Applied Islamic Banking

By:
Prof. Dr. Mohd. Ma’sum Billah
masum@applied-islamicfinance.com
masum2001@yahoo.com
+6019-3699542

Introduction

In finance, there are two main ways that any company or organization could use to raise fund and finance any one of its project. One of those methods is equity financing, through the issuing of shares to the public, especially for listed companies. The second method is debt financing through the issues of bonds in the stock market or loans from bank.

As far as Islam is concern, not all those means of financing are Shariah’s complaint, or at least, there are some restrictions in using the mode of financing specifically in the case of debt financing as far as it involve riba or any other haram elements such as gharar and gambling. Almost, all Muslim scholars are of the opinion that buying selling or holding shares is lawful given that the company’s main business is online with the Islamic law.

Islamic venture capital is a type of equity financing through the use of Musharakah. In fact, venture capital as a concept is not a new but it has a long history. Sami Al-Suwailem (2000) said: “although the concept (venture capital) as such is not new, a formal market for venture capital in the U.S. started only after World War II. Venture capital institutions currently manage over $30 billion in the U.S and another $30 billion in Western Europe”. People use venture capital to finance projects, which may require a large amount of capital and it may not be available the with project’s owner. Nowadays, business is using capital venture to finance fully or partially technology base projects. Form this point of view, it is strongly advisable for the Muslim countries to have mutual contracts or win-win strategy to help each other in the era of globalization, in which stronger will eat poorest people. On the other hand, most of the Muslim nations have enough recourse but they are in lack of skills and expert management team such as the Gulf countries, and some Muslim countries seem to have highly skilled people such as Malaysia. Therefore, it will be of great advantages for Muslim countries to have a deal of such kind. To give example, The United Arab Emirates and Malaysia had build together a Technological City in Dubai last year. We need to take the hands of each other to live in the new era of globalization. In the next section, we need to explain the concept of Musharakah since it’s the base for the use of Islamic venture capital.

Musharakah literally means sharing. In the context of business and trade is refers to a joint enterprise in which all the partners share profit or loss of the joint venture. It is a contract base on mutual consent, Is a contract whose validity does not depend on conditions of a valid contract, but the most important aspects in Musharakah are parties should be capable of entering in to a contract, existent of consents, and the contract should be free from duress, fraud or misrepresentation.

Basic rules for implementation of Musharakah

There are basic rules which need to be spell out during implementation of Musharakah contract. The distribution of profit and loss, the nature of capital, management of Musharakah and termination of Musharakah must be clearly and precisely outlined.

Distribution of profit

The proportion of profit to be distributed must be determined and agreed upon by contracting parties. If it is not determined, then the contract is invalid. The profit sharing ratio should be based on actual profit accrue to the business not on how much each contributed. If the profit is distributed on capital ratio and at predetermine rate then such contract is invalid but question arise is;

* Is it necessary that the ratio of profit of each partner conform to the ratio of capital invested by him? There are differences of opinion among Muslim jurists about this question.

According to the Imam Malik and Imam Shafi the contract is valid if the distribution of profit base on capital contribution. For instance, if “A” contributed 40% of the capital in Musharakah, he is entitling to 40% of the profit that arise from such business. If he receives more or less than amount he contributed then, the contract is invalid. However, the view of Imam Ahmad, the contract still valid even if the ratio of profit differs from the ratio of capital invested with condition that the partners agreed upon. For example A may invest 40% of the capital in to the business, but he/she may get above 60% of profit if the partners accept that. Lastly, Imam Abu Hanifah agrees with views of Imam Ahmed that ratio of profit to capital contributed may differ but with condition that all partners are active a not sleeping partner. If there is any sleeping partner, then for such contract to be valid his profit must base on capital that he contributed. (Taqi Usman, 2004).

Sharing of loss

There are no disagreement among jurists incase of sharing a loss. All Muslim jurists unanimously agreed that, incase of loss, partners must share it exactly to the amount of capital he invested in to the business. This argument is base on principles of maxim, which said:

“Profit is based on the agreement of the parties, but loss is always subjects to the ratio of investment”

The Nature of Capital

Most of the jurists are of the opinion that the capital should be in monetary form but not on commodities. However, there are different views in this respect. Imam Malik argued that partners can contributes capital in form of money since it is not a condition for the validity of Musharakah but also permissible to invest in kind with condition that the partner share is subject to market price of that commodity.

According to Imam Abu Hanifah and Imam Ahmad they disagreed that no contribution in kind is acceptable in a Musharakah. Their argument base on two reasons: the commodities is not the same, even if the same in form but differ in qualities and values, hence Musharakah is invalid if the property are distinguished from one another. Secondly, share-capital redistribution cannot be possible, since commodities are subject to price fluctuations. But he agrees on commodities capital if the commodities are dhawat-ul-amthal. Dhawat-ul-amthal is commodities which if destroys can be compensated by similar commodities like rice, Imam shafi is also of the same opinion that if the commodities is dhawat-ul- amthal then is acceptable on the ground that it can be mix with other commodities of the same type, but he disagree on dhawat-ul-qeemah.( commodities which can not be compensated with similar commodities like cattle. ( Taqi Usman,2004).

