Rationale Underlying the Concept
The concept of time value of money (TVM) contemporarily means that the value of money differs with time. Since an argument that money held today can be invested to yield more than the current value through interests. However, this concept is not appreciated in the Islamic society. It is against the Islamic law to lend money and expect payback with riba (interest). Islamic scholars reason that TVM concept and the interest rates charged on money lent are haram and contribute to keeping the poor individuals poorer and the rich folks richer. For this reason, the present value and the future value of money is presumed to be equal. Similarly, the Islamic perspective condemns charging more for the credit sales but instead advocates for a humane and ethical standards of payments that safeguard and prevent people from exploitation. Islamic perspective offers more flexible concept as compared to conventional lending, which should be on mutual agreement between the two parties, because the credit value is free to fluctuate depending on the market conditions (Parameswaran, 2008).
1. Islamic Financing
This is one of the reasoning behind opposition of the time value of money concept by the Islam religion. Islamic financing is the form of financing that adheres to all the principles and laws of Islam in relation to money and riba. Money lending in Islamic perspective is regarded to be a noble and ethical act and is religious in nature. Lending and financing are viewed as a means of helping others and of furthering cooperation, support, and self-sustenance in the Muslim community. It gives an opportunity to people with no money to start their own businesses and make their own money as well as enhance self-development. The lenders who offer substantial repayment periods are considered to be kind, while those who fail to provide financial assistance to others and have the ability to, are believed to receive punishment from Allah (Choudhury, 1997). The act is also a form of obedience and worship to Allah. Islamic financing is, therefore, religion and culturally driven, but not economically driven.
Muslim banks employ three types of financing:
Investment financing; this includes Musharaka, Mudarabha and the estimated return method. Musharaka is joint venture involving the bank and the other party, where both parties have different roles. Mudarabha is an arrangement where the bank is the main financier of the venture while the other party provides management and labor services. This is the most preferred type of investment financing that minimizes managerial complications likely to be experienced when the bank is actively involved running the business. Estimated return method, on the other hand, is where the bank estimates the amount of return expected from a particular business and uses that to set an amount that the lender needs to repay for the financing (Rahman, 2008). In this method, the lender is allowed to keep the extra return in case the business does better than projected. Similarly, the bank may also lower the rates if the return is lower than expected.
Trade financing; this is where Muslim banks offer markup facilities to their clients. For example, the banks may lease or purchase a particular commodity for the customer and then agree on repayment amount.
2. Islamic Banking
Islamic banking system is controlled by Sharia law that prohibits charging any interest on money lent to clients. The banks instead adopt a profit and loss sharing system. This viewed to be a fair and ethical way of giving credit to individuals and businesses without exploiting them (Rahman, 2008). It is also noted that Muslim banks are more humane when recovering bad debts as compared to conventional banks. Clients of the Islamic banks are also considered to be shareholders, thus receive a portion of the bank’s profits (Choudhury, 1997).
Money as a Commodity
Money is considered as a commodity as it can be sold and bought in the open public places as it happens in the Forex Markets where different currencies are exchanged at different prices. The introduction of money in most markets began with gold coins and materials that had an inherent value. Whoever owns the money is equal to the person owning a commodity to be exchanged as it were during barter trade. In this regard, money is a commodity. The early currencies were made of valuable and precious metals like gold coins, which could be sold or exchanged for something else of value (Surhone, 2010). Because of the increasing need for money as a commodity, people changed from barter trade to monetary trade to store these monetary reserves.
Money is considered as a commodity because of: (1) having varying supply and demand forces across a certain market; (2) its price is being determined by market functions; (3) has uniform quality in all monetary units and (4) has different producers. High or low demand of the commodity determines the price of the product in the Forex Market. For this reason, the value of currencies fluctuates based on the market situations. Money as a factor of production can generate wealth just like other commodities such as land and labor. Land can be sold or leased; labor is hired, while money is lent. When money is regarded as a commodity that generates income, then charging interest becomes justified. Conventional banks, in this regard, lend out some amount of money (commodity) to individuals or businesses and anticipate payment after a particular period of time (Surhone, 2010).
Money is also viewed as an asset since it can be stored in a bank. The physical money stored in a bank can easily be liquidated by a simple authorization to allow release of the required amount. Since asset refers to anything that has value, money qualifies to be an asset owing to the fact that it has value.
Islamic perspective, on the other hand, does not categorize money as a commodity as it is in the capitalist theory. Islam views money as the thing that has no intrinsic value and cannot satisfy human needs on its own without buying any good. Islamic standpoint points out that money is basically a medium of exchange to purchase goods with intrinsic value, thus has no value on its own. They argue that even if an individual has money reserves, the value will only be felt if a good is purchased.
