Mohsin Khan’s recent article (1986) on Islamic banking notes various trends in this respect and provides a valuable list of references. His main purpose, however, was to provide a “theoretical analysis.” This is indeed a much-welcomed contribution and should appeal to anyone researching the possibilities for similar nontraditional financial systems, such as the 100 percent money proposal of Simons (1934) and Fisher (1945), Khan alludes to this application when he notes that “Islamic banking is really a particular variant of equity-participation systems” (Khan (1986, p. 7)). The fact that some countries are actually using the Islamic system does provide us all with valuable experimental information.

Abstract

Mohsin Khan’s recent article (1986) on Islamic banking notes various trends in this respect and provides a valuable list of references. His main purpose, however, was to provide a “theoretical analysis.” This is indeed a much-welcomed contribution and should appeal to anyone researching the possibilities for similar nontraditional financial systems, such as the 100 percent money proposal of Simons (1934) and Fisher (1945), Khan alludes to this application when he notes that “Islamic banking is really a particular variant of equity-participation systems” (Khan (1986, p. 7)). The fact that some countries are actually using the Islamic system does provide us all with valuable experimental information.

Mohsin Khan’s recent article (1986) on Islamic banking notes various trends in this respect and provides a valuable list of references. His main purpose, however, was to provide a “theoretical analysis.” This is indeed a much-welcomed contribution and should appeal to anyone researching the possibilities for similar nontraditional financial systems, such as the 100 percent money proposal of Simons (1934) and Fisher (1945), Khan alludes to this application when he notes that “Islamic banking is really a particular variant of equity-participation systems” (Khan (1986, p. 7)). The fact that some countries are actually using the Islamic system does provide us all with valuable experimental information.

There are two major questions I would like to raise about Khan’s article. Should he have chosen a different model to contrast the Islamic and traditional banking systems? Should he have tried to contrast these alternative systems in more ways that just that of economic stability?

Khan assumes that the banking system is solely carrying on a saving-investment operation and that all money is “outside money” (pp. 10–11). Although this does help with simplifying his analysis, there are certain difficulties. Would it not have been better to have assumed much the opposite, that the private banking system is responsible for creating most, if not all, the money in the system, and that it holds a mixture of demand and savings deposits? Surely this is more the situation we have in North America. A model that incorporated such assumptions and that could also be reformulated along the lines advocated by the 100 percent money school would probably have been more appropriate.

It certainly would have helped the reader when it comes to understanding Khan’s discussion about two windows for deposit transactions (pp. 20–21). It appears that the model used is too rigid and does not really permit as full an analysis of the matter as one would like.

The use of a more appropriate model may also have permitted at least some discussion of other issues of concern to economists such as Simons and Fisher. It would help to show how the move toward a 100 percent reserve plan could help to reduce government debt and taxes. It also might explain how industrial concentration might be reduced, especially if this is considered a problem. Finally, it might throw some light on questions of a political nature.

In a recent paper (Doak (1988)) I have constructed a simple model that attempts to deal with some of the concerns mentioned above. The model assumes that private bank deposits, D, constitute the only type of money in circulation, that the central bank can control the growth of money supply through its purchases of government debt, C, and that the simple money-multiplier rule applies; that is,

D=C/r

where r is the private banks’ required and actual cash reserve ratio. A number of theorems can be derived from this model. The most significant finding, however, is that of an objective measure of usury, U:

U=[(i)(1X)(GT)]+{(i)[XrXr(1X)](GT)r},

where i is the loan rate of interest, X is the percent of public debt purchased annually by the central bank, and G – T is the amount of annual borrowing by government to cover its deficit. The usury is of two major types: the usury on public debt, which can be eliminated by making X = 1 = 100 percent, and the usury on private debts, which can be eliminated by making r = 1 = 100 percent. The possibilities for increased transfer payments and lower taxes can also be demonstrated.

The principles of Islamic banking and the Simons-Fisher 100 percent money school seem to share the view that private banks should not have the power to create money, that money creation should be a power reserved for the government or its central bank. North American principles are obviously in conflict with these ideas, which may suggest or explain why the relative burdens of interest payments, taxes, and debts are excessive. To the extent that any government can wisely use the power of money creation to pay for its expenses, taxes could be reduced and the private sector freed from having to incur unnecessary debts.

Khan begins his article by referring to the “general resurgence of fundamental Islamic values in many parts of the world” and by describing how some countries are transforming their economic systems “to accord more closely with the precepts and conditions of Islam” (p. 1). It would have been valuable had Khan’s model been such as to demonstrate more of the benefits of such a transformation of the banking system.

These comments notwithstanding, Khan’s article was valuable, and it is to be hoped that he and other Fund staff will continue to pursue the subject, including the questions raised here.

References

  • Doak, Ervin John, “Interest and Usury,” paper presented at the Twenty-Fifth International Atlantic Economic Conference, London, April 20, 1988 (unpublished; Halifax, Nova Scotia, Canada: St. Mary’s University, 1988).

    • Search Google Scholar
    • Export Citation
  • Fisher, Irving, 100% Money (New Haven, Connecticut: City Printing, 1945).

  • Khan, Mohsin S., “Islamic Interest-Free Banking,” Staff Papers, International Monetary Fund (Washington), Vol. 33 (March 1986), pp. 1- 27.

    • Search Google Scholar
    • Export Citation
  • Simons, Henry C., A Positive Program for Laissez-Faire (Chicago: University of Chicago Press, 1934).

*

Mr. Doak is an Associate Professor of Economics at Saint Mary’s University in Halifax, Nova Scotia, Canada.