Giordano Dell-Amore Foundation

Research Center on International Cooperation of the University of Bergamo

PROFIT AND LOSS SHARING AS A SUBSTITUTE FOR INTEREST IN ISLAMIC BANKING /

DISTRIBUTION DES BÉNÉFICES ET DES PERTES COMME SUBSTITUTION DE L'INTÉRÊT DANS LES
BANQUES ISLAMIQUES
Author(s): Shahrukh Rafi Khan
Source: Savings and Development, Vol. 11, No. 3 (1987), pp. 317-328
Published by: Giordano Dell-Amore Foundation
Stable URL: http://www.jstor.org/stable/25830119
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PROFIT AND LOSS SHARINGAS A SUBSTITUTE FOR
INTERESTIN ISLAMICBANKING

Shahrukh Rafi Khan

Pakistan Instituteof Development Economics

1. Introduction

Almost two decades ago, the InternationalDevelopment Review carried an article on

the firstexperiment with Islamic banking1.

Although the initialexperiment was aborted forvarious reasons, its founder became
an importantand active member ofwhat has recently started to be referred to as the
"Islamic Banking movement". Reviews of thismovement can now readily be found in
the growing literatureon Islamic banking2. In this article I intend to concentrate only
on the novel financial instruments introduced by Islamic banking. Itwill be compared
with conventional banking and finance to highlight the differences. This pedagogic de
vice could be useful to a western audience but has unfortunatelybeen neglected so
far.Since there are some substantive difference, in theory, in the operational mode
of the conventional and Islamic banks or banking system, itappears worth-while to ex
pose the reader unfamiliarwith these developments towhat may otherwise appear an
irrelevantcuriosity.Beyond this,since religious sentiments of the large bulk ofmuslems
may have urged governments to trythese experiments, whether with an electoral man
date or forpolitical legitimacy in itsabsence, these recent innovations are very likey
to be around fora considerable time. Since Islamic banks, and inparticular the syste
mic change to Islamic banking, can have importantsocio-economic consequences in
some developing areas of theworld, there isa need to expose more scholars and ge
neral readers concerned with development to these new or rather revived concepts.
The primarymotivation behind Islamic banking isgenerally stated to be the elimination
of riba; this is narrowly defined as interest though most scholars now accept a wider
definition for the concept. The definition adopted for this paper is as follows: riba is
an excess which, inan exchange or sale, accrues to the lenderwithout the returnof
any equivalent countervalue, substitute or recompense to the other party3.
Legitimate countervalue isdetermined with reference to Islamic law ofwhich there are

1 R.K. Reddy, ?The Egyptian Municipal Saving Project?, International Development Review 9, No. 1 (1967):
2-5.
2 Traute Wohlers - Sharf, Arab and Islamic Banks (Paris: OECD, 1983).
3 See Joseph Schact, ?Riba, Encyclopaedia of Islam, 1939 ed. Also see Ziaul Haque, ?Riba, Interest,Profit?,
Pakistan Economist (May 24, 1980): 16.

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SAVINGS AND DEVELOPMENT -No. 3 - 1987 -XI

several sources and schools4. However, there isa broad consensus that the provision
of diverse formsaf labour or the shouldering of riskattached to a socially productive
activityor enterprise do qualify as legitimatecountervalue. There isalso a body of opi
nion thatholds thedrawing of rental income,whether itbe interestor rents fromabsentee
ownership, monopoly, hoarding or speculative activity to be prohibited5. On the other
hand, profitaccuring from transactions ina freemarket system have been viewed by
jurists as legitimate.
The arguments most commonly proffered insupport of the banning of interest income
is that it isa prespecified fixedsum irrespectiveof the outcome of the business venture
the funds finance. Thus the drawers of interest income inmost cases effectivelypass
the entire riskof the business activityon to the borrowers/entrepreneursand hence they
are not entitled to a returnaccording to how riba has been defined above. That money
inof itselfhas a time value is not viewed as reason fora return to accrue to it.The
generalisation of this is the viewing of diverse formsof unearned income as illegitimate.
This broad definitionof riba therefore has an advantage in that itunifies the premise
on which seemingly unrelated activities have been banned in Islam.Most countries have
adopted a narrow view of riba as simply interest and have not concerned themselves
with the other economic activities banned in Islamwhich may fall under the rubricof
riba. This is inkeeping with the "modernist" view thatequates riba with only usury or
excessive interest,although what constitutes an excess indifficulttodefine6.1 will utilise
the broad definitionof riba since it iseasier towork back to conceptualise the function
ingof institutionsusing a narrower definition.
The novel instruments introduced by proponents of Islamic banking, as a substitute
for interest,are based on profit-and-loss sharing (PLS). The basic idea is that instead
of a fixed predetermined interes rate, the parties to a financial contract agree inad

