This action might not be possible to undo. Are you sure you want to continue?
Time Value of Money and Riba¶: Islamic Perspective
Azah Atikah Binti Anwar Batcha 0900157 CIFP Full-Time
This project paper is a partial fulfillment of Module SH 1003 of Part I of Certified Islamic Finance Professional (CIFP) INCEIF September 2009
Abstract ................................................................................................................................................... 3 Introduction ............................................................................................................................................. 4 Literature Review .................................................................................................................................... 8 1.0 2.0 Definition of Money: Conventional and Islamic Concept .............................................................. 9 Characteristic of Money: Conventional and Islamic Perspectives. ............................................... 10
3.0 Origin of Money and Its Creation ..................................................................................................... 12 3.1 The Emergence of Money ............................................................................................................ 13 3. 2 Creation of Money from Islamic perspective ............................................................................... 14 4.0 Time Value of Money ................................................................................................................ 16
4.1 Time Value of Money and Its Perspective in Islamic Finance ....................................................... 16 4.2 General Consensus on Time Value of Money ............................................................................... 19 4.3 Fiqhi Justification on Time Value of Money ................................................................................. 20 5.0 5.1 5.2 Definition of Riba ...................................................................................................................... 22 Types of Riba ......................................................................................................................... 23 Prohibition of Riba ................................................................................................................. 24
6.0 Relationship between Time Value of Money and Riba ..................................................................... 25 7.0 Effects of Riba ................................................................................................................................. 26 7.1 Moral Effects to Individuals and Society ...................................................................................... 26 7.2 Economic and Financial Effects ................................................................................................... 27 8.0 Interest-Free Banking as an Idea and Alternative .............................................................................. 28 Conclusion ............................................................................................................................................ 30 Bibliography.......................................................................................................................................... 31
Time Value of Money and Riba¶: Islamic Perspective
Azah Atikah Binti Anwar Batcha
This paper attempts to discuss the relationship between Time value of money and riba as well as the consequences in our daily lives. The paper discovers that there are differences between time preference and time value of money. While the first is considered natural because scholars do not object to cash price being lesser than deferred price, they allow the latter to be much more than the former. Hence in view of these differences TP is not objectionable. Furthermore, there is a relationship between TVM with riba. Since money is considered a commodity from the conventional perspective, time is an economic factor. Hence, this paper will analyze the related effects of interests on individual as well as the general economy. The paper equally addressed money from the historic perspective, its definition and its characteristics. Drawing a relationship with money and time value is a critical aspect of the topic. It concludes with proposal for an alternative to riba. This proposal looks at the establishment of an interest free banking in Islamic economy.
This paper basically investigates the possible modus operandi of time valuation according to the Shariah perception in relation to the concept of money. In addition, it will also investigate whether any value can be attributed to time while considering money¶s value. Furthermore, it will also touch on the objectives of Shariah in regard to the prohibition of Riba and examine the consistency of such Fatwas with these objectives apart from this; it will discuss the objectives of the prohibition of Riba, the rationale of the prohibition of Riba and motives to re-derive the objectives or ³the Maqasid´ of this prohibition.
The time value of money is a basic investment concept and a basic element in the conventional theory of finance (Ahmad and Hassan, 2004). This is not being rule out from the Shariah consideration as the Shariah does not prohibit any increment in a loan given to cover the price of a commodity in any sale contract to be paid at a future date (Ahmad and Hassan, 2004). However, what is prohibited is making money¶s time value an element of any lending relationship that considers it to have a predetermined value (Ahmad and Hassan, 2004). Predetermining a profit over money lent out means that the creditor is not assuming any risk whatsoever. If the venture is successful does not matter as the debtor is obliged to pay the interest. The Shariah requires that a loan be due in the same currency in which it was given in the first place. For instance, the value of purchasing power of paper currencies varies due to changes in many variables over which the two parties of a loan contract usually have no control (Ahmad and Hassan, 2004).
0900157 Understanding time value of money concept in the conventional sector and how riba (interest) derived from there is crucial in order for us to understand the fundamental reasoning behind the prohibition of Riba (Rosly, 2005). According to Toutounchian (2009), the fuqaha or also known as the Shariah scholars in Islamic Jurisprudence had meet a mutual agreement that an excess over and above the sum lent would become interest and is treated to be stricly prohibited. This fact is borne out in the Quran, therefore it completes the detailed discussion by all the fuqaha of all the schools of thought without any exception.
Time value of money is related to riba in financial transactions when people think that one dollar today would worth much more than one dollar tomorrow. This line of thinking reclines on the notion of positive return at all times. In view of this, they become believers of positive time preference (Rosly, 2005). Rosly (2005) added that the capitalistic system are based from such belief and that people embraced positive time preference. The implication of this is that there would be a contractual payment and receipts of interest regardless of the business outcome. Financial transaction fundamental laws require debtors to pay interest on loans. Therefore, in this way, creditors who had forgone the pleasure of current consumption are guaranteed a contractual surplus on the loan they give out as a compensation for postponing current consumption (Rosly, 2005). Hence, it is important to understand the underlying issues of the above scenario as in capitalistic system, compensations for waiting are contractual in nature and influenced by the uncertain future (Rosly, 2005). Without any hesistance, this contractual payment must be made in order to compensate for the utility loss from delayed consumption. Therefore, this does not make sense as we should always be certain that we are going to get (Rosly, 2005).
