Sharing contracts' marginalisation, adverse selection and markup calculation

• Published date: 01 March 2018
• Date: 01 March 2018
• Author: Fayçal Amrani
• DOI: http://doi.org/10.1111/twec.12510

SPECIAL ISSUE ARTICLE

Sharing contracts’marginalisation, adverse

selection and markup calculation

Fayc

ßal Amrani

Department of Economics, Paris-Dauphine University, Paris, France

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INTRODUCTION

Sharing contracts have founded the original paradigm of contemporary Islamic finance while

markup contracts were conceived only as subsidiary financing tools. Earlier contemporary Islamic

literature (Haque & Mirakhor, 1986; Khan, 1984; Naqvi, 1982; Siddiqi, 1991) has been dedicated

to present sharing contracts and defend the relevance of a financial system they can constitute.

Thereafter, several authors (e.g., Al-Suwailem, 2003; Presley & Sessions, 1994) have attempted

to demonstrate the superiority of sharing contracts on fixed income contracts (whether conven-

tional or Islamic).

However, the practices of Islamic financial institutions

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have gradually moved away from this

original paradigm; sharing contracts have given way to markup ones. This assessment is made by sev-

eral authors, for mixed financial systems—like that of Egypt—as well as full-fledged Islamic systems

—like that of Iran (e.g., Aggarwal & Yousef, 2000; Dar & Presley, 2001; Yasseri, 2002).

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Even in

Malaysia—which is one of the most important markets of Islamic finance—sharing arrangements are

very marginal representing only 0.5% of assets (Chong & Liu, 2009). Several theoretical contr ibu-

tions have attempted to explain this sharing paradigm’s failure. Most of them base their argumenta-

tion on information asymmetry issues (e.g., Aggarwal & Yousef, 2000; Ahmed, 2002; Haque &

Mirakhor, 1986; Khalil, Rickwood, & Murinde, 2002), which is in contradiction with others’theoreti-

cal contributions that show an excellent capacity of sharing contracts to reduce information asymme-

try (e.g., Al-Suwailem, 2003; Presley & Sessions, 1994; Stiglitz, 1974).

Thus, while dominance of markup contracts is an obvious fact, its theoretical explanation remains

ambiguous. Our paper reviews the information asymmetry considerations in an attempt to reconcile

the two previous positions. Despite the similar nature of information asymmetries inherent in sharing

and markup contracts, coexistence of these two contractual categories in the same market is impeded

by a dual pricing that produces an additional (or artificial) dimension of adverse selection.

Moreover, we propose specialised use of two Islamic contractual categories as a device for

eliminating artificial adverse selection. Furthermore, this specialisation allows to calculate—on the

basis of financing cost unification—an endogenous markup, that is independently of the interest

rate. However, we have to make clear that financing cost unification does not mean that each

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Including banks, companies and investment funds.

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On the Iranian market, mudharaba and musharaka together represented 26% of all financing contracts in 1995 and just 16%

in 1998 against 45% of credit sales (including murabaha) in 1995 and 56% in 1998.

DOI: 10.1111/twec.12510

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©2017 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/twec World Econ. 2018;41:738–751.