There are many things in life that we take for granted as truths, simply because that is just how it has always been. On the one hand it allows us to function more efficiently but on the other had it locks us into path dependency. In this mode of thinking we are always looking for reasons as to why we must not or cannot change rather than why we must change, until something shocks the system.
An example of something that shocks the system is Tesla. It has turned everything that the auto industry held as inviolable truths, upside down. As a result, Tesla’s valuation has rocketed passed a trillion dollars, making it more valuable than the next top 6 car companies combined and 3 times bigger than Malaysia’s GDP.
Another example is the 2008 financial crisis. The long-held justification for short selling was that it was an effective way for price discovery and jurisdictions that did not allow short-selling was seen as backward. Yet in Sept 2008 as the financial crisis was unfolding, the first thing that several European countries and the US did was ban short selling. These are cases of truth giving way to reality; and this situation has been mentioned in the Quran “…it is possible that ye dislike a thing which is good for you, and that ye love a thing which is bad for you…”
One of the truths that the pandemic has upended in the authour’s opinion is the concept of Time Value of Money (TVM). It is something that had always been taken as a truth until the discussions on loan moratoriums came to the fore. With it, the discussions on modification losses, being the difference between the present value (PV) of the modified contractual cash flows against the PV of the original contractual cash flows, and then the permissibility of charging customers for this difference so the banks are fully compensated. In simple terms, this is akin to giving a loan, and then when the borrower asks for more time to repay, an additional charge is imposed on the borrower.
While there is clear textual evidence on the permissibility for taking time as a factor in pricing, that is not the same as putting a price on time, which is what TVM does. There is no issue about selling a thing for the price of $10 to be paid on the spot or $20 to be paid a month later. However, the analogy does not carry over to the value of money; for example, to exchange a $10 note for 10 $1 notes today or for 20 $1 notes a month later is usury (riba), and this is exactly what TVM does. TVM creates an equivalency of a future sum of money to the value of money today.
The big questions therefore are, was TVM a concept practiced at the time prior to and during the time of the Prophet PBUH? Was it really a medieval practice sanctioned by canon law or is it a post 1582 Simon Stevin invention of interest tables? Certainly Eugene Von Bohm-Bawerk’s (1884) Positive Theory of Capital did get the ball rolling, but if all schools of thoughts (religious, political, philosophical, economics) all banned or criticised usury, then where did TVM emerge from? For this, the authour made reference to a great extent to Jones and Smith (1982).
The original concept was Equivalent Annual Cost (EAC), an engineering concept developed by A.M. Wellington in 1887 to evaluate alternative choices in locating railways. Irving Fisher’s The Rate of Interest (1907) was the first to use Net Present Value (NPV) in finance. In 1930, Wellington’s main source of reference, Engineering Economics by Eugene Grant, was first published with extensive discussions on capital budgeting. Whereas in the world of Finance, asides from a mention in R.H. Coarse’s 1938 article, there was hardly any mention of TVM until 1950 when two articles appeared, discussing the Internal Rate of Return (IRR) concept. TVM only went mainstream in the world of finance in the 1960’s with Bierman and Schmidt’s 1960 book The Capital Budgeting Decision and followed by Charles Herngren’s Cost Accounting: A Managerial Emphasis in 1962.
In fact, in 1938 J.F. Ebersole, after examining 757 cases on file at the Harvard Business School, concluded that “the interest rate is not viewed as an important problem by business management; the interest rate is seldom considered as a factor in entrepreneurial decisions of business to expand of contract and is a controlling factor in a negligible number of instances.”
To quote J.M Keynes in his General Theory of Employment, Interest and Money (1936) “I was brought up to believe that the attitude of the Medieval Church to the rate of interest was inherently absurd, and that the subtle discussions aimed at distinguishing the return on money- loans from the return to active investment were merely Jesuitical attempts to find a practical escape from a foolish theory. But I now read these discussions as an honest intellectual effort to keep separate what the classical theory has inextricably confused together, namely, the rate of interest and the marginal efficiency of capital. For it now seems clear that the disquisitions of the schoolmen were directed towards the elucidation of a formula which should allow the schedule of the marginal efficiency of capital to be high, whilst using rule and custom and the moral law to keep down the rate of interest.” In a sale with delayed payment, there is no doubt on the permissibility of taking time into consideration in the deferred price, but we cannot take that and reverse it although it looks just the same. TVM puts a price on time PV = FV/(1 + i/n)^(n*t); which in effect indicates that future amount of money is equal to this present amount of money after taking into account the effect of time, interest and compounding periods. Taking time into account of price and putting a price on time i.e. “time value of money” may look very similar, but is not the same. Therefore, we should go back to Quran 2:275 which reads: .”.. they say, ‘Trade is like usury (riba)’ but God has permitted trade, and forbidden usury (riba)”.
In effect, the widespread adoption of TVM is a new concept and it makes money which on its own is sterile to be treated as if it is fertile. The concept of money making more money runs counter to the concept of Islamic finance. In the words of Sheikh Yusof Qardawi “Money does not give birth to money.” Therefore, in the practice of Islamic finance, we have to take cognisence of the difference between time in price and price in time as it is as thin a line as “Trade is like usury (riba)”.
