Limited purpose banking (LPB) and Islamic finance: Could LPB model be applied to Islamic finance?

This paper primarily aims to review and analyze a new model for Islamic finance based on Laurence J. Kotlikoff's idea of limited purpose banking (LPB). In addition, this paper aims to highlight, explain and discuss various aspects of LPB and how it suits the original aspirations of pioneer writers in Islamic finance.

Based on an extensive literature review, this paper aims to highlight, explain and discuss the reform of the Islamic finance industry based on Kotlikoff's model of LPB.

Based on a modified LPB model, Islamic financial institutions could be established to provide specific services with clear aims and objectives. These LPB Islamic financial institutions would operate in a similar way to LPB.

As there is no perfect plan, the proposal of this paper is far from being perfect and is open to discussions and improvements. The paper will, hopefully, spark off quite a discussion on the topic; may result in a better understanding of the model; and provide some alternative solutions to the current structurally ill financial system.

The paper provides some practical ideas for a better implementation of Shari'ah principles in financial intermediation of the Islamic financial system.

Kotlikoff's LPB proposal for reforming the financial system is new and has been directed to the conventional financial system. This paper represents the first attempt to apply his proposal to the Islamic finance industry.