Profit Loss Sharing in Islamic Banking

Profit-loss sharing

In order to be able to understand the core factors that contribute to the lack of profit-loss sharing in Islamic banking, this mode of financing must first be introduced. The fundamental basis for PLS is based on equity orientation. Such a mode of financing allows all parties involved to share both risks and losses in the ratio of their individual capital input, while the profit is allocated on an agreed ratio. This Islamic mode of banking guarantees the sharing of profits or losses and ensures no accrual of a fixed rate of interest, which promotes the efficiency and stability of the Islamic banking system. According to one of the leading Sharia scholars, Muhammad Taqi Usmani, "The real and ideal instruments of financing in Sharia

are mudarabah and musharakah” (Farooq, 3:1996).

Mudarabah

Mudarabah is an alternative in financing where two parties form a special type of partnership in which one partner provides the capital (rab-ul-mal) while the other individual conducts managerial operations (mudarib). Any profit generated is allocated and shared based on agreed ratio determined by both parties. Moreover, if a loss is incurred, the financier is the one who bears loss, bearing in mind that the mudarib was not negligent (Al-Omar, Abdel-Haq, 1996).

Musharakah

Musharakah exhibits some of features of common partnerships. It is described to be a contractual relationship created by the mutual agreement of parties for sharing any profits or losses in joint business activity. This type of financing involves an Islamic bank that provides funds, which are mixed with the funds of the business enterprise and any other operations. The capital providers are permitted to participate in management, yet it is not requir...

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