4 The fourmajor Sunni Schools of Islamic Law were founded by Abu HanTfa (d 767), Malik ibnAnas (d. 795),
Muhammad ibn idrlsal-Shafi'T (d 819) and Ahmed ibnHanbal (d. 855). For an analysis of differences in their
methodology see Umar Abd' Allah, ?Malik's concept of 'Amal?, (Ph. D diss., University of Chicago, 1978), pp.
101-129, 146-195. Although the Shi'a sect has itsown schools, Iran,where the Shi' as are inoverwhelming
majority, is experimenting with the same financial instruments in itsbanking reformas are all the other muslim
countries. See William Pike, ?lran banks go back to the roots?, South (June 1984): 39.
5 Haque, ?Riba?, pp. 14-35. Also see Abd-al-Hamid Abu -Sulayman, ?The Economics of Tauheed and Brother
hood?, Contemporary Aspects of Economic Thinking in Islam (n.p. American Trust Publications, 1976), pp. 5-54.
6 Sabri F. Ulgener, ?Monetary conditions of Economic Growth and the Islamic concept of Interest", Islamic
Review 55, no. 2, (1967): 12; Homayoun Katouzian, ?Riba and Interest inan Islamic Political Economy, Peuples
Mediterraneens No. 14 (1981): 102.

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 S. RAF! KHAN - PROFIT SHARING IN ISLAMICBANKING

vance to a portion of the profit ifany accrues and also to the portion of the liabilityin
a loss ifthat occurs.
This paper iscomprised of two sections. In the firstsection the instrumentsand institu
tional structure of Islamic banks are brieflyoutlined. In the second section an Islamic
financialsystem iscompared toa conventional financialsystem. The economic ramifica
tions of this financial reformhave been covered elsewhere7.

2. Islamic Financial Framework

Islamic financial instrumentscurrently inuse are adaptations of commercial contracts

foundexisting during the inceptionof Islam. Islamic legal literatureis the original source
material fora description of these instruments8. This paper isconcerned with theircon
temporary adaptations.
The method foradapting medieval financial practice tomodern banking is tomodify
modern banking institutionsso that they embody the principles implicit in the former.
Four of these principles of particular importance are listed here. First, all loans must
finance socially productive activity. Second, risk-taking,when related to a productive
activity isentitled to a reward. Third, financial risk rests solely with the lenders and not
with themanagers or agents. Fourth, as earliermentioned, interestis forbiddenbecause
it isa predetermined fixed sum due to the owner of loanable funds irrespective of the
outcome of the business venture. Two of the financial modes that do embody these
principles are musharaka and mudarabah.

Musharaka isessentially a partnership contract. Under the latter,the bank and the bor
rower or agent undertake to contribute jointly to the capital and management of the
business venture. The share inthe profitand theduration of the jointventure are agreed
upon inadvance. Insome cases, a "self-liquidating" formof partnership can be agreed
upon, inaccordance with the agent's ability to pay back the principal. Loss is shared
inproportion to the contribution of each party to the capital, unless the agent is proven
to be the cause of loss due to negligence or some wilfulaction. The contractmay specify
that the agent iswholly responsible for themanagement and must keep the bank in

7 Shahrukh R. Khan, ?AnEconomic Analysis of PLS Banking?, Pakistan Journal ofApplied Economics (Winter1985).
8 For a comparative account of these instruments in the different schools of Islamic Law see A.L. Udovitch,
Partnership and Profit inMedieval Islam (Princeton: Princeton University Press, 1970).

