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A critical analysis of Mudarabah & a new approach to equity financing in Islamic finance

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  • Shaikh, Salman Ahmed

Abstract

Financial intermediation serves a valuable purpose, but it can also be structured using equity modes of financing. This can relieve the financee and increase diversity of entrepreneurial undertakings as in debt based commercial financing, there is little room for diversity with obligatory and stipulated servicing of debt. Using Islamic equity modes of financing poses the challenge of the agency problem and moral hazard. The extent of this agency problem in Mudarabah and its impact on economic payoffs between counterparties is analyzed in this study with a simulation model. Based on review of alternate solutions proposed, the author presents two possible covenants which could make Mudarabah mode of financing more acceptable and widely usable in financial intermediation. This would also further the egalitarian objectives of an Islamic economic order.

Suggested Citation

  • Shaikh, Salman Ahmed, 2011. "A critical analysis of Mudarabah & a new approach to equity financing in Islamic finance," MPRA Paper 19697, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:19697
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    File URL: https://mpra.ub.uni-muenchen.de/19697/1/MPRA_paper_19697.pdf
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    References listed on IDEAS

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    1. Muhammad Faheim Khan, 2003. "Guaranteeing Investment Deposits in Islamic banking System ضمان الوديعة الاستثمارية في النظام المصرفي الإسلامي," Journal of King Abdulaziz University: Islamic Economics, King Abdulaziz University, Islamic Economics Institute., vol. 16(1), pages 45-52, January.
    2. Mr. Abbas Mirakhor & Mr. Mohsin S. Khan, 1991. "Islamic Banking," IMF Working Papers 1991/088, International Monetary Fund.
    3. Shaikh, Salman Ahmed, 2010. "Proposal for a New Economic Framework Based On Islamic Principles," MPRA Paper 23000, University Library of Munich, Germany.
    4. Abdel-Fattah A.A. Khalil & Colin Rickwood & Victor Murinde, 2002. "Evidence on agency-contractual problems in mudarabah financing operations by Islamic banks," Chapters, in: Munawar Iqbal & David T. Llewellyn (ed.), Islamic Banking and Finance, chapter 4, Edward Elgar Publishing.
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    Cited by:

    1. EL Fakir, Adil & Fairchild, Richard & Tkiouat, Mohamed, 2019. "A hybrid profit and loss sharing model using interest free-debt and equity financing: An application of game theory as a decision tool," The North American Journal of Economics and Finance, Elsevier, vol. 49(C), pages 352-360.
    2. Fuad Al-Fasfus, 2019. "Reasons of the Difference of Murabaha Accounting Standards in Islamic Banks," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 11(1), pages 28-36, January.
    3. Kaouther Jouaber & Meryem Mehri, 2012. "A Theory of Profit Sharing Ratio under Adverse Selection: The Case of Islamic Venture Capital," Post-Print hal-01525795, HAL.
    4. Abdullah Ibrahim Nazal & Fuad Al-Fasfus, 2018. "Impact of Liquidity Rules on Shareholders’ Returns in Jordan Islamic Bank," International Journal of Business and Management, Canadian Center of Science and Education, vol. 13(6), pages 225-225, April.
    5. Wesal M. Aldarabseh, 2019. "The Interest in Islamic Finance Contracts in Saudi Arabia as Viewed by Google Trends," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 11(9), pages 1-12, September.
    6. Adil EL Fakir & Mohamed Tkiouat, 2016. "Single or Menu Contracting: A Game Theory Application of the Hersanyi Model to Mudaraba Financing," International Journal of Economics and Financial Issues, Econjournals, vol. 6(1), pages 221-230.
    7. repec:dau:papers:123456789/9551 is not listed on IDEAS

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    More about this item

    Keywords

    Interest free economy; Islamic Economic System; Mudarabah; Agency Problem; Moral Hazard; Adverse Selection;
    All these keywords.

    JEL classification:

    • L38 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Public Policy
    • I31 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General Welfare, Well-Being
    • O10 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - General

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