### Abstract

The purpose of this paper is to include the profit sharing and loss bearing (mudharabah) contract in Islamic financial intermediation theory. The aim is to identify under which situations the mudharabah contract can reach the optimal point. Theoretically, the mudharabah contract can be used to overcome two major problems in financial intermediation theory i.e., asymmetric information and transaction costs. The findings show that the optimal contract can be achieved in three situations. First, if π*^{b} = π^{b} Islamic bank cannot provide an incentive because the probability of profit and value of h equal to zero. Second, this situation also shows that Islamic bank cannot achieve the optimal contract because the probability of profit and value of h is less than zero. Meanings that π*^{b} ≤ π^{b}. Third, Islamic bank is capable to maximize profit and provide incentive to the entrepreneur if π*^{b} ≥ π^{b}. That means probability of profit and value of h is more than zero. Hence, only the third situation can produce the optimal contract in financial intermediation theory.

Original language | English |
---|---|

Pages (from-to) | 184-192 |

Number of pages | 9 |

Journal | Investment Management and Financial Innovations |

Volume | 10 |

Issue number | 2 |

Publication status | Published - 2013 |

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### Keywords

- Economic development
- Financial intermediation
- Financing
- Optimal contract
- Profit-sharing

### ASJC Scopus subject areas

- Business and International Management
- Strategy and Management
- Economics and Econometrics
- Finance

### Cite this

*Investment Management and Financial Innovations*,

*10*(2), 184-192.

**Profit sharing and loss bearing in financial intermediation theory.** / Kamarudin, Wan Norsyakila Wan; Ismail, Abd. Ghafar.

Research output: Contribution to journal › Article

*Investment Management and Financial Innovations*, vol. 10, no. 2, pp. 184-192.

}

TY - JOUR

T1 - Profit sharing and loss bearing in financial intermediation theory

AU - Kamarudin, Wan Norsyakila Wan

AU - Ismail, Abd. Ghafar

PY - 2013

Y1 - 2013

N2 - The purpose of this paper is to include the profit sharing and loss bearing (mudharabah) contract in Islamic financial intermediation theory. The aim is to identify under which situations the mudharabah contract can reach the optimal point. Theoretically, the mudharabah contract can be used to overcome two major problems in financial intermediation theory i.e., asymmetric information and transaction costs. The findings show that the optimal contract can be achieved in three situations. First, if π*b = πb Islamic bank cannot provide an incentive because the probability of profit and value of h equal to zero. Second, this situation also shows that Islamic bank cannot achieve the optimal contract because the probability of profit and value of h is less than zero. Meanings that π*b ≤ πb. Third, Islamic bank is capable to maximize profit and provide incentive to the entrepreneur if π*b ≥ πb. That means probability of profit and value of h is more than zero. Hence, only the third situation can produce the optimal contract in financial intermediation theory.

AB - The purpose of this paper is to include the profit sharing and loss bearing (mudharabah) contract in Islamic financial intermediation theory. The aim is to identify under which situations the mudharabah contract can reach the optimal point. Theoretically, the mudharabah contract can be used to overcome two major problems in financial intermediation theory i.e., asymmetric information and transaction costs. The findings show that the optimal contract can be achieved in three situations. First, if π*b = πb Islamic bank cannot provide an incentive because the probability of profit and value of h equal to zero. Second, this situation also shows that Islamic bank cannot achieve the optimal contract because the probability of profit and value of h is less than zero. Meanings that π*b ≤ πb. Third, Islamic bank is capable to maximize profit and provide incentive to the entrepreneur if π*b ≥ πb. That means probability of profit and value of h is more than zero. Hence, only the third situation can produce the optimal contract in financial intermediation theory.

KW - Economic development

KW - Financial intermediation

KW - Financing

KW - Optimal contract

KW - Profit-sharing

UR - http://www.scopus.com/inward/record.url?scp=84891907030&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=84891907030&partnerID=8YFLogxK

M3 - Article

AN - SCOPUS:84891907030

VL - 10

SP - 184

EP - 192

JO - Investment Management and Financial Innovations

JF - Investment Management and Financial Innovations

SN - 1810-4967

IS - 2

ER -