Profit sharing and loss bearing in financial intermediation theory

Wan Norsyakila Wan Kamarudin, Abd. Ghafar Ismail

Research output: Contribution to journalArticle

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 = 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.

Original languageEnglish
Pages (from-to)184-192
Number of pages9
JournalInvestment Management and Financial Innovations
Volume10
Issue number2
Publication statusPublished - 2013

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Profit sharing
Financial intermediation
Profit
Optimal contract
Islamic financial institutions
Incentives
Information costs
Transaction costs
Entrepreneurs
Asymmetric information

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

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

In: Investment Management and Financial Innovations, Vol. 10, No. 2, 2013, p. 184-192.

Research output: Contribution to journalArticle

Kamarudin, Wan Norsyakila Wan ; Ismail, Abd. Ghafar. / Profit sharing and loss bearing in financial intermediation theory. In: Investment Management and Financial Innovations. 2013 ; Vol. 10, No. 2. pp. 184-192.
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