Riba vs. Rate of Return 63
in an agreed ratio whereas losses are borne in the ratio of the respective
capital contributions.
The Time Value of Money
It is a common misconception that by prohibiting interest on loans Islam
denies the concept of the time value of money. Islamic scholars have always
recognized the time value of money, but maintain that the compensation for
such value has its limitations. Recognition of an indirect economic value
of time does not necessarily mean acknowledging any right of equivalent
material compensation for this value in all cases. According to the Shari’ah,
compensation for the value of time in sales contracts is acknowledged, but
in the case of lending, increase (interest) is prohibited as a means of provid-
ing material compensation for time.
The Islamic notion of the opportunity cost of capital and the time value
of money can be clearly understood by reviewing the distinction between
investment and lending. Time by itself does not give a yield, but can only
contribute to the creation of value when an economic activity is undertaken.
A sum of money can be invested in a business venture or it can be lent for
a given period of time. In the former case, the investor will be compensated
for any profi t and loss earned during that time and Islam fully recognizes
this return on the investment as a result of an economic activity. On the
other hand, if money is in the form of a loan, it is an act of charity where
surplus funds are effectively being utilized to promote economic develop-
ment and social well - being.
In response to the contemporary understanding that interest on a loan
is a reward for the opportunity cost of the lender, Islamic scholars maintain
that interest fi xed ex ante is certain, is tantamount to indulging in riba and
is therefore unlawful. The element of uncertainty diminishes with time
and the resultant return on investment is realized, rather than the accruing
of return due to the passage of time. In short, Islam’s stand on the time value
of money is simple and clear. Money is a medium of exchange; time facilitates
completion of economic activity, and the owner of capital is to be compen-
sated for any return resulting from economic activity. Lending should be a
charitable act without any expectation of monetary benefi t.
RATIONALE FOR THE PROHIBITION OF RIBA
The fundamental sources (the Qur’an and the sunnah) do not provide any
detailed rationale for the prohibition of riba beyond asserting, axiomatically,
that charging interest is an act of injustice. Contemporary Muslim scholars,
particularly the economists among them, have provided various rationales
for this prohibition by alluding to the consequences of the existence of inter-
est in modem societies, or by arguing that modem economic theory has not
provided any justifi cation for the existence of even the necessity of interest