Can profit and loss sharing (PLS) financing instruments reduce the credit risk of Islamic banks?

An Islamic bank is an interest-free financial institution that is growing rapidly in both Muslim and non-Muslim countries. It provides loans based on both PLS and non-PLS concepts, where the PLS concept shares both profit and loss with the customers, while the non-PLS concept allows charging a fixed...

Full description

Saved in:
Bibliographic Details
Published in:Empirical economics 2021-09, Vol.61 (3), p.1397-1414
Main Authors: Farihana, Shahari, Rahman, Md. Saifur
Format: Article
Language:English
Subjects:
Banking
Banks
Capital
Credit risk
Customers
Econometrics
Economic theory
Economic Theory/Quantitative Economics/Mathematical Methods
Economics
Economics and Finance
Finance
Insurance
Islam
Islamic countries
Islamic financing
Loans
Macroeconomics
Management
Risk reduction
Statistics for Business
Variables
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:An Islamic bank is an interest-free financial institution that is growing rapidly in both Muslim and non-Muslim countries. It provides loans based on both PLS and non-PLS concepts, where the PLS concept shares both profit and loss with the customers, while the non-PLS concept allows charging a fixed profit rate. The customers are treated as partners who invest either labor or an equal portion of capital. The PLS financing raises an issue of whether the Islamic bank is able to recover the financing amount which is disbursed without any form of collateral. Therefore, this paper explores the possible implication of PLS theory and examines whether the PLS financing instrument reduces the credit risk of Islamic banks. PLS financing is a focus variable, while bank-specific and macroeconomic variables are considered as control variables that enable us to draw a reliable and unbiased result. The study evaluates several hypotheses by employing two-step system GMM estimation technique. It offers several outcomes; PLS financing instrument reduces credit risk. The bank-specific and macroeconomic variables have a mixed effect on credit risk. The study suggests significant policy implications for the Islamic banks for sustaining the competitive banking industries.
ISSN:0377-7332
1435-8921
DOI:10.1007/s00181-020-01912-5