Islam and Financial Intermediation

THE PURPOSE OF THIS PAPER is to describe certain steps that have been taken toward the Islamization of the financial systems in Middle Eastern and Asian countries. It should be emphasized at the outset that conclusions based on such a study must of necessity be preliminary in nature. Theoretical discussion of the issues involved is at a relatively early stage among Islamic economists, and practical steps to change institutional structures have only just begun to be taken. Moreover, in preparing this paper, the author has used only English language sources.


THE PURPOSE OF THIS PAPER is to describe certain steps that have been taken toward the Islamization of the financial systems in Middle Eastern and Asian countries. It should be emphasized at the outset that conclusions based on such a study must of necessity be preliminary in nature. Theoretical discussion of the issues involved is at a relatively early stage among Islamic economists, and practical steps to change institutional structures have only just begun to be taken. Moreover, in preparing this paper, the author has used only English language sources.

THE PURPOSE OF THIS PAPER is to describe certain steps that have been taken toward the Islamization of the financial systems in Middle Eastern and Asian countries. It should be emphasized at the outset that conclusions based on such a study must of necessity be preliminary in nature. Theoretical discussion of the issues involved is at a relatively early stage among Islamic economists, and practical steps to change institutional structures have only just begun to be taken. Moreover, in preparing this paper, the author has used only English language sources.

In order to reconcile their financial systems with Islamic principles, a number of Moslem countries have undertaken efforts to abolish Riba,1 which is the Arabic word for usury and interest. More precisely, Riba is defined as the fixed return for the use of money.2 This paper begins with a brief description of the Islamic attitude toward interest and profit (Section I) and proceeds to analyze the workings of an Islamic banking system based on the profit-and-loss-sharing (PLS) principle (Section II). Section III discusses the possible impacts of such a system on the mobilization of savings, on the allocation of scarce resources through banks, on investments, and on the effectiveness of monetary policy. Some tentative conclusions are offered in Section IV.

The Islamization of the financial sector has to be seen as an integral part of an attempt to establish an ideal Islamic society based on the principle of social justice.3 However, this paper will be confined to a discussion of Riba and the impact of its abolition on the financial system. The issue of abolishing fixed interest rates was brought up at the Islamic Conference held in Jidda in 1973. Measures to Islamize the financial system have been introduced in such countries as Saudi Arabia, Kuwait, Sudan, the United Arab Emirates (U.A.E.), Bahrain, Jordan, Malaysia, and most notably Pakistan. Iran, though it apparently follows Islamic principles closely in other areas, has taken only limited steps toward Islamization of the financial sector.4 In general, Islamization has consisted mainly in founding “Islamic banks,” which operate without charging or paying fixed interest rates on loans or deposits. Islamic banks are usually exempt from taxation, but they have to pay Zakat, or wealth tax, in the form of a levy on capital. Assets of Islamic banks are immune from confiscation and nationalization. A list of Islamic institutions working on the PLS principle is given in Table 1 in the Appendix.

The most far-reaching experiments with the PLS system have been carried out in Pakistan, where the abolition of Riba is an objective of the State’s constitution. The objective of the process under way in that country is not only gradually to phase out fixed interest payments but also to replace interest with equity participation arrangements that will allow incentives for savings and efficient resource allocation to be retained in a manner consistent with Islamic principles. Since January 1981, “interest-free counters” have been established in almost 6,600 branches of the five nationalized banks. Depositors still have the option of choosing between interest-bearing deposits and “interest-free” accounts. If they opt for the latter, depositors are entitled to share in the profits and losses of the investments financed by the banks. Because of the leading role of the Pakistani model in the Islamization of the financial system, this paper puts particular emphasis on the functioning of the “new” Pakistan banking system, although the experience of Islamic banks in other states will also be reviewed.

I. Islamic Attitude Toward Interest and Profit

Although the analysis of the Islamization of the financial system will focus on the economic, rather than on the religious, aspects, it is necessary to present a survey of Islamic views on interest and profits. One important Islamic commitment is the condemnation of usury. In various verses, the Holy Quran prohibits al-Riba, which can be translated as usury or interest.5 However, the interpretation of the Quranic prohibition of Riba is controversial. Riba literally means an excess or addition.6 In the pre-Islamic era, Riba referred to the then-prevailing practice of lending. The debtor had to pay a fixed amount above the principal to the creditor for the use of money loaned for a certain period. This additional amount, which could be more than double the principal sum due, was called al-Riba.7

The main controversy revolves around the question of whether the Quran prohibits usury but not interest or whether it prohibits the charging of interest altogether. The former, modernist view regards interest as legally prohibited when money is lent at exorbitantly high interest rates and thereby exploits the borrower.8 According to this view, interest charges are permitted where they are used: (1) by the government to induce savings; (2) to finance trade; (3) as a form of punishment for debtors who have not fulfilled their obligations; and (4) for loans made to finance productive investments. It has also been suggested9 that, in an inflationary environment, a system of indexing financial liabilities and claims to a price index need not be considered true interest, as this would not necessarily add to the real value of financial assets.

As opposed to this rather pragmatic viewpoint, the conservative view forbids every form of fixed, interest.10 It regards the levy of any fixed amount in excess of the principal lent as prohibited by the Quran. Since interest, however exorbitant or reasonable, is additional to the capital borrowed, it is a form of Riba and therefore does not comply with the Quran. Thus, Riba, or interest, is defined as any predetermined fixed return for the use of money.11 Therefore, it is irrelevant whether Riba relates to loans for consumption or productive purposes; whether the loans are personal or commercial; whether the borrower is the government, a private individual, or a company; and whether the rate of interest is high or low. Three main reasons are stated for this strict condemnation of Riba in Islam:12

(1) Interest or usury reinforces the tendency for wealth to accumulate in the hands of a few, and thereby diminishes man’s concern for his fellow men.

(2) Islam does not allow gain from financial activity unless the beneficiary is also subject to the risk of potential loss; the legal guarantee of at least nominal interest would be viewed as guaranteed gain.

(3) Islam regards the accumulation of wealth through interest as selfish compared with accumulation through hard work and personal activity.

A fourth reason based on economic grounds rather than on the Quran is that interest rates hamper investment and employment.13

To date, specific measures taken toward the development of an Islamic financial system have generally aimed at the abolition of all forms of fixed nominal interest and have thus sidestepped possible questions about how to define acceptable levels of interest or systems of price indexation.14 Although fixed rates are to be abolished, this does not mean that there will be no remuneration paid on capital. Profit making is generally accepted in an Islamic society unless such profits are unrestricted and abnormal15—that is, are derived from monopolies or cartels.

A major difference between profit sharing and lending at interest is that, in the latter case, the lender is less concerned with how the loan is used once it is authorized.16 So long as the loan is secured and interest payments are made, the lender has no direct financial interest in whether the loan is used to yield revenues or for consumption. This contradicts the Islamic ideal of social justice, since the entrepreneur is forced to bear the uncertainties of profit and loss alone, even though he uses funds borrowed from others. Similarly, it would be regarded as unjust for the recipient of a loan to use borrowed capital to make disproportionately large returns.

In contrast to interest, profit is not predetermined and fixed, but is uncertain and variable, and may even be negative. Profits are residuals that reward entrepreneurs for undertaking risky investments. If the owner of capital participates in a venture by providing credit to the entrepreneur on a profit-and-loss-sharing basis, it is to be expected that he will be much more concerned with the use of his funds than if he lends them at fixed interest rates.17

This positive attitude toward profit makes possible a financial system that allows each participant to play an active role in the economic process. As long as profits and losses are shared among savers, investors, and financial institutions, such a financial system would comply with the Islamic principle of Shirakat, which means partnership or cooperation.18 In Islamic finance, the technical name of partnership between the supplier and the user of capital is Modaraba. One or more subscribers of funds participate in a business with another individual or company that provides entrepreneurial skills.19 Two conditions must be fulfilled for a joint venture to be a Modaraba: (1) the gross or net return on capital or entrepreneurship should not be predetermined, and (2) the partners should share not only profits but also losses in proportion to their shares in the enterprise.20

Revenues can be shared on a pro rata basis among the various units of production after deducting incurred expenses. The distribution of profit shares is determined by a bargaining process between the investor (borrower) and the bank and between the saver and the bank. In the juristic literature (Fiqh), various percentage distribution formulas are offered, ranging from 50 per cent of the profits for each party to 25 per cent for the supplier and 75 per cent for the user of capital.21

Summarizing the previous discussion, interest and profits as they are set forth in Islamic literature may be formalized as follows. Let P0 denote the amount of principal lent to the borrower in period t0 and P1 the agreed amount of capital that has to be returned in t1. If P1 > P0 then the difference between P1 and P0 is the additional amount (Riba), or interest in the orthodox Islamic sense


Profits and losses (PL) involve an element of uncertainty. Each partner in a Modaraba business is sharing an agreed proportion Φ of the expected difference between total revenues R and total cost C. Expected profits for a participant in a joint venture are thus:


where E denotes expected value.

II. Methods of Islamic Financial Intermediation

In this section, practical issues raised by an Islamic banking system (with particular emphasis on the Pakistani model) will be dealt with. The implementation of the PLS system raises problems mainly with respect to various forms of Islamic banks’ lending operations. Banks and other financial institutions provide finance on the basis of participation in profits and losses using instruments and techniques such as Modaraba (partnership) companies, participation term certificates (PTCs), leasing, markups in price, and hire-purchase. The principle of profit-and-loss sharing is also applied to the liability side of financial intermediaries. The various forms of deposit accounts—such as investment and current accounts—at the disposal of an Islamic bank are set forth first.

funding operations of islamic banks

“Investment” deposits

Investment deposits correspond to fixed deposit or time deposit accounts and to savings accounts. Depositors in the first category are concerned with earning profits rather than holding funds for precautionary or transactions purposes. The funds raised in “investment” accounts are invested by banks on the basis of the PLS principle. The banks share the amount of profits resulting from their investments with depositors. The basis of distribution is a bank’s overall profit-and-loss position (in the case of unconditional long-term investment deposits).22

The calculation of profits and losses and a dividend declaration can be undertaken annually or every six months. Depositing funds in “investment accounts,” however, may lead not only to the earning of profits but also to the incurring of losses. Depositors are liable to bear losses in the same proportion they share profits. In some years, then, savers have to forgo earnings on their savings. It might even be possible for savers to lose part of their deposited amounts.23

In Pakistan, the PLS principle is applied to the fixed deposit accounts of banks that issue fixed deposit receipts (FDRs). These deposits are only accepted in amounts that are multiples of one thousand rupees (approximately US$100). Fixed deposits range from one to five years and can be withdrawn if advance notice to that effect is given to the bank. The deposits mobilized at “interest-free” counters are invested mainly in long-term and medium-term loans, government commodity operations, letters of credit, and inland bills. Profits earned by all branches of each bank are pooled before they are distributed. This reduces the possibility that depositors will incur losses on their deposits. Moreover, a certain percentage of profits (5–10 per cent) is kept for a reserve fund to offset a cumulative loss, if one occurs.24 An incentive for savers is the income tax exemptions for all profits of up to PRs 15,000 per annum earned by depositors on PLS accounts. While the ultimate objective in Pakistan is to transform the financial system so that it completely conforms with Islamic principles, this transformation is being carried out gradually. Depositors, therefore, will retain the option of choosing fixed-interest-bearing deposits for the time being.

