Affiliations 

  • 1 Universiti Teknologi MARA
  • 2 Universiti Kebangsaan Malaysia
MyJurnal

Abstract

The adoption of Profit-Loss Sharing arrangement in Islamic banking models can create value for their shareholders. Previous studies discuss Profit-Loss Sharing arrangement in the context of financial intermediation theory, but fail to link the adoption of Profit-Loss Sharing arrangement with value creation and to produce empirical evidence. The aim of this study is to address optimal conditions of the Profit-Loss Sharing contracts in Islamic banking models to minimize the problems of asymmetric information and transaction costs. Three propositions are presented to achieve the optimal conditions of Profit-Loss Sharing contracts in Islamic banking models that can create positive values, given that: First, for mudharaba contract, Islamic banks as rabbul maal give incentives of (0* (RP') to entrepreneurs if the positive value of the Islamic bank's expected net profit is obtained. Next, if an Islamic bank, as mudharib is appointed as wakeel, the depositors of mudharaba investment account are imposed 6*(m) for cost of processing information. Third, for musyaraka contract, the Islamic bank is proposed to incur monitoring cost of c* (y). In addition, this study also produces empirical evidence to determine to what extent the adoption of Profit-Loss Sharing arrangement in Islamic banks creates value for their shareholders. This study utilizes the Malaysian Islamic banks panel data from 2005-2009 and employs Economic Value Added (EVA) as a technique of value creation measurement of Islamic banks. The empirical findings reveal that there is no indication that the adoption of Profit-Loss Sharing arrangement on the deposits structure (MDIA) significantly creates positive value to Islamic banks. This result is consistent for both measurement of value creation against shorter and longer terms opportunity costs of capital employed. This suggests that Islamic banks utilize a lower cost of capital, as Non-mudharaba deposits accounts constitute a large amount of current and saving accounts. On the other hand, for asset structure, this study finds that funds allocated in Financing (FPLS) based on Profit-Loss Sharing arrangement results in a reduction in the value of Islamic banks. However, funds allocated in Securities Investment (FIM) using Profit-Loss Sharing arrangement are significant and create positive value. Collectively, the findings reveal that theoretically, Profit-Loss Sharing arrangement can create value for the shareholders of Islamic banks, and it is evident that Islamic banks need to extensively utilize Profit-Loss Sharing arrangement in Islamic banking operation.