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Basel framework and profit-sharing contracts: Islamic banking through the lens of capital requirements

Kévin Spinassou () and Leo Indra Wardhana
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Kévin Spinassou: LC2S - Laboratoire caribéen de sciences sociales - UA - Université des Antilles - CNRS - Centre National de la Recherche Scientifique
Leo Indra Wardhana: Universitas Gadjah Mada

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Abstract: This paper theoretically examines the impact of capital requirements on Islamic banks. Given the large use of profit-sharing investment accounts (PSIA) in Islamic banking and the recent implementation of Basel III capital framework, we develop a simple model where banks are able to offer PSIA contracts under a regulation applying risk-weighted capital ratios and leverage ratio restrictions. We find that banks with high or low returns on assets prefer " conventional " banking, while banks with intermediate returns on assets operate as Islamic banks, by selecting PSIA instead of deposits. We further highlight that capital requirements tend to increase this incentive to opt for Islamic banking, especially when Islamic banks benefit from a less competitive environment and from a locally tailored capital regulation.

Keywords: profit-sharing investment accounts; bank capital regulation; Islamic finance; profit- sharing investment accounts; Basel III; banking capital requirements; IFSB (search for similar items in EconPapers)
Date: 2021-02-04
New Economics Papers: this item is included in nep-cba and nep-rmg
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