While Islamic bonds are playing an increasingly important role for companies in emerging markets, the pricing of their risk by investors remains unexplored. We examine the impact of credit ratings on the yield-at-issuance of Islamic bonds and compare it to that of conventional bonds. Analysing 1560 Islamic bonds issued in emerging markets between 1997 and 2018 and comparing them to 837 comparable conventional bonds, we find that Islamic bonds offer lower yields than conventional bonds for a given rating, even after controlling for differences between the two populations. This suggests that investors are pricing in less credit risk in Islamic bonds. We explore several explanations for this phenomenon. We find that periods of relatively lower supply in the Islamic bond market contribute to the under-pricing of risk for a given rating. Religious preferences likely drive the segmentation of the two markets in terms of risk pricing.

Banks argue that holding higher capital will have adverse implications on their lending activities and thereby on economic growth. Yet, the effect of a stronger capital base on economic growth remains largely unsettled. We argue that better capitalized banks improve financial stability conditions and, in dire times, they are able to sustain credit to the economy thereby containing adverse macroeconomic implications. Using various methods, we test for the presence and strength of a financial stability channel and a bank lending channel by drawing evidence from 47 advanced and developing countries over close to two decades. We find that higher capital ratios improve financial stability and help sustain bank lending, ultimately exerting a positive influence on economic activity. These effects on real GDP growth are economically significant, reaching up to 1¼ percentage points for each percentage point acceleration in capital. Our main results are robust to various sensitivity checks, supporting the conclusion that safer banking systems do not bridle economic activity.

In this paper we study how a benevolent government that cannot commit to future policy should trade off the costs and benefits of public expenditure. We characterize and solve for Markov-perfect equilibria of the dynamic game between successive governments. The characterization consists of an inter-temporal first-order condition (a “generalized Euler equation”) for the government, and we use it both to gain insight into the nature of the equilibrium and as a basis for computations. For a calibrated economy, we find that when the only tax base available to the government is capital income—an inelastic source of funds at any point in time—the government still refrains from taxing at confiscatory rates. We also find that when the only tax base is labour income the Markov equilibrium features less public expenditure and lower tax rates than the Ramsey equilibrium.