Search

With diverse histories and attitudes toward risk-taking, different financial systems have a common aim: ensuring financial stability and efficiency within a geographical region. But differences exist between various financial systems as a result of their evolution and adaptation to their surrounding environment. This paper aims to analyze the incentive and sanction mechanisms of the Islamic mode of banking and the Grameen Bank model of microcredit in Bangladesh, and how they help ensure their financial stability and efficiency. We challenge the conventional explanations of their success. We point out that the informal sanction mechanisms embedded in the two modes of financial intermediation – avoiding non-compliance with Islamic Shari'ah (revealed divine law) in the case of Islamic banking, and kinship-based groupings or gushtis in the case of microcredit – play important roles in lowering the transaction costs of screening and enforcing contracts. We also point out how bank rent opportunity – the promised return from non-participatory financing and a high spread supported through low-cost funds provided by donor agencies and compulsory savings – is captured in each of the two modes, playing a further important role in maintaining their franchise values, given the specificities of the Bangladeshi financial context. [ABSTRACT FROM AUTHOR]