Risk Sharing in Corporate and Public Finance: The Contribution of Islamic Finance

The risk-sharing principles of Islamic finance have been most extensively adopted and used in non-Muslim countries. Early European city-states, especially those in Italy, used risk-sharing finance (RSF) to fund their development and build empires. Although some components of Islamic finance have survived in venture capital financing, with the passage of time RSF has been surpassed by debt financing (risk transfer). Today as the world struggles with the excesses of debt and leverage, the risk-sharing principles of Islamic finance offer a potential alternative. The profile of the debt-equity trade-off, which so heavily favours debt over equity, is altered when RSF based contracts are used. In this paper, we offer some preliminary thoughts on the design and implementation of RSF for both private and public sector funding, for revenue and non-revenue generating projects. It is argued that such financing avoids the leverage of conventional debt, minimizes the costs of dilution, reduces macroeconomic vulnerability and enhances financial inclusion. It also has the potential to be a less risky alternative for developing countries to finance public spending and economic growth.