Islamic Financial Intermediation and Banking 163
savers and entrepreneurs, eliminating the risks faced by their conventional
counterparts.
One of the most critical and distinguishing features of fi nancial inter-
mediation by Islamic banks is the inherent design by which the assets and
liabilities sides of the Islamic bank’s balance sheet are matched. In a con-
ventional bank, deposits are accepted at a predetermined rate, irrespective
of the rate of return earned on the bank’s assets side. This instantaneously
creates a fi xed liability without any certainty that the bank will be able to
earn more than it promised or was committed to paying to the depositors.
Since the return on the asset depends on the bank’s ability to invest the funds
at a higher rate than the one promised on the liability side and this rate
is unknown, it can lead to the classical problem of mismatch between assets
and liabilities.^2
Since there is no such predetermined rate on the assets side of the Islamic
bank, the asset–liability mismatch does not arise. It has been argued that
because of the pass - through nature of the business and the close matching of
assets and liabilities, fi nancial intermediation by Islamic banks contributes
to the stability of the fi nancial system.
Universal Banking
It is also interesting to note that the structure of a hypothetical Islamic bank
or fi nancial intermediary combines the activities of commercial and invest-
ment banking, as shown by the boxes on either side of the balance sheet in
Figure 8.1. Here, each box on the assets and liabilities sides represents a
specialized function or fi nancial service, whereas the arrows across liabilities
and assets indicate how assets and liabilities can be matched. Each box can
also help us understand the separation of assets and liabilities based on their
function, risk profi le, maturity structure and the targeted market. Similar
to a conventional commercial bank, such a fi nancial intermediary can raise
funds as deposits and invest them in low - risk, high - quality, investment -
grade trade fi nancing or asset - backed securities. Like an investment bank,
it can offer underwriting services, asset management through specialized
mudarabah funds and other advisory services such as research about fi nan-
cial markets, the maintenance of benchmarks, portfolio management, and
risk management.
Shari’ah Boards
One of the distinctive features of Islamic banking is the existence of a
Shari’ah board that comprises religious scholars and the infl uence this board
exerts on the operations of the bank. Islamic banks cannot introduce a new
product without the prior permission and approval of their Shari’ah board
and, depending on the affi liation of the religious scholars on the board to
any particular school of jurisprudence, this can determine the success or fail-
ure of a product with its target clients. A shortage of Shari’ah scholars well