Introduction
A fundamental concept in finance is the concept of time value of money. The time value of money is based on positive time preference which assumes that a sum of money given today is worth more than its equivalent at any other time in the future.
In other words, it hinges on the presumption that a unit of money today is valued more than a unit of money in the future.
Based on the foregoing, human being would prefer to receive a sum of money today in lieu of the same sum at a future date except if there is a reasonable expectation that they would receive a higher return on the money in the future. In fact, this concept is the brain behind the recognition of interest in conventional finance.
For instance, if an individual were to be made to choose between receiving $100 dollar today or in the next two years, he/she would prefer to have it today as current consumption is generally presumed by human to bring more satisfaction than future consumption. This analogy implies that time has an economic value in itself thus bringing the need for the monetary valuation of time the consequence of which is interest.
On the other hand, Islamic finance prohibits giving and taking of interest. To many, this could be seen as a denial of time value of money. A question that comes to mind is whether Islamic rejection of interest outrightly precludes recognition of the time value of money.
This article seeks to explore and explain whether any value can be attributed to time while determining money’s value under an Islamic financial framework. Likewise, an attempt was also made to provide answers to the following questions:
Does Islamic finance recognize time value of money? If it does, in what way does its recognition differ from that of the conventional finance? Also, how does Islamic finance conceptualize money? Lastly, what differentiates the concept of money in Islamic financial framework from that of the conventional framework?
Time Value of Money: The Capitalist View
Positive time preference, a genesis of the time value of money was first postulated by an Austrian economist Eugene Von Bohm-Bawerk (1851-1914). In a capitalist economy, the positive time preference (usually used interchangeably with the time value of money) lays the foundation for interest/usury.
It is believed that the present value of anything is greater than its future value. Thus, if Mr. A were to loan a sum of money to Mr. B for repayment at a future date, there must be a predetermined premium or increment which he should gain over and above his principal.
Consequently, the capitalist charges interest on loans as a way of compensating the lender for the delayed gratification.
Time Value of Money: Islamic Perspective
A review of some empirical studies previously conducted on this subject matter reveals that Islam recognizes the time value of money as can be seen in certain forms of sales transactions.
Although, some jurists are of the opinion that time value of money has no basis in Islamic finance framework, majority of the classical scholars have come to recognize its presence and reflections in some categories of business dealings.
In spite of this, the way Islamic finance recognizes the time value of money differs from the conventional approach. In fact, it is the way Islam conceptualizes money that makes it to prohibit interest in the strongest terms.
Islamic finance recognizes time value of money in as much as it is not stipulated as part of a lending agreement with a predetermined value.
However, in order to fully understand the peculiarity of the Islamic recognition of time value, there is need for us to appreciate how Islam perceives money.
The Concept of Money: Islamic Perspective
Very fundamental to the understanding of major Islamic financial rulings is the adequate understanding of the concept of money in Islam. Islamic finance views money differently from the conventional finance and this divergence of view no doubt accounts for the variations between the duo as regards money’s time value.
According to Ahmad and Hassan[i]: In a capitalist system, money is more of a commodity of trade and as such, can be bought, sold, and speculated freely. In other words, it has a time value and one who uses other people’s money must pay for doing so in the form of interest.
On the contrary, Islam views money as, on the one hand, something that cannot be hoarded and, on the other hand, something that cannot be wasted in large quantities”.
Given this distinction, it is clearly evident that the capitalist method is opposed to the Islamic finance as Islam considers money to be just a unit of account and a measure of value. In Islamic finance, money is not a store of value as it is not an asset possessing an intrinsic value on its own.
Money only becomes an asset when it is used to purchase a thing which brings value.
This is the same reason why Islamic finance tends to differentiate between capital and potential capital. For ease of understanding, money being held at hand is not yet a capital but a potential capital. It is when money is combined with other resources to undertake a productive venture that it becomes a capital. This is the point when time value of money would be recognized.
Obviously in a loan contract, the money being given to the borrower is not a capital in any sense as the lender has not undertaken to share in the risk involved in the venture wherein the money is being put.
