Economy — 20 October 2008

One of the mainstays of Western finance is the use of fractional-reserve banking.

Fractional-reserve banking is the practice where banks only hold a fraction of their deposits in reserve, and use the remainder as capitol for loans – supposedly an important function that allows for the expansion of economies. Though universally accepted across the globe as a part of modern banking, fractional-reserve banking is no more than fraud and theft.

Banks historically began as money warehouses. Whereby customers would typically deposit their (then) gold for safekeeping, and the money warehouses would charge a fee for the use of their services. Over time, these warehouses generally acknowledged that customers would only rarely withdraw their full deposits, and the warehouses soon discovered that the fraction of unused deposits could be used to generate profits, through the use of interest bearing loans. More so these warehouses – or banks – also began to issue receipts of non-existent deposits, in a greater effort to generate profit, all of which resulted in the increase of money supply beyond the actual deposit holdings.

If it were to be the counterfeiting of coins, or the theft of stored property – then these would be generally proscribed in any society. Not so for fractional-reserve banking. It is the largest heist that gets pulled every day, and eventually runs its course, to a devastating effect on the normal hardworking citizen.

Today’s world of credit-crunches and bailouts, is the natural cycle for boom-bust economies. Fractional-reserve banking is responsible for the increased inflation that is resultant of an increased money supply. Combine this with the temptation of easy credit that fractional-banking facilitates, and the picture of today’s financial crisis becomes clearer. Simply put easy credit punishes the caution of investors. In the case of the US, money poured into the real-estate sector, unscrupulous brokers took further advantage of unlimited credit, banks through the power of fractional-reserve banking, continuously pumped and primed more credit. The overheated real estate market fizzled and then crashed, bringing down with it the rest of the financial markets.

When markets get bowled over like skittles, naturally people worry. When they hear terms like ‘liquidity crisis’ or ‘insolvency’ affecting the banks in which their life savings are held, the first reaction is to withdraw their money – the money that is their decades of work, their retirement and the future for their children. This is the bank run. The banks had prayed to their false gods of Capitalism, that such a day would never come. That ‘fraction’ they hold, is merely that, a fraction, a small holding of which the rest was pilfered away.

In Islam, since neither usurious transactions nor fractional-banking exists, their is no relentless inflation from expanded money supply, or boom-bust cycles. With your money remaining your money, if you run to the bank, you’ll still find it waiting for you.

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