34 islam and entrepreneurship

Wafica Ali Ghoul

introduction
the number of Muslims worldwide was last estimated to be 1.6 billion, which represents about one-fifth of the worlds population. the number of Muslims who currently live in the Western world (north america and Europe) is growing. there are around 7.5 million Muslims who currently live in the united states, 4 million live in Germany, 6 million in france, 3 million in canada, and 1.8 million in the united Kingdom (hassan and carruthers 2007). Muslim entrepreneurs around the globe have been increasingly seeking to set up enterprises that are consistent with shariah law (islamic principles of living), because they believe that these entities will enable them to achieve their economic goals while respecting and abiding by their religious beliefs. feldman (2008) had the following to say about shariah:
shariah represents the idea that all human beings and all human governments are subject to justice under the law ... the word shariah connotes a connection to the divine, a set of unchanging beliefs and principles that order life in accordance with Gods will ... shariah is best understood as a kind of higher law, albeit one that includes some specific, worldly command.

feldman goes on to say that a fourfold combination the Koran, the path of the prophet as captured in the collections of reports, analogical reasoning and consensus amounted to a basis for a legal system which is commonly known as shariah.

a BriEf oVErViEW of islaMic EntErprisEs

What Are the Features that Distinguish Islamic Enterprises from their Conventional Counterparts? What follows is a brief overview of the main distinguishing features of islamic enterprises:

one of the most distinct features of doing business within the islamic framework is the prohibition of riba (the earning or charging of interest); the word riba is arabic for growth, which means that islam prohibits the growth of ones wealth through lending money to others and charging them interest as a compensation. in conventional enterprises the payment of interest is used to compensate lenders for their loss of liquidity, in addition to an inflation premium which makes up for a potential price increase, a default risk premium which is proportional to the credit risk of the borrower, and a maturity risk premium that increases with the life of the loan. shariah prohibits the payment or receipt of interest because it can 293

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World encyclopedia of entrepreneurship lead to an inequitable distribution of wealth, it does not promote productivity, and it can cause the exploitation of the poor and needy, besides the fact that usually there is no risk sharing in traditional lending. Money cannot be traded for money; all transactions should be based on real assets. this is intended to help society through the creation of jobs. one cannot sell what one does not own, which presents a problem for hedge funds that use short-sale as one of their main strategies for risk management. speculative activities are forbidden because they are considered to be gambling or gharar (which means uncertainty or deceit in arabic), and they involve taking risks which are intentional, avoidable and significant. another distinct feature is the fact that islam prohibits any vehicle or tool that promises a fixed rate of return because under islamic principles all shareholders should be on an equal footing. islam focuses instead on partnerships and risksharing. according to http://faraazm.tripod.com/id31.html the islamic conception of abolishment of fixed interest rates does not mean that no remuneration is paid on capital. profit-making is acceptable in islamic society as long as these profits are not unrestricted or driven by the activities of a monopoly. islam deems profit, rather than interest, to be closer to its sense of morality and equity because earning profits inherently involves sharing risks and rewards. profit-making addresses the islamic ideals of social justice because both the entrepreneur and the lender bear the risk of the investment.

What Are the Types of Enterprises which are Permissible in Islam? Muslim entrepreneurs are allowed to establish companies, whose activities are halal (lawful) not haram (unlawful), and thus are not objectionable under shariah islamic law. Business activities which are objectionable in islam are those which involve:

Money-lending and interest payment or receipt, thus conventional banks and insurance companies are haram. the production, distribution, and/or profiting from alcohol, pornography, tobacco, gambling, weapons, music, entertainment, processing pork meat or nonhalal meat (Ghoul and Karam, 2007). hotels and airlines which serve alcohol on their premises. in addition, restrictions are applied to certain financial ratios. thus the dow Jones islamic Market indices (dJiMi) apply the following screens to companies which pass the initial test shariah compliance test: total debt divided by trailing 12-month average market capitalization must be less than 33%. the sum of companys cash and interest-bearing securities divided by the trailing 12-month average market capitalization must be less than 33%. accounts receivable divided by the trailing 12-month average market capitalization must be less than 33% dJiMi, 1999.

some enterprises have been rather lenient in their application of the shariah compliance test. they have been taking the liberty to lower the restrictions on non-halal activities,

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Islam and entrepreneurship 295 as long as less than 5 per cent of their revenues are derived from such activities, with the condition that any profits from such activities shall be given to islamic charities. this process is known as portfolio purification. however, this is controversial and a subject of debate. typical businesses which generally comply with shariah are those involved in technology, telecommunications, steel companies, engineering, transportation, health care, utilities, construction, as well as real estate.