0900157 Apart from this, the relation of riba to the pricing of islamic product is that the exchange of money can be in spot exchange or a deferred exchange. Additionally, the exchange could be of two similar commodities or two dissimilar commodities (Anwar, 2001). As we know, a gain resulting from an exchange of similar ribawi commodities in different amount is considered as riba (Anwar, 2001). Citing from a hadith which was narrated by Imam Muslim and Imam Nawawy: The Prophet (p.b.u.h) said ³gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt, like for like, equal for equal, hand to hand. If these types differ, then sell them as you wish, if it is hand to hand´ (Al-Darees, 1997).
It is evident from the above hadith that spot (hand to hand) exchange of similar commodities in different amounts is disallowed because the difference in the amount would be riba. Furthermore, the hadith also indicates that spot exchange of dissimilar commodities in same as well as dissimilar amounts is allowed. Hence, any gain accruing in spot exchange of different commodities is also allowed (Anwar, 2001). In addition, according to the Quran, riba is present in deferred exchange of similar ribawi products in unequal amounts. The Quran states the following: ³If ye repent (from riba) ye shall have your capital sums: deal not unjustly, and ye shall not be dealt with unjustly,´ (Quran, 2:279). This holds the meaning that Islamic justice is served when lenders receive only principal amounts of their debts (Anwar, 2001). In other words, whatever commodity is indebted (deferred exchange) that commodity shall be received in its original amount. For instance, if our debt is in money form then we are entitled to retrieve the same amount of money. Hence, if there is any charge above the principal amount, it is called riba. In other words, gains obtained from deferred exchange of similar ribawi commodities are riba. However, if a charge above the principal amount of debt is allowed, then that particular
0900157 charge would represent a compensation for the duration of the debt (Anwar, 2001). Therefore, prohibition of such charge is tantamount to prohibition of time value of money. It is strictly prohibited because in the sense of time value of money it is treated as riba (Anwar, 2001). As such, gains from exchange of similar commodities are riba irrespective of whether the exchange is on spot basis or deferred basis. However, gains may result whenever heterogeneous commodities (or monies) are exchanged. A gainful exchange of heterogeneous commodities is permitted. Gains resulting from spot and deferred exchange of different commodities are permitted because ³Allah hath permitted trade and prohibited usury´ (Al-Quran, 2:275). Trading is permitted but the traders are also supposed to adhere to several other Islamic principles. For example, exchange must be, inter alia, by mutual willingness of the parties involved because Allah commands, ³O ye who believe! Eat not up your property among yourselves in vanities: but let there be amongst you traffic and trade by mutual goodwill´ (Quran, 4:29). In sum, profits do not result merely when parties seal a contract. However, an accrual of islamically legitimate profits must involve exchange of heterogeneous commodities (Anwar, 2001).
Finally, determining the Maqasid of the prohibition of Riba from the main texts in the Quran should be taken into consideration as it defines a contemporary interpretation of the Islamic concept of returns and revenues for generation (Kahf, 2006). According to Kahf (2006), there are two more conditions for the criteria of Islamicity which is to be applied. That is, the underlying asset must be of the kind that is liable to produce return, growth or increment and the transaction must be genuinely meant for what it is for or what defines it. Together, these three conditions channel financing contracts in the desired intended direction that is meant by the prohibition of Riba and at the same time makes it, by the nature of described processes, subject
0900157 to the moral and ethical screening that the Shariah at large calls for and aims at (Kahf, 2006). Within the limits of the Maqasid of the prohibition of Riba, a host of means that makes the risk management in innovative Islamic finance a challenging arena, it does not leave room to resort to dubious and counterproductive interest-mimicking approaches of financing that very often contradict the essence and basic objectives ³Maqasid´ of the prohibition of interest as well as other regulations of Islamic financing (Kahf, 2006).
This is a selective literature review. The writer is considering a few numbers of authors in this review. In a relation, money is a crucial topic to be understood before one tries to understand the basics of Time value of money (TVM) and riba. The concept of money in both Islamic and Conventional perspective was mentioned by Toutounchian (2009), Ikass (2009), and Meera (2002). TVM is a contentious issue in Islamic finance. The modus operandi of TVM had been discussed in detailed by many authors such as Mohsin (2009), Hassan (2004), Malik (1983), and Karim (2001). Also, a number of economists have written extensively on the concept. Rosly (2005) discussed TVM and time preference of money. He actually tries to differentiate between the two concepts. He argued that time preference has no objection from this scholars perspective. Ayub (2007) discussed time value of money and then differentiated between the values added upon trading of commodity as opposed to the value added of money. While the former is permitted from Islamic perspective, the latter is prohibited because it constitutes riba which is prohibited. The prohibition of riba has been clearly mentioned in the Quranic text as well as the Prophetic traditions. Scholars have given ample translation and commentary such as Yusuf Ali
0900157 (2005). Farooq (2006) elaborated about the general consensus among the Scholars. These Scholars have established and discussed the concept. Taqi Usmani (1997) discussed the rationale of the prohibition of riba is to prevent ill morality and selfishness. Gapur (2002) and Khan (2004) proposed the solution to this problem by putting forward the establishment of anr interest-free banking to be practiced in the economy. This review has been a selective method of literature scanning. It has not been exhaustive rather crucial to the most related write ups to this current topic. However, at the course of this writing, other authors or researchers were consulted. It appears that time value of money is indeed a phenomenal issue between the Islamic economists and the Shariah scholars. Each group has its own perspective.
