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Basel framework and profit-sharing contracts: Islamic banking through the lens of capital requirements

Author

Listed:
  • Kévin Spinassou

    (LC2S - Laboratoire caribéen de sciences sociales - CNRS - Centre National de la Recherche Scientifique - UA - Université des Antilles)

  • Leo Indra Wardhana

    (Universitas Gadjah Mada)

Abstract

This paper theoretically examines the impact of capital requirements on Islamic banks. Given the large use of profit-sharing investment accounts (PSIA) in Islamic banking and the recent implementation of Basel III capital framework, we develop a simple model where banks are able to offer PSIA contracts under a regulation applying risk-weighted capital ratios and leverage ratio restrictions. We find that banks with high or low returns on assets prefer " conventional " banking, while banks with intermediate returns on assets operate as Islamic banks, by selecting PSIA instead of deposits. We further highlight that capital requirements tend to increase this incentive to opt for Islamic banking, especially when Islamic banks benefit from a less competitive environment and from a locally tailored capital regulation.

Suggested Citation

  • Kévin Spinassou & Leo Indra Wardhana, 2021. "Basel framework and profit-sharing contracts: Islamic banking through the lens of capital requirements," Working Papers hal-01674376, HAL.
    • Handle: RePEc:hal:wpaper:hal-01674376
    Note: View the original document on HAL open archive server: https://hal.science/hal-01674376v4
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    References listed on IDEAS

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