factors that haVE contriButEd to thE risinG intErEst in islaMic EntrEprEnEurship

several factors have been contributing to the recent growing interest in setting up islamic enterprises. these include:

the recent surge in oil prices which has created excess liquidity in many parts of the Muslim world. the events of 11 september 2001 (9/11) in the usa, which led many Muslims to repatriate their money back home for fear of new Western regulations that resulted in increased scrutiny xombined with a backlash against Muslims around the world, both real and perceived. the high population growth rate in Muslim countries, currently estimated to be 1.6 billion Muslims, means that the target audience for Muslim enterprises is significant and growing. the recent religious awakening of Muslims and their realization of the importance of compliance with shariah rules and principles in their business dealings. according to feldman (2008), in the Muslim world, on the other hand, the reputation of shariah has undergone an extraordinary revival in recent years. a century ago, forward-looking Muslims thought of shariah as outdated, in need of reform or maybe abandonment. today, 66 percent of Egyptians, 60 percent of pakistanis and 54 percent of Jordanians say that shariah should be the only source of legislation in their countries. high unemployment rates, internal conflicts, wars with neighboring countries, poverty, gender issues, as well as political oppression currently plague most of the Muslim countries. consequently, the number of Muslims who are choosing to immigrate to the Western world (particularly north america and Europe) has been growing, which necessitates the establishment of Muslim enterprises in Muslim immigrant communities. there is an anticipated growth of interest by non-Muslim clients who have been seeking socially responsible and ethical products and services, which would contribute to sustaining the growth of Muslin enterprises (iir Middle East, 2007).

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factors that arE currEntly iMpEdinG thE EMErGEncE of islaMic EntrEprEnEurship

several factors present hurdles to the healthy growth of the islamic enterprises, these include the current lack of standardized regulation, an unclear legal framework, different scholars interpretations of the shariah, and different levels of strictness. Divergence Issues in Shariah Interpretation a major hurdle that currently faces the growth of islamic enterprises is that the shariah scholars who belong to different sects of islam have been issuing divergent interpretations of the teachings of the holy Koran. this is an issue because it affects the marketability and tradability of islamic products across the different Muslim countries. according to humayon dar, managing director of a london-based shariah consultancy, the dar al istithmar institute, there are perhaps 150 [such scholars] worldwide who are involved with islamic finance but only 20 are internationally recognized (tett, 2006: 1). one might think that with a very small number of recognized Muslim shariah scholars there would be a convergence of interpretations of shariah; however, the cause of divergence of interpretations is the diversity of personal beliefs of scholars, not to mention diverse islamic religious sects, regional, and cultural influences. this problem is compounded by the varying degrees of religious strictness among entrepreneurs and clients with whom they are dealing. interestingly, sheikh usmani argues that the interpretations of most aspects of Shariah are never disputed. For example, everyone agrees that interest is not allowed. It is when you address the alternatives to interest that some differences arise (Wigglesworth, 2007). deutsche Banks Geert Bossuyt, Managing director, regional head of Middle East structuring argues that shariah is inherently open to individual scholars interpretation; he has reportedly said:
shariah itself has inherent flexibility and fewer constraints than is often assumed by the financial services industry. fundamental research is the key to unlocking this inherent flexibility, thereby allowing this market to grow to its full potential ... too often, innovation is achieved by pushing the barriers and/or misusing fatwas by taking them out of their context. innovation ideally should be the result of a well documented and fundamental discussion on shariah. (MEnafn.coM, 2007)

Corporate Governance and Islamic Enterprises islamic enterprises have additional constraints imposed on them besides those dictated by generally expected good corporate governance practices, which conventional enterprises have to abide by. an islamic enterprise has to operate within the framework of islamic law known as shariah, this requires respecting the fundamental values of islamic shariah which balance the interests of society and individuals. these values include fairness, non-exploitation of the poor, moral responsibility, accountability, and equity in financial dealings. not surprisingly, most of the reported development efforts of islamic governance models have been observed in the financial sector of islamic business, which is what we focus on next.

