An Economic Theory of Islamic Finance Regulation

Al-Jarhi, Mabid (2015): An Economic Theory of Islamic Finance Regulation.

Abstract

We argue that regulation can improve the performance of conventional banks up to a limit, but cannot eliminate the deficiencies resulting from the use of the conventional loan contract. Islamic finance requires complicated and costly procedures compared to conventional finance. Yet, it has significant macroeconomic benefits, which cannot be internalized by individual banks. Therefore, Islamic bankers tend to mimic conventional finance in order to cut costs and maximize short-term profits. Regulation can modify bankers’ incentives in order to capture the benefits of Islamic finance. Based on Al-Jarhi’s macroeconomic model (1983), we construct an economic theory of Islamic banking regulation. Results point out to the potential of designing regulations that discourage mimicking conventional finance in order to benefit from the Islamic finance advantages.

• Item Type: MPRA Paper
• Language: English
• Keywords: Al-Jarhi’s model, Islamic banking, Islamic finance, monetary economics, financial economics, banking, banking regulation, banking regulation, banking supervision, Islamic economics, financial economics, finance, financial intermediaries.
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E42 - Monetary Systems ; Standards ; Regimes ; Government and the Monetary System ; Payment Systems; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E50 - General; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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