Abstract
Purpose: Although the treasury bill is the most important monetary instrument in central banking, its application in different phases of the business cycle, especially in a liquidity trap, is not working well. To remove this obstacle “Interest-Free Treasury Bond” (IFTB) is introduced as a substitute for conventional treasury bills.
 Design: IFTB is a valuable paper which is issued by government treasury through a barter contract and is sold to central or commercial banks. The issuer is a debtor to the holder and has to pay back the nominal value at maturity; in addition, the issuer is committed to lending a similar amount of money to the paper holder for an equal period. Zero interest rate is nominated for lending and borrowing.
 Finding: IFTB is a zero-coupon, asset-backed note with no interest and is designed upon “debt equal to future loan”, or “loan equal to future debt” with “time-withdrawal right”. The paper holder can supply and transact her bond in the secondary market at a competitive price.
 Practical implication: It can be used as a substitute for conventional treasury bills. All conventional and non-usury systems can implement IFTB.
 JEL: E43, E44, E52, E58, E62, E63
Highlights
Interest-free financial instruments are categorized in Islamic finance, but without the Islamic notion of the Interest-Free Bond (IFTB) that is introduced in this paper; this instrument can be used in both Islamic and conventional banking systems
This paper examines the potential for some of the interest-free bonds as new instruments for central banking operation, which could be attractive for generating funds by the central banks under both conventional as well as an Islamic banking system
This paper introduced a substitute for treasury bills, which, in addition to being interest-free, can be used in monetary and fiscal policies efficiently
Summary
Interest-free financial instruments are categorized in Islamic finance, but without the Islamic notion of the Interest-Free Bond (IFTB) that is introduced in this paper; this instrument can be used in both Islamic and conventional banking systems. Monetary contraction is done by selling central bank monetary instruments (securities) which do not need to have a counterpart or assetbacked, in the real sector This contradiction is one of the main constraints of applying Islamic instruments in an interest-free central banking system. This paper examines the potential for some of the interest-free bonds as new instruments for central banking operation, which could be attractive for generating funds by the central banks under both conventional as well as an Islamic banking system. To our knowledge, this is the first paper to address a theoretical background for such an issue.
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