Download TIME VALUE OF MONEY FROM AN ISLAMIC

TIME VALUE OF MONEY FROM AN ISLAMIC PERSPECTIVE
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OUTLINE
I. INTRODUCTION
A. History of money
B. Fiat money
C. Time value of money from a European perspective
D. Cash flow diagram
E. Interest rates in Islam
II. LITERATURE REVIEW
A. Rationale/Underlying Consent
B. Concept and nature of money
C. Money as a commodity
D. Lending money
E. Islamic insurance
F. Sukuk in Islam
III. ANALYSIS
A. Duplicity of money
B. Credit vs credit price in Islam
C. Monetary value of time in Islam
D. Capitalist and Muslim theory
IV. CONCLUSION
Abstract
The time value of money is not appreciated in Islam. It is forbidden to lend money and
expect the money paid back in return with some interest. Islamic law claims that this
form of practice is illegal and is the reason why many nations in the world are suffering.
Islamic scholars say that the time value of money and the interest rates imposed on
money lent are the reasons why the poor keep on getting poor and the rich richer.
These scholars claim that the „modern‟ form of lending is responsible for the financial
crises that the world has experienced in the twentieth century. Islam does not recognize
the need of charging more for credit sales but instead sees it fit to have humane and
ethical standards that protect and prevent exploitation of various parties by others.
Islamic credit is far more flexible in comparison to conventional lending since the credit
price is free to fluctuate according to market conditions. The Islamic approach to money
has been found to offer new ways in which money should be looked at. Capitalism and
globalization often look for answers in new things, in new ideas and in new concepts but
on the other hand fail to gain understanding from what already exists. The Islamic
approach to money is indeed a more ethical way in comparison to the capitalist
approach. Even as the world progresses and people become free to trade, free to move
and free to set their own rules a new definition on money and interest is needed.
INTRODUCTION
History of money
Money is a very useful commodity and has become the main form of exchange all over
the world. Money came about as a solution to a need that people had; how to trade and
exchange goods and services in a fair and effective way. With the introduction of money
came banks and financial institutions. The banks and private lenders later introduced
the concept of interest; generation of additional revenue from money.
The development of money in most markets started with gold coins and objects that had
an inherent value. This made trade and work easier for people as they were able to
avoid the tiring and cumbersome processes involved with barter trade. The early
currencies were made of precious metals and this meant that the money itself could be
sold or exchanged for something else of value (Surhone, 2010).
With the introduction of money made from precious metals business and trade were
able to boom. People all over the globe changed over from barter trade to monetary
trade. With the thriving economic conditions came the need to store these monetary
reserves. This was mainly due to security, convenience and storage reasons. This is
where the banks came in and they were able to provide storage and transportation
services for people.
Fig.1: Ancient Arabic gold coins
The banks had huge monetary reserves and this meant that they had enough capital to
fund and finance commercial projects. The banks went into financial lending where they
lent money to people and in turn got paid the principal amount with some added
interest. This is where the commercialization of money was started; by banks and
lending institutions.
Throughout history banks have lent money to people in return for some interest. Money
is therefore a commodity and the banks sell money as it is their commodity. The sale of
money occurs when a person lends the other and in return gets the principal with some
additional interest. Similar to a trader in the market who sells his products to prospective
buyers the banks sell money to their clients (Choudhury, 1997).
Fiat money
With time money changed its form from a commodity that had intrinsic value like goldthat could be sold and smelted to having a value by virtue of guarantee. Many
currencies are guarantees that the government gives to its citizens and traders. It is
illegal to refuse to accept any form of legal tender and thus many people were bound to
accept fiat currency in its introductory phases. Banks were the major players in the
development of fiat currency and in the development of the time value of money.
Without banking institutions there can be no time value of money and the interest
system would cease to work.
The flow and regulation of fiat money is done by the Federal Reserve or Central Bank
that acts as the central banking body. The central banks in most cases are responsible
for issuing and regulating the flow of fiat money in an economy. The banks are also
responsible for replacing worn out and spoilt currencies and replacing them with new
ones. The fiat monetary system is based on a guarantee or promise issued by a central
bank to people thus making the fiat currency a representation of a certain unit (Drake,
2009).
Fig.2: Fiat currency
Time value of money from a European perspective
The time value of money is the ability of money to earn some interest with time. In the
modern economy, the time value of money concept is practiced and accepted by many
businesses. Modern banks charge some interest on money lent and also pay some
interest on the money deposited by their policy holders.
This means that money on its own is a form of capital that is able to generate more
money on its own. This is because a certain amount of money in the bank is able to
generate a small interest in a monthly or yearly basis; by virtue of being deposited into a
bank.
The concept of the time value of money was developed by a person named
Martín_de_Azpilcueta who was an early economist and theologian. Azpilcueta proposed
that money in itself was a commodity that could be sold, be bought and used to
generate some revenue. He also came up with the monetarist theory that claimed that
money is similar to any type of commodity and that its value is determined by its
demand relative to its supply. This theory has come to shape and is used in economics
to control the value and exchange rates of different currencies (Parameswaran, 2008).
Money has different values that are dependent on time. The time value of money
concept claims that money has a present value and a future value. The future value is
calculated from the present value based on a certain interest rate. The time value
formulae are used to calculate the present and future values of cash, annuities and
perpetuities. There are a set of equations and formulas that are used to calculate the
actual value of a certain sum in relation to time.
Fig. 3: Sample chart showing time value of money
The present value is the current projection of an amount in the future. This value is
calculated from a future promised or expected amount and discounted at a certain rate
to get the present value. A typical example is where a person asks for a certain amount
