Difference in Cash and Credit Price and Islamic Finance

Difference of cash and credit price charged by suppliers looks like Time value of Money and in Islam charging for time in relation to money is prohibited as Riba. Is it so? The answer can be found by analyzing what is Riba, nature of money in Islamic Economics, Time Value of Money and rulings on credit transactions.

Usury from Medieval Latin usuria, "interest", or from Latin usura, "interest") originally was the charging of interest on loans; this included charging a fee for the use of money, such as at a bureau de change. In places where interest became acceptable, usury was interest above the rate allowed by law. Today, usury commonly is the charging of unreasonable or relatively high rates of interest. The term is largely derived from Christian religious principles; Riba is the corresponding Arabic term and ribbit is the Hebrew word. "When money is lent on a contract to receive not only the principal sum again, but also an increase by way of compensation for the use, the increase is called interest by those who think it lawful, and usury by those who do not." (Blackstone's Commentaries on the Laws of England, p. 1336).

The Holy Qur'an did not give any definition for the term for the simple reason that it was well known to its immediate audience. It is like the prohibition of pork, liquor, gambling, adultery etc, which were imposed without giving any hard and fast definition because all these terms were well known and there was no ambiguity in their meaning. Similar was the case of riba. It was not a term foreign to Arabs. They all used the term in their mutual transactions. Not only Arabs but all the previous societies used to practice it in their financial dealings and nobody had any confusion about its exact sense.

Hadith while explaining the word riba has mentioned in detail the transactions of riba which were used to be effected by the Arabs of Jahiliyya on the basis of which the earliest commentators of the Holy Qur'an have defined riba in clear terms. Imam Abubakr Al-Jassas (D.380 AH) in his famous work Ahkamul Qur'an has explained riba in the following words: "And the riba which was known to and practiced by the Arabs was that they used to advance loan in the form of Dirham (silver coin) or Dinar (gold coin) for a certain term with an agreed increase on the amount of the principal advanced." On the basis of this practice the same author has defined the term in the following words: "The riba of Jahiliyya is a loan given for stipulated period with a stipulated increase on the principal payable by the loanee." The well-known Imam Fakhruddin Al-Raazi has mentioned the practice of riba in the days of Jahiliyya as follows: "As for the riba An-Nasiah, it was a transaction well-known and recognized in the days of Jahiliyya i.e. they used to give money with a condition that they will charge a particular amount monthly and the principal will remain due as it is. Then on the maturity date they demanded the debtor to pay the principal. If he could not pay, they would increase the term and the payable amount. So it was the riba practiced by the people of Jahiliyya."

The claim of an increased amount over the principal had different forms in the days of Jahiliyya. Firstly, while advancing a loan the creditor used to claim an increased amount over the principal and would advance loan on this clearly stipulated condition as is mentioned by Imam Al-Jassas in his Ahkamul Qur'an already quoted above. Secondly, the creditor used to charge a monthly return from the debtor while the principal amount would remain intact up to the day of maturity as mentioned by Imam Ar-Raazi and Ibn Aadil already quoted. The third form is mentioned by Mujahid, but the full explanation of this transaction is given by Ibn Jarir himself on the authority of Qatadah in the following words: "The Riba of Jahiliyya was a transaction whereby a person used to sell a commodity for a price payable at a future specific date, thereafter when the date of payment came and the buyer was not able to pay, the seller used to increase the amount due and give him more time." The same explanation has been given by al-Suyuti on the authority of Faryabi in the following words: "They used to purchase a commodity on the basis of deferred payment, then on the date of maturity the sellers used to increase the due amount and increase the time of payment." This form of Riba has been frequently mentioned by the commentators of the Holy Qur'an because they wanted to explain a particular sentence of the verses of Riba which is as follows: "The non-believers say that sale is very similar to Riba." (Aya 275 of Sura Al-Baqarah). This saying of the non-believers clearly refers to the particular transaction of sale mentioned above. Their objection was that when we increase the price of commodity in the original transaction of sale because of its being based on deferred payment, it is treated as a valid sale. But when we want to increase the due amount after the maturity date, when the debtor is not able to pay, it is termed as Riba while the increase in both cases seems to be similar. This objection of the non-believers of Makkah has been specifically mentioned by the famous commentator Ibn Abi Hatim on the authority of Said ibn Jubair: "They used to say that it is all equal whether we increase the price in the beginning of the sale, or we increase it at the time of maturity. Both are equal. It is this objection which has been referred to in the verse by saying 'They say that the sale is very similar to Riba.'” The same explanation is given in al-Bahr al-Muheet by Abu Hayyan and several other original commentators of the Holy Qur'an. It clearly shows that the practice of increase at the time of maturity relates to two situations: firstly, a situation where the original transaction was that of sale of a commodity as mentioned by Qatadah, Faryabi, Saeed Ibn Jubair etc, and the second situation was where the original transaction was that of a loan whereby monthly interest used to be charged by the creditor and the principal amount used to remain intact until the date of maturity, and if the debtor would not pay the principal at that point of time, the creditor used to increase the due amount on the principal in exchange of further time given to debtor. It is thus established that the Riba prohibited by the Holy Qur'an was not confined to one transaction only. It had different forms which all were practiced by the Arabs of Jahiliyya. The common feature of all these transactions is that an increased amount was charged on the principal amount of a debt. At times, this debt was created through a transaction of sale and it was created through a loan. Similarly, the increased amount was at times charged on monthly basis, while the principal was to be paid at a stipulated date, and some time it was charged along with the principal. All these forms used to be called Riba because the lexical meaning of the term is increase. That is why, the commentators of the Holy Qur'an like Imam Abu bakr al-Jassas have defined the term in the following words: "The Riba of Jahiliyya is a loan given for a stipulated period against increase on the principal payable by the Loanee."

