Islamic Finance (5-2-2010) There is a strong correlation between formal property rights and economic developments. The earlier property rights are established the earlier economic development can start. Property rights in Islam are rock solid. This is because infringing upon somebody’s property rights is considered a great sin. Moreover, Islamic law attaches great importance to property rights this is proven by Hudud punishments. Thus, both religion and law are combined to protect property rights in Islam. Redistribution of wealth: In regards to the effectiveness in redistributing wealth Waqf comes on top. This is because an individual donates a large sum of money voluntarily. It is very effective method, because the wealth is being transferred. Mudharabah (Qiradh) How can we combine different factors of production without the use of interest? Since the only way to combine the different factors of production is through business partnership, which has at its essence the concept of profit and loss sharing, then this means business partnership constitutes the most important institution in Islamic finance, and that without business partnership there will be no Islamic finance. Prophet Muhammad practiced Mudharabah so there is no question about its legitimacy. The practice however was pre-Islamic, and can be traced back to the Assyrians. All other partnerships are derived from Mudharabah. In theory you can have infinite derivatives from the basic Mudharabah structure. The implications for financial engineers are that the possibilities are endless. The advantage of designing an instrument based on such a basic structure is that it is already approved. The complete freedom granted to the agent from any liability for the capital in the event of loss and the disjunction between the provider of the capital and third parties constitute the novel and distinctive features of the Mudharaba. Whether Inan or Mudharabah a partnership contract usually contain the following clauses: the nature of the contract; the amount of the investment; the provisions regarding profit division; and the limits of the agent’s or partner freedom in utilizing the entrusted capital. Obligations of the agent toward third parties cannot be claimed directly from the investor. Actually, third parties need not even know of the investor’s existence. All of this also applies to Inan. Third parties can satisfy their claims only with the partner with whom they had their dealings. The latter alone is responsible for the entire sum involved. The agent first satisfies the third parties and only then he can demand restitution from his associate. However, The losses incurred by the agent over and above the capital invested by the principal accrue to the agent only. With respect to the agent’s freedom in Mudharabah there are two types of contracts: a limited and an unlimited Mudharabah mandate. An unlimited Mudharabah mandate was characterized by the Arabic clause إعمل فيه برأيكor act with it as you see fit. In such a case the agent was granted a number of privileges such as buying and selling all types of merchandise or selling on credit. He was further authorized to combine the capital entrusted to him with his own resources, and give it as a Mudharabah to a third party, or to invest it in Inan partnership with a third party. This very possibility of involving numerous investors and agents in one partnership contract formed the basis from which a number of other business forms emerged in later centuries. The Mudharabah/commenda paved the way for the incorporated joint-stock companies. - - In classical Mudharabah the capital provider provides the entire capital, so the pecuniary loss follows the capital, and the Mudharib will loss his reputation and effort. In Mudharabah there is limited liability. If the Mudharib does business with a third party this business does not affect the capital provider beyond the capital he provided. This means there is a disjunction. Division of profit must be proportional. In a simple Mudharabah there will be two partners a principle and an agent. The entire capital is provided by the principle. The agent contributes only his time, efforts, and knowledge but no cash. The agent takes possession of the capital physically, and tries to generate a profit. The venture is concluded when the agent returns the original capital back to the principle. If there is profit it is shared according to mutual agreement. This mutual agreement is in the form of percentages and it is clearly stated in the contract. If there is a loss the entire pecuniary loss accrues to the principle and the Mudharib suffers non-pecuniary losses and he goes unpaid for his effort. In general profit follows mutual agreement and loss follows capital. - The principle may loss his entire original investment and nothing beyond original investment. The third party may not be aware of the original investor. The agent should act in good faith. Otherwise, the principle has the right to hold the agent liable for any losses resulting from negligence or misconduct. The agent is not liable for any losses to third party or to Rab Al-Mal as long as there is no evidence pointing to negligence or misconduct on the part of the Mudharib. Q The Multiple Mudharabah - - - Islamic law of partnerships allows the agent to pool the capital of several principles. Thus, total capital entrusted with a single agent can be considerably enhanced. If we increase each factor of production by a certain amount we observe the quantity increases by more than that amount. Moreover, there will be reduction in transaction costs, which means the transaction cost will be reduced per unit. The agent signs separate Mudharabah contracts and the combined capital generates larger profit. An agent can engage several principals, and at the same time a principal can engage several agents as well. In the latter case this arrangement can take the shape of an agreement between an investor and a ship captain who usually will not receive a salary from the people who commissioned his services. Instead he shared in the profits. Nor were the members of the crew employed by the owner of the ship. They too had a share in the trade. Thus, the captain as well as every sailor was considered agents or Mudharib with a share in the profits. Capital on the other hand was provided by the investor. This Mudharabah contract is an investment contract. It is also an employment contract. It is also an agency contract, and it is also a liability contract. It is a highly sophisticated contract form and because of that it spread all over the world. Islamic Finance (13-2-2010) The Inan partnership In simple inan partnership, the agent seeks a greater profit share than is possible in Mudharaba for which he agrees to shoulder greater risk. The agent does this by contributing to the capital of the partnership and it is this capital input, in addition to his entrepreneurial input, which qualifies him for a greater share in the profit. Thus, Inan gives a greater share for the agent in return for shouldering greater risk. Characteristics of Inan: in Inan partnership the partners usually contribute unequal amounts to the partnership capital. The passive partner contributes the larger part, while the active partner contributes the smaller part. It is also possible for the two partners to contribute equal amounts of investments with unequal distribution of profits. However once the partners are committed the capital becomes the joint capital of the partnership. The partnership can be established with a fixed or flexible term. If it is a fixed term, then at the end of the term the partnership ends. However, if it is flexible and the partnership has only two partners it can continue until one of the partners dies or goes insane. In this case it will be immediately liquated. However, if there are more than two partners, then the partnership can continue. In Inan partnership it is usually the active partner who manages the joint capital. Profits are distributed among the partners according to mutually agreed percentages. As for losses they are distributed according to capital contribution of both principals. As for contributions it must be in cash. The Inan partnership is usually considered under two categories: the specified and the general. The specified Inan pertains to the trade in a certain category of merchandise. In a general Inan partnership, any legitimate trading activity comes within its purview. Expanded Inan The two inan partners empower each other with full trust and the passive partner gives unlimited mandate to the active partner. Then first of all it is permitted for an active inan partner to enter into a separate partnership with a third person. If the new partnership is unrelated to the basic activity of the inan, then there is no need to obtain the approval of the other inan partner. If however the activities are related such permission is needed. Question: this means that even if the passive partner gives unlimited mandate to the active partner, the latter must obtain permission from the former in order to enter into activities that are related to the basic activity of inan. Question: Is the permission necessary because it may create a disadvantage to the original inan partnership? Secondly, the active partner can mingle the capital of the partnership with his own capital so as to have greater bargaining power with the third parties. Thirdly, he can use the partnership’s expanded capital to establish another inan partnership with a third party. The Hanfites and the Hanblites allowed the rewarding of professional manager or agent with extra shares, while the Malikites and the Shafites refused such a practice. Liquidation of partnership: If the Inan partnership has two partners then the death of one of the partners causes the liquidation of the partnership. If however, there are three or four members in an expanded Inan, then the partnership continues and only the dead partner’s share