Free Banking

The sole purpose for a business is to earn money and be as profitable as possible and it is more often that business men forget the ethical boundaries they need to remain in order to achieve their ulterior motive. This forgetfulness is intentionally or unintentionally inculcated among the workers as well through their owner. However, one may not realize it but the limitation of legal and ethical litigations are hard to follow but highly indispensable. Therefore in order to be successful in the long run everyone associated with an activity needs to be assured as far as the border line of ethical precincts are concerned.

Keeping this perspective in mind, the following is the detailed proposal of a bank which would highly abide by legal and ethical laws, committing no intentional ethical gaffe. The Bank would not exploit the customers by charging inappropriate and exorbitant charges in pretense of late fee. As by definition an ethical bank would be stated in a way that “An ethical bank, also known as social, alternative or sustainable bank, is a bank concerned about the social use of its investments and loans.

Although there are differences among the main ethical banks, they share a common set of principles, the most prominent being the transparency and the social or environmental aim of the projects they finance. Some of them are specialized in microcredits.”  (Ethical Banking).

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Aside from all this, it would not forget the ulterior motive of its existence which is profit. Although the style of earning would be different from the usual way as among the banking industry because it would not exploit the customers by charging obscenely expensive charges for late payment or charging senselessly high interest rate. In fact it would earn profit on the basis of on the basis of profit sharing. This bank would act as an intermediary and, that is, would invest the depositor’s money with the financer’s complete consent and earn equal or decided percentage of money through mutual agreement.  Hence earning money would be based on profit sharing.

Background

“A bank, [bæ?k] is a business that provides banking services for profit. Traditional banking services include receiving deposits of money, lending money and processing transactions. Some banks (called Banks of Issue) issue banknotes as legal tender. Many banks offer ancillary financial services to make additional profit; for example: selling insurance products, investment products or stock broking.” (Bank). Therefore one needs to understand that the practices that banks follow, despite of being in complete accordance with legal laws are exploiting the end consumers. Since charging interest and late fee for delayed payment is not a crime or illegal, therefore currently functioning banks have found ways to exploit the customers disguised in legal limitations.

“Although the type of services offered by a bank depends upon the type of bank and the country, services provided usually include:

• Taking deposits from their customers and issuing checking and saving to individuals and businesses.
• Extending loans to individuals and businesses
• Cashing cheques
• Facilitating money transactions such as wire transfers and cashier cheques
• Issuing credit cards, debit cards and ATM cards
• Storing valuables, particularly in a safety deposit box.
• Cashing and distributing bank rolls.” (Bank)

The proposed bank would also provide such facilities without backing out on any commitment due to its altered way of dealing in transactions. The point of difference would be its extra concern for its customers displayed by action of not charging interest and exobitant late fees. Hence, providing it an edge over other financial institutions.

This point is of notice here that this concept proposed is somewhat similar to that of Islamic Banking. Islamic Banking offers interest free banking with a promise of investment in all ethical business although it abides with certain factors which are exclusive to only Muslims such as restriction of investment in pork or liquor. This restricts such banking to the rules and principles of Muslims only.

The description of Islamic Banking when asked Himy, the owner of the site of Islamic bank, replied “Being Muslim, we don't eat pork nor consume intoxicants nor should we deal in RIBA, of which Usury (a Latin word meaning 'simple interest'), is a major component. Being an observant Muslim, I decided in my teenage years to focus on this neglected area of civil society: Interest-Free Living” (Rothfuss).

Although what the proposed bank would be offering is somewhat the same but this bank would refrain from investment in any socially disturbing, terrorist-associated material such as arms or drugs etc. hence, protecting the society and the citizens in every which way.

Banking Industry in US

The history in the banking industry starts way back from the 17^th century when the first bank was formed in Philadelphia, it was given the monopoly status in the currency department. Then many revolutionary changes took place over the period of time and many banks emerged in the US Banking Industry but the strongest banks plays a pivotal role in the economic system of United States. The statistics of the banks are as follows in terms of “top ten bank holding companies in the U.S. ranked by assets. Figures as of March 31, 2006, in U.S. dollars

1. Citigroup Inc. — 1.586 trillion
2. Bank of America Corp. — 1.375 trillion
3. J.P. Morgan Chase ; Co. — 1.273 trillion
4. Wachovia Corp. — 541 billion
5. Wells Fargo ; Co. — 492 billion
6. HSBC North America Holdings Inc. — 441 billion
7. Taunus Corp. — 391 billion
8. U.S. Bancorp — 209 billion
9. SunTrust Banks, Inc. — 178 billion
10. Countrywide Financial Corp. — 177 billion” (Banking in the United States)

Similarly the top bank in terms of US deposits is Bank of America only with a massive 577 billion dollars worth of deposits. The reason behind it could be the credibility of the bank as also the fact that it’s a government owned bank therefore the default risk is low. (Banking in the United States)

As far as the banking laws are concerned “banking and lending laws vary by state in the United States. Each state has its own commercial and consumer regulatory guidelines. Each state has a banking commission or finance department.” (Banking in the United States)

Banking Features

The proposed bank would have the usual functions as in any other commercial banks such as lending to individuals and businesses loans etc. The difference would lie in the lending methods. The prime notice of concern would be the area of investment that is where the money lent would be invested since the unethical investments would not be accommodated in the provision of loans. These unethical investments would include production of weapons or arms and ammunitions, production of drugs etc.

