Contractual Agreement Creates New Principles in the Financial Intermediation Theory

This paper discusses the differences in the key arguments of the traditional financial intermediation theory and Shariah principles. The main issues have been identified as the fundamental arguments in explaining the existence of financial intermediaries are transaction cost, asymmetric information and risk management. The aim of this paper is to provide an insight of the roles of financial intermediaries in the traditional financial intermediation theory and Shariah principles from the aspect of contractual agreement. Since, both equity and debt contracts be present in the financial market, Islamic financial institutions expose to the same issues as discussed in the financial intermediation theory. Therefore, in contractual agreement additional monitoring, supervision and alignment of incentives are required to minimize transaction costs and asymmetrical information. Indeed, the roles of Islamic financial institutions are essential to achieve the objectives and rationales of the Shariah, (maqasid as-Shariah), which intend to protect and preserve interests related to the overall well being and welfare of the economic system.