Participation Finance Model in the Fight Against the Informal Economy

PARTICIPATION FINANCE SYSTEM 12.03.2021, 23:40
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Participation Finance Model in the Fight Against the Informal Economy

The informal economy is defined as all kinds of economic transactions and activities that are not notified officially or not documented to the government, thus, cannot be audited by the public.

The main reason why individuals or companies choose not to document their economic activities is that they want to evade paying taxes. But their preference adversely affects many social and economic areas.

Undocumented and ungoverned economic activities;

  1. Are not included in GNP figures since they are not measured. Make it difficult for states to make strategic and economic planning accordingly.
  2. Lay the foundation for speculative transactions as they cause the emergence of uncontrolled and dirty money. Disrupt macroeconomic balances and harm small investors.
  3. Disrupt free competition in the market by creating a difference in income and profits on a company basis. Interrupt and prevent foreign and new investments.
  4. Cause illicit employment and exploitation of labour as they are not governed. Problems in the social security system prevent the increase in social welfare.

We need to fight the informal economy, which has other negative impacts in other areas as well. There are many suggestions and practices in financial, legal, and social areas to fight the causes and negative consequences of this type of economy. In this article, I will talk about how the Participation Finance Model can be used effectively to fight the informal economy.

Participation Banks inspect the content of the transactions that they may provide financing.

You cannot find ungoverned transactions at the heart of the Participation Finance Model that may damage the public and incur losses in the state. Participation banks applying this model carry out all their transactions based on an official document in line with this principle.

Participation banks inspect the content and check the documents of the transactions they consider for financing. They perform the murabahah transaction, which is the most common financing application, over the amount specified in the invoice or sales contract. They make their payment directly to the bank account of the seller with official methods; they do not make a cash loan payment to the customer's account. Thus, people or companies in need of financing do not receive money in cash. Cash emission demand is high, and payments are made in cash in informal economies. The cash credit transactions of conventional banks further facilitate the growth of the informal economy. Participation banking supports the registered economy by the nature of its financing transactions.

Economic activities documented and governed by this financing model have the following benefits against the above-mentioned adverse effects:

  1. Informal economic activities are decreased with murabahah payments made directly to the seller in return for an invoice or sales contract. This leads to transparent and accurate company balances. House, vehicle, good, and service procurements can be monitored. This makes it easier for government to make their strategic and economic planning.
  2. The murabahah transactions of participation banks find a place directly in the real economy with its intended use. This prevents speculative transactions. A consumer or a company, for example, can directly purchase foreign currency or gold with the cash credit it receives from conventional banks without transferring it to the real economy. This may lead to pressure on exchange rates. Cash credits can go directly to the stock market for purposes other than their intended use. Rising stock markets in an uncontrolled way with cash loans under a balloon effect can have reverse effects with the start of loan instalments. This can especially have an adverse effect on small investors. The Participation Finance Model adds dynamism to the real economy.
  3. Since every transaction is recorded, investors can measure profitability through transparent analysis of the sector. The number of companies that do not pay taxes for their unrecorded sales and generate unfair income will decrease. The conditions and data will be the same for all investors. Unfair income and profit differences will be eliminated on a company basis. This will turn economies into an open market for new and foreign investors. High rates of informal economy and cash usage discourage foreign and new investors.
  4. The popularisation and increase of Participation Finance institutions will inspire companies and individuals to comply with their principles. Those who purchase their goods through informal ways will want to make all their transactions official and registered to benefit from the financing opportunities offered by Participation Banks. They will start to show the volume, income, and expense of their companies accurately and transparently. They will start to register the previously unregistered employees. This will lead to the minimisation of the exploitation of labour and social security problems. It will increase social welfare.

Underdeveloped and developing countries have low rates of direct tax income in their economies. This further increases the indirect tax burden, which is easier to collect on low- and middle-income groups. Income justice cannot be achieved in economies with high indirect tax rates. Unlike conventional banks, the murabahah payments made by Participation Banks in return for invoices to the seller will help companies to display their balance sheets correctly and increase the direct tax income of the state. The incomes increasing through the direct tax will help to reduce the debt ratios of governments, ensuring income justice.

And when people use consumer loans from conventional banks for a product they want to buy, we see that they choose the loan not as much as the price of the product, but as much as the maximum limit offered to the person by the bank. These people can buy the product they need without an invoice, with some of the money transferred to their accounts in cash. And the remaining loan can return to the economy as passive and inefficient. Instead, with the system established by Participation banks in retail stores, businesses provide automatic murabahah financing to the buyers over the product they sell. And the financing becomes the maximum amount of the product in this case. Retailers also record the product they sell. Here, we can easily measure which products the retail loans focus on and prepare our strategies accordingly. Fast financing also saves labour and time. Extending this practice, which is an "inherited business model" for the financial world, to all retail stores and service procurements is important in the correct use of credit resources and the fight against the informal economy.

To sum it up, the informal economy is a huge problem for developing economies. It is not possible to get rid of this problem with the conventional model of the current banking system. However, Participation Finance Model can be the solution we have been searching for both by preventing the informal economy and eliminating the economic problems that harm society. The Participation Finance Model can be a way out from the local and global crises faced by the Turkish and world economy. This model is not a palliative solution proposal, but the address of the permanent solution itself.  The Future Lies in the Participation Finance Model.

Yunus Emre Kekeç

www.yunusemrekekec.com                                                                                                

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