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Islam and entrepreneurship 297 a KpMG report (2006) pointed out the lack of a unified islamic governance model by stating that demonstrating compliance with shariah can be difficult as different institutions have different governance models by which they set, measure, and monitor their compliance. these varying governance models have added a level of operational risk for any islamic financial institution. two organizations have been spearheading the effort for setting standards for corporate governance at islamic financial institutions, the ifsB and the aaoifi. the islamic financial services Board (ifsB) is based in Kuala lumpur, it began operating in 2003; it is an international organization which has been issuing standards for the effective supervision and regulation of islamic financial institutions. the accounting and auditing organization for islamic financial institutions (aaoifi), is based in Bahrain, it has been working on a set of standards which cover accounting, ethics, and shariah compliance; it claims that its principles are followed by the majority of islamic financial institutions. islamic corporate governance requires the establishment of operating procedures that guarantee that a shariah supervisory Board (ssB) certifies all products, transactions, and services in advance, as well as facilitating the continuous monitoring of the permissibility of existing offerings and practices. sol (2007) has defined shariah non-compliance risk as the risk that the terms agreed in a contract do not effectively comply with islamic jurisprudence and thus are not valid under islamic law, this is the risk that islamic corporate governance practices aim to minimize, through the supervision, guidance, and continuous monitoring by shariah scholars. Besides being external auditors, the ssB scholars function as consumer advocates by ensuring that all the transactions conducted by islamic financial institutions, as well as their products and service offerings are consistent with shariah law, thus respecting the wishes of the Muslim believers who deal with such enterprises. it is very important that customers have full confidence in the independence, integrity, ability, and credibility of shariah scholars who certify a product or service as being halal. however, these virtues have been the subject of a lot of debate and controversy lately. sheikh yusuf talal delorenzo, one of the best known shariah scholars, compared the responsibilities of a shariah supervisor to those of a financial auditor (delorentz, 2000; emphasis added):
the functions of a shariah supervisor may be compared to those of an independent financial auditor, in the sense that regulatory compliance is ensured, shariah supervisors have both religious and fiduciary responsibilities there is a need for impartiality and independence. in the same way that independent auditors are brought in to review the finances of a business, shariah supervisory Boards review compliance to shariah precepts. independent audits are understood as ways to gain and maintain the trust of investors and consumers. independent shariah supervision is the best way to gain and maintain the trust of Muslim investors and consumers.

additionally, any defects in the products offered should be stated in the ssB report with recommendations for rectifying the defects.

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Financing Islamic Enterprises as with conventional small and medium enterprises, islamic enterprises have to deal with the difficulty of access to capital, however, there is an additional hurdle which is that when capital is available it has to be compliant with shariah. according to Khan (2008) the growth and development of many Muslim owned small businesses is constrained as a result of the unavailability of islamic financial services. next we present a simplified discussion of some islamic finance vehicles commonly used by islamic enterprises, these are financing vehicles which are considered to be halal substitutes to conventional vehicles: 1. Murabaha: Cost-plus-mark-up financing. individual (a) who desires to buy a house for $100 000 approaches an islamic bank (B), which buys the house, marks it up to $120 000 and sells the house to (a) at a cost plus a declared profit for deferred payments. Ijara: Lease-based products. individual (a) needs to use a machine (a productive asset) which costs half a million dollars, bank (B) buys the machine, and rents it out to (a), charging him rental payments, which is ijara in arabic. if (a) ends up buying the machine, the contract would be Ijara-wa-Iqtana, which means a lease with an option to buy (Iqtana is arabic for ownership, wa means and). Bai-Salam: Advance purchase. this is similar to a forward or a futures contract. in arabic, the word Bai means sale, Salam is supposed to stand for delivery; it really should be Tasleem or handing over of commodities. assume that merchant (a) wants to have suits manufactured by factory (B), (a) pays (B) in advance, and in return (B) charges (a) a lower price, thus splitting the profits with (B). this contract represents a transaction rather than a loan. Istisnaa: Progressive financing. the word Istisnaa in arabic means manufacturing, assume individual (a) wants to build a house, he approaches bank (B) which will pay the builders on behalf of individual (a) as the work progresses. this allows for deferral of payment as well as delivery. Musharakah: Company or partnership contract. two or more persons contribute to the financing as well as the management of the business, in equal or unequal proportions. Musharakah (which means sharing in arabic), is an equity financing arrangement and partnership where profits are shared according to an agreed ratio, whereas the losses are shared in proportion to the capital/ investment of each partner. Mudarabah: Investment partnership. the investor (Rab al mal which means provider of capital in arabic), provides capital to the bank (the Mudarib, which means the one who is competing with investor for profit). the bank invests the money in halal activities. profits are shared on a pre-agreed ratio, whereas losses are born by the investor only. a Mudarabah contract is very similar to a mutual fund because both pool money from many investors and invest it on their behalf, sharing in the profits but not the losses. Sukuks: Islamic bonds. the word Sukuk is arabic for a bond, that is, an indenture. conventional bonds are used to borrow money for financing a project or an asset acquistion, they pay a fixed interest rate to bond holders semiannually. in islamic finance, a Sukuk issuance is a method of financing that has to be backed by the

