Contents

 The concept of fiat money and its status in Shari'ah;

 Gold standards;
– Is return to gold standard a demand of the Shari'ah or
of prudence?
 The concept and practice of fractional reserve
banking system;
 Full-reserve banking as an alternative;
 Credit expansion and inflation;
 Credit creation – Islamic perspective;

IRSHAD AHMAD AIJAZ | Shari'ah Adviser BankIslami Pakistan 1 # Center for Islamic Economics, Slid
 Fiat money and its status in Shari'ah

 Fiat money and gold standards link to each other closely;

 Fiat money is a money that is declared by a government as a
legal tender;
 Historically there was a commodity money like wheat, rice,
sugar, milk, salt etc. etc.;
 Later on Gold and silver and other precious metals have been
used as medium of exchange;
 Afterwards, the receipts of gold and silver issued by
goldsmiths to those who deposited their gold and silver with
them for safekeeping, have been used instead of gold and
silver;
 The reason of use of these receipts was ease in transportation
of money and safety;
 This trend later on turned to paper currency system which has
been taken over by government;

IRSHAD AHMAD AIJAZ | Shari'ah Adviser BankIslami Pakistan 2 # Center for Islamic Economics, Slid
 Fiat money and gold standards

 Gold standards means making gold a standard for money.

Under this system gold used as a base for paper currency
and every currency note reflects the gold behind it which is
kept by the government in its exchequer;
 The Bretton Woods system was set up after world war II
and pegged the value of currency with gold. Under this
system the currency was convertible with gold when
demanded by currency holder;
 In 1971 this system was stopped and convertibility to gold
is not there anymore;
 This debasement on paper currency from gold some
decades back, made the present time currencies are
baseless or we can say they are based on credit
worthiness of the countries;

IRSHAD AHMAD AIJAZ | Shari'ah Adviser BankIslami Pakistan 3 # Center for Islamic Economics, Slid
 Fiat money and gold standards

 Now the question is that whether or not such

debasement of currency from gold or silver is
acceptable to Shari'ah?
– If the answer is no then all the currencies stand void and
unacceptable to Shari'ah;
– We find solution for this in past. Classical Fuqaha did not
argue on coins (Fuloos) which issued in past by Muslim
rulers like coins of leather and metals;
 Therefore, basing of currency on gold is not a
Shari'ah requirement in view of majority of present
time Fuqaha like Shaikh Taqi Usmani, Dr Qardawi;

IRSHAD AHMAD AIJAZ | Shari'ah Adviser BankIslami Pakistan 4 # Center for Islamic Economics, Slid
 Fiat money and gold standards –
Shari'ah viewpoint
 As I said the issue of currency is not a Shari'ah issue
what should be its status in Islamic economic system?
 In fact actual standing in this regard is that debasement
of currencies from gold is an issue of prudence and good
governance and not a Shari'ah issue;
 Such decisions are left to Muslim society to decide
what is better for its systems;
 Yes, the current discussion sometimes show there is
injustice in debasement of currency and there is a
movement among Muslims for pegging the currency with
gold;
 But deep study of the movement show this is a political
standing rather than an Islamic one.

IRSHAD AHMAD AIJAZ | Shari'ah Adviser BankIslami Pakistan 5 # Center for Islamic Economics, Slid
 Fractional reserve banking system

 Fractional reserve banking system, credit creation, credit

money and monitory policy are interrelated topics;
 Fractional reserve banking is a system in which banks keep a
fraction of deposits in reserve and lend out the remaining
portion;
 This fraction of deposits kept as statutory and liquidity
requirements for the bank. Usually it is kept with central banks
and the fraction ratio differ for each country based on its way
of regulation;
 This function expends money supply beyond actual size of
money supply. This money supply expends through deposits
of borrowers the same amount in banking system;
 Because of this system most of the economies have multiple
larger money supply than the base money issued by central
banks;

IRSHAD AHMAD AIJAZ | Shari'ah Adviser BankIslami Pakistan 6 # Center for Islamic Economics, Slid
 Fractional reserve banking system
 Example of FRB is if regulatory requirement is 15% of
deposits then 15 rupees out of every 100 rupees will be
kept with central bank and rest 85 will be with the
deposit taking bank;
 This deposit taking bank can issue these 85 rupees as a
loan to borrower A, and the borrower after taking these
85 may deposit these all 85 with any other bank;
 The second bank will again deposit 15% of this Rs. 85
(Rs. 12.75) to central bank and the remaining Rs. 72.25
may be lent to depositors B and he will again deposit
this amount to a third bank and the will keep 15% of
deposit with central bank and case will go on same
pace;
 By this way banks are allowed to create money as the
Rs. 100 have been deposited and credited many times
by different people. This ultimately lead to multiplying
on money by many times;

IRSHAD AHMAD AIJAZ | Shari'ah Adviser BankIslami Pakistan 7 # Center for Islamic Economics, Slid
 Fractional reserve banking system

 This system is also known as money multiplier;

 Through this system credit is created by lending
from bank A to Mr Z and depositing by Mr Z the
same amount in bank B;
 So both banks write liability and asset both which is
based on credit;
 The money created through it is based on credit;
 Now the question is its validity from Shari'ah
viewpoint;

IRSHAD AHMAD AIJAZ | Shari'ah Adviser BankIslami Pakistan 8 # Center for Islamic Economics, Slid
 Credit expansion and inflation

 Money multiplying process is a credit expansion

process as it provides credit money to a borrower;
 When money supply increases the purchase power
of borrower increases and the demand from this
borrower increases;
 This increased demand lower down the supply of
goods and services and any increase in demand
equals to increase in price;
 Therefore, credit expansion process ultimately
increases the price i.e. it results in inflation;

IRSHAD AHMAD AIJAZ | Shari'ah Adviser BankIslami Pakistan 9 # Center for Islamic Economics, Slid
 Fractional reserve banking system –
Shari'ah status

 FRB (Fractional Reserve Banking) is a matter of hot

debate among conventional economists as well;
 According to Shari'ah this is again a matter of
prudence and good governance and not a Shari'ah
issue;
 Creation of money by individuals or governments is
not purely a Shari'ah issue. It may be analyzed on
the basis of Maqasid ul Shari'ah;

IRSHAD AHMAD AIJAZ | Shari'ah Adviser BankIslami Pakistan 10 # Center for Islamic Economics, Slid