Chapter 8The Financial System
- The essential role and functions of a financial system.
- The link between the real and the financial sector.
- The notion and implications of risk sharing in finance.
- The contrast between conventional and Islamic banking.
- The menu of permissible and prohibited instruments and the nature of risk-sharing financial assets.
- The form of Islamic insurance.
- The nature of Islamic capital markets.
- The importance of vibrant stock markets in the Islamic system.
- The stability and growth implications of the Islamic financial system.
The primary role of a financial system is to create incentives and mechanisms for an efficient allocation of financial and real resources for competing aims and objectives across time and space. A well-functioning financial system promotes investment by identifying and funding the best business opportunities; mobilizes savings; monitors the performance of managers; enables the trading, hedging, and diversification of risks; and facilitates the exchange of goods and services. Within a financial system, financial markets and banks perform the vital functions of capital formation, monitoring, information gathering, and facilitation of risk sharing. An efficient financial system is expected to perform four functions.
- The system should facilitate efficient financial intermediation to reduce information and allocation costs.
- It must be based on a stable payments system.
- With increasing globalization and demands for financial ...