Money is deposited in a savings account partly to earn income and partly to provide protection against unexpected future expenditures. Therefore, a savings account has to fulfill the functions of an investment account as well as a current account. Since, however, funds deposited in savings accounts will be invested on a profit-and-loss-sharing basis like fixed deposits, they are viewed as part of the investment account.25 In Pakistan, savings accounts (so-called Savings Banks accounts) are treated in the same way as fixed deposit accounts; both types of account work on the PLS principle, though there are differences in the conditions of savings deposits and fixed deposits. For example, the minimum amount required to open a PLS account is, at PRs 100, less than that required for fixed-term deposits.

Current account deposits

Current account deposits are held for transaction and contingency motives. The investment motive plays a strictly secondary role. Services that banks render to current account holders include the provision of checking facilities, overdrafts, and the like. For these services, banks may levy service charges to cover the costs incurred. The depositor does not receive any remuneration for depositing funds in current accounts because, it is argued, these funds will not be used for profitable investment. Funds mobilized in current accounts can legally only be used to meet short-term financial needs, such as balancing the liquidity position of companies.26 Funds deposited in current PLS accounts cannot, therefore, be used for long-term finance.

lending operations of islamic banks

Long-term and short-term finance for industry and commerce

In traditional, or western-type, financial systems, companies raise funds mainly through the issuance of equity shares or bonds or through medium-term and long-term borrowing from banks at fixed interest. The latter two financing possibilities are, however, not in accordance with Islamic principles.

Islamic countries are taking various steps to bring their existing financial systems into conformity with Islamic tenets. The Government of Pakistan, for example, passed the Modaraba law to base financial transactions on the PLS principle. Moreover, it introduced participation term certificates to replace interest-bearing bonds. Banks and other financial institutions are asked to grant long-term loans on a PLS basis to provide long-term finance to industry and commerce.

Under the Modaraba law,27 management companies, banks, and financial institutions can register themselves as Modaraba companies. Legally, Modaraba means a business in which one person participates with his money and another with his efforts and skills. It can be of two types: (1) a multipurpose Modaraba with more than one specific objective, and (2) a specific-purpose Modaraba (e.g., for raising housing finance). 28 Modaraba companies may only engage in business that is permitted under the Shariah (Islamic religious law). A religious board ensures that the firm’s activities are not opposed to the injunctions of Islam. Funds collected in a Modaraba business can be used, on a PLS basis, for most types of investment, including project financing, leasing industrial equipment, financing real estate, and commodity trading (a short-term activity), though not of course for certain religiously proscribed activities such as trade in alcohol or for ventures such as nightclubs or gambling halls. Other provisions of the Modaraba law are very similar to company laws in western countries. The company, its officers, and their relatives are not permitted to borrow from the company. Not less than 10 per cent of the total amount of capital the Modaraba company offers for public subscription must be fully paid up. Annual reports must be submitted that include a balance sheet, a profit-and-loss account, and a statement of financial changes.

Banks and other financial institutions are able to provide risk capital to a Modaraba business in the form of equity and loans with equity features. For the amount of capital provided, banks receive Modaraba certificates, which are transferable certificates with a specific face value. Before profits are distributed among Modaraba certificate holders, the board of the Modaraba company decides which part of them should be kept back as reserves for meeting contingencies or for equalizing distributions of profit. No explicit statements are given about the distribution of losses. However, the PLS principle suggests that losses would be shared among Modaraba fund subscribers after free reserves and unappropriated profits of the company were exhausted. If accumulated losses exceed 50 per cent of the subscribed capital, the Modaraba company is liquidated.

Another means of channeling long-term bank funds to industry and commerce is the participation term certificate,29 which was developed to replace fixed-interest-bearing bonds. PTCs are transferable corporate instruments based on the principle of profit-and-loss sharing. They have a specified maturity period that may not exceed ten years, excluding the grace period, and are secured by a legal mortgage on the fixed assets of the company. The proceeds of the PTC are exclusively used for implementing the project intended. In order to control the use of funds, a trustee is appointed who has wide-ranging auditing rights. The PTC holders share in profits of the company on a basis determined by mutual agreement between themselves and the company’s manager. For the purpose of determining return to PTC holders, profits are defined as pretax profits before appropriations. If losses occur, first recourse is made to the free reserves, including the credit balance in the profit-and-loss accounts of PTC issuers. When no reserves are available, losses are shared between PTC holders and other providers of funds in proportion to the funds they have subscribed. Options exist for PTC holders to convert a certain portion of outstanding PTCs into ordinary shares, and conversely stockholders may subscribe to new issues of PTCs. There are no special legal provisions concerning the relation of PTCs to Modaraba certificates, especially with respect to liability in case of losses and to priority of distribution of profits and losses.

In Pakistan, the National Investment Trust (NIT) and the Investment Corporation of Pakistan issue PTCs instead of bonds to raise funds. Apart from acquiring PTCs, banks and other financial institutions can grant medium-term and long-term loans on a PLS basis instead of demanding a fixed interest rate on the principal. Institutions that make long-term PLS loans share in the overall profits and losses with holders of Modaraba certificates and PTCs. The share of profits that accrues to the banks and other financial institutions should correspond to the share of long-term PLS loans in the total funds provided by all suppliers. If banks grant long-term PLS loans only for special investment purposes, care must be taken to ensure that profits resulting from these specific uses of funds are clearly imputed to these loans. Otherwise, profits earned on funds provided by holders of Modaraba certificates and PTCs might be transferred to banks providing long-term loans.

Since there is no detailed description of how to distribute losses on PLS loans, it is assumed that losses are negative profits and are handled analogously. At first, losses could be covered by accumulated reserves or by the credit balance in the profit-and-loss account. If reserves are not available, banks have to sustain losses on long-term PLS loans proportionate to the percentage of PLS loans in total capital and borrowed funds.30 Serious difficulties will not arise as long as losses are small or occur only in some business years. On the balance sheet, losses could be carried forward as debit balances of the profit-and-loss account and reduced or eliminated with future profits. If borrowers default, losses may affect traditional banks charging fixed interest rates as well as banks granting loans on a PLS basis. However, the rate of return depends more on the performance of the borrower in the Islamic banking system than in the traditional banking system. Therefore, long-term PLS loans are subject to greater variability in their nominal return than loans made on a fixed-interest basis.31

Another way to enable banks and other financial institutions to provide medium-term and long-term finance is the leasing system (Baj Muajjal). Banks acquire certain fixed assets like machinery and lease them for a specified period to their customers for a hire fee. The main feature of such arrangements is that the lessor (bank) retains the ownership of the asset, while the lessee (the entrepreneur) has the possession and use of it. Banks and their leasing subsidiaries are sharing in the profits and risks of the entrepreneur’s business as long as the rent for the leased assets is not fixed in advance, but related to financial success.32 A problem that has not yet been fully resolved is how to tie the rentals to the profits and losses of the lessee to bring the leasing system into accord with the partnership principle. One possibility would be to make lease or rental payments a certain percentage of annual profits that were assigned to the assets leased. Such a profit-related leasing system, however, could become very complex if the number of assets leased were high and the value of single items were low relative to the total amount of funds provided. A more tractable solution, therefore, might be to relate rentals to the output of an asset.

An important part of modern banking business is the provision of short-term loans or overdrafts to industry and commerce. Typically, banks provide trade finance and working capital. Short-term loans are usually granted for a period of three months or less. Where fixed interest charges are not permitted, a problem arises concerning how banks can be remunerated for the services they provide. One proposal is that banks should provide short-term funds free of charge.33 In case of excess demand for short-term funds, Ahmad (1952) suggests that bills of exchange could be cashed only up to a certain percentage (of less than 100 per cent) of current deposits the trader holds at the banks.34 According to this proposal, banks would have to determine what percentage of current deposits would be appropriate in order to equalize the demand for short-term funds with the supply of resources available to the bank for this special purpose. However, it is not clear what incentive this proposal would offer for financial intermediation (as opposed to simple deposit-holding), since depositors could only borrow up to the limit of their deposits.

Providing short-term finance without explicitly charging interest involves costs for the banks. Expenses arise for banking personnel and equipment, as well as the maintenance of the money transmission mechanism, and these costs have to be borne either by banks or their customers. If banks are profit-oriented business institutions, then they should be rewarded for their short-term lending as well as for their long-term lending. This can also be justified by the fact that the borrower derives a return on the use of these funds.

If it is accepted that banks should be remunerated for providing short-term financing without using fixed interest rates, then the issue arises of how short-term loans can be granted on a PLS basis as demanded by Islamic tenets. Profits could be imputed to loans that have maturities of less than a year by calculating the profits for each respective period. This is done by some enterprises that draw up quarterly accounts for internal purposes of budget control and management support.35 A certain percentage of quarterly or monthly profits corresponding to the share of short-term finance to overall funds could then be attributed to short-term PLS loans.

Although this method of distributing profits to short-term finance is possible in principle, there are a number of practical difficulties to overcome. First, the company or the entrepreneur would need a rather efficient bookkeeping system (e.g., the necessary computerized accounting systems) that could quickly provide statements on the profit-and-loss situation for periods of less than a business year. Second, since current-period profits are not usually known when a short-term loan is repaid, some method of approximating current returns would have to be found. Lenders could be remunerated retroactively, but in this case the bank would have to wait for its remuneration until profits were determined. The forecasting of future profits does not seem to be a reliable alternative because of the difficulties involved. If, however, some known past rate of profitability were used as the criterion to determine the remuneration paid to banks for short-term loans,36 this would not be in accordance with Islamic principles, since this rate would be predetermined and fixed.

