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Article
Publication date: 31 March 2023

Khoutem Ben Jedidia and Hichem Hamza

Bank lending is the major source of monetary expansion. Bank-led money creation is a key issue in both conventional and Islamic financial systems. The purpose of this paper is to…

Abstract

Purpose

Bank lending is the major source of monetary expansion. Bank-led money creation is a key issue in both conventional and Islamic financial systems. The purpose of this paper is to examine the issues related to Islamic banking money creation. In this conceptual paper, the authors investigate the involvement of profit and loss sharing (PLS) in money creation and especially how can PLS limit money creation “out of nothing.” In this regard, the authors examine the potential of the PLS principle in tackling the excessive money creation phenomenon.

Design/methodology/approach

This study uses a normative approach regarding Islamic bank money creation that fits Sharia directives. In fact, this study discusses “what ought to be,” that is, the values and norms of PLS money creation that impede excessive money creation.

Findings

Overall, Islamic banks create money differently compared to conventional ones. Especially, by avoiding a purely financial intermediary, money creation under the PLS principle sustains a strong relationship with the real economy and leads to a lower money multiplier. Therefore, PLS mechanisms allow financing through real assets and not credit assets “out of nothing.” This could prevent excessive money creation from causing harmful effects on indebtedness and financial instability.

Practical implications

PLS offers a valuable resolution for banking system money creation through the optimization of Islamic bank financing by facilitating the separation of the monetary function from the credit one. This reform thought reinforces the stability value of money allowing it to fully perform its functions with reference to the directives of Sharia. This especially allows the integrity and purchasing power of money, the reduction of the gap between the evolution of both real and financial economies and, consequently, the indebtedness and crisis. It is recommended to promote PLS financing by reforming institutional and regulatory constraints.

Originality/value

This study addresses the contemporary issue of money creation by Islamic banks through the PLS approach. The conceptual framework of this paper highlights the reformist role of PLS in limiting money creation through Mudarabah approach within fractional reserve banking.

Details

Journal of Islamic Accounting and Business Research, vol. 15 no. 3
Type: Research Article
ISSN: 1759-0817

Keywords

Article
Publication date: 5 May 2021

Hamdi Khalfaoui and Abdelkader Derbali

This paper aims to investigate the relationship between money creation process and banking performance for Tunisian listed banks, particularly in the context of increased economic…

Abstract

Purpose

This paper aims to investigate the relationship between money creation process and banking performance for Tunisian listed banks, particularly in the context of increased economic policy uncertainty.

Design/methodology/approach

In the relevant literature, there are two theories of money creation. The theory of money creation out of nothing, by using the central bank for refinancing and the theory of financial intermediation, from which money creation is made from preexisting savings. In this paper, the authors utilize a panel data for a sample composed of 11 Tunisian banks during the period of study from 1999 to 2019.

Findings

The study’s empirical analysis show that both forms of money creation have a positive impact on bank profitability as measured by the return on assets (ROA) and return on equity (ROE) ratios. However, the same analysis shows that the channel of money creation out of nothing is the most profitable for banks. Also, the authors show that economic policy uncertainty negatively influences the relationship between money creation and banking profitability only when credit creation is derived from savings.

Originality/value

This paper contributes to the literature by explaining the nexus between money creation and Tunisian banking performance which depends on the implementation of stable and conducive economic and political environment. Also, this link requires the implementation of monetary measures to encourage savings and develop an efficient capital market and judicious monetary policy enabling the central bank to inject more liquidity into the economy.

Details

International Journal of Social Economics, vol. 48 no. 8
Type: Research Article
ISSN: 0306-8293

Keywords

Article
Publication date: 23 March 2022

Md Shamim Hossain, Ahmed Razman Abdul Latiff and Mohammad Noor Hisham Bin Osman

The purpose of this study is to explore stakeholders’ perceptions on money creation and the impact of the accounting treatment for commercial banks’ money lending activity in…

Abstract

Purpose

The purpose of this study is to explore stakeholders’ perceptions on money creation and the impact of the accounting treatment for commercial banks’ money lending activity in Malaysia.

Design/methodology/approach

A phenomenological approach was used to examine the stakeholders’ perceptions through experience-sharing. A semi-structured interview approach was used to collect the data. Ten individuals from different stakeholder groups have been interviewed with their prior consent. For the data analysis, the current study adopted the inductive thematic approach.

Findings

Perceptions on money creation are influenced by the informants’ understanding and awareness of the research issue. Informants have agreed on the accounting treatment (debit loan and credit deposits) but explained the impact of this accounting treatment differently. The accounting treatment creates an opportunity for the commercial banks to create money as they want, and hence, the excess created money can create inflation and threat for the potential financial crisis. On the contrary, it is argued that money creation results from the systematic approach of the fractional reserve banking (FRB) in Malaysia. In addition, this money creation is not a threat to the economy as long as there is a strong controlling role of Bank Negara Malaysia (BNM).

