Composite Profit-Sharing-Formulas for Musharaka Financing

Banks avoid participatory financing due serious information asymmetries, adverse selection and moral hazard problems with negative impacts for the return on capital provided. Even financing instruments with a participatory legal form such as musharakah sukuk have been stripped of their risk sharing substance and became functional equivalents of interest-bearing bonds. Several authors have addressed these issues, but some proposals are applicable only for (listed) joint stock companies, while others imply Shariah compliance issues. To overcome these limitations, a self-adjusting profit sharing ratios is proposed, based on building blocks found in AAOIFI Shariah standards for musharakah financing and musharakah sukuk. These building blocks allow a (surprisingly) wide range of discretionary adjustments of participatory contracts, provided the contracting parties come to an agreement in re-negotiations of the contractual terms.