Ownership effects of fractional reserve banking: an Islamic perspective

Abstract

PurposeThe purpose of this paper is to show that fractional reserve banking (FRB) has implications for the ownership structure of assets in the economy that violates the Islamic principles of ownership.Design/methodology/approachThis is a theoretical paper that looks into the works of Islamic scholars on the issue of ownership that are based on Qur'an principles and the traditions of the Prophet, and evaluates the FRB from that perspective.FindingsThe conclusion of the paper is that money creation through FRB is creation of purchasing power out of nothing which brings about unjust ownership transfers of assets, from the economy to the bank effectively paid for by the whole economy through inflation. This transfer of ownership is not based on human effort by taking on legitimate risks and neither with the knowledge nor the consent of the initial owners. This violates the ownership principles in Islam and is tantamount to theft. It also has the elements of riba. Islamic governments should therefore not create fiat money since this is equivalent to taking assets of the people, rich and poor alike, forcefully without compensation.Research limitations/implicationsEmpirical investigations into how bank loans along the years have changed the asset ownership structure in economies may shed further light.Practical implicationsIt is, therefore, important that Shariah scholars render a fatwa on both the fiat money and the FRB system. Such a fatwa is urgent and pertinent before Islamic banking and finance, that operate under these systems, takes a course that may prove difficult to reverse later. The Islamic economics and finance cannot be founded upon a money system that is fundamentally equivalent to theft and riba.Originality/valueThe paper shows how the operations of Islamic banking and finance within the fiat money, FRB system are invalid from the Islamic perspective.