Does Islamic finance support entrepreneurship?
Friday, 15 January 2010
Rasem N. Kayed and M. Kabir Hassan
EACH country has its peculiar problems that challenge aspiring entrepreneurs. But certain problems could be common in all societies. The common problems that hinder entry into business, include lack of financial resources, government regulations, and social attitudes that discourage risk-taking. But mobilisation of capital for starting a business is widely recognised as a major obstacle of for new entrepreneurs everywhere. It is not confined to a particular culture or landscape, although it could be more acute in developing countries.
Conventional lending financial institutions in developing countries usually shy away from providing credit to new entrepreneurs. The reluctance is attributed to the risk of lending to unknown borrowers. The administrative cost of lending to new entrepreneurs, who begin with small firms is high and economically unviable. Lack of understanding of the nature and the dynamics of small and medium enterprises and absence of qualified personnel for feasibility studies as well as for evaluation and monitoring of small business loans for the lending institution contribute to this reluctance.
The conditions of lending institutions to provide previous business records on profitability to guarantee repayment, prove hard for the new entrepreneurs to fulfil. Beginners cannot furnish credit history or records of previous successes. The commercial banks also hesitate to take the risk in financing new products, not knowing how they would fare in the market. To ensure the security of a loan, the bank asks for collateral exceeding the value of the credit. For their tough conditions, a new entrepreneur cannot count on the conventional banks for the start-up capital. Excessive interest charged by alternative institutions compel an inspiring entrepreneur to abandon his or her dream.
Even if a potential entrepreneur satisfying of all the other conditions of the lending institution discourages him or her demanding higher interest. High lending rate increases the debt burden on the entrepreneur. The extra cost of creates a disadvantage for the beginner. The higher interest puts an unfair burden on a beginner who makes his or her venture a success. If the business activity fails the lender goes for unfair and harsh recovery. The practice of unfair and unjust recovery is explicitly prohibited in Islam.
Commercial banks widen the rich-poor divide using their interest-based lending. Economists need to study the issue going deep into the practice. Many Muslim entrepreneurs prefer sharing rather than bearing the risk associated with new business undertakings. Not a new concept, the roots of Islamic economics can be traced to the time of the revelation of the Holy Qur'an, fourteen centuries ago.
Islamic banking can better produce and promote entrepreneurs. Islamic Shariah stipulates rules to govern economic, social, political and cultural aspects of Islamic societies. Qur'an and Sunnah are the main sources of Shariah. The philosophical thinking underlying the principles of the Islamic financial system supports wealth creation and distribution. It is fair towards the rich minority and unbiased towards the poor majority. The ultimate aim is socio-economic justice. Although Islamic banking is a core component of the Islamic financial system, it is a common mistake to consider Islamic financial system and Islamic banking synonymous with Islamic economy.
The prohibition of interest (riba) in Islamic economics has drawn much attention. Many western economists consider the prohibition on interest as anti-capitalist and an obstacle to the functioning of a modern economy. They think it would limit, if not an impede economic development and growth. But the other argument is that there is no moral or economic justification to charge or receive interest. They describe interest counterproductive as it adds to the burden of the entrepreneur. An interest-based economy, they say, can provide socio-economic justice.
Money generated out of "rent-seeking activity" including interest creates new but artificial capital which, by no means, is the life-blood of the markets. The essence of the market is entrepreneurship. Trade, not banking, is the primary function of markets, they maintain.
Partnership arrangements between the financier and the entrepreneur, stipulated in Islamic finance, eliminate the negative effect of banning interest, if any, on market. Islamic finance stipulates the instruments of profit or loss sharing as alternatives to interest-based arrangements employed by conventional banking.
Profit and loss sharing operates under the concept of 'rate of return' for the financier and the entrepreneur to share the risk. It is like sharing the profit or loss out of investment according to an agreed upon ratio. It contrasts fixed pre-determined 'interest rate' to be paid by a borrowing entrepreneur in addition to the principal, regardless of the outcome of the business undertaking.
Islam prohibits paying or receiving interest at predetermined rates on money borrowed or lent. Interest tends to push the poor into greater poverty to create more wealth for the wealthy without doing work or sharing the risk involved a business undertaking. Riba further interest creates wealth money lent without actual productive economic activity or transaction. Islam, therefore, considers all interest-based financial arrangements to be unfair, unjust and morally unjustifiable. It also considers money generated by such lending to be unearned money. That is why it made interest unlawful. Not surprisingly, all the major religions including Judaism, Christianity and Islam, as Buddhism and Hinduism denounce interest as unethical and immoral.