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 SAVINGS AND DEVELOPMENT -No. 3 - 1987 -XI

formedwith regular progress reports.Alternatively,the banks may be granted new rights

to oversee the utilisation of the funds.
Under mudaraba all funds are contributed by the bank, and the agent issolely respon
sible forentrepreneurship. Profitsare once again shared on some agreed-upon formula
whereas the losses are entirely borne by the lenders, except forthe qualification men
tioned above. The agent, incase of business failure, loses his time and effort.
The difference inthe two contracts seems reallyone of degree rather than of principle.
What distinguishes them fromeach other iswheter or not theagent supplies any capital
of his own. Because of theirsimilarity inmost other operational aspects, both are broadly
referred to as profitand loss sharing (PLS) contracts. Mudaraba is often referred to
as "profit-sharing". However, since the agent does stand to lose his time and effort,
the broader term PLS has been adopted for italso.
So far,one importantunanswered question concerns the source of funds for the bank.
To answer thisquery, one must review the typeof accounts an Islamic institutionoffers
and, by doing so, introducedepositors as the thirdparty to the PLS contracts. Islamic
banks invitedeposits inchecking, saving, and investmentaccounts. The firsttwo are
similar (though not identical) to conventional banking accounts of the same names. One
difference is that banks sometimes have to obtain permission of the depositors to use
fundsdeposited in these accounts forfinancial investment.The deposits are guaranteed,
but there is principle no returnof any formon them. In practice, some banks do offer
special privileges, like interest-freeloans for the purchase of consumer durable on in
stallments, or even profit-shares on savings accounts. Without these inducements, there
would be no way of distinguishing between saving and checking accounts. Since saving
accounts are guaranteed, no risk is borne by the saver. Given this absence of risk,a
returnon savings accounts in the formof profit-shares,or special privileges granted by
the banks, may be viewed as a violation of a fundamental principle of Islamic banking.
Investmentdeposits are presented as account unique to Islamicbanking. These deposits
which are not guaranteed-have to be above a minimum amount and forat least a
minimum specified timeduration.Withdrawal fromthe account before the specified time
would result ina penalty in the formof foregoing part or all of the profit.Deposits are
either "authorized", i.e used forparticular projects that the bank intends to be a party
to or theyare ?unauthorized?, i.e. used for the general investment fund. In the former
case, depositors would share in the profitor loss of a specific project, whereas in the
lattercase, theywould be a party to the generalised outcome of the bank's loaning
and investment activities.

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 S. RAFI KHAN - PROFIT SHARING IN ISLAMICBANKING

Both of the PLS contracts avoid riba in that no predetermined share for the lender is
specified irrespective of the otucome of the business venture. Also, risk is borne by
the lenders rather than the agents. However, there are certain cases inwhich the return
to lenderscould be considered questionable because the capital issubjected to negligible
risk.This appears tobe the case inunauthorized investmentaccounts because inmodern
banking risk can be reduced to a negligible amount by diversification.
Although bank failures are not unheard of, especially when economic conditions are
depressed, there is no way of establishing whether the profitearned on unauthorized
accounts is commensurate with the risk undertaken. In fact, in practice banks are
establishing a reserve fund,by retaining some percentage of the profits ineach fiscal
year, toguarantee depositors a return. While thisbanking innovation-whichmost banks
currently inexistence are practicing-may encourage investmentdeposits, itserves the
direct linkbetween a productive endeavor and the subsequent profitor loss to the finan
cial contributor.Authorized accounts avoid these pitfalls by tying the fortunes of the
lender to that of the particular project they finance.

3. Islamic vis-a-vis Conventional Financial Markets.

Financial markets in the advanced industrialeconomies are highly sophisticated and

complex. They function to provide lenders and borrowers with choices depending on
their liquiditypreference and risk-returntrade-offs. Inaddition, there are institutionsto
oversee themarket and intermediate between lenders and borrowers. Here, only the
broad features of thismarket will be contrasted with PLS financing. For this purpose,
Iwill firstconsider how PLS is to replace debt and equity financing as commonly prac
ticed, and second, how PLS institutions will be expected to replace various intermediary
institutionsof a conventional financial market.

