Shariah Compliant Financial Intermediation in Dual Banking System

Abstract

Islamic principles of financial intermediation require that IFIs refrain from impermissible financial transactions and play an active role in pursuing objectives of Shariah. Muslim countries have implemented dual banking system in their economies that in turn affect the achievement of these goals. This study examines Islamic perspective of the theory of financial intermediation and assesses if its desired objectives can be achieved in dual banking system. It is found that, in a dual banking environment, it is extremely difficult to achieve the desired objectives of Islamic financial intermediation, due to the high competition with conventional banks, lack of suitable products, inability of system to support IF transactions and lack of expertise of the staff of IFIs to effectively perform risk sharing based transactions. Muslim governments should design effective liquidity management frameworks for Islamic banks and focus on developing strong Islamic financial institutions and integrated Islamic money markets, in order to achieve the desired goals of Islamic financial intermediation.