Many Muslims possessing financial resources are confronted with the question of how to safeguard their money while remaining faithful to the principles of Islamic financing. Islam forbids money hoarding because hoarding money means preventing it from achieving its intended objectives and negates its function as a viable tool for development. Hoarding money is also prohibited on the ground that it obstructs the Muslim population from realising socio-economic justice among its members- “those who hoard up gold and silver and do not spend it in the way of Allah, give them the tidings of a painful punishment” (Qur’an 9:43). The logical alternative to hoarding is investing and investment could be realised through having a range of opportunities.
Money can be passively invested in commercial banks to earn fixed interest This form of investment is deemed unlawful, hence condemned and prohibited in Islam. Investments could also take the form of investing in the stock market, real estate, and import/export and in many other alternatives. This line of investments involves productive as well as unproductive or even destructive business activities. Islam sanctions only productive business activities, which abide by the rules of the Shari’a and preserve Islamic values.
The Islamic alternative to hoarding is spending in the way of Allah, which includes investing in business activities that are moral, productive and socially desirable. The Muslim investor, therefore, is encouraged to start a business of his/her own or enter into a partnership agreement with a potential entrepreneur to create a new business entity. It is important to appreciate that not every individual Muslim with extra money to invest possesses the qualities, traits and personality to be an entrepreneur. Thus, the comprehensibility of the Islamic financial system accommodates such situations by allowing the investor to have a share in the business venture through a partnership arrangement with the potential entrepreneur who does not have the financial resources to start his/her business. This concept of partnership is best understood within the Islamic financial arrangements of musharaka and mudaraba (direct partnership with the entrepreneur or through an Islamic financial institution). Such an arrangement ensures that the potential entrepreneur will not start the business disadvantaged with a heavy interest burden added to the initial borrowing which has to be repaid regardless of the outcome of the business venture.
While capitalism considers money to be capital, Islam argues that capital is the portion of wealth that is used in productive work. Money is a measure of value and a means of exchange, and it is not a commodity for speculation. Thus it remains potential capital until it is invested in a productive economic activity together with other means of production (land, labour and entrepreneurship). Accordingly, Islamic banking plays a crucial role in economic development by transforming money into capital through the act and the process of entrepreneurship. Both Islamic and classical economics consider capital to be a factor of production along with land, labour and entrepreneurship, but they differ in their view of profit generated by capital as an outcome of the production process. While classical economics accepts interest as capital’s share of income, Islamic economics defines capital’s share of income in terms of profit/ loss generated by capital through the act of partnership, i.e. profit-loss sharing (PLS) between the financer and the entrepreneur.
Islamic banking through the mudaraba and musharaka instruments is preferentially situated to play a positive role in advancing the cause of Islamic entrepreneurship, where financial capital is combined with human capital to create new business entities. Islamic banking provides current and potential entrepreneurs with needed halal capital to start/expand their businesses. It also provides them with protection against risk and uncertainty by spreading the risk between the entrepreneur and the investor through partnership arrangements. The expertise of the bank team under musharaka will encourage entrepreneurs to engage in more innovative and original business undertakings. Quality entrepreneurship would also be promoted as entrepreneurs compete to take advantage of available financial capital, financial suppliers will have the opportunity to evaluate entrepreneurs’ proposals and business plans and to enter into partnership contracts where prospects seem promising.
The most common Islamic models of finance are qard al-Hasan (benevolent or good loan), murabaha (cost plus financing), mudaraba (silent partnership) and musharaka (partnership financing). Qard al-Hasan is an interest-free loan to be repaid at the amount of borrowed principal. This form of Islamic financing does not bear interest and does not forge a business relation between the lender and the borrower. It is most likely to take place where the lender and the borrower enjoy a form of personal relationship. Mudaraba and particularly musharaka are the two types of Islamic financial instruments that are highly significant to entrepreneurship since they have defined risk boundaries and strict PLS rules.
Mudaraba (silent partnership): This is a contract between two parties: the financial institution (bank) and the entrepreneur. The bank acts in the capacity of being the financer by providing needed capital and the entrepreneur devotes his/her ideas, skills, expertise and time to invest the money in a productive and socially accepted halal business venture. The agreement is based on the principles of PLS; profit when realised is shared by both parties according to pre-negotiated ratios. In the case of incurring a loss, the bank bears the entire financial burden and loses all the invested money – unless caused by irresponsible behaviour, misconduct or negligence of the managing partner (the entrepreneur) or breach of the conditions mutually agreed upon by both financial institution and entrepreneur. Otherwise, the entrepreneur’s loss is limited to his/her invested time and effort
“As Muslim entrepreneurs in an interest-free economy do their utmost to maximise their returns, they end up also maximising the earnings of their partners – Islamic financial institutions. This mutually beneficial relationship promotes a true spirit of cooperation and partnership between the entrepreneur and his/her wider community (the local investors), and consequently advances the cause of entrepreneurship through the participation of the common man and woman.”
Research has demonstrated that banks are very cautious in their response to potential entrepreneurs and are not keen on being part of such financial arrangements. Under mudaraba, the entrepreneur assumes total management of the business, rendering the financial institution a passive partner with little or no real authority to influence the process of the business venture. The bank usually has to rely on faith, trust, and a sound confidence in the entrepreneur who is expected to abide by Islamic business ethics. In addition, the bank insists on the entrepreneur having a convincing argument for the economic feasibility of the proposed business undertaking.
