Islam prohibits charging of interest on financial transactions and employs various practices to prevent this; the Islamic financial system promotes the concept of participation in a transaction backed by real assets, utilizing the funds at risk on a profit-and- loss-sharing basis. Such participatory modes used by Islamic banks are known as participatory modes of financing.
Participatory financing caters to the needs of those Muslim capital-holders who wish to earn an income using their capital without involving themselves in Riba. The Islamic option for this group is the concept called Mudaraba and Musharka which is usually translated as profit-and-loss-sharing but is in fact profit-sharing-and-loss-absorbing, in case of Mudaraba and profit-Loss sharing in case of Musharka. In its simplest form it involves two partners, one with capital and the other with technical knowledge or experience, get together to undertake an entrepreneurial activity. If the enterprise ends in profit they share the profit in a pre-arranged proportion; if it results in loss the entire loss is borne by the financier in case of Mudaraba and at pre arranged rate in case of Musharka. It is possible to develop multiple products using different variations of the same basic concept. We can analyse the products falling under this category in more detail now.
- Diminishing Musharka