Fundamentals of Islamic

Economic System
CAPITAL
Capital
Capital is the third factor of production. It is that wealth which assists in the production of
further wealth. It is “produced means of production” or in other words “man-made instrument
of production”
Distinguished from land and labour, which are called primary or original factors of production,
capital is man-made or produced factor of production.
Capital
Capital is generally classified into fixed capital
and working capital:
◦ [Link] capital comprises durable-use produce
goods which are used in production again and
again till they wear out. (Plant and machinery,
tools and instruments, tractors and trucks, etc);
◦ 2. Working capital comprises single-use producer
goods like raw materials which are used up on a
single act of use.

*It is called fixed capital because it is money spent

upon durable-use goods like plant and machinery
becomes ‘fixed’ for a long period
 Importance of Capital
Capital is like blood in human body which runs into the veins of industry and keeps it going :
◦ If man does not use tools and machines in farming, mining and manufacturing sectors and works with
his own hands, productivity would be very low
◦ Capital occupies a pivotal position in the process of economic development as well as in creation of
employment opportunities

The Qur’an talks of the use of cattle wealth as capital goods of production:
- And the cattle hath He created, whence ye have warm clothing and uses, and whereof ye
eat…….. And they bear your loads for you unto a land ye could not reach save with great trouble
to yourselves……… And horses and mules and asses that ye may ride them……….
(16:5-8)
Importance of Capital
- And Lo! in the cattle there is a lesson for you. We give you to drink of that which is in their
bellies…….. pure milk palatable to the drinkers.
(16:66)
- And Allah hath given you in your houses an abode, and hath given (also), of the hides of
cattle, tent-houses which ye find light (to carry) on the day of migration and on the day of
pitching camp; and of their wool and their fur and their heir, caparison and comfort for a while.
(16:80)
In the mentioned verses, the Holy Qur’an has referred to various uses of cattle and horses as
factors of production such as in transportation, in production of milk, wool, fur, hides for tent-
houses, and so on.
Capital Formation
Capital formation means increasing the stock
of real capital in the country. It involves
production of more capital goods, encouraging
savings and investments, etc.

