RESEARCH PAPER

Conventional. vs. Islamic. Monetary Instruments

Prof. Dr. Mohd. Ma'sum Billah Independent Researcher and Scholar Applied Islamic Finance

Abstract

A digital reading edition preserved from the original research document.

CONVENTIONAL VS. ISLAMIC MONETARY AND NEGOTIABLE INSTRUMENTS By: Prof. Dr. Mohd. Ma’sum Billah masum2001@yahoo.com applied-islamicfinance@yahoo.com

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Introduction

Money is a one-form instrument to exchange for a commodity. It also gives a standard value for the product and services and helps society in measure their wealth. During Islamic history, the Arabs in pre-Islamic times used gold and silver as their financial in order to exchange for a commodity. Nowadays, the financial instrument is totally changed and differ with the pre-Islamic times which money are promote in term of currency which is each state have their own currency i.e. Ringgit Malaysia for Malaysia, Dollar for United States and Yen for Japan.

Instead of money as a financial instrument to exchange for a commodity, there are a financial instrument which is it vary with money in term of the functions and application. It is a negotiable instrument. Negotiable instruments are well known in today business practice and are widely used in commercial and financial. Their purpose is to secure payment and the usage is increasingly applied by the companies in order to creating, transferring and procuring satisfaction of financial liabilities.

In this paper, we will discuss about the definition of money and negotiable instrument according to conventional and Islamic perspectives. With both conventional and Islamic perspectives also, we will present the types of negotiable instrument that commonly applied in commercial and financial transaction.

Definition Of Money According To Conventional And Islamic Perspectives

The definition of money is truly defined by its functions. According to McConnell Brue, money generally has 3 functions; first and foremost, money is a medium of exchange that is usable for buying and selling goods and services.[1] As medium of exchange, money allows society to escape the complications of barter. Barter system was an old system, which no longer exists, for example a bakery owner receives a bunch of bananas in exchange for a baked cake. However, Money is readily acceptable as payment.

Besides, it provides a convenient way of exchanging goods, money enable society to gain the benefit of geographic and human specialization Second function of the money is a unit of account. For example, in United States, money is recognized in dollars as monetary unit. This monetary unit may state the price of each product and services. With money as a unit of account, it also will give the value of product and services in term of the quantity and the quality of the product and services. It helps buyers and sellers in decision-making by comparing the prices of the product and services.

McConell Brue alos stated that money would permit us to define debt obligation, determines taxes owed, and calculate the GDP of the state. Thirdly, money also functions as a store of value. It permits people to transfer purchasing power from the present to the future. Instead of spending the money, people also will place or store their money in the safe place in the period of time such as the saving account. It is because money is the most liquid of all assets where they can withdraw their money from their account to buy goods immediately.

The money that they store also will give the value of people’s wealth and it also is the best way to preserve their wealth especially in inflation situation. In Islamic point of view, also have functions as above i.e. medium of exchange, unit of account and store of value. However, the difference between both perspectives money in Islam can’t make money from money or money as a potential capital. It in itself does not have value and therefore should not be used to generate more money, via fixed interest payments, simply by being put in a bank or lent to someone else.

Only human effort and taking risk in starting and managing a venture are the means of generating money. In other words, money should be used as a form of debt rather than being capital, and this debt should not be allowed to generate interest. For this reason, Muslims are encouraged to purchase goods and services rather than accumulating it and or earning interest on it, whether by depositing it in interest-based banks or lending it to people for benefits in return.

Definition Of Negotiable Instrument According To Conventional And Islamic Perspective

According to Shovlin H.P, he defines negotiable instrument as a written contract in which a full and legal title is transferable by either simple delivery of the instrument or endorsement or delivery of the instrument. The passes instrument should be free from any prior claim and transferee must take it in good faith and for value.[2] From the definition above, it was clear that, firstly, full and legal title passes on delivery. It means the transferee can sue in his own name in respect of his rights under the instrument.

Secondly, the liable party on the instrument would not give notice of transfer as a title pass to transferee. Thirdly, the passes title must be free from equity or defects of any previous instrument holder.

Then, the parties involve in transfer of negotiable instrument should be always in good faith. For example, A, transferee aware that the transferor has stolen the transfer document from the owner and A ignored the facts. In this case, from the fact A was not acting in good faith.

