Author: Adil and colleagues.
Islamic finance offers a unique structure by operating with two parallel modes of financing: profit and loss sharing contracts, known as PLS, and non-risk sharing contracts, known as non-PLS. This study investigates how these financing modes influence real economic activity, particularly sustainable production, across eleven countries that hold the largest share of global Islamic financial assets. Using quarterly data from 2014 to 2021 and panel regression analysis, the research provides an in-depth look at the connection between Islamic financial structures and economic outcomes, with a special focus on the role of credit risk and asset quality in Islamic banks.
The findings indicate that PLS financing, while often highlighted as a cornerstone of Islamic finance, has proven to be a weaker driver for channeling funds into economic activity. In contrast, non-PLS financing shows a stronger and more consistent impact on industrial production output. This preference is largely due to the lower risk of information asymmetry and greater transparency offered by non-PLS contracts compared to their risk-sharing counterparts. The study also reveals that the link between Islamic finance and economic output becomes even stronger when the asset quality of Islamic banks is high, underscoring the importance of maintaining a robust financial infrastructure.
These insights strongly connect with the United Nations Sustainable Development Goal 9: Industry, Innovation, and Infrastructure. By demonstrating that non-PLS financing supports industrial output and sustainable economic growth, the study emphasizes the need for regulators and policymakers to strengthen frameworks that balance both PLS and non-PLS modes. Encouraging innovation in risk-sharing contracts while maintaining high asset quality can reduce agency conflicts and enhance trust in financial systems. Ultimately, these strategies can make Islamic finance a more effective driver of sustainable production and long-term economic resilience.
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