Research limitations/implications

Stakeholders’ perception indicates that awareness of the research issue can be a cause of crucial consequence for money lending activity. Moreover, this study may stimulate the chief regulatory body such as BNM, the central bank of Malaysia, to be more cautious in controlling the commercial banks’ money lending activity to prevent the potential future crisis. Furthermore, findings may help to explain the conflicting concept between the textbook explanation for FRB and current commercial banks’ money lending practice through the accounting treatment.

Originality/value

Monitoring and controlling of money creation and commercial banks’ money lending activity by BNM can be benefited from the stakeholders’ perceptions on this research issue. Because this is the first time study of the stakeholders’ perceptions on money creation and commercial banks’ money lending activity in Malaysia and hence, findings of this study may be worked as the input in the process of monitoring and controlling the money creation activity in Malaysia.

Details

Qualitative Research in Financial Markets, vol. 14 no. 5
Type: Research Article
ISSN: 1755-4179

Keywords

Article
Publication date: 2 December 2021

Othman Ibrahim Altwijry, Mustafa Omar Mohammed, M. Kabir Hassan and Mohammad Selim

The purpose of this study is to develop and thereafter validate a Sharīʿah-based FinTech Money Creation Free [SFMCF] model for Islamic banking.

Abstract

Purpose

The purpose of this study is to develop and thereafter validate a Sharīʿah-based FinTech Money Creation Free [SFMCF] model for Islamic banking.

Design/methodology/approach

The study has adopted a qualitative research methodology, using three approaches, namely, a survey of the literature to identify the research gap and the variables needed for developing the model, content analysis to construct the variables into a model and semi-structured interview with 10 experts in banking, Sharīʿah and Financial Technology (FinTech) to validate the SFMCF model.

Findings

The major findings of the study lie in developing the SFMCF model for Islamic banking, empirical validation of the model’s viability and acceptability and the implications for the main stakeholders of Islamic banks.

Research limitations/implications

The SFMCF model is specific to Islamic banking and its validation is based on the views of 10 experts.

Practical implications

The SFMCF would necessitate changes to the central bank regulatory framework, convince Islamic banks to forego their powers and advantages of creating money and enhance their abilities to fully adopt Sharīʿah-compliant FinTech.

Social implications

The proposed model if implemented would change positively the perception of the society particularly the stakeholders of Islamic banks and restore their trust and confidence about the direction of the institution toward achieving the Sharīʿah objectives.

Originality/value

The novelty of this work lies in developing and validating the viability and acceptability of the SFMCF model for Islamic banking.

Details

International Journal of Islamic and Middle Eastern Finance and Management, vol. 15 no. 4
Type: Research Article
ISSN: 1753-8394

Keywords

Article
Publication date: 12 February 2018

Gerry Cross

This paper aims to consider recent arguments that post-crisis regulatory reform has misunderstood the nature of banks’ activities. These arguments suggest that a bank’s role is…

Abstract

Purpose

This paper aims to consider recent arguments that post-crisis regulatory reform has misunderstood the nature of banks’ activities. These arguments suggest that a bank’s role is not that of intermediation between savers and borrowers but the systemically riskier one of private money creation.

Design/methodology/approach

The paper assesses whether banks’ activities are best understood as private money creation rather than intermediation. It considers the argument that regulatory reform has not gone far enough to prevent a recurrence of future credit spirals ending in financial crises.

Findings

This paper analyses banks’ activities and finds that it is incorrect to consider that they engage in relatively unfettered money creation. While fractional reserve banking does create flows of money through the economy, these flows are tethered to banks’ funding requirements. Multiple use of that money, rather than representing an ill-understood risk, simply reflects the nature of maturity transformation. This has not been missed in designing the post-crisis regulatory framework. The revised framework contains many features that are not fully recognised by proponents of the money creation critique and goes significantly further than they allow. Once completed, it will address many of the concerns they raise. They are right to call for further consideration of whether the countercyclical features of the new framework are sufficiently developed.

Originality/value

The paper provides an early detailed response to recent criticism of the post-crisis regulatory reform programme coming from a money creation perspective of banks’ role in the economy.