As an alternative to computing periodic profits, a more direct method of determining the specific rate of return on short-term loans has been proposed.37 Since these funds are usually obtained for the classical type of self-liquidating bills of exchange, it is argued that profitability can be computed without serious difficulties by deducting the purchase cost from the sale price. While this can be used for certain types of transactions (e.g., pure trade financing), it is less appropriate in cases where the physical character of the goods being financed is transformed as they pass through the production process. In such cases, it is necessary to assign an arbitrary cost to the factor services used to transform raw materials into intermediate and finished goods, in order for the difference between sale price and purchase price to be calculated on a net basis.

A particular problem is the remuneration of short-term loans with maturities of less than 30 days. These funds are usually provided in the form of credit lines or overdrafts for short-term liquidity requirements. The application of the PLS system is likely to be even more difficult in such cases, since funds are typically not attributable to specific items of inventory or work in progress. Although such short-term loans are not used for direct investment, they yield implicit returns, since they facilitate the synchronization of inflows and outflows and thereby secure the liquidity position of a company. Banks could be compensated for the cost incurred on these credit lines by means of a service charge levied on a per transaction basis (not related to the duration of the loan or to the amount borrowed) as suggested by Uzair.38 The Islamic Development Bank determines service fees solely on the basis of its administrative expenses.39 Although this service charge can be applied without practical problems, it does not reflect the scarcity of funds unless it reflects changing market conditions. If this service charge is a fixed amount, it will correspond to some interest rate on the short-term loan even if the service charge is not explicitly tied to the duration of the loan or to the amount borrowed. There is an inverse relationship between the size of the loan and the effective fixed rate of interest on it. The service charge is not in accordance with the PLS principle because the charge is not related to the profits and losses of the borrower. The only solution that would seem to be both practical and in accordance with the PLS principle would be to calculate a return related ex post to the level of output or to some general measure of profitability of the enterprise concerned.

Another possible method of compensating providers of short-term financing of input requirements and trade is the “markup” technique (Murabaha).40 It involves a sale in which the profit margin, or markup, of the seller has been mutually agreed upon between the seller and the buyer in advance. Bankers act as merchants by acquiring domestic or foreign inputs or commodities for their clients, who pay the banks for these goods either in a lump sum or in installments. The markup differs from interest in that it is not explicitly related to the duration of the loan but instead is computed on a per transaction basis.41 The markup technique has been used in Pakistan since January 1, 1981 for all bank financing of commodity operations of the Government, its agencies, and certain other Government-run organizations and for import bills drawn under letters of credit. Export bills purchased or negotiated under letters of credit denominated in foreign currency are provided for the exchange rate differentials (which correspond to markups). On rupee bills, a commission fee is imposed.42 The Islamic Development Bank in Jidda has been using the markup technique, especially for foreign trade financing. If the markup is fixed in nominal terms before the transaction takes place and the time period between acquisition and sale of the commodities is known, then this method of lending would, in practice, involve a fixed return. If this was felt to be objectionable, a possible solution might be to tie the markup amount to factors that are not known in advance, such as world prices or current holding costs of the commodity.

Finance for agricultural sector

The need for finance in the agricultural sector arises mainly from the seasonal nature of farming. Most credit extended to farmers consists of short-term loans made for periods ranging from one season (e.g., for a planting cycle) to one or two years. Some medium-term and long-term loans are used for purchasing livestock or equipment. In rural societies, noninstitutional moneylenders usually meet the financial needs of peasants. The access of conventional commercial banks to the rural population is sometimes rather limited, particularly if peasants are skeptical about modern banking techniques and if—because of maximum lending rate limitations, high administrative costs (especially for small, short-term loans), and excessive default risks—banks find such activities unprofitable.

The introduction of a banking system that works on principles endorsed by religious leaders could be helpful in reducing peasants’ reluctance to use the services of banks. The PLS principle could be applied to agricultural lending by sharing output or net profits according to an agreed percentage formula between the bank and the farmer. Part of the profits could be used to build up reserves as a buffer against possible future losses. In order to link farmers more closely to their banks, a certain part of the farmers’ profits could also be used to acquire bank shares.43 This more direct involvement of banks in agricultural activity could be further enhanced if the banks also acted as traders in both inputs (such as pesticides and fertilizers) and outputs. Such a development would be more likely to occur if input and crop financing were conducted on the markup basis described previously. It is to be hoped that this sort of credit cooperative arrangement incorporating a distribution network would result in higher net revenues. A further improvement of the profit situation could be achieved if banks provided some technical assistance to farmers on methods that could improve agricultural production. Profits would also be increased if the participation of banks in the PLS system enabled them to monitor more carefully the uses made of funds they have lent.

Consumer credit

For commercial banks in developed countries, consumer credit has become a very important business activity. Consumer loans are granted not only to enable borrowers to deal with personal or family emergencies but also to help them raise their living standards by purchasing durable consumer goods or houses.

Islam does not absolutely forbid lending for consumption purposes. In former times—and even today—in some Moslem countries, special consumption loans, the so-called “worthy credit” or welfare loans (Quarz-i-Hasana), were made.44 These loans were made in hardship cases by neighbors or friends without any financial consideration. The debtor had to repay the principal at his convenience. Religious laws demanded that the borrower clear all his debts before his death; otherwise, he would be regarded as a sinner.45 This form of charitable assistance cannot, however, become the basis for consumption lending of profit-oriented commercial banks, except in extraordinary cases. Therefore, if lending to finance consumption is to take place, banks will have to be remunerated for it just as for any other service.

The application of the partnership principle to consumption loans does not seem to be an acceptable solution. Consumption loans are usually not directly productive in terms of yielding profits that could be shared by lender and borrower. They may be productive in the sense that they enable the debtor to improve his physical working ability or that they raise aggregate demand and income. Moreover, they can increase welfare by changing the time distribution of a given total of expenditures. However, these returns cannot easily be calculated and attributed to consumption loans. The profit-and-loss-sharing principle cannot, therefore, be applied to consumer credit extended by banks.

Because of the difficulty banks have in deriving profits from their consumption lending, it has been proposed that such loans be granted either through some government agency or through people’s cooperative societies.46 However, simply changing the lender would not solve the problem of obtaining the necessary remuneration on such loans. A governmental credit agency could grant interest-free consumption loans (or charge only moderate service fees) in order to provide some sort of social security system, but then all, or at least a large part of, the costs of this “interest-free” lending would have to be borne by taxpayers. The alternative proposal, which entails the founding of credit cooperatives, might provide a solution to the problem of remunerating consumption loans. Such cooperatives would initially require members to purchase a certain amount of shares. Out of the funds raised, loans would be granted to the shareholders, who would repay them in installments. Expenses would be covered by a “tax” on every loan application.47 Funds not used for consumption loans would be invested in profit-yielding deposit accounts of Islamic banks. This system might work if steps were taken to ensure that the repayment ratio of loans was kept high, administration costs were kept low, and the funds invested (and not used for consumption loans) yielded revenues to cover expenditures. There would remain, however, two questions to be solved: (1) Would savers have enough incentives to deposit part of their savings in a credit society without receiving any financial yield or benefit apart from the right to borrow money at some future date? (2) How would the cooperative allocate its funds if there was excess demand for loans? Such a situation is likely to occur when money is being lent at interest rates close to zero (including the tax as a sort of service charge).

A third way of providing consumer credit is the hire-purchase (Bai Salam) arrangement, under which banks and other financial institutions acquire certain assets and then sell them to their clients. Under this arrangement, ownership gradually passes to the customers with the payment of installments.48 Although the hire-purchase technique may be used for financing of industry, commerce, and agriculture, it is particularly apt for certain forms of consumer lending, such as the financing of housing or durable consumer goods.49

In Pakistan, the House Building Finance Corporation (HBFC) advances loans for housing on a hire-purchase basis. The HBFC jointly owns each property it finances with the purchaser for a specified time period. The purchaser pays installments until the entire principal is repaid. The corporation assesses both the total value of the house to be built and its rental value. The HBFC is entitled to a share of the rent, from which its profits are derived. If the purchaser sells his house before the loan is fully repaid, he has to repay the entire principal and share the capital gain or loss accrued on the property with the HBFC. However, by using this formula for an “interest-free” housing loan, the HBFC in effect receives the same rate of interest it would have received on a straight loan.50

Lending to the government

The PLS system cannot be applied directly to government borrowing since revenues resulting from investments can usually be assigned only very roughly to the uses made of borrowed funds. Direct income can only be determined in circumstances where people deriving benefits from the government’s spending can be required to pay for them. If it is not possible to exclude people unwilling to pay for governmental services they benefit from, then direct revenues cannot be generated.

Three broad categories of government expenditures can be distinguished. For expenditures in the first category—which includes general administration, defense, and police—specific user fees cannot be levied. A second category consists of expenditures for projects from which direct revenues can be obtained, in principle, but, in practice, usually are not collected because administrative costs would be very high. Canals or irrigation facilities fall into this category. Collecting directly for the use of roads can be done to some extent, though it is not easy to do on a sufficiently general basis. A third category consists of expenditures for various government-run enterprises (e.g., steel mills and power plants) that are mainly profit-oriented but may also pursue political or social goals. The operating expenses of these enterprises are covered, in whole or in part, by the proceeds from the sale of the goods and services they produce. Borrowing for government investments in such income-earning projects could therefore be treated similarly to borrowing for privately run ventures. The first two categories of government spending, however, have to be financed through taxation or credit.51 Since the direct application of the PLS system is not suitable for the financing of budget deficits, a more general way of determining the returns from such expenditures should be considered.