1.0 Definition of Money: Conventional and Islamic Concept
What is money? Money is any good that is widely used and accepted in transactions involving the transfer of goods and services from one person to another. Economists differentiate among three different types of money (Notes, 2009). These three are namely commodity money, fiat money and bank money (Notes, 2009). Commodity money is a good whose value serves as the value of money. Gold coins are an example of commodity money. In most countries, commodity money has been replaced with fiat money.
In the capitalist concept, money is also a commodity since it can earn interest. As such, money can be rented out with a contractual rentals income earned which known as interest (Rosly, 2005). Conventional banking is fundamentally based on loan from both depositor and customer sides (Toutounchian, 2009). Thus, these banks have properly been called Fund
0900157 Intermediaries. However, acting as agents from depositors' side and as shareholders from financiers' side the Islamic bank plays a new role never considered by Western economists (Toutounchian, 2009).
On the other hand, in Islam, money must be allowed to depreciate, meaning it must be susceptible to both possibilities of appreciation and depreciation. In fact, according to Rosly (2005), both will take place if it is channeled into trade and commerce (al-bay¶). In Islam too, money is subject to zakat if idle cash or checkable deposits exceeding the nisab is held over the year (Rosly, 2005). A nisab is the amount required in a specific asset deductable for a zakat purposes. In fact, zakat payments on wealth, including idle money, confirm the rule that money must not be hoard, since doing so will mean loss in purchasing power. Zakat is one way how Islam helps discourage people to hold idle cash for an indefinite time, as doing so disallows those who needs the currency for transaction purposes (Rosly, 2005).
2.0 Characteristic of Money: Conventional and Islamic Perspectives.
In order to understand more on Time value of money relationship with riba, it is crucial to develop a basic understanding on money. According to Ikass ( 2009), the conventional perspective, money can be seen as: 1. Money is a commodity and is used to obtain other goods. 2. Widely Marketable as it is highly in demand and valued good. Thus, it is sure that it can be used anytime and anywhere.
0900157 3. It can be transport easily. Money is made to make human life easier therefore to make sure that it is convenience is important. 4. Relatively scarce as it is high in demand and high in value, which means it holds a high value in small quantities. 5. Money is relatively imperishable. It is durable and can be use for future purchases. 6. Easy to store. 7. Easily divisible. 8. Money lasts forever. 9. All units of money are similar, meaning to say that it is easy to distinguish and estimate the value of the money.
As for the Islamic perspective, Mohsin (2009) and Meera (2002) found that:
1. Money has no intrinsic value. Meaning to say that it cannot be utilized in direct fulfillment of human needs. Money to Islam can only be used to acquire goods or services. It is not a commodity which can e utilized directly without exchanging it for some other things. 2. All units of money of the same denomination are 100 percent equal to each other. 3. In commodity, the transactions of sale and purchase are affected on an identified and specific commodity. 4. Money is a medium of exchange. It is a way to define a value of a thing, but not to itself. 5. Money has standard of value which measures the relative different goods and services.
0900157 6. Money is a unit of account in which values are stated, recorded and settled. It simplifies the exchange of goods and services between buyers and sellers by ensuring that they work in the same pricing units. 7. It is long lasting and durable. 8. It is difficult to counterfeit, and the genuine product should be easily identified. 9. Money makes it easier to do trading. 10. It must be of certain specific weight or measure in order to be in a position of verification. 11. It is divisible into small units without destroying its value. 12. It should be fungible, meaning one unit or piece should be equivalent to another.
3.0 Origin of Money and Its Creation
According to Wikipedia (2009), the history of money spans thousands of years. The scientific study of money and its history and all its varied forms is called Numismatics. Commodity money such as natural scarce precious metals, conch shells, barley, beads and such have been used because it was thought of having value. Both modern money and most ancient money are essentially an abstraction to the current money being used. Furthermore, paper currency is known to be the most common type of physical money today. And both gold and silver present many of money¶s essential properties. The term price system is sometimes used to refer to methods using commodity valuation or money accounting systems (Wikipedia, 2009). Having discussed the history of money, the next section further elaborates on the emergence of money.
0900157 3.1 The Emergence of Money
The emergence of money all started when then Sumer civilization developed a large scale economy based on commodity money. It was then the Babylonians and their neighboring city states developed the earliest system of economics as it is today (Wikipedia, 2009). In addition, the legal rules on debt, legal contracts and law codes relating to business practices and private property also started by them (Wikipedia, 2009). Apart from this, in ancient Babylon, the Code of Hammurabi, which is known to be the best preserved ancient law code, was created. It was then enacted by the sixth Babylonian King Hammurabi. The earlier collections of laws include the codex of Ur-Nammu, who is the King of Ur since 2050 before century, and Codex of Eshnunna since 1930 before century and the codex of Lipit-Ishtar of Isin since 1870 before century. These law codes formalized the role of money in civil society. They set amounts of interests on debt, set fines for people who did wrong, and give out compensations in money for various infractions of formalized law (Wikipedia, 2009).