Making Money Out of Money
This has been the business of banks and other financial institutions in the contemporary world. The banks have huge monetary reserves generated from the deposits customers make for storage purposes. This makes the banks to have enough capital to finance their own commercial projects or lend to individuals and private businesses, and get returns that include the principal amount lent plus some added interest. This refers to the commercialization of money where financial institutions make money out of their money reserves. In the Islamic perspective, this concept is also applicable though not in the form of interest, but inform of Musharaka, Mudarabha or the estimated return method where ultimately they share the profits. They also use trading finance to make money where banks lease or purchase a particular commodity for the customer and then agree on repayment amount that has some little profit.
Lending money is the main business for either the Islamic or capitalism systems. The amount of money supply from the federal reserves and amount of credit issued impacts on the availability and value of money in an economy. The level of credit issued should, therefore, be regulated within the economy (Surhone, 2010). Lending under Islamic perspective is different from the capitalism system. Islamic systems are designed to be nonprofit oriented, but mutual in nature referred to as non-harams (Parameswaran, 2008). Lending in Islamic perspective is controlled by Sukuk.
Sukuk in Islam
The term sukuk in Islamic perspective refers to all types of bonds, which are regulated by the Sharia law. This word was drawn from the ancient Islamic period and referred to a form of contract that promised some kind of payment to the bond holder. The Sharia law that controls issuance of sukuk prohibits charging of interest rates on money lent. For this reason, there are no interest rates pegged on any kind of sukuk. Sukuk in Islam provides an opportunity for people to store their assets in the form of money like bonds (Rahman, 2008).
In Islam, there are a number of sukuks: (1) equity based sukuks involving cash lending; (2) agency based sukuk that contracts an individual to act in place of another or company; (3) asset based sukuks where assets are acquired or leased and agreement made on payment amount and time and (4) debt based sukuks. Islamic perspective tries as much as possible to distance the meaning of sukuk from the conventional meanings of bonds, which has a debt meaning. On the contrary, Islam sukuk denotes a contract that represents ownership of an asset or business. This means that any person holding any kind of sukuk is a shareholder and is a partial owner of the asset (Rahman, 2008). The growth of sukuk is also controlled by Sharia law to guard against any form of haram that may be brought about by the time value of money.
Duplicity of Money: Money versus Credit
Money is believed to have both implicit and explicit value bringing about the duplicity, and that the values are interdependent. One value of money is that, which is influenced by the market value of the currency and the other value is that shaped by public opinion of the currency. In case people harbor poor opinion about a currency in relation to its stability, acceptability or its purchasing power, there is likely to be a reduction in its value. It is noted that the cumulative value of currency is significantly determined by the implicit value as compared to the explicit value. According to Drake (2009), financial institutions need to ensure that money supply is scarce in order for the implicit value to remain high.
This implicit feature of money is intangible but can only be felt and experienced in the market based on its purchasing power. This is the value of money that prompts demand and desire for its acquisition, as well as the value to be exchanged with other commodities. The intrinsic value of money depends much on people’s perception. For example, the dollar currency is perceived to have high implicit value globally, thus demanded by all. This means that in case people would stop perceiving legal tender as having any value, it will stop holding any value (Drake, 2009).
The implicit value of any legal tender is dependent on the social and political factors in an economy. Therefore, unfavorable political environment such as war reduces trade and demand of the affected countries’ currency. This in turn reduces the value of the currency. For example, during Gulf War Two, many people began losing faith in the U.S. government and as a result, the value of a dollar had dropped drastically in the Forex Markets. This was further aggravated when most people who had kept massive reserves tried to offload their dollar deposits.
The value of money is also affected by the amount of credit issued. High amount of credit increases amount of money in circulation in the economy. This means that credit is strongly influenced by its explicit value, since the demand for credit usually increase with the reduction of the cost of credit, which in most cases is the interest rates in the conventional system.
Monetary Value of Time in Sales Transactions
Monetary value of time in the transactions is acknowledged by Islam. This explanation is made by the Islamic economists using the Bay’ mu’ajjal and Bay’ salam concepts, which are acceptable in Islam. Bay’ mu’ajjal indicates that the selling price of a commodity sold on credit is likely to be different from the price fetched if the commodity was sold by cash on spot, preferably higher than the spot price. Bay’ salam, on the other hand, states that advance payment price of a commodity can be different from the spot price preferably lower than the spot price (Kahf, 1994). These two concepts demonstrate that Islamic perspective acknowledges the difference in value of commodities due to time-element. Transactions made by cash realize more than those whose payments are made in advance and the transactions made on credits in the long run may fetch higher selling prices. This is a clear indication that the concept of time preference is acknowledged in Islam. However, the fact that Islamic jurists permit a difference between the future values and present values of a good does not necessarily mean that it is a result of the time value of money concept. The acknowledgement of the Bay’ mu’ajjal and Bay’ salam prices of commodities may be as a result of the supply and demand forces of that occasionally prompt prices to differ at different periods (Kahf, 1994).
