Edited by Mervyn K. Lewis, Mohamed Ariff and Shamsher Mohamad
Chapter 2: A theoretical perspective on Islamic banking and financial intermediation
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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