Also as mentioned earlier it would include the concept of interest-free banking majorly because “it transfers wealth from the poor to the rich and from declining areas - often rural ones - to more prosperous parts” (Panel: Why interest-free Banking Matters) and such a thing would not happen with the bank proposed since “People save with us because they either want to borrow interest-free themselves or because they want to assign the right to an interest-free loan to a relative, a son or daughter, perhaps or to an organization they support. This means that most money is lent out in the same area that it was collected, and, if it's not, it's only loaned in a place and for a purpose which the original saver has approved” (Panel: Why interest-free Banking Matters).

The existing commercial banks have late fees charges as a vital mode of generating revenues and therefore they have no mercy when setting those expenses on the consumers and since it has become a trend therefore no customer complains as they believe it’s a part and parcel of banking. But such a concept would not be present in the proposed Bank, saving its sources of revenues to other forms.

Although the Bank has to fulfill the purpose of its existence which it would do via profit sharing. The percentage of profit shared would be decided before the occurrence of the transaction. It could be either 50 percent each or the financer could have the major chunk of the profit or vice versa depending on the type of transaction and the mutual agreement between the two parties. All the terms and conditions regarding the project would also be discussed beforehand. The loss-sharing scenario would also be discussed between the lender and the borrower to avoid any misconception and future disagreements.

Operational Management

The profit earning part seems a bit vague but when discussed later in detail would explain how this venture would be profitable along with full concern for consumer’s interest. This query might disturb many potential customers or for that matter anyone interested that whether this system makes sense or not? Why isn’t this Bank charging interest for the risk it would face and value it would loose over the time period of late payment?

The answers to this are pretty simple; this bank “requires its borrowers to lend it the sum that they borrow for an equivalent length of time. This means that, while they are lending to the bank, customers lose roughly the same amount of interest that they would have paid” (Panel: Why Interest-free Banking Matters).

To understand this, first we need to understand the psyche of individuals who believe in this form of dealing “The roots of this type of thinking run back to the time when gold was used as currency. Since gold did not increase itself, and very little was being mined, where, people asked, was the extra bullion to come from to pay the interest when both principal and interest had to be handed over at the end of the year?” (Panel: Why Interest-free banking Matters).

The logic to it is quite plain, that “obviously, the borrower could only obtain more gold if someone else had less, so lending money at interest meant that either the borrower impoverished himself when he paid over the extra or he impoverished someone else.” (Panel: Why Interest-free banking Matters)  and, at that point in time neither outcome was acceptable or rather desirable, “usury, as all forms of money lending were called no matter how low the interest rate, stood morally condemned by both the Roman Catholic Church and by Islam” (Panel: Why Interest-free banking Matters).

The other features such as lending loans, leasing etcetera would be carried out in more or less the same way as regular commercial banks such as the checking of the of documents for the credibility of the borrower before extending loans. This step is more important in the proposed Bank since there are no charges for late payment, therefore one need to assure the confirmation of payment return.

Financial Requirements

Banking is not an easy deal to indulge into as it requires hefty financial backing to support its existence since there has been an international standard set for all financial institutions around the world. The instructions for Minimum Capital Requirement (MCR) and various other financial requirements for the qualification of the presence of a Bank are presented in the documents of Basel Accord. “In 1986, the Fed approached the Bank of England and proposed the development of international risk-based capital requirements. This led to the 1988 Basel Accord, which replaced the asset-based primary capital requirements for US commercial banks. The concepts of primary and secondary capital were incorporated into the new accord as tier 1 and tier 2 capitals.” (United States Financial regulations).

The reason for such strict guidelines to maintain a minimum balance is to ensure safety and balance risk in the financial sector all around the world. A misbalance in one geographical location would eventually result to be disastrous in other part of the globe as the world is now a single platform and the divisions now only remain a formality.

