Applied Islamic Banking

By:
Prof. Dr. Mohd. Ma’sum Billah
masum@applied-islamicfinance.com
masum2001@yahoo.com
+6019-3699542

INTRODUCTION

Currencies have been the focus of the international economy in the past year especially during economic recession in year 1997, whereas there have been currency collapses in many East Asian and Southeast Asian countries. As a result, many of these countries suffer from it, many factories and companies did not able to pay their debts and had to close, level of unemployment increased and inflation rate was also increased. To solve these problems, some of the countries such as Indonesia and also Thailand accepted financial assistant package from International Monetary Fund (IMF). As been quoted by former Prime Minister of Malaysia, Tun Dr. Mahathir Mohamed, he believed that the currencies have been speculated and manipulated by George Soros, a speculator from United State.

On the other hand, members of European Union (EU) were also looking for implementing a common monetary policy and single currency with the aim of increasing economic prosperity and contributing to “an ever closer union among the people of Europe”.

Based on both situations, Tun Dr. Mahathir Mohamed introduced an idea of using one single currency named as Islamic Gold Dinar to less dependency on US Dollar and avoids our currencies from being attacked by the speculators and also manipulators. In like manner, members of European Union (EU) introduced Euro. It has been introduced to less dependency on US Dollar and boosts their economic activities.

The word dinar refers to gold coins used as a medium of exchange by Muslims through out the Islamic history until the fall of the Ottoman caliphate. Dirhams, which were silver coins, were also commonly circulated. However, the dinar and dirham were in circulation even before the advent of Islam but continued to be used by the Prophet (peace be upon him).The dinar was the bezant gold coin whereas the dirham was the silver coins of the Sassan.The Islamic gold dinar was first issued in Damascus by Caliph Abdul Malik ibn Marwan in the year 77H. On that time, gold dinar has been used as the major international currency circulating throughout the Muslim world and the Christian Europe as well, so that the dinar was minted in large quantities .On a global scale, the gold standard was basically practice throughout the world where currencies were redeemable for a certain amount of gold.After World War II, the gold standard collapsed and was replaced with Bretton Woods system.

Recently, the issues of gold dinar were raised again. According to Khaled Hanaf ; “Islamic Gold Dinar Will Minimize Dependency On US Dollar”;Islam Online.Net(2003) gold dinar was not a new issue.The idea of the Islamic gold dinar belongs to Professor Omar Ibrahim Fadillo, founder of the Morabeteen International Organization founded in 1983 in South Afrika. The first gold dinar, equivalent to 4.25 grams of 22-karat gold, was issued in 1992 on a very limited scale between members of the Morabeteen. In 1997, the idea developed to be implemented into an exchange framework. It was known by electronic dinar, a system based on using the gold as fund through transactions made on the Internet. The e-dinar company is based in Labuan, Malaysia.

The idea of using gold dinar as one single currency for trading among Islamic countries was adopted by former Prime Minister of Malaysia, Tun Dr. Mahathir Mohamed. He had conducted a bilateral talks in year 2002 with several Islamic countries including Bahrain, Libya, Morocco and Iran, tried to convince those countries to use the Islamic gold dinar as a way of payment in their commercial dealings with Malaysia.

The plan aims to prevent another currency crisis of the scale seen in Asia in 1997-1998. Though Malaysia had pegged its Malaysian Ringgit (RM) to the US Dollar with US$ 1 is equivalent to RM 3.80 in1999 has brought some semblance of stability, the currency is nonetheless still subject to constant volatility. Although gold might not solve the problem, it is less unstable than the US dollar and has an intrinsic value that paper money does not have. It is believed that with gold, speculation and manipulation could be avoided and thus the international trade would safe from being undermined.

Many people are still confusing and questioning, “how the gold dinar will be used? Is it for daily settlement or it’s only for trading among countries? Is gold dinar going to replace the national currencies or it’s going to be a common currency for all countries? Who will participate and use gold dinar?” To answer those questions, Tun Dr. Mahathir Mohamed had explain briefly during a presentation; “The Gold Dinar in Multi-Lateral Trade” made in Kuala Lumpur on November 2002.

The plan is not intended to use the gold dinar as currency for everyday transaction in the domestic market but it will be used for international trade. It is for bilateral payment arrangements and also multilateral payment arrangements. Since there will be no physical transfer of gold, settlement of trade balance between countries could be conducted through their respective central banks every three months.

It is also not the intention to make the dinar as a common currency for all countries. It is not really the Gold Standard with a fixed value against local currency. If countries print more local currency there would still be inflation within the country. But trade would be stable and enhance. Speculators and manipulators will not be able to undermine international trade.

Furthermore, the gold dinar can be used as a trading currency for all countries, not necessarily for Muslim countries only. For the initial stage, Malaysia is going to use the gold dinar for bilateral trading among Muslim countries because Muslim countries are in the best position to demonstrate the viability of the system.

