Theory, Practice and Education
Edited by Mohamed Ariff and Munawar Iqbal
Chapter 5: Development, History and Prospects of Islamic Banking
Munawar Iqbal 1.0 INTRODUCTION Banks are the most important financial institutions in a modern economy. They perform some very important functions for the society and in this process significantly influence the level of economic activity, the distribution of income and the level of prices in a country. Although over time they have come to provide a number of services such as safe custody of valuables, transfers of money, issuing letters of credit and guarantees, collection of utility bills, etc., their basic function remains financial intermediation which involves mobilizing savings and transferring them to entrepreneurs. In any economy, there is a need to transfer funds from savers to investors because people who save are frequently not the same people who have the ability to exploit the profitable investment opportunities, i.e., they are not entrepreneurs. This function is performed through the process of financial intermediation in the financial markets. The most important operators in the financial markets are commercial banks. Financial intermediation enhances the efficiency of the saving/investment process by eliminating the mismatches inherent in the needs of surplus and deficit units of an economy. The surplus units are often small households who save relatively small amounts and the deficit units are the firms who often need relatively large amounts of cash. Financial intermediaries remove this size mismatch by collecting the small savings and packaging these to make them suitable to the needs of the users. In addition, users of funds in general need funds for relatively long-term deployment, which cannot be...
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