Research Notes 

Are Checking Accounts. in Americat 
Banks Permissible Under Islamic Laws� 

A Note 
b11 

Ali F. Uarrat ·· 

The purpose of this note is to stimulate the thought of Muslim scholars 
about a neglected aspect of American banking· business. namely the 
payment' of ·interest on demand deposits (checking accounts). 

Demand deposits represent funds' that ·commercial banks use to 
extend loans to the public and purchase ihterest-bearing securities. The 
revenues from these activities are a major source of · mcome for 
commercial banks. Consequently. fierce competition· exists among 
banks.to attract'such funds: However, competition for these fonds. until 
recently, could not take the:form of-an explicit interest rate bec·ause the 
American banking la:ws · prohibit the·payments of explicit iht'ereStl'ates 
on demand deposits .. Existing laws have relaxed this prohibition for 
some forms of demand deposits(e:g. Negotiable Orders of Witndrawa'ls. 
NOW accounts), though the prohibition still holds in the case of what i's 
commonly called in the banking jargon regular checking ·accounts, i:e .. 
checking accounts·that do not explicitly yield interest to·the holders: 

Because of the in.temity of competition among commercial ;banks:to 
attract public deposits. and · in the presenee··of th�· legal· prohib-itioh 
against explicit interest payments on regular checking accounts. banks 
have devised alternative outlets to compete for the checking accounts 
funds. Perhaps the most obvious alternative is for a bank to reduce (or 
remit) charges to depositors for the use of bank payments services below 
the cost to the bank of providing those services. Others take the form of. 
for example. providing a wide range of cash management services at 
very nominal fees and occasional gifts. In economic literature. these are 
called implicit interest rates, and many recent empirical studies have 
established the fac.tthat commercial hanks in the U.S. do in fact pay high 
implicit interest rates on non-interest bearing· ,demand deposiis of 
approximately equal value to the rate whi�h wo4ld be explkitly p�id in 
the a�s�;1c� 9f th� legal I;)r<;>�ibition.,1. 

• Air f'.' Darrat 'is Assistant Professor·of Econoni1cs at-the'University of Kentucky.

'See. for example. Klein (1978), Startz (1979) and Rush (1980).

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