The time value of money is one of the essential principles in investment, both conventional and Islamic. However, it stems from the conventional finance point of view that presumes today’s money is more favorable to people than future dates. To illustrate, a person will prefer to receive USD 100 today than a year later. This is because humans likely presume that current consumption is more satisfactory than in the future. Such a concept is also known as a positive time preference of money. Based on the concept, a debtor who borrows money from others should compensate such preference of interest charged for the given loan. It also relates to the opportunity cost of holding present cash for the debtor.
Islam extensively prohibits charging increment for a loan given to other people. It is a truly riba al-nasia (additional usury on loan). In line with this, does it mean that Islam does not recognize the time value of money? The following sections will briefly explain the essential points to answer the question.
Time Value of Money: Capitalist Viewpoint
An Austrian economist Eugene Von Bohm-Bawerk (1851-1914), initially introduced the concept of positive time preference. In a capitalist economy, charging interest or usury relies on such a concept. The current value of anything is thought to be larger than its future value. Thus, if Mr. A ought to lend a sum of money to Mr. B with the intention of repaying it at a later period, he would deserve a specified premium or increment in addition to his principal. As a result, in the capitalist economy, charging interest on loans is to compensate the lender for the delay in receiving payment.
Time Value of Money: Islamic Perspective
Some sharia scholars opine that the time value of money has no basis in the Islamic finance framework. However, some prominent classical scholars reported an extent of recognition for the time value of money. For example, Ibn Rushd quoted in his book “Bidayat al-Mujtahid wa Nihayat al-Muqtasid” that time has a share in the price. Similarly, Ibn Taymiyya commented in his verdict book saying that deferment takes a percentage of the price. Despite this, Islamic finance considers the time value of money differently than conventional finance. The recognition applies as long as it has no direct relationship in lending transactions. It is a benevolent or voluntary transaction for a Muslim to others.
The Concept of Money: Islamic Perspective
In a capitalist system, money represents more of a commodity of trade. It has time value and one who uses others’ money has to pay interest as compensation for doing so. As such, people can freely trade money, hoard, or even speculate on money. Conversely, Islam views money differently from that concept. Money is just a unit of account and a measure of value. Furthermore, it is not a mere store of value with its intrinsic value. It becomes an asset only when people deem money as a medium of exchange in trading activities.
Islamic finance distinguishes capital from potential capital. Simply put, when people hold money in their hands, it is not capital, but rather, it is potential capital. Money becomes capital only when it engages in productive activities adding values or generating revenues. In other words, when money is combined with other resources to undertake a productive venture, it becomes capital. The recognition of the time value of money takes place at this point. Based on this, it is clear why charging interest on the loan contract is impermissible in Islamic finance. The lender has not to undertake risk involved in the loan, and therefore it is not capital.
As a result of the preceding, we conclude that time value does not apply in exchanging debts or monetary things. Rather than that, it applies solely to the trading of products. On this point, it is necessary to emphasize that Islam does not restrict the use of time value of money in sales-like transactions in which payment is deferred until a later date (as in a credit sale). Where deferred payment(bay’ muajjal) exists, Islamic finance permits a seller to charge a higher price than applicable on the spot or cash basis.
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