Does PLS in Islamic banking limit excessive money creation?

Khoutem Ben Jedidia and Hichem Hamza

Journal of Islamic Accounting and Business Research, 2023, vol. 15, issue 3, 422-442

Abstract: Purpose - Bank lending is the major source of monetary expansion. Bank-led money creation is a key issue in both conventional and Islamic financial systems. The purpose of this paper is to examine the issues related to Islamic banking money creation. In this conceptual paper, the authors investigate the involvement of profit and loss sharing (PLS) in money creation and especially how can PLS limit money creation “out of nothing.” In this regard, the authors examine the potential of the PLS principle in tackling the excessive money creation phenomenon. Design/methodology/approach - This study uses a normative approach regarding Islamic bank money creation that fits Sharia directives. In fact, this study discusses “what ought to be,” that is, the values and norms of PLS money creation that impede excessive money creation. Findings - Overall, Islamic banks create money differently compared to conventional ones. Especially, by avoiding a purely financial intermediary, money creation under the PLS principle sustains a strong relationship with the real economy and leads to a lower money multiplier. Therefore, PLS mechanisms allow financing through real assets and not credit assets “out of nothing.” This could prevent excessive money creation from causing harmful effects on indebtedness and financial instability. Practical implications - PLS offers a valuable resolution for banking system money creation through the optimization of Islamic bank financing by facilitating the separation of the monetary function from the credit one. This reform thought reinforces the stability value of money allowing it to fully perform its functions with reference to the directives of Sharia. This especially allows the integrity and purchasing power of money, the reduction of the gap between the evolution of both real and financial economies and, consequently, the indebtedness and crisis. It is recommended to promote PLS financing by reforming institutional and regulatory constraints. Originality/value - This study addresses the contemporary issue of money creation by Islamic banks through the PLS approach. The conceptual framework of this paper highlights the reformist role of PLS in limiting money creation throughMudarabahapproach within fractional reserve banking.

Keywords: Money creation; Islamic banks; Profits and losses sharing; Indebtedness; Financial stability; E42; E51; G21; Z12 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jiabrp:jiabr-02-2022-0047

DOI: 10.1108/JIABR-02-2022-0047

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