The Shekel referred to an ancient unit of weight and currency. This term came from Mesopotamia since 3000 before century and referred to a specific mass of barley which related other values in a metric such as silver, bronze, copper and so on (Wikipedia, 2009). A barley or in other word, shekel, was originally known to be both unit of currency and unit of weight. In cultures where metal working was unknown, shell or ivory jewellery were the most divisible, is easily storable and transportable, scarce, and hard to counterfeit objects that could be made. It is highly unlikely that there were formal markets in 100,000 before century (anymore than there are in recently observed hunter13
0900157 gatherer culture in recently observed hunter-gatherer culture (Wikipedia, 2009). In the absence of a medium of exchange, non-monetary societies operated largely along the principles of gift economics. When barter did in fact occur, it was usually between either complete strangers or would-be enemies (Wikipedia, 2009).
3. 2 Creation of Money from Islamic perspective
The monetary and credit policies in any economy have a great impact on the functioning of its financial system through their impact on the quantity and value of money. In Islamic financial system, exploitation of one by another is strictly prohibited and the supply or growth of money should match the supply of goods and services (Ayub, 2007). In short, the three sources of monetary expansion namely financing of government budgetary deficits by borrowing from the central bank which is the major source of expansion. Other than this, secondary credit creation is by commercial banks and the exogenous factors. The central bank would gear its monetary policy to the generation of growth in the money supply, which is neither ³inadequate´ nor ³excessive but just sufficient to exploit fully the capacity of the economy to supply goods and services for broad-based welfare (Ayub, 2007).
In the dual system where Islamic bank is linked to the conventional banking system through fiat money, fractional reserve requirements and interest rates, the bank cannot operate independently and interest rates, the bank cannot operate independently from the conventional banking system according to its own principles (Meera, 2002). This is because arbitrage opportunities would set in if there are any ³price´ differentials between
0900157 the Islamic and conventional systems. Profiteering such arbitrage opportunities would move the pricing in these two systems to converge, a fore in economics called the Law at One Price (Meera, 2002).
Therefore, in the present system the Islamic bank cannot be independent from even the interest rates in the economy, the very thing it tries to avoid it in the first place. In fact, it is only a matter of time even the Islamic bank to truly operate on Islamic bank to truly operate on Islamic principles, it is imperative to redefine money and eliminate interest rate (Meera, 2002).
The above statements are truth as in many nations, including Malaysian banks, are operating presumably on Islamic Shariah principles. The banks claim they do not indulge in interest or riba that is strongly prohibited in Islam, and also design their financial products and instruments based on the Shariah principles. The banks should be commended for coming up with such products and instruments that strive to provide Muslims with an alternative banking and finance which are in line with the teachings of Islam. However, it should be noted that in a dual system where Islamic bank operates in a fiat money and interest-based financial system, the banks would also be creating money. Thus, instead of being a solution to the problem, Islamic banks too, works almost the same as conventional banks (Meera, 2002).
0900157 4.0 Time Value of Money
The main objective of this section is to examine the rationale of the concept of time value of money and how it works. This relates to the previous section of this topic that discussed money, its history and creation. As a result, the main conclusion of the section is that the concept of time value of money would open door of riba and its acceptance would allow riba to stay intact in the economy. In between these pages, we shall find that the examination of the concept reveals that it is unacceptable on rational grounds. However, the debate on time value of money has become nonstop as both Shariah as well as Islamic economists have collectively dealt with the concept.
4.1 Time Value of Money and Its Perspective in Islamic Finance Study had shown that time has an economic value. This happens when all consumption and production activities take place within a given time. As such, time is known to be a valuable economic resource and a point of reference. For example, a lecturer may earn a minimum of RM300, while other lecturers with the same qualification would earn as much as RM6, 000. By doing so, the lecturer had chosen to improve his self-worth and wealth. And if he had chosen not to lecture, then he had lost the opportunity to increase his earning (Mohsin, 2009).
Time value of money is an important cornerstone of modern finance as earlier mentioned. In basic terms, it means that money has its own time value. RM 2,000 today is not the same as RM 2,000 after a year (Mohsin, 2009). A rational individual would prefer the former than the latter. The basic fundamental reason behind this are that, first, a cash flow
0900157 of RM 2,000 now to an individual implies that he can purchase and consumer goods and services worth the amount now, while RM2,000 in a year¶s time would mean that he has to wait until then before he could consume. The sacrifice involved in the postponement of consuming the money requires the individual to be ³compensated´ for ³waiting´ (Mohsin, 2009). Arguably, concern on consumption in the ³future´ always hit individuals just as hard as their concern towards current consumption. Moreover, if an individual consciously saves either for the rainy day or to finance specific needs in the future, such future consumption if often more important than the present consumption. And of course, one must realize that saving for the rainy day occurs only when one has started out on one¶s current needs (Mohsin, 2009).
