Shari`ah perspective of money creation in Islamic Banking : a proposal for an alternative model

Abstract

Islamic banking provides banking products and services based on Shari’ah rules and principles. The critical role played by Islamic banking has been discussed because of the gradual expansion and growth of this sector. The resilience of Islamic banking during the global financial crisis in 2007 also attracted considerable attention to the role it can play in the global economy. Islamic banking has significant economic and social influence, particularly in Muslim societies seeking Shari’ah based banking activities. Therefore, this study investigates the position of Islamic banking towards the issue of money creation and discusses it from Maqasid al-Shari’ah, Akhlaq and Fiqh viewpoints. These noble objectives are achieved through the analysis of library sources and by developing a viable model for Islamic banking to overcome the issue of money creation, especially in Islamic banking. With a view to meet this objective, a qualitative semi-structured interview method is adopted. The findings of this study demonstrate that Islamic banks create money due to the adoption of the conventional banking system that is based on the fractional reserve system. This goes against the main objectives of the Shari’ah such as preservation of people’s wealth since this created money would decrease the value of people’s wealth due to inflation and encourage banking default and financial crisis. Due to these negative impacts of money creation in Islamic banking, from an Akhlaq viewpoint, it is contrary to the Shari’ah that seeks to ensure the justice of wealth distribution and not to burden people with additional debt. Similarly, Fiqh views the money creation in Islamic banking as unlawful due to evidence from the Quran, Sunnah and Shari’ah scholars. One evidence is that gaining profit from money creation promotes fraudulence and deceit prohibited by Allah “Woe to the fraudulent” (Al-Mutaffeen 83: 1). Consequently, this study develops a viable model that prevents Islamic banking from creating money and its implications. It differs from current and saving accounts whereby the current account must be 100% fractional reserve to prevent banks from creating money. The saving account will become similar to an investment account that Islamic banks can use for financing and expansion in the form of partnership or agency concepts. Due to the nature of investment account, the deposit would not be guaranteed, meaning that there is no need for fractional reserve. Therefore, the Islamic banking will not be able to create money, and the return from the depositors’ money is shared between the Islamic bank and the depositors. These findings are expected to contribute significantly to Islamic banking.