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Does an unregulated financial system absorb too many productive inputs? This paper studies this question in the context of a dynamic model with heterogeneous producers. In the absence of a financial system, the only way to purchase inputs is using internal funds. Producers are subject to idiosyncratic productivity shocks, and will decide to produce only if their productivity is high enough. Otherwise, they will hold money. A financial intermediation technology allows producers to purchase inputs in excess of their internal funds, by borrowing from unproductive agents. However, intermediation requires the use of costly monitoring services. In equilibrium, intermediation increases the money in circulation and raises nominal prices, thereby reducing the value of internal funds and making producers increasingly reliant on costly monitoring services. For this reason, society is better off when intermediation is restricted.

Access to Finance --- Costs of the financial sector --- Debt Markets --- Economic Theory & Research --- Finance and Financial Sector Development --- Financial intermediation --- Financial regulation --- Fiscal & Monetary Policy --- Islamic Finance --- Liquidity --- Macroeconomics and Economic Growth

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Derivatives are few and far between in countries where the compatibility of financial transactions with Islamic law requires the development of shari'ah-compliant structures. Islamic finance is governed by the shari'ah, which bans speculation and gambling, and stipulates that income must be derived as profits from the shared generation of goods and services between counterparties rather than interest or a guaranteed return. The paper explains the fundamental legal principles underpinning Islamic finance with a view towards developing a cohesive theory of derivatives subject to shari'ahprinciples. After critically reviewing accepted contracts and the scholastic debate surrounding existing financial innovation in this area, the paper offers an axiomatic perspective on a principle-based permissibility of derivatives under Islamic law.

Banks and banking --- Derivative securities --- Derivative financial instruments --- Derivative financial products --- Derivative instruments --- Derivatives (Finance) --- Financial derivatives --- Securities --- Structured notes (Securities) --- Banks and banking, Islamic --- Islamic banks and banking --- Non-interest banks, Islamic --- Religious aspects --- Islam. --- Econometric models. --- Banks and Banking --- Investments: Futures --- Investments: Options --- Money and Monetary Policy --- Islamic Banking and Finance --- International Financial Markets --- Criteria for Decision-Making under Risk and Uncertainty --- Pension Funds --- Non-bank Financial Institutions --- Financial Instruments --- Institutional Investors --- Other Economic Systems: Public Economics --- Financial Economics --- Financing Policy --- Financial Risk and Risk Management --- Capital and Ownership Structure --- Value of Firms --- Goodwill --- Monetary Systems --- Standards --- Regimes --- Government and the Monetary System --- Payment Systems --- Finance --- Financial services law & regulation --- Monetary economics --- Islamic finance --- Futures --- Options --- Hedging --- Currencies --- Financial services --- Financial institutions --- Financial regulation and supervision --- Money --- Islamic countries --- Financial risk management --- Malaysia