Effective Capital

Definition of "Effective Capital"

Used with reference to Islamic financing by some writers who profess that profit-loss sharing should not be proportionate to face-value of capital but should be pro-rata ‘effective capital’. The sum of effective capital is to be a factor of exposure to risk and period of investment. It would be arrived at by multiplying face-value of the capital by a ‘risk exposure factor’. The share of profits of a particular class of capital to the total profits will bear the same ratio as the effective capital of that class bears to the total effective capital. See also risk exposure factor.