TIME VALUE OF MONEY IN ISLAMIC BANKING
NAJMUL HASSAN, GENERAL MANAGER,
Corporate & Business Development
Meezan Bank Limited
July 30 - Aug 05, 2007
The global financial services industry is witnessing a rapid rise in the demand for Islamic Banking services. This demand has essentially been fueled by the need of Muslims the world over to ensure that their financial and economic dealings are in accordance with the principles of Shariah. The growing Islamic Banking infrastructure, an answer to this demand, is comprised of various critical stakeholders, namely Shariah scholars, financial institutions, and the consumer. In Pakistan, the Islamic Banking movement has had a checkered history, with an initial noble intention but an ineffective execution, resulting in the dilution of the credibility of this model and a further compounded misunderstanding of its essence in the minds of the public. Renewed efforts, supported by extensive global success transfer, have resulted in a new premise with its own regulatory mechanism, track record, and in-built initiatives that seek to illustrate its meaningful difference from the conventional interest-based system. This infrastructure's success is noteworthy with a tremendous growth in assets, a rapidly mushrooming customer base, and the prolific examples of leading Banks (both local and foreign) offering their own Islamic Banking windows, all to a demanding and discerning market.
Islamic banking and finance is based on the laws of contract in Islam as laid down in Islamic Fiqh, and the transactions and products offered by most Islamic banks today are built around the various tenets of such laws. This fundamental point is inexorably linked to two important and illuminating facts which will be elaborated upon ahead; firstly the historical paradigm of Islamic Finance, and secondly it's present comparison to conventional banking.
Present day Islamic finance is nothing new per se in its essence and fundamentals. The basis of this infrastructure and approach is Islamic Law, detailed in the Qur'an and the authentic (Sahih) hadith of the Messenger (May Allah bless him and grant him peace), both sources forming the basis for the scholarly consensus of the Ummah over the last many centuries. Such sources have not changed and their immutability is unquestionable to both Muslims and educated non-Muslims alike.
Historically speaking, one may ponder as to what was the modus operandi of Muslims in carrying out their financial transactions. Pioneering Muslim progress in social infrastructure, engineering, science, medicine, trade and exploration (which was in itself the sole basis of the European Renaissance), represented a thriving civilization that was a hallmark of Islamic values and human progress. In this dynamic setting, how was all this activity funded, transacted, documented, maintained, and controlled? By the basic financial transactions and structures that were in line with the Shariah. Fast forward to the present, and what we have are core financial transaction needs that are inherently similar, but just more complex. In this present setting the practice is also inherently similar, just packaged a bit differently.
Unfortunately, the rise and proliferation of the present interest based system was synchronous with the decline and subjugation of the Muslim world. As a result, the wealth of Islamic knowledge, guidelines, and processes so to speak were not only not used, but also largely forgotten. While this chronic absence of awareness and implementation set in, various misinformed and ill gotten notions about Islamic finance gained currency and replaced sound Shariah principles in the general understanding of the Ummah.
Secondly, looking at modern financial transactions many question whether Islamic finance differs meaningfully from conventional finance. Outwardly in form and packaging, many structures do bear a similarity in various respects. Again, the present day operating environment is a conventional one, from market structuring and dynamics, to rate benchmarks and the circulation of money, to regulatory controls as well. However, the way these two options function with respect to core defining parameters is very different. Many things look the same but are in essence different in fundamental perspectives.
We begin with basic principles. One is interest based money lending, while the other operates like a trade house. What allows this difference? Two core principles lie at the centre, the elimination of Riba and Gharar. Any Islamic transaction needs to assess these two things first and foremost. The Qur'an itself clearly mentions Riba in a number of places (Surah's Rum, Imran, Nisa, and Baqra), with a very strong view against such people who indulge in it. Furthermore, any misgivings as to the relevance of these Divine regulations to the commercial interest prevalent today are completely baseless. They are categorically the same through and through. It is now exactly the same as it was then. Just the methodology has evolved into a more complex form. One cannot also help but wonder as well as to why the recent gross misinterpretation of Quranic verse on Riba? Why this sudden promulgation that the riba spoken of in the Qur'an may be different from interest, when for the entirety of Islamic history, the consensus on this issue was consistent amongst the highest scholars of the Ummah. Interest was present always. It has always been rampant. Hence it was prohibited in the Qur'an.
Also, Islamic rulings covering loans (Qard) as opposed to investment transactions are different. The authentic definition from hadith (with the chain of transmission being Hazrat Ali) leaves no room for ambiguity: 'every loan that draws a gain is riba.' However, an 'investment' is different, covered under the trading ayat. When you invest with an Islamic bank your funds are used to essentially trade.
