Concept of Money From The Islamic Perspective

1. Concept of Money From The Islamic Perspective

2. Definition of Money The Concept and Nature of Money in Conventional system : • Money is a commodity and is used to obtain other goods. • Widely Marketable as it is highly in demand and valued good. Thus, it is sure that it can be used anytime and anywhere. • It can be transport easily. Money is made to make human life easier therefore to make sure that it’s convenience is important. • Relatively scarce as it is high in demand and high in value, which means it holds a high value in small quantities.

3. Nature of money under Conventional system • Money is relatively imperishable. It is durable and can be used for future purchases. • Easy to store. • Easily divisible • Money lasts forever. • All units of money are similar, meaning to say that it is easy to distinguish and estimate the value of the money.

4. Nature of money under Islamic system • Islam treats money as unit of account to determine the relative worth of goods and services. • A medium of exchange, and not a store of value. • All units of money of the same denomination are 100% equal to each other. • It becomes useful only when it is exchanged into a real asset or used to buy services. • Money cannot be sold or bought on credit.

5. Money: An Islamic Viewpoint Money vs. Commodity • Money has no intrinsic utility whereas a commodity has an intrinsic utility and can be utilized directly. • Commodities can have different qualities, while money’s sole quality lies in the fact that it is a measure of value or a medium of exchange.

6. Money: An Islamic Viewpoint Money vs. Commodity Shariah treats money differently from commodities for two main reasons: • money is not allowed to be the subject matter of trade like other commodities. • if money has to be exchanged for money or is borrowed for exceptional reasons, the payment on both sides must be equal so that it is not used for any purpose for which it is not meant to be used (i.e., trading in money itself).

7. Time Value of Money in Conventional Financial System • TVM is a basic concept in the contemporary monetary system. • It originates from the concept of interest which is prohibited in Islam • It impacts consumer finance, business finance, and government finance.

8. Time Value of Money in Conventional Financial System Time value of money RM10,000 today or RM10,000 in 5 years? Obviously, RM10,000 today. Suppose you can purchase a bicycle today for RM10,000, would you be able to purchase the same bicycle 5 years from now.

9. Time Value of Money in Conventional Financial System Conventional financial theory suggest that an efficient funds management requires a better funds allocation and arrangement. e.g. there is always an opportunity to earn an interest rate on deposits instead of exposing them to other investment opportunities.

10. Time Value of Money in Conventional Financial System • Simple Interest Interest paid or earned on only the original principal amount borrowed or lent. • Compound Interest Interest paid or earned on the principal and any previous interest earned.

11. Simple Interest Example Assume that you deposit RM100 in an account earning 8% simple interest for 2 years. What is the accumulated interest at the end of the 2nd year? Simple interest = P0(i)(n) = RM100(.08)(2) = RM16

12. Compound Interest • An interest rate that applies both on the principal amount and the interest earned on it during the previous year or years. • Most of the deposits in financial institutions earn compound interest. • Deposits grow exponentially in compound interest where as with simple interest they grow linearly.

13. Future Value of a Deposit • Assume that you deposit RM1000 at a compound interest rate of 7% for 2 years. 7%

14. Future Value of a Deposit FV1 = P0 (1+i)1 = RM1,000 (1.07) = = RM1,070 During the first year of deposit simple and compound interest will remain the same i.e. RM70, but from second year the principal amount will become RM1070 for compound interest calculations.

15. Future Value of a Deposit FV1 = P0 (1+i)1 = 1,000 (1.07) = RM1,070 FV2 = FV1 (1+i)1 = P0 (1+i)(1+i) = 1,000(1.07)(1.07) = P0 (1+i)2 = 1,000(1.07)2 = RM1,144.90 You earned an EXTRA RM4.90 in Year 2 with compound over simple interest.

