Benefit and problem of profit sharing and no profit sharing.

Profit sharing

Non profit sharing

More suitable for short term financing. The

shorter the period of financing, the fewer the
evaluation of the share proportion conducted.
This condition of course will increase the
efficiencies for both sides, i.e. banks and
customers

Trade-based modes, such as murabaha, having less

risk and better liquidity options

Need participation from

knowledge in that field

provide flexibility of choice to meet the needs of

different sectors and economic agents in the
society

bank-need

Reduce income inequalities

not be as fruitful in reducing income inequalities

anks allowing financing on PLS basis are exposed to

risk of losses as even a profitable company may
sustain genuine loss due to various factors even
beyond their control
absorbs the impact of inflation not influence by

informational asymmetry.

Read this article too

http://www.islamic-banking.com/iarticle_2.aspx
https://www.academia.edu/3148241/How_Do_Islamic_Banks_Optimize_Profit_and
_Loss_Sharing_Arrangements

Problem:
Three major challenges may be the reason for the status quo.
Regulation. Higher risk weightages and proportionately higher capital
requirements prescribed for mudarabah and musharakah contracts disincentivise
Islamic banks from the usage of profit sharing in their operations.
Displaced commercial risk. In the dual banking environment, Islamic banks
compete for scarce funding resources with conventional banks and hence may
be pressured into arrangements that are guaranteed to generate timely returns.
It is therefore understandable why Islamic banks decide to stay away from PSF
related engagements, given the essentially risky nature of PSF.
Information asymmetry. Information asymmetry also makes it harder for Islamic
banks to partake in PSF. A higher burden is placed on an Islamic bank with regard
to monitoring of business arrangements to avoid fraud and negligence on the
part of its business partners. PSF requires active management of projects, in
which the Islamic bank normally lacks expertise this acts as another deterrent
for the application of PSF in Islamic banking operations.
Venture capital industry techniques

PSF has existed in the developed world under the guise of private equity
financing and/or venture capital. The importance of these sources of funds in
powering innovative growth has been widely accepted and has prompted
governments to introduce a range of incentives supporting investments in
startup ventures. The management of such investments has been stellar; thus, it
may be helpful for the Islamic finance industry practitioners to borrow venture
capital strategies in an effort to bolster the implementation of PSF in Islamic
finance.

Fund raising. In Islamic banking, a portion of the prevalent fund raising model
through deposits should be reclassified as a unit trust model, in which customers
understand the risks involved and are willing to participate in the long-term.
Such realigning of customer expectations can reduce displaced commercial risk.

Project selection. Islamic banks should utilise a process of syndication for project
risk appraisal. Syndication helps venture capitalists gather information on given
investment opportunities, which improves the selection process and eventually
impacts the post-investment involvement of venture capital firms. Empirical
evidence suggests that syndicated investments tend to exhibit higher returns
and higher volatility than standalone investments. These syndication benefits
may be taken advantage of by Islamic banks to enhance the performance of PSF
deals.

Risk management. To reduce fund exposure, following the model of VCs, Islamic
banks can utilise a process of staging to deal with information asymmetry.
Staging is a special mode of investment that reportedly has a positive influence
on investment performance, increases efficiency in financial contracting and
leads to optimal investment decisions both on the part of the investor as well as
the entrepreneur. Staging involves the sequential disbursement of capital from a
private equity or venture capital fund to a portfolio company, often dependent on
whether companies receiving funding have satisfied predetermined targets. Most
empirical results tend to indicate that staging has a positive effect on investment
returns in the beginning of the investment relationship.

Insurance. Aside from internal management techniques utilised by the venture

capital industry to manage their risks, there exist certain conventional insurance
products which, if converted to takaful, would assist Islamic banks in managing
the risk of PSF. Utilisation of takaful products is not new to Islamic banks, for a
major bulk of their financing is protected via mortality takaful products.
Therefore, similar models should be extended to Islamic banks PSF projects.

Director liability. One of the biggest risks faced by Islamic banks is partners
fraud and/or negligence. Due to perverse agency incentives, business monitoring
alone arguably may be not sufficient to prevent fraudulent activities. Although
according to the Shariah, an Islamic bank may recover its capital if negligence is
proven on the part of a partner, the legal costs involved in the process and the
existence of bankruptcy laws complicate the issue. Therefore, an Islamic version
of the director liability insurance could be used instead to compensate the
Islamic bank in the event the partner does not perform his or her duties in the
best interests of the project stakeholders.

Third party risk. In PSF, even if the partner is successful in completing the
mandate, there still exist issues of third party defaults which could result in
losses for the joint venture company. There exist conventional insurance
products that can help mitigate this risk. Trade credit insurance and performance
bonds are examples of insurance that protect against from non-performance of
obligations by third parties. Takaful alternatives of these products could be
beneficial in managing PSF risk.