Risk and Regulation of Islamic Banking

Risk and Regulation of Islamic Banking

Foundations of Islamic Finance series

Edited by Mervyn K. Lewis, Mohamed Ariff and Shamsher Mohamad

From a single product offering in 1963, the Islamic financial services industry has grown to an estimated $1.6 trillion in assets. Products must comply with profit and risk-sharing criteria and regulations preventing banks from venturing into activities with high risk and excessive uncertainty. This timely volume analyses these matters and considers the range of new products, discussing both conceptual and practical dimensions. It connects Islamic finance to the mainstream theoretical literature on financial intermediation while also exploring its differences. The expert contributors also examine why an ethical foundation is important and why the system requires well-thought-out regulations to ensure outcomes that protect the community’s well-being.

Chapter 2: A theoretical perspective on Islamic banking and financial intermediation

Mervyn K. Lewis

Subjects: asian studies, asian economics, economics and finance, asian economics, financial economics and regulation, islamic economics and finance, money and banking


As financial intermediaries, Islamic banks collect deposit funds from investors, both by means of mudaraba investment accounts and other deposit accounts, on one side of the balance sheet, and then invest these funds in a variety of Islamically acceptable forms, on the other side. In doing so, they conduct financial intermediation in ways quite different from conventional banks since profit-and-loss modes of finance and investment in trade and commodities via sales-based and leasing contracts feature extensively in their activities. There is a large literature in banking theory and finance that examines the optimality of the interest-based instruments used by conventional banks. In order to explore the differences that may result from substituting the Islamic financing instruments for the conventional techniques of banking, we need to review the theories of financial intermediation.

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