Monetary stability and interest-free banking revisited

This paper revisits the issue of the efficiency of the Islamic interest-fre e banking system. Recently, Youser et al. (1997) used a testing methodology proposed in Darrat (1988) and claimed that the evidence does not support i nterest-free banking in the case of Iran. However, by their own admission, the empirical results they report are consistent with the superiority of in terest-free over interest-based banking system in Iran, in three out of the four operational criteria used. Only over one criterion, the monetary aggr egate/price link, do Youser et al.'s results appear in conflict with the ef ficiency of the Islamic banking system. On this score too, it is shown that their 'evidence' is in doubt due to the possibility of significant specifi cation errors. Once these errors are corrected, the results seem unanimous in their support of the efficiency of interest-free banking system in Iran.