is liquidated and given to his inheritors. However, if there is a clause for the continuity of the partnership, then the other partner or partners can liquidate the share of the dead partner and give it to the inheritors or he can buy the share of the dead partner and continue with the company. Moreover, a partnership between two partners can continue with the provision of Hibah to one of the relatives or one of his family members. This means that the person who receives the Hibah can continue with the partner in the partnership. The Mufawada partnership In Mufawada partnership partners contribute capital in exactly equal amounts to the venture and share profit as well as loss in exactly equal proportions. In Mufawada the communality comprehends all things. Thus, Mufawada is understood as an unlimited liability partnership. As a result, in Mufawada partnership the passive partner bears the loss as well as the active partner. Thus, losses must be distributed equally and it is an unlimited liability partnership. This is equivalent to dealing with a partnership firm. This stands in sharp contrast to the Mudharabah contract where the investor’s liability towards third parties is limited by the original amount he has invested in the partnership. The reason why such a partnership exist is due to the fact that it facilities for the third party an incentive to do business with the partnership. This is because in case of loss if the third party catches a partner he automatically catches the second partner, so the partnership has a judicial personality. If the loss arises from natural circumstances can the third party ask for compensation? Q In cases where the partners invest equal amounts of capital but agree on an unequal distribution of the profits due to greater reputation enjoyed by one of them or they invest unequal amounts while they divide the profits equally the partnership is not considered a Mufawada. The termination of a Mufawada occurs by the mutual consent of the partners, or by the accomplishment of its aim, or by the expiry of its term stipulated in the contract or upon the death or insanity of one of the partners., or if equality in capital lapses. Al-Mafalis partnership This partnership occurs when two merchants buy goods on credit from a third party and sell the goods with a profit, then the two merchants pay the price to the third party. This partnership is rejected by the Shafie and Malikis, and accepted by the Hanfis and Hanblis. For those who permitted such partnership it was due to the fact that approving such a partnership meant the ability to return to business for merchants who lost everything and have nothing but their good reputation. Al-Mafalis partnership introduced the idea of shares. This is because the two merchants forming such a partnership can have different shares in the merchandise which makes the Mafalis partnership in the form of Inan, or they can have equal shares in the merchandise which makes the Mafalis partnership in the form of Mufawada. As for profits in a Mafalis partnership they have to be distributed according to each partner’s share in the investment. This is due to the fact that the entire capital of this particular partnership has been obtained as credit. There is a Mafalis partnership in the form of Inan, and there is a Mafalis partnership in the form of Mufawada. Is it limited liability or unlimited liability? Q Comparison Type of partnership Mudharabah Capital Contribution One partner provides the entire capital Profit Sharing Loss Sharing Termination According to mutual agreement According to capital. Agent losses effort Inan Both partners provide unequal amounts of capital According to mutual agreement According to capital contribution If two partners it ends with the death or insanity of one of them or mutual agreement or unilateral abrogation or apostasy from Islam As in Mudharabah if there are two partners if more partnership can continue Liability to 3rd Party Investor’s liability limited to the amount invested. Agent is not liable. Unlimited several but not joint Mufawada Both partners provide equal amounts of capital Mafalis No pecuniary capital only good reputation Equal for both partners Equal for both partners As in Mudharabah if there are two partners if more partnership can continue. Also termination occurs if equality in capital lapses Unlimited several and joint according to According to each each partner’s partner’s share in the share in the asset asset A liability is said to be joint and several when the creditor may sue one or more of the parties to such liability separately, or all of them together at his option. Islamic Finance 20-2-2010 Murabaha: Murabaha is the sale of a commodity for the price at which the vendor has purchased it, with the addition of a stated profit known to both the vendor and the purchaser. Thus, it is a costplus profit contract. It is important to note that the cost include all the expenses related to the commodity. Another definition of Murabaha is the sale of an object for the price at which it was originally bought by the seller with the addition of some profit. Weather a moveable or immovable object is the subject of a Murabaha contract it is not permissible for the buyer to resell it prior to his actual or constructive possession of the asset. If it is a future price payment then the exact date of delivery should be indicated in the contract. Islamic position towards trade: (It is He Who has made the earth manageable for you, so traverse ye through its tracts and enjoy of the Sustenance which He furnishes: but unto Him is the Resurrection). 67:15 هو الذي جعل لكم االرض ذلوال فامشوا في مناكبها وكلوا من رزقه واليه النشور This verse encourages Muslims to conduct business with ethical control, and it is an auto-control. This is the essence of Islamic capitalism. However, this auto-control disappeared during the enlightenment in Western capitalism. (He knew that (E) sick/diseased will be from you, and others moving (traveling) in the land/Earth wishing/desiring from God's grace/favour/blessing, and others fighting in God's way/path , so read what eased/became flexible from it (what you can). ان ربك يعلم انك تقوم ادنى من ثلثي الليل ونصفه وثلثه وطائفة من الذين معك وهللا يقدر الليل والنهار علم ان لن تحصوه فتاب عليكم فاقرؤوا ماتيسر من القران علم ان سيكون منكم مرضى واخرون يضربون في االرض يبتغون من فضل هللا واخرون يقاتلون في سبيل هللا فاقرؤوا ماتيسر منه واقيموا الصالة واتوا الزكاة واقرضوا هللا قرضا حسنا وماتقدموا النفسكم من خير تجدوه عند هللا هو خيرا واعظم اجرا واستغفروا هللا ان هللا غفور رحيم This verse mentions trade with Jihad. Thus, this verse bestows on merchants a great honor. (O ye who believe! When ye deal with each other, in transactions involving future obligations in a fixed period of time, reduce them to writing Let a scribe write down faithfully as between the parties). 2:282 ياايها الذين امنوا اذا تداينتم بدين الى اجل مسمى فاكتبوه وليكتب بينكم كاتب بالعدل This verse teaches Muslims how to write a contract. There are also many Hadiths encouraging Muslims to do honest trade. The prophet peace be upon him said: “a person who undertakes a journey to earn his livelihood and then returns with it towards his dependents, will be under the shade of Allah’s throne”. In another hadith the prophet said: “a merchant honest in purchase and sale will be among the virtuous in paradise”. As a result of the above quranic verses and Hadiths the Muslim world was able to link the Mediterranean world economy with the Indian Ocean world economy for 1000 years. This was facilitated by the Islamic policy of unhindered trade by sea and land, which was introduced by the Caliph Umar bin Abdul Aziz when he said: (both sea and land belong to Allah and he has subdued them to his servants to seek his bounty in both of them. How then should we intervene between his servants and their means of livelihood). Trade in Islamic capitalism: Islamic capitalism promotes free trade. Trade is given importance and supported by many institutions. The number one institution is pilgrimage which promotes trade. Every Muslim trader must perform Hajj once in his life. ." " ليشهدوا منافع لهم ويذكروا اسم هللا في ايام معلومات على مارزقهم من بهيمة االنعام فكلوا منها واطعموا البائس الفقير:قال تعالى “That they may witness things profitable to them and mention God's Name on days well-known over such beasts of the flocks as He has provided them: "So eat thereof, and feed the wretched poor”. Protection of pilgrimage caravan is the most important symbol of legitimacy. The traditional Islamic policy is free trade and the institution of pilgrimage supports free trade, without imposing taxes. Moreover, pilgrimage is linked to property rights. The reason for such linkage is the fact that accumulation of property is considered legitimate and Islamic, because when an individual accumulates property he will be eligible to perform pilgrimage. So in a way the rite of pilgrimage encourages individuals to accumulate wealth and property so as to be able to perform pilgrimage. Moreover, pilgrimage can be considered as a single centre for meeting all of the merchants. Such fairs cannot be compared with the fairs of champagne, in which Christian traders gathered and their numbers did not exceed 20,000.00. Whereas, in Hajj the number reached 70,000.00 Taxes are not considered a major tool for distribution of income from the rich to the poor. Taxation is at the bottom of the list, because it is considered a disincentive for work. It can be imposed temporarily for defense, and under certain conditions. As a result of this non-quranic taxation became a tradition. Money: To start with Prophet Muhammad discouraged barter and encouraged conducting trade with money. As a result, the demand for money must have increased. Matching this huge demand with an equally great supply was made possible by military conquest. In this way, the huge increase in the demand for money could be matched by an equally dramatic increase in the supply of money. As