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An economic theory of Islamic finance

Al-Jarhi, Mabid (2016): An economic theory of Islamic finance.

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We have demonstrated by using macroeconomic, banking and finance theories that Islamic finance, when applied according to our paradigm (Al-Jarhi, 1981) would have distinct advantages. In addition, it provides a justifiable prescription for reforming the contemporary market economy. The advantages of Islamic finance formulated above, although noteworthy, are not sufficient to induce Islamic bankers to be true to Islamic finance. The reason is that such advantages are mostly external and can only induce behavior after being internalized. An important policy implication is that such internalization is left to banking and finance regulators. Only when the license of Islamic banking is strictly enforced by the monetary authority that Islamic bankers would stop mimicking conventional finance. Our main policy implications are only one headline that requires more detailed explanation that is found somewhere else (Al-Jarhi, 2014). In addition, some Islamic finance contracts require special guidelines in order to reduce the amount of information asymmetry associated with them. In addition, certain modifications have to be introduced to the corporate governance of Islamic banks, especially in allowing investment account holders to be represented on their boards of directors.

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