The writer can be reached at
e-mail: kabirhassan63@gmail.com. Rasem N. Kayed is with the Arab American University, Palestine and M. Kabir Hassan with the University of New Orleans, USA
EACH country has its peculiar problems that challenge aspiring entrepreneurs. But certain problems could be common in all societies. The common problems that hinder entry into business, include lack of financial resources, government regulations, and social attitudes that discourage risk-taking. But mobilisation of capital for starting a business is widely recognised as a major obstacle of for new entrepreneurs everywhere. It is not confined to a particular culture or landscape, although it could be more acute in developing countries.
Conventional lending financial institutions in developing countries usually shy away from providing credit to new entrepreneurs. The reluctance is attributed to the risk of lending to unknown borrowers. The administrative cost of lending to new entrepreneurs, who begin with small firms is high and economically unviable. Lack of understanding of the nature and the dynamics of small and medium enterprises and absence of qualified personnel for feasibility studies as well as for evaluation and monitoring of small business loans for the lending institution contribute to this reluctance.
The conditions of lending institutions to provide previous business records on profitability to guarantee repayment, prove hard for the new entrepreneurs to fulfil. Beginners cannot furnish credit history or records of previous successes. The commercial banks also hesitate to take the risk in financing new products, not knowing how they would fare in the market. To ensure the security of a loan, the bank asks for collateral exceeding the value of the credit. For their tough conditions, a new entrepreneur cannot count on the conventional banks for the start-up capital. Excessive interest charged by alternative institutions compel an inspiring entrepreneur to abandon his or her dream.
Even if a potential entrepreneur satisfying of all the other conditions of the lending institution discourages him or her demanding higher interest. High lending rate increases the debt burden on the entrepreneur. The extra cost of creates a disadvantage for the beginner. The higher interest puts an unfair burden on a beginner who makes his or her venture a success. If the business activity fails the lender goes for unfair and harsh recovery. The practice of unfair and unjust recovery is explicitly prohibited in Islam.
Commercial banks widen the rich-poor divide using their interest-based lending. Economists need to study the issue going deep into the practice. Many Muslim entrepreneurs prefer sharing rather than bearing the risk associated with new business undertakings. Not a new concept, the roots of Islamic economics can be traced to the time of the revelation of the Holy Qur'an, fourteen centuries ago.
Islamic banking can better produce and promote entrepreneurs. Islamic Shariah stipulates rules to govern economic, social, political and cultural aspects of Islamic societies. Qur'an and Sunnah are the main sources of Shariah. The philosophical thinking underlying the principles of the Islamic financial system supports wealth creation and distribution. It is fair towards the rich minority and unbiased towards the poor majority. The ultimate aim is socio-economic justice. Although Islamic banking is a core component of the Islamic financial system, it is a common mistake to consider Islamic financial system and Islamic banking synonymous with Islamic economy.
The prohibition of interest (riba) in Islamic economics has drawn much attention. Many western economists consider the prohibition on interest as anti-capitalist and an obstacle to the functioning of a modern economy. They think it would limit, if not an impede economic development and growth. But the other argument is that there is no moral or economic justification to charge or receive interest. They describe interest counterproductive as it adds to the burden of the entrepreneur. An interest-based economy, they say, can provide socio-economic justice.
Money generated out of "rent-seeking activity" including interest creates new but artificial capital which, by no means, is the life-blood of the markets. The essence of the market is entrepreneurship. Trade, not banking, is the primary function of markets, they maintain.
Partnership arrangements between the financier and the entrepreneur, stipulated in Islamic finance, eliminate the negative effect of banning interest, if any, on market. Islamic finance stipulates the instruments of profit or loss sharing as alternatives to interest-based arrangements employed by conventional banking.
Profit and loss sharing operates under the concept of 'rate of return' for the financier and the entrepreneur to share the risk. It is like sharing the profit or loss out of investment according to an agreed upon ratio. It contrasts fixed pre-determined 'interest rate' to be paid by a borrowing entrepreneur in addition to the principal, regardless of the outcome of the business undertaking.
Islam prohibits paying or receiving interest at predetermined rates on money borrowed or lent. Interest tends to push the poor into greater poverty to create more wealth for the wealthy without doing work or sharing the risk involved a business undertaking. Riba further interest creates wealth money lent without actual productive economic activity or transaction. Islam, therefore, considers all interest-based financial arrangements to be unfair, unjust and morally unjustifiable. It also considers money generated by such lending to be unearned money. That is why it made interest unlawful. Not surprisingly, all the major religions including Judaism, Christianity and Islam, as Buddhism and Hinduism denounce interest as unethical and immoral.
The writer can be reached at
e-mail: kabirhassan63@gmail.com. Rasem N. Kayed is with the Arab American University, Palestine and M. Kabir Hassan with the University of New Orleans, USA