ISLAMABAD  -   Economic experts on Thurs­day noted that Pakistan’s huge debt servicing problem can be resolved through full reserve banking, which will eliminate high inflation, government debt, and interest costs.

Full reserve banking repre­sents a transformative shift toward financial stability, eco­nomic growth, and inclusive prosperity; it has a clear over­lap with the principles of Is­lamic economics and the true foundations of Islamic banking.

This was proposed by Qanit Khalil, chartered accountant and economic analyst, during a roundtable titled “A Solution for Tackling Huge Government Debt, Interest Costs, and In­flation in Pakistan: Full Re­serve Banking Model” held at the Institute of Policy Studies (IPS), Islamabad. The session was also addressed by Khalid Rahman, chairman, IPS, Tahir Hijazi, former member Plan­ning Commission, and econo­mists and financial experts. In his proposal to address Paki­stan’s economic challenges, Qanit Khalil advocated adopt­ing full reserve banking as a transformative solution with far-reaching implications. He said that a staggering 60 per­cent of government revenue is currently allocated to interest payments, fueled by increased expenditure on debt servic­ing from less than Rs200 bil­lion in 2003-04 to a staggering Rs7,300 billion in 2023-24. Out of this, 90 percent of interest costs are for servicing domes­tic loans and not foreign loans.

The speaker highlighted that with continuously increasing domestic debt, the Government of Pakistan had to take large loans from banks to pay for the huge interest costs due to the State Bank of Pakistan’s high-interest rate policy. The rupee has also fallen to a record low because of the increased money supply and a massive deficit in the external trading account.

SBP’s high-interest policy im­plemented to curb inflation has proven counterproductive and resulted in diametrically oppo­site results, he lamented. Quot­ing the Pakistan Economic Sur­vey 2022-23, he underscored that interest rates and inflation have been increasing simulta­neously. Referring to the World Bank Report on the counterpro­ductive SBP policy, he indicated that financing the fiscal deficit through bank borrowing has rapidly increased the monetary base, contributing to inflation­ary pressures. Speaking on the fractional reserve banking cycle, Khalil stated that the gov­ernment of Pakistan has heavily relied on budgetary borrowing from the SBP, leading to an un­sustainable monetary expan­sion as a 5 percent reserve ratio has a 20x multiplier effect.

He proposed that an innova­tive economic solution to these problems is full reserve bank­ing to tackle high government debt and interest rates. In this model, the State Bank would maintain 100 percent reserves against deposits, ensuring cen­tralized and controlled money creation. Moreover, payment and credit extension process­es, or deposit and investment banking, would be completely separated; deposits could not be used for financing loans. In­stead, loans would be financed by the investment accounts of savers in investment banks.

This approach seeks to elimi­nate the colossal government debt burden, with interest rates reduced through a more streamlined financial system. Khalil stated that the fractional reserve system, responsible for money supply fluctuations, can be efficiently replaced with a full reserve system, creating a stable economic environment. He further said that a deeper ex­amination of the concept of full reserve banking reveals a clear overlap with the principles of Islamic economics and the true foundations of Islamic banking.

Tahir Hijazi mentioned that according to recent data, only a small number of Pakistanis have bank accounts, high­lighting the need to increase financial accessibility. The proposed banking model is not without difficulties and risks; for instance, various lobbies could create hurdles in its implementation. He rec­ommended that deeper re­search and discussions should be conducted to cover more topics like integrating profit-sharing into interest rates.

In his concluding remarks, Khalid Rahman highlighted that implementation issues of the full reserve banking model must be addressed, and experts should develop and discuss alternative options to tackle prevalent challenges. He emphasized developing a legal framework more condu­cive to a banking system that facilitates businesses, enables progress, and offers solutions to individual needs through real utilization of resources. He added that the proposed full reserve banking model has the potential to provide a comprehensive plan to address Pakistan’s financial inclusion problems by taking small, in­cremental measures. Rahman further said that the IPS will facilitate the discussions and research into this idea for its refinement and viability for the good of all stakeholders.