The essence of Islamic concept of economic justice is to take and give what is genuinely due, nothing more, nothing less. Economic injustice is the rationale for prohibition of interest in Islam. The related Quranic verse—“ you shall not wrong, nor shall you be wronged” –is crucial as it captures the essence of economic justice.
This article is focused on the treatment of depositors by banks in general and Islamic banks in particular and how far this meets the requirements of Islamic economic justice. I Stating the obvious, the banks have been exploiting depositors and the exploitation has intensified in recent years.
Banks have been extremely niggardly in increasing the return on deposits in proportion to the returns they get. The weighted average of return on bank advances has improved from 6.49 in June 04 to 11.27 per cent at the end of December 07, but the weighted average of return to depositors has gone up from 1.31 to 4.13 per cent As a result, the banking spread has widened from 5.23 to 7.14 per cent. The ratio of the spread to the return on deposits works out to 173 per cent. This has enabled banks to make huge profits and their after-tax profit has gone up from Rs24.7 billion to Rs84.2 billion.
The amount of mark-up\return\interest earned by banks increased from Rs116.7 billion in CY 03 to Rs307.1 billion in CY 06, but their expenses on these accounts rose from Rs42.1 billion to Rs133.6 billion, the difference more than doubled from Rs74.6 billion to Rs173.5 billion.
The banking spread for Islamic banks is not available but they seem to be no different from conventional banks as may be obvious from the Table:
The return on deposits, small in nominal terms, has been negative in real terms because of increasing inflation. The return has also been subject to 10 per cent withholding tax regardless of the fact whether the person qualified for income tax or not. The minimum income for income tax is Rs150 thousand and rate of tax in the first bracket is five per cent. The depositors subject to income tax are able to club the return with their other income and get relief of five per cent in the initial tax rate bracket, but the depositors not rich enough to be in that class have to bear the full brunt of the tax. This makes a mockery of equity.
As a further measure to deny return to small depositors, banks lay down the condition of minimum balance to earn return, which is quite high in relation to the average annual per capita income. For instance, it is Rs20 thousand in case of NBP and that represents 38.2 per cent, or 4.4 months’ per capita income. This leaves the small depositors in the cold. Banks have also fixed minimum balance to be maintained and in case of shortfall, there is the minimum monthly service charge of Rs50 which eats away very small deposits in no time.
No wonder, despite economic growth and increase in population, particularly in urban areas, the number of deposit accounts has fallen from 31 million in June 1999 to 25 million in December 07. The main reduction has been in personal bank deposits (they include non-corporate business) and they are now down to 16 million accounting for only 10.1 per cent of the population. The ratio of volume of balance in these accounts to GDP (FC) in FY07 was 17.3 per cent.
Being the guardian of financial institutions, the central bank is looking after the interest of depositors who are not organised to have an effective lobby to protect their interest. The SBP Governor has been publicly urging banks to improve the return to depositors.
Unfortunately, the State Bank has been a party to the exploitation and wittingly or unwittingly, it plays an active role. For the then interest-free banking, it laid down the formula for distribution of income between the banks and depositors. In terms of BCD Circular No.34 dated 26th November, 1984, for non-interest income, banks were allowed to charge, on the balance arrived at by deducting from the income proportionate administrative cost and provision for bad\doubtful non-interest based assets 10 per cent as management fee.
The weightage for PLS deposits ranged from 0.65 percent for special deposits withdrawable at 7 to 29 days’ notice to 1.3 per cent for term deposits for in excess of six months. In sharp contrast, banks’ equity could be given a weightage not exceeding five, as determined by the bank concerned. There can be no justification for the management fee on top of administrative cost and weightage of as much as five to the banks’ equity at the discretion of the bank concerned. This is a blatant favour to banks and gross injustice to depositors.
The State Bank also indirectly works against the interest of depositors. Instead of serving as the lender of the last resort, which means temporarily easing the liquidity problem of banks on a limited scale, it has been serving as a source of capital on a massive scale. The developmental role of the SBP for supporting financial institutions is a relic of the late forties and early fifties of the last century when there was dearth of private capital.
This is no longer justified as private capital is available in abundance. The other reason is the central bank lending to government to meet the fiscal deficit. In the process, the State Bank has been creating primary reserves thus adding to excess liquidity making banks complacent and indifferent to deposit mobilisation As of end-December 07, the bank’s claim on financial institutions and government (net) accounted for as much as 55.7 per cent of reserve money.In fairness to depositors, the State Bank should immediately scrap the weightage given to bank’s equity for distribution of the income and make it proportionate. There is no justification for the management fee. The bank should also give up its developmental role and confine itself to its traditional function of lender of the last resort. The central bank financing of the fiscal deficit should be given up totally. Let the financial institutions and government go to the market, which has enough capacity to more than meet these requirements. It would only make financing a bit more costly but that should be no concern of the central bank. Let government, instead of tinkering with cost of borrowing to contain the burden of domestic debt, do something about the volume of borrowing through proper financial management and live within its means.
There is a plethora of literature on Islamic banking but it is mainly confined to the asset aside of banks and any discussion of their liability side is conspicuous by its absence and depositors suffer from this neglect. PLS accounts are just a misnomer as they are not based on any kind of profit and loss, whether of banks or their borrowers. What needs to be sorted out is the status of banks vis-a-vis depositors. Is this relationship that of a (a) trustee, (b) agent, (c) borrower, or (d) partner? Only the return to depositors properly related to these categories can assure justice to the depositor.
