Working papers // The Levy Economics Institute 555
This paper explores the significance of Islamic banking in Malaysia for stability in the country's economy as a whole. Neither conventional theory nor Islamic economics puts forward a systematic explanation of financial intermediation; consequently, neither is capable of identifying destabilizing elements in the system. Instead, a flow- of-funds approach similar to Minsky's own is applied to the (post-) modern consumption-led) business cycle and financial (and asset) market. Malaysia's structural current account surplus contributes to the overcapitalization of domestic firms. This in turn finances a financial (as opposed to an industrial), consumptionled (instead of investment-led) business cycle, where banking favors destabilizing asset price inflation. Islamic banks operating interdependently with conventional ones contribute to economic destabilization channeling surplus funds from the corporate to the household sector.