Changing tracks: ‘Time multiple counter loans’
The innovative concept – which operates on interest-free loans –may change the face of banking forever.
LONDON:
Some initiatives have been taken around the world which attempt to offer interest-free loans to programme participants.
One such initiative is the Swedish JAK Medlemsbank (translated as Members’ Bank), which also has operations in Ireland. There are other banks that attempt to help the charity sector grow, and have contributed to the development of social enterprises in their respective jurisdictions. Charity Bank and CAF Bank in the UK are two such examples. If studied, such initiatives can potentially influence and benefit the banking sector in Pakistan – where interest free loans are still a dream for many – and its role in developing and supporting social enterprises in the country.
A novel approach was suggested by a Pakistani economist, the late Sheikh Mahmud Ahmad, in this regard in the 1970s to the State Bank of Pakistan (SBP). Although he failed to convince the SBP leadership at the time, his thoughts, nevertheless, are worth revisiting. His basic proposition centred on what he termed as Time Multiple Counter Loans (TMCL).
The idea can be summarised with the help of two concepts: a vertical loan and a horizontal loan. A vertical loan is a large amount borrowed for a short period, while a horizontal loan is small, but borrowed for a longer period. A vertical loan and a horizontal loan are considered equal in value if their amount-period values are the same. For example, a loan of Rs1,000 for 30 days (a horizontal loan) is equal in value to a loan of Rs30,000 for one day (a vertical loan).
A banking system based on TMCL allows banks to offer interest-free vertical loans against interest-free horizontal deposits. For example, someone applying for an interest-free loan of Rs100,000 for one year will have to deposit a sum of Rs10,000 for 10 years or a sum of Rs5,000 for 20 years. While the customer returns the loan after one year, the bank uses the money deposited by the customer for a longer period for its own benefit.
The system is more just and equitable than the existing interest-based banking model. Comparing the two models will explain the differences: suppose an interest-based bank offers a loan of Rs100,000 to a borrower at a 10% rate of interest for a period of three years. If simple non-compound interest is applied, the borrower returns Rs100,000 and Rs30,000 interest over a period of 36 months in monthly instalments of Rs3,611.11. On the other hand, a TMCL of Rs100,000 for three years would require the borrower to make a horizontal deposit of Rs15,000 for 20 years. The borrower can return the money in one go at the end of the three years or, preferably, in 36 monthly instalments of Rs2,777.77.
The total cost of borrowing from an interest-based bank would therefore be Rs30,000; while a borrower on the basis of TMCL would forego the use of Rs15,000 for a period of 20 years (his net cost of borrowing would be Rs15,000 minus Rs2,229.65, which equals Rs12,770.35 – if we consider the present value of Rs15,000 and assume a discount rate of 10% for a period of 20 years).
It can be shown that a banking system based on TMCL is not only more just for borrowers, but also reasonably profitable for the banks. For example, when the customer receives his Rs15,000 back at the end of 20 years, the bank will have earned a profit of Rs85,912 from the investment of the 20-year deposit (assuming an annual rate of return of 10%).
Although the interest-free bank seems worse off as compared to an interest-based bank, it would receive a number of other benefits which the former would not enjoy. Customer loyalty is on top of the list. In an environment where an interest-based bank charges significantly more upfront (or in instalments), comparatively, the interest-free bank would have a huge competitive advantage over the former. The deposit-base of the interest-free bank would be fixed and long-term as compared to an interest-based bank.
If the TMCL model is combined with some of the characteristics of the Swedish JAK Medlemsbank, it is expected that this hybrid model will help in improving savings amongst its customers. While conventional banks may be reluctant to adopt the TMCL model, it has profound implications for the further development of Islamic banking in Pakistan.
A smart application of TMCL in Islamic banking will raise the image of Islamic banking as more responsible, more just and a more equitable form of banking as compared to conventional banking. The latter is fast losing credibility in the world – especially in the Western world – where a visible social movement against exploitative practices of banking and finance has emerged over the last few years.
THE WRITER IS AN ECONOMIST AND A PHD FROM CAMBRIDGE UNIVERSITY
Published in The Express Tribune, June 18th, 2012.
