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Islamic Finance

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Differences Between Profit Equalization Reserve and Investment Risk Reserve

The profit equalization reserve (PER) is the amount appropriated by an Islamic bank or financial institution out of the mudaraba income before allocating the share of al-mudarib. This reserve aims to maintain a specified level of return on investment (ROI) for investment account holders (IAHs). In other words, it represents a measure of profit stabilization over different financial periods. The PER is also formed for the purpose of increasing owners’ equity.

The investment risk reserve (IRR) refers to the amount appropriated by an Islamic bank or financial institution out of the income of investment account holders (IAHs), after the mudarib share is allocated. This reserve is used as a cushion against future losses that IAHs may incur.

The following table enlists the major differences between the two types of reserve:

PER IRR
Source Mudaraba income IAH income
Stage of appropriation Before mudarib share is allocated After mudarib share is allocated
Purpose/use Profit stabilization/smoothing Cushion against future losses
Ultimate beneficiary IAHs and al-mudarib IAHs

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