INNERSANCTUMVECTORN360™|Finance

LIBRARY OF CONGRESS ISSN 2833-0455

OMAR M. ALMAHMOUD Chief Executive Officer of the ICT Fund,

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In this Special Edition we feature two short articles from OMAR M.

ALMAHMOUD, the Chief Executive Officer of the ICT Fund, a federal

development fund launched by the UAE’s Telecommunications & Digital Government Regulatory Authority with the purpose of catalyzing the ICT sector in the UAE through investments in education, R&D, incubation and national technology initiatives.

OMAR M. ALMAHMOUD, Chief Executive Officer of the ICT Fund,

Contemplating the news from Russia introducing Islamic Banking possibly due to geopolitical turmoil and severe western sanctions, seeking alternatives in all aspects of life and business is always a good way to enrich ones perspective.

Our current global banking system which is based on Fractional Reserves is so entrenched that very few question other alternatives. I have much to share about this topic and delve into some alternative view points as well what the Fractional Reserves system is or as other people coin the Printing Money from Thin Air System.

Fractional reserve banking is a financial system where banks retain a portion of the total deposits they receive from customers as reserves, lending out the remaining funds. This system operates under the assumption that, at any given time, most depositors will not withdraw all their deposited funds. Consequently, it enables banks to allocate a fraction of the deposited money for loans, thereby facilitating economic

growth and expanding the money supply.

Basic Concept: When an individual deposits money into a bank, the bank is mandated to retain a fraction of that deposit as a reserve and can utilize the remainder for lending purposes. The reserve ratio is typically determined by central banks or other regulatory authorities.

Economic Implications: This system engenders the creation of money through the lending process. As banks extend loans, the funds from these loans are re-deposited within the banking system, enabling further loan disbursements and, consequently, more money creation. It serves as a fundamental instrument through which central banks can influence the money supply and, by extension, control monetary policy.

Risks and Criticisms: In the event that numerous depositors simultaneously demand the withdrawal of their deposits, triggering a bank run, the bank may face liquidity

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Fractional Reserve Concept by Narrow Banking

challenges in meeting these demands, potentially leading to bank failures.

•Some critics contend that this system intrinsically fosters financial instability, given the interconnected nature of the banking system.

•It is important to note that many banking systems employ deposit insurance schemes to mitigate the risk of bank runs.

One of the most significant bank runs in history occurred in the United States during the Great

Depression of 1929. In a time of financial instability, numerous investors chose to withdraw their funds, overwhelming the banks.

This led to a heightened state of panic, prompting even more individuals to withdraw their deposits, ultimately resulting in a multitude of bank failures.

Fractional Reserves and Inflation The relationship between the fractional reserve system and inflation is multifaceted, rooted in the mechanisms by which the banking system influences the money supply.

A Bank Run in 1930 New York

Money Creation: In a fractional reserve system, banks generate money when they grant loans. When a bank extends a loan, it simultaneously creates a deposit for the borrower, thereby increasing the money supply.

As these funds circulate and are re-deposited into the banking system, the cycle repeats, creating a multiplier effect. The actual multiplier is contingent on the reserve requirement and other factors, with a higher reserve requirement resulting in a smaller multiplier.

Inflationary Pressure: If the increase in the money supply surpasses the growth in an economy's production capacity or the demand for money, it can lead to inflation. This occurs when an excess of money chases the same volume of goods and services.

Put simply, when the money supply expands at a rate faster than an economy's real output, the resulting surplus demand can escalate prices, triggering inflation.

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Central Bank's Role: Central banks, cognizant of the connection between the money supply and inflation, employ various tools to manage this dynamic. By setting reserve requirements, central banks can exert influence over the extent to which commercial banks create money. Additionally, central banks can utilize open market operations, discount rates, and other mechanisms to steer the money supply and, consequently, inflation.

pace of money creation within a fractional reserve system.

Other Factors: While the fractional reserve system can contribute to inflation through money creation, it is pivotal to recognize that inflation can be influenced by an array of other factors, including supply shocks, demand-driven influences, built-in inflation, and expectations.

While the fractional reserve system inherently permits the amplification of the money supply, a phenomenon that can exert inflationary pressures, the actual inflation rate remains a product of numerous factors, both domestic and global. The management of inflation is an art and science residing within the domain of monetary policy, necessitating central banks to continuously adjust their tools in response to evolving economic conditions. The insights of luminaries such as Adam Smith, Milton Friedman, John Maynard Keynes, and others provide a foundational understanding of these dynamics.