3.1 Debt and Equity Capital9

Ina conventional financialmarket, business can relyon debt or equity financing tomake
up fortheirshortage of long term funds.Debt financingmay take the formof term loans.
Since these are negotiated directly between borrowers and lenders, theyminimise for
mal procedures incomparison tobond or stock financing.They also allow forthe possibili

9 This section is in large part based on Eugens F. Brigham, Fundamentals of Financial Management (Illinois:
Dryden, 1978).

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SAVINGS AND DEVELOPMENT -No. 3 - 1987 -XI

tyof a change incontract, ifthe need arises, due to changed economic circumstances.
Like bonds and stocks, PLS contracts have several member as parties to the contract,
and therefore are unlikely tomaintain the flexibilityof term loans.

Issuing bonds may insome circumstances be an easy and cheap source of credit. As
is trueof loans bonds entail repaying the principal on maturityand a fixed interest.Bonds
can be of numerous types, themost common ofwhich are the following:mortgage bonds,
debentures, subordinated debentures, convertible bonds, income bonds, index bonds,
or redeemable bonds. These differentcategories allow the various needs of the bor
rowerand lender to be accomodated and thereforewiden themarket. However, bond
financing differs from term loans and PLS in that the contracts themselves are
transferable.This does allow forthe possibilityof capital gains or losses. Also, the return
on bonds isconsidered unacceptable froman Islamic view-point since it ispre-specified
and fixed inamount. In both debt financing and PLS there is a principal due back to
the lenderwhen the loan matures as specified in the contract.
In equity financing, the lenders forward capital to firms in buying shares of stock.
However, unlike debt financing, the size of theirstock holdings determines the extent
of theirownership of a corporation and hence theirrighttovote. Ownership can therefore
be used as an instrumentof control by casting votes to elect the directors, who in turn
select themanagement. The existing stockholders also have the rightto the firstpur
chase of new shares. This can limitthe dilution of ownership. Itcould enable an out
side group of stockholders (those not controlling management) to pre-empt manage
ment fromwarding offa bid forcontrol (bymeans of a proxy fight)by issuing new stock.
Although proxy fightsare rare, te threat can serve to focus management's attentions
on the stockholder's interests.

Under debt capital or PLS, the same countervailing pressure cannot be applied since
forwarding funds is not tied to ownership. In these cases, the firm'spossible need for
futurecapital may keep itin line.Equity capital isalso advantageous because dividends
can only be paid out of profits,which prevents having to liquidate as in the case of a
default on loans. In this aspect, PLS, does resemble equity financing, since itactually
eliminates the borrower's riskof default.Whereas inequity financing, the borrower has
discretion indetermining dividend policy, under PLS the borrower must part with the
lender's share of the profitonce that isdetermined. Stocks, likebonds are transferable.
In this case, ideally, the performance of the firmis reflected in themarket value of the
stock. However, the market value can depart from the real value due to speculative
activity.

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 S. RAFI KHAN - PROFIT SHARING IN ISLAMICBANKING

PLS participation certificates can be made transferable under certain restrictionswhich

