Profit and Loss Sharing System - Solution for Trade-offs between Banking Profitability and Economic Efficiency of Intermediation

Abstract

Objective - The higher the difference between the loan interest and the deposit interest is, the better it is for a bank. This reflects a higher margin/profitability. However, it also shows less efficiency of the intermediation mechanism. Using literature research, this study aims to understand how the mechanism of Profit and Loss Sharing System (Islamic Banking System) can become the solution for the trade-off. Methodology/Technique - This study uses literature search and review as the method to gain an understanding of the fundamental concept as well as to offer critique by noting the trade-offs associated with the micro and macro objectives of banking. Findings - In the profit and loss sharing system made accessible through partnership, the returns that will be earned by one part depends on the other part. This requires each part to behave professionally and responsibly. Depositors' returns depend on banks' returns and banks' returns depend on mudharib's return. Therefore, there is no difference between banking profitability and efficiency of the intermediation. Novelty - With the same implications noted between the micro objective of banks (advantage as a business entity) and the efficiency of intermediation as well as the implications for the affordability and social justice, there is no trade-off between profitability and economic efficiency of intermediation. In addition, the profit and loss sharing system can also be a solution for the trade-off itself. Type of Paper: Review Keywords: Profit and Loss Sharing System, Micro-macro Trade-off, Banking Profitability, and the Economic Efficiency of Intermediation