JAK Bank: An authentic framework for interest-free banking
The prohibition on interest is widely attested in the scriptures of monotheistic religions – including Islam, Christianity and Judaism – but several economists have long argued that an interest-free economy could “never work” in today’s complex and globalised world.
Recent developments, however, are starting to challenge such attitudes. The Islamic financial services industry, for example, has been experimenting since the mid-1970s to develop an interest-free financial system based on the values of justice, equality and morality.
As a new and emerging industry, Islamic finance is currently facing growing calls to develop new business models that serve as catalysts to enable grassroots financial inclusion and offer greater authenticity. The pioneering JAK Bank in Sweden is one such innovative and successful interest-free banking model that today’s Islamic finance practitioners could learn from.
JAK Bank – a member-owned and regulated deposit taking financial institution – can trace its roots to Rotating and Savings Credit Associations (ROCSA); a practice popular in many communities in Asia, Africa and South America (commonly referred by local names such as “Committees” in the Indian subcontinent, “Susus” in South Africa and the Caribbean and “Arisan” in Indonesia). The ROSCA concept involves group of individuals lending to one another in turn without interest. JAK Bank has elevated the ROSCA concept to integrate with the existing banking framework through an innovative use of savings points system.
Founded in 1965, JAK bank’s primary aim is to provide its members with a feasible interest-free financial solution which is sustainable for the environment and serves the local economy. In particular, JAK members believe charging interest leads to: (a) widening of income inequality (i.e. the rich continue to earn risk free return); (b) fuels inflation (i.e. interest adds to cost of production); and (c) promotes inefficient allocation of resources (i.e. asset bubbles especially in residential property).
JAK Bank operates largely as a conventional bank with respect to credit standards, security enforcement, operations, liquidity and risk management. The key differences are on the savings requirement and capital structure. Here’s how the Jak Bank model work:
Depositors in JAK bank receive savings points, instead of interest, which reflect the amount saved and overall duration by the individual in the institution. For example, $1 saved for 1 year (with 100% saving ratio) will result in 1 savings point, allowing the individual to borrow 1 dollar interest free for one year (JAK bank varies the savings ratio depending upon current/fixed deposits and is always less than 100% given the reserve and liquidity requirement).
Savings can be done prior (Pre-saving), or during the loan period (Post-saving). Saving after taking out the loan (Post-savings) would involve significantly higher transfers to the lending institution resulting in significantly lower loan amount for the borrowing members/customers (approximately halves borrowing capacity). Post-Savings however from collateral prospective is quite advantageous, the savings portion acts as cash collateral against the outstanding loan, in fact half way through the Post saving loan the principal loan amount is fully covered by the Post-savings. Customers/members who would therefore like to receive a loan amount equal to that of a comparable conventional bank would initially need to save with the JAK bank (Pre-save) to meet the monthly debt burden.
Securing savings point by customers prior to borrowing (Pre-savings) would not automatically guarantee the loan; borrowing customer must always show the capacity to repay. In analyzing the capacity to repay both the ability to pay back:
- The principal;
- Post-savings; and
- Loan admin fee (The borrowers are required to pay a small flat lending fee of 1-2% to cover operating costs. This fee has evolved over the years, but the primary purpose of the fee is to cover operating costs of the bank)
In order to meet the regulatory requirement for capital, every borrowing customer at the initiation of the loan contributes ~ 6-8% of the loan amount towards equity of JAK Bank (referred to as ‘Loan equity deposit’). Upon completion of the loan, and approval from the regulatory authorities, the Loan equity deposit is refunded from the proceeds of new borrowing members (the new owners). From a process prospective issuance and completion of loans happens on a continuous basis but the actual change in ownership among the borrowing members only twice a year (subject to relevant regulatory approvals). This would mean that Loan equity deposit of the borrower would be eligible for a refund within 6 months of loan repayment. This capital structure is intuitively quite robust as it grows directly in proportionate to lending (risky assets), and the cooperative nature also reduces moral hazard.
The only treasury activities of the bank involve investing the, ‘Loan equity deposit’ and regulatory reserve amount in Swedish treasury bonds, income from which further adds to the earnings and thus building of the capital base. The bank does not invest in any other financial instrument. The bank maintains a conservative Loans to deposit ratio
A small group of committed people in Sweden have developed a deposit and lending system, which in my view, is absolutely more authentic than the current Islamic commercial banking business model. The question is, are the Islamic banking stakeholders ready to listen.