Usury, Profit and Time Value of Money (TVM)

By Prof. Saiful Azhar Rosly,
Director of Consulting and Executive Programme (CEP)

Bearing in mind that interest-rate benchmarking is not prohibited in Islamic finance, it is timely to raise the TVM issue. Apparently no explicit fatwa is available to address this matter, except for some dalils quoted in the middle of this page.

Conceptually, TVM deals with our preference to spend our money in a certain time horizon, say whether to spend it today or in the future. Those who prefer to spend it today believe that doing so will give him more satisfaction compared with doing it say, tomorrow. Making such a choice is actually matter of personal preference defined by the environment around us rather than a rule to be dutifully obeyed.

The interest rate system came into being when those who are offered to lend out money and hence postponing their current spending are compensated with interest for the loss of foregoing it i.e the consumption today. This is how conventional thinking uses TVM or to be more specific, positive time preference (PTP) to justify the receipt and payment of interest rates.

The Islamic position of TVM can be appreciated by examining the evidences from early Islamic scholars about profits generated from credit sales, some of which are given below:
1.Price will possibly rise due to its deferred payment (Badai’ as-Sonaie, Al-Kasani, 5/187)
2.“The deferment for some period of time has a value in the price” (Bidayatul Mujtahid, Ibn Rush Al-Hafid, 2/108)
3.“The period is part of the price” (Fatawa Ibn Taimiya, 29/499.
4.“This is the evidence that the period of time in sale and purchase (al-bay) has its portion in the price; and it is permissible for sale and purchase contracts” (Al-Mughni, Ibn-Qudamah, 6/385)

These evidences suggest that profits can be gained by the trader when the buyer pays for the goods in the future at the higher price. The difference between credit and cash price constitutes the TVM or we can call it time value in price (TVP) instead. However, this will hold only when the transaction is based on sale and purchase contract (al-bay) and not from a loan (qard). Otherwise interest as riba will be implicated here.

This leads us to the interest benchmarking issue where TVM in conventional thinking is a consequence of lending and borrowing of monies while in Islamic finance it deals with trading and commerce (al-bay).

For example, the yield on the 3-month Treasury bill constitutes the true time value of money (TTVM) as the government security is free from default. This is the pure interest rate or opportunity cost of money which the interest benchmarking is based on. The BLR or now known as base rate (BR) is the cost of funds that the bank uses, say 3-month FD plus a spread that consists of the overhead and statutory costs of holding reserves to charge borrowers minus the credit risk spread. Interest rate benchmarking also uses the 3-month FD or 3 month-Kuala Lumpur interbank offer rate (KLIBOR) to price the Islamic credit sales.

The point raised here is that the interest benchmarking may be a right thing to do when the risks associated with Islamic credit sales is similar to the risks in loans. This however is arguable when the Islamic credit sale characterises a structure that evidences the inherent nature of trading which is the holding of business risk. When none of the Islamic credit sales are exposed to business risk, it is quite accurate to pursue the interest rate benchmarking in determining the profit rates.