prevent themarket value and the value quoted at different intervalsby the investment
company fromdiffering. In practical terms, the difference between these certificates
and equities is that the profit isadded to the face value of the certificate and reflected
in its increased value but not appropriated as dividends. Similarly, losses are actually
subtracted fromthe face value, rather than registered ina fallor absence of dividends,
and in the drop in themarket value of a security. These gains or losses are actually
realized when the certificatematures. In the meantime, someone inneed of liquidity
can pass on a committment of funds (to a project) by selling the certificate for itsstated
worth at a certain time.
Even inthiscase, speculation can be attempted.One may choose to sell a certificateand
realise the profits ifone expects the project being financed to perform lesswell. However,
ifothers expect the same, then thiswill not be reflected ina fall in the value of the cer
tificatebut in the individual's inabilityto sell it.Thus, adherence to the face value of the
certificatemay make it less liquid. Ineffect, this comes about from refusingto allow any
capitalisation to take place, which happens implicitlyin the determination of themarket
value of securities. For stock, the performance of a company, along with several factors
concerning theeconomic environmentwhich affect the company's performance,would be
implicitlycapitalised into itsmarket value. Due to expectations, it is possible in this case
forthemarket value not to reflectthe realitiesof a company's past productive performance.
These expectations may also be the cause of bringingabout capital gains or losses, which
may or may not accurately reflectthe performance of a company.
In the case of PLS participationcertificates,capital gains are ruledout since the value at
any time reflects the historyof the economic performance of a company from the time
the contractwas engaged in,and this is theonly value at which purchase ispossible. The
sellers of a certificatecan claim a share only up to the time theywere participants ina
company. Inbeing constrained to sell at the stated value, theyare prevented fromarriving
at the value of the certificateby capitalising on the basis of expectations of the futureper
formanceof the company. By purchasing the certificateat itsstated value, the new owners
grant to the old the profitor loss that is theirdue for the risk they have borne and are
simultaneously contracting to be participants inthe futureprofitsor loss of the company.
Avoiding the use of a stock exchange entirely is a very extreme measure which would
lead to severe rigidities in the financial system. Ina sense, attempting to get ridof the
stock market because itisopen toabuses is likegetting ridof thewhole market system
because it isopen to abuses, i.e.,monopoly and hoarding. Inboth cases, the answer

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SAVINGS AND DEVELOPMENT -No. 3 - 1987 -XI

probably is to impose regulations rather than throwingout the baby with the bath water.
In the case of a stock market, the normalmalpractice regulations could be accompanied
by a capital gains tax, tailored to vary inverselywith the lengthof holding of securities.
Unlike debt financing, both PLS and equity financing are suited to projects that have
a great deal of fluctuation in their returns10.However, equity financingdiffers fromPLS
in that the costs of flotationare often substantial and may run up to 25% of the issue
price forsmall issue. Also, unlike PLS the character of stocks can be altered to provide
for the needs of both the lender and the borrower. Thus forexample, stocks can be
categorized intoeither class A or class B, where the latterwould be company stock,
with sole voting rights,but these would not pay any dividends until the company has
established itsearning power. Provisions forconvertibility,such as converting class
A intoclass B, when B pays more than the amount specified forA, enhance the flex
ibilityof stocks as a financial asset. Preferred stock and cumulative preferred stock,
which afford no ownership privileges, make available the risk/return option.

3.2 Financial Institution

PLS can be embodied invarious kinds of financial structures. Incurrent practice, some
countries have opted for joint-stock banks co-existing with interest-based banks (the
Middle Eastern approach) while others have opted fora wholesale change of the bank
ingsystem so thatall transactions are on an Islamic footing (Iran and Pakistan present
examples of such experiments).
As explained, ordinary commercial banks functiondifferentlyfrom the Islamic institu
tions. Certain other financial institutionsexist inadvanced industrialcountries' finan
cial markets, whose functioningdiffers in less obvious ways from,forexample, an islamic
joint stock bank.
Investmentbanks are one such financial institution11. New corporations which cannot
use stock exchanges and find itdifficultor inconvenient to dispose of theirown stock
may relyon investmentbanks. Of course, these banks will sell stock only of corpora
tions theyconsider promising. Profitsof the bank result fromselling stock at prices greater
than those quoted to them. Although investment banks are subject to the riskof un

10 This point ismade in the context of a comparison of debt and equity financing by Ernest W. Walker, Essen
tial of Financial Management (Englewood Cliffs: Prentice-Hall, 1965), p. 101.
11 For an overview of investment banking see IrvingFriend et. al., Investment Banking and the New Issues
Market (Cleveland: World Publishing company, 1967), pp. 1-79.