Keeping in mind the definition given in Hadith as mentioned above one can now dwell into the discussion of Time Value of Money and the workings of present day Islamic Banks. For this we would have to look at the differences in ways in which modern capitalist theory (the basis of interest based banking) views 'Money' and 'Commodity' from the principles as defined by Islam.
According to modern capitalist theory there is no difference between money and commodity in so far as commercial transactions are concerned. According to the proponents of this theory both are treated at par and can be sold at whatever price parties agree upon. For them selling Rs100 for Rs110 or renting Rs100 for a monthly rental of Rs10 is the same as selling a bag of rice costing Rs100 for Rs.110 or renting a fixed asset costing Rs.100 for a monthly rental of Rs10.
Islamic principles do not agree with the above mentioned concept due to the fact that Money and Commodity have different characteristics, for instance (a) money has no intrinsic value but is only a measure of value or a medium of exchange, it is not capable of fulfilling human needs by itself until and unless it is converted into a commodity, while on the other hand a commodity can be used to fulfill human needs directly, (b) the commodities can be of different quality while money has no differential quality in the sense that a new note of Rs.1,000 is exactly equal in value and quality to an old note of Rs1,000, (c) commodities are transacted or sold by pinpointing the commodity in question or at least by giving certain specifications. Money however cannot be pinpointed in a transaction of exchange. Even if it is pinpointed it would be of no use since the different denominations of money summing into equal amount are exactly the same.
Keeping in view the above differences any sane mind would be compelled to agree that exchanging Rs1000 with Rs1100 in a spot transaction would make no sense since the money in itself has no intrinsic utility or a specified quality and thus the excess of amount on either side is without consideration and hence not allowed under Shariah. The same would hold true if we were to exchange these Rs1000 with Rs1100 to be delivered after a period of one month, since the excess of Rs.100 would be without any consideration of either any utility or quality but only against time. The same is not true when commodities are involved. Since a commodity is known to posses an intrinsic value and quality, the owner of such a commodity is allowed to sell his commodity at what ever price the buyer and himself mutually agree to transact, provided the seller does not commit a fraud and subjected of course to the forces of demand and supply. The above would hold true even if the price that is mutually agreed upon is higher than the prevailing market price.
In conclusion, any excess amount charged against deferred payment is Riba only where money is exchanged for money, since the excess charged is against nothing but time. The proof lies in the fact that if the debtor fails to repay at the stipulated time extra money is charged from him. In contrast where a commodity is being exchanged for money the seller may take into consideration different factors (like demand and supply situation, quality, utility, special features etc) including the time of deferred payment. It is true the seller may take the factor of time in increasing the price of his commodity in credit sale but the increased price is being fixed for the commodity and not exclusively for time nor the time is the exclusive consideration in fixing the price; therefore once the price is fixed it relates to the commodity and not to the time. For the same reason if the purchaser fails to pay at the agreed time, the price will remain the same and the seller under no circumstances would be allowed to charge more than what he actually owes.
Keeping in mind the above discussion, the use of KIBOR as a benchmark by present day Islamic Banks in calculating the selling price of their commodities in Murabaha sale transactions is not only justified but necessary to remain competitive given the current banking industry dynamics in which Islamic Banks have a pretty low share in the overall banking industry.
It must be understood that the use of KIBOR as a benchmark to determine the profit is only for indicative purposes and this does not make the transaction impermissible if all the conditions of a valid sale are fulfilled. It is quite frequently observed in our daily life that every trader whether large multinational trading corporations or a roadside store decide on their profit margin rates based on various factors of which a major variable is the competitive environment in which the trader operates his business. If a rice trader or a cloth merchant uses KIBOR as the basis of adding profit margins to the cost of their commodities and arriving at the price, this would not tantamount to interest or Riba and would not make transaction impermissible. Similar is the case with Islamic banks when they arrive at the selling price of their commodities using the KIBOR. In contrast conventional banks price their loans based on the KIBOR, which does result in Riba since it is an exchange between money and money and not a sale transaction in which commodities are exchanged with money.
It is being questioned in some circles, whether Islamic banks could price their commodities by applying some other benchmark rate. The rationale behind using KIBOR is the banking environment dominated by conventional banks, which discourages the development of an Islamic benchmark rate. However, as more and more Islamic banks come into the operation, an interbank market between Islamic banks will be created and a new benchmark for the Islamic banking industry can be developed.