for example 100 units in the present instead of 500 units ten years. This is because 100
units in the present may be worth more in comparison to 500 in future.
The present value of an annuity or periodical payment can also be derived using the
time value formulae. These formulae are used to substantiate the present value of a set
of annuities that will be paid or received in a prolonged period of time. The annuities are
discounted and their present value is acquired (Rahman, 2008).
The present value of perpetuity is also calculated when determining the time value of
money. Perpetuities tend to involve an endless and constant stream of income through
„eternity‟. The present value of perpetuity can be calculated using the formula:
Cash flow diagrams
A cash flow diagram is an aide that is used to calculate the time value of money. This
diagram is made up of a horizontal line that has the present time on one end and the
future time on the other end. This diagram often has the various cash inflows and
outflows plotted along the line.
The line is divided in equal portions or periods of time that could either be in days,
months or years depending on whatever may be convenient to the user. All transactions
are plotted along the line either as positive or negative transactions. Money paid out
results in a reduction in the total balance and thus is recorded as negative cash flow.
Negative cash flows are represented using arrows that are pointed downwards while
positive cash flows are represented using arrows that point upwards.
Fig.4: Cash flow diagram
There are several conditions that must be met so that the cash flow method can work;
there must be equal time periods, all transactions must be carried out at the beginning
and at the end of each time period, the interest rates must always remain constant and
all transactions made throughout the diagram must be equal (Drake, 2009).
Interest rates in Islam
The time value of money is not appreciated in Islam. It is forbidden to lend money and
expect the money paid back in return with some interest. Islamic law claims that this
form of practice is illegal and is the reason why many nations in the world are suffering.
Islamic scholars say that the time value of money and the interest rates imposed on
money lent are the reasons why the poor keep on getting poor and the rich richer.
These scholars claim that the „modern‟ form of lending is responsible for the financial
crises that the world has experienced in the twentieth century. According to Muslim
scholars the recent financial crisis of 2007 to 2010 was as a result of capitalist
businesses and systems of the modern world.
According to Islam the charging of interest rates, Usury is forbidden and whoever does
so is likened to a person who is under the control of the devil. Unlike the modern view
point that sees usury as a form of commerce it is evil in Islam to charge interest on
money lent. This brings into the question the time value of money in Islam as no interest
is often charged. The basis of this argument is not financial in nature but is based on
ethics and religion.
Interest rates are said to result in curses according to Islamic scholars, and whoever
charges interest rates has poor regard for the teachings of the prophet Muhammad
(pbuh). This has a significant impact on all businesses that operate in Islamic
environments since some of the common practices in the modern world are not
compatible to Islam. This means that businesses operating in Islamic societies need to
take a different stand point in regards to money. Islamic scholars claim that most
financial institutions result in lower interest rates so as to deal with deficit issues in the
face of economic hardships. This is a clear pointer that interest rates are an illegal way
that banks and institutions use to exploit people. Deficits that economies face are owed
to the interest rates that are charged on these debts. According to economists who
support the Islamic model, interest rates result in an increase in debts and in the
generation of economic deficit. Modern economies are in financial crises due to debt
and this is a major shortcoming of the modern model of money lending. Scholars who
are against charging of interest claim that the modern form of banking is bound to
collapse in a few generations due un-backed currency and payment of interest on this
„virtual‟ currency (Surhone, 2010).
LITERATURE REVIEW
Rationale and Underlying consent
Islamic financing
Islamic financing is referred to as a type of financing that conforms to all the laws and
principles of Islam in regard to money and interest. Most Muslim economies of the world
employ an Islamic type of financing and banking. Islamic financial institutions are
against the payment of interest on money lent and in the investment of capital in
businesses that are regarded as haram according to Islamic sharia law.
Lending in Islam is considered to be noble act that is both ethical and religious in
nature. Lending is seen as a way of helping others and of fostering cooperation and self
sustenance in the Muslim community. Lending also allows those with no money to be
able to start their own businesses and make their own money.
Those who lend to others and offer considerable repayment periods are seen to have
carried out a form of worship and obedience to Allah. Lending in Islam is different from
the secular form of lending that is driven by the need to gain profits from money lent.
Those who refuse to lend and provide financial assistance to fellow men are believed to
receive punishment from Allah as this is an act of unkindness (Choudhury, 1997).
Islamic financing can therefore be said to be driven by religion and culture rather than
economic incentive. This form of financial system is advantageous as money for
borrowing is easily available and costs less to borrow. Such a system can stimulate
economic growth in instances where the borrowers are small business holders. On the
other hand, this type of financial system is less profitable for banks as they are not able
to exploit the time value of money so as to make profits.
There are three types of financing that are used by Muslim banks. These are investment
financing, trade financing, and lending. Under investment financing there is Musharaka
which refers to a joint venture between the bank and the other party. In a Musharaka
both the bank and the lender have different roles and to play in the joint venture. The
second type of investment financing that Islamic banks can provide is called
Mudarabha. This involves the bank which is the main financier and the other party
which provides management, supervision and labor services. This is the most common
type of investment financing as it does not actively involve the bank in any operation of
the business. This type of financing also eases managerial problems that could arise
when the bank is actively involved in a business venture. The last type of investment
financing that Islamic banks provide is called the estimated return method. In such a
method the bank estimates the level of return that is expected by a certain business and
then sets an amount that the lender is to pay in return for the financing. An advantage of
this system is that if a business tends to do better than what was expected the lender
