Salman Ahmed Shaikh

It is encouraging to see the commitment of the authors to engage with criticism of their proposal. Such efforts to engage with critical issues of the economy and society are highly respectable and deserve appreciation.

Some further clarifications are humbly provided in response to the rejoinder by the authors.

It would have been better for the authors to present a counter-example of how full-reserve banking has been applied in practice and with what results. There is zero evidence in this regard both in the book and the rejoinder. It is because no country has ever fully applied the 100% full reserve banking.

The authors present the case for full-reserve banking by citing the macroeconomic problems. Their claim is that these macroeconomic problems are caused by the fractional-reserve banking system. It was humbly requested earlier that mere correlation or concurrence cannot be called evidence of causality. The authors need to establish causality through a theoretical model and rigorous empirical evidence.

The noted authors have stellar careers in accounting, auditing, and finance. However, in the academia of economics, when reference is made to empirical evidence, it is expected that rigorous analysis will be carried out to determine causality. Merely presenting the balance sheet of the central bank and replacing historical accounting numbers with new numbers ignores the fact that economic data are the result of choices by investors, depositors, and businesses, and cannot be treated as fixed historical accounting records.

The authors assume that business will continue as usual while:

• writing off all government debt with the stroke of a pen;

• bringing the interest rate to zero;

• imposing a 1% deposit-handling fee on all deposits;

• banning the withdrawal of investments in fixed deposits for six months, and subsequently requiring a one-month notice to withdraw investment deposits after the lapse of the six-month period;

• linking monetary expansion with GDP growth, to be decided by a money-creation committee; and

• capturing remittances by non-resident Pakistanis to be used by the State to pay foreign debt.

The authors, who are accomplished accountants, are confident that these six changes will allow business to continue as usual and that the previous balance sheet of the central bank will be transformed into a new balance sheet, with nothing changing on the ground in terms of the expectations and choices of investors, depositors, and businesses.

In the book review (see here), it was humbly stated that things will not remain as usual. Of course, when there is no actual applied example or case study of full-reserve banking, the ‘hypothetical’ and ‘never implemented’ proposal can only be analysed in the light of economic theory. The summary of concerns raised in the original book review regarding the proposal was:

• A government with no obligation to pay debt and capturing 100% seigniorage revenue (difference between nominal face value and printing cost of money) can become more irresponsible in spending than in the current system;

• giving money-creation authority to a money-creation committee will create conflicts of interest and opportunities for political manoeuvring;

• linking money creation to GDP growth will stagnate the economy further under supply shocks. When real GDP growth goes down and becomes negative, money-supply contraction can be counter-productive;   

• a 1% fee on deposits will result in bank withdrawals and flow of investments into gold, foreign currency, and real estate, as well as capital flight;

• with an abrupt zero-percent interest rate, deposits in investment accounts will only be kept by those who are willing to bear investment risk; the rest will invest in gold, foreign currency, and real estate or simply take their investment out leading to capital flight;

• a decrease in demand and investment deposits will make financing even more difficult to obtain for micro-enterprises, start-ups, and small firms under 100% full-reserve banking;

• large and long-term financing needs will be difficult to meet when the average maturity profile of investment deposits is short-term and the pool of investment deposits available for financing under 100% full-reserve banking is small;

• As a result of point 6, 7 and 8, if the government does expand fiat money supply by not necessarily pegging it with the exact fixed rate of GDP growth, then this monetary expansion can lead to inflation; 

• state capture of remittances to pay foreign debt will cause people to avoid sending remittances, or at least avoid formal banking channels.

As explained in the book review, the authors have not talked about replacing fiat money with asset-based or commodity-based money, such as gold. They are not apprehensive of fiat money; rather, they are apprehensive and critical of the fractional-reserve system. Hence, fiat money creation will be decided by the ‘money creation committee’.

If the authors strictly link it to GDP growth under 100% full-reserve banking with a 0% interest rate, then it could stall the economy during recessions. If they relax this fiat monetary expansion so that it is not necessarily tied strictly to actual GDP growth, then this centralized money creation can be more uncoordinated and susceptible to political economy challenges than the current system, in which banks are licensed to create money while issuing loans, where each loan transaction is carefully evaluated from all angles in a decentralized way.

