Profit and Loss Sharing: an Economic Analysis of an Islamic Financial System.

Several Muslim countries are attempting to operate either individual banks, or their entire banking system, without the use of interest. This experiment--which follows the recent "resurgence" of Islam--is based on the prohibition of riba in the Qur'an. Riba has been defined as a appropriation of value without the return of "socially legitimate" countervalue, as ascertained according to Islamic Law. Riba has been broadly interpreted to ban several transactions, such as drawing rent on agricultural l and or interest from savings accounts. Muslim economists have sought to revive medieval Islamic financial transactions and to embody them within the operation of modern banking. Profit and loss sharing (P.L.S.) is the major financial instrument designed for this purpose. As applied to productive loans, P.L.S. differs from debt financing in that a specified percentage share of profit is due the lender only if the venture financed by these funds is profitable. Unlike equity financing, participation in a P.L.S. contract implies no ownership rights, and the borrower has no discretion in determining a profit distribution policy once a contract is established. This dissertation contains five chapters and a conclusion. Chapter One establishes the context by discussing the political economy of an Islamic system. Chapter Two reviews the alternative institutional frameworks for P.L.S. and the ethical underpinnings of related economic issues: indexation, capital gains, speculation, reserve banking, and nationalised banking. Chapter Three analyses the feasibility of a banking system based entirely on P.L.S. and illustrates the consequent working of the market for loanable funds. Chapter Four discusses P.L.S. as an alternative tenure arrangement to renting and sharecropping. Chapter Five reviews some evidence on the implementation of P.L.S. in various countries. The analytical chapters in this dissertation indicate that in the absence of interest, profit shares would equilibrate the market for loanable funds and also reflect the opportunity cost of capital. The economic pros and cons of implementing P.L.S. have been discussed in the dissertation. However, Islamic proponents of interest-free banking are primarily concerned with the ethical and social benefits of P.L.S. rather than with any economic advantage.PhDEconomicsUniversity of Michiganhttp://deepblue.lib.umich.edu/bitstream/2027.42/159406/1/8314306.pd