Money Creation in Conventional and Islamic Finance

MONEY CREATION IN CONVENTIONAL AND ISLAMIC

FINANCE.MUFFADDAL SHABBIR

AHMED RAZA

AHMED RAZA HASSAN QASIM SHERIYAR

ROAD MAP INTRODUCTION BY HASSAN QASIM MONEY CREATION IN CONVENTIONAL

FINANCE BY MUFFADDAL SHABBIR HOW SOCIETY IS FAILED BY AHMED

RAZA MONEY CREATION FROM ISLAMIC

PERSPECTIVE BY AHMED RAZA KHAN CONCLUSION BY SHEHRIYAR

WHAT IS MONEY CREATION?

In economics, money creation is the process by which the money supply of a country or a monetary region is increased.

HOW MONEY IS CREATED IN CONVETIONAL FINANCE?

Commercial banks lending creates money in the form of bank deposits. After bank separates reserve requirements , then the excess reserves are multiplied through fractional reserve banking.

CORE CONCEPTS:

WHAT IS FRACTIONAL RESERVE BANKING?

Fractional reserve banking is a practice whereby banks takes in deposits, create credits or make loans and holds reserve(to satisfy demands for withdrawals) that are less than the amount of customer deposits.

CORE CONCEPTS: WHAT IS LEGAL RESERVE

REQUIREMENTS? The legal reserve requirement is a

central bank regulation that sets minimum fraction of costumer’s deposit that each commercial bank must hold as reserves rather than lend out. The reserves are normally in form of deposits made with central bank or cash stored physically in bank vault.

CORE CONCEPTS:

WHAT IS POTENTIAL MONEY MULTIPLIER?

The increase in the money supply that is potentially generated by a change in demand deposits. It can be find out by a simple formula i-e: M = ID/LRR

CORE CONCEPTS:

For example: If the legal reserve requirement (LRR)

is 25 percent and the initial demand deposit (ID) is $100,000, then what is the maximum potential increase in the money supply (M)

M = $100,000/.25 = $400,000

PROCESS OF MONEY CREATION

Suppose that the banking system initially has $100,000 in demand deposits, and loans out $80,000. Those who borrow this money in turn put it in their demand deposit accounts. How much money is now held in demand deposit accounts?

$100,000 + $80,000 = $180,000.

PROCESS OF MONEY CREATION

So, when bank receives 100,000 it keeps 20% aside as reserve requirements and lend out 80,000 on interest. Which is again deposited to bank by the borrower again bank separates 20% of 80,000 and lend out remaining 64,000 to borrower this process goes on until bank utilizes 100% potential of base money in this case which would be : ID/LRR= 100000/.20= $500,000.

PROCESS OF MONEY CREATION

PROCESS OF MONEY CREATION

HOW BANK FAILS? If most of borrowers fail to return

money banks will fail to return money to depositors.

If rumors spread out about bank failure depositors fearing that they may lose their money, and having lost confidence in the banking system, some of them will demand their money back from their deposits.

HOW BANK FAILS? Too many depositors withdrawing

their money from their demand deposit accounts will overwhelm the fractional reserve system, and may cause it to fail. Many people will lose their money, loanable funds for investment will be eliminated, and a recession may result.

FACTS BANK FAILIURE

FACTS BANK FAILIURE For years after the Great

Depression, the number of bank failures was insignificant. All that changed in the 1980s. With the recession of 1982, bank failures increased dramatically. In 1988 alone there were more bank failures than the combined total for the previous 25 years.

FACTS BANK FAILIURE

HOW SOCIETY FAILS? BANK CREATE NEW MONEY WHEN

PEOPLE GO INTO DEBT: when you take new money is

created. As people borrow more, more new money comes to economy. All the extra spending of this new money makes people think economy is doing well, which encourages them to borrow even more, hence resulting in more debt.

HOW SOCIETY FAILS?

FOR EVERY POUND OF MONEY THERE IS A POUND OF DEATH:

Because bank create money when people borrow, for every pound of money in the economy there will be a pound of debt. If there’s $100 in your bank account, someone else must be in $100 in debt.

HOW SOCIETY FAILS? DEBT TRAP: When you pay down your debts, the

money leaves your bank account doesn’t go anyone else it just disappears. Bank creates money when they make new loans and destroy money when loans are paid back. So when lots of people try to pay off their debts at same time money disappears from economy. This means it’s almost impossible for us to reduce our debts without causing a recession.

HOW MONEY IS CREATED IN ISLAMIC FINANCE?

Almighty Allah has created the heavens and the earth and everything between them, and He is the Only Owner of everything to be found there, and of everything between them, as well as of everything below the surface of the earth.

Allah the Almighty says in Qur’an:

“To Him belongs all that is in the heavens and all that is on the earth, and all that is between

them, and all that is under the soil.”

HOW MONEY IS CREATED IN ISLAMIC FINANCE?

Allah (S.W) the Almighty owns everything, while man just has the right of dealing with it, and Allah the Almighty will call him to account on the Day of Judgment and he will be questioned about his money.

That’s why we should avoid the man-made ways of creating money and follow what we are told in our religion.

HOW MONEY IS CREATED IN ISLAMIC FINANCE?

Mushaarakah: This is an arrangement where you give

the bank your capital, and it seeks out projects for growth and invests in them. The profits and loss is shared between you and the bank

Importantly the rate of return is not fixed and there is some element of risk.

HOW MONEY IS CREATED IN ISLAMIC FINANCE?

Ijaarah: The bank purchases an asset and

rents it to the client. The assets remain the property of

bank. Bank obtains rent on the asset It could possibly end in purchase.

HOW MONEY IS CREATED IN ISLAMIC FINANCE?

Ijaarah Muntahiya Bittamleek : This is an arrangement where the bank rents an asset, eg. a house, to a client. Over time, the client pays the bank more than the pure rent price for the asset. This excess is used to increase the share of ownership of the asset, such that by the end of the term, the client owns 100% of the asset.

HOW MONEY IS CREATED IN ISLAMIC FINANCE?

Advantages: Riba free business No inflation Society won’t be divided into classes Transparent economic activity Preparation for the next life by

performing good deeds.

CONCLUSION

Being Muslims it is our responsibility to spend our life in an Islamic way. Our belief is that this is not our final destination. Our real life is the life after death which is forever. Hence we shall prepare ourselves for that life by doing what we are told to do in our religion.

CONCLUSION Islamic way of creating money is

Riba free and being Muslims this is our belief that anything including this system told by ALLAH is the best system and no man made system can replace it.

THANKYOU.