Theoretical and practical underpinnings of equity-based financing and credit risk in Islamic bank

This study resolves the gap between Profit and Loss Sharing (PLS) theory and the practice of Islamic banks in financing customers. Two-step GMM estimation technique is used in the investigation. The empirical finding of the study is consistent with the PLS theory of reducing credit risk and inconsistent with the practice of Islamic banks. Equity-based financing has been found to reduce credit risk, while bank-specific determinants such as credit growth, profitability, and cost inefficiency influence the credit risk. Furthermore, institutional development is a macroeconomic indicator that reduces credit risk. This study offers policy implications for risk-minimised decisions in financing clients.