One possibility that, to the author’s knowledge, has not been suggested by writers on Islamic financial systems would be for the government to issue bonds that did not offer fixed rates of interest but instead offered returns tied to the annual rate of nominal gross domestic product (GDP) growth (either in absolute or per capita terms). In this case, the rate of remuneration for providing capital would not be fixed and predetermined, but variable, as Islamic principles require. Moreover, this financing method would avoid the difficulties involved in determining the rate of return on various government outlays. Admittedly, the GDP growth rate is only a very rough proxy for the return on capital, since such other factors as the supply of labor and the sectoral structure of the economy influence the latter rate, but the GDP growth rate would nevertheless be an indicator of the state’s activities, especially in countries where the government sector plays an important role in the economy. An advantage for savers purchasing these bonds would be that they might yield positive real rates of return, thereby probably increasing the savings rate. An advantage for the government would be that it could raise noninflationary funds without aggravating the budget situation, since income taxes would rise by about as much52 as the variable payments on bonds. This financing method would also serve social and economic purposes in involving government debt holders in the performance of the economy.

alternatives to a profit-and-loss-sharing system

Providing finance on a PLS basis requires constant vigilance by the banks over the utilization of funds. This can provide benefits (as conventional banking systems have also come to realize) in the form of improved financial control. However, for the reasons that have been discussed previously, shifting all lending to a PLS basis involves numerous practical problems. These problems can be partially solved by introducing techniques—such as leasing, markup, and hire-purchase—that have already been discussed as alternatives to a pure PLS system. Nevertheless, banks are still likely to have to increase their staffs by employing engineering and management experts to evaluate projects more thoroughly than they can using traditional lending techniques. This will result in increased costs that bankers will have to balance against prospective increases in rates of return that could be earned by making more efficient use of funds.53

Because it is aware of the practical difficulties of Islamizing the financial system, the Government of Pakistan has also considered possible alternatives to the PLS system that would not rely on fixed predetermined interest rates.54 One proposal is to introduce a system of indexing bank deposits and advances. The indexation would be related to some multiple of the rate of inflation.55 The rate of indexation could be higher than, equal to, or lower than the rate of change of the price level. The central bank would decide each year in what proportion bank deposits and advances should be indexed and could thereby take into consideration the size of the required return on savings and the cost of borrowing.56

Although the proposed system does not include the PLS principle, it could be considered to be in accordance with Islam because the indexation rate is tied to the variable and uncertain inflation rate.57 Economically, the indexation offers the chance for savers to receive a positive real rate of return on their deposits if the multiple for the indexation rate is greater than one. This could encourage them to save more of their incomes. On the borrowers’ side, the indexing system would reduce the demand for investment funds for projects that do not yield a return compatible with the economy’s capital endowment. Therefore, the gap between desired savings and investments could be closed, or at least narrowed, if an appropriate rate of indexation were chosen—that is, one corresponding to the rate of inflation. Two other advantages are the relative ease with which this indexing system can be handled and its low administrative costs compared with those of the PLS system. However, it would be advisable for the commercial banks to determine the indexation rate, rather than the central bank. Such a practice would be particularly helpful to the banks in making advances because they could vary the indexation rate according to the creditworthiness of the borrower. Choosing a multiple for the indexation rate that was unequal to the inflation rate would, however, lead to shifts of wealth between lenders and borrowers. The higher the inflation rate was, the larger would be the wealth transfer.

Another proposal aimed at long-run loan financing is the Investment Auctioning System.58 Under this system, financial institutions would auction investment authorizations to investors. Supply of, and demand for, investable funds would determine the scarcity price of available capital. This Investment Auctioning System would take into account the resource endowment of the economy. In order to ensure that the system reflected social investment priorities, the government would specify several categories of investment and would set maximum monetary limits on them. If a limit were reached, investment auctioning in that category would stop. Within the framework of an Investment Auctioning System, entrepreneurs would remain solely responsible for their investment decisions, whereas banks would serve only as financial intermediaries. Scarce capital resources would flow into those investments with the highest expected rates of return. The optimal allocation of capital, however, could be biased by the limits placed on certain investment categories. The administrative costs of the Investment Auctioning System are difficult to evaluate because these details are not included in the proposal.

III. Effects of a Profit-and-Loss-Sharing Financial System on Economic Development and Stability

This section analyzes the impact of the abolition of fixed interest rates and their replacement by the PLS system on broader macroeconomic questions of development and financial stability. First, the role of interest in savings and investment will be discussed briefly. Then, the significance of the financial system for economic development will be set forth. Within this framework, the effects of a PLS-based financial system on savers, financial intermediaries, and investors are dealt with. Finally, some aspects of implementing monetary policy in such a system will be pointed out.

effects of an islamic financial system on savings and investment

Islam prohibits fixed interest mainly on the ground that it represents a rentier income. Since the lender of money gets back more than he supplied to the borrower, this is seen as an exchange of assets of unequal value and therefore as exploitative.

In conventional economic theory, interest is simply the return received by savers for abstinence or waiting and the price paid by borrowers for the earlier availability of resources.59 It measures the rate at which people exchange the use of goods today for their use at some future time. The rate of interest strongly influences savings and investment decisions of individuals over time and is generally positive, for two reasons. First, people in the aggregate have a positive time preference, which means that at the margin they prefer consuming goods now to consuming goods in the future. Second, resources can be used for productive investments that increase in value over time. Since present resources can be turned into future goods at a profit, the investor is willing to pay a positive interest rate to the supplier of resources.

Within the framework of neoclassical theory, the rate of interest balances desired saving against planned investment. An increase in the interest rate induces savers to save more and causes investors to refrain from making investments that have a rate of return lower than the current interest rate.60

The decision to save or to invest depends on the expected or ex ante rate of interest and not on the ex post rate of interest, because it is the anticipated return that influences economic decisions about the allocation of resources.61 A wealth owner will shift his assets (and liabilities) until the expected return on each asset has been equalized at the margin. Differences in the returns on various assets—such as fixed-interest bonds, shares, or loans—reflect, therefore, differences in risk (and, of course, institutional factors such as liability to tax). Setting a fixed interest rate in a contract between lender and borrower is simply a means of reducing uncertainty concerning the nominal return to be paid and received.62

Banks and other financial institutions can contribute to the economic development of a country by providing a market in which the complex needs of savers and investors are matched. Savers keep their wealth in various forms of real and financial assets. Depending on the individual’s preferences, assets (and liabilities) must have certain features of safety, liquidity, and yield. In developing countries, savers usually hold a large part of their nonfinancial wealth in the form of land, livestock, inventories (e.g., foodstuffs), and to a certain extent in durable consumer goods. Wealthier individuals, and sometimes poor people as well, hold valuables such as gold and jewelry. The share of productive capital goods is relatively small in comparison with the share of nonproductive assets in total wealth.

Financial institutions can change the composition (and also the desired aggregate level) of savers’ wealth by offering certain financial assets that correspond better to the needs of savers in terms of liquidity, security, and yield than existing assets. It may be less risky and may cost less to hold savings in monetary form than in the form of real goods. Banks transfer the financial assets they attract to investors, who then use the funds for income-yielding investments. Because of savers’ preference for safe and liquid assets, a smaller volume of funds is likely to be channeled to investors when financial intermediation does not take place than when it does. Financial institutions can reconcile the needs of savers and investors through the transmutation of relatively safe and liquid short-term financial claims into riskier, less liquid, long-term real assets. The financial system thereby improves the allocation of scarce resources and makes possible a faster development of the economy.63

The introduction of financial intermediation based on the PLS principle may have impacts on the behavior of savers, banks, and investors. The PLS system turns savers into entrepreneurs, at least to some extent, by encouraging them to participate directly in the financial success of the investor’s business, thereby sharing the risks involved. Savers then face a different type of uncertainty in an Islamic financial system than that faced by savers in a traditional banking system. In the latter system, the expected yield depends on the nominal rate of interest banks offer on various forms of time deposits and on the expected rate of inflation. While the nominal rate of interest is fixed, uncertainty arises from the fact that the actual inflation rate may differ from the rate expected when the act of saving took place.

In an Islamic banking system, not only is the expected rate of inflation a risky variable, but the nominal yield on investment deposits as well. Therefore the riskiness of the expected real yield on investment deposits consists of two components: uncertainty concerning the ex post nominal return that will be received and uncertainty concerning the inflation rate. If these two sources of uncertainty are independent (in a statistical sense), then it is clear that the aggregate uncertainty (in the sense of statistical variability) of the real yield on bank deposits will be greater under a PLS system than under a fixed-interest system. However, it is possible that the two sources of uncertainty may not be independent, in which case this conclusion would not be valid. Increases in the nominal price level may tend to be associated with increases in the nominal return on investment; if so, unexpected variations in the nominal yield of PLS deposits might tend to offset unexpected variations in the inflation rate and could even reduce the variability of the real yield on savings.

If a country’s entire financial system were to be altered so that it was based on the PLS principle, the effect of this alteration on savings incentives would depend on the extent to which the two kinds of uncertainty were offsetting. Since it is safe to assume that savers are, in the aggregate, risk averse, it would be important to determine whether the two sources of variability in returns on investment deposits were (or were perceived to be) additive.

Where an Islamic banking system works side by side with traditionally operating banks, the effects on savings are unambiguously positive, since the menu of savings instruments is expanded and no existing savings outlet is eliminated. Savings attracted into PLS accounts will include not only existing savings in the form of other assets but also savings of individuals who either have a religious inhibition concerning the use of the traditional banking system or consider the economic characteristics (risk, return) of the new assets sufficiently superior to the old ones to induce them to increase their savings.

The analysis has so far assumed that rates of return are the same when a country is switching from a traditional to an Islamic banking system or when both systems are operating competitively. The reasoning behind this assumption is that both banking systems are confronted with the same investment opportunities and use them in equally efficient ways. Proponents of the PLS system might argue, however, that its yields to depositors could be higher than those offered by the conventional system and that PLS offers a better chance of compensating depositors for an unexpected acceleration in the rate of inflation. These factors would tend to enhance the attractiveness of PLS accounts and therefore to limit, or even to eliminate, the system’s possible adverse consequences for financial savings mobilization that were noted previously. It could also be argued that banks working on a PLS basis are more concerned with the use of mobilized funds than traditional banks. Since the former share in the profits and losses of investors, they would be more likely to direct their resources to more productive and profitable investment opportunities.64 Investments yielding higher expected rates of return usually involve greater potential variability in their rates of return, however. Islamic banks would presumably be willing to bear greater risks only if they were compensated by high enough returns. Nevertheless, Islamic banks might accept investments with greater variability in the expected rate of return because part of the increased risk would be borne by the depositors. Moreover, it is possible that Islamic banks require less collateral for loans because they monitor them more closely than traditional banks. This reduced requirement could especially favor new entrepreneurs who have not yet established their creditworthiness but might be very innovative.

