Economics and Business

The Time Value of Money Concept in Islamic Finance

Abstract : The time value of money is a basic investment concept and a basic element in the conventional theory of finance. The Shari`ah does not rule out this consideration, for it 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. What is prohibited, however, is making money’s time value an element of any lending relationship that considers it to have a predetermined value. Here, the Shari`ah requires that a loan be due in the same currency in which it was given. The value (i.e., 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. This study examines possible modus operandi of time valuation according to the Shari`ah’s precepts vis-à-vis the concept of money, and whether any value can be attributed to time while considering money’s value. For this purpose, it investigates the juristic views on such relevant issues as the permissibility of difference between a commodity’s cash and credit prices and an increase and reduction of the loan’s amount in return for early repayment.

Introduction

Islam prohibits giving and taking riba1 in the strongest terms.2 This prohibition can be considered a sort of denial of time’s monetary valuation. Considering time’s monetary valuation is not ruled out in Islamic legal financial theory and practice, as long as it is not part of a lending relationship in which it is claimed as a predetermined value. In credit-based sale contracts, where a commodity’s price is allowed to differ from the spot price being time element is involved in the process of exchange, can be considered a sort of recognition of money’s time value in Islamic finance. Besides, as far as rents and wages are concerned, when they include a fixed and predetermined element as a compensation for time, the Islamic prohibition of riba denies any recognition for the money’s time value. In case time’s monetary valuation is not recognized by Islam, as it may be assumed, there would be no need for money’s time value in project evaluations and feasibility studies. On the contrary, if Islam recognizes it, then what are the principles under which such value can be determined and distinguished in a loan contract from an investment contract? This study attempts to resolve some of these relevant issues.

Modern banking and finance are based on the concept of money’s time value.3 This value is considered a basic investment concept and also a basic element of conventional financial theory and, in return, is fully compatible with the conceptual system of economic science. The established techniques of cash-flow analysis, as well as the cost of capital and valuation of assets, constitute the modus operandi of modern finance, as well as of such financial institutions as the stock exchanges, central banks, commercial banks, non-bank financial institutions, and the world of trade.

Islamic finance does not rule out time’s monetary valuation, for the Shari`ah (Islamic law) does not prohibit increment in loan in the price of a commodity in any sale contract to be paid at a future date. What the Shari`ah does prohibit is making money’s time value an element of a lending relationship where it is claimed as a predetermined value. Here, the Shari`ah requires that a loan be paid back in the same currency by which it was given. The value (i.e., purchasing power) of paper currencies varies with changes in many variables over which the two parties of a loan contract usually have no control.

The preferred course is derived from the Qur’an and the Sunnah of Prophet Muhammad (peace and blessings be upon him). The guiding principle in contracts, terms, and conditions is permissibility when there is no explicit prohibition. Given this, any modern type of contract not mentioned in the Shari`ah is allowed if it does not conflict with the Qur’an or the Sunnah and is based on ijma` (consensus) and qiyas (reasoning by analogy) and maslahah mursalah (considerations of the public good), and also is free of any evil. As the Shari`ah has solved day-to-day problems in its underlying rules and ethics over the years, it also has dealt with such concepts as money’s time value and the like.

Within the context of Islamic finance, this concept is established by the fact that the Shari`ah prohibits the mutual exchange of gold, silver, or monetary values – except when this is done simultaneously. 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, a situation of which the other party could take advantage. Furthermore, time valuation is possible only when goods are traded, not when exchanging monetary values and loans or debts. On the other hand, the Shari`ah considers a loan to be a gratuitous contract. That is why when one makes a qard hasan (a beautiful loan), the return on his/her loan is forwarded to the Hereafter, thereby making the loan a loan to God for which, in return, his/her reward will be multiplied. Therefore, no time value can be added to the loan’s or the debt’s principal after it has been assumed or the purchaser’s liability has been stipulated. Since Islam views a loan as a gratuitous contract, lending at a premium amounts to riba, defined as an increase for which there is no counter-value. Unlike the Shari`ah, such an arrangement is considered the same as unjust enrichment and, being an antithetical concept, must be rejected. Thus, any enrichment from trading in debt is forbidden.

Islam acknowledges an increment in a commodity’s price in any sale contract to be paid at a future date, as long as money’s time value is not claimed as a predetermined value. In other words, any conditional increase in the loan’s principal in return for a deferred repayment due to an expected depreciation in the value of the money, asset, or other factors (e.g., inflation and commercial losses) is prohibited.

There is near consensus among Islamic jurists that in a credit sale contract where repayment is deferred, a commodity’s price may be increased. Although this juristic opinion seems to be inconsistent, since it views time differently in the case of loans and credit sales, on closer scrutiny of Islam’s actual perception of time’s economic role, one may conclude that this matter is not as people assume. From an Islamic legal financial perspective, this issue remains unresolved. This study attempts to resolve, in general, some of the relevant questions and, in particular, to examine the possible modus operandi of time valuation according to the Shari`ah’s precepts vis-à-vis the concept of money as to whether any value can be attributed to time while considering money’s value. For this purpose, it investigates the juristic views on such relevant issues as the permissibility of difference between a commodity’s cash and credit prices and an increase or a reduction in the loan’s amount in return for early repayment.

The organization of the paper is as follows: Section 1 gives a short introduction to the core topic; section 2 presents a review of previous literature on the subject; section 3 discusses how Islam and capitalism view money, attempts to deal with the Shari`ah’s permissibility of credit sale, and the difference between a commodity’s cash and credit prices in sale transactions; and section 4 summarizes and presents some concluding remarks investigating the juristic views regarding the Islamic legal and financial positions on time’s monetary valuation.

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