Concept of Time Value of Money in Islamic Finance and Banking:
There is no concept of time value of money in Islamic finance, and Islam does not recognized the value of money in any type of rescheduling of the debts. Once a sale is mutually agreed between the parties, any addition of money to this price due to delay is prohibited and haraam. This is because, the commodity once sold even on credit, belongs to the purchaser, and seller has no right to re-price it. Any addition in its price is considered as Riba or interest.
However, this concept should not be mixed with some authentic modes of Islamic finance. For Example:
Price of Commodity:
The increase in price of commodity in the original transaction is because of deferred payment, which is a valid sale. As it could be seen in Murabahah contract.
Future Delivery of Goods:
Salam as a forward contract enables payment in advance for future delivery of the goods, which is genuinely less than the cash-n-carry price.
Regarding the time value of money in Islamic finance, it may be concluded that:
- Time-value of money in Islamic finance is acceptable in respect of the pricing of assets and their usufruct.
- Interest is prohibited due to being increase over any loan or debt.
- Murabahah is subject to fulfillment of Shariah rules and conditions, however, mark-up technique should not be used, as a back door for allowing interest.
Settlement of Debts and Currency Rate Fluctuation:
According to Islamic Shariah, when financial contribution takes the form of a loan or a debt, it is to be paid back exactly in the same kind and quantity, irrespective of any change in the value of currency, or price of commodity lent or borrowed.
This principle is applicable on: Loans, debts, credit, barter, deferred exchange of currency, indemnity, change in the unit of currency, and delayed payment of remuneration after devaluation or revaluation.
However, if currency of the debt becomes extinct not available, its counter value will be paid, and rate of due date will be applicable.
Following was concluded in the 5th Session of OIC Fiqh Academy:
“It is significant that a fixed debt is repaid in its own currency, and not by its counter value, because debts are settled in the same currency. Thus, it is not permitted to attach fixed debts, whatever their source to currency fluctuation”.
Rules from OIC Fiqh Academy:
Regarding the time value of money in Islamic finance, the Fiqh academy, on 8th session approved the following:
- The creditor and debtor may agree on the day of settlement, but not before, to the settlement of the debt in a currency other than the one specified for the debt, provided the rate of exchange applied is that applicable on the settlement date.
- Similarly, for debts due in installments in a specific currency, the parties may agree on the day of settlement of any installment, to have it effected in full in a different currency, at the prevailing rate of exchange, on the date of settlement.
- A conditional requirement in all cases is that, no part of the amount subject of the currency exchange, should remain outstanding, as required under Shariah rules of exchange of currencies.
- The two parties to the contract may, at the time of contracting, agree to the settlement of the deferred cost or salary in a specific currency to be settled in single payment, or in installments in a variety of currencies or against a given amount of gold the settlement may also be made.
- A debt contracted in a specific currency, should not be recorded against the debtor in its counter value in gold or other currencies. This is because such practice would make it compulsory to the debtor, to settle the debt in gold or the other currency, as agreed upon for the settlement.
Note: The study contents on “Time value of money in Islamic finance” are taken from the Islamic banking courses and Islamic finance course, which are designed for the diploma in Islamic finance and master in Islamic finance programs.