a result, the West borrowed from the Islamic world a world currency, which helped it to re-monetize its economy. Money as an institution without which long distance trade would be impossible, because if there is no money then the only method of exchange is barter. However, barter necessities a double coincidence of wants. That is to say, what merchant A wants to exchange, should be needed by merchant B, and what merchant B wants to exchange should be needed by merchant A. Also, barter has to be done face to face in the market. However, in a monetized market long distance trade is possible. A merchant can sell his merchandise to a third party and with the money he receives he can travel to another market and purchase from another party other commodities. The rule of law: Throughout history there were two important trades silk and spices. The first was relatively easy because it was conducted on a land route. However, spice trade was more difficult because it has to cross the Indian Ocean. The Europeans discovered a route when Vasco De Gama sailed around the Cape of Good Hope and reached the Malay Archipelago. The Portuguese entered the Indian Ocean with huge warships and floating armadas. In order to counter this threat the Dutch needed large companies to pool capital from a lot of participants in order to accumulate wealth and fight not only the oceans but also the Portuguese and the Spanish. On the other hand, the Muslims did not need any powerful warships, and thus they did not need any powerful companies. In short, the Ottoman Sultan was omnipotent and there was no separation of powers. The reflection of this political system on economy took the form of what can be called “the protopseudo Ottoman socialism”. “proto” because it emerged centuries before Karl Marx and “Pseudo” because it was not based on class conflict but on harmony between the classes. The Ottomans succeeded in establishing harmony among the social classes and thought that thanks to this harmony their state would last. But while trying to impede the rise of the merchant class above the others, they ended up choking their private enterprise. Property rights are essential for the development of any economy and they must be protected, and they can only be protected by the rule of law. The Dutch war of independence financed by the institutions of the Dutch public finance and then the English civil war and the revolution of 1688. These events saved Europe from absolutism, and led to the establishment of the rule of law. The industrial revolution would not have taken place in 1750 if the rule of law did not exist. Cross-cultural borrowing: A lot depends on whether the demand to borrow originates at the top or the bottom of the society and whether the borrowed institution is well understood and accepted by the rank and file. If the demand originates at the bottom and the institution is borrowed through some sort of a democratic pressure, the “transplant effect”, which impedes the efficiency of the borrowed institution in the borrowing society, would be minimized. Elite initiated and imposed institutional borrowing would be less likely to succeed, unless there is a real need for these institutions. Of equal importance is the possibility of a synthesis of the borrowed institution with those that already exist within the institutional matrix of the borrower, B. The more the “transplant effect” is minimized through general acceptance caused by widespread need and the better the synthesis, the greater the potential for success for institutional borrowing. By contrast, commenda, the European version of mudaraba, evolved into the massive incorporated joint-stock companies with hundreds of share holders, each, may be investing modest amounts, but in total, huge sums.51 Why then did joint-stock companies emerge in the West but not in the Islamic world, despite the fact that the mudaraba embodied the most important characteristics of them? The answer lies in the concept of incorporation, a unique contribution of Europe to the history of finance. Origins of this concept can be traced back to the Roman law. A corporation is a community of individuals considered as a fictitious person that has its own distinct legal personality independent of its members. The members may die, or voluntarily withdraw from the partnership by selling their shares, and new members may enter the community, but the corporation continues its independent existence. The debts of the individual members are not the debt of the corporation and the debt of the corporation is not the debt of the members. Third party debts are owed to the corporation not to its members. A person can be a member of various corporations. The fact that the corporation had a life independent of its members or founders contrasts sharply with Islamic enterprises. According to Islamic law, when a partner dies, the whole partnership has to be liquidated and distributed among the heirs. This had several negative consequences: first, enterprises subject to Islamic law had, by definition, short life spans. For, their duration was limited to the life spans of the partners. An untimely death of any of the partners brought with it the death of the enterprise as well. By contrast, western corporations enjoyed perpetual existence.60 Second, the independent existence of a corporation led to massive accumulation of capital in the western firm. This is because the partners could feel secure. Third, theoretically the perpetual existence of the firm facilitated the inflow of capital from third parties as well because there was no fear that the firm would suffer an untimely liquidation. Fourth, thanks to the incorporation, the third parties entered into legally binding contracts only with the corporation whereas under Islamic law they had to enter into such contracts with each and every partner, a situation, which obviously increased the transaction costs. This proved to be a great impediment when outside parties were asked to lend to the company. In the West, loans from them went directly to the corporations but under Islamic law, lenders had to sign contracts with each partner. Consequently, the loan would not exceed the repayment capability of the weakest partner. To sum up, corporate structure and the resulting perpetual and independent existence of the western company directly led to massive accumulation of capital in the firm, contributed both by the founders and outside parties (Kuran, 2003) so that not only the firm but also its capital was perpetuated. What the Islamic world provided to the West and to the world of finance in general were the concepts of limited liability, ability of the passive partners to merge their capital, transfer of the thus merged capital to the agent, the arrangement of the sophisticated relations between the passive partners and the third parties, principles and details of profit and loss sharing, enhancement of entrepreneurship and shares. But in Europe these sophisticated financial techniques borrowed from the Islamic world were then granted, thanks to judicial personality and incorporations, with perpetual life and capital; concepts borne in the complicated and fascinating historical circumstances of the medieval West. Ottoman economic doctrine has been said to rest on three “pillars”: fiscalism, provisionism and traditionalism. According to traditionalism, harmony between the social classes was desired and the expansion of a certain class at the expense of another was deemed undesirable. It is possible that the idea may have been inspired by the Qur’an In any case, whatever the underlying causes, the business class, the social group with the greatest potential for expansion, was carefully contained. This was done by a strict and deliberate policy of price and profit controls. Under these conditions of very narrow margins in the private sector, or even negative rates of real profits, available liquid capital in the economy, naturally, did not flow into the commercial sector. It went instead to the state sector. This is because, profit limitations that prevailed in the private sector, were not applied to government finance. To sum up, if European corporate law was not borrowed by the Ottoman jurists, that may well have been because it was not needed. In the Ottoman economy, where the private sector was consciously constrained and vigorously controlled75, the need for corporations probably simply did not arise. Indeed, to own a powerful company, would have invited the state’s wrath, as painfully experienced by those merchants, celeps, who were made to contribute to the provisioning of Istanbul at administered prices, the narh. Islamic Finance 27-2-2010 The prophet peace be upon him said: “Gold for Gold, equivalent for equivalent; silver for silver, equivalent for equivalent; wheat for wheat, equivalent for equivalent; barely for barley, equivalent for equivalent; salt for salt, equivalent for equivalent; dates for dates equivalent for equivalent; and whoever exceeds or asks for excess, he practiced Riba. Sell gold for silver as you wish if it is hand to hand (prompt delivery) and sell barely for dates as you wish if it is hand to hand” (Sahih Muslim). The wisdom behind this Hadith is not easy to understand. Actually even today some important scholars admit openly they do not really understand it. The reason they do not understand it is because they consider the Hadith from Fiqh perspective and ignore the historical perspective. With this Hadith the prophet clearly makes barter impossible and encourage monetized trade. If they are to barter then they have to do it with total disregard to quality differences. He wanted to see to it that if we want to change product with product then it must be equivalent. This makes barter entirely impractical and impossible to do. From these sayings of the Prophet, and other sayings, the following general rules that govern commodity Riba have been concluded: 1. When trading metal for metal and food for food (e.g. gold for gold or wheat for wheat), two conditions must be fulfilled: (a) the quantitative equality of both objects and (b) prompt delivery 2. When trading metal for metal or food for food of two different kinds (e.g. gold for silver or wheat for barely) one condition should be met: the promptness of delivery (equality is not a required condition). The lecturer agrees that trading metal for metal of two different kinds can take place using an exchange rate. However, as for trading food for food of two different kinds he states that you cannot exchange wheat for barley but you can sell wheat for cash, and then use the cash to buy the barley. 