In the current system, banks check the creditworthiness and possible operational, liquidity, credit, default, and market risks related to each loan contract, the subject matter, and the resulting implications of each loan transaction for the bank’s own solvency, capital adequacy, and liquidity coverage. Banks operate under Basel Accords, central banking oversight, and prudential regulations. They are first set up with actual paid-up capital to get a license to conduct banking. In Pakistan, commercial banks need to put up their own paid-up-capital of up to Rs 23 billion and maintain capital adequacy ratio of 10% to 15% depending on their risk profile.

Furthermore, the authors do not discuss alternative pricing benchmarks for contracts such as Murabaha, Ijarah, and Diminishing Musharakah. The authors wrote in the book that these contracts will still be used even after bringing interest rates down to zero. The authors and other researchers may read this research paper, which provides an alternative pricing benchmark: https://www.emerald.com/jiabr/article/doi/10.1108/JIABR-12-2024-0495/1364261/Pricing-Islamic-finance-contracts-by-decoupling   

Lastly, the noted authors are established accountants, auditors, and tax experts. However, in academia, when the term ‘empirical evidence’ is used, it does not refer to summary tables and time charts of macroeconomic indicators in isolation. Just because the current financial system is not perfect, it does not automatically mean that one should try a ‘never-implemented’ proposal that carries such apparent challenges.

There is nothing sacred or perfect about fractional-reserve banking. It can be replaced with a better system if it leads to better results comparatively. However, rather than being replaced with 100% full-reserve banking, it is now increasingly being replaced by a transformed monetary regime where there are no reserve requirements to begin with. Many advanced countries have even done away with formal mandatory reserve requirements.  

In the fractional reserve system, as the money is created when a loan is granted, it is also destroyed when the loan is repaid, as also acknowledged by the authors in the book. Therefore, it is not like monetary expansion just drifts away with no controls and restraints. When the economy is to be cooled down and inflation is to be checked, the interest rates are raised to check monetary expansion. Even in the current monetary systems, there are multiple regimes, such as ‘nominal income targeting’ as well as ‘inflation targeting’.

Economists generally are not too apprehensive if the inflation rate is low as it provides the adjustment through the business cycles when the wages are downward sticky. The problem comes when the inflation rate is high and unanticipated. By and large, working under the fractional reserve system and now even ‘no reserve’ system, the advanced economies having a higher penetration and depth of the fractional reserve system do not have high inflation, high interest rates and high rates of poverty to begin with.

As per the quantity theory of money, monetary expansion with no subsequent effect on real GDP will result in inflation if the velocity of money is constant. Debt based money creation where government owes debt to the private sector restrains government. Monetary expansion through money creation committee without debt can potentially relax the restraint. The authors clarify that the restraint in their system will be a fixed-rule based monetary expansion where monetary expansion is linked to the real GDP growth. But, as highlighted, this can be highly problematic under the supply shocks.

Furthermore, the banks are able to provide long-term financing even when the average maturity of deposits is shorter than average maturity of the loans under the fractional reserve system. By bifurcating deposit and investment function and tying credit creation to the asset pools maturity wise in a full 100% reserve banking system, the long term financing will decline if the actual investment deposits of long term maturity also decline after the implementation of the proposal. The large corporations will still be able to issue bonds and Sukuk, but the small microenterprises, start-ups, SMEs and households requiring house finance will face a disadvantage.  

Citing a few quotations from the last 100 years—most of which belong to the pre-1974 era—does not meet the requirements of academic rigor and causality analysis. A working paper (not a peer-reviewed, published paper) by two economists who happened to work for the IMF is cited as the only empirical study. However, the DSGE model that the working paper uses takes certain exogenous parameters for calibration. Applying the Lucas Critique, when a radical proposal such as the one outlined in the book is implemented, it is not realistic to think that the exogenous parameters will remain the same. It will lead to changes in expectations and, hence, choices by investors, depositors, and businesses in a small open economy like Pakistan.

An economic analysis should not assume away how such a radical transformation will affect the expectations, choices, and adjustments of investors, depositors, and businesses. It is suggested that the authors should look at these humble submissions with due care and consideration to further refine the proposal and make it robust. They may discuss one by one the 9-points summary outlined above and provide explanation as to how these concerns will be tackled in their proposal.

There are some other points already highlighted in the original review, which can be read here. To avoid repetition, these are not discussed in this reply to the rejoinder. The original book review is available at:  https://islamiceconomicsproject.com/2026/05/08/breaking-the-trap-of-debt-inflation-interest-and-poverty/

Editor’s Note: The authors subsequently wrote the second rejoinder which can be read here