1) Definition of Economic Welfare
Economic welfare is a general concept which doesn't lend to easy definition. Some says it is a branch of economics that focuses on the optimal allocation of resources and goods and how this affects social welfare.
Basically, this relates to the study of income distribution and how it affects the common good.
Economic welfare is also considered as the level of prosperity and quality of living standards in an economy by focusing on the optimal allocation of resources and goods and how this affects social welfare. It is based on that economy can be measured through a variety of factors such as GDP and other indicators which reflect welfare of the population such as literacy, number of doctors, levels of pollution, etc but it is usually measured in terms of Real Income, real GDP. An increase in Real Output and real incomes suggests people are better off and therefore there is an increase in economic welfare.
However, economic welfare will be concerned with more than just levels of income.
For example, people's living standards are also influenced by factors such as levels of congestion and pollution. These quality of life factors are important in determining economic welfare.
2) Two Approaches: The early Neoclassical approach, The New Welfare Economics approach
There are two mainstream approaches to welfare economics: the early Neoclassical approach and the New welfare economics approach.
2-1) The early Neoclassical approach (the first approach)
‘The greatest meliorator of the world is selfish, huckstering trade.’(R.W. Emerson, Work and Days)
To establish the first approach, we need to sketch a general equilibrium model of an economy.
Assume all individuals and firms in the economy are price takers: none is big enough, or motivated enough, to act like a monopolist. Assume each individual chooses his consumption bundle to maximize his utility subject to his budget constraint. Assume each firm chooses its production vector, or input–output vector, to maximize its profits subject to some production constraint. Note that we assume self-interest, or the absence of externalities: An individual cares only about his own utility, which depends only on his own consumption. A firm cares only about its own profits, which depend only on its own production vector.
The invisible hand of competition acts through prices; they contain the information about desire and scarcity that coordinate actions of self-interested agents. In the general equilibrium model, prices adjust to bring about equilibrium in the market for each and every good. That is, prices adjust until supply equals demand. When that has occurred, and all individuals and firms are maximizing utilities and profits, respectively, we have a competitive equilibrium.
The first approach establishes that a competitive equilibrium is for the common good. But how is the common good defined? The traditional definition looks to a measure of total value of goods and services produced in the economy. In Smith, the ‘annual revenue of the society’ is maximized. In Pigou (1920), following Smith, the ‘free play of self-interest’ leads to the greatest ‘national dividend’. The modern interpretation of ‘common good’ typically involves Pareto optimality, rather than maximized gross national product.
This approach says that all perfectly competitive equilibria with complete markets to deal with externalities and uncertainty are Pareto efficient*.
2-2) The New Welfare Economics approach(the second approach)
The New Welfare Economics approach is based on the work of Pareto, Hicks, and Kaldor. It explicitly recognizes the differences between the efficiency aspect of the discipline and the distribution aspect and treats them differently. Questions of efficiency are assessed with criteria such as Pareto efficiency and the Kaldor-Hicks compensation tests, while questions of income distribution are covered in social welfare function specification. Further, efficiency dispenses with cardinal measures of utility, replacing it with ordinal utility, which merely ranks commodity bundles (with an indifference-curve map, for example).
The second approach establishes that the market mechanism, modified by the addition of lump-sum transfers, can achieve virtually any desired optimal distribution. Under more stringent conditions than are necessary for the first approach, including assumptions regarding quasi-concavity of utility functions and convexity of production possibility sets, the second approach gives the following:
The second approach of Welfare Economics. Assumes that all individuals and producers are self-interested price takers. Then almost any Pareto optimal equilibrium can be achieved via the competitive mechanism, provided appropriate lump-sum taxes and transfers are imposed on individuals and firms.
Source
Allan M. Feldman, Welfare Economics 2006, http://newmonetarism.blogspot.com/2011/07/economic-welfare.html, http://www.investopedia.com/terms/w/welfare_economics.asp#axzz1dxuSDV1L, http://www.economicshelp.org/blog/1041/economics/economic-welfare/, http://en.wikipedia.org/wiki/Welfare_economics
1) Information disclosure in general
A bank discloses their financial and other information, aimed at providing a broad and reasonably up-to-date view of the bank through annual reports. Major groups of the reports users are ⒜ Shareholders; ⒝ Account holders and depositors (clients of the bank); ⒞ Borrowers and others who transact with the bank; and ⒟ Regulatory bodies.