It also stated that the transferee must give consideration regarding the value of the negotiable to the transferor. The value of the instrument that the transferee needs to consider such as money, goods, services or a promise to deliver value after 30 days i.e. a 30-day bill of exchange.

The definition of the negotiable instrument in Islamic perspective is not much difference from the conventional perspectives. However, there are some exceptions in the issuance of Islamic negotiable instrument, where it has to follow Shari’ah precepts i.e. prohibition of interest (riba) and speculation (gharar).

a) Prohibition of interest (riba) Normally issuance of bond is like selling debt certificate where the certificates are considered as a commodity. In primary market, bonds are issued to public by bond issuer such government or limited companies. This issuance purposely is to seek funds from the bondholders and they are promised to receive a guaranteed return at the end of period.

Nevertheless, the guaranteed return is considered as interest (riba), which was strong forbidden in Islam. The prohibition was clearly stated in ayah:

“Those who devour usury would not stand except as stand s one whom the Evil One by his touch hath driven to madness. That is because they say: “Trade is like usury,” but Allah hath permitted trade and forbidden usury. Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (the offence) are Companions of the Fire; they will abide therein (forever)”.[3]

(Quran 2:275)

b) Speculation (Gharar) Under conventional concept of negotiable instrument, a debt certificate can be transferred or sell either in primary market or secondary market which mean selling from the first holder to the other persons with markup price.

Though, Islam prohibited such practices because selling through secondary market it may contain speculation on the value of the certificate. As was mentioned in ayah:

“O ye who believe! Eat not up your property among yourselves in vanities: But let they be amongst you traffic and trade by mutual goodwill: Nor kill (or destroy) yourselves: for verily God hath been to you Most Merciful!” [4]

(Quran 4:29)

Types Of Conventional Negotiable Instruments

According to Shovlin H.P, the types of negotiable instruments are divided into 3 categories, namely international trade, money transmission and financing instruments.[5] Following are individual instruments for each category:

Though, these instruments listed are not comprehensive list but they are among the most widely used and common form of negotiable instrument.

a) International trade i) Bill of Exchange A bill of exchange is a written, dated, and signed instrument that contains an unconditional order from the drawer that directs the drawee to pay a definite sum of money to a payee on demand or at a specified future date. It is an instrument that can be transfer free of claims that the drawer might have. b) Money transmission i) Bank Notes Bank notes is like a promissory notes in which bank promise to pay the bearer on his demand the sum of money stated on the face of the notes. ii) Cheques A cheque is the most practices of the negotiable instrument.

A cheque is convenient form of passing money from one person to another. Normally, a cheque will honoured by the bank unless there is money in the cheque issuer’s account or the issuer is permitted overdraft his account.

ii) Bank Draft A bank draft is a type of the cheque. But, there is a different where individual account holder does not draw it but it’s drawn by the bank. Bank draft can only issue by bank and their branches. The bank draft usage is relatively low compared with the cheque and they are most acceptable because of their reliability. c) Financing Instrument i) Promissory Notes A promissory note is a promise made by a maker to pay a determine sum of money to a payee. A promissory of note is a negotiable instrument, which is considerably similar to a trade bill of exchange.

However, the slightly different of a promissory note is ‘a promise to pay’ whereas a bill of exchange is ‘an order to pay’. ii) Negotiable Certificate of Deposit It is a financial instrument that it can be considered as a promissory note. Though, this kind of promissory note given by bank in exchange for the deposit of a sum of money for a fixed period of time. iii) Treasury Bills Treasury bill is also a promissory note where it issued by the Treasury to raise short-term loans for Government fund.[6] It also can consider as bond.

According to McConnell Brue, bond is a financial device through which a borrower (a firm or government) is obligated to pay the principal and interest on a loan at specific date in future.[7]

Types Of Islamic Negotiable Instrument

Islamic negotiable instrument are still new in today business activities. There are few research and practical of Islamic negotiable instruments. Specifically, the exercise of negotiable instrument in Malaysia can be listed as following: Acceptable Islamic Bill, Negotiable Islamic Certificate of Deposit (NICD) and Islamic bond (Sukuk).

a) Acceptable Islamic Bill

Acceptable Islamic bill is a negotiable instrument which is it applies the concept of bay’ al-dayn. It is a written promise that the person who takes the bill as a form of payments will be paid in cash when he presents the bill at the proper place and at the proper period of time. The seller (exporter) of goods will receive money before the buyer pay or exporters can obtain cash as soon as possible after they have exported their goods. The importer also can make payment later until they receive the goods.[8]

b) Negotiable Islamic Certificate of Deposit (NICD)

The Negotiable Islamic Certificate of Deposit (NICD) is a product similar to conventional Negotiable Certificate of Deposit (NCD). The NCD is also known as debt certificate or security. The NCD should be based in the concept of bay’ al-inah in order to making the NCD become Islamic and follows the principles of Shari’ah principles.

