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Comparing Negative Interest Rates Policy & Mudarabah Investment Deposits

April 22, 2019
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Comparing Negative Interest Rates Policy & Mudarabah Investment Deposits

By Muadz Abdul Jalil

Heavyweight economies such as Sweden, Denmark, Switzerland, Japan, and EU (via the European Central Bank) initially introduced negative interest rate policies in order to stimulate their economies through money lending activities and to attract more local and international borrowers.

The negative interest rates policy is a financial policy practiced by central banks by cutting interest rates to below zero. This makes borrowing cheaper but savings less attractive as depositors have to pay for keeping their money with banks. Most policymakers took this path to reduce borrowing costs for companies and households and drive demand for loans.

In June 2014, the European Central Bank (ECB) reduced its interest rate, at which it lends to commercial banks, to 0.15% and its deposit rate, which it pays to banks on their reserves, to -0.1%. Three months later, the ECB reduced the deposit rate again, to -0.2%. Later on, the Central Bank of Denmark set its main policy rate below zero for much of the past three years to repel capital inflows. In January 2015, the Swiss National Bank resorted to negative interest rates to deter investors from buying francs. In February 2015, Sweden’s Riksbank set its main policy rate to negative to weaken the krona. In January 2016, the Bank of Japan followed the same approach by introducing 0.1% charges on banks for parking additional reserves with the Bank, to encourage banks to lend and prompt businesses and savers to spend and invest.

Although its early intention was to stimulate lending transactions in the economy, empirical research has shown that negative rates are less accommodative, could pose a risk to financial stability if lending is done by high-deposit banks, causes the usual transmission mechanism of monetary policy to break down due to lesser profits for banks and could contract the total effect on aggregate output.

Shariah Views, Solutions to Negative Interest Rates

From the shariah perspective, there have been concerns that negative interest rate policy could harm both the domestic and global economies. As far as Islamic shariah is concerned, the concept of Riba or prohibition of interest or usury does not differentiate between positive or negative interest rates. Both are riba.

Islamic financing instruments, especially those offering real-asset backed and profit-risk sharing features, could be a robust alternative to interest rate financing. Equivalent alternatives for interest-based loan transactions include Shariah-compliant models such as zero-profit-loan Qard Al-Hasan, cost-plus-profit of Murabahah sale contract, and risk-and-profit-sharing contracts of Mudarabah and Musharakah.

Specifically, the Mudarabah investment deposits offered by Islamic banks are perceived as the most similar model to interest-based money-lending transactions. To strengthen Islamic finance, we hope to promote Islamic financial instruments as a competitive alternative to conventional financial products.

However, one drawback of Mudarabah investment deposit instruments is its lower profit rate, in comparison to comparable interest-based instruments. More could be done to improve the operational aspects of Islamic financial institutions in order to increase the efficiency and lower the cost of financing, thus increasing the potential profit rate. This could help establish Islamic finance instruments as a robust alternative to interest-bearing instruments, whether positive or negative.

This is the executive summary of a case study written by Muadz Abdul Jalil, as a requirement for the MIA Islamic Finance Mini Pupillage Programme.

You might also be interested to read the article on ‘Improving the Governance of Shariah Committees’ by Halimaton Mohamad.

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