Another argument put forward which favors the time value of money concept is that it holds greater merit. Furthermore, it asserts that an individual would prefer RM 2,000 now over tomorrow since he would have the alternative to invest this amount now and earn a return immediately. As for this rate of return, it is known in conventional finance as rate of interest (Rosly, 2005).
In Islamic perspective, Time value of money does exist. The return available to the individual saver does not always have to be related to riba-based transaction. As example, the return available on the next best permissible´ investment which is from trade or others would constitutes time value of money in Islamic finance (Mohsin, 2009). The concept of time value of money in the context of Shariah is also established from the fact that Shariah prohibits mutual exchanges of gold, silver or monetary values except
0900157 when it is done simultaneously. This is because a person can take benefit from the use of a currency which has been received and has not been given counter value from which the other party would benefit from (Ayub, 2007).
The fact that Islam forbids riba does not mean that it is against the concept of positivetime preference (PTP). Indeed, Islam does recognize PTP as evident in the statements of the Prophet (pbuh), ³Virtuous are they who pay back their debt as well´ (Rosly, 2005). Within the context of Islamic finance, the Shariah prohibits the mutual exchange of gold, silver, or monetary values except when it is done simultaneously and equally (Hassan, 2004). The reasoning behind this is that Islam does not allow people to profit from using a currency that they have received before being given its counter-value, whereby a situation of which the other party could take advantage of the other. Furthermore, time valuation is possible only when goods are traded, not when exchanging monetary values and loans or debts (Hassan, 2004). Thus, in Islam, recognizing PTP does not imply awarding a contractual increase on the principal loan. Any increase from an Islamic financing (qard) can only be stated on maturity and not up front as normally practiced in interest-bearing financing contracts. The increment, which is voluntary, is set by the debtor. In contract, the increment from riba financing is contractual and set by the creditor (Rosly, 2005).
On the basis of the above rationale, an overwhelming majority of Islamic economics believe that economic agents in an Islamic economy will have a positive time preference and there will be indicators available in the economy to approximate the rates of their
0900157 time preferences, generally determined by the preference in an Islamic economy, as made in a number of studies on investment behavior in the Islamic perspective (Ayub, 2007). Having deliberated previously on the TVM, the next section considers what the scholars have said on the concept regarding their agreement or differences.
4.2 General Consensus on Time Value of Money
Shariah scholars had a general consensus that the credit price of a commodity can genuinely be more than its cash price. That is, providing that one price is settled and this should be done before separation of the parties (Ayub, 2007). As opposed by many jurists, the difference between the two prices is approved by the Nass (clear text of Shariah).
Apart from this, The Islamic Fiqh Academy of the OIC and Shariah boards of all Islamic banks approve the legality of this difference (Ayub, 2007). Hence, this is tantamount to the acceptance of time value of money in pricing goods. However, any addition to the price once agreed because of any delay in its payment would be prohibited (Ayub, 2007). The rationale behind this is because the commodity, once sold on credit would generates debt and belongs to the purchaser on a permanent basis and the seller has no right to reprice a commodity that he has sold and which does not belong to him (Ayub, 2007). Since scholars have given consensus on of the tvm, the next section shall discuss on the fiqhi justification.
0900157 4.3 Fiqhi Justification on Time Value of Money
There is evidence of prohibition of the practice of time value of money based from the Holy Quran verses, Prophet (pbuh) or best friends¶ sayings or also known as hadith as well as sunnah. We shall also look into the Ijma, which is the consensus of opinion by a specified group of scholars.
In the Quran, it is stated that Islam permits the increase in capital through trade. At the same time, it blocks the way for anyone who tries to increase their capital through lending on the basis of usury or interest. To this effect, Almighty Allah says, ³He has permitted trading and forbidden riba´ (Quran: 2:275). and also,´O you who believe, observe your duty to Allah and give up what remains (due to you) from riba, if you are (in truth) believers´ (Quran, 2:278).
According to Malik (1983), hadiths on Time Value of Money is stated below: Mujahid reported that Abd Allah b. ³Umar took some dirhams as a loan and paid back better dirhams. He said: O Abu Abd al-Rahman, these are better than dirhams I loaned out to you. Abd Allah b. Umar replied: ³Yes I know, but I paid out of my own good will and pleasure´.
On other occasion µAta b. Yasir reported Rafl¶ said: ³The Apostle of Allah (pbuh) took on credit a small camel. When camels of sadeqah arrived, and he asked me to pay back a like camel, I said: Apostle of Allah, the camels
0900157 are all big and four years old. The Apostle of Allah (pbuh) said: Give from them, Virtuous are they who pay back their debts well´.
In addition to this, take this example of one Scholar, Professor Rashid who has a PhD in economics from Yale University. Currently, he is teaching economics at the University of Illinois. In an unpublished, privately circulated essay "The Value of Time and Risk in Islamic Economics in the year 1983 which he wrote, he explained his problem with the riba-interest equation and why the denial of "time value of money" from an Islamic viewpoint leads to anomalous situations and would render Islamic economics inefficient from the economic viewpoint. He wrote: "If it were indeed true that Islam does not permit any time-discrimination of economic values, it would also follow that the Islamic system must be economically inefficient. This is not the case (Farooq, 2006)."
