The Islamic banking system is a relatively young institution that gains influence not only in the Islamic world but also in non-Muslim countries with big Muslim communities. The first Islamic bank, Dubai Islamic Bank, was erected in 1975; today about 265 Islamic finance institutions operate in more than 70 countries, and their assets have increased more than 40-fold since 1982 to exceed $230 billion. More and more western banks erect Islamic branches; the first was Citibank in 1996.
This paper discusses the influence of an Islamic banking system on the start-up of young, innovative businesses. A negative influence would hinder these businesses to develop – if not counterbalanced by other measures like state involvement. In non-Muslim countries it would constrain religious Muslims from participating in the contemporary economical changes, determined by an opening-up of markets and privatization, which requires the start-up of new businesses.
The Islamic banking system operates according to Islamic law; hence several Islamic restrictions, the most important is the prohibition of riba (=interest), limit its freedom to develop suitable financing instruments for the support of young, innovative businesses.
These restrictions enlarge the risk of the bank especially when financing these businesses, so the bank either avoids these businesses or tries to bend the Islamic law and operates – de facto – like a conventional bank. In this case, however, the bank is facing problems with the Religious Supervisory Board, an integral part of every Islamic bank, which will stop the bank from deriving from the Islamic law (sharī´a).
After discussing these determinants, I will discuss the existing interest-free financing instruments of Islamic Banking suitable for the start-up of young, innovative enterprises.
On the example of the PLS-concepts musharaka and mudaraba, I will analyse the factors that make these financing concepts not attractive for banks, especially when financing young, innovative business. On the example of the Mark-up activities murabaha (Trade Financing) and ijara/ijara al-waktina (Leasing) I will analyse, why these concepts are only suitable for financing very special cases of young businesses and are not a suitable alternative to Western banking concepts for the majority of young entrepreneurs.
Finally I will show ideas how to improve the system without violating Islamic law, but also discuss the limits of the Islamic banking system.
Table of Contents
1. Introduction
2. The Problem of the Prohibition of Interest (riba) and Alternatives
3. The Meaning of the Higher Supervisory Religious Board for Young Enterprises
4. PLS Concepts: Mudaraba and Musharaka – And Why Banks Shy Away From These Concepts
4.1. Mudaraba - “Sleeping Partnership”
4.2. Musharaka - “Sharing”
5. Other Forms of Loans in Islamic and their Limited Applicability for Young, Innovative Enterprises
5.1. Qard Hasan - “Credit Without Interest” - Not Available for Business Financing
5.2. Ijara – “Leasing” / Ijara wa-Iktina - “Hire-Purchase” - Just Suitable in Exceptional Cases
5.3. Murabaha – “Trade Financing” – Feasible Just for a Minority of Entrepreneurs and at the Cost of Deriviation from the Original “Halal” Concept
6. Conclusion and Proposals for Improvements Inherent to the System
Research Objectives & Key Themes
The primary objective of this paper is to examine the influence of the Islamic banking system on the financing of young, innovative businesses during their start-up phase. The research investigates how inherent Sharia-compliant constraints and profit-maximization goals create barriers for entrepreneurs lacking established collateral or financial records.
- Prohibition of interest (riba) and its restrictive impact on credit availability.
- Role of Higher Supervisory Religious Boards and their influence on transaction costs.
- Evaluation of Profit-Loss-Sharing (PLS) concepts: Mudaraba and Musharaka.
- Limitations of alternative financing tools like Ijara and Murabaha for new enterprises.
- Proposals for systemic improvements within the Sharia-compliant framework.
Excerpt from the Book
4.1. Mudaraba – “Sleeping Partnership”
The concept of mudaraba describes a partnership between the bank and the borrower according to the profit-loss-sharing principle (PLS). The bank gives the money and the enterpriser gives his labour force and experience. Theoretical this concept means that the bank and the enterpriser set up an enterprise together and the bank is taking part as a sleeping partner. United Arab Emirates Civil Transaction Act No. 5 of 1985 defines mudaraba as follows:” A mudaraba is a contract whereby the person owning property puts in a capital and the mudarib puts in effort or work, with a view to making a profit.”42 The enterpriser can use the money according to the conditions of the contract and the profit will later on be shared between the bank and the mudarib according to a quota previously fixed in a contract.
