CREATION OF PAPER MONEY – AN ISLAMIC PERSPECTIVE:

0
132

OVERVIEW OF PAPER MONEY:

The whole discussion on paper money in Islamic, creation of money and credit in literature on Islamic finance is centered on the assumption that the Model would base on two-tier Mudaraba or Shirkah system for mobilization and use of the resources. Although the Islamic banking system in vogue is not based on this Model and Islamic banks are using fixed-income modes, yet it is worthwhile to briefly discuss the stance of Islamic economists on this important area of far-reaching implications.

In the institution of credit and bank money has been an important key issue discussed by the Islamic economists and specialist of Islamic banking and finance. Early writers on Islamic economics saw something morally wrong in it.  Some doubted its need and ascribed its proliferation to the vested interests of the banks. More recently, it has been realized that interest is the villain of the piece. Abolition of interest will, to a large extent, curtail the harmful features of the creation of credit by banks.

ISLAMIC SCHOLAR’S OPINIONS ON PAPER MONEY:

According to the first school, who happen to have advocated 100 per cent reserve system, banks gain a lot out of thin air or of no air at all. They create an artificial purchasing power and take advantage of the demand for it. This demand is also illicitly created by those who have managed to liquidate their assets and preferred to enjoy a guaranteed income against their withheld money. These economists say that if any extra money is needed for financing fresh transactions, it should be issued by the central bank.

Those who find no fault in credit creation argue that the crucial question with regard to causation of trade cycles is related to the role of interest in such a credit system and not credit creation as such.  Under interest based system, the entrepreneur has to aim at a rate of profit which may be three times as high as the rate of interest or even higher:  This high pitching of profits forces him to either raise the price of the product or lower the wages of labour. Whatever proportion is assigned to either of the alternatives, effective demand is slashed. The remedy suggested by these economists suggests reshaping the credit structure so that loans cease to command any interest and profits get reduced to the level where they pay only for the labor of the enterprise.

 

PAPER MONEY AND PROFIT-LOSS SHARING:

Under profit loss sharing interest free system it should not be difficult to conclude that possibilities of over-expansion here will be severely limited, especially as the liability to losses will attach to the banks -the creators of credit.

According to Islamic finance MSc research, those who favor credit creation they have argued that in the Islamic system of banking, credit would be created only to the extent there exist genuine possibilities of creating additional social wealth through productive enterprise. Demand for profit-sharing accommodation will be limited by the extent of the available resources and banks ability to create credit will be called into action only to the extent of this demand, subject to the constraint imposed by profit expectations that satisfy the banks and their depositors. They say that credit should not be ascribed in any way being the child of interest as banks’ ability to create credit is independent of the terms and conditions on which it is created.

Depending as it does on the public’s habit of keeping only a part of its income in cash and depositing the rest with the banks, credit will continue to be created even after the switch from interest to profit-sharing basis of bank advances to businessmen. The relationship of an Islamic bank with its clients is that of a partner, investor or trader, and not of a creditor or debtor, as in a secular bank. Hence, Islam lays stress on equitable sharing of profit and loss between capital and enterprise that should be by mutual consent.  Working along these lines the commercial banks will be creating credit as their counterparts do in the present system. Creation of credit by the banks depends on the public habit of keeping their incomes and savings in the form of bank deposits and making most of their payments through cheques. This enables the bank to meet public demand for cash by keeping fractional reserve against their deposits. The overall volume of credit would fluctuate as banks’ cash reserves change due to changes in the public demand for cash or central bank’s policies.

 

ROLE OF CENTRAL BANK IN PAPER MONEY:

Central bank of any country should gear its monetary policy to the generation of growth in money supply which is neither ‘inadequate’ nor ‘excessive’ but just sufficient to exploit fully the capacity of the economy to supply goods and services for broad-based welfare.  In Islamic financial system the supply or growth of money/credit should match with supply of goods and services. There might be some minor mismatches but persistent mismatches are not consistent with the principle of Islamic finance as they generate distortions in the payments system. To ensure that, it would be important for the central bank to monitor carefully the two major sources of monetary expansion viz. financing of government budgetary deficits by borrowings from the central bank and the secondary credit creation by commercial banks.  A large part of money is created by the banking system as the balance sheet counterpart to interest bearing loans.

 

ROLE OF COMMERCIAL BANKS:

Commercial banks deposits constitute a significant part of the overall money supply.  These deposits may be ‘primary deposits’ which provide the banking system with the base money (cash-in-vault + deposits with the central bank) and ‘derivative deposits’ which, in a proportional reserve system, represent money created by commercial banks in the process of credit extension and constitute a major source of monetary expansion.  Since derivative deposits lead to an increase in money supply in the same manner as currency issued by the government or the central bank and since this expansion has the potential of being inflationary in the absence of an offsetting growth in output, the expansion in derivative deposits must be regulated if the desired monetary growth is to be achieved.  This could be accomplished by regulating the availability of base money to the commercial banks – reference to executive diploma in Islamic banking & finance.