will keep the extra earnings but if the business performs lower than expected the bank
may opt to lower the rates so as to support the lender. This is unlike conventional
banking that sets standard interest rates on money lent regardless of the economic
prevail (Rahman, 2008).
Fig. 5: Islamic lending flow chart
In trade financing services, Muslim banks offer mark up services to their clients. This
involves instances where the banks purchase a certain commodity for the client and
then agree on the amount that the client is to pay the bank; with some added profit.
Leasing is another method used in trade financing by Islamic banks. In this method a
bank purchases a given commodity for the client and leases it to him/ her for an agreed
period of time before the client pays an agreed sum and taking full ownership of the
commodity. Other trade finance services that Muslim banks offer include: hire purchase
where the bank buys a product for the client and sells it to him/her in installments, sell
and buy back services where the bank buys a client‟s assets and sells it back to the
client after an agreed period of time.
Islamic banking
The Islamic banking industry is similar to the conventional banking system but is guided
by Muslim Law. For any type of banking to be referred to as Islamic banking it must
exhibit practices that are consistent with the Muslim Sharia law. Most Islamic banks
were established in the 20th century in a bid to try and streamline business in Muslim
states. The Islamic banks facilitated the implementation of Islamic principles in the way
banks and institutions carry out business.
Early Islamic banks have been found to have charged interest on fiat money. This was
applied to paper currency/ currency that was bound by guarantee. However no interest
was charged on currency such as gold and silver units. The reason for this was that the
value of gold and silver remained constant and thus the need to charge an interest was
not seen (Drake, 2009).
The formation of Islamic banks began in the early 1950s as a result of fundamentalist
works by Muslim economists such as Muhammad Uzair. The Muslim economists of the
time questioned the charging of interest rates in Muslim banks as this was against
Muslim Sharia law. This resulted in a shift of Muslim opinion and the formation of
Islamic banks was set on course. In the 1970s various Muslim governments were
actively engaged in discussions on how to form Islamic banking institutions. In 1975 the
Dubai Islamic Bank which was a pioneer Islamic bank was formed. This was one of the
first banks to embrace the conventional banking principles and integrate these
principles with the Sharia law.
Islamic banks do not charge any interest on money lent but instead operate on a profit
and loss sharing system. This is a method whereby the banks lend money to a business
and expect to share the profit generated with the business. The business is often given
a specific time period by the banks so as to have repaid the loan. This according to
Islam is a fair and ethical way of lending money to individuals and businesses without
exploiting them. Many Islamic scholars also claim that Muslim banks are more lenient
when it comes to recovering bad debts in comparison to conventional banks. Another
strength of the Islamic banking system is that the clients are considered the
shareholders of their respective banks and thus receive a proportion of the bank‟s
profits (Choudhury, 1997).
The Muslim model of banking has not been without its fair share of problems and
difficulties. The profit and loss sharing system used by these banks is difficult to
implement and execute. Muslim banks have undergone difficulty in executing the no
interest policy in low yield investments, projects that span over long periods of time,
financing small businesses and financing government expenditure. This has resulted in
limited financing in these areas by Muslim banks as the returns and risks may not be
worthwhile. This is a major shortcoming of Muslim financing; the goodwill of these banks
expressed on paper is much more difficult to execute in real life. This results in poor
financing of businesses that fall in this category.
Islamic banking terms
Conventional banking
Description
terms
Al Wadiah
Custodianship
Savings and deposits
Al Mudharabah
Profit sharing
In this case the bank
provides financing for a
business. The profits are
shared according to an
agreed ratio. In the event of
a loss the bank covers the
cost
Al Musyarakah
Joint venture
This is a joint venture
between the bank and the
lender. If losses are
experienced they are
shared between the bank
and the lender.
Al Murabahah
Cost plus profits
In this scenario the bank
purchases a commodity for
the client and then sells it to
him/her at a profit
Al Bai Buthamin Ajil
Deferred payment type of
Used for housing loans
sale
Sukuh
Bonds
Used in borrowing and
lending
Hiba
Gift
Riba
Interest
Forbidden amount charged
on money lent
Fig.6: Chart of different Islamic financing options
Islamic entrepreneurship
Business and entrepreneurship in Islam is driven by two major factors namely
community and ethics. Entrepreneurship in Islam should ideally benefit the entrepreneur
as well as the society and the less fortunate people in it. Muslim idealists claim that
businesses should provide conducive environments for all people to prosper unlike in
capitalism where the rich are more likely to get richer. Contrary to capitalist
entrepreneurship, Islamic entrepreneurship does not support the notion “All men for
themselves and God for us all”. In Islam the entrepreneur is solely responsible for the
success or failure of his/her business but at the same time is required to share the fruits
of his/her labour with the community. Entrepreneurs in Islamic environments have a
responsibility to others as commanded Muslim law (Parameswaran, 2008)
Islam as a religion acknowledges business and entrepreneurship to be noble practices.
In fact the Quran praises businessmen as the Prophet himself (pbuh) was once a
businessman. According to Islam entrepreneurs and businessmen have two roles:
service to humanity and adherence to the commands of Allah. This means that
entrepreneurship in Islam has a deeper purpose in comparison to conventional
businesses; to make profits. Islamic business has also been found to be fair and free of
discrimination. This is because the Quran condemns any kind of discrimination be it of
race, color or religion. A significant difference between capitalist business and Islamic
business is that profit takes a primary place in capitalist business while it takes a
secondary place in Islamic business.
One of the major virtues promoted in Islamic business is trust. Trust is a major virtue in
Islam and its practice is encouraged by the Quran. Justice and honesty are also
promoted by Muslims when doing business with each other. Muslims are commanded
to be truthful in all the business operations that they conduct regardless of whether it is
with fellow Muslims or with non Muslims. Muslims are required to be considerate of
other people and not only be driven by their self interest but by the general good of all
people. Islam forbids entrepreneurs and businessmen from carrying out certain
activities namely:

Trade in products considered to be „haram‟ e.g. Alcohol, Drugs etc

Any kind of trade that has loopholes which are bound to create future conflicts

Hoarding of products so as to control market forces and in an expectation of high
profits

Any fraudulent dealings and business operations

Facilitating any illegal operation through business

The paying and receiving of interest rates on money or any other commodity
Concept and nature of money
Global perspective
From a global perspective money has three functions namely to store wealth, as a unit
of keeping account and an accepted medium of exchange. Money in the modern world
is mainly paper money that is guaranteed by financial institutions or governments.
Another aspect that comes to play when considering money concepts in a global
economy is the measurement of money; is the nominal value of liquid instruments that
exist in an economy (Parameswaran, 2008).
In global business money is considered to be an asset and not just a unit of trade.
Therefore similar to any other commodity the prices for money can be controlled by the
laws of demand and supply. This theory was put in place by an economist called John
Maynard Keynes in 1936 and has been at play in modern economics ever since. Since
money is considered is to be an asset and has a price tag when the demand for money
goes up then its prices also go up. According to Maynard the prices for money refer to
interest rates. Therefore the scarcity and availability of money is used by financial
institutions in capitalist economies so as to regulate the value of money and control
inflation.
The forces of demand for any form of money are affected by speculation, precautionary
instinct and the transactions motive. The transactions motive refers to instances where
a person may opt to have his/ her assets in liquid state so as to cover for transaction
costs that may arise, the precautionary motive is what causes people to store cash in
banks so as to safeguard against unexpected occurrences while the speculative motive
is when people have speculations that the prices of bonds may fluctuate in future.
The global concept of money has been found to lack in the recent decades. In the early
1990s economists started to notice the various shortcomings of the current global
money concept. The failure of the global money concept as an ideal solution for
economics has become more noticed in the recent years due to multiple failures of this
concept. These are the financial crisis of 2007 to 2011 and the inability of the pure
monetary policy between 2001 and 2003 to stimulate the economy in the United States
of America (Surhone, 2010).
Notable economists who strongly oppose the conventional monetary policy include John
Maynard Keynes, Milton Friedman and Anna Schwartz who brought to light the
numerous shortcomings of the global monetary concept.
Islamic perspective
The Islamic concept of money is very different from the global concept. This is mainly
because the Islamic concept of money is centered around religion and the teachings of
the prophet Muhammad (pbuh). According to Islam all money belongs to Allah and the
improper use of money is forbidden. Islamic teachings claim that money is God‟s
property but that has been entrusted to man for proper use. Muslims believe that all
money that they earn is a gift from Allah himself and not merely a reward for their work.
This is very different from the global perspective where money is seen as a mere
reward for work done or services rendered and thus belongs to people. According to
Islamic teachings on money, all money belongs to Allah.
Islam says that money is a temptation and a „necessary evil‟. Muslims need money to
so as to be able to finance their daily activities but at the same time they are warned of
the evils that are associated with money. Money is seen as a tool to fulfillment yet at the
same time has a great potential for self destruction. This is very different from the global
perspective that views money as good and a means to attaining anything. Another
difference between the global and Islamic concept is that in the global concept the
means of acquiring money are not important as long money can be made unlike in
Islam where money and religion are intertwined (Drake, 2009).
Islam prohibits exorbitant spending of money. This means that the religion defines a
way in which money should be spent and is against any wasteful spending of money.
Quoting the Quran “Allah has prohibited three things: gossip, much questioning, and
wasting money”
Women in Islam are regarded as the „keepers‟ of the society and the source of
continuity in the society. Islam acknowledges the ability of women to make money and
their responsibility towards the society. Islam bestows equal rights to both men and
women when it comes to making and handling money. The Islamic concept of money
says that with money comes great responsibility to both Allah and to the society.
Islamic teachings also say that all money belongs to Allah and that he merely lends this
money to men so that they could use it. Therefore men are bound to offer a certain
percentage of their money to Allah. Together with taxes Islamic societies give a certain
percentage of their earnings for the propagation of Islam and for the assistance of the
less fortunate. Below is a chart that highlights differences between the global and
Islamic perspective on money:
Global concept
Islamic concept
Money belongs to man
Money belongs to Allah but is given to
man for his use
Money can be earned in any way or from
Money can only be earned from activities
any activity
that are accepted and supported by Islam
People have an obligation to pay taxes to
People have an obligation tom pay taxes
their local government / authorities
to authorities as well as zakat to Allah
No rules on the way in which money
Gives guidelines on how money should be
should be spent
spent; should not be spent wastefully
Fig. 7: Global concept vs Islamic concept
Money as a commodity
Money is referred to as a commodity in modern economies as it has evolved into an
asset. Money is a short term asset mainly because it has higher liquidity as compared to
other types of assets. Money in itself has the ability to make more money. This is in the
form of interest accrued due to lending or from depositing the money into a bank
account (Rahman, 2008).
Money is also referred to as a commodity as it can be sold and bought. Common
examples of markets where money is traded include forex markets that exchange
different currencies at different prices. Factors that define money as a commodity
include:

Has varying supply and demand forces across a certain market

Its price is often defined as a result of market functions

Has uniform quality in all monetary units

Has different producers

Sold and bought in markets that are open to the public i.e. forex markets
Money has the ability to make more money and thus is a generator of wealth. This
means that money just like land and labour is a factor of production that is used to
generate revenue. All factors of production are sold or leased and therefore money is
not an exception. Land can be leased or sold, labour is hired and money is lent. The
reward for lending out money is interest. When money is viewed as a commodity then
charging of interest rates becomes justified as it is a factor of production like the others.
Money can be sold but is often sold in for a much higher price than what is worth. This
is because the seller forfeits the benefits that may he/she may have accrued as a result
of investing the money. An example of this scenario is when a bank lends money to a
business or individual. The bank in such an instance sells a certain sum of money to the
business but expects payment after a certain period of time. The interest in such an
instance is the profit that the bank accrues from the sale of the „commodity‟. Money is
the principle factor of production. This is because all other factors of production are
either directly or indirectly related to money.
The definition of money as an asset stems from the fact that money can be stored in a
bank. Money stored in a bank is an asset in that it can easily be converted into cash by
simply authorizing the bank to release the said sum. Money is one of the most popular
assets as it has its advantages such as easy liquidity and acceptability among many
people. Money has an economic value as it can be controlled and can be exploited so
as to satisfy human needs. Assets are also defined as anything that owns value thus
qualifying money to be an asset.
Money however does not have an inherent value. A house has inherent value as it can
shelter the owner and protect the owner from the vagaries of the weather and nature.
The value of money is driven by market forces; money is simply paper but the forces of
demand and supply result in these pieces of paper gaining value. Money gains value
since many people want money but it is limited in supply thus it becomes a valuable
commodity (Surhone, 2010).
Some analysts argue that the future value of money is sustained by the beliefs that
people hold on this issue. They argue that if people cease to believe that money has a
future value then it would actually cease to have a future value. This has been
challenged by another set of economists who claim that money would never cease to be
perceived as having value and that the only possibility that could occur is the shift of
general opinion. It is said that if people lost faith in a certain currency and wanted to
dispose the currency then there would be a greater supply of this money compared to
its demand. This would then result in a drop in value of the money. Zimbabwe has one
of the most valueless currencies in the world. This happened as a result of political
instability and people who had assets in Zimbabwean currency were quick to dispose
them. This resulted in a global fall in the demand for Zimbabwean currency and thus the
reason for the current inflation that the economy is facing. The numerous incidences of
inflation in the world have proven than money is a commodity like all the rest and is
greatly influenced by the general opinion of people.
Fig.8: Forces of demand and supply
Inflation is the increase in value of goods and services in an economy. There are
different concepts as to what causes inflation such as the hoarding but the main reason
behind inflation is the fall in value of the „commodity called money‟ in comparison to
other commodities in the market. This causes people to want to exchange their
commodities for a higher quantity of money. Money therefore has a very fragile value
and thus governments and banks must always strive so as to regulate the flow and
supply of money in an economy. If the value of money was left to balance on its own
like other commodities then many economies would crumble. This shows that money is
an artificially regulated commodity whose scarcity must always be ensured so as to
ensure that the global monetary system remains in place.
Lending money
Money vs Credit
The supply of money and credit has an overall effect on the value and the availability of
money in an economy. Therefore, commercial banks are required to control the level of
credit that they issue out to their clients so as to regulate the forces of demand and
supply in an economy (Surhone, 2010).
The price and quantity of money in an economy at any point in time is determined by
commercial banks and the amount of money and credit that they issue/ receive. Credit
similar to money when issued in excess leads to inflation and the fall of value of
currency. Therefore commercial banks are required to regulate the amount of credit that
they release into an economy.
Banks depend on credit and as this is their major source of income. When banks sell
credit they are able to make profits in the form of interest. Just like any commodity the
demand for credit is affected by the laws of demand and supply. When the interest rates
go up there is a pronounced increase in the overall credit due to a decrease in the loss
and earnings ratio in comparison to the total bad debts (Choudhury, 1997).
The demand for credit according to analysts has been found to increase when the costs
for borrowing are decreased. Therefore central banks often set the nominal interest
rates below the expected interest rate so as to safeguard against the risks of credit
driven monetary growth. The central bank is often in a position to buy an unlimited
quantity of assets to be used in its portfolios by issuing out domestic money in
exchange. This makes the central bank be able to lower or increase interest rates to the
desired levels.
Credit unlike money is not a physical asset. This is because credit is not perfectly liquid
and does not have an immediate purchasing ability but is instead a financial claim
against institutions. Other limitations of credit are that it has an inherent credit risk
(Choudhury, 1997).
Credit transfers have a great effect on the movement of capital in an economy. The
availability or scarcity of credit is dependent on the creditworthiness of the parties
involved in an exchange process. Similar to money credit has value and is traded in
markets. The credit default swap market is an example of a market where credit risks
are traded. The market involves a seller who agrees to sell protection to a buyer so as
to safeguard the buyer in an event of bad credit.
Fig. 9: The credit default swap
Islamic insurance
Insurance in Islamic economies is a relatively new concept. A very small percentage of
the Islamic population actually uses any form of insurance. This is because many
practices that are carried out in modern insurance are often contrary to Islam. This has
resulted in many Muslims having a negative opinion on insurance and thus the poor
spread of insurance among Muslims. Studies show that Muslim economies have a
lower level of insurance service penetration in comparison to the emerging markets in
the globe.
Common practices that are often carried out by insurance firms are contrary to Islam.
This is the major reason why many Muslims do not want to provide or purchase
