Risk Sharing as an Alternative to Debt 107
In this situation, Presley and Sessions show that a profi t / loss (muda-
rabah) contract between the agent and a group of investors may result in a
more effi cient revelation of any informational advantage possessed by the
agent over the principals. Again, and as mentioned a number of times above,
it should be noted that there is an important moral dimension to Islamic risk
sharing, strengthening society by enhancing cooperation between principals
and bringing agents and principals closer together.^3
Enhanced Cooperation among Economic Agents
When risk is spread by means of risk/reward-sharing contracts, closer coor-
dination is forged between the real and fi nancial sectors of the economy. Risk
transfer by means of interest - based debt contracts, in contrast, weakens that
linkage. Particularly when risk transfer is combined with high leverage, the
growth of interest - based debt contracts and their pure fi nancial derivatives —
those with little or no connection to real assets — outpace the growth of
the real sector, leaving the liabilities in the economy a large multiple of real
assets needed to validate them. This phenomenon is called “fi nancial decou-
pling” (Menkoff and Tolkorof 2001) or “fi nancialization” (Epstein 2006;
Palley 2007), whereby fi nance is no longer anchored in the real sector. The
result is fi nancial instability leading to frequent crises. Reinhart and Rogoff
(2009) have catalogued the high frequency of historical occurrences of crises
in the conventional interest - based system and have clearly shown that all
crises, whether classifi ed as a currency or banking crisis, have been at their
core a debt crisis.
Risk Sharing vs. Risk Transfer
Interest rate-based debt contracts have two major characteristics. First,
they are instruments of risk shifting, risk shedding, and risk transfer. Second,
in such contracts, the creditor acquires a property-rights claim on the
debtor, equivalent to the principal plus interest and whatever collateral
may be involved, without losing the property - rights claim to the money
lent. This is a violation of Islamic property - rights principles as described in
Chapter 2.
The “sharing of risk” has many possible meanings, depending on how
risk sharing is organized. All forms of organized risk sharing have a “mutu-
ality” dimension in their activities. The most familiar are cooperatives of
various forms designed to share risk faced by their members. Producer,
consumer and farm cooperatives allow members to share risks of produc-
tion, consumption, crop output and related activities. In the case of Islamic
insurance such as takaful, a group pools its resources to insure its members
against risk. Ordinary insurance, where a person buys an insurance con-
tract for a fee (indicated by a premium), is not an example of risk sharing
but of “risk transfer,” where for a fee the insured transfers part of his/her
idiosyncratic risks to a fi rm willing to provide protection against possible