Fractional reserve and genuine Islamic banking where the core deposits are based on profit sharing and the core financing operations are for asset financing, the client actually getting ownership o the assets - is actually a more stable and efficient alternative.

1. Suggestions for reforming
the global banking system
– what have Islamic
banking, fractional
reserve system and the
Chicago Plan in common?
Tariqullah Khan

2. Suggestions for reforming the global banking system
100% reserve banking system
The current banking system, which is based on fractional reserve, allegedly empowers the banks to generate
financing, far exceeding the needs of the real economy. Scenario-1 of the next slide shows this possibility. 1)
conventional banks create credit based on the credit worthiness of clients rather that financing a real economic
transaction. 2) In the economy there are users of funds with different credit ratings and with different spreads for risks
and 3) hence a $100 initial credit, which in the first place is not linked to the real economy, can create an unlimited
number of subsequent credits. As a result, the financial sector of the economy far exceeds the real sector and we
experience reoccurring banking instabilities and financial crises. One solution is the replacement of the current
fractional reserve banking system with a system based on 100% reserve, curtailing the banks’ power of credit creation.
See, the August 2012 - IMF working Paper (WP/12/202) “The Chicago Plan Revisited” by Jaromir Benes and Michael Kumhof -
http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf
Does Islamic banking make a difference?
Islamic banks are creating finance by two different variants of deferred trading, described as Scenario – 2 and Scenario
– 3 of the next slide. Scenario -2: This scenario represents a case in which the client is genuinely interested in buying
an asset (e.g., a car) with the financing of the bank in the form of a deferred sale, known as financial Murabahah.
Without the asset in question, in fact there is not possibility for the bank to create finance. Hence finance remains
within the boundaries of the real economy. By consensus, this scenario represents a core legal and genuine Islamic
financing arrangement , which obviously is driven by the financing needs of the real economy.
Scenario-3 , in contrast, represents a situation in which the client is not interested in buying any asset, rather, the
client is interested in obtaining cash from the bank. The asset is merely used to complete a legal trick and hence the
same asset can be used for creating multiple financing transactions exactly, like the first scenario of interest-based
credit creation.
Therefore, Islamic banking can make a difference only if its genuine form is followed. The
genuine form also allows for harnessing the benefits of fractional reserve system, while
strictly tying finance creation with the needs of the real economy; simultaneously, also
achieving the goals of the Chicago Plan in promoting banking stability.

3. $100 $100 $100 $100 $100
$100
$100 $100 Tawaruq
$100 Tawaruq Tawaruq
$100 Tawaruq
Tawaruq
Financing Scenario -3: But if we make non-genuine
Murabahah like Tawaruq as the core business, this
scenario prevails which is almost similar to Scenario -
1, where financing gets out of the real economy.
BANK Murabahah Financing Scenario-2: If we make genuine Murabahah
as the core business of banks, this scenario prevails,
for asset where financing cannot get out of the real economy.
In this scenario, we can benefit from the advantages
$100 of the fractional reserve banking system but at the
same time also avoiding the excessive and unhealthy
credit creation by banks.
5% interest
7% interest
10% interest
Financing Scenario-1: If we make lending as the core
commercial activity of banks, financing gets out of the real
15% interest
economy and this scenario is the real possibility as lending will 20% interest
be primarily based on ratings and credit risk.
$100 $100 $100 $100 $100