Idealization of PLS Mode in Islamic Finance

One of the key precepts of Islamic finance is that under conventional systems based on interest, neither profit and loss nor risk is shared by the contracting parties

 Profit Loss Sharing (PLS) dominates the theoretical literature on Islamic finance. Broadly, PLS is a contractual arrangement between two or more transacting parties, which allows them to pool their resources to invest in a project to share in profit and loss. Most Islamic economists contend that PLS based on two major modes of financing, namely Mudaraba and Musharaka, is desirable in an Islamic context wherein reward sharing is related to risk-sharing between transacting parties

The most important feature of Islamic banking is that it promotes risk-sharing between the provider of funds (investor) and the user of funds (entrepreneur). By contrast, under conventional banking, the investor is assured a predetermined rate of interest. Since the nature of this world is uncertain, the results of any project are not known with any certainty  so there is always some risk involved. In conventional banking, all  this risk is borne by the entrepreneur. Whether the project succeeds and produces a profit or fails and produces a loss, the owner of capital gets away with a predetermined return. In Islam, this kind of unjust distribution is not allowed. In Islamic banking both the investor and entrepreneur share the results of the project in an equitable way. In the case of profit, both share this in pre-agreed proportions. In the case of loss, all financial loss is borne by the capitalist and the entrepreneur loses his labor

 To remedy the claimed harms of interest-based arrangements, the orthodox Islamic finance claims that financing should be based on fair sharing of profit/loss and risk

  reference:
Partnership, Equity-financing and Islamic finance: Whither Profit-Loss-Sharing?  by Mohammad Omar Farooq

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