158 AN INTRODUCTION TO ISLAMIC FINANCE
a securitized market. First, as “originator” of the assets, they can become
the main and constant source of assets for the securitized market. In this
way, Islamic banks become the supplier of the assets to the securitized
market and then replace those assets with new assets. Second, similar to
a conventional investment bank, Islamic banks can perform the important
function of underwriting the asset - linked securities and also act as broker
or dealer. Third, they can build a portfolio of asset - linked securities on
their assets side. By keeping “asset - linked” securities on the assets, Islamic
banks thus benefi t from the liquidity of assets and the ability to buy and sell
securities at market prices, which enable them to perform better portfolio
management.
Table 8.5 shows different functional components of an Islamic bank
from maturity and risk perspectives to show that an Islamic bank as a fi nan-
cial intermediary is able to offer the full spectrum of commercial and invest-
ment banking services in an effi cient fashion. There is suffi cient diversity on
both the asset and liability sides to undertake all critical functions expected
from an effi cient fi nancial intermediary.
DISTINCTIVE FEATURES OF THE ISLAMIC MODE OF
INTERMEDIATION AND BANKING
Financial intermediation and banking differs from conventional banking in
several ways. These are set out below.
Nature of Fiduciary Responsibilities
The agency theory has generated considerable interest in fi nancial econom-
ics, including Islamic banking. In an agency relationship, one party (the
principal) contracts with another party (the agent) to perform some actions
on the principal’s behalf, and the agent has the decision - making authority.
Agency relationships are ubiquitous: for example, agency relationships exist
among fi rms and their employees, banks and borrowers, and shareholders
and managers. Jensen and Meckling (1976) developed the agency model of
the fi rm to demonstrate that a principal–agent problem (or agency confl ict)
is embedded in the modern corporation because the decision - making and
risk - bearing functions of the fi rm are carried out by different individuals.
They noted that managers have a tendency to engage in excessive perquisite
consumption and other opportunistic behavior because they receive the full
benefi t from these acts but bear less than the full share of the costs to the
fi rm. The authors termed this “the agency cost of equity,” and pointed out
that it could be mitigated by increasing the manager’s stake in the ownership
of the fi rm. In the principal–agent approach, this is modeled as the incentive -
compatibility constraint for the agent, and an important insight from this
literature is that forcing managers to bear more of the wealth consequences
of their actions is a better contract for the shareholders.