One of the wrong presumptions on which all theories of interest are based is that money has been treated as a commodity. It is, therefore, argued that just as a merchant can sell his commodity for a higher price than his cost, he can also sell his money for a higher price than its face value, or just as he can lease his property and can charge a rent against it, he can also lend his money and can claim interest thereupon.

Imam Al-Ghazzali (d.505 A.H.) the renowned jurist and philosopher of the Islamic history has discussed the nature of money in an early period when the Western theories of money were non-existent. He says:

"The creation of dirhams and dinars (money) is one of the blessings of Allah…. They are stones having no intrinsic usufruct or utility, but all human beings need them, because every body needs a large number of commodities for his eating, wearing etc, and often he does not have what he needs and does have what he needs not.. Therefore, the transactions of exchange are inevitable. But there must be a measure on the basis of which price can be determined, because the exchanged commodities are neither of the same type, nor of the same measure which can determine how much quantity of one commodity is a just price for another. Therefore, all these commodities need a mediator to judge their exact value…. Allah Almighty has, therefore, created dirhams and dinars (money) as judges and mediators between all commodities so that all objects of wealth are measured through them… and their being the measure of the value of all commodities is based on the fact that they are not an objective in themselves. Had they been an objective in themselves, one could have a specific purpose for keeping them which might have given them more importance according to his intention while the one who had no such purpose would have not given them such importance and thus the whole system would have been disturbed. That is why Allah has created them, so that they may be circulated between hands and act as a fair judge between different commodities and work as a medium to acquire other things…. So, the one who owns them is as he owns every thing, unlike the one who owns a cloth, because he owns only a cloth, therefore, if he needs food, the owner of the food may not be interested in exchanging his food for cloth, because he may need an animal for example. Therefore, there was needed a thing which in its appearance is nothing, but in its essence is everything. The thing which has no particular form may have different forms in relation to other things like a mirror which has no color, but it reflects every color. The same is the case of money. It is not an objective in itself, but it is an instrument to lead to all objectives…

So, the one who is using money in a manner contrary to its basic purpose is, in fact, disregarding the blessings of Allah. Consequently, whoever hoards money is doing injustice to it and is defeating their actual purpose. He is like the one who detains a ruler in a prison…

And whoever effects the transactions of interest on money is, in fact, discarding the blessing of Allah and is committing injustice, because money is created for some other things, not for itself. So, the one who has started trading in money itself has made it an objective contrary to the original wisdom behind its creation, because it is injustice to use money for a purpose other than what it was created for…. If it is allowed for him to trade in money itself, money will become his ultimate goal and will remain detained with him like hoarded money. And imprisoning a ruler or restricting a postman from conveying messages is nothing but injustice."

Time value of Money has been defined as The idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. Money that you hold today is worth more because you can invest it and earn interest. After all, you should receive some compensation for foregoing spending. A key concept of TVM is that a single sum of money or a series of equal, evenly-spaced payments or receipts promised in the future can be converted to an equivalent value today.  Conversely, you can determine the value to which a single sum or a series of future payments will grow to at some future date. The basic idea of time value of money is that a Rupee today is worth more than a Rupee tomorrow. This can be shown in many ways, many people find it easiest to understand if they think in terms of something they already know: food. For example having the money today allows you to buy some food immediately. Alternatively you may be willing to forgo current consumption and wait until later to purchase your food. Thus you could lend your "food money" to another with the promise of being paid back at some future time. Since you are passing up food today you would demand a return sufficient to allow you to buy at least as much food in the future that you are giving up now. As we do not know the future this type of deal involves risks. For example the borrower may decided to not pay you back. This is called default risk. Or the borrower may pay you back but due to rising prices you can no longer purchase the same amount of food as you had expected to be able to buy. As a result of these risks (you as a lender) would require a higher interest rate to compensate for accepting the risks. However if you ask for too high of interest rates you will not find any takers for your loan.

Islam acknowledges an increment in a commodity’s price in any sale contract to be paid at a future date, as long as money’s time value is not claimed as a predetermined value. In other words, any conditional increase in the loan’s principal in return for a deferred repayment due to an expected depreciation in the value of the money, asset, or other factors (e.g., inflation and commercial losses) is prohibited. The following few quotations from traditional jurists exemplify that increasing the price of a commodity for delay is acceptable:

1. Al-Kasani (Hanafi) in Bada’i`i al-Sana’i`i: “The price may be increased based on deferment.”
2. Ibn Rushd (Maliki) in Bidayat al-Mujtahid: “He has given time a share in the price.”
3. Al-Nawawi (Shafi`i) in Al-Majmu`: “Deferment earns a portion of the price.”
4. ‘Ibn Taymiyah (Hanbali) in his Fatawa: “Deferment takes a share of the price.”