Apart from this, another example of a famous Scholar, Dr. El Gamal who is the Chair of Islamic Economics, Finance and Management, and the Professor of Economics and Statistics at Rice University. He has produced many scholarly works in this field. He is noted for his emphasis on mutuality in organizing the Islamic financial institutions, which is currently not the case."We have thus dispensed with the overly-simplistic and false assertions regarding Islamic finance being 'interest-free,' denying the 'time value of money´ (Farooq, 2006). the previous section considers time value of money and its justification from the Fiqhi perspective, what comes next shall be the definition of riba and its ruling.
0900157 5.0 Definition of Riba
There is no doubt in Islam that riba is prohibited (haram). The prohibitions are clearly stated in the Quran (2:274-280). Apart from this, it is also mentioned in Ar-Rum: 29 and Ali-Imran: 130. In fact to the Muslim society, it is an act of kufr to say the contrary. Sad though, many would want to know the reasons behind its prohibition or in what way riba is equated with interest (Rosly, 2005).
As stated by Usmani (1997), in the context of the Shariah, riba is an increase or gain financially without any financial consideration. Similarly, Gapur (2002) agrees that interest is the extra amount a capital-owner demands and received from the borrower, for partying with his money for a specific period. In addition, in a normal commercial banking practice, the funds used for lending are derived through the time deposit and savings deposit accounts. The bank would pay a certain percentage as interest to the depositors which are also known as the capital-owners and bank would recover it from the borrowers when it lends. This is interest or riba, pure and simply. Therefore, according to Gafoor (2004), this component of cost of borrowing falls into the prohibited category. Furthermore, riba includes the increase which is obtained by offering money on credit because repayment of the principle is obtained against the amount originally lent. Kinds of sale, purchases are also included in riba where any increase is obtained without offering anything in exchange (Usmani, 1997). Therefore, riba is prohibited in Islam as it appears explicitly in the Holy Quran. There is a complete unanimity among all Islamic schools of thought regarding the prohibition of riba. Since the Quran is the undisputed source of guidance in Islam and to all Muslims, there is unanimous
0900157 agreement on the fact that Islam has forbidden the practice of riba (Hosein, 1997). The ulama have made it crystal clear that it is haram and we should stay away from it (Mohsin, 2009). All along, the definition of riba was discussed and its rule according to the Qur¶an and Sunnah, the following part will consider its types and their rule and how it can be eliminated.
5.1 Types of Riba
There are 3 types of riba which are namely Riba Fadl, Riba Nasi¶ah, and Riba Jahiliyah. Table 1 below provides a summary on riba. It states the types, causes behind it prohibition, and ways to eliminate the underlying factors causing its unlawfulness as mentioned by Karim (2001).
Method to eliminate elements of riba Both parties must ensure these factors: 1.Quality 2.Quantity 3.Price 4.Delivery Time Both parties make a contract detailing respective rights and responsibilities to ensure none shall gain return without being responsible of risk;or enjoy income without being responsible of expense 1.Take no benefit from any contract/transaction of virtue (tabarru); 2. If benefits is expected resort to business contract (tijarah),
Gharar (uncertainty in both parties)
Al ghunmu bi la ghurm; al kharaj bi la dhaman (return without risk, income without expense)
Kullu qardin jarra manfa¶ah fahuwa riba (commercial provision of voluntary loan;while every loan that expects benefits is riba)
0900157 and not tabarru.
Table 1: Types of Riba Source: Karim (2001), Islamic Banking: Fiqh and Financial Analysis, pp. 39
5.2 Prohibition of Riba
Riba is strictly prohibited (Hayes, 2008). Unfortunately, negligent interpretations of the meaning of those verses has led many individuals to assume that the prohibition only relates to situation where the creditor is likely to charge exploitatively high rates of interest as accroding to Jalal (2006), Saleh (1992) and Iqbal (2001). One of the most popular translations of the meaning of the Quran, by Ali (2006) translates the meaning of verses (2:278-279) which says: ³O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye indeed believers´ (Quran, 2:278). And, ³If ye do not, take notice of war from Allah and His messenger: but if ye turn back, ye shall have your capital sums; Deal not unjustly, and ye shall not be dealt with unjustly´ (Quran, 2:279). Apart from this, there are also numerous hadiths that detail out that prohibition of riba (Al-dareer, 1997). In the interest of brevity, two related hadith is mentioned below:
Muslim narrated on the authority of Abu Sa¶id Al-Khudri that the Prophet (s.a.w.) said: ³Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt; like for like, hand to hand, in equal amounts; and any increase is riba´.
0900157 Muslim narrated on the authority of Abu Sa¶id Al-Khudri: Bilal visited the Prophet (s.a.w) with some high quality dates, and the Prophet (s.a.w) inquired about their source. Bilal explained that he traded two volumes of lower quality dates for one volume of higher quality. Therefore the Prophet (s.a.w) said: ³This is precisely the forbidden riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the other´.