16. General Formula of Future Value FV1 = P0(1+i)1 FV2 = P0(1+i)2 General Future Value Formula: FVn = P0 (1+i)n

17. Time Value of Money in Islamic Financial System: Cash vs. Credit Price in Sale Transactions The Permissibility of Sale on Credit: The Legal Evidences • The following Quranic verses: “Allah has permitted trade and forbidden riba. (2:275) “O you who believe! When you deal with each other in transactions involving future obligations in a fixed period of time, record them in writing. (2:282) • Ummul Momineen Syeda Ayshah reported that the Prophet (pbuh) bought some foodstuff on credit from a Jewish trader and mortgaged his armor to him. (Bukhari and Muslim)

18. Cash vs. Credit Price in Sale Transactions There is consensus among the scholars on the permissibility of selling on credit if the due date is known and also the permissibility of increasing the prices of a sale on credit • The price may be increased based on deferment. Al-Kasani (Hanafi) • time has been given a share in the price. Ibn Rushd (Maliki) • Deferment earns a portion of the price. Al-Nawawi (Shafi`i) • Deferment takes share of the price. Ibn Taymiyah (Hanbali)

19. Cash vs. Credit Price in Sale Transactions Reducing the Loan Amount for Early Repayment • The juristic consensus is that making such a reduction in the case of a deferred debt conditional on earlier repayment is not allowable. • However, some of the companions permit : Ibn al-Qayyim, and, more recently, has been adopted by the OIC Fiqh Academy, which states: Reduction of a deferred debt in order to accelerate its repayment, whether at the request of the debtor or the creditor, is permissible under the Shariah. It does not constitute a forbidden riba if it is not agreed upon in advance and as long as the creditor-debtor relationship remains bilateral. If, however, a third party is involved, it becomes forbidden, since it becomes similar to the discount of bills

20. The Monetary Valuation of Time in Credit Transaction The Monetary Valuation of Time in Sale Transaction Price differentials compensating for the delay in fulfilling a party’s contractual obligations or for the opportunity cost of the money used by a contractual party in providing goods, have been recognized as legitimate under traditional jurisprudence.

21. The Monetary Valuation of Time in Credit Transaction The Monetary Valuation of Time in Lending Transactions • Islam does not recognize any loan for deferral based on money’s time value designed to benefit the lender. It only recognizes a Qard e Hasan loan.

22. Economic Value of Time • Shariah admits the concept of money’s time value to the extent of pricing in a credit sale, it does not endorse placing “rent” on money advances, as interest does in the case of credit and advances. • Time valuation is possible only when goods are traded, not when exchanging monetary values and loans or debts • While money’s time value is acceptable in the case of pricing assets and their usufruct, it is not acceptable in the case of any addition to the loan’s or debt’s principal. • It is better to use term economic value of time instead of time value of money.

23. Islamic Comparison between Conventional and Islamic Perspective Money is not a commodity though it is used as a medium of exchange and store of value. Therefore, it cannot be sold at a price higher than its face value or rented out Conventional Money is a commodity besides medium of exchange and store of value. Therefore, it can be sold at a price higher than its face value and it can also be rented out.

24. Islamic Comparison between Conventional and Islamic Perspective Profit on trade of goods or charging on providing service is the basis for earning profit Conventional Time value is the basis for charging interest on capital.

25. Islamic Comparison between Conventional and Islamic Perspective Islamic bank operates based on profit and loss sharing. In case, the businessperson has suffered losses, the bank will share these losses based on the mode of finance used (Mudharaba, Musharakah). Conventional Interest is charged even in case the organization suffers losses by using bank’s funds. Therefore, it is not based on profit and loss sharing.

26. Comparison between Conventional and Islamic Perspective • While disbursing cash finance, running finance or working capital finance, no agreement for exchange of goods & services is made. • The execution of agreements for the exchange of goods & services is necessary, while disbursing funds under Murabaha, Salam & Istisna contracts. Conventional Islamic

27. Islamic Comparison between Conventional and Islamic Perspective Islamic banking tends to create link with the real sectors of the economic system by using trade related activities. Since, the money is linked with the real assets therefore it contributes directly in the economic development. Conventional Conventional banks use money as a commodity, which leads to inflation.

28. Summary of the Lecture In this lecture we discussed • the concept of time value of money in the conventional financial system. • Its concept in Islamic financial system. • A comparison between the conventional and Islamic perspective about time value of money.

29. THANK YOU