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 S. RAFI KHAN - PROFIT SHARING IN ISLAMICBANKING

marketable stocks, inpractice, theyminimize this riskby formingan underwriter's syn

dicate inconjunction with other banks.
An Islamic joint stock bank receives an agreed upon share of the profits depending
on itsshare (derived fromthe sale of stock) of the total funds loaned.When banks are
not pure intermediaries,theirfortunesare linkedto the business ventures being financed
even iftheirown contribution of funds is negligible. This linkingoccurs because the
bank's share of profits is determined by PLS contracts. In fact, the banks engage in
a double PLS contract. As usual, the borrowers contract with the banks, but the banks
are now activily represented as lenders. The second contract isbetween the banks and
theirdepositors, with the banks represented as borrowers. Ultimately, the bank's profit
depends on the differential inprofit-shares itcan negotiate to pay the borrowers and
itsdepositors. Being a party to the riskand hence to profitsof a business undertaking,
the bank undertakes more thanmerely arranging the financing. Itsco-operation with
business could range froma shared project appraisal tomanagerial advice or direc
tion,depending on the nature of the contract it isengaged in.Whereas ultimatelyboth
institutionsare intermediariesbetween lenders and borrowers, investmentbanks cater
more to the needs of the borrowers. Islamic banks are structured such thatserving their
own needs theysimultaneously serve those of the lender (depositor) and borrower.Never
theless, this harmonious engagement ina productive endeavor should not be exag
gerated, as itoften is. Prior to the establishment of a contract, a potential forconflict
exists in the determination of profit-shares.

Nationalized Islamic banks that functionas pure intermediarieswould be operationally

the same. However, in this case, the bank would have no direct stake in the profitor
loss resultingfromthe contract itfacilitates.Such a unit,arid particularlyone thathandles
authorized accounts, could be viewed as performingthe functionof an investmentbank.
However, as a pure intermediary,itwould not be performing the underwriter's function
and would exist on a management fee rather than the profits from the distribution of
new issue.

Inadvanced capital markets, various financial intermediaries also work on behalf of

the lender.These include personal trustcompanies, consumer credit institutions,and
various formsof saving institutions,such as mutual saving banks and the saving and
loan associations. Insofaras these functionon the basis of fixed interest rates, which
are made possible by the use of theirdeposits for financial investment, they are less
relevant to the discussion of Islamic banking.
Investmentcompanies and mutual fundswork by drawing savers' funds inselling them

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SAVINGS AND DEVELOPMENT -No. 3 - 1987 -XI

shares and in returnpaying both dividends and capital gains12. Once again, they are
able to do this because they use their reserves to invest ina whole range of financial
assets that furnishboth a regular source of income fromdividends and interest.Capital
gains can be realized from the buying and selling of securities, and these in turnare
also distributed as capital gains to shareholders.
Investmentcompanies are referred to as ?close-ended? insofaras they issue a limited
number of securities, which are then traded on the securities market. Innovationswith
this formula have been taking place. Mutual funds are ?open-ended? in that they con
tinuously sell their shares to investors,who can redeem them after a specified time
period at net asset value. Various kinds of funds emphasize providing income, securi
ty,or capital appreciation. Mutual fundsare essentially a formof indirectsecurity owner
ship. Investors have the advantage of relyingon the skilled management of the fund.
As is trueof all institutionalinvestments,due to theirsize economies, themutual funds
possess other advantages: more is expended on research; diversification ismore ef
fective; there ismore access to inside corporate information;large sums ofmoney can
be committed for longer periods of time. Thus, the lendermay conveniently draw in
come froma relativelysafe and liquid investment.The same claim may be made for
Islamic PLS banking to some extent.
Although some similarities exist, the differences are focussed on here. The major dif
ference is the form the financial investment takes. First, an Islamic bank must commit
itspool of unauthorized funds toproductive investmentand may not use itforspeculative
securities trading tomaximize capital gains distribution for itsstockholders. Thus, a
one-to-one relationshipmust exist between the bank's loaning of funds and the financ
ingof productive activity.This relationship is not necessary inmutual funds. Second,
a mutual fundmanagement will have considerable discretion indeclaring returns to
itsshareholders, whereas a PLS contract commits the parties to pre-specified shares
of profit.Third, PLS contracts commit funds fora defined investmentperiod and hence
are less liquid. Further, ifthe share is not allowed to be freely transferable, no capital
gains and losses are involved, as is possible when a mutual fund share is redeemed
or sold. The capital value of the principal committed in the PLS contract may change
depending on the performance of the project. Fourth, the high loan value generally in
curred due to advertisement expenses of the distribution company, dealer, and

12 This description of mutual funds is based on Stuart B. Mead, Mutual Funds (Massachusetts: D.H. Mark,
1971), pp. 1-36, 88-89.

