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Failure and potential of profit-loss sharing contracts: A perspective of New Institutional, Economic (NIE) Theory

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  • Abdul-Rahman, Aisyah
  • Abdul Latif, Radziah
  • Muda, Ruhaini
  • Abdullah, Muhammad Azmi

Abstract

This paper theoretically evaluates why profit–loss sharing (PLS) contracts in Islamic banking fails and its potential for improvement within the scope of the New Institutional Economic Theory (NIE). The objective of the evaluation is to draw conclusive theoretical arguments of whether Islamic banking institutions in Malaysia should act as either financial intermediaries or entrepreneurs. Further, we analyze this issue from the perspective of agency theory, financial intermediation theory and entrepreneurship theory with four economic agents in the Islamic banking sector, namely entrepreneurs, depositors, shareholders, and the Islamic banks. Specifically, the first three economic agents represent the asset (equity-based financing), liability, and equity of the Islamic banks, respectively; while the latter is the Islamic banks, which act as a separate legal entity. Finally, we suggest that PLS contracts would best be positioned if Islamic banks play the role of genuine entrepreneurs.

Suggested Citation

  • Abdul-Rahman, Aisyah & Abdul Latif, Radziah & Muda, Ruhaini & Abdullah, Muhammad Azmi, 2014. "Failure and potential of profit-loss sharing contracts: A perspective of New Institutional, Economic (NIE) Theory," Pacific-Basin Finance Journal, Elsevier, vol. 28(C), pages 136-151.
    • Handle: RePEc:eee:pacfin:v:28:y:2014:i:c:p:136-151
    DOI: 10.1016/j.pacfin.2014.01.004
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    Cited by:

    1. Lassoued, Mongi, 2018. "Comparative study on credit risk in Islamic banking institutions: The case of Malaysia," The Quarterly Review of Economics and Finance, Elsevier, vol. 70(C), pages 267-278.
    2. Reviewed By: Tariq Aziz, 2019. "Yasushi Suzuki and Mohammad Dulal Miah (Editors) Dilemmas and Challenges in Islamic Finance – Looking at Equity and Microfinance مراجعة كتاب: المعضلات والتحديات في التمويل الإسلامي – النظر في المشاركة," Book reviews and book reports published in the Journal of King Abdulaziz University: Islamic Economics. 738, King Abdulaziz University, Islamic Economics Institute..
    3. repec:idn:jimfjn:v:4:y:2018:i:1b:p:1-16 is not listed on IDEAS
    4. Muhammad Nouman & Karim Ullah & Saleem Gul, 2018. "Why Islamic Banks Tend to Avoid Participatory Financing? A Demand, Regulation, and Uncertainty Framework," Business & Economic Review, Institute of Management Sciences, Peshawar, Pakistan, vol. 10(1), pages 1-32, March.
    5. Seho, Mirzet & Alaaabed, Alaa & Masih, Mansur, 2016. "Risk-Sharing Financing of Islamic Banks: Better Shielded Against Interest Rate Risk?," MPRA Paper 82558, University Library of Munich, Germany.
    6. Ibrahim, Mansor H., 2016. "Business cycle and bank lending procyclicality in a dual banking system," Economic Modelling, Elsevier, vol. 55(C), pages 127-134.
    7. Imronudin & Javed Ghulam Hussain, 2016. "Why Do Bank Finance Clients Prefer Mark-up to Profit Loss Sharing Principles? Evidence from Islamic Rural Banks and Small to Medium Enterprises in Indonesia," International Journal of Economics and Financial Issues, Econjournals, vol. 6(4), pages 1407-1412.
    8. Kok, Seng Kiong & Filomeni, Stefano, 2021. "The holding behavior of Shariah financial assets within the global Islamic financial sector: A macroeconomic and firm-based model," Global Finance Journal, Elsevier, vol. 50(C).
    9. Kok, Seng Kiong & Akwei, Cynthia & Giorgioni, Gianluigi & Farquhar, Stuart, 2022. "On the regulation of the intersection between religion and the provision of financial services: Conversations with market actors within the global Islamic financial services sector," Research in International Business and Finance, Elsevier, vol. 59(C).
    10. Sutrisno Sutrisno & Agus Widarjono, 2022. "Is Profit–Loss-Sharing Financing Matter for Islamic Bank’s Profitability? The Indonesian Case," Risks, MDPI, vol. 10(11), pages 1-12, October.
    11. Siti Nurzahira Che Tahrim & Mohd Zulkifli Muhammad & Mohd Syakir Mohd Rosdi & Mohd Nor Hakimin Yusoff & Azizah Musa & Noormariana Mohd Din, 2019. "The Revival of Mudharabah Contract: A Proposed Framework," Research in World Economy, Research in World Economy, Sciedu Press, vol. 10(2), pages 70-73, July.
    12. Ibrahim, Mansor H., 2015. "Issues in Islamic banking and finance: Islamic banks, Shari’ah-compliant investment and sukuk," Pacific-Basin Finance Journal, Elsevier, vol. 34(C), pages 185-191.
    13. Fianto, Bayu Arie & Gan, Christopher & Hu, Baiding & Roudaki, Jamal, 2018. "Equity financing and debt-based financing: Evidence from Islamic microfinance institutions in Indonesia," Pacific-Basin Finance Journal, Elsevier, vol. 52(C), pages 163-172.
    14. Kabir, Md. Nurul & Worthington, Andrew & Gupta, Rakesh, 2015. "Comparative credit risk in Islamic and conventional bank," Pacific-Basin Finance Journal, Elsevier, vol. 34(C), pages 327-353.
    15. Asyari & Mohammad Enamul Hoque & M. Kabir Hassan & Perengki Susanto & Taslima Jannat & Abdullah Al Mamun, 2022. "Millennial Generation’s Islamic Banking Behavioral Intention: The Moderating Role of Profit-Loss Sharing, Perceived Financial Risk, Knowledge of Riba, and Marketing Relationship," JRFM, MDPI, vol. 15(12), pages 1-22, December.
    16. Smaoui, Houcem & Ghouma, Hatem, 2020. "Sukuk market development and Islamic banks’ capital ratios," Research in International Business and Finance, Elsevier, vol. 51(C).
    17. Hydzulkifli Hashim Omar* & Abubakar Yusuf Sanyinna, 2018. "Administrative Challenges of WAQF Institution in the Contemporary World: Future Prospects," The Journal of Social Sciences Research, Academic Research Publishing Group, pages 294-299:6.
    18. Meslier, Céline & Risfandy, Tastaftiyan & Tarazi, Amine, 2020. "Islamic banks’ equity financing, Shariah supervisory board, and banking environments," Pacific-Basin Finance Journal, Elsevier, vol. 62(C).
    19. Alam, Nafis & Parinduri, Rasyad, 2014. "Islamic banks do not turn “more Islamic” when their contracting environments get better: They remain similar to conventional banks," MPRA Paper 59939, University Library of Munich, Germany.
    20. Sharifah Faigah Syed Alwi & Ismah Osman & Mohd Bahroddin Badri & Amirul Afif Muhamat & Ruhaini Muda & Uzaimah Ibrahim, 2022. "Issues of Letter of Credit in Malaysian Islamic Banks," JRFM, MDPI, vol. 15(9), pages 1-15, August.
    21. Shahari Farihana & Md. Saifur Rahman, 2021. "Can profit and loss sharing (PLS) financing instruments reduce the credit risk of Islamic banks?," Empirical Economics, Springer, vol. 61(3), pages 1397-1414, September.
    22. Yusuf Faisal & Nirdukita Ratnawati & Egi Gumala Sari, 2021. "Profit Islamic Bank from Mudharabah and Musharakah Finance with Islamic Social Responsibility Disclosure," International Journal of Finance & Banking Studies, Center for the Strategic Studies in Business and Finance, vol. 10(3), pages 84-91, July.
    23. Houcem Smaou & Hatem Ghouma, 2019. "Sukuk Market Development and Islamic Banks’ Capital Ratios," Working Papers 1329, Economic Research Forum, revised 21 Aug 2019.

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    More about this item

    Keywords

    Profit loss sharing; New Institutional Economic; Islamic bank;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L80 - Industrial Organization - - Industry Studies: Services - - - General
    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • L20 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - General
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics
    • I00 - Health, Education, and Welfare - - General - - - General
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • P51 - Political Economy and Comparative Economic Systems - - Comparative Economic Systems - - - Comparative Analysis of Economic Systems

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