Risk, Return, and Profit-Loss Shared Lending under a Zero-Interest Financial System

Owing to its unique nature, writing a profit-loss shared lending (PLSL) contract for a Zero-Interest Financial System (ZIFS) bank is a challenge. Like venture capitalists and stock owners, a PLS lender faces some of the same risks as the borrower. However, as a lender and not as an investor (as opposed to the classical definition), it does not share in any increment or loss in the value of equity. While the share of profit going to capital may be constant, the absolute amount going to the lending bank is likely to diminish over a fixed period of time until the loan is paid. In economies where attempts to float a PLSL contract is strong, it is made worse by an abundance of adverse selection (AS) and moral hazard (MH) factors: lack of knowledge and training, errors in planning and projection, tardiness in identifying and reacting to problems, limitations of oversight, nepotism, favoritism, corruption, falsification, legal loopholes, tendency to cut corners, etc. So, despite its obvious benefits PLSL contracts are finding it difficult to take root and become established as a standard financing arrangement. This is vitiated by internal competition posed by mark-up financing. Pivotal to a viable PLSL contract, relevant equations incorporating AS and MH and related explicit and implicit costs are identified. Then risk-adjusted return to ZIFS bank, capital’s share of profit, absolute income accruable to banks and relevant first order conditions are derived.