Musharaka (partnership financing): Musharaka in the Arabic language means “partnership”. Musharaka as well as mudaraba are two PLS-based financial instruments that conform entirely to Islamic financial principles. Musharaka is an identical mudaraba contract between the entrepreneur and the financial institution, except where the entrepreneur contributes to the starting capital in addition to his/her physical and mental contributions towards the business venture.
Thus, the two instruments differ in the sense that musharaka gives both the entrepreneur and the bank the opportunity to share the finances (assets or working capital) as well as the management of the business. Consequently, the entrepreneur will be exposed to capital loss. Under the musharaka arrangement, the bank has a say in the operation of the business and profit is shared according to pre-determined proportions such as the partners’ percentage contribution to the start-up capital after deducting the entrepreneur’s management fees. Losses are also borne accordingly in line with the partners’ proportion of capital contribution. It has been pointed out by scholars that as Muslim entrepreneurs in an interest-free economy do their utmost to maximise their returns, they end up also maximising the earnings of their partners – Islamic financial institutions. This mutually beneficial relationship promotes a true spirit. of cooperation and partnership between the entrepreneur and his/her wider community (the local investors), and consequently advances the cause of entrepreneurship through the participation of the common man and woman.
Another positive implication of the partnership between the Islamic financial institutions and potential entrepreneurs will be manifested in the quality of the emerging enterprises. Being under a moral obligation to protect the interest of their shareholders and depositors, Islamic banks will be obliged to implement cautious but practical measures when weighing their investment options, thus entering into partnership agreements with the most promising business plans.
“Disadvantaged groups and marginalised poor individuals have incontestable rights to the zakat funds. The implications of this entitlement go beyond providing the needy with the basics to meet their immediate needs. Rather, it is an opportunity to cultivate in them the spirit of entrepreneurship and productivity through financial assistance and training, so they might start a business of their own.”
Of these two arrangements, musharaka is the option preferred by the banks because it exposes the entrepreneur to the real risk of losing a portion of his/her investment, hence motivates him/her to exert that extra effort and be more cautious. Musharaka arrangements also provide the financial institution with the opportunity to be an active participant in the entrepreneurial activity and to oversee the operation of the business.
The Islamic model of entrepreneurship does not incorporate taxes into its structure. Instead, the fourth pillar of Islam, zakat, requires all Muslims, including entrepreneurs, to pay annually a pre-determined percentage (2.5%) on their wealth (including any idle wealth) exceeding nisab (threshold allowance) in order for the Islamic state to ensure the proper and just redistribution of zakat funds amongst the needy. In most contemporary Islamic countries, it is left to the goodwill of the individual Muslim to decide on how much zakat to pay without the meddling of the state. Fulfilling its responsibility of overseeing the overall well-being of all its citizens, especially the underprivileged, does not necessarily make the Islamic state a welfare state. Therefore, the nature and the function of zakat are by no means to be linked to, or interpreted in welfare terminology. Zakat is an effective empowering instrument and the zakat funds should be employed to achieve the ultimate goal of realising socio-economic justice.
The role of zakat as a developmental tool is reflected in three distinct groups of Muslims: the givers, the recipients and the Muslim population at large. First, by attending to their obligations towards zakat, Muslims are fulfilling one of Islam’s five pillars; hence, it is an act of ibada (worship). Muslims also regard the payment of zakat as a purification of their wealth that eventually will result in the growth of their capital instead of leading to its decrease. The Prophet Muhammad (pbuh) said, “Sadaqa [zakat or charity] does not reduce property”. The idea of growth through giving, which acts as a purification of wealth, is unique to Islam. It may appear counterintuitive and incomprehensible to the western mentality of increasing personal wealth through giving away a portion of it, but by paying zakat this is an anticipated consequence. More importantly, Muslims have much higher spiritual satisfaction in paying zakat due to their expectations of reaping the promised rewards in the hereafter.
Disadvantaged groups and marginalised poor individuals have incontestable rights to the zakat funds. The implications of this entitlement go beyond providing the needy with the basics to meet their immediate needs. Rather, it is an opportunity to cultivate in them the spirit of entrepreneurship and productivity through financial assistance and training, so they might start a business of their own.
Zakat is also a means to realise a just redistribution of wealth by taking (a specific portion) from the rich and giving it to the needy. When a citizen in a non-Islamic country pays high taxes, she does not expect rewards beyond better state services. Muslims, on the other hand, individually determine the due amount of zakat and they pay it willingly. They do so because of their conviction that by paying zakat they are contributing to the establishment of Islamic socio-economic justice through a more just distribution of the nation’s wealth. Furthermore, zakat nurtures the spirit of unity, cooperation and mutual respect, rather than jealousy and resentment, between the members of society thus paving the way to the emergence of a more productive and cohesive society.
Islam deplores the act of keeping the money idle or invested in passive bank deposits. Muslim scholars unanimously agree that idle money in excess of the nisab still falls within the definition and under the jurisdiction of money hoarding, even if the Muslim has paid the due zakat on such idle wealth. The idea is to encourage Muslims to spend the accumulated wealth in the cause of the Almighty Allah by investing it in a productive and useful manner. One can strongly argue that commanding zakat on any idle wealth could be interpreted as a conspicuous call for Muslims to engage their wealth in productive business activities, and also as a penalty imposed for averting such wealth from contributing to the well-being of the Muslim umma (through the act of entrepreneurship). A sound conclusion that can be drawn from this discussion is that Islam is explicitly motivating and even pushing Muslims towards productive economic activities, and that is to say, towards the creation of new business entities –towards entrepreneurship.