Details

Journal of Financial Regulation and Compliance, vol. 26 no. 1
Type: Research Article
ISSN: 1358-1988

Keywords

Book part
Publication date: 19 February 2020

Samuel Demeulemeester

This chapter discusses the “seigniorage argument” in favor of public money issuance, according to which public finances could be improved if the state more fully exercised the…

Abstract

This chapter discusses the “seigniorage argument” in favor of public money issuance, according to which public finances could be improved if the state more fully exercised the privilege of money creation, which is, today, largely shared with private banks. This point was made in the 1930s by several proponents of the “100% money” reform scheme, such as Henry Simons of the University of Chicago, Lauchlin Currie of Harvard and Irving Fisher of Yale, who called for a full-reserve requirement in lawful money behind checking deposits. One of their claims was that, by returning all seigniorage profit to the state, such reform would allow a significant reduction of the national debt. In academic debates, however, following a criticism first made by Albert G. Hart of the University of Chicago in 1935, this argument has generally been discarded as wholly illusory. Hart argued that, because the state, under a 100% system, would be likely to pay the banks a subsidy for managing checking accounts, no substantial debt reduction could possibly be expected to follow. The 100% money proponents never answered Hart’s criticism, whose conclusion has often been considered as definitive in the literature. However, a detailed study of the subject reveals that Hart’s analysis itself appears to be questionable on at least two grounds: the first pertains to the sources of the seigniorage benefit, the other to its distribution. This chapter concludes that the “seigniorage argument” of the 100% money authors may not have been entirely unfounded.

Details

Research in the History of Economic Thought and Methodology: Including a Symposium on Public Finance in the History of Economic Thought
Type: Book
ISBN: 978-1-83867-699-5

Keywords

Article
Publication date: 10 November 2022

Mohamad Mehdi Mojahedi Moakhar, Mahmoud Esavi, Amir Khademalizadeh and Fathollah Tari

The purpose of this paper is organized as follows. Section 2 reviews the literature on the subject matter, focusing on western economic literature and the Islamic economic…

Abstract

Purpose

The purpose of this paper is organized as follows. Section 2 reviews the literature on the subject matter, focusing on western economic literature and the Islamic economic paradigm, including the Quran, Sunnah, jurisprudence and Islamic philosophy thinking, to illustrate the origins of the Islamic approach to monetary systems. The money interest rate and its studies are explained, and the role of money and credit in the production function is considered. Then, it is shown that money maintains the demand for money in the overlapping generation model, as well as the consumption behavior of households. It is followed by an explanation of general Pareto optimality and the role of the money interest rate in inefficiency and nonoptimality for households and firms. Finally, Section 4 concludes the paper.

Design/methodology/approach

This paper studies the effects of money issuance and bank creation on Pareto optimality. In explaining the origins of the Islamic approach to monetary systems, the literature review, it focuses on western economics’ literature and Islamic economics paradigms such as the Quran, sunnah, jurisprudence and Islamic philosophy thinking. In modeling section, the authors show how banks’ fractional reserve credit is profitable. The authors also examine how the introduction of the money interest rate can change the Pareto optimality. In this regard, the comparison between two situations, namely, financing by the stock of money and borrowing in the credit market, indicates that welfare is reduced by the creation system and is inefficient (or nonoptimal). The result is that no money and no credits are created. The provision of this system compensates money by increasing the real money supply or deflation. To ensure Pareto optimality, it has been proven in the field of microfoundation that there should be no fixed money contracts and no money interest rates. It is necessary that the interest rate on consumption credit is zero or Qarz-al-Hasna is broken. Moreover, profit sharing is offered in the production sector.

Findings

As a result, the authors proved mathematically that the money interest rate must be zero to ensure productivity and Pareto optimality. On the other hand, the introduction of money or credit through loanable money leads to inefficiency, both in production and households and in the general equilibrium. The inflation generated by the credit system stimulates the change in the price level and perpetuates this inefficiency. Thus, if the authors want to return to the optimality condition, the interest rate on consumption credit must be zero or Qarz-al-Hasna is breached. However, the behavior of the fractional banking system and the credit mechanism teaches us that the money interest rate is an integral part of credit and loanable funds. Thus, the elimination of the money interest rate from the banking system without bank creation is implausible. Finally, to ensure Pareto optimality, it has been mathematically proven in the field of microfoundation that there should be no fixed money contracts and no money interest rate. It is necessary that the interest rate on consumption credit is zero, or Qarz-al-Hasna is broken. Moreover, profit sharing is offered in the production sector. The result is that no money and credit are created. The provision of this system compensates money by increasing the real money supply or deflation.

Originality/value

The capitalist theory of the definition of interest plays a decisive role in economic science. In this context, the authors are dealing with different vocabularies and terms for the interest rate. These different vocabularies have their origin in the different economic situations and especially determine the thinking of the schools. Because of the relationship between future and spot, the authors have to transform the variable “level” into the variable “interest rate” in the dynamic space. Finally, the exact explanations for the movement and evaluation of the economy are revealed by the correlation of the different interest rates.

