The Role of Money in Islamic Finance
What is the role of money in Islamic finance and what implications does it have?
By Tarek El-Ghamrawy
In ancient societies, selling and buying were done through barter. Money was later invented to facilitate the evaluation and exchange of goods and services. This role of money is fundamental in Shariah and Islamic finance. The function of money in Sharia is that it is a standard for the values of things and a medium for exchange, whether the exchange is on the spot or in debt.
Ibn Rushd (d. 595 AH) said: “When it became difficult to perceive the equality (in value) of things that are different in themselves, the dinar and dirham were used to evaluate them, I mean to estimate their relative value” (Ibn Rushd, Bidayat al-Mujtahed). Ibn Rushd refers here to the function of money being a standard for the values of things.
Al-Ghazali (d.555 AH) said about gold and silver, which were the main currencies in his time: “Allah Almighty created them so that they circulate among hands and be rulers over wealth with justice; and also for another reason, that is, through them, people reach all things, because they are valuable and there is no purpose in themseves (…) Whoever owns them is as if he owns everything” (Al-Ghazali, Ih’ia’ Oloum al-Din”. By that, he means that whoever owns money can obtain any commodity easily because money takes the place of any commodity and this feature is only found in money. By saying “they could circulate among hands”, he refers to the advantage of liquidity in money, and by saying “be rulers over wealth with justice” to the use of money in estimating the true relative values among things. By saying “there is no purpose in themselves”, he indicates that money is not intended for its own sake, but rather for reaching goods and services.
Money only generates money when it is linked to the production of a real good or service. If money became a purpose for profit from itself, production and work would be disrupted, since there would be no incentive for investing in real activity as long as money generates profit by itself.
On this basis, money is not intended to generate profit by itself. It is not permissible to profit from exchanging money for money or to rent and lease money. Money only generates money when it is linked to the production of a real good or service. If money became a purpose for profit from itself, production and work would be disrupted, since there would be no incentive for investing in real activity as long as money generates profit by itself. That would open the door to manipulating money by a few, and cause fluctuation in prices, upsetting people’s finances. The rich would get richer and the poor would get poorer. That is why Ibn al-Qayyim (d. 751 AH) said: “Currencies are not intended for themselves. Rather, they are intended to reach commodities. If they become a commodity that is intended for itself, people’s affairs will be spoiled” (Ibn al-Qayyim, I’lam Al Mowaqqe’in).
This role of money in Sharia has had many manifestations in the rulings of Islamic finance. These are some examples. Any required increase in a loan is considered as usury (riba), which applies to bank and bond interests. Exchanging gold for gold or a currency for itself is not allowed with a difference in the amount. Similarly, selling a debt for cash is not allowed unless the cash is of the same amount as the debt. Guarantees cannot be done for a return.
Western economists have generally concurred with scholars of Islam on this concept of the role of money. They stipulated in the nineteenth century that money has the three functions mentioned in economics and finance textbooks: that it is a medium of exchange, that it is a unit for evaluating things, and that it is a store of value in the sense that it is saved and preserves its value for use in the future (the latter is based on the assumption of no or low inflation). Although the fact that money is not a commodity is a well-established matter in positive economic theory, practical application has completely abandoned this principle and has come to deal with money as a commodity.
Nowadays, economics and finance depend on this new view of money intensively, as reflected for example in the banking system. Banks act merely as borrowers from and lenders to individuals, businesses, governments and other banks.In fact, banks lend much more than the cash they receive from depositors, in the form of new deposits made by the bank to borrowers which they can withdraw from at any time, causing the so-called money creation. Banks earn multiplied interests on these new loans.
All this is based on the idea that money is a commodity. Indeed, many advocates of bank interests nowadays argue by saying that money is a commodity like any commodity that is sold and rented, and thus it has a price; in order to interpret interest as a price or a fee on money. Obviously, this argument is a mistake from both Sharia and economics perspectives, which has its great adverse impact on economies and societies.