26 - May 2, 2010

Jinnah University for Women carries the distinction of being the first women-only University of Pakistan. It was established in 1998 by an Act passed by the Sindh Provincial Assembly. It is one of a number of educational institutions established through the zeal and life-long dedication of legendry (late) Alhaj Rayazuddin Ahmed.

Recently, a seminar on conventional versus Islamic banking was held at Jinnah University for Women.

Hosts of the seminar were Professor Syed Rasheed Ahmed Zaedi, Dean and Chairperson Faculty Business Administration and his team of learned faculty members and highly energetic students.

A few names that my weak memory allowed me to retain are Kiran and Nudrat Waheed from faculty; Roshan Ayesha and Anum from students side. Co-speaker in the seminar was Dr Mujeeb Baig, a prominent scholar of Islamic Finance and a leading practicing Islamic banker. Since, owing to his preoccupation, Dr Mujeeb joined us late, I was the first to do my part of job that is to apprise the audience comprising students and faculty of my views on conventional banking. The following is the summarized version of my talk.

We are living in the age of man and money degradation. The factors responsible for this condition are:

1. Fiat money system
2. Interest based economy
3. Banks' unbridled power to create credit money
4. Expansionary and inflationary nature of world economic model

Fiat money system allows a simple piece of paper printed by the government to assume huge economic value without any intrinsic value. The 1945 Britton Woods system pegged the value of US dollar at $35 to an ounce of gold. Other world currencies were pegged to the US$. World central banks were entitled, and the US Federal Reserve was bound to convert their stock of dollars accumulated as a result of foreign trade into gold. The uncontrolled expansion of dollar resulting from an irrational urge to control world economy put the US in a tight corner when claims for conversion to gold started rising worldwide. Encouraged by its formidable military strength, US unashamedly took the unilateral decision of abolishing the convertibility of dollar to gold in 1971. That was a bizarre economic decision that pushed the entire world economy into the grip of perennial inflation. Pakistan rupee had to undergo a massive devaluation of 131 per cent. The economies were now free to print as much money as they liked without any gold or any other precious metal backing. The interest based economy and the fiat money system work in unison to fuel inflation. An interest charge adds to the cost of doing business and since interest has to be paid each year, the prices of goods and services keep on rising ad infinitum.

Besides governments' prerogative to throw as much fiat money into the economy as it may wish, the bank's unbridled power to create credit money adds another dimension to the inflationary economic model.

Presently our total bank deposits stand at Rs4.4 trillion against the total issued currency of Rs1.4 trillion. The corridor between the total real money - issued currency and total bank deposits is represented by the credit money created by the banking system. The conventional banking relies on its core business of accepting customer deposits and lending money to the three main sectors of economy namely corporations, small and medium enterprises (SMEs) and consumers. It raises credit money by allowing loans to these sectors from the money it holds in the shape of customer deposits. The money so allowed as loans ultimately comes back to the banking system in the shape of deposits of some other individual or business entity. The total cash position of the banking system remains unaltered but the deposits go up. This is the mechanism that has resulted in a gap of Rs3 trillion between the total issued currency and total bank deposits in Pakistan.

The conventional banking operations are closely linked to the SBP policy rate which is the rate state bank uses for overnight lending to the banking system. The money market that engages in the function of managing inter-bank money flow develops its own rate called KIBOR which is naturally pegged to the state bank policy rate. State bank's present policy rate is 12.5 per cent and the KIBOR which changes on daily basis maintains its closeness with the SBP rate - for example the 6-month KIBOR on 15 April was 12.36 per cent. Banks use KIBOR plus an additional 2 to 3 per cent, or so, to charge their borrowing customers.

Our banking sector is said to be strong and robust as it managed to brave the global financial crisis somehow. But the unfortunate aspect of this scenario is that the strength of the sector is not as much innate as it is greed-driven. During the current decade the banks flourished on a copious inflow of liquidity in the shape of increased home remittances after 9/11 and abrupt cuts and rises in the SBP policy rate. During SBP rate falls banks raked up money by taking to the consumer credit market thereby earning huge interest money income. They, however, allowed to their depositors profit rates as low as 2-3 per cent. During the SBP rate rising spree, they raised the price of their credit without increasing the rates of profit on deposits. The state bank, unfortunately, always feigned indifference to the atrocity of the banking sector. It was after a lot of hue and cry that SBP set a minimum limit of 5 per cent for profit on saving accounts. Even today, the banking spread which is the difference between the average lending rate and average deposits profit rate is 7.25 per cent which is unethically high.