In the next section, the relationship between TVM and riba is established going by the connection between the two concepts. It will be found that these concepts are closely interconnected. One leads to other. When money is given a value and considered as a commodity, through the time, it gains value.
6.0 Relationship between Time Value of Money and Riba
Riba is a result of the value given to money. When money is given value in relation to time, it constitutes its time value. While money has no intrinsic value in itself from the Islamic perspective, the conventional parlance considers money to be a commodity like any other. Therefore, when sold today, the price should not equate future sale. In this view, a dollar today is more valuable than what it will be tomorrow. With this relationship in conventional finance, money carries value from that perspective. Hence its time is valuable. Money today is more than tomorrow because it can be invested to yield positive returns.
0900157 Having said this, the stack difference to the treatment of money from Islamic perspective shows the difference in terms of its relationship. Since money is exchanged for money or sold for money, it attracts the ribawi rules in Shariah. However, in the conventional perspective the strong relationship is evident. Hence riba is prominent in this concept from the conventional perspective as it is a commodity. In regards to riba, Ibn Ashur (2006) has proposed that by
implementing the maqasid al-shari`ah and the maslahah will provide adequate ethical guidance to individuals and help preventing harm, along with the maslahah, have been the subject of wide discussion in the field of Islamic jurisprudence.
Evidences show riba has tremendous effect on the entire society. From ordinary individual to the whole community, riba has adverse economic impact. These effects shall be considered in the next discussion of the paper.
7.0 Effects of Riba
7.1 Moral Effects to Individuals and Society
One of the reasons for the prohibition of riba in our daily lives is that it destroys the good quality to ourself and promotes selfishness, mercilessness, and lust for money and miseries (Shanmugam, 2007). Islam aims in building a community which is based on kindness and love as well as cooperation for the good of all brotherhood (Usmani, 1997). The rationale behind this is to promote a community where all of us would be prepared and willing to:
0900157 (a) Help those in need (b) Consider own gain or loss of another person in the society (c) Spending their wealth for others benefits and practiced social well being
By creating these virtues it enables Muslim to portray mankind that could reach the pinnacle of humanity and nobility. The interest, regardless whether it is commercial or not would results in mentality where there is no room for the abovementioned values. Sad to say, the capitalist would think of nothing else except only for his interest (Usmani, 1997).
7.2 Economic and Financial Effects
According to Usmani (1997), the economic ills and problems caused by riba is that:
(1) A substantial portion of the capital remains unemployed as the capitalist awaits an increase in the rate of interest, despite the fact that several people may have viable business opportunities. Sadly, this results in a loss to the trade and industry and the economic condition of the common man deteriorates.
(2) The capitalist is always looking for the maximum rate of interest. Therefore, he does not invest in something which he genuinely wants it to be 50-50 sharing. It is solely based from his selfish motives. He would not even care about the poverty issues within the community. This emphasize how dangerous if everyone has the same
0900157 mentality. The underlying reason is that, he will never engage himself into a simple and fair profits or loss of the business.
(3) Sometimes capital is borrowed for large industrial and commercial projects and is subject to a specified rate of interest. Such loans are normally for 10,20 or 30 years and at the same time the interest rate is fixed. The result would be that, such businessman will be bankrupt or they will resort to unfair means to avert the crisis which will also result in corrupting the economic system in order to pay back the capital loan.
(4) The entire previous sections in this paper dedicated its discussion around time value of money, and riba. It also deliberated on effects of riba on societies. Earlier it considers types of riba, its definitions and Shariah rule on it. The next section will be proposing alternatives to riba. This alternative shall have similar or efficient disposition to the conventional.
8.0 Interest-Free Banking as an Idea and Alternative
Interest-free banking seems to be very new. However, the earliest references to the reorganization of banking on the basis of profit sharing rather than interest are found in the late forties (Ahmed, 2000). All the earliest economist such as Naiem Siddiqi, Mahmud Ahmad and Anwar Qureshi have all reorganized the need for commercial banks and the evil of interest in the
0900157 organization and they have come up with a proposed banking system based on the concept of mudaraba which is a profit and loss sharing (Gapur, 2002). According to Khan (2004), there are a number of things to look at in order for a financial institution to transit to a riba free economy and its brief explanations which are being mention below: (a) Settlement of the existing transaction There may be a need of to convert conventional accounts to profit and loss sharing basis so that the transition to riba-free economy will be smooth. (b) Increased cumbersome documentation required for other modes of Islamic finance. Every change entails certain costs that have to be incurred if we wish to move to a new system. It would appear difficult in the beginning but once adopted, it would be part of the routine. (c) Reserve requirements for Current Accounts. Since no one would be willing to allow the use of such deposits by banks for the purpose of earning some benefit, depositors would want to ensure the safety of their deposits. This would only be possible if banks are required to provide 100% reserve against such liabilities.
There are other matters to look into also such as Government Finances, New monetary policy, Contingent liabilities, required resources, availability of safe investment avenue foreign transactions and so on (Presley, 1999).
