151CHAPTER
8Islamic Financial Intermediation and Banking
and Banking
F
inancial intermediaries are different from other economic agents. They
not only channel resources from the capital surplus agents (generally,
households) to capital defi cit ones (the corporate sector), they also allow the
inter - temporal smoothing of household consumption and business expen-
ditures and thus allow both fi rms and households to share risks. Since the
early 1980s, the increased complexity and volatility of the fi nancial markets
have led fi nancial intermediaries to innovate and offer products to mitigate,
transfer, and share fi nancial risks.
The primary functions of a fi nancial intermediary are asset transfor-
mation, conducting orderly payments, brokerage and risk transforma-
tion. Asset transformation takes place in the form of matching the demand
and supply of fi nancial assets and liabilities (for example, deposits, equity,
credit, loans and insurance) and entails the transformation of maturity, scale
and place of the fi nancial assets and liabilities of the ultimate borrowers and
lenders. The administrative function of an accounting and payments system
(check transfer, electronic funds transfer, settlement, clearing) is considered
another important intermediation function. Typically, fi nancial intermediar-
ies have also offered brokerage or match - making between the borrowers and
lenders, and facilitated the demand and supply of non - tangible and contin-
gent assets and liabilities, such as collaterals, guarantees, fi nancial advice,
and custodial services.
The nature of intermediation has changed drastically over the last four
decades because of changes in macroeconomic policies, the liberalization
of capital accounts, deregulation, advances in fi nancial theory and techno-
logical breakthroughs. Financial intermediation in the form of traditional
banking has declined considerably in developed countries, where market -
based intermediation has become dominant. Traditional bank lending oper-
ations are being replaced by more fee - based services that bring investors
and borrowers directly in contact with each other. Some degree of “dis -
intermediation” has taken place due to the development of capital markets
An Introduction to Islamic Finance: Theory and Practice, Second Edition
by Zamir Iqbal and Abbas Mirakhor
Copyright © 2011 John Wiley & Sons (Asia) Pte. Ltd.