Islam believes in all such measures except

interest on investments as interest is
prohibited.
Capital Formation
Some of the steps taken by Islam in ensuring capital
formation are:
1. Zakat has been imposed on hoarded wealth in
the form of gold and silver, bank deposits, cash, etc.
If this wealth is put into productive channels, its
Zakat would be paid out of its income and thus the
wealth would grow despite Zakat. But if the wealth
is kept hoarded and idle, the regular payment of
Zakat out of it every year would reduce it and
ultimately diminish it. This helps in capital
formation.
Capital Formation
2. Wealth employed in production has been exempted from Zakat. For example agricultural
land is exempt from Zakat; cattle employed in farming are exempt; horses used for riding,
transport and jihad are exempt; plant and machinery used in factories and farms for production
of goods are exempt; tools and instruments used by a professional or an artisan are exempt, and
so on.
3. Those who dispose of their capital assets like house or land have been enjoined upon by
the Prophet (PBUH) to re-invest the cash in the purchase of some other land or house. The
Prophet is reported to have said:
“God may not bless the price of that land and that house which is not again re-invested in land
or a house”.
Capital Formation
4. Squandering of wealth on extravagant spending has been strictly prohibited. Spending on
luxuries is strongly forbidden and ostentatious living has been discouraged. The Qur’an says:
- Eat and drink, but be not prodigal. Lo! He (Allah) loveth not the prodigals.
-(7:31)
- ……….. and squander not (thy wealth) in wantonness. Lo! the squanderers were ever
brothers of the devil……..
-(17:26-27)
Reward for Capital
In Islamic economy, the saver can either invest his capital as a sole proprietor and do the
business, or he can invest in a Mudarabah or a Musharika.
In Mudarabah, one person provides capital, the other labour and both share in profit in
stipulated proportions, but in case the business results in loss the whole of loss in borne by the
capitalist.
In Musharika or Shirkat, all the partners put up their capital and do the business in partnership
sharing profits and losses in agreed proportions.
Fundamentals of Islamic
Economic System
ENTERPRISE
Enterprise and Entreprenuer
Enterprise, after land, labour and capital, is the fourth factor of production. It is the whole job of
organisation, planning and managing of business.
Due to emergence of lar
The entrepreneur is the a specialist in the work of organization. He may not own any land, he
may not have any capital, he will not be expected to be like a common labourer, but he
possesses organising ability and management skill.
The entrepreneur is the one who employs other factors of production, remunerates them and
gets maximum production with minimum cost. He is thus like a captain of a ship who steers the
ship of industry to safe waters in the harbour of economic prosperity
Enterprise and Entreprenuer
The story of Joseph relates how Prophet Joseph persuades the king of Egypt to appoint him in
charge of storehouses.
The relevant verse reads : “He said : set me over the storehouses of the land. Lo! I am a skilled
custodian.” (12:55). The Arabic version of this verse is more clear.
In that version two words ‘Aleem’ and ‘Hafeez’ have been used which mean knowledgeable and
trustworthy or custodian. Both these qualities are essential requirement for a entrepreneur or
organiser. Thus on the basis of these two qualities, the great Prophet requests the king to put
him over the organisation of storehouses of kingdom.
 Forms of Organisation
In the modern world, enterprise finds its manifestations in the form of different business
organisations. Sole proprietorship, firm or partnership, Joint-stock company, public sector
corporation, etc. are examples of business organization.
In Islam, mainly business organisations like sole proprietorships, Mudarabah, Shirkah and
Agency, etc. have existed.
In the following sections, the Islamic business organisations like Mudarabah and Shirkah shall be
discussed.
Mudarabah
Mudarabah is form of business organisation in which one person gives capital to another person
for business and both of them share profits in mutually agreed proportions.
The former, the supplier of capital, is called the ‘Mudarib’ and the latter, the user of capital or
entrepreneur, is called ‘Darib’.
Thus ‘Mudarabah’ is a contractual relationship executed between two parties, one supplying the
capital and the other supplying the labour and skill, for business the profits of which are shared
by both in accordance with agreed terms.
Mudarabah
The ‘Mudarabah’ is an Iraqi term which is derived from the Arabic word ‘Darb’. The ‘Darb’ means
to walk or travel in the land. It is so called because in mediavel times the ‘Darib’ had to travel in
distant lands for commercial ventures to make profits.
The Medinites called this form of business as ‘Muqaradah’ which is derived from the Arabic
word ‘Qard’. ‘Qard’ means loan which signifies surrender of right over capital by the owner to
the user. The Muqaradah is also called Qirad.
The Holy Prophet himself is reported to have worked as Darib for Khadijah during his youth. His
companions are also reported to have been practicing this form of business partnership.
However, there is no reference to it in any Qur’anic verse and there is hardly any instruction
about it in any tradition of the Prophet of Islam.
It appears that concept of Mudarabah was developed by the Muslim jurists later on
Mudarabah
Rules & Conditions:
1. Two or more persons, of their own free will, should enter into contract whereby one party
provides a specified amount of capital to the other who employs this capital in business to make
profit.
2. Share of each party in the profit should be clearly defined in definite ratio or percentage.
However, the loss of business should be the responsibility of the Mudarib.
3. The capital should be in terms of gold or silver coins or standard money in circulation and
not in commodities.
Mudarabah
4. The Mudarib should hand over the capital to the Darib before the Darib starts business.
5. The Darib is absolutely free to trade or do business with the capital as he deems fit. Any
condition limiting his freedom may render the contract invalid.
6. The duration of Mudarabah is neither predetermined nor limited but either party can
terminate it by giving a notice of his intention to do so.
Musharikah or Shirkah
Shirkah means conjunction of two or more estates. In law, however, Shirkah stands for
partnership of two or more persons in business or in property.
During the time of the Prophet and his companions, partnership was popular among the
Muslims not only in business but also in agriculture and gardening.
Kinds of Partnership:
1. Shirkah Milk or partnership by the right of property applies where two or more persons are
owners of one thing. It is compulsory where properties of two or more persons become united
without their willful act, for example inheritance.
2. Shirkah Abid or partnership by contract comes into existence when two or more persons, by
their free consent, enter into contract to do some business with a view to share its profits and
losses
Musharikah or Shirkah
Four Kinds of Shirkah Abid:
1. Shirkat-ul-Mufavadha : In this form of partnership, the capital contribution of the partners
and their shares in profits and losses are equal.
2. Shirkat-ul-Anan : In this form of partnership, the partners neither contribute equally in
capital nor do they share the profits and losses equally. This form of partnership was very
common among the men with women or children or between masters and their servants.
3. Shirkat-ul-Sanai : In this form of partnership, artisans, technicians and other manual
labourers participate.
4. Shirkat-ul-Wujooh : This is a form of partnership which is started by the person who have
neither capital nor skill but they start the business on credit as partners and share the profits
among themselves.
Musharikah or Shirkah
Conditions of Partnership:
1. All the partners should enter into contract with their own free consent to do a business in
partnership, and the date from which partnership would come into force would be clearly
mentioned in the contract.
2. Partnership contract, according to some jurists is legal only if it is in legal tender money.
3. Jurists like Imam Sarikhsi prescribe that partnership contract should be executed in
writing. According to him, Quranic condition laid down in verse 282 of its chapter 2 for a
contract of debt is also applicable to contract of partnership because like contract of debt this
contract is also made for a definite period.
Musharikah or Shirkah
4. The amount of capital contributed by each partner should be clearly stated in the deed of
partnership.
5. The share in the profit or loss to be obtained by each partner should also be clearly stated
in the deed so as to avoid any dispute which may arise.
Fundamentals of Islamic
Economic System
INTEREST
RIBA
Riba is an Arabic word drive from word RIBH which means Profit.
Ribh means excess, increase or addition in accordance to the Islamic guidance for commercial &
business practices & correctly interpreted according to Sharia'h terminology as
Double Profit.
RIBA is any earning, income, profit or benefits being earned, taken or received through wrong means,
bad intentions, shady practices or wicked participation.

