Islamic Economics Studies Bi-quarterly Journal

Explaining the Concept of Money Creation from Nothing in the Conventional Banking System and Moving to Wards Full Reserve Banking System: An Application of SFC Model

Document Type : Research Paper

Authors

1 Assistant Professor, Faculty of Economics, Vali-e-Asr University of Rafsanjan, Rafsanjan, Iran

2 Assistant Professor, Faculty of Economics, Arak University, Arak, Iran,

3 Economic Researcher,

Abstract

Recent financial and banking crises in the world, has raised concerns among economists about the inefficiency of conventional banking system. In conventional banking, banks, through the creation of credit and the creation of money, have led to a rise in liquidity and false claims, resulting in many of the unorganized economic consequences, such as inflation, unemployment, unfair distribution, stagnation, and so on. Over the past decades, various theories have been developed in the domain of banking system: the financial intermediation, the fractional reserve and the credit creation theories of banking. Empirical evidence suggests that the third theory is superior to first and second theory. That is, banks alone can make money from nothing, which is illustrated by a simple bank accounting process. The statistics also show that the creation of bank credit and liquidity of banks has been steadily increasing over the recent years, and it is coincided with decreasing legal deposit rates for banks. In this paper, based on the Stock-flow Consistent) SFC (model and in a closed economics the effect of the creation of money in the full reserve banking system has been investigated. The empirical results indicate that the creation of money in this system can hold government debts at a fixed level and to zero even in the long term and the government brings with it a permanent budget surplus. Because the money created by the banking system is not created, it increases the level of wealth of the households with the creation of money. Hence, moving towards full-reserve banking and Islamic banking will play an important role in reforming the banking system and attaining a sustainable economy.

