This Banking Model Can Eliminate Inflation, Debt, and Interest Costs from Pakistan

Pakistan’s huge debt servicing problem can be resolved through full reserve banking, which will eliminate high inflation, government debt, and interest costs. Full reserve banking represents a transformative shift toward financial stability, economic growth, and inclusive prosperity; it has a clear overlap with the principles of Islamic economics and the true foundations of Islamic banking.

This was proposed by Qanit Khalil, chartered accountant and economic analyst, during a roundtable titled “A Solution for Tackling Huge Government Debt, Interest Costs, and Inflation in Pakistan: Full Reserve Banking Model” held at the Institute of Policy Studies (IPS), Islamabad. The session was also addressed by Khalid Rahman, chairman, IPS, Tahir Hijazi, former member Planning Commission, and economists and financial experts.

In his proposal to address Pakistan’s economic challenges, Qanit Khalil advocated adopting full reserve banking as a transformative solution with far-reaching implications. He said that a staggering 60 percent of government revenue is currently allocated to interest payments, fueled by increased expenditure on debt servicing from less than Rs. 200 billion in 2003-04 to a staggering Rs. 7,300 billion in 2023-24. Out of this, 90 percent of interest costs are for servicing domestic loans and not foreign loans.

The speaker highlighted that with continuously increasing domestic debt, the Government of Pakistan had to take large loans from banks to pay for the huge interest costs due to the State Bank of Pakistan’s high-interest rate policy. The rupee has also fallen to a record low because of the increased money supply and a massive deficit in the external trading account.

SBP’s high-interest policy implemented to curb inflation has proven counterproductive and resulted in diametrically opposite results, he lamented. Quoting the Pakistan Economic Survey 2022-23, he underscored that interest rates and inflation have been increasing simultaneously. Referring to the World Bank Report on the counterproductive SBP policy, he indicated that financing the fiscal deficit through bank borrowing has rapidly increased the monetary base, contributing to inflationary pressures.

Speaking on the fractional reserve banking cycle, Khalil stated that the government of Pakistan has heavily relied on budgetary borrowing from the SBP, leading to an unsustainable monetary expansion as a 5 percent reserve ratio has a 20x multiplier effect.

He proposed that an innovative economic solution to these problems is full reserve banking to tackle high government debt and interest rates. In this model, the State Bank would maintain 100 percent reserves against deposits, ensuring centralized and controlled money creation. Moreover, payment and credit extension processes, or deposit and investment banking, would be completely separated; deposits could not be used for financing loans. Instead, loans would be financed by the investment accounts of savers in investment banks.

This approach seeks to eliminate the colossal government debt burden, with interest rates reduced through a more streamlined financial system. Khalil stated that the fractional reserve system, responsible for money supply fluctuations, can be efficiently replaced with a full reserve system, creating a stable economic environment. He further said that a deeper examination of the concept of full reserve banking reveals a clear overlap with the principles of Islamic economics and the true foundations of Islamic banking.

Tahir Hijazi mentioned that according to recent data, only a small number of Pakistanis have bank accounts, highlighting the need to increase financial accessibility. The proposed banking model is not without difficulties and risks; for instance, various lobbies could create hurdles in its implementation. He recommended that deeper research and discussions should be conducted to cover more topics like integrating profit-sharing into interest rates.

In his concluding remarks, Khalid Rahman highlighted that implementation issues of the full reserve banking model must be addressed, and experts should develop and discuss alternative options to tackle prevalent challenges. He emphasized developing a legal framework more conducive to a banking system that facilitates businesses, enables progress, and offers solutions to individual needs through real utilization of resources. He added that the proposed full reserve banking model has the potential to provide a comprehensive plan to address Pakistan’s financial inclusion problems by taking small, incremental measures.

Rahman further said that the IPS will facilitate the discussions and research into this idea for its refinement and viability for the good of all stakeholders.

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