Details

International Journal of Islamic and Middle Eastern Finance and Management, vol. 16 no. 2
Type: Research Article
ISSN: 1753-8394

Keywords

Article
Publication date: 6 April 2012

Richard Wood

The purpose of this paper is to review monetary policy options in countries assumed to be suffering from two common economic problems: deficient private demand and high and rising…

1603

Abstract

Purpose

The purpose of this paper is to review monetary policy options in countries assumed to be suffering from two common economic problems: deficient private demand and high and rising public debt.

Design/methodology/approach

The analytical approach assumes that relevant authorities have decided that new money creation is necessary to address their economic problems. The paper asks the question: how should this new money creation best be deployed to create the required economic stimulus in the context of rising public debt?

Findings

The first finding is that the latest rounds of “quantitative easing” in the USA (QE2) and Japan are likely to be inefficient, largely ineffective and have adverse side‐effects, and that in periphery countries the risk of debt default is being increased by current defensive policy settings. The second finding is that the policy of financing budget deficits by printing new money is likely to be more effective (than “quantitative easing” and current Eurozone policy) in raising demand, output and employment without adding unnecessarily to already high levels of public debt.

Practical implications

There are very substantial practical policy implications, involving a potential change of monetary policy strategies for two of the world's largest economies and for Eurozone periphery countries. Post‐earthquake reconstruction in Japan could be financed in the manner recommended in this paper.

Originality/value

The originality/value lies in demonstrating that current monetary policy orthodoxy is misplaced, and that an alternative policy strategy has been overlooked and is likely to be more effective.

Article
Publication date: 22 May 2009

Ahamed Kameel Mydin Meera and Moussa Larbani

The purpose of this paper is to show that fractional reserve banking (FRB) has implications for the ownership structure of assets in the economy that violates the Islamic…

3668

Abstract

Purpose

The purpose of this paper is to show that fractional reserve banking (FRB) has implications for the ownership structure of assets in the economy that violates the Islamic principles of ownership.

Design/methodology/approach

This is a theoretical paper that looks into the works of Islamic scholars on the issue of ownership that are based on Qur'an principles and the traditions of the Prophet, and evaluates the FRB from that perspective.

Findings

The conclusion of the paper is that money creation through FRB is creation of purchasing power out of nothing which brings about unjust ownership transfers of assets, from the economy to the bank effectively paid for by the whole economy through inflation. 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. This violates the ownership principles in Islam and is tantamount to theft. It also has the elements of riba. Islamic governments should therefore not create fiat money since this is equivalent to taking assets of the people, rich and poor alike, forcefully without compensation.

Research limitations/implications

Empirical investigations into how bank loans along the years have changed the asset ownership structure in economies may shed further light.

Practical implications

It is, therefore, important that Shariah scholars render a fatwa on both the fiat money and the FRB system. Such a fatwa is urgent and pertinent before Islamic banking and finance, that operate under these systems, takes a course that may prove difficult to reverse later. The Islamic economics and finance cannot be founded upon a money system that is fundamentally equivalent to theft and riba.

Originality/value

The paper shows how the operations of Islamic banking and finance within the fiat money, FRB system are invalid from the Islamic perspective.

Details

Humanomics, vol. 25 no. 2
Type: Research Article
ISSN: 0828-8666

Keywords

Article
Publication date: 4 April 2008

Zubair Hasan

To reopen for discussion the issue of credit creation and control in the area of Islamic banking.

3212

Abstract

Purpose

To reopen for discussion the issue of credit creation and control in the area of Islamic banking.

Design/methodology/approach

In view of a rapid expansion of Islamic banking in recent decades, the answer to questions whether Islamic banks can create credit like mainstream banks and, if yes, what methods central banks could use to control it in their case is of paramount importance. An overview of the literature on the subject is provided and credit creation process is explained as background material for the discussion.

Findings

The literature on the subject is scanty, controversial and inconclusive. One reason seems to be the mismatch between structural design of Islamic banks and the objectives they are supposed to meet. It is concluded that Islamic banks can create credit in the usual manner but central banks will have to design new tools for credit control applicable to Islamic banks.

Research limitations/implications

It is not a rigorous analytical exercise as the main purpose of the paper is to reopen an important issue for discussion. It is an opinioned work and presents rather tentative answers to the questions raised.

Practical implications

The findings of the paper may have serious implications for the current structure of Islamic banks and the legal framework for regulating their credit creation activities.

Originality/value

The paper draws attention to a rather neglected issue in Islamic banking and offers guidelines to resolve it.

Details

International Journal of Islamic and Middle Eastern Finance and Management, vol. 1 no. 1
Type: Research Article
ISSN: 1753-8394

Keywords

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