3. When trading metal for food (gold or silver for wheat or barely) neither condition is required. The transaction is fulfilled through free trade. When trading metal for metal of two different kinds an exchange rate is used, and such an exchange rate changes over time and place. This exchange rate is determined by the supply and demand of the market. However, as for trading food for food of two different kinds he states that you cannot exchange wheat for barley but you can sell wheat for cash, and then use the cash to buy the barley. It is reported that the Prophet said to one of his companions, Bilal ibn Rabah, who exchanged two measures of low quality dates for one measure of high quality (dates), “It is exactly Riba. Never do it, but if you want to buy such (high quality) dates you can sell yours for money and then buy the dates you want” (Sahih Muslim). In addition to seeking the advantages of monetary transactions over the less advanced market mechanism of barter transactions, monetary transactions help eliminate the elements of ambiguity related to the process of estimating ‘equivalence’ in the objects traded. Thus, the prophet in this hadith was teaching the companions how to trade like objects using money. The rationale behind the above restrictions seems to lie in discouraging barter transactions in favor of monetary transaction. Moreover, the prohibition of barter is to avoid unjustified enrichment. Thus, real wisdom must be sought in the entirety of the Hadith. In this case, the Prophet peace be upon him applied a hierarchy of restrictions to lead them from barter to monetized trade. In a way, it is revolutionary. Without this the Ummah would not have become the center of world trade. Therefore, the Prophet peace be upon him was catapulting the Ummah from barter to monetized trade. However, in order to achieve this we need to increase the supply of money in the market. So How can this be achieved on the ground? During the time of the Prophet when the bi-metallic system was in use, there were two ways through which you can increase the money supply. Either discover a silver or gold mine, or debase the currency by lowering the content of pure silver or gold in it. However, for the Muslims they were able to increase the money supply through military expansion. This is because the Byzantine Empire had churches in which large amounts of gold were kept. This is the same with the Sassanid Empire whose temples contained large amounts of silver. So the Muslims took the gold and silver and minted it. Thus, monetized trade became possible, and was achieved in two stages: 1. The Muslims accepted the coins of the conquered lands, and considered them valid. In this way, world trade will continue with minimum disruption. 2. When the Muslims began to mint the gold and silver, they kept the content of gold and silver in the coins lower than the content of gold in the byzantine coins and the content of sliver in the Sassanid coins. Thus, they minted a lower value coins because they wanted to dominate world trade. Whenever you issue a new gold or silver coin which has less pure gold or silver in it than the original coins of the Byzantine and Sassanid Empires, then the original coins which have more pure gold and silver would disappear from circulation and people horde it for the bad days. So the less valuable coins dominate the market. This is in line with Gresham’s law, which the Muslims understood 1000 years before it was introduced. Islamic Finance 12-03-2010 “Taxation and institutions of tax collections” The actual tax land imposed by the Islamic empire was by no means limited to Quranic taxes. A whole set of extra Quranic taxes were imposed by the Seljuks and the Ottomans. The extra taxes were legitimized by the argument that the Ottoman Empire was in a continuous warfare against the infidels, and the Sultan had the right to impose these taxes in order to defend the world of Islam. Daman and Qabala: This system was established in the 9th century AD to relieve the state treasury when insufficient tax revenue and little booty from campaigns made it difficult for the government to pay army salaries. Actually the system is not an Islamic invention and has been observed in the Roman and the Sassanid Empires. It provided an indirect system of tax collection. The system was based on dividing the land and each piece of land was assigned to an individual, who took the responsibility of collecting the taxes from the farmers. The sultan granted the right to collect taxes from a certain Muqata’a for a certain period of time to a certain individual. This could be either in the form of a reward for a service, or against a loan to the state, or in order to reconcile an important person to the cause of Islam. During the auction all the interested parties assembled in front of the mosque. A man declared the names of the villages for which the tax amounts were agreed in contracts, while the scribes noted down the villages for which the auction had been completed, and the names of the individuals from among the crowd who had made successful bids. The tax-farmers formed partnerships in order to compete in the auction and agreed to collect the taxes of a specific Muqata’a for a period of four years. The characteristics of this system are as follows: - The tax collection from the entire Egyptian countryside appears to have been organized in this system. The decision as to who should collect the taxes from each tax zone was taken as a result of a competitive auction, with the highest bidder being delegated the authority to collect the taxes. The tax-farmer guaranteed to pay the state the certain sum determined in the auction. The term of the contract was valid for four years. Thus, if the revenue or taxes collected exceeded his total cost (the amount he paid to the treasury plus his operational expenses) the tax-farmer enjoyed a profit. However, if the taxes he collected fell short of the amount he promised to the state in the auction, he suffered a loss. Iltizam System: During the auction all the interested parties assembled in front of the mosque. A man declared the names of the villages for which the tax amounts were agreed in contracts, while the scribes noted down the villages for which the auction had been completed. If the Multezim managed to collect more revenue than his total cost he enjoyed a profit, otherwise he suffered a loss. A Multezim not able to pay the state the promised amount determined by the auction, risked confiscation or imprisonment. The Multizem could lose the Muqata’a at any time if someone else offered to pay a higher amount to the treasury. Over-exploitation of the tax source, extortion, and lack of long term investment were the inevitable undesirable effects of this practice. When a Multizem obtained a tax-farm, in an auction he was given a receipt, which bore at the bottom the name of the tax-farm. The tax-farmer then had to obtain a guarantor, Kefil, who set down on the receipt his agreement to compensate the treasury should the Multizem fail to meet his obligations. The Multizem then took the receipt to the appropriate scribe of the treasury, who set down at the top a complete description of the tax-farm, all those having a share in its auction price and the total amount of tax owed annually to the treasury. The need for these Kefils arose from the fact that the tax-farmers could not pay the auction price in bulk and in advance. They paid the state, instead a part of the promised amount and paid the rest in installments. The Kefalah system was introduced in order to ensure some degree of reliability for the payment of these installments. There were two types of Kafils, the so-called Kefil bil Mal, surety in wealth, and Kefil bil Nafs surety in person. The former guaranteed to the state the payment of a certain part of the auction price. The liability of the Kefil was limited to the amount guaranteed to the state. The latter, on the other hand guaranteed to the state that in the case the tax-farmer went bankrupt and disappeared, he personally would hand him over to the authorities. It is quite possible that the Kefil actually paid this amount to the tax-farmer who paid it to the state. This amount must have constituted the partnership capital between one of the principals (Kefil/Rabul Mal) and the tax-farmer (Mudharib). Moreover, since the liability of the Kefil/Rabul Mal to the third party, in this case to the state, was limited this was a Mudrabah arrangement. Thus, the amount that was above the limit guaranteed by the Kefil Rabul Mal was the responsibility of the tax-farmer whose liability to the state was unlimited. In the case of the tax-farmer failing to pay the installments, the state first tried to get the tax-farmer to meet his obligations, and only in cases where he could not be located did it return to the Kefil and demand that he meet his obligations. Inan partnership can also play a role in Iltizam system. This can be done when a number of tax-farmers pool their funds together to get hold of one tax-farm. In this case, the partners use their own funds and at the same time work together in managing the tax-farm. In this case, their liability to third parties can be undertaken jointly in proportion to their share of liability assigned to them in the partnership contract. The decision as to who