CASH WAQFS AND VENTURE CAPITAL
MURAT CIZACKA
The leaders of the Muslim World grapple with the problem of how best to manage their economies. Despite the problems inherent in the capitalist and communist systems – never more painfully apparent than now as the worst recession since the war increases its strangle-hold on the West and the ex-Communist countries struggle to beat spiralling inflation – Muslim leaders still look to these systems for guidance.
Yet the answers to the economic problems lie in their own history and tradition. One such period which Muslim leaders should learn from is the Ottoman Empire, where economic success brought the Muslim world much power and influence.
History
One of the most striking features of the Ottoman Empire’s financial system was the Cash Waqf (Awqaf al-Nukud). This was considered an important means of increasing the money supply, from those with funds, to those who needed capital, primarily entrepreneurs, but often ordinary members of the public as well.
The Cash Waqf was regarded as a trust fund, the returns on which would be used for serving mankind in the name of God. In a society where health, education and welfare were entirely financed by gifts and endowments, the Cash Waqfs carried serious implications for the very survival of the Ottoman social structure.
These endowments were approved by the Ottoman courts as early as the beginning of the 15th century and by the end of the 16th, they had become extremely popular all over Anatolia and the European provinces of the Empire, although surprisingly they did not take off in the Arab provinces.
Their importance in relation to the more traditional Awqaf, i.e., the Land Waqfs, increased dramatically over time. While the Cash Waqfs constituted about 16 per cent of the Awqaf established during the reign of Mehmed the Conqueror, in the year 1505 the ratio increased to 50 per cent and by about 1560 they had become the dominant mode of endowment.
Legal Background
Whilst at first the legal issues surrounding the Cash Waqfs appear many and complex, they can be reduced to two points: the problem of perpetuity and the threat of Riba in the transferring of endowment funds.
According to the Hanafi school -the dominant school of thought during the Ottoman period – the perpetuity of the endowed asset is the essence of any Waqf, and in principle, at least, should consist of real estate. However, if the endowed real estate includes moveable assets such as oxen or sheep then the assets become Waqf.
The next question to be considered is whether money qualifies as a moveable asset. This was answered by Imam Zafer, who ruled that money could be considered as a moveable asset and so qualified as Waqf.
Zafer outlined how such an endowment could be organised in order to avoid Riba. The endowed cash would be given as the capital of a Mudaraba partnership, rather than being placed in an interest-making account, and the profit thus obtained would be spent in accordance with the general purpose of the Waqf.
Or, if the moveable assets endowed were not cash, then they could be sold and the return could be used as the capital of the Mudaraba.
The acceptance of moveables as the basis of a Waqf, combined with Imam Zafer’s interpretation of cash as a moveable asset and approval of the cash endowment, constituted the foundation upon which the later Ottoman jurists built the structure of the Cash Waqfs.
Demise
However, the Cash Waqfs were to disappear as quickly as they had appeared. A probable explanation for this can be found in the way the profits generated by the Awqaf were utilised. According to studies, only 30 per cent of the Cash Waqfs generated profits above costs, which were then used entirely for religious or educational purposes. Reinvestment of profits and the enlargement of the original capital was conspicuously lacking.
All well and good, one might say, but how relevant is a Cash Waqf which had its hey-day in the 16th century to modern-day Muslim economies? And assuming that these institutions can be up-dated, is it possible to avoid the mistakes of the past and maintain the virtues?
Cash Waqfs and the Modern World
As has been said, the function of the Cash Waqfs was to transfer – within the framework of Islamic financial principles – the excess savings of the wealthy Muslims to those who needed capital. At the moment, this function is performed by Islamic banks. However, in the future. Cash Waqfs may develop a role in modern Muslim economies as a complementary system to the Islamic banks.
Such a dual system would help the development of Muslim economies. While Islamic banks have proven themselves, they are nevertheless subject to criticism for resorting excessively to Murabaha in transferring their funds to entrepreneurs. However, there are those who believe that Murabaha, in the modern context, is dangerously close to Riba and so Mudaraba and Musharaka partnerships should be utilised.
Islamic banks are faced with a dilemma: on the one hand they generate handsome profits, thanks to Murabaha; on the other hand, they are criticised for using this instrument. In response to such criticism, the Islamic banks have made earnest efforts to utilise Mudaraba and Musharaka partnerships, but to no avail. The problem persists and Murabaha dominates investment portfolios at the rate of 95 per cent.