Riba is not only treated as immoral, unjust filthy but furthermore threat to SOCIO ECONOMIC LIFE
OF SOCIETY.

Riba leads to crimes of various nature, through Cruelty, Humiliation, Exploitation, Self-importance,
Discrimination, Power, Lust Selfishness, Greed and self-esteem
HOLY QURAN AL-BAQARAH 2:275-6
People who indulge in Riba shall be raised like those who have been Driven to
madness by the touch of Devil. That is because they say that Riba-based transaction is
just like trading, while Allah has permitted trade and prohibited Riba.
Hence those who have received the warning from Allah and have stop accordingly, may have
what has already passed, their case being entrust to Allah but those who revert to
Riba-based dealings, shall be the inhabitants of the hell-fire and
abide therein for ever. (You must know that) Allah deprives Riba from all blessings and
blesses charity; He loves not any ungrateful sinners.
HADIATH REINFORCE CONCEPT OF QURANIC
RIBA
Prophet Muhammad Said At the last Pilgrimage,
All Riba of Jahilliya is null and void. In this respect, the first Riba I withdraw that the
borrowers owe to my uncle Abbas; it is cancelled completely.
The Prophet cursed all those who
take Riba, who give Riba, who write a Riba
contract and the two witnesses to a Riba contract.
He further said: "They are all alike
(in fault).“ (Muslim 2995)
RIBA IN FINANCIAL AFFAIRS
Riba must be eliminated from the financial transactions.

Riba convert financing system into lending system that make the money as a commodity and
owner of the wealth, a seller and user of the same as buyer.

Riba does not justify money to be a medium of exchange and brings the love of money instead
of respect for the money.
Interest defined
Interest is an earning through lending on money by lender from borrower on
condition that lender shall charge a fixed amount of money in addition to the
principal.
Interest is prohibited in Islam and people are not allowed to make money by lending
their capital on interest.
Capital is to be invested in productive manner that increases the profits.
INTEREST IS THE PRICE OF MONEY
Whereas money is just an intermediary between exchanges of transaction.
There are many categories of Riba.
INTEREST is one of the categories of Riba
 Riba does not justify money to be a medium of exchange and develop the love of money in
several ways that disrupt the entire system of mankind.
Islam stresses a respect of money by disregard lending and borrowing
Islam guide to financing on participation by uniting money with skill as equal in
volume against value by making effort, utilization and participation in gaining
the purpose.
 Islam guides the point of origin and limit of destination of monetary transaction.
Islam defines duties and responsibilities between money owner and money user.
The combination and participation of money and effort brings the result which is
share according to the pre-agreed terms of understanding is the

creation of Profit
FUNDAMENTAL FACTS ON RIBA
“NO ISLAM EXISTS IN A PLACE WHERE THERE IS RIBA BASED
SYSTEM”.
Riba based system is a misery not only on humanity, faith, morals or imagination
of life, but also in every core of economic and practical life.
It is the most hateful system, which eradicates human satisfaction and frustrates
its civilized and neutral developments.
Ethics & reality cannot be separated in Islam & cannot be practiced alone.
Riba practices corrupt the individual’s ethics, behavior, and feelings towards
community and the society.
It also corrupts the human life, culture and the relationship by spreading the
spirit of greed, selfishness, sneakiness and gambling in general.
RIBA AL NASSIEAH

Riba al Nassieah practiced before Islam as man paying his money to another for a pre agreed
period.
In return, he took from him a certain amount every month without taking the principal amount.
When date of payment came, he asked him for his capital and if he was unable to repay would
increase in his fund and the term of repayment.
RIBA AL FADI

