Qard al-Hassan as a tool of monetary policy, framework and application

Abstract

Monetary policy is widely recognized as being responsible for promoting economic growth, controlling inflation and maintaining financial stability. The banking sector has a key role in achieving these targets considering channels through which monetary transmission works. However, the rapid growth of Islamic banking institutions may undermine the potency of one of the most effective channels, namely traditional interest rate channel and consequently caution the impact of monetary actions in the dual banking systems. Moreover, in full-fledged Islamic banking systems, monetary policy lacks effective instruments and becomes arguably neutral. This necessitates central banks to diverse their monetary policy instruments including non-interest based frameworks and tools. This study proposes a new approach in which Qard Hasan could be applied within the statutory reserve framework to influence money supply through Islamic depository institutions. The proposal provides a new formula of calculating the statutory reserve requirement incorporating Qard Hasan as a monetary tool.