Islamic Finance and Participatory Financing Constraints in Pakistan

Abstract

Islamic financial contracts are designed to facilitate financing according to Islamic norms. Islamic financing in its first stage used only the partnership modes of Musharakah and Mudarabah. Later it is realized that, to avoid moral hazards, yet compete successfully with conventional banks, it is necessary to use all permissible Islamic modes and, consequently, trade and leasing techniques were developed. This paper aims to identify the constraints faced by Islamic financial institutions in the adoption of participatory finance, i.e. Musharakah and Mudarabah financing. The two basic categories of financing are (1) profit-and-loss sharing (PLS), also called participatory finance, i.e. Musharakah and Mudarabah, and (2) purchase and hire of goods or assets and services on a fixed return basis, i.e. Murabahah, Istisna’, Salam and Ijarah, also called non-participatory finance. This paper suggests that innovation and creativity is necessitated more than ever to promote participatory modes of financing and to make it the preferred choice for meeting the increasingly sophisticated and diversified financial needs.