AN ECONOMIC ANALYSIS OF A PLS MODEL FOR ‘THE FINANCIAL SECTOR

This paper discusses the main analytical issues pertaining to PLS banking. The risk-return trade-offs and their bearing on the supply of funds are considered in a financial system where PLS deposits are the only income bearing financial asset. A PLS model is presented in which banks are pure intermediaries and the sole source of funds (mudarabah). The workings of this model is illustrated with some simple comparative static exercises. Other cases considered are where banks are not pure intermediaries and where entrepreneurs have their own source of funds in retained earnings (musharika). Some economic implications of PLS banking are suggested, including those that bear on the size and composition of total investment.