from the public or indirectly through the commercial banks. • Exemption of money lent to the State from the Zakah levy could be an added incentive to the lenders. Some other tax concessions have also been suggested.

10. MONETARY POLICY (MP) • It is regulating the quantity of money, its availability and its cost. • Price stability, balance of payments, growth of the economy and distributive justice are the objectives of MP. • In the absence of interest-bearing securities, sale and purchase of a certain kind of share and 'loan certificates' could provide the means of 'open market operations’. • The ‘Refinance Ratio' refers to the offer of the Central Bank to provide additional cash to the commercial banks to the extent of a certain percentage of the interest-free loans granted by them. Raising or lowering this ratio will have the effect of expanding or contracting the supply of short term credit by the commercial banks.

11. MONETARY POLICY (MP) • Lending Ratio which refers to the percentage of demand deposits which the commercial banks will be obliged to lend out as interest-free loans. • 'ratios of profit sharing' i.e., the percentage of profits accruing to the entrepreneur , which would flow back to the bank. • ‘Moral suasion’ • The marriage of capital and enterprise, effected by the replacement of interest by profit-sharing, will contribute towards growth and development.

12. MONETARY POLICY (MP) • Presently, the chief practical concern for Monetary Authorities in the Muslim countries is controlling inflation. • With the creation of high-powered money entirely vested in the central banks, and the automatic curtailment of credit with the abolition of interest and curbs on speculation, inflation can be more easily controlled in the framework of Islamic policies and interest-free institutions.

13. INTERNATIONAL BANKING • Interest-free national banking systems will have to interact with the interest-based system dominating the world. • While transactions with interest-based institutions would involve payment as well as receipt on interest, these transactions can be channeled through the central bank which could, as far as possible, insulate the indigenous economy from the effect of these transactions. • The establishment of the Islamic Development Bank at Jeddah followed by the formation of Islamic banks at Dubai, Cairo, Khartoum and Jordan have prepared the ground for international monetary cooperation free of interest.

14. INTERNATIONAL BANKING • The recently founded International Association of Islamic Banks is a step in that direction. • One of its declared aims is to advise its members on investment and to attend to their liquidity problems, besides effecting coordination in their working and standardization in their practices. • Foreign exchange reserves of the oil rich countries are exercising inflationary pressures at home and have, surprisingly enough, increased their vulnerability to the maneuverings of international high finance. • Interest-free loans on a liberal scale and long-term profit-sharing arrangements, possibly with an initial period of grace, could usher in an era of rapid all-round development to the advantage of the entire region.

15. CONCLUSION • Abolition of interest has become the hallmark of Islamic Economics in modern times. • Operational model of interest-free banking is need of the time. • The twin principles of Zakah and abolition of Riba is more just and more efficient than any other alternative. • It is now receiving attention not only from trained economists but also from professional bankers and from governments. • Meanwhile, the entire area of non-bank financial intermediaries, of near-money, of transactions in foreign currencies and the vital subject of international monetary organisation awaits the attention of Islamic economists.

16. Thank You