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2016 | OriginalPaper | Chapter

11. Loans Provision and Adverse Selection Within Orthodox Religious Communities

Authors : Suren Basov, Ishaq Bhatti

Published in: Islamic Finance in the Light of Modern Economic Theory

Publisher: Palgrave Macmillan UK

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Abstract

In this chapter we investigate the wisdom of restricting business loans to the members of a club, which can be interpreted as a community united along social, cultural or religious principles. Members of the club can be more trustworthy, which will help to mitigate moral hazard problems, but may also possess lower levels of human capital. If human capital is imperfectly observable, this will create an adverse selection problem. We discuss this trade-off, developing a multidimensional screening model of loan provision. As a particular application of the general model we consider business loans provision by Islamic banks.

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previous chapter Business Loans, Trust, and Contract Restriction Faced by Islamic Banks
next chapter Shariah Compliance and Risk-Incentive Trade-Offs
Footnotes
1
More generally, the requirement is that the losses should be shared proportionally to the investment. Assuming the entrepreneur has no own funds implies α = 0.
 
2
For a discussion of how this constraint can be incorporated in the problem, see Basov and Bhatti (2011).
 
3
For an arbitrary utility function \(v(\cdot )\) the certainty equivalent is defined as a solution to v(CE) = Ev(x).
 
Literature
Basov, S. 2005. Multidimensional screening, Series: Studies in Economic Theory, vol. 22. Berlin: Springer-Verlag.
Basov, S., and S. Danilkina. 2010. Multitasking, multidimensional screening, and moral hazard with risk neutral agents. The Economic Record 86(s1): 80–86.CrossRef
Picard, P. 1987. On the design of incentive contracts under moral hazard and adverse selection. Journal of Public Economics 33: 305–332.CrossRef
Metadata
Title
Loans Provision and Adverse Selection Within Orthodox Religious Communities
Authors
Suren Basov
Ishaq Bhatti
Copyright Year
2016
Book
Islamic Finance in the Light of Modern Economic Theory

Print ISBN: 978-1-137-28661-1

Electronic ISBN: 978-1-137-28662-8

Copyright Year: 2016

DOI
https://doi.org/10.1057/978-1-137-28662-8_11