COMMERCIAL BANKING IN THE PRESENCE OF INFLATION (PB)

Preface
Inflation has become a fact of life and affects nearly everybody, every country, and every aspect of life. As far as commercial banking is concerned, it erodes the value of the depositors’ savings as well as the banks’ loans. Yet the banking system does not explicitly address this problem, for there is neither any legal requirement to do so nor any technical necessity. Legally, the problem does not exist – one thousand today in any currency is legally one thousand tomorrow or ten years later, irrespective of any changes in its purchasing power. Technically, the rate of inflation is so similar to the interest rate that the bank has to simply increase its interest rate by an estimated inflation rate to aCCommodate the concerns of all the parties involved: the bank, the depositors and the borrowers.
However, since this estimated rate is only an estimate and is made at the beginning of the term of the deposit (or the loan), it may well tum out to be an overestimate of the inflation rate realized during the term or an underestimate. In either case one of the three players is going to bear the loss at the expense of another, since no corrective step is taken when the realization turns out to be different from the estimate. This is an unsatisfactory situation. The results of a study undertaken to inquire into this problem are reported in this book. The main aim was to devise a method to aCCurately determine the realized inflation component contained in the interest paid (or charged) by the bank.
The study was spurred by the special concerns of those who abhor receiving interest payments for religious or other reasons. For when they reject the paid interest, they also reject the little compensation for inflation contained therein resulting in their capital losing some of its purchasing power. It is as if they are being punished for their religious (or other) conviction, and for their desire to act on it. This too is unfair. The question needs to be squarely faced and satisfactorily resolved if an interest-free banking and financing system is to become a viable reality.
I must apologize for the long delay in bringing out this volume. It is more than two years overdue. Partly my poor health is to blame, and partly the very nature of the subject under investigation. But then it is this very illness that brought me to this field. And the delay has only helped to give more thought to the study and its presentation. In fact, when I thought I had come to the end of the book, I had to reconsider the entire approach and completely re-write the book.
The solution offered may be controversial, but I would kindly ask the reader to bear with me and approach the book with an open mind and read through it in chapter-sequence, without skipping sections. The important thing is the method of approach, not the solution itself. I welcome all constructive criticism.
I am grateful to many of my friends and family for their moral support and encouragement. And to the publishers for their understanding of the delay, often at the expense of their reputation at not being able to positively respond to many orders for the book.
Professor Elmer Sterken, Professor Jan Oorburg, Professor Gerard Sierksma and Dr. Fouad Koudjeti have critically commented on previous versions of this work. There are also others who have read the manuscript but have not had much to comment. l am thankful to all of them. I must also thank Professor Khurshid Ahmad, Dr. Fahim Khan and Dr. Nawwaf Kharma for their interest in my work. It sustained me through the last few hurdles. Causal Perera and Wobbc Langeveld readily agreed to go through the manuscript, and have done a very good job of editing. They deserve my special thanks.
All errors are of course mine alone.
A.L.M. Abdul Gafoor
ABOUT THE BOOK
Inflation has become a fact of life in nearly all countries, but it is a very serious problem in developing countries. As far as commercial banking is concerned, it erodes the value of depositors’ savings as well as that of banks’ loans. Yet the banking system does not seem to specifically address this problem. This book makes an attempt at finding a way of compensating for the loss of value suffered by capital due to inflation.
The book studies various existing measures of inflation, rejects all as unsuitable for measuring inflation on capital with which the present work is concerned, specifies the characteristics required of a measure appropriate to the purpose, and constructs a new index to measure inflation on capital. Banking transactions affected by inflation are identified, and the new measure is used to compute the loss suffered by capital in those transactions. The method presented here is a general one, universally applicable to all lending-borrowing operations, to neutralise the effect of inflation on such transactions. It is simple and straightforward.
The method has special relevance to interest-free banking. For whereas in a conventional system, the interest paid to the depositors may fully or partially compensate for the loss, and the banks may include it in the interest they charge the borrowers, in an interest-free system the depositor will have to bear, the full loss.Therefore a method for compensating that, loss becomes even more urgent. It is on that aCCount that this book forms the third in a series of three books which, taken together are expected to provide a comprehensive banking and finance system that addresses the concerns and needs of Muslims today The other titles are :
Interest -free Commercial Banking and Participatory Financing through Investment Banks and Commercial Banks.
Written lucidly in simple English, it is suitable for reading by professionals and academics as well as by the general public.