Can Islamic banking ever become Islamic?

This paper attempts to explain the dominance of asset side debt contracts in Islamic banks, even though many consider alternative Islamic joint venture (IJV) contracts to be the ideal Islamic financing mode. Theoretical models based on asymmetric information are used to argue that adverse selection...

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Bibliographic Details
Published in:Pacific-Basin finance journal 2015-09, Vol.34, p.253-272
Main Authors: Azmat, Saad, Skully, Michael, Brown, Kym
Format: Article
Language:English
Subjects:
Islamic banks
Islamic joint venture finance
Moral hazard
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Summary:This paper attempts to explain the dominance of asset side debt contracts in Islamic banks, even though many consider alternative Islamic joint venture (IJV) contracts to be the ideal Islamic financing mode. Theoretical models based on asymmetric information are used to argue that adverse selection and moral hazard alone cannot explain this phenomenon. The model is augmented with risk averse depositors to show that the emergence of asset side IJV could be deterred by Islamic banks' liability side. This paper suggests that for IJV, affiliated venture capital and private equity might prove more successful institutions than banking. •Explains dominance of debt products by Islamic banks using theoretical models•Considers asymmetric information, bank depositors, contracts and legal punishments•Adverse selection is the biggest impediment to Islamic bank's use of IJV financing.•With asymmetric information borrowing firm maximises profit through debt contracts.•Islamic bank depositors may be a reason for the lack of IJV finance offered by Islamic banks.
ISSN:0927-538X
1879-0585
DOI:10.1016/j.pacfin.2015.03.001