would collect the taxes from each Iqta’ was taken in the form of a competitive auction, and the highest bidder obtained the right to collect taxes from the tax source the Muqata’a. The term of the contract was limited to 4 years. The tax-farmers, who bid in the auction, were risk taking entrepreneurs, who pledged to pay to the state a fixed amount in cash and expected to recuperate their investment by collecting the taxes from the tax source the Muqata’a. If the total amount of taxes they collected exceeded what they paid to the state they made a profit, otherwise they suffer a loss. The risk taken by the tax-farmers can be seen in the fact that the tax-farmer commits to pay a certain amount to the state, and if he cannot collect such an amount he has to pay from his own money. Moreover, if a Multazim was not able to pay the state the promised amount he risked confiscation of the land and imprisonment. As for the risk of the state it can be seen in the fact that it is committed to pay fixed amounts of money in the form of salaries to the military from the collected taxes. Thus, we can notice that the uncertainty is shared by both the tax-farmers and the state. Based on this the jurists did not object to the system because the risks are shared between the two parties, the taxfarmers and the state. This resulted in the spread of the system to the extent that under the Ottomans about 80% of the revenues of Egypt were collected through this system. Shortcomings of the Iltizam System: First: the tenure of the tax-farmer was unreliable. This is because the state had the right to transfer the tax-farm to another tax-farmer who offered to pay a higher amount at any time. This had undesirable consequences, because the tax-farmer wanted to maximize his revenue collection as quickly as possible. This in turn led to the over-exploitation of the tax source the Muqata’a. Second: the system was loaded with risks for both the tax-farmer and the state. When the stae became risk averse, it tended to transfer the risks toi the tax-farmer. This reduced the earnings of the state from the Muqata’a tax-sources to a bare minimum and allowed the risk taking Multazem to reap the real benefits. Thirdly: Iltizam was slow in generating revenue. By the early 1690s the Ottomans were involved in a fierce struggle, and they needed more revenue. The solution was found in a major institutional reform, which took the form of a new system called the Malikane. Malikane system: Under the Malikane system the Muqta’a was now auctioned off not for a few years but for the entire life span of the tax-farmer. Moreover, under this system the Malikaneci made two different types of payments to the state. First, the Muccala معجل, which is a lump sum and usually a very large amount determined in public auctions, and the annuities which were fixed by the state and paid regularly every year. The Muccala could not go below a minimum amount fixed by the state. This minimum amount was calculated by the state as two to ten times the annual average estimated profit of the tax-source. These minimum amounts were displayed at the doors of the finance ministry. The candidates then came and registered the actual Muccala amounts they were prepared to pay. Thus, bidding up the minimum amount calculated by the state in the process. Thus, the highest bidder obtained the tax-source for his life time. This person, Malikaneci was then given a document, berat, confirming his rights over the Muqata’a. Moreover, the Malikaneci was permitted to sell his Malikane as he wished, and after 1735, such sales were subjected to a tax equal to 10% of the original Muccala. The Malikane system expanded throughout the Ottoman heart-land, and remained in force for a long time. This system should be considered as a form of domestic borrowing from the state. As larger and larger tax-sources were auctioned off by the state, it became necessary to sell these tax-sources in shares. Thus, the Malikane system gradually assumed a quasi-joint stock character. With the introduction of the Malikaneci system the risk averseness of the state was complete. This is because the Muccala payment can be described as a Kefalah for the regular payment of the annuities. If the Malikaneci failed to pay these annuities, he would risk losing the entire tax farm and with the Muccala. Moreover, for the first time in Ottoman history a member of the Askeri class could enjoy during, and for the extent of his life-time, something that was akin to private property. He could reap all the benefits of the tax-source that he was controlling. Thus, if the stream of earnings for the rest of his remaining life exceeded his total payments to the state he made a profit, otherwise he suffered a loss. Moreover, the security of the tenure in the Malikane system played a significant role in the adoption and acceptance of the new system by the askeri class. In addition, the malikaneci could obtain the shares of various malikanes and thus forming a portfolio that could keep his wealth largely intact even after his retirement and still enjoy a regular income. Thus, the growing risk aversness of the state, enormous budget deficits, and the willingness of the askeri class to accept the new system made it very popular. In Iltizam in times of depression many tax-farms remained unsold and the state ended up managing these with salaried officials. Moreover, there was the so-called arrears problem, which refers to the unpaid debts of the tax-farmers. Both of these problems were solved under the Malikane system. The former was solved by selling the tax-source on a life-term basis. The latter was also solved because if a Malikaneci failed to pay his annuities then he risked his entire Malikane for which he had already paid a very large Muccala. The Malikaneci lived in major urban centers and entrusted the management of their tax-farms to local managers. This led to a system of sub-tax farming. Moreover, in doing so, the Malikaneci resorted to former Iltizam managers to manage the affairs of their tax-source. They did this by organizing a limited auction, in which they auctioned their tax-farms and the entrepreneur or Multazim who pledged to pay the highest amount became the new manager for the Malikaneci. Thus, the former Iltizam system did not disappear and simply continued at a lower level. The system had several achievements the first one is a drastic increase in the revenues of the state. The second is the protection of the tax source from over exploitation. The third is the emergence of private property. The fourth is the reliability of tax collection. The system continued to expand albeit with a fall in the auction prices. This was a normal reaction on the part of the Malikaneci who felt they were facing higher risks. The expansion of the system continued till 1775, when the new system Esham was introduced. Esham System: Whereas, in the former system the entire revenue of a tax source was sold off to a Malikaneci for his life-term, subject to the regular payments of Mal and Muccala, in the latter only the annual profit of the tax-source was sold off for a life term. Moreover, this sale of the annual expected profit of the taxsource was realized in shares, hence the name Esham. Assume tax-source generated gross annual revenue of 35,000 gurus in a single year. In the same year this Muqata’a had to spend 20,000 gurus for operational expenses. Thus, the tax-source will yield an annual profit of 15,000 gurus. Its annual profit would be divided into a certain number of shares, let us say 100. In this case each share would represent an annual profit of 150 gurus. Thus, this annual profit will be sold in cash for a lump sum payment Muccala. Let us assume further that each share was sold for five times its estimated annual profit 750 gurus. By paying this amount of 750 to the state the investor had actually bought one full share. This would result in him receiving 150 gurus annually by the state. Moreover, these payments would continue for as long as he lived. Upon the death of the holder the share would revert back to the state which would then re-sell it to another investor. The Esham system was introduced in 1775, when the Ottomans were forced to pay war indemnity amounting to 7.5 Million Grus to the Russians. Thus, they had to find a new system which can yield high revenue in short time. In the Esham system the annual revenue is divided into shares, which are then sold to the public. The first tax farm to implement such a system was the Tobacco tax-farm of Istanbul, which yielded great revenue to the government. This tax farm has already been sold on life time basis to a group of Malikanecis. So they paid them back their Muccala and the government took back the farm. By applying this system the management will be done by the state, and the annual profits will be divided and be sold as shares on life-term basis. Thus, the annual profit of this tax-farm which amounted to 400,000.00 gurus was divided into 160 shares, with each share representing 2500 gurus of profit. The price for each share was determined as 12,500 gurus. Thus, the treasury managed to gain 2 million gurus from this particular tax-farm. Each share comes with a Berat, which is attached to the share and registered the share to a specific person. Both the shares with Berat and without Berat were not usurious because they are not structured as loans. In this case, the borrower was the government and it was not obliged to redeem the Esham shares, and because there was no obligation they were not considered loans. The instrument became usurious after 1800s because the government was not trusted to pay the annuities, and the government took the responsibility to redeem them or guarantee its redemption. The government was not able to sell the shares so they started guaranteeing their redemption. Esham was not usurious because Riba constitutes the following: - Excess or surplus over the loan capital to be returned to the lender. - The surplus