Interplay with Interest Rates: In a bid to curb inflation, central banks may opt to raise interest rates, elevating the cost of borrowing and rendering saving more attractive. This can curtail lending and borrowing, consequently decelerating the

Global Considerations: In today's interconnected global economy, cross-border capital flows can impact domestic inflation. For instance, a country employing a fractional reserve system that garners significant foreign investment may observe an expansion in its money supply, potentially culminating in inflation, unless the central bank takes countermeasures.

The Money Supply VS Interest Rates by Visual Capitalist

Automating the Rate of Inflation Being an avid proponent of all things automation I have a notion of automating the control of inflation and the fractional reserve system algorithmically in an ideal world which in self is intriguing and draws inspiration from various monetary and economic theories. Such automation would entail adjusting monetary parameters by use of algorithms in response to realtime economic data without direct human intervention. While some components can be automated, there are

accompanying challenges. Real world case studies exist in the crypto world but that is for another time to explore.

Prospects for Automation: Rule-Based Monetary Policy: For instance, the Taylor Rule suggests that central banks should adjust interest rates based on deviations of inflation from its target and deviations of actual GDP from potential GDP. An automated system could potentially implement such adjustments.

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Cryptocurrencies and Algorithmic Stablecoins: Certain cryptocurrencies, notably algorithmic stablecoins, strive to stabilize their value through algorithms that adapt supply according to demand.

These systems can be perceived as a form of automated monetary policy, albeit operating outside the traditional fractional reserve banking system.

Data-Driven Decision Making: With advancements in big data and real-time economic indicators, it is conceivable that algorithms could adjust reserve requirements, interest rates, or other monetary tools based on actual economic data.

Challenges and Concerns: Complexity of Economic Systems: Economies are intricate systems characterized by numerous interacting variables. Capturing all nuances in an algorithm is challenging, and

over-reliance on automation could lead to unforeseen consequences.

Political and Social Considerations: Monetary policy decisions often bear social and political consequences. Automating such decisions would necessitate a consensus on algorithmic objectives and might face resistance due to perceived loss of human control.

External Shocks: Economic shocks, such as natural disasters, pandemics, or geopolitical events, can hold significant economic ramifications. An automated system may struggle to respond adequately to unforeseen events of this nature.

Model Risk: Any form of automation would rely on economic models, all of which exhibit limitations. Overreliance on a particular model can lead to systematic errors.

Ethical Considerations: Monetary policy affects livelihoods, wealth distribution, and economic well-being. Delegating these decisions to algorithms raises ethical concerns pertaining to accountability and transparency.

Money Supply M2 VS Inflation by Longtermtrends

Given these challenges the key therefore lies in achieving a harmonious balance between automation and human oversight. The dynamic interplay of various economic factors, coupled with the inherent unpredictability of economic systems, suggests that human judgment and discretion will remain pivotal components of effective monetary policy. Thus a hybrid system may be the ideal approach instead.

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Alternatives to the Fractional Reserve System If I had a magic wand, I would create an alternative to the fractional reserve banking system.

The Fractional Reserve system contradicts some of my personal held values. Specifically, I find it problematic or possibly even unethical when transactions are made without the underlying asset being readily available as a collateral.

This gives the transacting parties perception that an asset exists when, in reality, it doesn't — and this occurs not just with one party but multiple parties.

The quest for an ideal alternative to the fractional reserve system has long been a subject of debate among economists, policymakers, and financial experts. Over the years, several alternatives have emerged, each with its own set of advantages and disadvantages.

Here are some prominent alternatives:

Full Reserve Banking (or 100% Reserve Banking): In this system, banks are mandated to maintain 100% of deposits in reserve.

Consequently, they cannot create money through lending, as is the case in the fractional reserve system.

•Advantages: It significantly mitigates the risk of bank runs and reduces the need for deposit insurance. It may also lower the likelihood of banking crises and associated economic downturns.

•Disadvantages: It might restrict the availability of credit and potentially lead to higher borrowing costs, potentially affecting economic growth due to reduced lending capacity.

Narrow Banking: In a narrow banking system, banks retain all deposits in secure, liquid assets, such as government bonds, while other financial institutions undertake lending and investment activities.

Advantages: This approach insulates the payment system from risks associated with lending and investment.

•Disadvantages: The strict separation of various financial functions might result in reduced efficiency in financial intermediation.

Sovereign Money System (or Central Bank Digital Currencies CBDCs): Under this system, the central bank issues digital currency directly to the public, thereby diminishing the role of commercial banks in money creation.

