0900157

Time Value of Money and Riba’: Islamic Perspective

Azah Atikah Binti Anwar Batcha0900157

CIFP Full-Time

This project paper is a partial fulfillment of Module SH 1003 of Part I ofCertified Islamic Finance Professional (CIFP)

INCEIF

September 2009

1

0900157

ContentsAbstract.......................................................................................................................................................3

Introduction.................................................................................................................................................4

Literature Review........................................................................................................................................8

1.0 Definition of Money: Conventional and Islamic Concept................................................................9

2.0 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 Definition of Riba..........................................................................................................................22

5.1 Types of Riba.............................................................................................................................23

5.2 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

2

0900157

Time Value of Money and Riba’: Islamic Perspective

Azah Atikah Binti Anwar Batcha

Abstract

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.

3

0900157

Introduction

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 “the 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).

4

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).

5

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 “gold 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: “If 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

6

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 “Allah 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, “O 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

7

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 “Maqasid” of the prohibition of interest as well as

other regulations of Islamic financing (Kahf, 2006).

Literature Review

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

8

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

9

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.

10

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.

11

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.

12

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 hunter-

13

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 “inadequate” nor “excessive 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 “price” differentials between

14

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).

15

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

16

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 “compensated” for “waiting”

(Mohsin, 2009). Arguably, concern on consumption in the “future” 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

when it is done simultaneously. This is because a person can take benefit from the use of

17

0900157

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 positive-

time preference (PTP). Indeed, Islam does recognize PTP as evident in the statements of

the Prophet (pbuh), “Virtuous 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

time preferences, generally determined by the preference in an Islamic economy, as made

18

0900157

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 re-

price 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.

19

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, “He 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. “Umar 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: “Yes I know, but I paid out of my own good will

and pleasure”.

On other occasion ‘Ata b. Yasir reported Rafl’ said:

“The 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

20

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.

21

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

22

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).

Type Cause Method to eliminate elements of riba

Riba Fadl Gharar (uncertainty in both parties)

Both parties must ensure these factors:1.Quality2.Quantity3.Price4.Delivery Time

Riba Nasi’ah Al ghunmu bi la ghurm; al kharaj bi la dhaman (return without risk, income without expense)

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

Riba Jahiliyah Kullu qardin jarra manfa’ah fahuwa riba (commercial provision of voluntary loan;while every loan that expects benefits is riba)

1.Take no benefit from any contract/transaction of virtue (tabarru);2. If benefits is expected resort to business contract (tijarah),

23

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: “O ye who believe! Fear Allah, and give up what remains

of your demand for usury, if ye indeed believers” (Quran, 2:278). And, “If 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:

“Gold 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”.

24

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: “This 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.

25

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:

26

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

27

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

28

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).

29

0900157

Conclusion

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.

30

0900157

BibliographyThe 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-i-consensus.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-money-1192619?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.

31

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.topicArticleId-9789,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

32