Demand for and Supply of Mark-Up and PLS Funds in Islamic Banking: Some Alternative Explanations

Abstract

Profit and loss-sharing (PLS) and bai’ al murabahah lil amir bil shira (mark-up) are the two parent principles of Islamic financing. The use of PLS is limited and that of mark-up overwhelming in the operations of the Islamic banks. Several studies provide different explanations for this phenomenon. The dominant among these is the moral hazard hypothesis. Some alternative explanations are given in the present paper. The discussion is based on both demand (user of funds) and supply (bank) side considerations. The central conclusion is that mark-up is consistent with firms’ preference to re-invest profits in their own growth. It implies that PLS instruments which can allow profit retention by the user of funds and redeem consequently, could be more popular, particularly among risk-averse start-up firms.