The Chicago Plan for 100 per cent reserve banking was motivated by the experience of financial upheaval in the 1930s: unsecured bank lending, commercial insolvencies, the Wall Street crash and the Great Depression. Its core focus was the radical reform of commercial banking – new legislation would abolish the ‘money substitutes’ created by fractional reserve banking. Commercial bank lending is especially profitable when it is not fully backed by reserve assets. Problems arise when there is an exceptional withdrawal of bank deposits; and if those withdrawals persist, ‘fire sales’ of assets may become the forerunner of bankruptcy. Under the Chicago Plan, commercial banks would hold only central bank money (i.e., banknotes and reserves). Interest paid on banks’ deposits would cease, and customers would instead pay a charge for deposit security. Longterm investments would be financed by the provision of capital in equity form. Although there are neither contemporaneous nor recent comparisons, the Chicago Plan resonates with the principles of Islamic banking, as initially established in the relatively small communities of the distant past, where local knowledge, close personal relationships and wide income disparities shaped the social context. Benign and/or quasi-feudal relationships were integral to the rich lending to the poor, and to a perspective wherein interest was judged badly: as unproductive; as an exploitation of borrowers by lenders; as delivering fixed returns without risk of loss; and as inciting speculation. Where banking and finance are founded upon Islamic principles, perceptions are encouraged of an enhanced efficiency, greater prosperity and social stability. Islamic banking prohibits riba (charged interest), and promotes equity partnerships: an investor provides capital and a trading partner provides skill and labour. Among a number of options are: a trust that owns and leases a property for rent, where an entitlement exists to buy the property; a bank that purchases a commodity on behalf of a client, who makes deferred payments; an investment or purchase that is jointly funded, with bank and client sharing risks and returns in predetermined proportions; and a bank that receives fees for managing a client’s trading activities. Yet, the prohibition of riba runs against a definitional problem: the payment of interest is implicit in every value transaction over time. For example, as the current owner of rawmaterials eventually sells those commodities or goods manufactured from them, the ratio of future value to the initial value defines a proportionate yield (i.e., interest). As every inter-temporal trade defines a proportional yield (interest), riba cannot be the core issue. For Western banking, a repurchase agreement (repo) is most commonly used by commercial banks to increase its holdings of reserve assets. With a repo transaction, a commercial bank sells a security to the central bank, thereby obtaining reserves; the conditional agreement is to repurchase the security at a later date. The difference between the repurchase price and the sale price sets the opportunity cost of reserves (liquidity). Inter-bank competition ensures that inter-bank lending occurs close to that rate. Although ‘interest’ is central to the transaction, a Shariah-compliant ‘agreement’ achieves a near-identical outcome. This is the ‘sell-and-buyback transaction’, which follows the Western form except for the substitution of a ‘fee’ within an otherwise identical transaction. By another arrangement, sukuk (Islamic bonds) serve as collateral for tenors of up to one year, where the Shariah 42 | ‘‘ ’’ Although there are neither contemporaneous nor recent comparisons, the Chicago Plan resonates with the principles of Islamic banking, as initially established in the relatively small communities of the distant past, where local knowledge, close personal relationships and wide income disparities shaped the social context...
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