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Islamic banking is perceived to be at its ‘tipping point’turning from a niche market phenomenon into a mainstream product (BBC, 2006; Credit Suisse, 2006). Although the total international assets of Islamic banks are still marginal, growth rates are phenomenal especially in the Middle East and Southeast Asia. Yet, Islamic banking seems incomprehensible to most Western economists. As discussed below due to the prohibition of interest and collateral Islamic banking is hardly reconcilable with Western economic theory dominated by the asymmetric information paradigm. Islamic scholars, however, claim that it is superior to conventional banking mainly due to the inherent stability of Islamic banking in reducing economic fluctuations and recurring crisis. The third section shows that these claims are questionable.

This chapter explores the significance of Islamic banking in Malaysia for stability of the economy as a …