•Advantages: It provides central banks with more direct control over the money supply and reduces the risks linked to bank runs.

•Disadvantages: It might concentrate excessive power in the hands of the central bank and lessen the involvement of the banking sector in the economy.

Mutual Fund Banking: Banks function as mutual funds and only issue shares against assets they possess. These shares are redeemable on demand.

•Advantages: This approach may create a more transparent connection between bank assets and liabilities.

•Disadvantages: The system might be more susceptible to runs during economic downturns.

Determining the "most ideal" alternative hinges on the objectives and priorities of policymakers and the particular economic and social context of a region or nation.

Each system has its merits and challenges, with key considerations encompassing financial stability, the efficiency of financial intermediation, the potential for economic growth, and the role of regulatory oversight.

In exploring the nuances of Fractional Reserve Banking I want to make it evident that I am not providing or claiming a definitive solution or answer to the dilemma posed by Fractional Reserves with this article.

Journeying through its fundamental mechanics, the profound economic implications it brings, and the potential of integrating automation into its framework is food for thought.

Delving into the various alternatives that have been proposed over time and with the complexities of global financial systems, interwoven with technological advancements and ethical considerations is to highlight, as with many intricate

economic quandaries, the path forward may lie not in seeking a perfect solution but in continually adapting to the ever-evolving challenges and opportunities that arise.

1. Fractional Reserve Banking: Banks hold only a fraction of deposits as reserves, using the rest to promote economic growth through lending.

2. Automation in Banking: Algorithm-driven adjustments could provide real-time monetary responses to economic indicators.

3. Challenges in Automation: Economic complexities, unpredictability, and ethical considerations highlight the importance of human judgment.

4. Alternatives to Fractional Reserve: Options include Full Reserve Banking, Narrow Banking, and Sovereign Money Systems.

5. Balancing Approaches: Achieving stability and growth may require a mix of traditional banking, automation, and alternative systems.

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An oil painting representing Social Proof generated by AI

OMAR M. ALMAHMOUD, Chief Executive Officer of the ICT Fund,

My deep interest in Behavioral Economics and the recent announcement of the United Arab Emirates joining the BRICS bloc lead me to shed some light and brief commentary on the matter especially with Digital Currencies being at the forefront of a looming geo-political financial upheaval in the years to come.

The recent inclusion of the UAE and other nations into the BRICS coalition represents a significant reshaping of the geopolitical and economic landscape. The BRICS group, initially comprising Brazil, Russia, India, China, and South Africa, has long been viewed as a counterweight to Western economic hegemony. By expanding its membership, BRICS not only increases its economic and political clout but also signals a desire for broader cooperation and integration among emerging and established economies.

Coupled with this expansion is the intriguing possibility of a singular central bank digital currency (CBDC) being introduced by this bloc.

This potential move towards a unified digital currency signifies a bold step in the evolution of global finance, challenging the traditional financial systems and pointing towards a future where digital assets play a central role.

Such profound shifts naturally give rise to reflections and speculations on what the future might hold. Behavioral economics, rich in its exploration of human decision-making processes and biases, provides an invaluable lens through which we can speculate on the potential trajectory of these groundbreaking developments.

Loss Aversion and Dollar Dominance Loss aversion is a term that stems from prospect theory, which was developed by Daniel Kahneman and Amos Tversky. It implies that people tend to prefer avoiding losses than acquiring equivalent gains. For example, the pain of losing $100 is typically greater than the pleasure of gaining the same amount. In the context of the article, countries' reluctance to move away from

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the US dollar's dominance can be attributed to loss aversion. The perceived risks (or losses) associated with shifting away from a familiar currency standard like the USD outweighs the potential gains or benefits from adopting a new standard.

Loss aversion - The Decision Lab

Historically, countries have been resistant to change when it comes to global financial standards. The US dollar's dominance is, in part, a manifestation of this loss aversion on a grand scale. Nations have traditionally felt safer with the known (USD) than the unknown, even if the latter might offer better utility or security.

Status Quo Bias and CBDCs Status quo bias refers to the human tendency to prefer things to stay the same rather than change. This resistance to change is rooted in our desire for consistency and familiarity. In financial contexts, it can lead to inertia, where investors or policymakers stick with their current decisions rather than making changes, even when change might be beneficial.

In the article's context, even if a BRICS-backed CBDC offers better utility or benefits, the pull of the status quo might hinder its widespread acceptance, especially if the transition is seen as complex or risky.