should be related in time with a definite date of redemption. - All of this must be in the loan agreement. In the Esham system all three conditions did not apply. Uncertainty pertaining to the life span of the shareholder eliminated the first two conditions and there was no loan agreement to speak of. Moreover, there was no obligation on the part of the state to redeem Esham. It was also permitted for the holder of the share to sell it to another investor. This permission naturally lengthened the payment period for the state. Having realized this, the state soon imposed a tax at the rate of 10% of the Muccala on transactions of shares between the investors. When a person buys a share he actually buys a paper stating the amount paid Muccala, and the annual rate of return. When the shareholder actually paid in his Muccala to the cashier of the fiancé ministry, he was issued an invoice. The purchaser then went with this invoice to the berat office where he was given a statement to the effect that the share was his property. Thus, the share became a registered share only upon the issuance of a berat. During the time of war, the berat office had to move to the front. Thus, it was not possible to issue berats to those purchasers who continued to buy shares during the war. Meanwhile, the shares without their accompanying berats, began to circulate. The tax, for instance, which was charged upon the sale of a share to another person, could be avoided. When insufficient cash could not be found for this purpose, shares were offered to the sarrafs who accepted them only on the condition that they should be issued without the accompanying berats. When the state was forced to accept this condition, bearers’ shares were officially endorsed. The new system evolved from the Malikane system. However, the element of securitization was the essential characteristic of Esham. Such a characteristic had a very long history. The idea of securitization can be traced back to the 7th century in the world of Islam. The first example refers to the circulation of IOU documents based on agricultural produce during the time of Marwan Bin Al-Hakam. The second instance of securitization dates back to the 8th century, and refers to similar documents called Sukuk. They were based on crops to be harvested from certain lands. The merchants, who had purchased these crops still on the field, obtained IOUs from the peasants. These merchants wanted to sell their IOUs to third parties, and they ask Said bin Al-Musaib about the permissibility of such a transaction. Said bin AlMusaib did not object to this transaction on the condition that the crop should be first harvested, so that the Gharar element can be eliminated. Equally important, is the condition of actually possessing the asset and then transferring its ownership still constitutes one of the most important aspects of modern Islamic finance. It can be stated that the Esham system was inspired by a Medieval European instrument, which is the permanently funded public debt. And despite this assumption the former can still be considered Shari’ah based. Rente contract was based on the Carolingian census contract that many monasteries had long utilized in order to acquire bequests of lands, on condition that the donor receive an annual usufruct income from the land, in kind or money, for the rest of his life and sometimes for the lives of his heirs. The census evolved into two related financial contracts. The older of the two, provided for the sale of real estate or some form of fixed property in return for a perpetual annual income. The other form which is more relevant to the history of public finance is a contract by which the property holder sold for a specified sum, the right to receive a fixed annual income from his property or other real assets while retaining the ownership of the property. In 1204 Venice and Genoa were able to take control of Constantinople because they were able to mobilize funds through this instrument. The Dominican theologians argued that the uncertainty of the buyer’s death, made the return of the rente uncertain, and thus, the contract was not usurious. Pope Innocent IV declared that the annuities were legitimate contracts and not usurious providing that the annual payments were based on real assets. And in 1416 the council of Constance ruled that rentes were licit, and that the seller had the right to redeem them, provided that the amount equaled at least the nominal purchase value. Finally three papal bulls overcame any remaining moral and legal doubts regarding these contracts and they declared them licit provided that three conditions are fulfilled. Three conditions for the permissibility of Rentes: 1. The contract must be linked to real assets. 2. The annual payments do not exceed 10% of the capital. 3. The issuing authority and not the purchaser has an unrestricted right of redemption. In the 17th century another confirmation came from the Leuven theologian Lessius who said: “Where there is no loan, there is no usury”. The principle governing the theological discussion was that anyone who purchased a rente was denied the right to demand repayment of the principal sum, so long as the seller honored the obligation to make the annual annuity payments for which he had pledged all of his assets. Thus, a holder who wished to regain some or the entire principal had to find a third party willing to buy the rente at a discount. Furthermore, counts also used this instrument to raise public funds from the sale of renten secured against aides and other payments received from the towns. These counts chose however to have the municipal governments sell the renten on their behalf for two reasons: first, because they had already established effective market procedures, with a reliable corps of financial agents. Second, few medieval princes could be trusted to pay annuities for a long period to a mere money-lender. The first feature of this institution is the time dimension. Although domestic borrowing can be observed in Italian city states as early as the 13th century a similar system was introduced into the Ottoman economy only at the end of the 18th century. Actually there is no explanation for this delay. This meant that the European states were able to borrow from their public huge funds at very low cost since the 13th century in a quasi democratic cities such as the cities of Northern France, Flanders, and Tuscany. The second feature is the fact that the debt was permanent in that it constituted of perpetual annuities from the government to the holders. Moreover, the debt was redeemable any time at the discretion of the issuing authority. That is to say the issuing authority usually the state or the municipal authority could redeem them when it suited them. This is in sharp contrast to ordinary loans with stipulated fixed redemption dates. Thirdly, the obligation was national, which means it was a personal obligation of the state. Fourthly, the annual payments on such annuities and their redemptions were authorized by that parliament, which undertook to fund the obligation by levying specific taxes, usually on consumption. Fifthly, the sale of these annuities occurred without any coercion on the part of the state. Members of the public purchased these annuity yielding instruments voluntarily. Sixthly, the state was able to give the public the confidence that it would always honor its obligation of paying the annuities on time. Seventhly, annuities were freely negotiable through financial intermediaries in secondary markets for purchase by any buyer both inside and outside national boundaries. Islamic Finance 19-03-2010 In France as long as the annuities were paid regularly, it traded between par and 75%. However, when it fails to pay the annuities, the purchasers demanded a discount of 50%. This instrument was most successful in the countries where the rule of law prevailed and the state has to be trustworthy. The success of the rente was also due to the opening of the Antwerp stock exchange. In Flanders the rentes took two forms: - Erfelijke Rente: the traditional perpetual hereditary rent. - Lijf Rente: extinguished upon the death of the holder. The annual payments on single-life rentes were always higher than and sometimes twice as high as those on perpetual or hereditary rentes, perhaps because the latter, being assignable, proved to be more marketable. When this instrument became popular, its price would increase and the yield would decrease as a result of this. In the 13th century the yield was 12.5% it fell to 10% or even 8% in the 15 th century. In fact, during the 14th and 15th centuries the rate of these annuities was as low as 5% to 3%. This reflected the popularity of the instrument. In England, they consolidated all of their debts in the middle of the 18th century and they issued a new instrument called “Consol”, which is short for consolidated annuity. It was fully transferable, negotiable, and redeemable at the convenience of the state. The public kept buying these instruments because it was to their advantage, since they kept taking their annuities. As for the government the cost of borrowing went down from 100% in the 11th century to 3% in the 18th century. In short, the medieval prohibition of usury has promoted rather than retarded longterm European growth. At the same time England was able to borrow 24 million sterling, Spain 6 million, and France 16 million, the Ottomans were only able to raise 5 million pound sterling only. Waqf: The founder of Waqf can provide capital and in return the scholar produces knowledge that becomes a reward, which is shared between the scholar and the founder of Waqf. Thus, it is Mudharabah. Producing the wrong knowledge is a risk. Also, getting non-Halal money from the founder is another risk. There are several conditions for Waqf such as: - What is endowed must be privately owned - It should be endowed in perpetuity - It should generate revenue in perpetuity. - The revenue