In case of a loss only the bank, as the financer, will loose money. The client guarantees to return the funds only if he is negligent in the use of the funds or if he breaches the conditions of the mudaraba43 The bank is not allowed to ask the mudarib for a guarantee for economical success, today however many banks move around this Islamic law and ask for guarantees.
Summary of Chapters
1. Introduction: This chapter introduces the growth of the contemporary Islamic banking system and outlines the core research question regarding its impact on the start-up of young, innovative enterprises.
2. The Problem of the Prohibition of Interest (riba) and Alternatives: This section explores the religious and economic implications of the prohibition of riba and how it limits the bank's ability to offer standard interest-based loans.
3. The Meaning of the Higher Supervisory Religious Board for Young Enterprises: This chapter analyzes how the oversight of these boards increases transaction costs and creates planning uncertainty for both banks and entrepreneurs.
4. PLS Concepts: Mudaraba and Musharaka – And Why Banks Shy Away From These Concepts: This section details the mechanisms of profit-loss-sharing and explains why banks generally avoid these high-risk models in favor of mark-up transactions.
5. Other Forms of Loans in Islamic and their Limited Applicability for Young, Innovative Enterprises: This chapter assesses alternative instruments like Qard Hasan, Ijara, and Murabaha, finding them largely unsuitable for the foundational capital needs of new businesses.
6. Conclusion and Proposals for Improvements Inherent to the System: This final section summarizes the main findings and offers suggestions for modernizing the system to better support innovative entrepreneurship without violating Islamic law.
Keywords
Islamic Banking, Riba, Mudaraba, Musharaka, Murabaha, Ijara, Profit-Loss-Sharing, Start-up Financing, Sharia, Entrepreneurship, Transaction Costs, Economic Development, Financial Instruments, Risk Management, Islamic Economics
Frequently Asked Questions
What is the core focus of this research paper?
The paper focuses on the challenges that the contemporary Islamic banking system poses to the start-up phase of young, innovative business firms, specifically in terms of access to appropriate financing.
What are the primary thematic areas covered?
Key areas include the prohibition of interest (riba), the operational mechanisms of Sharia boards, the evaluation of PLS (Profit-Loss-Sharing) concepts, and the limitations of mark-up financing methods like Murabaha and Ijara.
What is the central research question?
The paper asks how the Islamic banking system, bound by specific legal restrictions, influences the development and financing of young, innovative enterprises, and whether its current structure hinders their growth.
What scientific methods does the author use?
The author employs a qualitative analysis of theoretical Islamic economic literature, empirical data on bank portfolios, and comparative case studies from regions such as Pakistan, Jordan, and Sudan to test the effectiveness of Islamic financial instruments.
What does the main body discuss?
The main body breaks down the specific banking concepts (Mudaraba, Musharaka, Ijara, Murabaha), evaluates their practical utility for small businesses, and analyzes the structural and institutional barriers, such as the scarcity of qualified bank staff and the conservative nature of Sharia oversight.
Which keywords best characterize the work?
Key terms include Islamic Banking, Profit-Loss-Sharing (PLS), Mudaraba, Musharaka, Sharia-compliance, and Innovative Entrepreneurship.
How does the author characterize the role of the Higher Supervisory Religious Board?
The author argues that these boards, while necessary for Sharia legitimacy, often impose a "conservative worldview" that restricts banks from entering new, innovative investment areas, thereby increasing transaction costs and decreasing planning security.
What is the author's primary conclusion regarding Mudaraba and Musharaka?
The author concludes that these concepts are largely ineffective for financing the start-up of risky, innovative firms because they force the bank to take on high risks without adequate mechanisms for monitoring or profit-sharing that would make such ventures attractive to institutional investors.
- Quote paper
- Dipl. Paed. Kathrin Nina Wiedl (Author), 2006, The Islamic banking system - Not conductive to the start-up of young, innovative business firms, Munich, GRIN Verlag, https://www.grin.com/document/50897