insurance services. Practices in insurance that are contrary to Islam are the charging of
interest rates, gambling/ excessive risk taking, vague and ambiguous contracts and the
investment in outlawed businesses. Similar to banking the few insurance industries that
operate in Muslim economies have been modified to fit in with Sharia law. The
differences between Islamic insurance and conventional insurance are that Islamic
insurance is designed to be non profit and mutual in nature, can only invest in non
harams, and share profits with insurance policy holders. Credit in some cases is not
insured as it involves excessively high risks that are contrary to Sharia law. This is what
makes credit in Islamic economies to be different from credit in conventional economies;
credit in and Insurance in Islam are governed by religion and culture and not entirely left
to the laws of nature (Drake, 2009).
Sukuk in Islam
The term Sukuk in Islam is used to refer to all types of bonds. The issuing of bonds in
Islam is regulated by the Sharia law. Since the Sharia law is against the charging of
interest rates, there are no interest rates that are charged on sukuk. In the ancient
Islamic era sukuk referred to a form of agreement or contract that promised a form of
payment to the holder of the bond. Sukuk in Islam offers a way through which people
can store their assets in the form of money i.e. bonds (Rahman, 2008).
There are different types of sukuks in Islam; agency based sukuk, equity based sukuks,
debt based sukuks and asset based sukus. Islam distances the meaning of sukuk from
the conventional definitions of bonds since sukuk refers to a contract that serves to
represent the ownership of an asset or business while bonds are obligations of debt.
The growth of sukuk in Islamic economies is in a way limited by Sharia law. This is
because of the Muslim view point on the time value of money and the existences of
haram practices. Another hindrance to the growth of sukuk in Islamic economies is the
ability of any third party guarantee to be issued without any charges. The issuer of the
sukuk also insures against any shortcomings in capital that may arise (Rahman, 2008).
The Islamic concept on the time value of money has been found to regulate and control
various sectors of Islamic finance including sukuk. A hybrid sukuk is needed so as to
ensure profitability to the issuers and conformance to Muslim Sharia law.
ANALYSIS
Duplicity of money: money versus credit
Money is said to have two values namely the implicit value and the explicit value. This is
explained in the duplicity principle that talks about the varying in stock market prices in
difficult economic times. A proper example of duplicity in economics is when stock
markets fall. There are various factors that affect the price of a stock; these are the net
worth of a company and the public opinion of a company. The principle also says that
an institution cannot have an explicit value without an implicit value. This is because a
company may be worth billions of dollars but if public opinion of the company is poor
this would result in a fall in stock prices of the company. Therefore the duplicity principle
says that the implicit value and the explicit value often go hand in hand and are
interdependent.
Similarly money has been found to have two values one that is affected by the market
value of the money and the other by public opinion of the currency. When people have
poor opinion of a currency and have doubts as to its acceptability, stability or purchasing
power this would result in a drop in value of the said money. The aggregate value of
money is greatly influenced by the implicit value as compared to the explicit value. For
money to remain valuable institutions and banks must ensure that it is scarce so that its
implicit value remains high (Drake, 2009).
The implicit aspect of money is „virtual‟ and cannot be touched. This is an aspect that is
difficult to quantify but can be felt and seen at play in the market. This is a value of
money that is intangible and imaginary. The implicit value of money is what causes
people to desire the commodity and want to acquire it. It is what causes people to work
and offer services in exchange for. The implicit value of money is concerned with what
money can do and with what it can buy. This value has more to do with perception that
with the actual value of the money. Money in the world is used because it has an implicit
value and is perceived to have some value by people. If people were to stop perceiving
money as having value then its value it would cease to be useful (Drake, 2009).
The implicit value of money has the ability to affect the demand and supply of money.
The dollar is perceived to have value throughout the globe. This is a major factor that
contributes to the strength and the demand of the dollar. This is owed to the security
and stability that the United States is known to have and thus this affects its money‟s
implicit value. The implicit value of a currency is controlled by political and social factors
in an economy. During the Gulf War 2 when people had started to lose faith in the U.S
government the value of the dollar had plummeted. This is because people who had
stacked their reserves in dollars got jittery as to the possibility of experiencing losses if
the dollar‟s value was to plummet. This resulted in many people „offloading‟ their dollar
deposits. This in turn resulted in a surplus supply of dollar money and therefore a fall in
value of the dollar.
Credit on the other hand is strongly controlled by its explicit value and the demand for
credit is seen to rise when the cost of credit goes down. Unlike money it not greatly
affected by an implicit value as the major determinant of the demand and supply of
credit in an economy is interest rates.
Cash versus credit price in Islam
The cash price of a commodity refers to the amount that the seller of the commodity is
willing to accept in exchange for the commodity. The cash price usually includes all the
expenses that the seller may have incurred in order to get the product to the market or
may sometimes be just the market price. Most commodities are valued according to
their cash prices as this is the most common type of pricing that many sellers and
buyers are willing to use. Studies show that many businesspeople prefer to sell their
commodities in cash as compared to other types of sale. This is because selling on
cash guarantees that the seller gets his money and the buyer acquires his product on
the spot. Cash sales are also secure as the seller is guaranteed by the spot on
payment. This form of payment is common among new traders and people who have
not yet established enough mutual trust. This form of payment is the most secure and
fraud free way of making and accepting payments.
Credit payments refer to instances where the seller and the buyer agree on a method of
payment that is different from the cash payment method. When a product is sold on
credit this means that the seller gives the product to the buyer on debt and expects
payment at a future date. This type of trade is common among acquaintances or people
who know each other. However credit sales have their own risks such as bad debts and
defaulted payments. A credit sale could be settled in any manner that is agreed on by
both the seller and the buyer and there is no standard way in which credit sales are
settled. The debt could be settled in installments or in a full amount (Parameswaran,
2008).
The credit price is often higher in comparison to the cash sale. This is because of
certain reasons:

The time value of money

The inherent risk in a credit sale

An allowance made for bad debts
Money has time value and when a product is sold on credit this means that the seller
will have foregone the benefits that he/she could have acquired as a result of having the
money. For example if a product is to be sold on credit and the buyer is expected to
make payments after a period of six months then the seller will have to compensate for
the TVM (Time Value of Money) that he will have foregone for the six month period. It is
for this reason that a certain interest rate is usually added onto the credit price so as to
compensate for the TVM of money.
All credit sales have an inherent risk and therefore insurance for such sales is often
needed. Banks and large institutions often insure against their debts and that is why
credit often has an interest rate charged on it. In case of a small business the owner
may insure him/herself from bad debts by charging an additional fee on all credit sales.
Credit sales are a very sensitive issue and that is why businesses often offer credit to
acquaintances or other businesses with good reputation (Rahman, 2008).
Credit is based on trust and mutual understanding. This is what makes credit a
complicated way of doing business. Credit also eliminates the need for money and thus
is a possible substitute for monetary transactions. Below is a chart of differences
between credit and cash pricing:
Cash pricing
Credit pricing
Money is the unit of pricing
Units of accounts are used in pricing
Dependent on trust and creditworthiness
Independent on trust and creditworthiness
Is made up of value of commodity on sale
Made up of value of commodity on sale
plus interest rates and insurance on risks
undertaken.
Fig.10: Credit pricing vs cash pricing
Credit sales in Islam are very different from what is seen in the conventional world.
Islam is against the charging of interest on money or any other commodity. Therefore
many credit sales in Islam are often repaid without charging of interest rates. Thus this
means that the lender often forfeits the time value of money and assumes the cost of
insurance. Such sales in Islam are common among family members, close friends and
business acquaintances. This means that such sales in an Islamic setting are based on
trust and religious principle (Parameswaran, 2008).
Islam does not recognize the need of charging more for credit sales but instead sees it
fit to have humane and ethical standards that protect and prevent exploitation of various
parties by others. Islamic credit is far more flexible in comparison to conventional
lending since the credit price is free to fluctuate according to market conditions. For
example if a shirt was lent when shirts were going for 2 units and the debt was due in 5
months. If 5 months later a shirt is going for 1.5 units then the debtor is expected to pay
1.5 units and not the initial 2 units.
Monetary value of time in Islam
The time value of money is a principle that is accepted all over the world by businesses
and institutions. However Islam does not recognize this principle and such ideology is
found to be exploitative and unethical. Because Islam prohibits the charging of interest
on money this means that it does not acknowledge the ability of money to make more
money on its own (Rahman, 2008).
Islam does not recognize money to be a capital but instead views money as what
enables people to gain capital. This difference in ideology is what causes the great rift
between Islamic and conventional concepts on money. However some Muslim scholars
claim that Islam recognizes that money gains value with time but is actually against
setting predetermined values for money. The conventional TVM concepts can be able to
project the value of money for up to 10 years in future. This is what Islam is against as it
is an unfair and unsure way of determining the value of money due to market
fluctuations. Islam acknowledges that money has a time value but it strongly prohibits
this value from being used in any lending activity in the form of a predetermined value.
When trying to consider the concept of time value of money there various religious
issues that must be considered; riba which is prohibited in Islam, it does not go against
accepted ijma, qiyas, maslahah mursalah. Ijma refers to an agreed consensus, qiyas
refers to analogy in thinking and maslahah mursalah refers to ethics and public welfare
considerations. The time value concept from the Islamic perspective should also be free
from evil; concept of the value of money increasing at a predetermined value is
considered to be evil in Islam, thus the failure of these two concepts to marry (Rahman,
2008).
Technically Islam acknowledges that money lent in the present may have a higher value
in future. This could be due to inflation or a change in market prices of commodities.
However Islam is against the idea that the future value of money can be predetermined.
Therefore according to Islam the formulae and the tools of calculating the time value of
money are ineffective and unfair means of judging the future value of money. The issue
of time value of money is still controversial as it has not yet been well expounded on.
The Quran provides several rules and regulations that should guide money and lending.
In the ancient world the recommendations of the Quran provided complete solutions to
issues that were related to money. The world has changed and money/finance has
become much more dynamic. This calls for Islamic scholars and economists to sit down
and define a proper approach to the time value of money (Surhone, 2010).
Some critics argue that Islam is plagued by double standards and that its stand on
money is confused. This is because Islam allows the selling price of a commodity to be
increased in case its payment is deferred. Another group of Muslim scholars claim that
credit is banned and illegal in Islam. This group of scholars claims that the prophet
Muhammad (pbuh) forbid trade of all forms in credit. According to these scholars the
Quran forbids the exchange of gold or silver on credit. In the ancient times gold and
silver were the forms of currency and thus were money; this shows that Islam is against
credit sales. In the modern world money is often exchanged for other commodities.
Therefore if the teachings of Islam are interpreted in a modern day setting it would
mean that the sale of products on credit is strictly prohibited. Scholars against this idea
say that the Prophet (pbuh) was an advocate for credit sales and that he himself at one
point bought food on credit from a certain Jew and mortgaged his shield in return.
Islam bans the overall change in price with time. This is in line with the views that
money should not and does not change value in time. Another view is that money
should not increase in value with time nor should it decrease in value with time. This is
another controversial aspect of the time value of money in Islam as reduction in prices
with time is not regarded as a forbidden practice (Drake, 2009)
Majority of Muslim economists have the notion that credit prices can be higher as long
as there is mutual consent between the seller and the buyer. Without the mutual
consent credit prices cannot be higher than cash prices as this would be termed as
charging of riba. The only instance where this is allowed is if the seller and the buyer
openly discuss on a credit price and on the terms of payment. Islam accepts that credit
prices could be higher than the cash prices in regard to human nature and the
preference that humans have for the immediate rather than the delayed. This is what
causes Islam to give room for negotiations on credit prices but not because it
recognizes the time value of money.
Muslims are motivated to lend as they expect a reward from Allah contrary to the
conventional world where people expect monetary rewards in the form of interest rates.
Muslims believe that when a person lends money he /she is able to acquire some
rewards from Allah which he/she would not have otherwise acquired had he chosen not
to lend the money. Therefore the rewards for lending in Islam are religious in nature and
those who lend expect favours and blessings from Allah. Idle storage of money is
considered unwise as it does not result in any form of rewards and thus lending to the
needy is seen as an ethical and accepted way to deal with idle cash. General views
among Muslims scholars on interest rates charged on accredit are:

Interest rates exploit the poor and needy

Interest rates are an unethical and unfair way of doing business

Interest rates regulate and hinder the flow of money in an economy

Interest rates promote the selfish amassment and accumulation of idle money

Interest rates affect the economy of a nation as the poor are unable to access
credit while the rich get obscenely richer
Another explanation against charging of interest on credit is that time on its own cannot
generate any yield. Therefore from an Islamic view it is improper to assign a value to
money on the basis of time. In Islam the time value of money is seen as a donation that
the creditor gives to the borrower as a form of worship to Allah. These are the major
differences between credit from a conventional perspective and lending from an Islamic
perspective.
Capitalist theory and Muslim theory
The future value and present value of money are based on the time value of money. It
has become greatly difficult to marry Islam with the time value of money. This means
that money in Islam could only have one value.
In Islam the concept of money having different values is not accepted. According to
Islam money in the present will have the same value in future. Islam does not give room
for charging of interests or determining the value of money at a future date.
Conventional finance claims that money is an asset and thus it appreciates value with
time. From a Muslim stand point, money can have a future value but this future value is
often negotiated and agreed upon by the parties involved in a trade. Islam agrees that
though money at a future date may have a higher value this extra value could be
forfeited as a form of donation and is dependent in market conditions (Rahman, 2008).
Modern capitalist finance is almost similar to Islamic finance but there are some distinct
differences between these systems. Capitalist theories believe that money is a
commodity and thus commodity is money. This is in the sense that money in itself is a
commodity and cannot be differentiated from other commodities. The capitalist theories
say that the value of money similar to other commodities can be negotiated and agreed
upon. Capitalist theories also allow for the trading of money in free markets i.e. a person
selling money can set any price similar to a person selling a bag of oranges. The
capitalist theory takes a liberal stance towards money and its capacity to serve as a
commodity. Islamic theory on the contrary does not classify money as a commodity.
According to Islam money does not have a value on its own (intrinsic) and cannot
satisfy human needs on its own. Islamic principle says that money is simply a medium
of exchange and through which commodities could be purchased. Therefore the
concept of money being able to generate value with time is strongly opposed in Islam.
The only exception to this ideology is that the potential benefits of money could be
forfeited in instances where money is lent and thus the lender could opt to compensate
his creditor by offering an extra amount to the principle.
Islamic principles also claim that commodities tend to have varying and fluctuating
values. For example an old car is worth less in comparison to a new one as a car
depreciates with time. There a car could qualify to be called a commodity as its value is
seen to change with time. However, money cannot be called a commodity as its value is
not seen to change. A 100 dollar note is worth the same as a new 100 dollar note.
Money is therefore not seen to have a differential quality in Islam and thus cannot be
classified as a commodity (Choudhury, 1997).
Commodities in Islam have specification and sizes. For example a certain cargo
shipment would its unique weight, size and shape characteristics. However money
cannot be specified and differentiated from other money. This according to Islam
disqualifies the concept that money is a commodity. An example used to highlight this is
an example of an exchange of $1000 for $1000. Such an exchange is said to be
meaningless. According to Islam commodities that have an intrinsic value can be
exchanged for other commodities. The Islamic argument is that if money is a commodity
indeed then why can‟t a certain sum of money be exchanged for another? Islam says
that charging interest on money by virtue of time is not justified since the extra amount
charged will not reflect an improvement in quality of the money or an increase in utility
but is merely based on time.
Compensation for money lent is often charged in Islam but this amount is often based
on the commodity and not the money. The amount compensated for any form of
delayed payment is usually preset and is independent of the time taken to repay the
debt. This shows that time and money are independent in Islamic theory
Globalization and effect on finance in Islam
The globalization phenomenon has been felt in many regions of the world. The Muslim
community is not an exception and there has been a significant effect on the Muslim
economies as a result of globalization. There have been several changes felt in Muslim
economies as a result of globalization and these include the revolution of the
information technology industries, there has been an excess of trade flow in comparison
to capital growth and the involvement of the services industry in the financial flows.
There are three effects of globalization on the Arab world. These are: social aspect,
political aspect and the economic aspect. However the Arab world has been found to
have a slower globalization rate in comparison to other regions of the world. The
reasons for the slower globalization witnessed are, high population growth rates versus
lower productivity, rigid cultural and religious framework, huge and inefficient public
bodies, ineffective educational systems and numerous trade restrictions (Drake, 2009).
There are many arguments on the importance of globalization that exist. However many
Islamic economists claim that globalization has its downsides. Complete globalization of
the Muslim world would mean an erosion of its culture and religion. This would have
negative effects on the Muslim way of life and thus it would be inappropriate to allow
globalization to change the way Muslims live and operate. Therefore a controlled form
of globalization is needed so that the Muslim society can be able to filter out what is
appropriate from conventional systems.
Globalization has been found to affect the Arab economy in three ways. These are the
culture, the institutions that exist, the organizations that are present and how business is
transacted. Therefore in an attempt to streamline Islamic finance with global trends
special care must be taken so as to ensure that the culture, institutions, organizations
and businesses conform to the teachings of Quran. Contrary to this Muslim economies
would cease to be Muslim and would instead be conventional.
The financial systems used in Muslim economies vary from those used in majority of the
globe. There have been substantial efforts to globalize the Islamic finance while at the
same time uphold religious teachings on money. The time value of money is a
controversial aspect that differs greatly from the global and Islamic stand point.
CONCLUSION
Money is a very important and sensitive aspect in any economy. The issue of money
and finance is very critical in Islam. The study has shown that money is indeed a very
important aspect of the Muslim life and the Quran in full knowledge of this has spoken
enough on this issue. According to Muslims money is good and the Quran does not
condemn money in any way. In fact the teachings of Islam encourage people to work
hard and do trade so as to make money.
Islam acknowledges the need of people to earn a living and it respects the individual
earnings of each person. Similar to capitalism Islam proposes that each and every
person should be free to enjoy the fruits of his/her labor. This type of stance is what
encourages people to work and build the economy of a nation as the fruits of individual
labor are secured.
There are distinct differences that have been noted between the ideologies of Islam on
money to capitalist ideologies. The root cause of the difference between these
viewpoints is the definition of money. From a capitalist view point money is a commodity
that can be sold and bought. This definition has resulted due to the modern banking and
economic systems that exist. The capitalists propose that if money is a commodity then
it can be able to generate value on its own. An example is a piece of land that is able to
generate revenue even if it is not utilized. When money is viewed as a commodity then
this also means that it can be able to generate revenue on its own by virtue of time.
According to capitalism money can be able to generate interest with time.
Therefore an analytical view of the capitalist theory brings to light the modern concept of
money. The modern concept believes that money is a commodity and whenever it is
used to purchase another commodity it is in the real sense an advanced form of barter
trade. This is because modern transactions involve the exchange of money-a
commodity, for another commodity. The only difference between capitalist barter to
ancient barter is that one commodity-money, has a uniform standard and unit measure.
According to Islam money does not qualify to be called a commodity. There are various
arguments used by Muslim scholars to disqualify money from being classified as a
commodity. The study shows that a popular argument against capitalist claims on
money as a commodity include the fact that money does not have a utility of its own.
This is because money cannot be used on its own to do anything useful. The only utility
that money could provide is if it is exchanged for something else. Without the exchange
of money it would cease to be useful as it is merely made up of pieces of paper. The
study also shows that from a Muslim perspective money is seen as a unit of exchange
and not a commodity. It is merely a facilitator through which goods and services are
exchanged.
The distinct difference between Islam and capitalism on the definition on money is what
causes the differences in views on the legitimacy of interest. The study has shown that
Islam does not allow the charging of interest on money lent. This stems from the
perception of Islam on money; a unit of exchange. Islam says that money cannot
acquire value by virtue of time and it is merely a tool of exchange and has no inherent
value. It has also been noted that interest rates are forbidden in Islam and thus the
possibility of merging some capitalist concepts with those of Islam is minimal. Money in
Islam cannot gain value with time since the only factors that can affect the value of a
commodity are said to change in quality or an increase in utility. An example is an
umbrella that trades for one unit in the dry season and two in the rainy season. The
increase in price of the commodity is allowed as it has increased in utility. Land can also
increase in value as time progresses as land becomes scarcer. However money has not
been found to have any of these aspects, thus the Muslim concept could be justified.
Muslim financial institutions must therefore remain unique and independent of global
phenomena. This is because Muslim societies and economies are based upon the
Quran and the teachings of Muhammad. Capitalism is contrary to the teachings of the
Quran and thus the solutions and systems used in the conventional world may not work
in an Islamic setting. Capitalism has not been without failures and it does not offer a fool
proof way to define money and interest on money. Islamic economies have indeed
come a long way in attempting to embrace global ideology but at the same time
upholding their culture and religion.
The Islamic approach to money has been found to offer new ways in which money
should be looked at. Capitalism and globalization often look for answers in new things,
in new ideas and ion new concepts but on the other hand fail to gain understanding
from already exists. The Islamic approach to money is indeed more ethical way in
comparison to the capitalist approach. Even as the world progresses and people
become free to trade, free to move and free to set their own rules the relationships
between people and businesses need to consider the less fortunate and needy. The
Islamic approach to money ensures that money can be acquired more easily and that
the amount of idle money is reduced.
Capitalism if left on its own would be like a jungle where the powerful eat the weak. The
Islamic approach regulates the level in which businesses and people relate to each
other in regards to money and thus could offer a few if not all solutions to the problems
faced in conventional economies.
REFERENCES
Choudhury, M. (1997). Money in Islam: a study in Islamic political economy. New York:
Routledge.
Drake, P. (2009). Foundations and Applications of the Time Value of Money. New
Jersey: John Wiley and Sons.
Parameswaran, S. (2008). Interest Rates And Time Value Of Money. New Delhi: Mc
Graw Hill.
Rahman, Z. (2008). Money and You in Islam. New York: True wealth.
Surhone, L. (2010). Time Value of Money. Washington: BetaScript Publishers.
APPENDIX
Pbuh - Peace Be upon Him