Information disclosure leads to transparency and supervision and regulation of the banking sector. Moreover, it gives banks stability in consequence, despite the fact that almost all banks’ activities face a variety of risks. For that reason, major global financial institutions such as the World Bank and IMF’s Financial Sound Indicators system have emphasized the importance of transparency and disclosure as one of the core components of bank stability because transparency which arises from greater disclosure by banks will further benefit the financial system as a whole, by reducing the doubts and it provides an essential foundation to a more stable and efficient financial system.
2) Information disclosure in Islamic banks
Not only in conventional banks but also in Islamic banks, truthful and relevant disclosure of information is necessary and Islamic banks, which avoid Gharar and follow Mudarabah principle, are encouraged to make more extensive disclosure since it shows banks’ strategies and relevant risks and also assists depositors and other investors to make well-informed decisions on where to put their money.
Islamic banks apply a Shariah and legal framework which ensures effective risk management practices, adequate financial disclosure and governance to their information disclosure. This leads them to have a strong financial system by including these components as follow: ⒜ Performance Overview; ⒝ Statement of Corporate Governance; ⒞ Directors’ Report; ⒟ Statement by Directors; ⒠ Statutory Declaration by Director or person responsible for reparation of financial statements of the reporting institution; ⒡ Auditors’ Report; ⒢ Shariah Committee’s Report; ⒣ Balance Sheet; ⒤ Income Statement; ⒥ Statement of Changes in Equity showing either all changes in equity or changes in equity other than those arising from capital transactions with owners and distributions to owners; ⒦ Cash Flow Statement; and ⒧ Accounting Policies and Explanatory Notes.
This form of information disclosure based on a Shariah and legal framework has increased the reliability of the Islamic financial system and strengthened the incentives for banks to maintain sound banking practices. Besides, it provides both the supervisory authorities and the public with better information of a bank's strategies and risks including Islamic banks’ special risks.
Sources
1) Reserve Bank of New Zealand, “Your bank's disclosure statement: what's in it for you?”
2) Nafis Alam & Prof. Bala Shanmugam, “Promoting Transparency in Islamic Banks”, THJ Jan/Feb 2007 edition
3) Luca Errico & Mitra Farahbaksh, “Islamic Banking: Issues in Prudential Regulation and Supervision”, IMF Working Paper, March 1998
4) Islamic Banking and Takaful Department of Bank Negara Malaysia, “Guidelines of Financial Reporting for Licensed Islamic Banks”
5) Mohamed Abdelhamid, “Islamic Banking”, Department of Economics in Carleton University, September 2005
Although Islamic finance is playing a more and more important role in the world, I even didn't know what is different between conventional and Islamic banks. I thought it was not my business as I'd never seen any Islamic bank in Korea.
Things are always changing though. I happened to come to Malaysia and this country is closely connected with Islamic banks. It's time I needed to know at least what it is!
I asked my Thai friend if she knew anything about it and she said there's something different in their interest system. I found out later that it was about riba, which is one of the most crucial concepts in Islamic finance.
Then what is Riba?
Literally, riba means ‘excess’ or ‘increase’ in the Arabic language, which is also thought to be ‘effortless profit’ in the Islamic terminology and translated into ‘interest’ in English. However, riba is so much more than what I mentioned above in fact. There are a number of opinions about the definition of riba, depending on scholars, and the meaning seems to be too general and indefinable, so we are going to have a look at it from the different angle in order to get a better understanding of what riba is by explaining 1) why riba is prohibited in Quran and 2) why a profit in the Islamic banking is not riba.
1) why riba is prohibited in Quran
In the conventional economics, a loan is considered a means to make greater economic benefits. That is why the lender returns to the borrower more and better than the quantity borrowed in compensation for the time value of their money.
However, it is assumed that those who are in difficulties borrow a loan to get out of the situation in the Islamic economics. In other words, what Quran prohibits is not ‘riba’ itself but the worse result which can be happened to the borrower not being able to pay back. This is the reason why riba is not accepted in Quran.
2) why a profit in the Islamic banking is not riba
Nevertheless, a profit called interest in the western banking still exists in the Islamic banking and it is one of the vital sources which allow the Islamic bank to run the business smoothly. Then why is the profit in the Islamic banking not riba?
While the borrower has to take the risk of the lender by paying them the interest in the conventional economics, the borrower and lender share not only the profit but also the risk as a partner in the Islamic economics. Moreover, either a product or a service must be delivered in Islamic banking transactions so that the profit is not riba anymore, but just a profit from their investment in the partnership.
It is true that the definition of riba has similarities to interest in some ways but we can find the certain differences between them and when the reasons, why riba is prohibited in Quran and why a profit in the Islamic banking is not riba, are taken into account, we can get a better understanding of the definition of riba.
