The Case Against Interest

Transcription

1. THE CASE AGAINST INTEREST : IS IT COMPELLING? by M. Umer Chapra Research Adviser IRTI/IDB Jeddah (Saudi Arabia) Notes for a lecture to be delivered at the International Conference on Islamic Banking to be held in Brunei on 5-7 January 2004
2. l   Why a new system of financial intermediation? Is there anything wrong with the prevailing interest-based system ? l  Evaluation of a system on the basis of its contribution to : l  Efficiency l  Ease and promptness in the transfer of funds from the surplus to the deficit sectors l  Economy in transactions costs l  Stability l  Equity (Socio-economic justice)
3. l   Interest-based system was never considered to be superior on the criterion of equity. Its superiority claimed on the criterion of efficiency, why? l  Confidence in the Efficiency of the system has been shaken by its persistent instability over the last four decades.
4. l  Call for a “New Architecture” — Sound Macro-economic policies — Sustainable exchange rates — Proper regulation and supervision l Adequate capital, proper risk management, effective corporate governance, greater transparency l Why is market discipline unable to ensure the faithful observance of these principles?
5. l   Reasons for the ineffectiveness of market discipline in the interest-based banking system: — As a result of the absence of risk-sharing: • Deposits are guaranteed - therefore depositors become complacent and do not monitor the banks carefully - do not demand transparency • Banks rely on the crutches of collateral, which ensures the repayment of their loans - they do not evaluate the risks carefully - tend to extend credit excessively. This promotes: – Public sector deficits – Private sector living beyond means – Highly leveraged short-term debt – Rapid movement of funds – Volatility l  The greater the reliance on debt and the higher the leverage, the more severe the crises
6. l  Some Examples: — East Asia Crisis — Long-term Capital Management (LTCM) —  Foreign Exchange Markets l Remedy lies in injecting greater discipline in the financial system – How? —  Introduce risk sharing to make market discipline more effective —  More effective discipline will complement the role of regulators and supervisors and help make the financial system healthier and more stable
7. l  Interest-free finance is intended to inject the needed discipline into the financial system through risk-sharing: — Risk-sharing by banks ? • The bank shares in the risk with the entrepreneur — Risk-sharing by depositors ? • Demand deposits (These do not share in the risks and do not therefore get any return –must be guaranteed) • Investment deposits (These must share in the risks – just like shareholders)
8. l  What about credit ? — There is credit and the rate of return is fixed in advance – Is this interest ? — There is no borrowing and lending – Rather there is purchase and sale of goods and services. — The financier bears some risk in the sales-based modes of financing : murabahah, ijarah, salam and istisna‘ l Wouldn’t this bring instability: NO — Credit expands in step with the growth of the real sector — Speculation minimized as a result of risk-sharing
9. l  This shows that even though Islamic finance is more difficult it can be more efficient.
10. l  What about equity? — Living beyond means — Need fulfillment — Full employment — Equitable distribution?