Status Quo Bias - The Decision Lab

The introduction of a BRICSbacked CBDC, especially one anchored in tangible assets like gold and oil, poses a significant shift from the status quo. The US dollar, for all its strength, isn't backed by physical assets in the same way gold or silver-backed currencies once were. Should BRICS successfully navigate the status quo bias that often hinders

financial innovation, it could position its CBDC as a formidable alternative.

Social Proof in Currency Adoption Social proof is a psychological phenomenon where individuals look to the actions of others to decide on their own actions.

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Essentially, "if others are doing it, it must be the right thing to do." In economic decisions, especially ones with uncertainty, seeing a significant economic bloc (like BRICS) adopt a new financial standard can provide validation or "proof" for other nations to follow suit. If BRICS shows economic benefits from their decisions, other nations might consider it evidence that adopting a similar strategy is a sound choice.

If one significant economic bloc adopts a new standard, it's likely others may follow, especially if initial adopters show signs of economic benefits. The move towards a tangible asset-backed CBDC could trigger a cascade effect, prompting other nations or blocs to explore similar paths.

Anchoring and the Crypto Age Anchoring refers to the cognitive bias where individuals rely heavily on an initial piece of information (the "anchor") when making subsequent decisions.

For example, if a product is first seen at a high price (the anchor), subsequent lower prices may seem like a good deal, even if they're still overpriced.

In the realm of global finance, the traditional concepts of money and value serve as anchors. As cryptocurrencies like Bitcoin redefine these concepts, they challenge and shift these anchors. The introduction of a gold and oil-backed CBDC would provide a new anchor, combining traditional tangible values with modern digital innovation.

Cryptocurrencies have already begun to reset global financial anchors. With decentralized finance and currencies like Bitcoin setting new standards, the very notion of what constitutes value is shifting. A gold and oil-backed CBDC from BRICS would merge traditional notions of tangible value with the innovation of digital currencies.

Anchoring Effect - The Decision Lab

As the BRICS nations navigate the challenges and opportunities of this digital financial age, understanding the behavioral undertones is key.

Their proposed CBDC, rooted in tangible assets, could usher in a new era of global finance – bridging the tangible past with the digital future.

The dance between behavioral in Anchoring Effect - The Decision

Labclinations and global economic shifts promises a future rife with challenges and opportunities.

•Loss aversion and its role in the US dollar's dominance is explained through behavioral economics principles.

•Status quo bias, which can impede financial innovation, may impact the success of a BRICS CBDC.

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•Social proof guides nations in their economic decision-making, and could cause a cascade effect for similar currencies.

•Anchoring with cryptocurrencies is redefining global value standards which could be further advanced by a gold and oil-backed CBDC from BRICS. •Overall, understanding the behavioral undertones of economic changes is key to navigating a digital future full of opportunities and challenges.

OMAR M. ALMAHMOUD is the

Chief Executive Officer of the ICT Fund, a federal development fund launched by the UAE’s Telecommunications & Digital Government Regulatory Authority with the purpose of catalyzing the ICT sector in the UAE through investments in education, R&D, incubation and national technology initiatives.

The ICT Fund is the investor behind the UAE’s Astronauts Program, the Mars 2117 Initiative, The Emirates Lunar Mission, the Smart Government Initiative, the Mohammed bin Rashid Smart Learning Program, the Drones & Robotics for Good Awards, the National Center for Space

Technologies & Sciences and the Emirates BT Innovation Center in addition to many other bold initiatives. The ICT Fund has a determined mission to provide strategic, targeted funding to empower and develop innovation and build a knowledge-based economy for the UAE. One of the youngest leaders in the UAE's public sector, technology, investments and entrepreneurship.

Degree in communications engineering from Khalifa University for Science, Technology and Research and stems from an entrepreneurial background with deep technical expertise.

LINDA RESTREPO is the Director of

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Education and Innovation at the Human Health Education and Research Foundation. With advanced degrees including an MBA and Ph.D., Restrepo has a strong focus on Cybersecurity and Artificial Intelligence. She also delves into Exponential Technologies, Computer Algorithms, and the management of Complex HumanMachine Systems.

She has played a pivotal role in Corporate Technology Commercialization at the U.S. National Laboratories. In close collaboration with the CDC, she conducted research on Emerging Infectious Diseases and bioagents. Furthermore, Restrepo’s contributions extend to Global Economic Impacts Research, and she serves as the President of a global government and military defense research and strategic development firm. She also takes the lead as the Chief Executive Officer at Professional Global Outreach.

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