It is worth mentioning also, that the entrepreneurial expertise and risk undertaken to run a venture or business is more important than the money that is used to finance it.
Based on the foregoing, time value of money would not apply in a loan transaction as the money being lent out is not is not yet qualified to be considered a capital.
So, where does Islamic finance recognise the time value of money?
Stemming from the above, we could say that time valuation does not apply when exchange of debts or monetary items take place. Rather, it only applies when goods are traded.
On this, it is pertinent to state that Islam does not prohibit time value of money in sale-like transactions where payment is deferred to a future date (as in a credit sale). Where payment is to be deferred to a future date (bay’ muajjal), Islamic finance allows a seller to charge a price higher than what would have been applicable had the sale been made in cash.
Though, whether this is truly a recognition of time value of money or not has been a subject of scholarly debates among Islamic jurists and there is no consensus regarding this.
Regardless of this divergence of opinions, some of the modern scholars such as Ibn Rushd are of the view that this constitutes a recognition of time value of money.
There are evidences from the Qur’an and the Sunnah that support the permissibility of credit sale. Some of them are as follows:
(i) Ijma’-the scholarly consensus on the permissibility of selling on credit when the due date is known
(ii) “…Allah has permitted trade and forbidden Riba…..”[ii]
(iii) ‘ ….O ye who believe, when you deal with each other in transactions involving future obligations in a fixed period of time, record them in writing….”[iii]
(iv) Also, there is a narration in the Saheehain[iv] narrated on the authority of Aisha that the Prophet (Peace Be Upon Him) bought a commodity from a Jewish trader and his armour was mortgaged to the trader.
While commenting on the permissibility of increasing the price of a commodity in a credit sale where payment is deferred to a known due date, Ibn Rushd was quoted as saying that “he has given time a share in the price”[v].
Likewise, the great scholar of Islam, Ibn Taymiyya commented in his book of verdict saying: “ Deferment takes a share of the price”
The above discussion clearly demonstrates the permissibility of increasing the cash price of a commodity when the same commodity is to be sold on credit and the payment is deferred to a known future date.
Consequently, this amounts to an acceptance of time value of money in some trading and business transactions. Islamic banks generally adopt the credit sale principles in the form of bai’-al-murabaha type. This credit sale contract allows an Islamic bank to purchase a product and sell it to a customer at a mark up price.
Furthermore, the same time value of money consideration also applies to leases with deferred payment arrangement (ijarah bi al-idafah).
Conclusion
From the discussions above, it is clearly evident that Islam only recognizes time value of money in business and trading transactions. Time value of money is not applicable in the exchange of monetary values in the form of loans or debt.
The justification for this has been earlier stated.
Furthermore, it is worth mentioning that Islamic finance has a genuine framework for converting money to assets from which time value of money may then be subsequently claimed through profit or loss sharing mechanisms (as in Musharaka) and price differentials (Murabaha, bay’ salam, bay’ muajjal and Ijarah).
REFERENCES
- Al-Qur’an
- Ahmad and Hassan. The Time Value of Money Concept in Islamic finance. The American Journal of Islamic Social Sciences 23:1
- Hisham AbdulHameed Hussein. Time Value of Money: A Shariah Perspective
- Muhammad Fairooz (2003). The Concept of the Time Value of Money: A Shariah Viewpoint, International Journal of Islamic Banking and Finance Volume 3 Issue 2
- Khan (1991) Time Value of Money and Discounting in Islamic Perspective, Review of Islamic Economics Volume 1 No 2
[i] Ahmad and Hassan. Time Value of Money Concept in Islamic finance, The American Journal of Islamic Social Sciences
[ii] Quran 2 Verse 275
[iii] Qur’an 2 Verse 282
[iv] Sahih al-Bukhari and Sahih al Muslim
[v] Ibn Rushd, Bidayat al-Mujtahid wa Nihayat al-Muqtasid (Damascus: 1379 AH): 2:108