The existing economic model which relies on the fetish of free market capitalism buffs like Milton Friedman rather than the sober economic theories of Maynard Keynes is expansionary and inflationary in nature. The economies following this model need to expand on a continual basis, and if they don't do so, they are doomed - expansion through deliberately created budget deficits that warrant throwing of more money into the economy year on year; expansion through banking system that keeps on increasing the gap between total bank deposits and currency in circulation by generating credit money; and expansion through uncontrolled creation of fiat money with zero intrinsic value.

We are heading towards an era when a truckload of money wouldn't b able to buy a single drop of water. How? See the table.


Flour per kg 33 paisa Rs.30 90 times
Pulses per kg Re1 (or even less) Rs.200 200 times
Beef per kg Re1 Rs250 250 times
Gold per tola Rs100 Rs35,000 350 times

The astronomical rise in the prices of basic food items and economically important metals without any quality improvement or value addition during the last 50-55 years gives an inkling of where we would be after another 50 years. The increase in the prices of gold could be attributed to resource scarcity as world gold deposits cannot be replenished unless new finds are made. But procurement of a continued rather enhanced supply of basic food items relates to land and animal fertility which can always be and is being continuously improved through technological advancement. So what is the logic behind the price increase of such items? This is the satanic power of our economic model that has not only hugely devalued our money but also eroded our human values. We are living in the age of man and money degradation.

In the second session of the seminar, Dr Mujeeb Beig took the rostrum and benefited the audience with the latest and hand-on knowledge of Islamic banking. It was not long after he started that I realized the difference between his approach and that of mine. In retrospect I sounded like a public speaker while Dr Mujeeb took to the role of a dedicated teacher focusing on the basic objective of imparting valuable knowledge to the students. I felt engrossed in his easy-to-follow explanation of the basics of Islamic banking. He informed the audience that Islamic finance restricts itself to asset-based transactions rather than money-based lending which is the function of conventional banking. It was this restriction to asset-based financing that saved the Islamic banking from worldwide financial losses during the recent global crisis. The popularity of Islamic finance in the non-Muslim world owes much to the conceptual and systemic strength of the operational framework that relies on genuine financial transactions rather than the use of financial derivatives of dubious utility.

Presently the Islamic banking assets are 5 per cent of the total banking assets but the potential of this sector and the opportunities to expand its domestic and international outreach are immense. Dr Mujeeb briefly discussed the currently-most-used instruments of Islamic financing namely Murabaha, Ijara (leasing) and Diminishing Musharika. He said that Mudarabah is an Islamic business arrangement based on bringing together two basic economic factors, skill and capital. The asset management company of a Modaraba provides business skill while the Mudarabah company itself provides business capital. They share profit and loss in an agreed ratio. He further informed that Diminishing Musharaka is an emergent Islamic finance instrument.

According to the Pakistan Economic Survey 2008-09, its contribution to the overall Islamic finance has increased from 6 per cent in 2003-04 to 29 per cent in 2008-09. Diminishing Musharaka is used to finance acquisition of property assets by the corporate, SME and consumer sectors. The total cost of the asset is divided into two parts depending on customer's liquidity position. After pooling the two sources of fund, the property is purchased in the name of the Islamic bank. The fund portion contributed by the bank is divided into a number of smaller amounts called units. The customer can take possession of the property by exercising the buy-back option. The ownership of the property is transferred to the customer after he or she buys back all the units of the fund contributed by the bank. During the intervening period, the customer keeps on paying the bank an agreed amount of rent. The paucity of time did not allow any intellectual interaction with Dr Mujeeb during which I would have loved to ask him to throw some more light on the mechanism of Diminishing Musharaka, particularly the question whether the rent is linked to the existing property rent market or the interest-based money rent market.

The seminar concluded with the closing remarks of Professor Rasheed Zaedi and distribution of merit certificates to the students and faculty members. The two speakers were honored with gracious gifts and a sumptuous lunch.