114 AN INTRODUCTION TO ISLAMIC FINANCE
is not as simple and straightforward as it may seem. The form of fi nancial
intermediation, the level of economic development, macroeconomic policies,
and the regulatory and legal framework are some of the factors that can com-
plicate the design of an effi cient fi nancial system.
FINANCIAL SYSTEMS: A FUNCTIONAL VIEW
A fi nancial system is better understood when viewed as a set of functions
it performs in an economy. Where a traditional view of a fi nancial system
restricts its role to mere capital mobilization, a functional view expects
it to perform an expanded role. By restricting the role of the fi nancial sys-
tem to capital mobilization, its deeper role under uncertainty, where risk
allocation becomes critical, is ignored. In addition, given information asym-
metries and incentive problems, capital markets may offer more effi cient
contracting through marketing for corporate control.^1 Another argument
favoring a functional view is that the functions of a fi nancial system do
not signifi cantly change over time and space, while the forms and functions
of institutions and intermediaries are subject to change.
Although, the most fundamental role of a fi nancial system is still fi nan-
cial intermediation, the following are the core functions expected from an
effi cient fi nancial system.
Effi cient Capital Mobilization
The ultimate function of a fi nancial system is to perform effi cient resource
allocation through capital mobilization between savers and users of capital.
This function is performed effi ciently when the economic agents have access
to capital through a liquid market for varying maturity structures; that is,
from the very short - to the very long - term needs. Access to capital has to be
easy, transparent, and cost effective, with minimal transaction costs and free
of information asymmetries.
Effi cient Risk Allocation
Under uncertainty and volatile market conditions, the function of risk shar-
ing, risk transfer, and risk pooling becomes critical in a fi nancial system. In
the absence of such functionality, the fi nancial system will discourage projects
that attract high risk but also high value - added to the economy. The “insur-
ance” function is vital for any fi nancial system and the availability of effi cient
risk - sharing facilities promotes diversifi cation and allocational effi ciencies.
Pooling of Resources and Diversifi cation of Ownership
A fi nancial system provides a mechanism for the pooling of funds to under-
take large - scale indivisible investments that may be beyond the scope of