All along this topic has addressed time value of money from Islamic perspective. It concludes that money from the Islamic perspective is different from the conventional. Unlike Islamic perspective, money is a commodity in the conventional standpoint. Hence, they have attributed value to it such that the present value is much more than the future value. This is a clear difference between the Islamic perspective which considers money as simply a medium of exchange rather than a commodity. Along this line of thought, the relationship between time value of money and riba was discussed because of the value attributed to money becomes riba. In view of this argument, Rosly (2005) thinks that Islam is not against time preference of money but scornful to the idea that time of money has value. The topic also defined money from the Islamic perspective and discovers that it is different from conventional definition. Furthermore, the characteristics of money and its origin were also highlighted. The process of creation of money in a typical dual-banking system was also discussed. There is a general consensus as the paper put forward that the Islamic Scholars are not against the fact that credit price is sometimes different from cash price due to the time preferences, not time value of money. From logical reasoning, inflation is also considered in this consensus due to time differences. Finally, the paper proposes interest-free banking as an alternative to riba. According to Ibn Ashur (2006), protection of wealth is a cardinal non-negotiable point Shariah requirement.
0900157 Bibliography The Holy Quran Ahmed, S. M. (2000). Towards Interest-Free Banking. New Delhi: Kitab Bhavan. Al-Dhareer, S. M.-A. (1997). Al-Gharar in contracts and its effects on contemproray transactions. Jeddah: Islamic Research and Training Institute. 'Ali, A. Y. (2006). The Meaning of the Holy Quran: Text, Translation and Commentary. Kuala Lumpur: Angkatan Edaran Ent. Sdn Bhd. Anwar, M. (2001). DEVELOPMENT OF MUDARABAH INSTRUMENTS:UNDERSTANDING THEIR PROFITABILITY,SECURITIZATION AND NEGOTIABILITY ASPECTS. IIUM Journal of Economics and Management , 9 (2), 165-185. Ashur, I. (2006). Treatise on Maqasid al-Shari'ah. London: International Institute of Islamic Thought. Ayub, M. (2007). Understanding Islamic Finance. England: Wiley Finance. Farooq, D. M. (2006, June). Retrieved November 2, 2009, from The Riba-Interest Equivalence:Is there an Ijma (consensus)?: http://www.globalwebpost.com/farooqm/writings/islamic/r-iconsensus.html Gafoor, A. A. (2004). Interest, Usury, Riba and the Operational Costs of a Bank. Kuala Lumpur: A.S Noordeen. Gapur, A. A. (2002). Interest-Free Commercial Banking. New Delhi: Islamic Book Service. Hassan, A. U. (2004). Time Value of Money Concept in Islamic Finance. 66. Hayes, F. E. (2008). Islamic Law and Finance: Religion, Risk and Return. London: Kluwer Law International. Hosein, I. N. (1997). The Importance of The Prohibition of Riba in Islam. New York: Masjid Dar al-Quran. Ikass, R. (2009). Characteristics Of Money. Retrieved November 1, 2009, from SlideShare Present Yourself: http://www.slideshare.net/reinis/characteristics-of-money1192619?src=related_normal&rel=954371#stats-bottom Iqbal, D. M. (2001). Islamic Banking and Finance: Current Developments in Theory and Practice. Great Britain: Anthony Rowe. Jalal, A. A. (2006). A mini guide to Islamic Banking & Finance. Kuala Lumpur : CERT Publications.
0900157 Kahf, M. (2006). Maqasid al Shari¶ah in the Prohibition of Riba and their Implications forModern Islamic Finance. Paper prepared for the IIUM International Conference on Maqasid al Shari¶ah, August 8-10,, (pp. 1-26). Selangor. Karim, I. A. (2001). Islamic banking: fiqh and financial analysis. Jakarta: National library:Catalonging in publication. Khan, W. M. (2004). Transition to a Riba Free Economy. New Delhi: Adam Publisher & Distributers. Malik, M. I. (1983). Lahore, Pakistan: Shiekh Muhammad Ashraf Publication. Meera, A. K. (2002). The Islamic Gold Dinar. Selangor: Pelanduk. Mohsin, D. M. (2009). Islamic Economics. Kuala Lumpur: INCEIF. Notes, C. (2009). CliffNotes The fastest way to learn. Retrieved November 1, 2009, from http://www.cliffsnotes.com/WileyCDA/CliffsReviewTopic/Definition-of-Money.topicArticleId9789,articleId-9744.html Presley, P. S. (1999). Islamic Finance: Theory and Practice. New York: PALGRAVE. Rosly, S. A. (2005). Critical Issues on Islamic Banking and Financial Markets. Kuala Lumpur: Dinamas. Saleh, N. A. (1992). Unlawful Gain and Legitimate Profit in Islamic Law: Riba, Gharar and Islamic Banking. London: Graham Trotman. Shanmugam, N. A. (2007). Islamic Finance: The Challenges Ahead. Selangor: Universiti Putra Malaysia Press. Toutounchian, I. (2009). Islamic Money & Banking: Integrating Money In Capital Theory. Singapore: John Wiley and Sons (Asia) Pte.Ltd. Usmani, H. M. (1997). The Issue Of Interest. Karachi: Darul iSHAAT. Wikipedia. (2009, October 29). Retrieved November 1, 2009, from http://en.wikipedia.org/wiki/History_of_money