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 S. RAFI KHAN -PROFIT SHARING IN ISLAMICBANKING

salesmen's commission is not a consideration in the PLS contract. Finally, whereas

themutual fundsgenerally have to declare bankruptcywhen theycannot redeem shares,
Islamic banks are structured such that theywould not be in that predicament.

4. Conclusion

Islamic banks functioningon a PLS basis bear considerable resemblance to several

existing mechanisms of financial intermediationand investment.A fewpoints, however,
are worthy of note. The most striking is the complexity of the conventional financial
markets, where numerous instrumentsand institutionscompete for the savers' funds
?
by providing a mix of risk,return,and liquidity which PLS seeks to replace. The most
distinctive features of PLS are its insistence that loans be tied to productive, non
speculative investment and the lack of discretion institutionshave in determining
dividends when profitshares have been decided. Also, even though the lenders are
paid what could be interpretedas a variable dividend and bear complete financial risk,
no ownership of a productive establishment is implied by being a party to a PLS con
tract.Thus, ownership rightscannot be traded, nor can any capital gains or losses be
realized fromspeculative trading.The latterrestrictionwould also contribute to the in
flexibilityof Islamic banking.
There are other disadvantages also. Since revenues can be understated and costs

overstated, policing costs in Islamic banking could be high. Furthermore, since banks
are a party to the production process therewould be more demands on theirstaff for
appraisal. However the congruence of interestof the banks and the entrepreneurs, once
profitshares are contracted, could be an advantage. Even more than forequity financ
ing, the riskof default is eliminated because profitsare shared only when theyoccur.
Further, PLS financing has another advantage over equity financing in that there are
no issue charges.

Perhaps the major advantage would be that of providing a populace with a financial
system in keeping with their beliefs and in certain cases this could lead to a larger
patronisation of the banking system as a whole or of specific Islamic banks depending
on the institutionalstructure adopted.

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SAVINGS AND DEVELOPMENT -No. 3 - 1987 -XI

DISTRIBUTIONDES BENEFICES ET DES PERTES COMME SUBSTITUTIONDE

L'INTERETDANS LES BANQUES ISLAMIQUES

RESUME

Le paiement d'un interet(comme un rendement fixepredetermine) etant interditdans

les pays islamiques, on cherche actuellement des instruments financiers de nature in
novative pour substituer le recours au financement traditionnel.Ces instruments finan
ciers sont bases sur le principe de la distribution des pertes et des benefices (P.L.S.:
profitand loss sharing). Les caracteristiques les plus sail/antes des methodes P.L.S.
consistent dans le faitque les preteurs regoivent le cas echeant une participation aux
profits des projets qu'ils financent. Dans le cas ou les projets enregistrent une perte
les preteurs risquent de perdre leurcapital. Malgre ce risque, participer a une methode
P.L.S. ne signifie jamais se transformeren entrepreneur. Les prets doivent financer
des investissements productifs non speculatifs et les entrepreneurs/emprunteurs ne
peuvent pas determiner a leur gre les dividends car la distribution des profits a ete
decidee a priori. II taut remarquer que les pourcentages et non lemontant absolu sont
determines a Tavance.

Dans sa formulationplus stride, les methodes P.L.S. apparaissent limitees et inflex

ibles. Etant donne que les recettes peuvent etre sous-estimees et les couts sur-estimes,
le systeme presente des difficultesd'application elevees. II fautajouter encore que les
banques se trouventchargees de taches accrues en ce qui concerne revaluation et
la supervision des projets a cause de la presence de risques eleves et de leur insertion
dans le processus de production.

L'avantage du systeme P.L.S. est peut-etre de nature en effet ce

non-economique:
systeme offre a la communaute musulmane une possibility detre fidelea ses croyances
religieuses. IIne fautpas oublier que les possibilites moins elevees de faillitepeuvent
amener a une plus grande stabilitydu systeme financieret a une plus grande demande
de ressources financieres pour I'investissement.

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