This is tantamount to the acceptance of time value in the pricing of goods. What is prohibited is any addition to the commodity’s price once it has been mutually agreed upon, because of any delay in its payment. Such a prohibition also suggests that Islam does not permit a fixed predetermined time value for money. The reasons behind the permissibility of increasing the price of a commodity in credit sales  is that once the commodity is sold, even on credit, the purchaser retains its ownership on a permanent basis, and thus the seller has no right to reprice the sold commodity, since it no longer belongs to him/her. Jalal al-Din al-Suyuti (d. 911/1507) and Ibn Jarir al-Tabari (d. 310/922) reported the similar situation of involvement with riba in which a person sold a commodity on credit; when the payment was due and the purchaser could not repay it, the price was increased and the time for payment was extended. Imam Tirmidhi (d. 279/857) reported that the Prophet (pbuh) forbade “two sales in a single contract.”

Following is a Hadith from Al-Muwata 31.74, which throws some light on the term “Two Sales in One Sale”.

Yahya related to me from Malik that he had heard that al-Qasim ibn Muhammad was asked about a man who bought goods for 10 dinars cash or fifteen dinars on credit. He disapproved of that and forbade it.

Malik said that if a man bought goods from a man for either 10 dinars or 15 dinars on credit, that one of the two prices was obliged on the buyer. It was not to be done because if he postponed paying the ten, it would be 15 on credit, and if he paid the ten, he would buy with it what was worth fifteen dinars on credit.

Malik said that it was disapproved of for a man to buy goods from someone for either a dinar cash or for a described sheep on credit and that one of the two prices was obliged on him. It was not to be done because the Messenger of Allah, may Allah bless him and grant him peace, forbade two sales in one sale. This was part of two sales in the one sale.

Malik spoke about a man saying to another, "'I will either buy these fifteen sa of ajwa dates from you, or these ten sa of sayhani dates or I will buy these fifteen sa of inferior wheat or these ten sa of Syrian wheat for a dinar, and one of them is obliged to me.' Malik said that it was disapproved of and was not halal. That was because he obliged him ten sa of sayhani, and left them and took fifteen sa of ajwa, or he was obliged fifteen sa of inferior wheat and left them and took ten sa of Syrian wheat. This was also disapproved of, and was not halal. It resembled what was prohibited in the way of two sales in one sale. It was also included under the prohibition against buying two for one of the same sort of food."

Islamic jurists have explained this to mean that, for instance, if a person tells someone: “I will sell this cloth for ten (dirhams) in cash and on credit for twenty (dirhams)” and, at separation, one price is not settled. If one of the two prices is settled, he sale is valid. Al-Tirmidhi also added that if a seller says: “I sell the cloth for 10 (dirhams) cash and 20 (dirhams) on credit” and the buyer accepts one of these prices or says: “I will purchase it for 20 (dirhams) on credit,” or the parties differ on the price, the sale is still valid.

While it is best to buy an article by paying cash, it is also permissible to buy on credit by mutual consent. A group of jurists are of the opinion that, should the seller increase his price if the buyer asks for deferred payments, as is common in installment buying, the price differential due to the time delay resembles interest, which is likewise a price for time; accordingly, they declare such sales to be haram. However, the majority of scholars permit it because the basic principle is the permissibility of things, and no clear text exists prohibiting such a transaction. Furthermore, there is, on the whole, no resemblance to interest in such a transaction, since the seller is free to increase the price as he deems proper, as long as it is not to the extent of blatant exploitation or clear injustice, in which case it is haram. Al-Shawkani says, "On the basic of legal reasons, the followers of Shafi'i and Hanafi schools, Zaid bin 'Ali, al-Muayyid Billah, and the majority of scholars consider it lawful." (Nayl al-awtar,vol. 5, p. 153. Al-Shawkani said, "We have compiled a treatise on this subject and have called it 'Shifa al'ilal fi hukum ziyadat al-thamam li mujarrad al-ajal' (The Reason for Increasing the Price Due to Lapse of Time), and have researched it thoroughly.")

The condition for the credit price to be different from cash price of a commodity is that the parties to transaction must settle one price before parting otherwise the difference of cash and credit price is not permitted.When one of the price is settled, seller cannot change the price based on any change in payment period as this would constitute Riba.

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. Time valuation is possible only in business and the trade of goods, not in the exchange of monetary values and loans or debts, as the Shari`ah considers a loan to be a virtuous act from which one cannot take any benefit. Therefore, no time value can be added to a loan’s or a debt’s principal after it has been created or the purchaser’s liability has been stipulated.

Yusuf Al-Qaradawi has followed the footsteps of Hazrat Umar (RAA) who said that “We have given up 90% of all legitimate transactions for the fear that an element of Riba might be present in them.” When you are in doubt about a transaction whether it involves an element of Riba or not just give up.