Contracts and Deals in Islamic Finance: A User s Guide to Cash Flows, Balance Sheets, and Capital Structures

Chapter 21Pricing, Income Distribution, and Risk Sharing in Islamic Banks

Pricing of shariah-compliant financial products has followed a similar track to pricing conventional products. The readers at this stage should not be surprised at the similarities by now. However, the legitimacy of a shariah-compliant product does not lie in its pricing but in the rights extended to parties to a contract and the obligations arising from the same. If these rights and obligations are shariah-compliant, the contract and hence the product is compliant. Price is not a litmus test. Income sharing is another crucial aspect of Islamic banking and we explore this concept along with risk sharing in this chapter.

Pricing of Islamic Financial Products

The price of any product is primarily a function of its cost. Other factors, such as demand, greatly impact the price of a product as well. A company that manufactures shoes, for instance, would incorporate into the price of one shoe the following five elements:

1. A portion of the fixed costs associated with the plant, property, and equipment that is dedicated to the manufacturing of shoes.
2. The variable costs of raw materials, utilities, wages, salaries, distribution costs, advertising costs, and packaging costs that are directly or indirectly related to the manufacturing of shoes.
3. The expected rate of inflation.
4. The costs of financing (if any).
5. A required rate of return on capital invested.

The sum of the above factors would resemble a murabahah