The history of Euro began when The Treaty Of Rome (1957) declared a common European market as a European objective with the aim of increasing economic prosperity and contributing to “an ever closer union among the peoples of Europe”. The Single European Act (1986) and the Treaty on European Union (1992) introduced Economic and Monetary Union (EMU) and laying foundations for introducing a single currency to be used.

The stage of EMU began on 1 January 1999, when the exchange rates of the participating currencies were irrevocably set. Euro area Member States began implementing a common monetary policy, where Euro was introduced as a legal currency and the 11 currencies of the participating Member States became subdivisions of the Euro. Greece joined on 1 January 2001 and so 12 Member States introduced the new euro banknotes and coins at the beginning of 2002.

Euro was being introduced because of several objectives. Firstly, members of the European Union want to strengthen their relationship. With this single currency, it is easy for them to cooperate among each other and increase trading transaction in which people, services, capital and goods can move freely. In addition, they want to strengthen their currency and reduce dependency on US dollar.

There are 12 Member States of the European Union participating in the common currency such as Belgium, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, The Netherlands, Austria, Portugal and Finland, Meanwhile, Denmark, Sweden and the United Kingdom are members of the European Union but are not currently participating in the single currency. Denmark is a member of the Exchange Rate Mechanism II (ERM II), which means that the Danish krone is linked to the euro, although the exchange rate is not fixed.

The new single currency, ‘euro’ originates in the Treaties. All the Treaties were prepared and signed by members of the European Council, which comprises the Heads of States or Government of each of the Member States of the European Union, and then ratified by each country according to national legislative procedures. The European Central Bank (ECB) was establish on 1 June 1998.It is based in Frankfurt am Main, Germany, and aims to maintain price stability and to conduct a single monetary policy across the euro area. This is done through its own activities and through working with the national central banks. Together, the ECB and the euro area national central banks are known as the Eurosystem. The Eurosystem’s primary objective is the maintenance of price stability. It meets its objectives through deciding and implementing monetary policy, conducting foreign exchange operations and operating payment systems.

	Comparison

Charecteristics	Gold dinar	Euro

Reduce dependancy	Many currencies including the	Before the introduction of Euro

on US Dollar	Malaysian Ringgit are floated	currency,the currency of the

	based on the US Dollar.	member countries of Euro

	As a result if the dollar pricing	were more often pegged to the

	goes up the value of the ringgit	is dollar.Eversince Euro introduced

	goes up and comes down if the	the demand of the currency is going

	value of the dollar comes down.	up and more countries are now

	Once the gold dinar is	pegged to the euro currency.

	Introduced , currencies will be

	pegged to the gold which has its

	own intrinsic value and is more

	stable.

Increased price stabilty	We find that in many Islamic	With the introduction of euro currency,

	countries, price of goods is	tremendous price stability has already

	determined by many other factors	been achieved because all the 12

	such as exchange value,price	member countries of Euro

	differentiation, demand ,supply	have become a single economy of goods.

	and so on. But if the goods are

	priced in terms of gold the value

	of goods with respect to gold

	will almost always be the same.




Allah(swt) says in the Quran," And O my people! Give full ,		measure and weight in justice and
reduce not the things that are due to the people and do not commit mischief in the land,
causing corruption.
Surah Hud,Verse-11:85

	Comparison

Charecteristics	Gold Dinar	Euro

Strengthen their currency	Currently most of the Islamic	The member states of th euro

	countries do not issue their	currency, were members of the

	currency based on the nation's	european union previously,but some

	wealth,i.e their natural resources,	countries because of their currency

	rather it is again based on U.S.	weakness,example Spain, Italy

	currency which is a fiat money	were unable to get favourable trade

	subjected to several trade cycles.	agreements.Now since such weak

	This can be improved when they	economies are integrated into the

	use Gold Dinar ,since gold dinar	Euro mainstream their currency

	doesnt involve credit creation	has automatically strengthened

	which means there will be no trade	thereby strengthening the

	cycles also ,and in the absence	economy also.

	of trade cycles,the currency gains

	stability.