Hence, in order to abide by all such rules one need to invest billions of dollars to continue in this business since only the bank at any cost need to maintain around two billion dollars or else it would be either merged or acquired or closed down by the regulatory authorities. Therefore, only a business group who is ready to invest a handsome amount of money would be interested in it. The Basel Accord originated from the Bank of Switzerland in Basel and the purpose of it to be in place is as follows

• “Define roles of regulators in cross-jurisdictional situations;
• Ensure that international banks or bank holding companies do not escape comprehensive supervision by a “home” regulatory authority;
• Promote uniform capital requirements so banks from different countries may compete with one another on a “level playing field.” (United States Financial regulations)

The capital requirements are discussed in such details in the document of Basel with its division is Tier I and Tier II. “Tier 1 ("core") capital included the book value of common stock, non-cumulative perpetual preferred stock and published reserves from post-tax retained earnings. Tier 2 ("supplementary") capital was deemed of lower quality. It included, subject to various conditions, general loan loss reserves, long-term subordinated debt and cumulative and/or redeemable preferred stock.

A maximum of 50% of a bank's capital could comprise tier 2 capital” and “The proposal also liberalized the definition of capital by adding a third tier. Tier 3 capital comprised short-term subordinated debt, but it could only be used to cover market risk.”  (United States Financial regulations) or in short the capital division by the operational plus market plus the credit risk should not be more than 8 percent.

Such regulations have made existence even tougher but it has a sincere meaning to it, that is, to bring everyone on the same ground and make the financial system of the world better and prolific. This stability in the financial sector attracts more foreign investors, hence increasing the amount of investment in a country and eventually affecting the overall GDP. This positive impact on the GDP would result to be beneficial for the overall organization. As show in the graph below

The financial projections for the first three years would include

Ethical Policies

“Business does not operate in a vacuum. Activities inevitably lead to a series of ecological and social impacts. Some industries, by their very nature, have a huge and obvious impact on the environment and society, whilst the impact of others, such as the financial services industry, is not always so immediately apparent.” (Ethical Policy). Hence abiding by ethical boundaries is very important as far as the overall functioning of the financial industries is concerned. The ethical code of conduct would be as follows;

• Restriction on money lending for unethical or immoral purposes such as production of weapons or arms and ammunitions, addictive drugs, smuggling material etc.
• No additional exorbitant charges for late payment would be charged.
• Banking would be interest-free, liberating the customers to pay expensive amounts for the various loans that the bank has to offer.
• The source of earning profit would be on the basis of sharing, that too would be settled beforehand to avoid any further confusion or misconception. This would keep the margin of error or the ability to fraud minimal.
• Aside from the core business activities, other management level activities would have to abide by ethical laws as well.

The above laws if followed religiously would help in establishing an overall ethical environment and ambiance, inculcating similar culture among the employees as well in order to establish itself as an ethical bank in the long run.

The question however remains as to how it would be assured that these ethical policies laid down would be complied? In order to be successful one needs to take special care of its customer’s concern and assure whether they agree with the Bank proposed policy or not. To assure that, every time a customer is interested in any of the Bank’s service, it would have to fill an Ethical Policy form, which would contain all the ethical guidelines. Any conflict or discrepancy that may arise would be reported to the Ethical Policy Department and if needed further research would be held. The result of it would decide whether to continue with that particular activity or not no matter how profitable it might be.

This would ensure the customers of our sincerity towards them and all the stakeholders including the society as a whole.

Customer Base

The customer base for interest-free banking include all the 70% potential customers who are still untapped and unaware and are willing to avail the service if and when provided. In fact if the bank is successful in providing what it plans to successfully then even the regular commercial bank customers might shift towards it and avail the services as much as possible.

Potential Quandaries / Limitations

Taking the first step in the society does need a few sacrifices or includes certain drawbacks. There are certain limitations that the proposed Bank has to face as well. These quandaries if dealt with properly and accordingly can lead to turn into opportunities and the Bank can prosper as a result of it.

The major disadvantage that such banks face is that “ethical banks usually work with narrower profit margins than traditional ones, and therefore they tend to have few offices and operate mostly by phone, Internet or mail” (Ethical Banking). Therefore they have to find means to survive within that profit margin. This would occur in the proposed Bank also because it has cut down on the most primary source of revenue for commercial, regular Banks, which is the interest revenue earned from interest charged from the customers. Also the Bank has restrcited itself from charging late fee on delayed payment, also cutting down on its earning through it.

Another problem that the proposed Bank faces is the crticism that it has to stand. The foremost criticism for interest-free banking feature states that it is just a mean of deception since only the name of ‘interest’ is changed to ‘profit’ or whatever. Hence, in order to widespread and diffuse in the market among the target customers one need to make sure that the public understands the conept behind the interest-free banking. Otherwise, if not understood, it would cause a lot the point of difference to become null and void.

Secondly, some people have the objection to interest-free banking as foreign trade is not possible without interest therefore an interest-free bank has limitation as far as the tade in forien markets are concerned. To defend this argument this point is of notice that initailly even the concept of interest free banking was considered as hypothetical and assumptious but later it was proved to be wrong when done practically. “Currently successful experiments have been carried out in various parts of the world including Kuwait, the Emirates, Sudan and Iran to eliminate ‘interest’ from the economy. Interest-free Banks are already working in Malaysia, Kuwait and Emirates” (Interest-free Banking).

