Mudaraba as a mode of finance in Islamic banking: theory, practice and problems

This paper seeks to analyze some of the aspects of mudarabah as a mode of financing business both from the theoretical and operational angles. At the theoretical plane the paper tackles the issue of the determination of the sharing of profit ratio for the outside financier in a competitive setting i.e. where the interest-free and interest-based systems operate side by side. It would show in a micro framework that the determination of this ratio would be a function of profit expectations, leverage ratio, rate of interest, and the risk factor. On the operational side, the paper analyzes the reasons of the unpopularity of the instrument not only with the financiers but also with the borrowers, and suggests some organizational arrangements to overcome the difficulties. The argument has a historical perspective