Transcript MONETARY POLICY IN ISLAMIC FRAMEWORK

Central Bank,
Monetary Control and
Monetary Policy in
Islamic Framework
Ausaf Ahmad
Preliminary Observations
 Monetary Policy is a catch all name for monetary
management, monetary control, regulation of
commercial of commercial banks, and management of
money market.
 Is multiple deposit creation possible under Islamic
banking?
 Power of deposit creation is not with a single bank. It is
with the banking system
 Power of deposit creation is because of fractional
reserve. With 100 percent Reserve Requirement, all
money is representative money and no further deposits
are created.
CENTRAL BANK IN
ISLAMIC ECONOMICS
 Functions of central bank in Islamic economy are
similar to any modern economy
 Regulation of money supply according to
requirements of the economy
 Influencing the movement and direction of bank
finance in desirable directions
 Providing a measure of safety and ensuring
prudent banking
ISLAMIC BANKS AND
CREDIT CREATION
 Controversy: Do Islamic banks create credit?
 Deposit creation through Mudarabah
 The Deposits never leave the banking system. It
comes back to the system through deposit in
another bank.
 Role of Fractional Reserve System
OBJECTIVES OF MONETARY
POLICY IN AN ISLAMIC
ECONOMY
 To Promote a sustained and balanced economic
growth and mobilize resources for economic
development.
 To maintain stability in the value of money so as to
avoid excessive periodic fluctuations.
 To maintain stability in the external value of money.
 To promote an equitable distribution of income and
wealth.
INSTRUMENTS OF
MONETARY CONTROL
 Quantitative Measures
 Qualitative Measures
 Prudential Measures
Quantitative Measures
 Legal Reserve Ratio
 Bank Rate Policy
 Open Market Operations
 Credit Rationing
QUALITATIVE MEASURES
 Margin Requirements
 Maximum and Minimum rates of interests
 Selective Credit Controls
PRUDENTIAL MEASURES
 Minimum Capital Requirements
 Maximum Exposure restrictions
 Mandatory Appropriation of Profits
 Moral suasion
Suitability of conventional
Measures
Method of Credit Control
Suitability to Islamic
economy
1. Legal Reserve Ratio
Suitable
2. Bank Rate Policy
Unsuitable
3.Open Market Operations
Modification Necessary
4. Credit Ceilings
Suitable
5. Selective Credit Control
Suitable
6. Lender of Last resort
Modification Necessary
7. Issue of Directives
Suitable
8. Moral Suasion
Suitable
Instruments of Monetary
Policy in Islamic Economy
Conventional
Instruments
New Instruments
1.Profit Sharing Ratio
Suitable
Unsuitable
Bank Rate
Policy
Legal Reserve Ratio, Credit
Rationing, Selective Credit
Controls, Issue of Directive, Moral
Suasion
2. Refinance Ratio
3.Public share of demand
deposits
4. Value Oriented Allocation
of Credit.
5.Qard Hasan Ratio
LEGAL RESERVE RATIO
 Required Reserve Ratio does not involve interest in
any manner.
 Controversy: Fractional reserve system Vs.100%
required reserve
 Application of cash reserve system only to
investment deposits
OPEN MARKET
OPERATIONS
 Open market Operations are based on interest.
 Direct manipulation of interest rates and indirect
manipulation of money supply
 Modification necessary
 Should the central bank be allowed to buy and sell
equity of companies?
 Mudarahah/ Musharakah/ Certificates
BANK RATE POLICY
 The bank rate policy refers to interest rate which
the central bank charges to commercial banks to
lend money. Through changes in bank rate, the
central bank indirectly changes the quantum of
credit in the economy.
 Unsuitable for the Islamic Central Bank.
CREDIT RATIONING
 More popular techniques in developing countries
because financial infrastructure is not fully
developed.
 A credit ceiling is allotted to each sector and to
each bank
 Because of its non interest nature, suitable for
controlling Islamic banks.
 Issue of Penalty
SELECTIVE CREDIT
CONTROL
 Quantitative measures control volume of credit,
SCC control direction of credit.
 May be more relevant in developing countries.
 Matching finance if bank finance projects in the
desirable sectors.
 Either as an interest free loan or at a lower profit
sharing ratio.
LENDER OF LAST RESORT
 Loans are provided to face liquidity crises.
 In Islamic economy, central banks would continue
to function as Lender of Last Resort.
 Interest free loans with or without service charge.
 Special Fund at the Central Bank.
 The case of International Bank for Investment and
Development in Cairo.
ISSUE OF DIRECTIVES
 In the conventional system, this is used to regulate
interest rates and channel credit in the desired
direction.
 In the Islamic system, the same directives may be
used to influence profit sharing ratios.
 The central bank may prescribe ranges for profit
sharing ratios for Mudarabah contacts and for
mark up in the case of Murabaha contracts.
MORAL SUASION
 Informal contacts, consultations, meetings, to
explain position of central bank on various issues.
 The technique remains available in the interest free
system. Some economists are of the opinion that
this technique may have to play greater role in the
new system.
INTEREST FREE
INSTRUMENTS OF
MONETARY POLICY
 Profit sharing ratio
 Refinance ratio
 Public share of demand deposits
 Value oriented allocation of credit
 Qard hasan ratio
 Maximum and minimum mark up ratio.
PROFIT SHARING RATIO
 Potentially it may perform the same role as interest
rate as it may work as a signaling device.
 Depositors’ and borrowers’ profit sharing ratio’
 Management of first may influence supply of
money and of the latter may affect demand for
money.
RE FINANCE RATIO AND
LENDING RATIO
 Re-finance ratio would move in the opposite
direction of cash reserve ratio.
 To reduce expansion of credit, refinance ratio
would be lowered, to increase supply of credit, it
would be raised.
 Appropriate changes in lending ratios would
reinforce the impact
PUBLIC SHARE OF
DEMAND DEPOSITS
 It is suggested that 25% of total demand deposits
may be diverted to public treasury. It is argued
that:
 Commercial banks do not pay any thing for these
deposits and public does not bear any risk on
these deposits if they are fully insured.
 The share may vary in accordance with the
economic conditions and objectives of economic
policy.
CRITIQUE
 It may encourage the governments to spend more.
 It may reduce Monetary Base (high powered
money) and hence indirectly reduce credit creation.
 Lacks swiftness of response.
 The proposal appears to be in conflict with the
Islamic concept of property.
CONCLUSION
Any fear of chaos in monetary management on account
of Islamic banking is not well founded. There are
enough tools in the battery of central bank to control
commercial banking activity and achieve the goals of
economic policy.
THANK YOU FOR YOUR
PATIENCE