ABSTRACT

That there may be greater resilience to cyclical downturns where Islamic precepts govern banking and finance is a motivation not so far removed from that of the Chicago Plan. In a Western context, a lender expects to receive a predetermined payment of interest, regardless of the success or otherwise of the project. Under Islamic precepts, that gives too much advantage to the lender. The alternative is that entrepreneurs compete to become the ‘agents’ of those who possess financial capital, with the latter scrutinizing the projects and their management teams. In having some ‘skin in the action’, Islamic banking may have reduced exposure to periodic financial crises. Where commercial banking in the West is criticised for the moral hazard of being a cornerstone of the payments system, a different set of problems may arise under Islam. Although Islamic practices may deliver more closely coordinated activities, less desirable consequences may follow. Inherent within conservative practices is a tendency to neglect the value that derives from dispersed local knowledge. The nub is that practices that follow traditional Islamic mores may enhance the coordination of activity at the cost of lowering the pace of innovation.

Simons opposed the use of short-term debt to finance both corporate and sovereign activities. With the implementation of the Chicago Plan and by the sale of undated bonds, short-term lending would be diminished. So, although Islamic banking has no direct relevance to the Chicago Plan, comparisons between Western and Islamic banking performance raise relevant issues. The greater resilience to cyclical downturns that is perceived to arise where Islamic precepts govern banking and finance is not so far removed from Simons’s motivations.