The process of financial intermediation could be affected if Islamic banks were somehow constrained in carrying out the task of transforming short-term liabilities into long-term advances. As was related earlier, it has been suggested that only investment deposits be used for long-term investments and that current account deposits be used for short-term lending—for example, for trade financing. If the uses of funds are strictly separated according to their origin, then loans for long-term investments will be limited by the volume of investment deposits. This would not be the case if funds originating from current account deposits were at the free disposal of the banks. If longer-term investments were linked to a particular project (so-called conditional certificates of deposit), then the process of financial intermediation would be constrained in another way.

In terms of banks’ relations with borrowers, a PLS system clearly fosters more direct involvement than a traditional system. Banks would require more information about the business activities they financed and would be more likely to seek to influence the business decisions of borrowers. On the one hand, this heightened involvement might discourage entrepreneurs who sought maximum freedom of maneuver in the use of the funds they borrowed. On the other hand, the enhanced role of the banks could bring about improvements in the skills of investors. Especially in small business and agriculture, banks could provide information and expertise that could increase the profitability of investments. They could also support entrepreneurs by providing them with technical and managerial assistance. Moreover, banks within the framework of the PLS system are themselves entrepreneurs who can influence business decisions positively. Therefore, the negative effects on investor’s willingness to accept risks caused by thorough credit supervision might be counterbalanced by the positive effects that the comprehensive support services provided by Islamic banks had on borrowers’ businesses. Finally, by sharing losses as well as profits, banks could function as absorbers of shocks stemming from the real sector and could thereby reduce the cost of adjustment.65 Since local entrepreneurs are hardly able to meet even temporary losses owing to their lack of resources, they may be overcautious in the implementation of projects that have a high expected return but high variability.

For the reasons given previously, it seems likely that greater administrative resources would be required to operate a PLS system effectively than would be required for the effective operation of a traditional system, though it is to be hoped that the resulting higher costs could be offset, or more than offset, by improved allocation of investment. Greater involvement by institutional providers of funds in determining the uses to which such funds are put should have a positive effect (as the experience of western financial institutions seems to show). Still, the difficulties already alluded to in finding a suitable means of providing and charging for short-term lending will need to be overcome if inflexibilities are not to hamper the smooth working of the financial system.

The limited evidence available demonstrates that Islamic banks have operated quite successfully during the past year. In Pakistan, the commercial banks have declared dividends on PLS savings accounts and PLS time deposits for the first half of 1981. A 9 per cent annual rate was paid on the former, whereas the latter yielded 11.5 per cent (for corresponding regular deposits, the yield was 9.5 per cent) for 6 months–1 year, 12.75 per cent (10.5 per cent) for 1–2 years, 13.25 per cent (11.0 per cent) for 2–3 years,14.25 per cent (11.75 per cent) for 3–4 years, 14.75 per cent (12.25 per cent) for 4–5 years, and 15.25 per cent (12.75 per cent) for more than 5 years.66 The Jordan Islamic Bank registered an overall profit of 8.2 per cent on investment accounts for 1980.67 One-year deposits yielded 7.4 per cent, 3-months-notice accounts 5.8 per cent, and 7-days-notice accounts 4.1 per cent. In 1980, traditional banks in Jordan paid between 7 per cent and 7.5 per cent on 1-year accounts. In 1980, depositors with the Bahrain Islamic Bank received dividends of 9–9.5 per cent on deposit accounts and 5.25 per cent on savings accounts.68 Interest rates for the same period on deposits in traditional Bahraini banks held up to 3 months were 7.5–8.0 per cent, and 8.5–9.5 per cent for deposits held 6–15 months. This evidence, however, cannot be regarded as conclusive, as rates paid on both conventional and PLS accounts were often controlled or influenced by the monetary authorities, who may have made special efforts to enhance the attractiveness of the new financial assets in the early stages of their introduction.

A further benefit could result from the introduction of PLS deposits if, for political and institutional reasons, interest rates on conventional financial instruments were “sticky,” particularly in the upward direction. It has been observed that in a number of countries with traditional banking systems, rates on deposits have been kept artificially low (i.e., below what market clearing rates would be in an unregulated environment).69 In such a situation, a PLS system without ceilings on rates of return could attract relatively more resources than a traditional banking system, especially where part of investors’ windfall profits were distributed to savers. However, this does not mean that a banking system based on the PLS principle is inherently more efficient than a traditional one, but rather that a PLS system is less vulnerable to outside pressures to fix rates of return.

A strong case can be made on religious grounds for the argument that an Islamic banking system could attract resources from devout savers. In a traditional banking system, they are not willing to accept fixed interest payments on their deposits, since they respect Quranic injunctions. The percentage of savers that rejects the traditional banking system on religious grounds is rather difficult to estimate. It might be higher in rural areas than in urban areas because religious laws are likely to be more strictly observed in the former. If the PLS system is introduced as a complement to the traditional banking system, overall savings held within the financial system may increase. Islamic banks would not only offer savers a variable pecuniary yield on investment deposits but also a nonpecuniary return in the form of religious satisfaction.

monetary policy in an islamic financial system

During the times of the Islamic Empire, there was a “central national finance house” called a Bait-ul-Mal, 70 that served as a sort of state bank. The central Bait-ul-Mal was always headed by the caliph and was located in the capital of the Empire, and the provincial Bait-ul-Mals were administered by the governors of the respective provinces. In contrast to central banks of today, the central Bait-ul-Mal did not have the right to issue currency. This responsibility was entrusted to the state. This function might, however, easily be transferred to a modern-day Bait-ul-Mal without changing its nature. The proponents of an Islamic financial system propose that an Islamic central bank provide credit to the member banks on a PLS basis.71 Monetary policy instruments that involve the application of fixed interest rates would not be used. Consequently, instruments such as open market operations and rediscounting of bills and securities would not be allowed. Instead, moral suasion supported by prescribed asset ratios would be emphasized as a method of credit control.72

IV. Conclusions and Outlook

The description of an Islamic financial system based on the PLS principle has revealed a number of unresolved issues in the practical handling of banking operations. In particular, full application of the PLS system would present problems in remunerating short-term loans for industry and commerce as well as consumer credit. Even if it were possible to compute profits and losses for very short periods by using sophisticated equipment and accounting systems, it is doubtful whether the variable return on loans would accurately reflect the scarcity price of financial capital. The remuneration paid on loans does not necessarily correspond to the opportunity cost of capital. Since profits are earned by all factors of production, the assignment of a residual to borrowed funds might be incorrect.

Another problem that has not been dealt with explicitly would be posed by foreign activities of Islamic banks. In Islamic jurisprudence, transactions between Islamic countries and those between Islamic and non-Islamic countries have to be treated differently.73 Investments abroad by the Islamic Development Bank yielding fixed rates of interest are in conformity with Islamic principles. Interest earnings, however, have been kept in a special account outside the Bank’s general account. In recent months, there has been a movement under way to adapt even transactions with non-Islamic foreign banks to the PLS system.74

The analysis of the effects of the PLS system on savers, banks, and investors has revealed that the system’s impact depends on the nature of the new financial instruments devised and the manner in which the system develops. If the PLS system is introduced on an optional basis, it seems likely that the enlargement of choice will have generally beneficial consequences, particularly for savings. Furthermore, increased investment could result from the role played by Islamic banks in the promotion of entrepreneurship. A complete conversion to a PLS system, however, would require satisfactory handling of several issues that are as yet unresolved, particularly those concerning the allocation and remuneration of short-term financing.

It is difficult to make any assessment of the prospects for the financial success of Islamic banks working on a PLS basis, since information on their performance is rather sparse. The limited evidence demonstrates that Islamic banks are able to compete with traditional banks. However, it appears that adequate solutions to a number of problems that would be presented by a complete conversion of the financial system have yet to be found.


Table 1.

Islamic Financial Institutions1

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Information not included in the table was not available.

Years following the names of institutions are those in which they were founded.

Figure is in Islamic Dinars.

Total balance sheet.


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Mr. Karsten, a summer intern in the Middle Eastern Department in 1981 when this paper was prepared, is currently Assistant Professor at the Institute for Economic Policy at Kiel University.


Where Islamic terminology is employed in this paper, the terms are taken from the sources used. While many of these words are of Arabic origin, some may be from other languages (e.g., Urdu).


See Ahmad (1952), p. 32.


See Naqvi and others (1980). Another measure designed to achieve a more egalitarian economic order is the introduction of Zakat, a form of wealth tax.


See Ali (1981 b), p. 86.


“Those that live on usury shall rise up before Allah like men whom Satan has demented by his touch; for they claim that usury is like trading. But Allah has permitted trading and forbidden usury,” The Koran, translated by N. J. Dawood (Baltimore, Penguin Books, 3rd rev. ed., 1968), p. 354. Besides the Holy Quran, other religious sources prohibit usury. See Qureshi (1967), p. 42.


For the modernist view, see Shawky El-Fangari (1979). This view is not greatly different from that held in western societies.


Orthodox views are expressed by Ahmad (1952), p. 24; Qureshi (1967), p. 100; Mannan (1970), p. 218.


See Ahmad (1952), p. 34. It may be noted that, in an economic sense, these objections to interest are directed against positive real rates of interest, rather than against nominal rates that simply compensate for price changes. Not surprisingly, religious texts rarely address this distinction directly.


In the following discussion, the term Islamic banking system refers to one based on the orthodox view of Riba. The terms traditional banking system or non-Islamic banking system refer to western-style systems.


This argument is put forward by Islamic theologians and economists. See Ahmad (1952), p. 197. However, it must be recognized that when a traditional bank provides finance to a borrower, it invariably inquires into the viability of the client and is concerned with how the loan proceeds will be used and whether the loan is secured adequately.


Ahmad (1952), p. 197. Land rents are not forbidden by the Quran as long as tenants are not forced to pay fixed rents to the landlords. If the landowner and the tenant share the yield of land in “certain proportion,” then this complies with Islamic principles (see Ahmad (1952), p. 33, and Mannan (1970), p. 153).


Uzair (1956), p. 49, footnote 2.


Uzair (1980), p. 6. The Investment Corporation of Pakistan (ICP) distributes its profits 60:40 in favor of depositors of funds, whereas any loss is shared in the reverse proportion (see “ICP Wins More Investors” (1981), pp. 6–7).


See Uzair (1956), p. 53. The Kuwait Finance House offers conditional deposits linked to a particular project. See “Banks for the Faithful” (1978). Specified accounts have also been introduced by the Jordan Islamic Bank. Profits and losses for these deposits are calculated only on the performance of the project (see Khouri (1981)).