is split into two parts: Asl Al-Mal, and Manfa’a Asl Al-Mal is the original capital that is the one which is endowed, and cannot be touched. It must generate revenue without getting reduced, and it continues to generate usufruct for the centuries to come, and that usufruct must be used for the purpose for which the Waqf was established. As long as the Waqf is left in peace, it can provide health and education and other services, and that is human capital, which is one of the most important components in economic development. The Christians borrowed the system of Waqf from the Muslims during the 3rd crusade. De Merton took the system to England and established the Merton college of Oxford. This was proven by Gaudiosi who studied the endowment deed and discovered that there was no such thing as perpetuity in Roman system. She found a perfect match between the endowment deed of Oxford and Islamic endowment deed. Cambridge was established in the same format of Islamic endowment. When the state becomes desperate, it will confiscate the property of Waqf. The confiscated Waqf property will be the end of the Sultan. The next Sultan will restore the Waqf again. It is a cycle of confiscation and restoration. But in the 19th and 20th centuries the cycle of confiscation was not reversed and the institution was killed. Islamic Finance 27-03-2010 Characteristics of Waqf Irrevocability: It is the most important feature of waqf, although Imam Abu Hanifah agreed that the founder of the waqf has the right to return the waqf property to his ownership and he can also sell it. There is a consensus among the Muslim jurists that the founder cannot revoke the dedication if the property has already been declared as waqf. This means that a waqf is irrevocable once a founder declares his property as waqf, and his/her heirs cannot change its status. Perpetually: It is the perpetuity of the waqf once it is created. The majority of the Muslims jurists believe that the waqf must be perpetual once it is created. This, on the one hand will ensure that no confiscation of waqf property will take place either by the government or by individuals. And on the other, it will ensure regular and continual support from the waqf property towards financing charitable matters. Inalienability of waqf once it is created. This feature originates as the property of waqf is transferred to Allah (s.w.t), although the usufruct derived from it can benefit man, all jurists agree that no one can ever become the owner to alienate it and that waqf property is thus in nature, like a ‘frozen asset’. It cannot be the subject of any sale, disposition, mortgage, gift, inheritance. Waqf Khayri (public waqf) is an endowment made by the founder to support the general good and welfare of the poor and the needy in society. Usually the founders created such waqf in the form of buildings such as mosques, schools, hospitals, orphanage-houses, guest-houses and providing basic infrastructure, or dedicating books, enclosing lands for use as cemeteries, dug-wells, etc. thus, if the revenue generated is spend entirely on charity such a Waqf would be known as Waqf Khayri. Al-Waqf al-Dhurri, Alwaqf al-ahli and waqf ala-wlad are all the same and refer to family waqf. In this case, the founder endows his property to his children, grandchildren, relatives or to other persons whom he specifies. If the beneficiaries by the founder are no longer alive, then only in this case will the waqf property be given for public welfare purposes. If the revenue is spent for family members of the founders, such a Waqf would be known as Waqf Ahli or Khas. The sharp distinction between the two is a western concept. The westerners invented it to destroy the Waqf system. Whereas, Islamic law considers every family Waqf as a potential Khayri Waqf and treats it as a legitimate potential Ahli waqf as long as the family descendants survive, but if the family members die, then it will become a Khyari Waqf. Al-waqf al-mushtarak (combined public and family waqf) is a waqf created by a founder to support both the public and his family, i.e. the founder dedicates a part of his property to his family and another part to the public. Real Estate Waqf: traditional real estate Waqfs functioned in a simple manner. They were either endowed in urban areas, where their corpus would be in the form of residential buildings, shops, houses, or other rent yielding urban property, or in rural areas in which case their corpus would be in the form of cultivable land. In the latter case, the land in question would be managed through share- cropping with a certain share of the produce going to the land owning Waqf and the rest to the peasants. The property could be destroyed but the solution was found in Ijaratyin (Read the book). Cash Waqf: when a waqf is established with cash capital, it is called cash waqf. Such a waqf is managed by investing its capital and channeling the returns to charity. Such waqfs can be traced back to the time of Zufar Fatwa which permitted the endowment of cash as waqf on the condition that the endowed cash is invested through Mudharabah. The position of the Hanafi School on Waqf (Read the book) In bursa alone there were 761 cash waqf during the 18th century, so it became very popular and led to the creation of a controversy. Imam Abu Yusuf and Imam Muhammad Al-Shaybani both of them approved the waqf of moveables. The only point at which they differ is that whereas Abu Yusuf approves of them subject to custom, Muhammad’s approval is subject to custom prevailing at his own time and country and subject to custom that may emerge after his time and in any other land. A wealthy individual declares his intention to establish a cash waqf once permitted he makes a cash endowment. It should be noted that only the right to utilize the waqf capital was distributed to the borrowers not the ownership of the capital. The original capital of the Waqf was protected by hefty collateral. Once the borrower gets the loan from the Waqf, the borrower will sale his house to the waqf and starts paying rent for the house. He continues to pay rent for one year, and at the end of the year he returns the loan and gets his house back. Thus, this is a form of sale-lease- and repurchase agreement similar to the mechanism applied in Sukuk Ijarah. The collected rent will be used to cover management expenses, and will also be used for the original purpose of the Waqf. Islamic Finance 3/4/2010 Incorporated Cash Waqf Waqf of stocks These traditional cash waqfs have been modernized. Thus, their traditional weakness has been eliminated. The 20th century Fatwa in Cairo and Karbla (Read the book) A Waqf of stocks or incorporated cash Waqf is established when a wealthy individual endows his shares for a charity. These shares belong to a multitude of companies. In this case, the dividend generated by the endowed shares is the main source of revenue for the Waqf. A portion of this revenue will be used for the original purpose of Waqf, while another portion can be used in property investment or some other investment activities. Finally, another portion will be put in an emergency fund. This fund will be used when capital enhancement takes place for the companies to whom the endowed shares belong. This is to maintain their percentage in the company’s shares at a constant level. The losses that are made by some of the companies will be compensated by the profits of the others. In any case, since the companies are managed professionally, a loss making manager cannot stay on and would be replaced. Thus, under normal circumstances the Waqf of stocks would regularly and continuously receive dividends from the companies whose shares it possesses. As a result of this East-West synthesis, the Ottomans cash waqfs have been tremendously transferred and improved. First of all, the Zufar condition that the corpus should be invested through Mudharaba, a condition which could not be applied in the past became a reality. This is because Mudharaba is practically identical to equity investment. Second, the Waqf of stocks enjoying the dividends and is no more obliged to lend its corpus as credit as was the case in the traditional cash waqf. In other words, the Waqf of stocks is not obliged to invest its corpus to generate revenue but it became a passive recipient of the profits generated by the associated companies. Third, the problem of Riba completely disappeared. This is because the Waqf of stocks earns its revenue not by lending its capital, but by the profits generated by the firms whose stocks it owns. The nature of profit has also changed, when profits are based not on credit-riba transactions, as was the case with traditional cash waqf, but on actual production of the partner firms. Fourth, the information asymmetry problem is also solved. That is to say, once the endowment is invested in some joint stock companies by purchasing their shares, the responsibility of investing this capital further is transferred to the mangers of these companies. It is no longer governed by the decisions of the founder taken centuries ago. The will of the founder however, still prevails in that the trustee of the Waqf of stocks obeys his directives in spending the revenue of the Waqf. Fifth, the waqf of stocks permit multiple endowments to be pooled. The latest research has shown that the new Turkish waqf of stocks has an average of 35 founders. Thus, a whole number of people may be persuaded to create endowments and to pool them in one major foundation. This can be done by several individuals who can pool their capital, they then can entrust this capital to a Waqf. The trustee of this Waqf is responsible for generating revenue, which is usually done by selling services such as health and education. Information asymmetry in Cash Waqf: the founder who establishes Waqf has the power, but no information, whereas the present Mutawli has information but no power. Details of the Waqf law of 1967 in Turkey (Read the book) Johor