One of the most fatal limitations it faces is the fact that people associate interest-free banking with Islamic Banking since they were the entrepreneurs behind it due to the restriction of earning interest in Islamic religion. On the other hand people believe that Islamic Banks are associated with terrorist and help promote terrorist, more so after the incidents of 9/11 and London Bombings. Hence, all this has created an air of concern for those who are interested.

Despite of all the hindrances interest-free Banking initially had, it is now a successful means of Banking and many Banks all around of the world have either a subsidiary of an Interest-free Bank or a window that deals with similar banking. This widespread acceptance of such kind of banking is a proof that people around the world have not started believing in interest-free transactions. Even the business men who start the business in banking are aware of the demand for interest-free banking because of which they are compelled to have it inculcated in their various banking services.

Future Prospect of Interest-Free Banking

As far as the current situation is concerned, it is quite a pleasurable scenario since the concept of interest-free banking is widely accepted and it has now successfully moved on to its maturity stage from the introduction phase of a service life-cycle. If this form of Banking continues to do so well, it would definitely go way ahead of the regular commercial banking, might at one point in time making the regular banking as obsolete.

Although the future seems a bit risky as “Consumer debt has reached record levels, and a few sectors, such as agriculture, show signs of weakness. Also, bank supervisors have recently voiced concerns that bank credit standards are weakening” (Spong and Sullivan). This indiciates the weakening position in terms of credit riskiness of the bank and since the proposed bank is interest-free and has no late payment charges therefore it is exposed more dangeroulsy to such kind of risk.

The reasons to iundulge in an interest free banking would include

• Billion of dollars are sitting idle in current accounts
• Reach the 70% of the untapped Market
• Reach to the grass-roots Level

The above mentioned 70% untapped indicates the opportunity for the interest-free banking. “According to our estimates, current banking has only reached only 30% of the potential clients in the Islamic world.  Consequently, 70% of clients needs are not being addressed. Due to the culture and unique value, most people do not go to bank until the point when they feel they do not have any choice at all” (Global Islamic Banking Consulting).

As far as reaching the grass-root level is concerned, there are still many individuals or businesses who are interested in this idea but it has not reached such basic levels.

Conclusion

The proposed bank “is unique in the commitment it inspires from its volunteers and staff. It provides affordable and responsible finance, and enables its members to have a say in where their money is invested. Without any doubt it will continue to be true to its purpose and values while exploring new frontiers in ethical finance.” (Carrie)

Work Cited

Ethical Banking. Wikipedia – The free encyclopedia. Retrieved on 4 December, 2006 from http://en.wikipedia.org/wiki/Ethical_banking

Bank. Wikipedia – The free encyclopedia. Retrieved on 4 December, 2006 from http://en.wikipedia.org/wiki/Banking

Rothfuss. Gregor J. Interest-free banking. April 24, 2003. Retrieved on 4 December, 2006 from http://greg.abstrakt.ch/archives/2003/04/interestfree_ba.html

Panel: Why Interest-free Banking Matters. Growth: The Celtic Cancer. Retrieved on 4 December, 2006 from http://www.feasta.org/documents/review2/interest_panel.htm

United States Financial regulations. Glossary, encyclopedia and Resource Locator. 1996. Retrieved on 4 December, 2006 from http://www.riskglossary.com/link/united_states_financial_regulation.htm

Ethical Policy. Retrieved on 4 December, 2006 from http://www.co-operativebank.co.uk/servlet/Satellite?cid=1077524332960&pagename=CoopBank/Page/tplPageStandard&c=Page

Interest-free Banking. Jamaat-e-Islami Pakistan. Retrieved on 4 December, 2006 from http://www.jamaat.org/qa/banking.html

Carrie. A. How interest-free banking works: The case of JAK. Growth: The Celtic Cancer. Retrieved on 4 December, 2006 from http://www.feasta.org/documents/review2/carrie2.htm

Spong, Kenneth,  Sullivan, Richard J. Outlook for the U.S. banking industry: What does the experience of the 1980s and 1990 tell us? Federal Reserve Bank of Kansas City - Economic Review,  Fourth Quarter 1999. Retrieved on 4 December, 2006 from http://findarticles.com/p/articles/mi_qa3699/is_199910/ai_n8870034

Why Open an Islamic Bank?  Global Islamic Banking Consulting. Your Banking Consulting Partner. GIBC. Retrieved on 4 December, 2006 from http://www.globalislamicbanking.com/why.html

Startup Financial Analysis Profile. Bizminer. June 2006. Retrieved on 8December, 2006 from http://www.bizminer.com/2006_June_Profiles/samples/FAStartup.asp

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