Moreover, there is the theoretical chance that depositors might have to pay an additional sum to cover losses exceeding the initial amounts they deposited if the companies to which the bank lends incur losses larger than the amounts of the loans they received from the bank.


See Uzair (1980), p. 8. Uzair changed his attitude of 1956, when he regarded savings deposits as nonproductive and therefore not apt for productive purposes, but only for appropriate consumption loans. See Uzair (1956), p. 50.


See Uzair (1980), p. 9.


The Bankers Equity, Ltd. in Pakistan is a multipurpose Modaraba. It mobilizes funds and channels them into various ventures (e.g., into the Twin Tower Modaraba—a specific-purpose Modaraba) to provide capital for the construction of a housing complex. See Shah (1981).


A proposal that the loss be borne exclusively by the bank except in case of detrimental acts by the entrepreneurs (see Mannan (1970), p. 226) is not in accordance with the PLS principle. It would also shift all of the risk of losses onto the suppliers of loan funds.


However, as in the traditional banking system, Islamic banks are able to reduce risk by securing their PLS loans.


The Islamic Development Bank practices this financial technique. However, no details are available. See Islamic Development Bank, Fourth Annual Report: 1399 H. (1979) (Jidda, 1980), p. 49.




See Uzair (1980), p. 18.


As suggested by Uzair (1980), p. 18.


Ibid., p. 19.


Ibid., p. 20.


Islamic Development Bank, Fourth Annual Report: 1399 H. (1979) (Jidda, 1980), p. 49.


Ibid. However, it must be seen that the markup technique involves a time dimension because commodity financing transactions are usually settled within a certain time period.


State Bank of Pakistan (1980), BCD Circular No. 26.


Ibid.; Mannan (1970), p. 224; Uzair (1980), p. 17.




In the case of the leasing arrangement, the lessor (the bank) remains the owner of the assets leased.


Before converting to Islamic financing techniques, the HBFC advanced loans at an annual interest rate of 12 per cent. Under the new system, house builders can use an “interest-free” Modaraba house building loan, which also costs them 12 per cent a year. See Ali (1981 b), p. 86.


Ahmad (1952), p. 193, proposes that budget deficits be financed by the monetary authorities.


Or even more if the income elasticity were greater than one.


It is not specified which price indices should be used.






However, the interest elasticities of savings and investment are ambiguous. For a discussion, see Khatkhate (1972), p. 539, and Crockett (1973), p. 58.


For a clear explanation of this distinction, see Santoni and Stone (1981), p. 15.


The nature of uncertainty in traditional and Islamic banking systems will be dealt with later.


These figures are the yields paid by the Habib Bank. See “8.5 to 9 P.C. Profit on PLS Accounts” (1981), pp. 1,7. Yields on PLS deposits in other banks have differed slightly.


This has been the case for several years in Pakistan for most types of deposits.


See Qureshi (1967), p. 130, and Mannan (1970), p. 236.


See Mannan (1970), p. 238.




Exchange Rate Dynamics and the Overshooting Hypothesisjacob a. frenkel and carlos a. rodriguez (pages 1–30)

This paper analyzes the determinants of the evolution of exchange rates within the context of alternative models of exchange rate dynamics. The overshooting hypothesis is examined in models that emphasize differential speeds of adjustment in asset and goods markets as well as in models that emphasize portfolio-balance considerations. It is shown that exchange rate overshooting is not an intrinsic characteristic of the foreign exchange market and that it depends on a set of specific assumptions. It is also shown that the overshooting is not a characteristic of the assumption of perfect foresight, nor does it depend in general on the assumption that goods and asset markets clear at different speeds. As long as the speeds of adjustment in the various markets are less than infinite, the key factor determining the short-run effects of a monetary expansion is the degree of capital mobility. When capital is highly mobile, the exchange rate overshoots its long-run value, and when capital is relatively immobile, the exchange rate undershoots its long-run value. Within the context of the portfolio-balance model, it is shown that the effects of a monetary expansion on the dynamics of exchange rates, and in particular on whether exchange rates overshoot or undershoot their equilibrium path, depend critically on the specification of asset choice, on the degree of substitution among assets, and on the quality of the various assets as hedges against inflation. Specifically, when internationally traded goods are a better hedge against inflation than nontraded goods, the nominal exchange rate overshoots the domestic price level, and conversely.

Interest Rate Consequences of Targeting Moneywarren l. coats, jr. (pages 31–47)

This paper examines the implications of pursuing monetary targets for the behavior of interest rates in the vastly differing economic and political environments found among countries. This behavior depends on the economic environment in which the policy is undertaken. The simultaneous pursuit of interest rate and monetary targets (by means of monetary policy alone) is not generally possible, except in a limited way, even in the most isolated, financially undeveloped economies. For this reason the major interest rate issue associated with targeting money for those countries with developed financial markets is its consequence for the volatility of rates. In examining the underlying relationships that link monetary and interest rate behavior in an effort to assess the magnitude of the impact of monetary targeting on interest rate volatility, several shortcomings of the existing literature are presented. When these shortcomings are taken into account (or are corrected), the earlier assessments that interest rates would be “much” more volatile are “greatly” attentuated. The paper concludes that while monetary targets may increase interest rate volatility somewhat, that increase should be modest.

Interest Rate Policies in West Africasergio pereira leite (pages 48–76)

Formulation and implementation of interest rate policies are extremely important in less developed countries from the point of view of promotion of savings, allocation of resources, and the control of inflationary pressures. The crucial question is how to ensure realistic interest rate policies in less developed countries where market imperfections and oligopolistic banking structures are dominant. Admittedly, leaving determination of interest rates to market forces in such conditions is not practical, and government intervention of some sort is unavoidable. However, it is important that this intervention be distortion attenuating instead of distortion accentuating. For this reason, it seems essential to devise a set of criteria that could be used by the authorities in less developed countries to determine the level and structure of interest rates. Four main criteria are suggested as guidelines for determining adequate interest rates: (a) positive real rates of interest; (b) world interest rates corrected for exchange rate expectations; (c) rates of return on investment; and (d) the spread between borrowing and lending rates. However, the importance of these criteria may vary somewhat from country to country, and the weight attached to each of them is judgmental. The relevance of the central government budget and the public sector investment policy is also highlighted. The interest rate structures in ten West African countries chosen to provide varying institutional and policy frameworks are examined in light of the analytical considerations mentioned above.

Potential of External Financial Markets to Create Money, Credit, and Inflationd.f.i. folkerts-landau (pages 77–107)

In this paper it is argued that neither the earlier Phillips type of fixed-coefficient or temporary equilibrium models nor the recent Tobin type of portfolio equilibrium models of the money supply process capture the money and credit creating potential of external financial markets. A partial equilibrium nature confines both types of model to an analysis of the effects on money and credit aggregates of an exogenous transfer of domestic deposits to an external bank intermediary. This literature thus offers no insight into the determination of the rate or volume at which deposits are transferred.

While it can be shown that the external money multiplier is less than unity, it is not possible to derive similar quantitative bounds for the rate at which deposits are shifted toward external financial markets. Innovations in the technology of external financial transactions, extended lender-of-last-resort facilities, and a better definition of the legal responsibilities of domestic banks toward external subsidiaries have reduced the transaction and risk costs of externally issued deposit liabilities. We outline a general equilibrium model of an international financial markets equilibrium in which such developments can be analyzed.

The contribution of the expansion in the liabilities of external depository intermediaries to domestic price inflation is determined by the growth of the portion of their monetary liabilities that is readily substitutable for the monetary liabilities of domestic intermediaries and is used in domestic transactions. Some numerical estimates for the United States are derived. The indirect inflationary potential of external financial markets, which arises from the possibility that the growth of external markets has made some types of monetary policy more inflationary, is then evaluated. In particular, the definition and measurement of the relevant money and credit aggregates has become much more difficult. Increased international mobility of capital, as well as the substitutability of assets denominated in different currencies, may have resulted in increased exchange market intervention or increased exchange rate variability. In the presence of asymmetries in the efforts to sterilize the monetary effects of exchange market intervention or asymmetries in the dynamics of domestic prices, increases in capital mobility will exert inflationary pressures.

Islam and Financial Intermediationingo karsten (pages 108–42)

This paper describes a number of steps that have been taken toward the Islamization of the financial system in Moslem countries; reviews some of the practical issues that have to be resolved; and analyzes the implications for savings, investment, and the development process. Particular attention is paid to the Pakistani model.

The main focus of the paper is on the abolition of Riba—the payment of fixed interest. Consideration is given to the social reasons for the abolition of Riba and the alternative forms of financial return, such as profit-and-loss sharing (PLS), that are consistent with Islamic injunctions. A description is provided of the new financial instruments that have been developed in Pakistan and the problems that arise in converting various banking sector assets and liabilities to a PLS basis.

In analyzing the implications of shifting the basis of banking sector operations to PLS, the paper notes the important distinction between a system in which profit-and-loss-sharing operations are optional and one in which all banking sector transactions are on this basis. Possible advantages of increased availability of profit-and-loss-sharing operations are, under certain circumstances, greater protection of ex post real rates of return against the effects of unexpected changes in the rate of inflation; greater de facto rate flexibility in circumstances where nominal yields are “sticky”; greater involvement of financial intermediaries in the financial performance of borrowers; and the attractiveness of new financial instruments to savers who have religious inhibitions concerning conventional interest-bearing assets.

Problems that have yet to be resolved include how to attribute the profits and losses of borrowers to individual sources of borrowed funds (particularly of short-term loans) and how to ensure that the uncertainties implicit in a PLS system do not undermine savings incentives.


