Reconciling western financial institutions with Islamic principles: Reforming the Saudi financial system

A healthy and vibrant economy depends on a safe payment system and the efficiency of the financial institutions in channeling funds from savers to those who need capital to invest. Many scholars have criticized the founding of Western financial institutions in Muslim countries because of a perceived contradiction between the people's belief and the fundamental principles of most Western institutions. This dissertation argues that the contradiction need not exist if financial institutions are created which conform to the institutional structure of Saudi society.;In such a market, institutional adjustment is required, and for Saudi Arabia, changes must make the financial system more compatible with the broader goals and institutions of Saudi society. Since Islamic banking is mainly an equity-based system, some Western financial institutions which are based on equity participation are examined in this dissertation. These are Community Development Banking, Mutual Funds, and Venture Capital. A safe and efficient payment system is also necessary, thus Narrow Banks will be evaluated.;This dissertation demonstrates the connection between the Islamic banking system, the economic system in Saudi Arabia, and some financial institutions that have been successful in the U.S. It proposes a modern financial system for Saudi Arabia which is consistent with Islamic principles and would attract savers and investors and accelerate the process of development and economic growth. Though difficulties may face the monetary authorities in creating these new institutions, their creation will allow Saudi Arabia to mobilize domestic financial resources within a more efficient financial system.;A market deficiency exists in Saudi banking system because the existence of interest rates impedes the efficient allocation of financial resources since most people avoid any transactions which bear interest. However, they are likely to use interest-free banking operations. The main hypothesis of this dissertation is that effective participation of Saudis in the banking system is low because most banking operations in Saudi Arabia are interest-based and therefore hold no attraction for the public at large. The Saudi banking system, when compared with both advanced countries such as the U.S. and other developing countries as well shows that in Saudi Arabia relatively more banks' deposits reside in non-interest banking accounts, (e.g. demand deposits). In addition, the contribution of banks to the economy, measured by Saudi banks' claims on the private sector, is relatively low compared to international norms.