A man sells an article in exchange of another article having same quality and nature with an
increase or decrease like gold sold for gold, rupee for a rupee, corn for corn and barley for
barley.
This kind is considered as Riba, as commodities are similar to each with different values not
ascertain.
Such transaction has the involvement of exploitation and injustice on any one’s part of the two.
Fundamentals of Islamic
Economic System
LOAN
General Rules
Islam recognises Qard Hasanah (gratuitous loan) only.
Loan may be in any form i.e. in cash or in commodity, it may be big or small, it may be for
personal needs of the debtor or for purpose of business
The loan shall be given without interest.
Interest has been prohibited by Islam and so it cannot be charged on any loan in any form.
No loan should be contracted except in case of extreme necessity. Borrowing for purpose of
luxurious and extravagant living is not permitted.
The lender can ask for some security in the shape of any asset or property from the debtor as a
guarantee of repayment of loan. It is technically called mortgage or ‘Rahn’.
Payment of debt is a first charge upon the estate of deceased before the estate is divided
among its legal heirs.
In the absence of any such contract, the repayment of debt voluntarily with excess amount is
lawful.
Loan should be contracted with an intention of repaying it.
Creditor has right to use harsh words against a debtor who does not pay back his loan.
When there is dispute between the creditor and the debtor regarding repayment of loan and
the debtor is unable to satisfy the demand of the creditor, the ruler or the judge should try to
make settlement between them.
If a poor person dies with unpaid debt leaving no property for its discharge, Islamic state is
responsible for its payment provided the debt is genuine and the Islamic state is financially in a
position to do so. It can repay such debts from its Zakat funds also.
Islamic teachings advocate
Fair and equitable Providing the poor with

distribution of wealth. basic needs for life.

Protection of the weak

against economic
exploitation.
What does the Qur’an teach us about the
distribution of wealth?

‘Wealth should not circulate between the

rich amongst you.’
(Qur’an 59:7
EFFECT OF DEBT
Often more is spent by poor countries on
debt repayments than on basic public services
such as healthcare or education.

The debt crisis has caused the world’s

poorest countries to be trapped in a
cycle of poverty.
What does the Qur’an teach us about
interest?
‘If the debtor is in difficulty, grant him time
till it is easy for him to repay. But if you remit
it by way of charity, that is best for you if
only you knew .’
(Qur’an 2:280)
Islam encourages ethical money lending.
Money lending should be undertaken on the basis of ‘equitable risk sharing’.

This means that both parties share in the reward, or the failure of the investment.

It is the obligation of the lender to provide loans in a responsible manner and not overburden
the borrower.
Islam supports full debt cancellation
If someone is
genuinely unable to
make a debt
payment:

Islam calls upon the

There should be no
lender to wait until
penalty for late
such a time as the
payment.
loan can be repaid.

For those unable to repay a loan, Islam encourages the lender to forgive the remainder of the loan.
FUNDAMENTAL FACTS ON RIBA
“NO ISLAM EXISTS IN A PLACE WHERE THERE IS RIBA BASED
SYSTEM”.
Riba based system is a misery not only on humanity, faith, morals or imagination
of life, but also in every core of economic and practical life.
It is the most hateful system, which eradicates human satisfaction and frustrates
its civilized and neutral developments.
Ethics & reality cannot be separated in Islam & cannot be practiced alone.
Riba practices corrupt the individual’s ethics, behavior, and feelings towards
community and the society.
It also corrupts the human life, culture and the relationship by spreading the
spirit of greed, selfishness, sneakiness and gambling in general.
 DUTIES OF DEBTORS
1. A person should avoid indebtedness because debt is a great burden and responsibility
2. Debt should be incurred only when it is unavoidable.
3. Debt should be taken with a clear intention to pay it back.
4. If a creditor demands for some security in shape of property or asset, the debtor is bound to
provide him the same.
5. Debtor should pay back the debt promptly on the promised date or earlier.
6. If the debtor does not honour his pledge and does not make the payment of loan despite
persistent demand of the creditor, the creditor has the right to use harsh words and sue him in a
court.
7. Non-payment of debt is a great sin. Therefore, the debtor is duty-bound to clear his debts before
his death. Otherwise his legal heirs should clear his debts.
8. Contract of loan should be reduced in writing in the presence of two witnesses.
 DUTIES OF CREDITOR
1. A Muslim who advances loan should know that interest is forbidden in Islam.
2. Loan should be advanced to a genuinely needy person who requires the loan for his genuine needs and not
for the purpose of luxuries or extravagant expenses
3. When a creditor lends money to someone, he should make a contract in writing with the debtor settling
terms and conditions of loan and the time for its return.
4. The creditor should be generous enough in extending the time of repayment of loan if the debtor is in
straitened circumstance and is unable to meet his demand.
5. If the debtor has become insolvent and is not in a position to pay back the loan, the creditor is enjoined upon
to remit the debt.
6. If the debtor is not able to make full payment, the creditor shall accept partial payment and remit the
balance or accept payment in installments.
7. Although a creditor is allowed to use harsh words in case of a solvent debtor who does not repay the loan
despite persistent demand, but still he is instructed not to lose his cool.
8. If the debtor has surrendered some property or asset as security to the creditor, the creditor is not entitled to
take any undue profit or benefit out of that because, according to jurists, it would amount to usury.