In this chapter we analyse how banks go about applying Islamic principles. The relevant ones are the ban on riba, the ban on gharar and maysir, the ban on haram products and the peculiarities of Islamic contract law. It is shown that some of 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.
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