Islamic Finance and Limited Purpose Banking (LPB): Two Sides of the Same Coin

Islamic Finance and Limited Purpose Banking (LPB): Two Sides of the Same Coin

Edib Smolo (SARAYCON - Saray Consultancy for Socially Responsible and Ethical Finance, Bosnia and Herzegovina)
Copyright: © 2020 |Pages: 17
DOI: 10.4018/978-1-7998-1611-9.ch006

Abstract

The saying that “history repeats itself” is best manifested in capitalist financial system operating worldwide. It seems people are not learning lessons from the history of financial crises. Leading economists and capitalist gurus are warning about an inherently fragile capitalist financial system and about an urgent need to do something about it before it is too late. After the recent global financial crisis, Kotlikoff proposed the most radical and the most comprehensive reform of the existing financial system. His proposal became known as the Limited Purpose Banking (LPB). Kotlikoff's proposal runs hand in hand with the aspirations of the pioneers of Islamic finance. He envisioned a financial system that is based on risk sharing, cooperation, and overall public interest (maslahah). In short, the idea of the LPB – after certain modifications and minor adjustments – can be applied in developing a true Islamic financial system. Thus, it can be said that the LPB and Islamic finance are two sides of the same coin.
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Critics Of Cfs And The Global Financial Crisis: The Event That Led To Lpb

Since the starting of the 21st century alone, about 24 economic and financial crises hit economies worldwide.1 Among these 24 crises, the most severe one is the recent global financial crisis of 2007-2009. In fact, it is so severe that basic tenets of the CFS, such as the notion of ‘the invisible hand’, are questioned openly.

This notion of ‘the invisible hand’ was introduced by the 18th century Scottish philosopher and economist Adam Smith in his book ‘The Theory of Moral Sentiments’. He used this phrase in two other places, but with a different meanings (Rothschild, 1994). In this case he refers to some rich landowners who are selfishly interested in their own wellbeing ignoring values such as “humanity” and “justice”. They go after precious commodities “from the labours of all the thousands whom they employ”. In doing so, They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species (Smith, 2006, pp. 215-216)

Nowadays, ‘the invisible hand’ is considered as the unobservable market force standing behind the demand and supply of goods and services in a free market and bringing about beneficial social and economic outcomes from an individual’s self-interested actions. This is, at least, how economists see the notion of ‘the invisible hand’, although this may not be at all Adam’s intention – as pointed out by Rothschild (1994).

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