Corporation: is a market-driven Johor State Government-linked Corporation. It is to date one of Malaysia’s leading business conglomerates, comprising more than 280 member companies and employing more than 60,000 employees in Malaysia as well as regionally. It was established in 1968 by a special decree. The enactment states that the institution is a body incorporate. Thus, the Johor Corporation is a truly corporate body in the Western sense. It has been possible to design it as a corporate body with judicial personality because Islamic law also recognizes this concept and does not object to it. Johor Corporation established a corporate Waqf which is called An-Nur Corporation Berhad. Johor Corporation transferred into it 75 percent of its equity stake in a private limited company, namely Tiram Travel Sdn Bhd. This “Corporate Waqaf” also involved the transfer to Waqaf of RM200 million (on Net Asset Value basis) of Johor Corporation shareholdings in its public listed subsidiaries involving 12.35 million share units (i.e. 4.68% of shares issued) in Kulim (Malaysia) Berhad, 18.60 million shares (9.25%) in KPJ Healthcare Berhad and 4.32 million shares (3.57%) in Johor Land Berhad. Johor Corporation had also endowed 61% of its shares in TPM Management Sdn Bhd (at NTA value of RM50.33 million then) that brought the total amount value of shares being endowed by Johor Corporation under Corporate Waqaf to exceed RM258 million on net asset value basis. All in all the corporate waqf has received shares from six companies under the Johor Corporation. Thus, the main source of revenue for the corporate waqf comes from the dividends of the six companies whose portions of their shares were endowed. 70% of the profit yielded by these companies will belong to the Johor Corporation. The remaining 25% to the Waqf, and the remaining 5% to the Majlis Agama Islam of Johor. The purpose of An-Nur Corporate Waqf is focused in four areas: - The microfinance of women who are trained to market semi-finished food stuff. The women will receive interest-free loans from the Waqf fund. Then they will market the food stuff which are produced by a member corporation. The food company will guarantee the return of the interest-free loans to the Waqf fund. - Building of Mosques. - Building of clinics. Islamic Finance 10-04-2010 Venture Capital Venture capital is a highly dynamic financial system that has successfully introduced the most advanced technology, provided tens of thousands of new jobs, and created massive export potential, first for the American economy, and now increasingly for Europe and India. The American venture capital industry is currently manging 257 billion up from 64 billion in 1997. Over the next five years the American venture capital funds plan to increase their commitments in the emerging markets. Asia is expected to receive 70% of the venture capital investments in these markets. Malaysian Islamic Capital Market believes that Islamic venture capital will be the distinguishing factor that differentiates Malaysian from other emerging markets. After WWII a French officer, general Doriot, who was teaching at Harvard established in 1946 the American research and development company. This was the first venture capital company. It invested 70,000.00 USD in 1957 to buy 71% of the common stock of a new company, the DEC, which was created by four MIT students. When financing Fed Ex, venture capitalists lost one million per month for 29 months. But when Fed Ex went public, the 25 million USD that the venture capitalists had invested was worth 1.2 billion USD. Venture capital is a high risk gain investment. It can also be defined as a large probability of a small loss combined with a small probability of a fantastic gain. The MacMillan Gap In the conventional venture capital the limited partners will provide capital in the form of equity finance by buying shares of the companies they support in return for an amount of profit proportional to their stake in these companies. In this system the limited partners are passive partners and the venture capital company acts as their agent. The limited partners will gain 80% of the profit, while the venture capital company will get the remaining 20%. As for the entrepreneur he will get profits in relation to the number of shares he owns in his own company. The process starts with an entrepreneur with a very promising project who applies to the venture capital company. In any given year up to 1000 entrepreneurs apply for funding from the venture capital company, and then there is ruthless process of selection called due diligence. Through this process nine out of 10 applicants are rejected, and 1000 are referred to senior management of the VC Company. Out of the 1000 applicants 400 are selected and they visit each one of them to conduct personal interviews, and they end up making 10-20 investments a year. Just like Mudharaba where profit is distributed according to mutual agreement, the venture capital company agrees with the entrepreneur on the number of shares to be bought. Thus, venture capital enables the entrepreneur to succeed, and this success will be reflected in the share value of the company. The process of selling the shares of a company which is unknown is called IPO offering “initial public offering”. When the company is registered the shares can be sold at a very high price. Islamic venture capital model (get the model from someone) There are several limited partners such as private investors and corporations, Tabung Haji, Islamic banks, university endowments, Waqf. In the case of loss, the venture capital company will shoulder the pecuniary loss if its agreement with the entrepreneur is based on Mudharaba and the entrepreneur did not invest any money in his company. However, if he has invested a certain amount of money in his company then both the venture capital company and the entrepreneur will share the losses according to their capital contribution in accordance with the Inan type of partnership. As for profits it will shared according to mutual agreement whether the partnership is based on Mudharbah or Inan. If Waqf was to participate in such venture capital company, then there is the risk of the Waqf losing its money in the case of loss, and as we know Waqf is suppose to protect its money and not participate in risky ventures. This dilemma has been solved in Jordan through the issuance of Muqarada bonds which are guaranteed by third party in this case the government. Thus, the venture capital company can issue such bonds without assuming any liability to compensate the holders of such bonds, and the Waqf institutions can participate by buying these bonds which are guaranteed free of charge by the government in the case the venture capital company suffers an unexpected loss. Thus, it can be said that the overall arrangement in Islamic venture capital can be described as a multiple two-tier Mudharaba. Thus, this format can be considered as a Shariah based structure and not Shariah compliant structure for the following reasons: - The venture capital model is based on Mudharaba or inan. - Mudharaba and Inan are Shariah based contracts. - There is neither interest nor collateral in the venture capital structure. - It is a purely profit and loss sharing system. - Profit is shared according to mutual agreement. It is expressed in the number of shares. - Pecuniary losses are shouldered by the venture capitalist alone in the case of Mudharaba, and proportionally in the case of Inan. - The venture capital company is established for a limited period of 10 years. Thus, it is a partnership in the classical Islamic sense. - The risks are truly shared. - The Islamic law does not put a limit on the number of shares bought by the venture capital company. Any increase in the value of the shares of the entrepreneur’s company will be reflected in the value of the shares of the venture capital company. Everything in the venture capital structure is based on the idea of a joint stock company. The entrepreneur will establish a joint stock company and incorporate it. And the venture capital company itself is a joint stock company. The concept of a joint stock company constitutes a synthesis of classical Mudharaba and Inan. All the shareholders of a company are considered as Rabul-Mal, and some of them may act as directors, so they can form an Inan partnership between them and the shareholders. However, if the directors do not own any shares in the company, then they can for a Mudharaba partnership with the shareholders of the company. The permissibility of the joint stock company is based on Qiyas and public interest. Malaysia established a venture capital state company financed by the tax payers’ money. In fact, the state is not in a position to establish a venture capital company in the form of a state run enterprise. However, the state can prepare the conditions for a flourishing venture capital system. In addition, venture capital companies do not require a large paid-up capital. This is because the founders of the company alone shoulder the risk of failure. Finally, a government can match the funds raised by a venture capital company, so that the government takes control of 49% of the shares, while the venture capital company takes control of 51% of the shares. Furthermore, capital gain tax should be reduced to the bare minimum. Also, we can add that there is no real need to insert a Shariah board in every venture capital company. This is because the structure applied by the venture capital company is Shariah based and is already approved by the Shariah. Instead, the government should publish certain guidelines to govern the practices of the venture capital company. High net worth Muslim individuals started to invest in equity finance venture capital companies in the Gulf region. As a result, an ever increasing percentage of the 1.5 trillion liquidity is being directed at private equity funds, which are based on the structure of venture capital.