Behavioral Equilibrium Analysis in the Implementation of Islamic Contracts in Iran’s Banking System: A Graph Model Approach in Game Theory

Document Type : Resear Paper (Islamic Banking)

Authors
Hossein Seilsepoor 1
Mohammad Javad Mohaqeqnia 2
1 Ph.D. Graduate in Finance and Banking , Department of Finance and Banking, Faculty of Management and Accounting, Allameh Tabataba’i University, Tehran, Iran
2 Associate Professor, Department of Finance and Banking, Faculty of Management and Accounting, Allameh Tabataba’i University, Tehran, Iran
10.30497/ifr.2026.249069.1998
Abstract
1. Introduction and Objective
More than four decades after the enactment of Iran’s Interest-Free Banking Law, the practical implementation of Islamic contracts continues to face substantial structural and behavioral challenges. Although the formal legal framework prohibits interest-based transactions and promotes Sharia-compliant modes of financing, the operational reality of the banking system reveals a dominant reliance on low-risk, exchange-based contracts—often executed in a formalistic rather than substantive manner. Participatory contracts, which are theoretically central to Islamic finance due to their risk-sharing and real-sector linkage characteristics, remain marginal in practice. This divergence between normative design and institutional performance raises a fundamental analytical question: Why does the system stabilize around suboptimal patterns of behavior despite repeated reform efforts?
Addressing this puzzle requires moving beyond purely doctrinal or legal analyses and toward a behavioral–institutional framework that captures strategic interactions among key actors. Drawing on institutional economics, organizational sociology, and non-cooperative game theory, this study conceptualizes the Iranian banking system as a structured arena of strategic interdependence. Within this arena, banks, customers, regulators, and supervisory bodies make choices under constraints shaped by formal rules, informal norms, incentive structures, and risk perceptions. The persistence of formalistic implementation is therefore interpreted not merely as regulatory failure, but as the outcome of a stable behavioral equilibrium embedded within an institutional configuration.
To analyze this configuration systematically, the study employs the Graph Model for Conflict Resolution (GMCR), a non-cooperative game-theoretic framework capable of modeling complex multi-actor strategic environments without requiring cardinal payoff information. The primary objective of the research is twofold: (1) to identify and evaluate the behavioral equilibria that characterize the current implementation of Islamic contracts in Iran’s banking system; and (2) to design feasible transition pathways toward a more efficient and substantively compliant equilibrium through minimal yet effective policy interventions. By integrating qualitative institutional analysis with formal equilibrium modeling, the study aims to provide both theoretical and policy-relevant insights into the dynamics of Islamic banking governance.

2. Methods and Materials
The research adopts a mixed-methods design, combining qualitative inquiry for structural identification with quantitative modeling for equilibrium analysis. The methodological strategy was structured in three sequential phases: actor–option identification, preference elicitation and modeling, and equilibrium evaluation with policy simulation.
Qualitative Phase: To capture the nuances of actor interactions, 26 semi-structured interviews were conducted with a purposive and snowball sample of banking executives, legal scholars, and Sharia-compliance experts. The gathered data underwent a three-stage thematic coding process (familiarization, coding, and theme development) based on the Braun and Clarke framework. This phase was critical in identifying the “game participants” and their respective “behavioral options.” We identified five major players: (1) Banks, (2) Customers, (3) The Central Bank, (4) The Sharia Council, and (5) the Government. A total of 13 behavioral options were extracted, reflecting the complexity of the operational landscape.
Quantitative Phase: The priorities of these actors were established using the Best-Worst Method (BWM) to ensure robust weighting of preferences. These inputs were then modeled in the GMCR+ software environment. After filtering for logical inconsistencies, dependencies, and Sharia-compliance requirements, the state space was narrowed down to 27 “feasible states.” We then applied advanced stability analysis, including Nash equilibrium, metarationality, sequential

stability, limited-move stability, and future stability. Finally, an “inverse-game analysis” was utilized to work backward from the desired state to the minimal set of policy interventions required to nudge the actors toward real-world implementation of participatory contracts.

3. Research Findings
The modeling process revealed two primary stable states in the Iranian banking system. In both, the dominant strategic behavior is characterized by the formalistic execution of exchange-based contracts, minimal enforcement by the Central Bank, and a “passive-flexible” stance by the Sharia Council.
The analysis of unilateral moves highlights that banks and customers are locked into these states. From their perspective, the cost of genuine participatory contracts—which entails higher information asymmetry, monitoring costs, and credit risk—outweighs the short-term benefits. Conversely, the existing regulatory interventions are insufficient to shift these preferences. Our findings demonstrate that as long as the cost-benefit profiles remain unchanged, the system will naturally revert to these inefficient equilibria, regardless of nominal legislative changes.
The simulation results further suggest that a transition to a “desirable state” (where participatory contracts are the norm) is possible only through a fundamental redesign of the incentive structure. Key findings include:
- Technological Supervision: A shift from manual auditing to AI-driven, real-time supervision is essential to increase the “cost of non-compliance” for banks.
- Incentive Alignment: Providing tax breaks and preferential credit lines specifically for profit-and-loss sharing contracts can significantly shift the bank’s payoff matrix.
- Regulatory Coalitions: The model underscores the necessity of a formal alliance between the Central Bank and the Sharia Council to harmonize regulatory authority, thereby reducing the “flexibility” that currently allows for the circumvention of Sharia requirements.

4. Discussion and Conclusion
The findings of this study offer a compelling argument: the formalization of Islamic banking in Iran is a classic collective action problem that cannot be solved by merely issuing new decrees or moral appeals. Rather, it is a structural challenge that requires “mechanism design.”
Our research suggests that policy reform should follow a multi-pronged approach. First, the “rules of the game” must be re-written to raise the opportunity cost of exchange-based formalism. Second, the “informational disadvantage” that currently hampers participatory banking must be mitigated through technological advancements, specifically by leveraging blockchain for transparent profit distribution and credit monitoring.
Furthermore, this study validates the utility of the Graph Model as a powerful diagnostic tool for policymakers. It allows for the simulation of complex institutional changes ex-ante, enabling regulators to predict how actors might respond to new policies before they are enacted.
In conclusion, moving toward a truly Islamic banking system necessitates a transition from reactive regulation to proactive, strategic policy design. By aligning the micro-level incentives of market participants with the macro-level objectives of social justice and economic efficiency, policymakers can break the current deadlock. This research contributes both to the theoretical literature on Islamic finance and to the practical policy agenda in Iran, providing a roadmap for evolving into a more transparent, stable, and Sharia-compliant banking system.
Keywords
Islamic Banking
Islamic Contracts
Game Theory
Graph Model
Behavioral Equilibria
Subjects
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  • Receive Date 30 September 2025
  • Accept Date 24 April 2026