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Capital and Entrepreneur in Islamic Finance in More Detail

Posted on 7th September 2012 by Camille Paldi,

Hawaii

 

By Mufti Taqi Usmani

Excerpt from Musharakah, Introduction to Islamic Finance

One Reason Why the Rich Keep Getting Richer and the Poor Keep Getting Poorer in the Capitalist Economic System

 

In the modern economic system, it is the banks, which advance depositors’ money as loans to industrialists and traders.  If industrialists having only ten million of their own, acquire 90 million from the banks and embark on a huge profitable project, it means that 90% of the project has been created by the money of the depositors while only 10% has been created by their own capital.  If this huge project brings enormous profits, only a small proportion i.e. 14 or 15% will go to the depositors through the bank while all the rest will be gained by the industrialists whose real contribution to the project is not more than 10%.  Even this small proportion of 14 or 15% is taken back by the industrialists, because this proportion is included by them in the cost of their production.  The net result is that all the profit of the enterprise is earned by the persons whose own capital does not exceed 10% of the total investment, while the people owning 90% of the investment get no more than the fixed rate of interest, which is often repaid by them through the increased prices of the products.  On the contrary, if in an extreme situation, the industrialists go insolvent, their own loss is no more than 10%, while the rest of 90% is totally borne by the bank, and in some cases, by the depositors.  In this way, the rate of interest is the main cause for imbalances in the system of distribution, which has a constant tendency in favor of the rich and against the interests of the poor…

Interest predetermines a fixed rate of return on a loan advanced by the financier irrespective of the profit earned or loss suffered by the debtor, while musharakah does not envisage a fixed rate of return.  Rather, the return in musharakah is based on the actual profit earned by the joint venture.  The financier in an interest-bearing loan cannot suffer loss while the financier in musharakah can suffer loss, if the joint venture fails to produce fruits.  Islam has termed interest as an unjust instrument of financing because it results in injustice either to the creditor or to the debtor.  If the debtor suffers a loss, it is unjust on the part of the creditor to claim a fixed rate of return; and if the debtor earns a very high rate of profit, it is injustice to the creditor to give him only a small proportion of the profit leaving the rest for the debtor…

Conversely, Islam has a clear cut principle for the financier.  According to Islamic principles, a financier must determine whether he is advancing a loan to assist the debtor on humanitarian grounds or he desires to share his profits.  If he wants to assist the debtor, he should resist from claiming any excess on the principal of his loan, because his aim is to assist him.  However, if he wants to have a share in the profits of his debtor, it is necessary that he should also share him in his losses.  Thus, the returns of the financier in musharakah have been tied up with the actual profits accrued through the enterprise.  The greater the profits of the enterprise, the higher the rate of return to the financier.  If the enterprise earns enormous profits, all of it cannot be secured by the industrialist exclusively, but they will be shared by the common people as depositors in the bank.  In this way, musharakah has a tendency to favor the common people rather than the rich only.


Posted on 7th September 2012 by Camille Paldi


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