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Islam and entrepreneurship 299 projects fixed assets. Sukuks give their owners a proportionate beneficial ownership in the underlying asset. profits from the project are distributed to owners. Islamic Enterprises and Risk Exposures Various types of unique risk exposures plague Muslim economies and need to be managed.

the prevalence of wars and conflicts in many Muslim countries raises the level of transaction, economic and translation risk exposures and necessitates the development of shariah-compliant risk management products. the economies of many Muslim countries depend heavily on petrodollars; the price of oil has been very volatile, which creates significant risks. the phenomenon of the globalization of trade and finance means that most business deals and investments involve multiple countries and currencies. a less-discussed source of risk exposure is the impact of global warming on agriculture; it is creating additional hazards for farmers crops world wide. after experiencing a boom for at least three years, stock markets in the Middle East are currently in a correction mode, the availability of risk management devices would attract additional local and foreign investors interest.

risK ManaGEMEnt and islaMic shariah

Muslim entrepreneurs are not currently taking serious measures to protect themselves from various risks. progress is being made mainly in developing instruments that protect against foreign exchange rate fluctuations (profit rate swaps) and stock price volatility (islamic hedge funds and alternatives to options). however, a concern remains that some Muslim entrepreneurs and their clients will not be comfortable with using them. the islamic finance industry is being criticized for synthesizing copycats of conventional financial derivative products. conventional risk management tools, such as derivatives, involve speculation which is equivalent to gambling. the holy Koran prohibits gambling by comparing its cost to its benefit: they ask you [o Muhammad] about wine and gambling. say there is great sin (harm, ithm) in them, and some benefit to mankind. however, their sin (harm, ithm) outweighs their benefits (2:219). Kamali (1999: 199) defines gharar as follows:
literally meaning fraud (al-khida), gharar in transactions has often been used in the sense of risk, uncertainty and hazard. in a contract of sale gharar often refers to uncertainty and ignorance of one or both of the parties over the substance or attributes of the object of sale, or of doubt over its existence at the time of contract. Gharar is, however, a broad concept and may carry different shades of meaning in relationship to different transactions.

El-Gamal (2001) cited professor Mustafa al-Zarqa who had the following definition of gharar: it is the sale of probable items whose existence or characteristics are not certain, due to the risky nature which makes the trade similar to gambling.

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thus for a contract to be shariah-compliant the object of the trade as well as the price has to be stated, which would eliminate ambiguities that are characteristic of gharar. Examples of Halal Risk Management Tools Profit-loss sharing account this is the equivalent of a conventional money market hedge. if a Malaysian company owes a British company a payment of 105 British pounds in 30 days, it can buy 100 pounds today, deposit the pounds in an islamic bank account, such as a Mudarabah account or a Musharakah account, such that in 30 days it can use 105 pounds to cover its liability, and only the amount above 105 is uncovered. alternatively, if the account falls below 105, then the foreign currency exposure would be limited to the shortage. Shariah-compliant non-derivative risk-management methods

invoicing payables and receivables in the same currency, as much as possible. Matching the levels of revenues and expenses in a foreign currency. holding similar levels of assets and liabilities in each currency. lagging and leading foreign currency payables payment strategies. portfolio diversification, in terms of financial products, currencies, and projects.

islaM and fEMalE EntrEprEnEurship

islam does not prohibit or frown upon women being entrepreneurs. in fact, the prophet Muhammad, peace be upon him, was married to a very wealthy and capable woman called Khadijah, peace be upon her, who helped him spread the message of islam. according to feldman (2008), there is an oversimplified assumption that Muslims want to use shariah to reverse feminism and control women ... large numbers of [Muslim] women support the islamists in general and the ideal of shariah in particular.

conclusion
there are some critics who are of the opinion that by insisting on complying with shariah law, to the letter, some Muslim entrepreneurs might be losing sight of the main objective of islam, namely, fairness and social equity, as well as protecting the well being (physical and mental health) and providing for a decent living of mankind. husain (2007) reports laldin, chairman of the shariah advisory committee of hsBc amanah Malaysia, to have said:
scholars look at three basic areas when assessing the compliance of products: belief, legalilty and morality ... products could fairly easily comply with islamic law but it is more difficult to ascertain whether they comply with the morals of islam. the price of a product may not be controversial from a legal perspective but if the product costs more than an equivalent conventional product, it may not fulfill islams moral obligations of fairness and social equity.

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