Islamic Finance

Islamic Finance

Principles and Practice, Second Edition

Hans Visser

This thoroughly updated and revised second edition analyses the ideas behind Islamic finance, the forms Islamic finance has taken in practice and the tension between the two that may occasionally arise. Along with an expanded section on the history of the ban on interest, this second edition contains a much more extensive discussion of investment and savings accounts, sukuk and tawarruq.

Chapter 5: Islamic banks

Hans Visser

Subjects: economics and finance, financial economics and regulation, money and banking


In this chapter we analyse how banks have tried to apply Islamic principles. It is shown that these principles may lead to serious moral hazard and information problems and we examine how the banks deal with those problems. We start with a survey of the financial instruments offered by the banks, that is, the liabilities side of the bank’s balance sheet. Next we discuss the specific problems thrown up by some of these liabilities. Then we turn to the problems associated with typically Islamic bank assets. Agency problems figure prominently. A few observations on the practice of Islamic banking follow before the chapter ends with a couple of conclusions. In Chapter 4 the various Islamic financial instruments were discussed. Islamic banks use these instruments to provide their clients with funds. We now turn to the other side of the balance sheet. How do the banks fund themselves, what are their sources of funds. Basically, they use a subset of the available Islamic financial instruments. Islamic banks thus are free to issue shares but not, for instance, conventional bonds. The peculiar character of the banking business warrants a separate analysis of the banks’ liabilities.

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