In conclusion, share capital can be in form of money or commodities, the market value of the commodities shall determine the share of the partner in the capital.

Management of Musharakah

The normal practice of partnership, all partners has right to take part in its management as well as to work for it. However there are two possibilities that management can be at hand of one partner base on consent of partners, but in this case the sleeping partners will receive his/her profit base on capital he invested. Or all partners can work as a team and each shall be treated as agent of the other in a matter of the business or any work, and all we have equal rights in day-to-day dealing of the business.

Termination

Right to termination. Every partner has right to terminate partnership any time. If the contract is terminated at will, and the asset is in form cash, then it will be distributed according to share each contributed. But if the asset is in form of non-liquid, then there are two options. One to distribute the physical asset base on the value of the asset, incase of dispute, then the physical asset will be sold and cash distributed on agreed ratio.
Incase one of the partner dies, and then partnership can be liquidated. However if the heirs accept to continue with Musharakah then is also permissible.
Incase of insane. If one of the parties becomes insane the partnership can be terminated if all partners agree or the other parties will continue with business and pays the share of the insane partner.

These conditions in termination of a Musharakah contract are allowed if all parties agreed upon at commencement of the contract, (Taqi Usman, 2004). As prophet (SAW) said in a famous Hadith;

“All the conditions agreed upon by the Muslims are upheld, except a condition which allows what is prohibited or prohibits what is lawful”.

Modern operation of Musharakah Model

In this Musharakah model, the banks identifies prospective companies with approval subject to due diligence. Companies can issue Musharakah preference shares to the bank at discount if the bank wants to buy the paper through Wadiah or discount sale. Incase bank does not intend to buy then the companies can sell it directly to the investors via the Musharakah deposits. For examples Bank may requires $ 70 million to finance four short and medium investments projects. Banks will issues $ 70 million worth of Musharakah shares to investors at $ 1 each. In this case the bank act as agent for both investors and the companies and charges some fees for service rendered. When project with gains of the$ 90 million, the net asset value per unit will increase to $ 1.5. In this case investors will enjoy capital gains. However if the project fail to succeed the investors will lost their capital.( Saiful Azhar,2001).

The Identification of Projects with a Potential Returns and Raise Medium-term Musharakah Capital.

Sources: Saiful Azhar

The Practical Scenario

In realty, venture capital is a real business deal in which both parties venture capitalists (the venture capital company) and the financed company work together and share efforts and returns, because simply there is no gain without pain and from here we could start fighting the concept of riba. At the same time, we could also say: how if we minimize the use of banking services specially loan services and we establish investments companies that will be based on Musharakah. Here down we are going to identify some steps that are used in venture capital: (for more details consult: Sami Al-Suwailem, 2000)

Company “The Ummah” is of a pharmaceuticals nature, it has the relevant skills to develop a new type of product and has no enough capital to finance the project.
The company found a venture capital company, which is going to finance about 90% of the total cost based on Musharakah contract, and later on the profit or loss will be divided according to the principle of Musharakah.
After the establishment of the venture capital, and the investment opportunities identified, the venture capitalist has the right to monitor the investment and analyze it step by step to make sure the project is successful and benefit able for both parties.
The contribution of the venture capital company can be converted into common stock, but it is not Islamic to be converted to preference stock which normally its holder receive fixed dividend.
The full amount of capital will not be provided at once, but each stage of the project has its enough budgets.
The Board of Directors contents people from parties, the recipient company and venture capitalist.
To minimize risk, the venture capital firm can build a portfolio investment by investing in other companies (Diversification).
After the project materialize the recipient company has the chance to go public
The profit earned from the project will be shared between involved parties based on pre-determined ratios.

Conclusion

If we would like to survive, as a Muslim Ummah, in the era of globalization, may innovations need to be considered in the Islamic financial sector? Innovations and positive thinking from the side of the Islamic scholars (Figh Scholars) are our engine to be a civilized Ummah in order for us to lead the current corrupted world otherwise we will be dreaming to be the leader of the World, and we will be part of the problem.

What is wrong of using others idea if its in line with the Islamic law. We do not need even to say: Islamic venture capital, we use the venture capital as a mechanism to finance our project using the equity financing. Muslims, especially businessperson should know what is wrong and what is right, what is haram and what is halal, from there he invest using the right mechanism for his investments, names of thinks should not be our concern.

We came to conclude that venture capital is a very important mechanism for rising of funds through the use of the Islamic ally accepted concept of Musharakah. It could help the developing Muslim countries to exchange skills and recourses and go further in developing our Ummah.