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Consequently, there is a likelihood that the actual market price obtained when the commodity is finally delivered may be less than the Bay’ salam price that was paid earlier, thus disapproves the concept of time value of money, as the reason behind Bay’ mu’ajjal and salam concept. Transactions involving rents are allowed to be higher than the present value of an asset. Islam recognizes time preference in the value of physical assets.
Monetary Value of Time in Lending Transactions
When products are sold on credit the seller usually relinquish the benefits of the money. In a conventional system, interest rates are added to compensate for the lost benefit. Similarly, credit transactions have inherent risks associated with them, thus insurance services are often needed. Most financial institution usually insures their money lent to individuals and businesses to avert the risk.
Credit transactions in Islamic perspective, on the other hand, are based on trust and mutual understanding between the parties. Islam prohibits charging of interest on money lent or any other commodity. In most cases, the lender forfeits the TVM and ignores the cost of insurance, and is commonly experienced among close friends, family members, and business associates, making the transactions be purely based on trust and religious principle (Parameswaran, 2008). Islamic perspective recognizes having humane and ethical standards involving sharing of returns after lending to protect the borrowers from exploitations of the interest rates as used in the conventional system (Rahman, 2008). Islamic credit system is more flexible in comparison to conventional lending system since the Islamic credit price fluctuates depending on the market conditions. For example, if a commodity was sold on credit when its market value was $3 and the debt is due in three months, then the market value of the commodity three months later is $2, the debtor will be expected to pay $2, but not the initial three units.
Islam does not consider money as capital but instead as what facilitates individuals to gain capital. A number of Muslim scholars acknowledge that Islam recognizes that the value of money increases with time, though Islam prohibits setting predetermined future values as put forward by the conventional TVM concepts, which can project the value of money for up to ten years. Similarly, Islam strongly prohibits using the TVM concept in any lending activity as a predetermined value, arguing that it is unethical. The Muslim scholars point out that when considering the concept of TVM, the basic religious beliefs such as riba that forbids interest , ijma (agreed concensus), qiyas (analogy in thinking), and maslahah mursalah that refers to ethics and public welfare must be considered. Moreover, the concept of time value of money that sets a predetermined future value of money is exploitative and evil (Rahman, 2008).
Future Values and Present Values
The future and present values of money are usually founded on the concept of time value of money. This concept is, however, not appreciated in the Islamic perspective meaning that money according to Islam could only have one value, that is the present value of is equal to the future value. Islam religion does not allow charging of interests on money lent or predetermining the value of money at a future date. Conventional finance considers money as an asset whose value appreciates with time. Muslim perspective, on the contrary, explains that in as much as money can have a future value, this value is negotiated and approved by the involved parties, and that the future dependents on market conditions (Rahman, 2008).
The conventional approach of discounting and compounding money concerns two similar values, but considered in two different points of time and as different values based on the time element involved. Since it is held that present consumption is usually preferred to future consumption, especially in the conventional system, future values are discounted to get their present values. Similarly, in the investment finance, present capital can be compounded to determine the future return of any venture based on the rate of growth inform of interest. This ideology of compounding and discounting, conflicts with the Islamic perspective, making it difficult to marry Islam and the concept of time value of money.
Time value of money is a concept that in conventional system means that the present value of money differs from future value. However, this is not appreciated by the Islamic perspective that considers charging interests as being exploitative and evil. The rationale underlying the Islamic concept includes adopting Islamic financing that adheres to all the principles and laws of Islam in relation to money and riba. Trade financing and investment financing, which involve Musharaka, Mudarabha and the estimated return methods are some of the methods that ensure no exploitation. Islamic banking system is also controlled by Sharia law that promotes sharing of profits and losses.
Islamic perspective does not recognize making money out of money as it is in conventional banking where banks offer credit at some cost. Conversely, Islam acknowledges monetary value of time in the transactions through the use of Bay’ mu’ajjal and Bay’ salam concepts (Kahf, 1994). The paper has also looked at the future and present values of money, which according to capitalistic theory are founded on the concept of time value of money, but not recognized by the Islamic perspective that considers present value to be equal to the future value.