There are many valid reasons why Islamic banks have failed to transform the structure of their investment portfolios. However, these are not the concern of this article. It has been suggested that if Islamic banks are not able to alter their portfolios, then Mudaraba and Musharaka partnerships ought to be utilised by venture capital companies (VCC).
There are remarkable similarities between the VCCs and Mudaraba and Musharaka partnerships, in that they provide not only long-term capital to the entrepreneurs, but are also willing to support them in case of difficulties.
The perennial problem for the VCCs is finance. The problem of where to obtain funds that can be transferred to the entrepreneurs through Mudaraba is one that is not easily solved. One obvious source is the Islamic banks. It has been recommended that the government force Islamic banks to allocate five per cent of their investment portfolio per annum, cumulatively, to the purchase of VCC equities.
Capital Shortage
However, equity purchase by Islamic banks cannot by itself solve this problem, as these banks may unexpectedly encounter liquidity shortage and be forced to sell the shares of the VCCs on the stock exchange. In such a situation, they would inevitably deprive the VCCs of much needed capital. Clearly, what the VCCs ultimately need is long-term capital.
It is at this point that the cash Waqfs enter the picture. Waqf capital, by definition, once endowed cannot be withdrawn by the founder. Thus, Cash Waqfs could solve the most serious problem faced by the VCCs – the shortage of long-term capital.
Cash Waqfs and Venture Capital
Let us now envisage how the Cash Waqfs can be combined with venture capital. Assume that a person wishes to establish a Cash Waqf with his savings, and help finance entrepreneurs. The founder of the Waqf approaches a VCC and deposits his savings with them. The VCC would then sign a Mudaraba contract with the Waqf, thus becoming its Mudarib.
When it comes to the transfer of Waqf fund s to the entrepreneurs, the VCC stipulates that the capital of the Waqf will be invested solely in Mudaraba or Musharaka partnerships, thus eliminating all doubts about the legitimacy of the investment from the Islamic point of view. Structurally speaking, this is now a triple Mudaraba, with three parties involved, the Waqf, the VCC and the entrepreneur.
In order to minimise and diversify the risk, the VCC should aim to invest the Waqf capital with several entrepreneurs. Once profits are generated, they can be distributed among the parties as follows: in a normal Mudaraba partnership, the usual profit-sharing ratio is l/4th to the Mudarib (entrepreneur) and 3/4th to the Rab al-Mal (VCC). So, the VCC obtains 3/4th of the profit of the entrepreneur plus the original capital whenever the project matures.
Since the VCC signed a Mudaraba contract with the Waqf, the same ratios are observed while distributing the profits between the VCC and the Waqf Thus, the Waqf obtains the original capital plus 3/4th of the profit earned by the VCC, and the latter keeps 1/4 of it for venture capital services rendered. Thus, in short, the Waqf obtains 3/4 of the 3/4th or 9/16th of the profit generated by the entrepreneur. Put differently, if the entrepreneur earns a profit of 100 dollars, the Waqf gets 56.25 dollars as its share, plus, of course, the original capital invested by the Waqf.
Avoiding Loss
Because what is involved here is essentially Waqf capital, the issue of perpetuity assumes great importance. The danger of loss can be reduced to a minimum by setting up two separate investment portfolios. The first one is established by the founder, who can divide his total savings among a number of VCCs, thus, in effect, establishing several cash Waqf, and the second is established by each of the VCCs, which can invest the Waqf’s capital with several entrepreneurs.
Another means of reducing the risks is the reinvestment of the profits generated. As will be recalled, the greatest weakness of the Ottoman Cash Waqfs was their inability to reinvest the profits and add to the Waqf capital. In view of this, it is proposed that the modern Cash Waqfs add their profit share to the original capital of the Waqf, thus ensuring the perpetuity of the endowment. It is quite possible that not only will the perpetuity be assured, but, if also managed properly, the original endowment will grow in real terms.
It is apparent that the bottom line for the success of the Waqf is proper management. Consequently, the involvement of a third party in the affairs of the Waqf may be desirable. By allocating, say 1/10th of the Waqf’s profit share to a neutral third party, a body of ‘inspectors’, who are capable of analysing the income and balance sheets of the VCC, can be recruited.
Potential
If the Cash Waqf were to be combined with the venture capital sector, their potential would be enormous. They would be able to operate in accordance with the Sharia and solve the problem of perpetuity in Waqf Capitals and also the problem of Riba.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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