The saying that “history repeats itself” is best manifested in capitalist financial system operating world- wide. It seems people are not learning lessons from the history of financial crises. Leading economists and capitalist gurus are warning about an inherently fragile capitalist financial system and about an urgent need to do something about it before it is too late. After the recent global financial crisis, Kotlikoff proposed the most radical and the most comprehensive reform of the existing financial system. His pro- posal became known as the Limited Purpose Banking (LPB). Kotlikoff’s proposal runs hand in hand with the aspirations of the pioneers of Islamic finance. He envisioned a financial system that is based on risk sharing, cooperation, and overall public interest (maslahah). In short, the idea of the LPB – after certain modifications and minor adjustments – can be applied in developing a true Islamic financial system. Thus, it can be said that the LPB and Islamic finance are two sides of the same coin.

Bosnia and Herzegovina (B&H) is a small, open economy. The country belongs to the geopolitical region of the Western Balkans and has been going through the transition process for the past three decades. The transition process, which started in Europe with the fall of the Berlin Wall in 1989, implies that a country transforms from a centrally planned to a market economy. A market economy is characterized by liberalized prices and trade and an enforceable legal system, including the protection of property rights. During socialism, prices were artificially determined, trade and investment were restricted, unemployment was practically non-existent, and all decisions were made by the central government, which indicates that efficient institutions did not exist. The transition process ends once a country joins the European Union (EU). Bosnia and Herzegovina, together with Croatia, Kosovo, Montenegro, North Macedonia, Serbia, and Slovenia, formed the Socialist Federal Republic of Yugoslavia (SFR Yugoslavia), a country known for its unique system of market socialism, which was more flexible than socialism in the Union of Soviet Socialist Republics (USSR) or Central and Eastern European (CEE) countries. Private property practically did not exist, as it was not considered compatible with the socialist economic system and its expansion was restricted by law (Uvalić, 2018). Most of the economy was state-owned. The state decided what and how much each company would produce and the inputs were provided by the state. If the quota could not be fulfilled, then the quality of the products had to be sacrificed, which did not create any problems since there was no competition among the enterprises (Berend, 2016). The manufacturers did not sell their products in the market; that was done by specialized companies. After the Second World War, Yugoslavia pursued rapid industrialization, where the priority was given to heavy over light industry (Uvalić, 2018). Therefore, transition economies lie between developed and developing countries; they are industrialized, but the technology is obsolete. Bosnia and Herzegovina, together with other former Yugoslav republics, produces less sophisticated goods, which is one of the reasons why the countries are not as competitive as they should be. SFR Yugoslavia ceased to exist in its original form in 1991. Bosnia and Herzegovina declared its independence on 1 March 1992. The break-up of SFR Yugoslavia was followed by several wars – in Slovenia (1991), Croatia (1991-1995), B&H (1992-1995), and Kosovo (1998-1999). The wars delayed the transition to a market economy. CEE countries that had a more strict form of socialism went through the transition process in fifteen years. Among former Yugoslav republics, Slovenia joined the EU in 2004, followed by Croatia in 2013. In the 1990s, B&H and other Western Balkan countries faced structural problems; hyperinflation, slow economic growth, high public deficits, and depreciating exchange rates (Estrin and Uvalić, 2016).

his paper empirically investigates the impact of finance and institutions on the economic growth of the Western Balkan economies – Albania, Bosnia and Herzegovina, Montenegro, North Macedonia, and Serbia – using a panel data analysis covering 2000–2020. While individually, neither finance nor institutions significantly impact economic growth, they increase the sample countries’ GDP when the two interact. Furthermore, the results suggest that the finance-growth relationship is non-linear, with a positive impact having a threshold. This relationship also depends on the sample’s institutional development (and vice versa). Similarly, this relationship depends on the proxy used, and hence, we need to be careful when making conclusions.