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

Author

Listed:
  • 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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    Keywords

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    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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