Keywords

Ahmad, Zuriyati and Abdul Ghafar Ismail (2017). Full reserve system and the Maqasid Shariah. Journal of Emerging Economies & Islamic Research, 5(2) 2017, 58 – 66.
Ahmad, Faruq, A.U. (2010). Theory and Practice of Modern Islamic Finance: The Case Analysis. USA:Brown Walker Press
Al Jarhi, Ali Mabid. (2004). Remedy for banking crisis: what Chicago and Islamic have in common: a comment. Islamic Economic Studies, Vol 11, No 2
Askari Hossein and Noureddine Krichene. (2016). 100 Percent reserve Banking and the Path to a single-country gold standard. The Quarterly Journal of Austrian economics, vol. 19 no.1, 29–64
Bagus, P. and Howden, D. (2013). Some Ethical Dilemmas of Modern Banking. Business Ethics a European Review. 22 (3), p: 45-235.
Bakhshi Dastjerdi, Rasul and Rahim Dallali Esfahan. (2012). Pathological Analyzing the Theory of Interest and Conventional Banking System. Yazd University Publications, (In Persian).
Bakhshi Dastjerdi, Rasul. (2014). Adaptation of interest-free banking system with the theory of Islamic economics. Islamic Banking Conference. Banking institute, (In Persian).
Bakhshi Dastjerdi Rasul, Mohammadreza Taleb Baghebani, Mohammad Mehdi Mojahedi Moakher and Mohammad Saleh Ahmadniya (2019). The System Dynamics Approach to Money Creation Effect on Inflation in Iran Economy. Quarterly journal of economic research and policies. 27(89). 99-137, (In Persian).
Benes, Jaromir and Michael Kumhof. (2012). The Chicago Plan Revisited. International Monetary Fund.
Dawoodi, Parviz and Muhammad Muhaqiq. (2008). Narrow Banking. Journal of Iran's Economic Essays. 5(10). 93-113, (In Persian).
Dixhoorn, Charlotte Van (2013). Full Reserve Banking: An analysis of four monetary reform plans. A study for the sustainable finance lab
Dittme, Kristofer (2015). 100 percent reserve banking: A critical review of green perspectives. Ecological Economics, 109, 9–16
Dow, Sheila, Guðrún Johnsen and Alberto Montagnoli (2015). A critique of full reserve banking. Sheffield Economic Research Paper series, SERPS no. 2015008
Dyson, Ben, Graham Hodgson and Frank van Lerven (2016). A response to critiques of ‘full reserve banking’ .Cambridge Journal of Economics, 40, 1351–1361
Dullien, Sebastian, Hansjörg Herr, Christian Kellermann (2011). Decent Capitalism: A Blueprint for Reforming our Economies, London, Pluto Press.
Ferguson, Niall. (2013). The Ascent of Money: A Financial History of the World. Translated by Shahla Tahmasebi. Akhtaran Publications.
Fontana, Giuseppe and Malcolm Sawyer (2016). Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’. Cambridge Journal of Economics, 1 - 18
Godley, Wynne, and Marc Lavoie. (2012). Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth. Second Edition [First Edition published in 2006]. Basingstoke: Palgrave Macmillan.
Hasan, Zubair. (2008). Credit creation and control: An unresolved issue in Islamic banking. International Journal of Islamic and Middle Eastern Finance and Management, Vol. 1, N. 1, p. 69 – 81.
Hasan, Zubair (2011). Money creation and control from Islamic perspective. Munich Personal RePEc Archive
Hossini Dolatabadi, Sayyed Mahdi (2016). The Nature of Bank and Its Implications for Islamic Banking Studies. Journal of Islamic Economic Studies. 8(2). 173-198, (In Persian).
Hu, Yiming and Siqi Li, Thomas W.  Lin and  Shilei  Xie, (2011). Large creditors and corporate governance: the case of Chinese banks.
Ismail, Ahmad Yani (2018). An insight into bankl’s money creation and the way forward. e- jurnal penyeldikan dan inovasi, Vol.5 No.1: pp125-139
Izadkhasti, Hojjat (2017). Analyzing the Impact of Credit Creation in Fractional Reserve Banking on Macroeconomic Variables in Iran. Journal of Iran's Economic Essays. 14(27). 9-34, (In Persian).
Lainà, Patrizio. (2015b). Proposals for Full-Reserve Banking: A Historical Survey from David Ricardo to Martin Wolf. Economic Thought, 4.2: 1-19,
Liana, Patrizio. (2015a). Money Creation under Full-reserve Banking: A Stock-flow Consistent Model. Levy Economics Institute. Working Paper, No. 851
Lainà, Patrizio (2018). Full Reserve Banking: Separating Money Creation from bank lending. Department of Political and Economic Studies. University of Helsinki .Publications of the Faculty ofSocial Sciences 89
Macleod, Henry Dunning (1891).Theory of Credit, Vol. 2.
Meera, Mydin, A. K. & Labarni, M. (2007). Ownership Effects of Fractional Reserve Banking: An IslamicPerspective. Humanomics, 25(2), 101-116.
Mirakhor, Abbas and Mohsen Khan (1991). Theorical studies in islamic banking and finance. Iran Banking Institute, (In Persian).
Mirmoezi, Sayyed Hossain (2005). The model of bank reserve deposits compatible with Islamic banking. Islamic Economy. 5. 45-74.
Mojahedi Moakher Mohammad Mehdi and Rahim Dallaly Esfahani. (2012). Lending Model in Islamic Thought and its Comparison with Competing Models of Conventional Economy. Money Economic Journal. Monthly Journal of Economic Research and Policie. (1). 69-84, (In Persian).
Mojahedi Mohammad Mahdi, Rahim Dallali Esfahani, Saeed Samadi and Rasoul Bakhshi Dastjerdi. (2011). Developing an Overlapping Generation Model of Fractional Reserve Banking Activity With Emphasis on Maurice Allais's Approach. Journal Of Economic Modeling Research. (5). 47-74, (In Persian).
Mojahedi Mohammad Mahdi, Rahim Dallali Esfahani, Saeed Samadi and Rasoul Bakhshi Dastjerdi (2013). The Study of Islamic Viewpoint and Western Approach to Subjective Concept Of Money and Credit. Journal of Economic and Policies. 21 (65). 201-230, (In Persian).
Mujtahid, Ahmad and Ali Hassanzadeh (2008). Money & Banking and Financial institution. Monetary and Banking Research In Stitue, (In Persian).
Monzer, Kahf (1997). A Review of Islamic Economics. Translated by Abbas Arab Mazar. Planning and Budget Organization.
Mousavian Seyyed Abbas and Meysamy Hossein. (2017). Islamic Banking: Islamic Central Banking and Monetary and Exchange Rate Policy- Making. Monetary and Banking research Institute, (In Persian).
Musavian, Sayyed Abbas. (2013). Optimal Model of Legal Reserve in Islamic Banking. 2(2). 7-26, (In Persian).
Nikiforos, M., & Zezza, G. (2017). Stock‐Flow Consistent Macroeconomic Models: A Survey. Journal of Economic Surveys, 31(5), 1204-1239.‏
Othman Ibrahim, Altwijry (2016). Shari’ah perspective of money creation in Islamic banking: a proposal for an alternative model. Munich Personal RePEc Archive
Sadr, Mohammad Baqir (2009). Bank Interest-free in Islam. Translated by Sayyed Yahya Alavi. Imam Sadiq University Publisher, (In Persian).
Sani. M.D, Arfah, Ahamed Kameel Meera, A. Aziuddin. (2012). Fractional Reserve Banking and Maqasid al-shariah, An incompatible Practice, May 31, Available at: SSRN: http://ssrn.com/abstract=2071164 or http://dx.doi.org/10.2139/ ssrn. 2071164.
Smirna, T. G. (2015). From commodity standard to deposit standard: the near completion of a secular cycle in monetary globalization. Journal of International Studies.Vol. 8, No 1, 2015, p. 107-113.
Samsami Hossein and Fereshteh Kianpour. (2016). The Possibility of Creating Money by the Banking System in an Islamic Financial System. Economic knowledge (Marifat Eghtesade). 7(1). 109-130, (In Persian).
Sobhani, Hassan and Hossein Doroudian.  (2017). Feasibilty Asibility Of "Money Creation by the Banking System" In the Islamic Banking. Journal Eghtesad-e Islami. 16 (64). 21-54, (In Persian).
Tutunchian, Iraj. (2000). Islamic money and banking and its comparison with the capitalist system. Tavangar Publications, (In Persian).
Werner, Richard A. (2013). Crises, the spatial distribution of economic activity, and the geography of banking Introduction. Environment and Planning, volume 45, pages 2789 – 2796
Werner, Richard A. (2014a). Can banks individually create money out of nothing?—The theories and the empirical evidence. International Review of Financial Analysis. International Review of Financial Analysis, 36, 1–19
Werner, Richard A. (2014b). How do banks create money, and why can other firms not do the same? An explanation for the coexistence of lending and deposit-taking. International Review of Financial Analysis, 36, 71–77
Werner, Richard A. (2016). A lost century in economics: Three theories of banking and the conclusive evidence. International Review of Financial Analysis. International Review of Financial Analysis, 46, 361–37
Wicksell, Knut (1907). The influence of the rate of interest on prices. Economic Journal, 17, 213–220
Islamic Economics Studies Bi-quarterly Journal
Volume 13, Issue 2 - Serial Number 26
May 2021
Pages 33-80