The controversy about the use of equity versus debt in Islamic finance is one which has been present for years. The shift towards ‘profit-and-loss sharing’ (PLS) modes of finance is growing in some countries, notably in Pakistan and Indonesia, with help from government policies to encourage it. The growth is clearer now that there is more consistent and easily accessible data compiled by the Islamic Financial Services Board (IFSB) as a part of their Prudential and Structural Islamic Finance Indicators (PSIFI) data program.
The first Reuters article linked above highlights the shift towards “profit-sharing” contracts like musharaka, istisna’ and salam and introduces some data from the PSIFI database:
As of December, murabaha represented 30.1 percent of financing extended by Islamic banks in Pakistan, down from 40.6 percent a year earlier, central bank data shows. Istisna and musharaka financing doubled during the same period, representing a combined 19.4 percent of financing by Islamic banks, up from 12.3 percent a year earlier.
Another interesting way to look at the data, rather than the time series presented here, is dividing among the (standalone) Islamic banks and the Islamic windows of conventional banks. This is even more notable for Pakistan because of findings in a recent IMF working paper that looked at the resiliency of Islamic banks during the 2008 banking panic in Pakistan (which the working paper did not link to the global financial crisis though the timing suggests at least some psychological link that influenced customers).
That IMF paper found significant differences between the standalone banks and the windows in whether they experienced outflows and found that windows actually saw increases at a time when there was a ‘bank run’ at some institutions. What this finding indicates for the present comparison of modes of finance is that one would expect that banks with fewer risk-sharing contracts (in the case of Islamic finance, profit-sharing is supposed to be accompanied by risk-sharing) to be perceived as more stable. As a result, a priori, one would expect Pakistan’s Islamic windows to have more financing using murabaha and ijara while the standalone banks would have more musharaka, salam and istisna’.
What you do find is that Islamic windows have a dramatically higher rate of murabaha—45.2% versus 30.5% for Islamic banks. However, the Islamic banks also have higher musharaka usages (10.4% versus 4.6%). The Islamic banks have much higher usage of diminishing musharaka (7.7% higher at Islamic banks) and Istisna’ (4.9% higher at Islamic banks). The rate of ijara is the same while Islamic banks use ‘other’ contracts (though it is not clear from the PSIFI what this entails).
This confirms the basic idea although the istisna’ and salam are usually structured in back-to-back form to create debt-based contracts with very similar economic outcomes to conventional debt (as well as murabaha). The diminishing musharaka is often set up in a way to replicate conventional debt as well.
The net effect of combining all the debt-based or debt-similar to compare whether Islamic banks use less is that the windows have 5.6% higher rates of using debt-based contracts than standalone Islamic banks. However, if the ‘others’ category includes debt-replication structures (and they likely do because of the impact of capital rules on Islamic banks preference for debt versus equity), then both banks and windows have similar debt-based shares (broadly defined the shares are 95.1% and 89.6%, respectively) of their overall financing.
Based on the similar financing structure and different performance of Islamic banks and Islamic windows during the 2008 crisis, there may be more differences between murabaha, istisna’, salam, ijara, diminishing musharaka and other than just the simple debt-versus-equity split.