PLS Based Financing for SMEs: Returns to IFIs

Profit and loss sharing (PLS) based financing without collateral and interest rate could ease the financing difficulty of small and medium enterprises (SMEs). However, this PLS based financing is not widely offered by Islamic financial institutions (IFIs). This exploratory study illustrates that PLS based financing to SMEs is viable for IFIs. Using financial information of SMEs to calculate profit sharing ratio and net income under PLS based financing context, this study determined the profit margin ratio of IFIs from extending PLS based financing to SMEs. The findings show that extending PLS based financing to hypothetical diversified portfolios of SMEs generate higher profit margin compared to conventional lending at low risk based on the Markowitz portfolio theory of diversification. Moreover, as the number of SMEs in the portfolio increases, the risk of insufficient returns from the portfolio when an enterprise suffers a loss reduces