Mudarabah and Musharakah as an Equity Financing Model: Issues in Practice

Muhammad Jais, Faizah Sofyan, Asmaou Mohamed Bacha

Abstract


Islamic banking industries maintain a corporate finance strategy that entails careful management of raising capital through equity and debt modes. Therefore, Islamic financial institutions as the role in provision of different models for financing short term and long term business projects. While it discourages high leverage, Shari’ah promotes equity- based financing of Mudharabah (profit-sharing) and Musharakah (joint venture). However, in practice, debt based financing is commonly used by Islamic banks than equity based financing despite its higher contribution to the economic well-being due to some issues. Debt based financing and equity based financing as the same as conventional banking system models, what distinct Islamic banking models is the underlying contracts that are components of Islamic law in business transaction.  Therefore, there are still some weaknesses in this practice because the nature of banking business avoids risk, the Islamic equity-based financing contracts which are based on risk-sharing are not generally friendly with financial intermediaries.  Banks mitigate risks through carefully structured securities, guarantees, and collateral, which are not accepted in the Musharakah and Mudharabah equity-based Islamic financing. For this reason, this paper attempts to highlight the practical issues in the Mudharabah and Musharakah as a mode of equity based financing and subsequently recommends possible solutions to mitigate these issues and improve the current practice.


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