Some initiatives have been taken around the world which attempt to offer interest-free loans to programme participants.
One such initiative is the Swedish JAK Medlemsbank (translated as Members’ Bank), which also has operations in Ireland. There are other banks that attempt to help the charity sector grow, and have contributed to the development of social enterprises in their respective jurisdictions. Charity Bank and CAF Bank in the UK are two such examples. If studied, such initiatives can potentially influence and benefit the banking sector in Pakistan – where interest free loans are still a dream for many – and its role in developing and supporting social enterprises in the country.
A novel approach was suggested by a Pakistani economist, the late Sheikh Mahmud Ahmad, in this regard in the 1970s to the State Bank of Pakistan (SBP). Although he failed to convince the SBP leadership at the time, his thoughts, nevertheless, are worth revisiting. His basic proposition centred on what he termed as Time Multiple Counter Loans (TMCL).
The idea can be summarised with the help of two concepts: a vertical loan and a horizontal loan. A vertical loan is a large amount borrowed for a short period, while a horizontal loan is small, but borrowed for a longer period. A vertical loan and a horizontal loan are considered equal in value if their amount-period values are the same. For example, a loan of Rs1,000 for 30 days (a horizontal loan) is equal in value to a loan of Rs30,000 for one day (a vertical loan).
A banking system based on TMCL allows banks to offer interest-free vertical loans against interest-free horizontal deposits. For example, someone applying for an interest-free loan of Rs100,000 for one year will have to deposit a sum of Rs10,000 for 10 years or a sum of Rs5,000 for 20 years. While the customer returns the loan after one year, the bank uses the money deposited by the customer for a longer period for its own benefit.
The system is more just and equitable than the existing interest-based banking model. Comparing the two models will explain the differences: suppose an interest-based bank offers a loan of Rs100,000 to a borrower at a 10% rate of interest for a period of three years. If simple non-compound interest is applied, the borrower returns Rs100,000 and Rs30,000 interest over a period of 36 months in monthly instalments of Rs3,611.11. On the other hand, a TMCL of Rs100,000 for three years would require the borrower to make a horizontal deposit of Rs15,000 for 20 years. The borrower can return the money in one go at the end of the three years or, preferably, in 36 monthly instalments of Rs2,777.77.
The total cost of borrowing from an interest-based bank would therefore be Rs30,000; while a borrower on the basis of TMCL would forego the use of Rs15,000 for a period of 20 years (his net cost of borrowing would be Rs15,000 minus Rs2,229.65, which equals Rs12,770.35 – if we consider the present value of Rs15,000 and assume a discount rate of 10% for a period of 20 years).
It can be shown that a banking system based on TMCL is not only more just for borrowers, but also reasonably profitable for the banks. For example, when the customer receives his Rs15,000 back at the end of 20 years, the bank will have earned a profit of Rs85,912 from the investment of the 20-year deposit (assuming an annual rate of return of 10%).
Although the interest-free bank seems worse off as compared to an interest-based bank, it would receive a number of other benefits which the former would not enjoy. Customer loyalty is on top of the list. In an environment where an interest-based bank charges significantly more upfront (or in instalments), comparatively, the interest-free bank would have a huge competitive advantage over the former. The deposit-base of the interest-free bank would be fixed and long-term as compared to an interest-based bank.
If the TMCL model is combined with some of the characteristics of the Swedish JAK Medlemsbank, it is expected that this hybrid model will help in improving savings amongst its customers. While conventional banks may be reluctant to adopt the TMCL model, it has profound implications for the further development of Islamic banking in Pakistan.
A smart application of TMCL in Islamic banking will raise the image of Islamic banking as more responsible, more just and a more equitable form of banking as compared to conventional banking. The latter is fast losing credibility in the world – especially in the Western world – where a visible social movement against exploitative practices of banking and finance has emerged over the last few years.
THE WRITER IS AN ECONOMIST AND A PHD FROM CAMBRIDGE UNIVERSITY
Published in The Express Tribune, June 18th, 2012.