The Interest Rating to Develop a Theory of Liquidity Preference Essay

The Interest Rating to Develop a Theory of Liquidity Preference - Essay Example When the economy is doing well, the corporate cash flows rise above what is required to pay the debt off. This leads to speculative euphoria where this act of borrowing and lending goes on and reaches a point where the borrowers are no longer able to pay off the debt. As borrowers are no longer able to pay back, it leads to financial crises where banks do not have liquidity. As a result of the borrowers’ default, banks further tighten their lending, which means that even deserving borrowers that could pay back do not get access to capital in such circumstances. According to Minsky, these swings are a part of a free market economy and cannot be avoided unless there is the provision of a government enforced the regulation. Mishkin, on the other hand, focused on the role of asymmetric information in the financial system. This essentially means that one party in the transaction has less information than the other party. For example, a lender is not aware of the potential ways in which the borrower is going to use the money, but in case the money is lost, it is always the lender who is at the losing end. This asymmetric information creates two problems, namely the adverse selection and the moral hazard. Adverse selection is a trend in which lenders choose borrowers who can pay a higher interest, knowing that they can pay higher interest because their business is riskier and hence there is a greater chance of losing the money on the part of the lender. The interest rate on such investments is quite exaggerated to reflect the risk premium. Moral hazard occurs when the borrowers may choose to invest the money in activities that are undesirable from the lenders’ point of view or else they simply do not work. As this loss is to be borne by the lenders, they will refrain from lending thus causing a financial crisis. Mishkin concentrates on interest rates to develop a theory of liquidity  preference.  

Islamic banking and financial in a global economy Assignment

Islamic banking and financial in a global economy - Assignment Example This growth is conspicuous from the emergence of new Shariah compliant instruments in various asset classes, ranging from equities, real estate, commodities and private equity (not bonds as interest bearing instruments are considered prohibited (haram)). Estimates suggest that since 1990, the market size of the Islamic Finance has multiplied five times from USD 150 billion to USD 900 billion in the year 2008; whereas it is expected to more than double at USD 2 trillion by the year 2010. The main markets currently involved in the Islamic finance and banking across the globe comprises mainly the active participation from the GCC countries, followed by Middle Eastern and North African countries. Slowly and gradually European states, Australia and other American states have started penetrating the market with wild growth rates. It is noticeable from the onset of Shariah compliant banking units of Citigroup (America), HSBC (Britain), and Deutsche Bank (Germany). As opposed to conventional banking, Islamic banking has its roots in the core values of the religion, Islam. Where, Islam itself is the way of life and conduct of living, the underlying theme of the Islamic Financial system is application of ethics and discipline to the banking and finance sector. It is not so simple; it does not only prohibit usury/interest (money on money), but aims at eliminating unjust behavior for the development of an equitable economy. Prohibition of interest, avoidance of uncertainty and contingency, restrictions on short selling, sharing in profits and losses are the core principles governing Islamic finance; it also places restrictions on financing sectors that engage in illegal and illicit activities – such as alcohol and tobacco, gambling, arms and ammunition, pornography and acts that are harmful for the environment. For the avoidance of all these prohibit able acts and indulgences, the community of Islamic shariah scholars have come up with