The Essence of Islamic Banking

Although the United States is not considered a Muslim country, in
spirit and in real terms more financing and investment along Islamic
lines is done in the United States than in all the Muslim countries
combined! Let me explain. Last year venture capital firms in the
United States invested in excess of $11 billion in equity capital to
help finance the growth and development of over 1,475 young companies
involved in the information technology (computer software, Internet,
and related technologies) and the health care industry.

There is no better example of Islamic mode of financing than venture
capital equity investment. This type of equity financing is provided
by affluent sophisticated individuals, pension funds, venture capital
arms of banking institutions and of course the venture capital funds
to young companies engaged in developing new technologies and
products. Venture capitalists thus become partners and share in the
losses and the profits with the founders. If the company being
financed becomes successful, the founders and the venture capitalists
take it public (IPO) and make a great deal of money. On the other hand
should the company fail, there is no obligation on the part of the
founders -typically bright engineers and scientists, to repay the
investment. The sharing of risk, is the essence of Islamic banking,
which regrettably exists in the United States but with few exceptions
is absent in for what passes for Islamic banking in the Muslim world.

Hundreds of companies in the Silicon Valley, including Intel, Sun
Micro Systems, Apple Computer, Netscape, Intuit, Compaq, Cisco
Systems, Oracle, to name just a few were financed by the venture
capital industry in the form of equity capital. All were created in
the last 20 years from nothing. Cisco's market capitalization equals
GM's. Intel and Microsoft, two other venture backed startups are among
the top five American firms by stock market valuation. Partly as a
result of the availability of this type of risk capital, the United
States became a world leader in computer software, computer operating
systems, and Internet technologies and helped create, some $100
billion of wealth, the largest legal accumulation of wealth in
history. Microsoft alone, through options to employees, has produced
some 6,000 equity millionaires. Additionally, hundreds of thousands of
new highly skilled and highly paid jobs were created. For example, by
1997, Kleiner Perkins, a leading venture capital firm, portfolio of
technology companies employed 162,000 people, rang up revenues of $61
billion, and had stock market valuation of $125 billion. And this is
just one of a dozens of venture capital firms. These companies would
not exist today if it had not been for the venture capital firms who
took the risk in backing talented engineers and scientists.

By contrast, Islamic banks in the Muslim world are very risk
averse. No financing similar to the venture capital investment is
available to bright and talented engineers and scientist in the
Islamic world. And much of what passes for Islamic banking is
suspect. Even such modes of financing as Murabaha, start with a
pre-determined margin over LIBOR- ending with a pre- determined
interest rate. And in Pakistan, they shamelessly talk of mark-up and
expected profits to be paid to depositors What a farce and a sham,
practiced at a grand scale and at such enormous costs in additional
legal fees and documentation costs. While a few banks, notably Faysal
Islamic Bank have made some progress in managing portfolios along
Islamic lines and financing projects on the basis of Musharaka, the
concept of sharing of risk is missing from most of the transactions
and if you peel away the elaborate and fancy legal documentation the
interest element is staring at you just as does in normal banking
transactions. Even more distressing is to note the inability of
Islamic bankers to come up with new products that truly conform with
the SHARI'A, despite being in this business for some 25 years and
despite having some $60 billion in funds under management.

From 750 AD. to about 1100 A.D., the golden age of Islam, Islamic
science and technology for surpassed those of Europe. Europe at that
time learned from the Muslims, especially through their contacts with
Spain where the Muslims ruled. Muslims made original inventions. I
would like to suggest that this was made possible by a culture and
environment that encouraged learning, research, creation of new
technologies and pursuit of change. The enlightened rulers helped by
funding research and sponsorship. Today, most of the technology used
in the Islamic world comes from the outside and Muslims continue to
depend on outside support. Native springs of invention seem to have
dried up. In fact nothing worthwhile has been invented in any of the
Islamic countries, at least in this century.

Let me hasten to assure the reader that the problem is not with the
intelligence and creative abilities of our youth because thousands of
Muslim scientists and engineers have managed to excel in the
West. Many own large computer companies, producing software or
hardware as well other computer related technologies and in the
process have become multi- millionaires. Others have made significant
scientific discoveries in medicine, and various technologies, for
government, university and corporate labs. The ones who succeeded in
business, in developing and bringing their products to the
marketplace, were largely financed by venture capital firms. This,
then is the crucial difference between the United States and the
Islamic countries. In the U.S. if a team of engineers or scientists
have an idea about a new product or application, they can get funding
from a venture capital firm, with the venture capital firm
contributing risk capital and the scientists contributing brains and
their labor. Sadly, in the Islamic countries, no such risk capital is
available to talented and bright engineers, scientists, and
entrepreneurs.

If the leaders in the Islamic world are truly interested in improving
the living standards of their people, gaining economic independence,
regaining their pride and days of glory, they must encourage original
discovery, research and invention. And the Islamic banks are in a
unique position to make a beginning. One idea would be for the leading
Islamic banks to set up a venture capital fund of about $2 billion,
each contributing, say five percent of their assets. The fund would,
assemble teams of engineers, scientists and entrepreneurs and finance
them as partners. Most of these people can be found working in the
Western world and some may be persuaded to come back, provided
sufficient incentives are provided both with respect to working
conditions as well as shares in respective companies. Affluent Muslims
in the United States could set up a similar venture capital firm to
finance on an equity basis bright computer engineers and scientists
currently working in the United States. The U.S. venture capital
funds make about 25% to 50% p.a. on invested capital. There is no
reason why the Islamic banks would make any less on their venture
capital fund. More compelling is the rationale for engaging in this
type of financing: it is the truest form of Islamic banking--the
marriage between brains and capital.