A Comparison of Transactions in Conventional and Islamic Economies

Al-Jarhi, Mabid (2000): A Comparison of Transactions in Conventional and Islamic Economies. Published in: Proceedings of the Fourth Harvard University Forum on Islamic Finance: Islamic Finance: The Task Ahead No. 2000 (2000): pp. 27-34.

Abstract

This paper compares the transactions costs in two economies, one conventional, the other Islamic. The conventional economy is characterized by borrowing to finance some current purchases, while the Islamic economy disallows interest-based lending and operates on the basis of universal banking that mixes commerce and commercial and investment banking. To finance current purchases, it provides customers with credit purchase agreements, which entail that the bank buy the commodities and assets from suppliers and resell them on credit to customers satisfying conditions of creditworthiness similar to those that conventional banks require for borrowers. The paper uses simple calculations to compare transactions costs in both economies. It argues that under competitive competition, credit purchase arrangements occasion lower transactions costs than borrow-and-purchase arrangements in the conventional economy. The most important implication is that a policy that lifts entry barriers in the Islamic banking market and allows banks to combine commerce with banking activities contributes to social welfare. The paper concludes with suggestions for further points of research.

• Item Type: MPRA Paper
• Language: English
• Keywords: transactions costs, Islamic economy, universal banking, credit, Islamic finance
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E49 - Other

References

1. Al Jarhi, Mabid Ali (1983). “A Monetary and Financial Structure for an Interest-Free Monetary Economy: Institutions, Mechanism and Policy” in Ahmad, Z., M. Iqbal, and M.F. Khan (eds.). Money and Banking in Islam. Jeddah: Center for Research in Islamic Economics, and Islamabad: Institute of Policy Studies.

2. Al Jarhi, Mabid Ali (1998). “Functions of Institutions in an Islamic Monetary and Financial System and Their Role in Monetary and Financial Policies and Financial Markets.” Applications of Islamic Economics. Proceedings of a seminar held in Morocco. Jeddah: Islamic Research and Training Institute.

3. Al Jarhi, Mabid Ali (1999). “Islamic Finance in the 21st-Century: The Way Ahead: An Inaugural Address.” Islamic Finance in the 21st-Century. Proceedings of a seminar held in Kuala Lumpur. Jeddah: Islamic Research and Training Institute.

4. Aoki, Masahiko (1994). “Monitoring Characteristics of the Main Banking System: An Analytical and Developmental View” in Aoki, M. and H. Patrick (eds.). The Japanese Main Bank System. New York: Oxford University Press.

5. Boyd, John H., Chun Chang and Bruce D. Smith (1998). “Moral Hazard under Commercial and Universal Banking.” Journal of Money, Credit, and Banking 30(3) (August, Part 2). pp. 426-468.

6. Diamond, Douglas W (1998). “Comments on Moral Hazard under Commercial and Universal Banking.” Journal of Money, Credit, and Banking 30(3) (August, Part 2). pp. 469-471.

7. Haubrich, Joseph, G. and Joao A.C. Santos (1999). “Banking and Commerce: A Liquidity Approach.” Working Paper No. 9907, Federal Reserve Bank of Cleveland. June 8.