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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
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
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
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
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
Type of
One partner
provides the
entire capital
Profit Sharing
Loss Sharing
According to
According to
capital. Agent
losses effort
Both partners
amounts of
According to
According to
If two
partners it
ends with the
death or
insanity of
one of them
or mutual
agreement or
abrogation or
from Islam
As in
if there are
two partners
if more
can continue
Liability to 3rd
limited to the
Agent is not
several but
not joint
Both partners
provide equal
amounts of
No pecuniary
capital only
Equal for
both partners
Equal for
both partners
As in
if there are
two partners
if more
can continue.
occurs if
equality in
capital lapses
several and
according to
According to
share in the
share in the
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 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
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
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
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.
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
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
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
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
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
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
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 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
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.
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
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
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
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
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
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.