Islamic Banking: Interest-Free or Interest-Based?

Abstract:     
A unique feature of Islamic banking, in theory, is its profit-and-loss sharing (PLS) paradigm. In practice, however, we find that Islamic banking is not very different from conventional banking. Our study on Malaysia shows that only a negligible portion of Islamic bank financing is strictly PLS-based and that Islamic deposits are not interest-free, but are closely pegged to conventional deposits. Our findings suggest that the rapid growth in Islamic banking is largely driven by the Islamic resurgence worldwide rather than by the advantages of the PLS paradigm and that Islamic banks should be similarly regulated as their western counterparts.

Number of Pages in PDF File: 39

Keywords: Islamic banking, interest-free, profit-and-loss sharing, mudarabah, bank financing, bank deposits

JEL Classification: G21, F37, P51

working papers series