La dynamique des taux de change et l’hypothèse du sur ajustementjacob a. frenkel et carlos a. rodriguez (pages 1–30)

La présente étude analyse les déterminants de l’évolution des taux de change dans le cadre de nouveaux modèles de la dynamique des taux de change. L’hypothèse du surajustement est examinée dans des modèles qui mettent l’accent sur les vitesses d’adaptation différentes observées pour les marchés des biens et les marchés des actifs financiers ainsi que dans des modèles qui font appel à des considérations relatives à l’équilibre de protefeuille. Il est montré que le surajustement du taux de change n’est pas une caractéristique intrinsèque du marché des devises et qu’il dépend d’une série d’hypothèses spécifiques. Il ressort aussi que le surajustement n’est pas une caractéristique de l’hypothèse de la prévision parfaite et ne dépend généralement pas de l’hypothèse selon laquelle l’ajustement des marchés des biens et celui des marchés des actifs financiers se font à des vitesses différentes. Tant que les vitesses d’ajustement des différents marchés sont inférieures à l’infini, le facteur clé qui détermine les effets dans le court terme d’une expansion monétaire est le degré de mobilité des capitaux. Lorsque les capitaux sont extrêmement mobiles, il se produit un surajustement du taux de change par rapport à sa valeur à long terme et lorsque les capitaux sont relativement peu mobiles, il se produit un ajustement insuffisant du taux de change par rapport à sa valeur à long terme. Dans le cadre du modèle d’équilibre de portefeuille, on constate que les effets d’une expansion monétaire sur la dynamique des taux de change et en particulier sur la possibilité d’un surajustement ou d’un ajustement insuffisant des taux de change par rapport à leur niveau d’équilibre, dépendent essentiellement de la spécification du choix de l’actif financier, du degré de substitution qui existe entre les actifs et de la qualité des différents actifs en tant que protection contre l’inflation. En particulier, lorsque les biens faisant l’objet d’échanges internationaux offrent une meilleure protection contre l’inflation que les biens non échangés, il se produit un surajustement du taux de change nominal par rapport au niveau des prix intérieurs et inversement.

Conséquences de la fixation d’objectifs monétaires sur les taux d’intérêtwarren l. coats, jr. (pages 31–47)

La présente étude examine les implications que peut avoir la fixation d’objectifs monétaires quantitatifs sur le comportement des taux d’intérêt compte tenu des conditions économiques et politiques extrêmement différentes qui existent d’un pays à l’autre. Ce comportement dépend de la situation économique dans laquelle se trouve le pays lorsque les autorités appliquent leur politique. La poursuite simultanée d’objectifs en matière de taux d’intérêt et d’objectifs monétaires (seulement au moyen de la politique monétaire) n’est généralement pas possible, excepté de façon limitée, même dans les économies les plus isolées et financièrement peu développées. C’est pourquoi, le problème majeur que pose pour les taux d’intérêt la fixation d’objectifs monétaires dans les pays pourvus de marchés financiers développés est l’incidence de ces objectifs sur la stabilité des taux d’intérêt. L’examen des relations fondamentales entre l’évolution des agrégats monétaires et le comportement des taux d’intérêt entrepris dans le souci d’évaluer l’ampleur des effets de la fixation d’objectifs monétaires sur la stabilité des taux d’intérêt, fait apparaître plusieurs lacunes dans les travaux consacrés à ce sujet. Si l’on tient compte de ces lacunes (ou si l’on y remédie), les assertions initiales selon lesquelles les taux d’intérêt seraient “nettement” plus instables, se trouvent “fortement” atténuées. L’étude conclut que si les objectifs monétaires peuvent quelque peu accroître l’instabilité des taux d’intérêt, cet accroissement devrait être faible.

Politiques de taux d’intérêt dans les pays de l’Afrique de l’Ouestsergio pereira leite (pages 48–76)

La formulation et l’application des politiques de taux d’intérêt revêtent une importance capitale dans les pays les moins développés en raison de leurs répercussions sur l’incitation à l’épargne, la répartition des ressources et le contrôle des pressions inflationnistes. La question cruciale est donc: comment faire pour que les politiques de taux d’intérêt soient réalistes dans les pays les moins développés, où les imperfections du marché et les structures bancaires oli-gopolistiques ont une incidence prédominante. Il faut reconnaître que, dans de telles conditions, il n’est pas pratique de laisser les forces du marché déterminer les taux d’intérêt et qu’une intervention de l’Etat, sous une forme ou une autre, est inévitable. Toutefois, il importe que cette intervention ait pour effet d’atténuer les distorsions et non de les accentuer. Il semble donc essentiel d’établir un ensemble de critères que les autorités pourront utiliser pour déterminer le niveau et la structure des taux d’intérêt dans les pays les moins développés. L’auteur propose quatre critères principaux sur lesquels les autorités peuvent s’appuyer pour déterminer les taux d’intérêt adéquats. Ce sont: a) les taux d’intérêt réels positifs; b) les taux d’intérêt mondiaux, corrigés pour tenir compte des anticipations relatives au taux de change; c) les taux de rentabilité des investissements; et d) l’écart entre les taux emprunteurs et les taux prêteurs. Toutefois, l’importance de ces critères peut varier légèrement d’un pays à l’autre et le poids qu’il convient d’attribuer à chacun d’eux est une question de jugement. L’auteur souligne, en outre, l’importance que revêtent la politique budgétaire de l’administration centrale et la politique d’investissement du sectuer public. Il examine la structure des taux d’intérêt dans dix pays d’Afrique de l’Ouest qu’il a choisis en raison de la diversité de leur cadre institutionnel et de leur politique générale, et compte tenu des considérations d’ordre analytique mentionnées ci-dessus.

Evaluation du potentiel inflationniste des marchés financiers extérieursd.f.i. folkerts-landau (pages 77–107)

Dans la présente étude, l’auteur fait valoir que ni les modèles antérieurs d’équilibre temporaire à coefficient fixe du type Phillips, ni les récents modèles d’équilibre du portefeuille du type Tobin, élaborés dans le cadre de l’analyse du mécanisme de l’offre de monnaie, n’appréhendent la création potentielle de monnaie et de crédit par les marchés financiers extérieurs. N’offrant qu’un équilibre partiel, les deux types de modèles se bornent à analyser les effets exercés sur les agrégats de la monnaie et du crédit quand des dépôts intérieurs sont transférés à l’étranger à un intermédiaire bancaire. Ils n’expliquent donc pays le rythme auquel les dépôts sont transférés ou le volume de ces transferts.

On peut montrer que le multiplicateur de monnaie externe est inférieur à l’unité, mais il n’est pas possible d’établir des limites quantitatives analogues pour le rythme auquel les dépôts sont transférés vers les marchés financiers extérieurs. Les innovations dans le domaine de la technologie des transactions financières extérieures, les facilités élargies de prêteur en dernier ressort et une meilleure définition des responsabilités juridiques des banques nationales à l’égard de leurs filiales à l’étranger ont réduit le coût des transactions et du risque en ce qui concerne les engagements à vue émis a l’étranger. L’auter présente les grandes lignes d’un modèle d’équilibre général des marchés financiers internationaux dans le cadre duquel on peut analyser cette évolution.

La contribution à l’inflation intérieure de l’accroissement des engagements à l’étranger des intermédiaires financiers est déterminée par la croissance de la fraction de leurs engagements monétaires qui peut être facilement substituée aux engagements monétaires des intermédiaires intérieurs et qui est utilisée dans les transactions intérieures. L’auteur établit quelques estimations chiffrées pour les Etats-Unis. Il évalue ensuite le potentiel inflationniste indirect des marchés financiers extérieurs, qui résulte du fait que l’expansion des marchés extérieurs peut accroître le caractère inflationniste de certains types de politique monétaire. Il est devenu notamment beaucoup plus difficile de définir et de calculer les agrégats pertinents de la monnaie et du crédit. L’accroissement de la mobilité des capitaux internationaux ainsi que la possibilité de substituer des actifs libellés en différentes monnaies peuvent être traduits par une intervention plus massive sur les marchés des changes ou une plus grande variabilité des taux de change.

L’Islam et l’intermédiation financièreingo karsten (pages 108–42)

Dans la présente étude, l’auteur décrit un certain nombre de dispositions qui ont été prises et qui ont pour objet d’islamiser le système financier dans les pays musulmans; il examine en outre certains problèmes d’ordre pratique qu’il faudra résoudre et analyse les conséquences que ce mouvement entraîne pour l’épargne, l’investissement et le processus de développement. Pour illustrer ses observations, l’auteur s’appuie tout particulièrement sur le modèle pakistanais.

L’étude porte principalement sur l’abolition du Riba—paiement d’un intérêt fixe. Elle expose les raisons qui, du point de vue social, justifient la suppression de ce système et examine d’autres formes de rendement financier—le partage des profits et pertes, par exemple—compatibles avec les exigences de la morale islamique. L’auteur décrit les nouveaux instruments financiers qui ont été mis au point au Pakistan, et les problèmes que pose l’adaptation des divers éléments de l’actif et du passif des banques au système du partage des profits et pertes.

Dans son analyse des conséquences qu’entraîne l’adaptation des opérations bancaires au système du partage des profits et pertes, l’auteur fait ressortir l’importante distinction qui existe entre un système dans lequel les opérations sous forme de partage des profits et pertes sont facultatives et un système dans lequel toutes les opérations bancaires s’effectuent sur la base de ce partage. Dans certaines conditions, l’extension des opérations sous forme de partage des profits et pertes peut présenter des avantages: elle peut accroître la protection du taux de rendement réel ex post contre les effets de variations imprévues du taux d’inflation, accroître le degré de souplesse effective des taux lorsque les rendements nominaux sont “rigides”, intensifier le rôle des intermédiaires financiers dan l’activité financière des emprunteurs, enfin, doter les nouveaux instruments financiers d’un attrait spécial aux yeux des épargnants qui, par scrupules religieux, renoncent à acquérir des actifs traditionnels rémunérés.

Certains problèmes inhérents au système du partage n’ont pas encore été résolus; il faudra notamment déterminer de quelle façon doit s’effectuer la répartition des profits et pertes des emprunteurs entre les divers bailleurs de fonds (en particulier les fonds à court terme) et quels moyens il convient d’adopter pour veiller à ce que les incertitudes implicitement liées à un système de partage des profits et pertes ne détournent pas les sujets économiques de l’épargne.


