FIAT MONEY & FRACTIONAL RESERVE BANKING

Fiat money is something (usually in the form of paper or coins) that is recognized as a legal medium of exchange in a country because it is determined by the government which has no value or back up in accordance with its nominal value.

The creation (publishing) of fiat money brings out new purchasing power from something that does not exist. Thus, fiat money provides an unfair advantage, commonly called seigniorage, for the party authorized to issue it.

Profit creation without ‘iwad (countervalue) in the form of ownership risk (ghurmi), value added (endeavor), or liability (daman) is categorized as usury by Ibn Arabi.

In an economic system that uses fiat money, the state authority which is given the authority to issue money (usually the central bank, monetary authority, financial department, or other designated institution) gets this seigniorage advantage. As a result, the purchasing power of money in the aggregate will decrease (or there will be inflation) according to the percentage of money added to the economy. Those who are disadvantaged by the issuance of new fiat money are all people who hold money. For example, if the cost of printing Rp100,000 is Rp2,000, the seigniorage created is Rp98,000.

Meanwhile, money in Islam is full bodied money, or money (usually in the form of gold and silver metal) which has intrinsic value equal to its nominal value, and fully backed money, or money (usually in the form of paper or coins) whose nominal value is in back up 100 percent with gold deposited by the issuing authority. In the issuance of this new money no new purchasing power is created (no seigniorage), so it does not contain elements of usury. Furthermore, in the issuance of new money, printing costs are borne by the government, so that no party is harmed by it.

In an Islamic economic system that uses this type of money, the state authority which is given the authority to issue money does not get a seigniorage advantage, instead it has to pay for printing. The amount of money issued and added to the economy is adjusted to the growth of value added, so that in general the Islamic economy is not inflationary and tends to be stable. Therefore, the value of the dinar and dirham has never changed. The price of a goat has always been equivalent to 1-2 dinars, and the price of a chicken has always been only one dirham. With this type of money the public is not disadvantaged by inflation as caused by the issuance of fiat money

The Fractional Reserve Banking (FRB) system means that banks are only required to keep reserves of a certain percentage of the deposits raised. The required minimum reserve banking varies, generally around 5% – 20%. With this system, banks have the ability to create other types of fiat money, namely bank money (demand deposits,

including electronic money), through multiple deposit creation. In this case money is created when banks provide loans. As an illustration, if the reserve must be set at 10%, deposits of Rp1 million, first recorded as a Deposit on the liability side and cash reserves on the asset side. Because the reserve must be set at 10%, the bank can provide a loan of Rp. 9 million, bringing the total savings to Rp.

With this example number, deposits of Rp1 million can create new money (deposits) nine times the initial savings of Rp9 million, bringing the total savings to Rp10 million. Thus, the fractional reserve bankingsystem also provides an unfair seigniorage advantage for banks which through this system are empowered to create new money. Once again, profit creation without ‘iwad was categorized as usury by Ibn Arabi. This also results in the aggregate purchasing power of money (or inflation) in accordance with the percentage of money added to the economy. The parties that are disadvantaged by the issuance of new fiat money by banks are also all people who hold money.

Meanwhile, the 100 percent reserve banking system does not provide an opportunity for banks to create new money, because 100 percent of reserves must be saved / returned to the central bank. The maximum bank can only distribute financing up to the initial deposit. Thus, no new purchasing power is created (there is no seigniorage), so it does not contain usury, does not cause the effects of inflation, and no party is harmed.

As an illustration, deposits of Rp1 million are first recorded as deposits on the liability side and cash reserves on the asset side. Because the required reserve is set at 100%, the bank can only provide loans of Rp1 million as well, so that on the side of the reserve assets turn into loans of Rp1 million.

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