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Bailout, why you might need to say yes!

By Admin

Added 3rd August 2016 07:00 PM

It is important to understand how we got to this point and the only way you can is by first understanding how banks work.

Bailout, why you might need to say yes!

It is important to understand how we got to this point and the only way you can is by first understanding how banks work.

By Yahya Kasujja

The thought of using government funds (Our money) to save the rich sounds so annoying that it shutters our ability to fully analyse what is at stake. Just like you, I do not know whether it is true or not but for the sake of this article let us assume it is true.

It is important to understand how we got to this point and the only way you can is by first understanding how banks work.

Banks are supposed to be financial intermediaries that mobilise funds from those with excess cash to save or invest and direct it towards those that have investment ideas but luck the funds to implement these ideas. Again for the sake of this article we will assume you are the saver with a current, fixed or savings accounts and these bailout list guys are the investment gurus.

Assuming you save sh10,000 with the bank, by law the bank is supposed to keep a percentage of its deposits with the central bank (Cash reserve requirement), for easy computation let us assume this is 10%. This means that the bank will deposit sh1,000 to BOU and lend out the sh9,000. This assumes that if 10 people deposited sh10,000 each, it is more likely that only one person will need to withdraw in the short run.

Now assuming this person who also borrows the money uses it to acquire land and the land owner deposits this sh9,000. The bank will deposit sh900 with BOU and lend the sh8,100. Remember the percentage of people who can afford to borrow is to low that it won't surprise you that the person who borrows the sh8,100 is the guy who has just bought the land and he is now using it as collateral to get the money for construction.

This cycle will continue until the loans that have been given out add up to 10 times the initial loan coming to sh90,000.

Now assuming all goes well, the bank will earn its usual interest of over 30% which would add up to over sh30,000.

But what if something goes wrong, what if the borrower finishes the building but the bank changes its terms due to changes in the financial situation, the interest rates go up or he does not get tenants so he cannot make the payments to the bank.

Remember the money that the bank lent out belonged to depositors not the bank shareholders. In this case it might be you. And to make matters worse, through recycling the initial deposit of sh10,000. It lent out sh90,000.

All the depositors (You) want to get their cash but its stack with the borrower (the guys on the bailout list). At this point the bank has one option to sell the properties of its client but wait a minute, who will buy it? Remember all the potential buyers are facing the same challenge, loans are in their necks.

At this point the bank has no option but to file for bankruptcy, which means running without giving back your money.

Hope now you get my point!

But wait a minute, could this have been prevented?

Yes, the main excuse the gentlemen on the bailout list give is the fact that they borrow money and agree to payback specific amounts only for the bank to turn around and adjust the rates upwards. The best example going around is one borrowing to invest in poultry business and the bank comes back with increased interest rates as if the borrower can force the hen to lay more eggs.

The only solution to this is Islamic finance; under Islamic finance banks are not allowed to adjust the markup it charges to its customers. But not only that, banks are also required to fully review their clients situation and work together towards solving their challenges even if it means extending the tenure of their financial arrangement.

On top of this, under the Islamic finance system, banks tend to be more hands on and fully scrutinise potential client's business plan on top of carrying out periodic performance reviews of the clients business to minimise risk and avoid unforeseen shocks. Islamic banks relationship with their clients is that of a partnership unlike the conventional banks which act like masters with clients as their slaves expected to go and hunt for them.

Let us all push for the introduction of Islamic finance just like those in the UK and US have done, we ought to learn from those who have suffered from the effects of financial crisis and act before it is too late.

Just walk to your bank and say you want to know about Islamic finance.

The writer is based in Malaysia and trained in ACCA, CPA, MBA (UK), MIFP (Masters in Islamic Finance Program) Malaysia






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