La dinámica de los tipos de cambio y la hipótesis del ajuste excesivojacob a. frenkel y carlos a. rodriguez (páginas 1–30)

En este trabajo se analizan los factores determinantes de la evolución de los tipos de cambio dentro del contexto de diferentes modelos de dinámica del tipo de cambio. Se examina la hipótesis del ajuste excesivo en modelos que hacen hincapié en las diferencias en la velocidad de ajuste en los mercados de activos financieros y de bienes, y en modelos que atribuyen gran importancia a los aspectos del equilibrio de cartera. Se demuestra que el ajuste excesivo del tipo de cambio no es una característica intrínseca del mercado de divisas y que depende de una serie de supuestos específicos. También se demuestra que el ajuste excesivo no es una característica del supuesto de previsión perfecta, y que no depende en general del supuesto de que en los mercados de bienes y de activos financieros la oferta y la demanda se equilibran a velocidades diferentes. Mientras las velocidades de ajuste de los diferentes mercados sean inferiores a infinito, el factor clave que determina los efectos a corto plazo de una expansión monetaria es el grado de movilidad del capital. Cuando el capital tiene mucha movilidad, el tipo de cambio sobrepasa su valor a largo plazo, y cuando el capital se mantiene relativamente inmóvil, el tipo de cambio no alcanza dicho valor. Dentro del contexto del modelo de equilibrio de cartera, se demuestra que los efectos de una expansión monetaria en la dinámica de los tipos de cambio y, en particular, en la posibilidad de que los tipos de cambio sobrepasen o no alcancen su línea de equilibrio, dependen crucialmente de cómo se especifique la elección de activos, del grado de sustitución entre los activos y de la calidad de los diferentes activos en cuanto protección contra la inflación. En particular, cuando los bienes que son objeto de comercio internacional constituyen una mejor protección contra la inflación que los bienes que no lo son, el tipo de cambio nominal sobrepasa el nivel de los precios internos, y viceversa.

Efecto de las metas monetarias en los tipos de interéswarren l. coats, jr. (páginas 31–47)

En este estudio se analiza la repercusión de la fijación de metas monetarias en el comportamiento de los tipos de interés dentro de la gran variedad de contextos económicos y políticos de los diversos países. Dicho comportamiento depende del marco económico en al cual se aplican las medidas monetarias. En general, aun en las economías más aisladas y financieramente subdesarrolladas, no es posible fijar simultáneamente metas para los tipos de interés y la oferta monetaria (valiéndose únicamente de la política monetaria). Por esta razón el principal problema de los tipos de interés vinculado con las metas monetarias en los países que cuentan con un mercado financiero desarrollado es la repercusión de dichas metas en lo que se refiere a la volatilidad de los tipos de interés. Al examinar la relación fundamental que vincula el comportamiento monetario con el de los tipos de interés en un esfuerzo por evaluar la magnitud de la repercusión de la fijación de metas monetarias en la volatilidad de los tipos de interés, se hacen notar varias deficiencias de los estudios existentes. Al tener en cuenta (o corregir) estas deficiencias, la conclusión tradicional de que los tipos de interés serían “mucho” más volátiles se ve “notablemente” atenuada. Finalmente, se concluye an el estudio que, si bien es posible que las metas monetarias aumenten en cierta medida la volatilidad de los tipos de interés, este aumento sería moderado.

Las políticas de tipos de interés en los países de Africa occidentalsergio pereira leite (páginas 48–76)

La formulación y puesta en práctica de las políticas de tipos de interés son sumamente importantes en los países en desarrollo, desde el punto de vista del fomento del ahorro, la asignación de recursos y el control de las presiones inflacionarias. El aspecto fundamental es cómo establecer políticas realistas de tipos de interés en los países en desarrollo, en los cuales existen imperfecciones en los mercados y estructuras bancarias oligopolistas. Se reconoce que, en esas circunstancias, no es práctico dejar la determinación de los tipos de interés a las fuerzas del mercado y que la intervención estatal—de una u otra forma—es inevitable. No obstante, es importante que esa intervención atuenúe las distorsiones y no las acentúe. Por esta razón, parece indispensable establecer un conjunto de criterios que las autoridades de los países en desarrollo puedan aplicar para determinar el nivel y la estructura de los tipos de interés. Se sugieren, como orientación general, cuatro criterios principales para determinar los tipos de interés adecuados: a) tipos de interés reales positivos; b) tipos de interés mundiales corregidos para tener en cuenta las expectativas en cuanto al tipo de cambio; c) tasas de rentabilidad de la inversión y d) la diferencia entre los tipos de interés aplicables a los préstamos obtenidos y a los concedidos. Sin embargo, la importancia de estos criterios puede variar de un país a otro y la importancia relativa que se asigne a cada uno es subjetiva. También se señala la importancia del presupuesto del gobierno central y la política de inversión del sector público. Se examina la estructura de los tipos de interés de diez países de Africa occidental—seleccionados en función de sus diferentes marcos institucionales y de política—teniendo presentes las consideraciones analíticas antes mencionadas.

Potencial de los mercados financieros externos para la creación de dinero, crédito e inflaciónd.f.i. folkerts-landau (páginas 77–107)

En este trabajo se aduce que ni los modelos anteriores tipo Phillips de coeficiente fijo o de equilibrio temporal ni los modelos más recientes tipo Tobin de equilibrio de cartera del proceso de la oferta monetaria captan el potencial de los mercados financieros externos en lo que respecta a crear dinero y crédito. La condición de equilibrio parcial limita ambos tipos de modelo a un análisis de los efectos que la transferencia exógena de depósitos internos a un intermediario bancario externo produce en los agregados monetarios y crediticios. Por consiguiente, lo que se ha escrito en este sentido no da ninguna idea de la determinación del ritmo a que se transfieren los depósitos o del volumen de los mismos.

Si bien se puede demostrar que el multiplicador externo del dinero es inferior a la unidad, no es posible calcular límites cuantitativos semejantes del ritmo a que los depósitos se desplazan hacia los mercados financieros externos. Con las innovaciones tecnológicas en las transacciones financieras externas, la ampliación de los servicios de prestamista de última instancia y una definición jurídica más precisa de las responsabilidades de los bancos internos ante las sucursales en el exterior se han reducido el costo y el riesgo de las transacciones relacionadas con obligaciones por depósitos emitidas en el exterior. Se esboza un modelo de equilibrio general en el cual los mercados financieros internacionales están en equilibrio y se pueden analizar estas cuestiones.

La medida en que el aumento de las obligaciones de los intermediarios externos que reciben depósitos contribuye a la inflación interna de precios viene determinada por el aumento de la proporción de sus pasivos monetarios que puede sustituir fácilmente a los pasivos monetarios de los intermediarios internos y ser utilizada en transacciones internas. Se obtienen algunas estimaciones numéricas correspondientes a Estados Unidos. Luego se evalúa el potencial inflacionario indirecto de los mercados financieros externos, que tiene su origen en la posibilidad de que, con la expansión de los mercados externos, algunos tipos de política monetaria resulten más inflacionarios. En particular, se ha tornado mucho más difícil definir y medir los agregados monetarios y crediticios pertinentes. Es posible que la mayor movilidad de los capitales internacionales y la posibilidad de sustitución entre activos denominados en monedas distintas hayan causado una mayor intervención en los mercados de divisas o un aumento de la variabilidad de los tipos de cambio. Se exiten asimetrías en los esfuerzos por neutralizar los efectos monetarios de la intervención en los mercados de divisas, o asimetrías en la dinámica de los precios internos, el aumento de la movilidad del capital ejercerá presiones inflacionarias.

Islamiso e intermediación financieraingo karsten (páginas 108–42)

En este artículo se describen varias medidas que se han tomado para islamizar el sistema financiero en los países musulmanes, se examinan algunas cuestiones prácticas que hay que resolver y se analizan las repercusiones de todo esto en el ahorro, la inversión y el proceso de desarrollo. Se señala especialmente el caso de Pakistán.

El estudio se centra principalmente en la eliminación del pago de intereses fijos, denominados riba en árabe. Se examinan las razones sociales que justifican la eliminación de los riba y otras formas de rentabilidad financiera, como por ejemplo las utilidades y pérdidas compartidas, que están en consonancia con los preceptos del islamismo. Se describen los nuevos instrumentos financieros que ha creado Pakistán y los problemas que se presentan al couvertir diversos activos y pasivos del sector bancario al sistema de ganancias y pérdidas compartidas.

Al analizar las repercusiones de la transición de las operaciones bancarias al sistema de ganancias y pérdidas compartidas, en este trabajo el autor señala la importante diferencia entre un sistema en que las operaciones del tipo de ganancias y pérdidas compartidas son facultativas y un sistema en que todas las transacciones del sector bancario se efectúen de este modo. Entre las posibles ventajas de la ampliación de la gama de operaciones del tipo de ganancias y pérdidas compartidas se cuentan, en ciertas circunstancias, la mayor protección de las tasas de rentabilidad real ex post contra variaciones inesperadas de la tasa de inflación; una mayor flexibilidad de facto del interés cuando los tipos nominales “no reaccionan” fácilmente; mayor interés de los intermediarios financieros por los resultados financieros que obtengan los prestatarios y las ventajas que tendrían los nuevos instrumentos financieros para los ahorradores que se sientan restringidos por su religión en lo que respecta a los activos tradicionales que devengan intereses.

Entre los problemas que quedan por resolver se cuentan el de la forma de distribuir las ganancias y pérdidas de los prestatarios entre las distintas fuentes de fondos obtenidos en préstamo (especialmente en el caso de los préstamos a corto plazo) y el de la forma de impedir que la incertidumbre inherente al sistema de ganancias y pérdidas compartidas menoscabe el incentivo al ahorro.

In statistical matter (except in the résumés and resúmenes) throughout this issue,

Dots (…) indicate that data are not available;

A dash (—) indicates that the figure is zero or less than half the final digit shown, or that the item does not exist;

A single dot (.) indicates decimals;

A comma (,) separates thousands and millions;

“Billion” means a thousand million;

A short dash (—) is used between years or months (e.g., 1977–79 or January–October) to indicate a total of the years or months inclusive of the beginning and ending years or months;

A stroke (/) is used between years (e.g., 1978/79) to indicate a fiscal year or a crop year;

Components of tables may not add to totals shown because of rounding.

International Monetary Fund, Washington, D.C. 20431 U.S.A.

Telephone number: 202 477 7000

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Adjustment and Financing in the Developing World: The Role of the International Monetary Fund

edited by Tony Killick

The following eight papers were presented at a seminar jointly arranged by the International Monetary Fund and the Overseas Development Institute that was held in Croydon, England in October 1981:

An Overview by Tony Killick and Mary Sutton

Disequilibria, Financing, and Adjustment in Developing Countries by Tony Killick and Mary Sutton

Economic Management and International Monetary Fund Conditionality by Manuel Guitián

Alternative Approaches to Short-Term Economic Management in Developing Countries by Daniel M. Schydlowsky

Roles of the Euromarket and the International Monetary Fund in Financing Developing Countries by Richard O’Brien

Some Issues and Questions Regarding Debt of Developing Countries by Bahram Nowzad

The Position and Prospects of the International Monetary System in Historical Context by Brian Tew

Developing Country Interests in Proposals for International Monetary Reform by Graham Bird

Pp. xviii + 232

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