Central Banking Operations in an interest-free banking system
In this paper the author argues that the overall monetary policy objectives of the central bank are universal irrespective of whether it is an interest-free system or not. The major objectives include (a) promotion of sustained and balanced economic growth; (b) maintenance of economic stability in the country; and (c) maintenance of stability in the external value of currency of the country. However, the primary concern of the central bank in an interest-free banking system. The following major conclusion emerge from the paper: (a) Instruments of control like bank rate and open market operations will be the ones where most adjustments are required to suit the interest-free banking system. However, instruments like ‘reserve requirements’ to regulate the liquidity position in the economy through banking system, can continue to be applied in an interest- free system as well. (b) The main responsibility of the central bank will be to regulate the profit-sharing ratios which govern the financial transactions between the commercial banks and their clients and between the commercial banks and the depositors. A pragmatic approach will be for the central bank to prescribe a narrow range within which the ‘ratio’ may vary from bank and case to case. Moreover, the central bank may vary the prescribed ratios from time to time as the situation may demand. (c) Greater reliance may have to be placed on ‘selective’ methods of control rather than ‘general’ methods in an interest-free system. Finally, while the paper suggests that there will be some need for public debt even in an Islamic economy, the power of the banking 40 system to create money need not and should not be eliminated. The central bank should have the final and ultimate authority with regard to creation of money supply.
Some conceptual and practical aspects of interest-free banking
In this paper, the author tried to explain that no proper explana- tion and no satisfactory interpretation is available to explain the rationale of the present-day interest on conceptual point of view it is difficult to establish a justification for separate existence of capital as a factor of production. I t seems desirable and pertinent that cap ital should be treated as a tool or instrument of enterprise, the dichotomy between enterprise and capital is resolved, and they jointly become one factor of production. This will mean that profit will be a reward for enterprise including capital. The main conclusion of the paper is that in the Islamic framework, interest-free banking can be run on the basis of Mudarabah or profit-sharing arrangement, between the suppliers of the capital and the users of the capital. There will be a two tier arrangement of profit-sharing between the entrepreneurs or the ultimate users of the investible fund and the banks and at the same time there will be a profit-sharing arrangement the banks and the depositors who are the savers or suppliers of the funds. The percentage or ratio of the profit-sharing can be two-thirds for the users and one-third for the suppliers of the funds. The banks will thus get a share of one-third from the profit earned by the actual investors. Similarly, the depositors will get (me-third from the share received by the banks. This will apply to the main profit-earning activities of the bank. The arrangement may seem to be complex at first sight, but will become mechanism and routine after a while. As for the very short-term loans required by the clients of the banks, they can be made available out of the idle funds available in the Current Account category of the commercial banks in an interest-free banking system. No interest will be charged. The banks can recover a service charge. As for the question of consumer credit, the genuine demand for consumer credit can be met by other sources of borrowing such as specialised agencies sponsored by the government or by borrowing from their employers, in the case of employed people. In this way, a conceptual and workable framework can be developed for interest-free banking.