To promote	A common currency would help to	Euro currency has been

cooperation	promote cooperation between	successful in promoting

	participating countries in various	cooperation among member

	spheres, as it vastly reduces	countries as in WTO talks,they are

	speculation,arbitrage and in turn	able to pose a common front and

	would boost trade ties and economic	win many potential agreements.

	development

Surah Al-Isra
Allah(swt) says in the Quran,"And give full measure when you measure, and weigh with a balance
that is straight.That is good(advantageous) and better in the end.
Verse-17:35
Charecteristics	Gold Dinar	Euro


Better representation	Since all Islamic countries	This has already been proven

in trade dealing	pose a common front, they	in the case of euro where because of

	are less likely to be rallied	the strength of their currency many

	over by the superpowers	trading countries especially

	using hedging and arbitrage	Asian countries prefer to keep their

	and various trading tactics.	foreign exchange reserves in Euros

	Trading deals can be in	rather than in US Dollar which used to

	terms of dollar equivalent to	be the norm in earlier days

	gold, and not fiat money

	equivalent to fiat money as

	is prevalent now

Inflation	Using Gold Dinar would mean	Since it largely follows the fiat money

	no credit creation like the fiat	system,the creeping of inflation

	money.Also there wont be any	cannot be avoided.Interestingly,

	need to print paper currency	the founders of Euro have realized the

	whenever the economy runs	importance of Gold, and are keeping

	short of funds to repay their	their currency closely pegged to gold

	debts.This is byfar the	besides depending on the floating

	greatest advantage in using	interest rate

	Gold Dinar because it follows

	Islamic Syariah priinciples



Surah-Al Mutaffifin-Verse-83:1
Allah(swt) says in the Quran, 'Woe to Al-Mutaffifin ( those who give less in measure and
weight)

A.Fiat Money

It is money created out of nothing by the power of an issuing authority. In todays monetary system fiat money may be in the form of paper money issued by governments, an accounting entry in the books of a bank,or even a binary bit memory space in a computer.Fiat money is legal tender which means that it must be legally accepted as a medium of exchange and for repayment of debt.

B.Fractional Reserve Requirement

Banks are required to keep a fraction of deposits made by its customers as reserves. This is called fractional reserve requirement.This reserve is required to satisfy normal day to day withdrawal of depositors.

C.Interest based financial system

Interest rates in the fiat money system increases money supply. Interest rates charged or paid by banks and other financial intermediaries are generally computed on a compounded basis.i.e interest is computed for a period of time-annually,monthly or even daily.Thus on a compounded basis,interest is also paid for interest earned in earlier periods.

Gold Dinar

The current fiat money and dinar may co-exist initially while a transition takes place gradually.This is highly desirable because it would provide a transition that is soft and smooth without any sudden shock to the economy.With the advent of Information Technology, it will be smooth going for the dinar as individuals and businesses could connect themselves through the internet and transact among themselves using electronic money with gold backing.

But,we have to admit that in the current malaysian scenario, the islamic instruments are ultimately tied to the interest rates of the fiat money.Interestingly,this is because we still continue using fiat money,once we shift over to gold dinar this problem will diminish soon

When two countries trade,say for example, malaysia and Dubai have trade. They have already certain gold balances with the central bank,say Bank of England. So the malaysian central bank and Dubai's central bank will have their respective gold balance with Bank of England.Here the two trading parties wont be paying each other in gold,rather they would calculate the quarterly balance and try to settle quarterly.

The difference,the party with a favourable balance for eg,malaysia would have the balance equivalent to gold credited in its account with Bank of England.

Multilateral Payment Arrangement

When more than two countries are involved they will all have their accounts with a common central bank.So each country's central bank would settle either quarterly or halfyearly or a suitable period of settlement,they prefer to choose. So when they settle it is the ultimate netoff as a result of trading transactions over a period which would be credited to the particular country's account with the central bank.If the country wants it can redeem its gold also.

E-Dinar

The first Islamic gold dinar ,equivalent to 4.25 grams of 22-karat gold,was issued in 1992 on a very imited scale between the members of the Morabeteen. In 1997,the idea developed into what was called the lectronic dinar,a system based on using the gold as fund through transactions made on the internet. Several countries around the world are currently dealing directly with 100,000 Islamic gold dinars and 50,000 silver dirhams issued by the company,hoping that one day it will replace the us dollar in the dealings of the 1.3billion citizens of the Islamic countries

Conclusion

Gold dinar like the Euro would face difficulties in the initial stage due to the transition from one currency to another currency.

As for the common man gold cannot be carried from place to place that easily, yet this can be solved by putting information technology to its effective use. With the introduction of e-dinar,e-gold this problem is already solved partially. Also gold dinar will have to face the challenge of global acceptability like how the Euro has been accepted by world's major economies. Here again since the value of the gold has been recognized through ages, this would’nt be a problem.

Major world currencies including the Euro, Yuan are trying to peg their currencies to the value of Gold, rather than the US Dollar. This clearly shows a change of focus of major economists, and they are slowly beginning to realize that the fiat money is in the early decline stage after the fall of the once stable US Dollar.

There is also a view that the main reason of U.S. waging a war with Iraq is to acquire the oil reserves so that to stabilise its currency against the increasing Euro.Taking into account all the factors, the only possible way out of these dangerous economic downturns and uncertainities is the introductionof gold dinar in full swing, thus bringing prosperity and stability to the global muslim ummah.

INTRODUCTION

Comparison

Gold Dinar

Multilateral Payment Arrangement

E-Dinar

Conclusion