Re-examining the structure of firms and the provision of finance / the case for Islamic partnerships

Abstract

Previously, prior to the onset of banking and the provision of debt finance, debt was an exception and not the rule. Muslims used loans as an act of charity through al-qard al-hassan and never expected profit out of a loan. Instead, partnerships were the main source of private equity finance and were significant in the Muslim world since the Prophet (pbuh) time and even before. And while Muslims relied on mudarabah and musharakah, in the Medieval Europe they were using commenda and societas for their investments which are equivalent to mudarabah and musharakah, respectively. But with the emergence and evolution of banks followed by corporations the whole financial system was altered, and the role of partnerships started to shrink, while banks became the main provision of debt finance and corporations are the main demanders or borrowers. On the other hand, partnerships were often combining capital and labor. Accordingly, many issues started to arise. For instance, there is no consensus among scholars and economists up until today on how banks work internally and whether they have the ability to create money. They adopted three different theories and each one is based on different understanding of how banks and money function and leads to totally different economic and policy implications. Moreover, corporations' structure raised many issues among which legal personality issue is the most important. In fact, the whole structure was borrowed from the English law and hence raised doubt about its compliance with Shari’ah. Accordingly, the study aims to re-examine the structure of corporations and the provision of debt finance under the principles of Islamic law and their effect on the economy as compared to the partnerships. The study combined different approaches such as library research, content analysis as well as case study to help answering the research questions. Findings were that neither the financial intermediation theory currently in use, nor the fractional reserve theory proved to be correct. The only correct theory that is supported by an empirical evidence is the money creation theory which states that banks can create money out of nothing. The study also found that Islamic banks are not different from conventional banks in terms of the economic substance. Moreover, after analyzing the concept of legal personality, the study found that this concept was not accepted by the classical scholars although the majority of the contemporary scholars insist on its validity. Finally, partnerships were found to be more efficient than the debt-based system in terms of allocating the investable resources and the marginal efficiency of capital. Some recommendations were given in the last chapter that help improving equity-based financing and partnerships. The suggestions included legislating mudarabah and musharakah restructuring and implementing Islamic private equity funds, codifying Islamic financial law and adopting some of the existent fintech strategies and innovate new ones in order to improve equity-based investment and hence improve the whole economy creatively while minimizing costs. The study also suggests carrying out future research especially on the concept of separate legal personality and calls the contemporary scholars to participate. 11