Advantages And Disadvantages Of Interest Based Finance

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Introduction of mode of financing
Islamic banks use a number of non-interest-based finance modes. The use of a mode is dependent on the nature, purpose and size of transactions. In selecting the modes, it is very much the know-how and knowledge of the Islamic banker which comes into play. These modes could be classified as debt type instruments, quasi - debt type Instruments, profit and loss sharing or hybrid instruments.

Debt type instruments involve Murabahah, Salam, Istisna’a, Tawarruq and Qard Hasan. Murabahah is a particular kind of sale, where the seller expressly mentions the cost he has incurred on the commodities to be sold and sells it to another person by adding some profit or mark-up thereon which is known to the buyer. One of
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Musharakah is used by Islamic banks for structured trade financing, real estate financing, project financing, working capital financing, asset financing, pre-export shipment financing and Import financing base. It is based on the concept of profit-and-loss sharing, the profit is shared in any agreed ratio the loss is shared in strict ratio to the capital contributed by each party. Diminishing Musharakah; that is used to Islamic banks for home financing, real estate financing, project financing and equity financing; provides a method through which the bank keeps on reducing its equity in an asset against periodical payments, ultimately transferring ownership of the asset to client. The rental payments to the bank reduce with the bank’s diminishing equity in the asset until no further rental payment has to be introduced. Mudarabah is another participatory mode that embodies the spirit of profit-and-loss sharing partnerships; whereby one party provides the capital while another party provides the labour and skills to manage the venture. Profits are shared between the parties according to a pre-agreed ratio; while losses are borne by the capital provider. This mode may be used by Islamic banks for project financing, working capital purpose, asset backed financing, asset acquisition financing and import financing. These projects which call for the use of a combination of modes. This is…show more content…
In the context of business, it refers to a joint enterprise in which partners (or parties) to the enterprise share the profit and loss ratio of the enterprise. Musharakah has far reaching implications for Islamic banking and finance in the modern context and providing excellent alternative to the interest-based economy.
In a Musharakah, the party investing the capital shares equally in both the profit and loss ratio, which is different from an interest-based system where the upside is limited while the downside is very nearly non-existent.

Basic Rules of Musharakah
1. Profit distribution
The ratio of profit for each partner must be determined in proportion to the actual profit arises to the business and not in proportion to the capital invested by him. For example if it is agreed between them that ‘A’ will get 1% of his investment, the contract is not
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