According to Rosly S.A, the procedure of NICD similar to the one apply in personal financing of bay al-inah and in his example, a company put RM 1 million in NICD with bank. Bank will sell an asset worth RM 1 million new deposits. Then, the company will sells back the share certificate to the bank at a deferred price, which is based on a profit rate, say 7.5% for a duration of six months. The selling price was at RM1, 037,500 where the company earns profit of RM37, 500. The bank pays the company by issuing NICDs worth RM1, 037,500.

The issuance of the NICD is undertaken as evidence of the RM1, 037,500 debt that the bank owes the company. Upon maturity date, the NICDs are redeemable at par value where the company gets back the RM1 million deposit plus RM37, 500.[9]

c) Islamic Bonds (Sukuk)

There are two types of Islamic bonds (Sukuk) that most applicable in nowadays which is Salam or Istisna’ sukuk and Ijarah sukuk. Accounting and Auditing Organizations of Islamic Financial Instituition (AAOIFI) have provided the accounting standard in order to accommodate the accounting practices of Islamic financial institutions which is it includes AAOIFI’s Financial Accounting Standard No.17 (FAS 17).

According to AAOIFI FAS 17, it highlights the recognition, measurement and disclosure of the Islamic bonds (sukuk). It classifies Islamic bonds (sukuk) into at least four types: Mudaraba sukuk, Musharaka sukuk, Salam or Istisna’ sukuk and Ijarah sukuk.

i) Mudaraba sukuk

It represents ownership of units of equal value in the Mudaraba equity and it registered in the names of holders on the basis of undivided ownership of shares in the mudaraba equity. The return of this investment is according to the percentage of ownership of share. The owner of sukuk is recognized as the rabbul-mal.

ii) Musharaka sukuk

This Musharaka sukuk are not differ from Mudaraba sukuk which is it indicate the ownership of its equity. However, the parties who involve in issue sukuk will forms a committee consists of the holders of the sukuk. This committee will be referring for making decision in investment.

iii) Salam or Istisna’ sukuk

Salam sukuk is a sale of a commodity on the basis of deferred delivery of commodity against immediate payment. The deferred commodity is a debt in-kind against the supplier because it refers to a commodity that is accepted based on the description of the seller.[10]

Istisna’ sukuk is similar to Salam sukuk except the payment. In the Istisna’ transactions, it is permissible to defer the payment, but not in Salam. In both sukuk, the subject matter of the sale is an obligation on the manufacturer or builder for Istisna’ and the seller for Salam. If the buyer or the seller of the commodity issues sukuk, both Istisna’ and Salam instruments can be neither sold nor traded before their maturity time. For that reason, these two sukuks are treated as investments held to maturity.[11]

iv) Ijarah sukuk

Ijarah sukuk is the most applicable Islamic bonds in commercial and financial transactions. With the concept of ijarah, this ijarah sukuk present the ownership of equal shares in a rental real estate or benefit (usufruct) of the real estate. The owner have the right to own the real estate, receive the rent and dispose of their sukuk. This right will not give effect to the right of the lessee. The sukuk holders will bear all cost maintenance of and damage of the real estate.[12]

Conclusion

Negotiable instrument are commonly practical application in commercial, financial transaction. The acceptance of this instrument among banks and other companies in dealing with business transactions because of it derives well-established rules and practice that contains in the instrument itself.

However, negotiable instrument are new practices in Islamic business transactions. It is because the negotiable instrument that existed now not complies with the Shari’ah principles. As discussed before, the most applicable negotiable instrument in Islam and accept by the Islamic business practicers is Islamic bonds or it also known as sukuk.

According to Shari’ah principles, the negotiable instrument should be from interest (riba) and speculation (gharar). The concept of bay’ al-inah and bay’ al-dayn can be apply in the Islamic negotiable instrument to avoid from the application of interest (riba) and speculation (gharar).

These term papers broaden our viewpoints on the importance of understanding the concept of negotiable instrument and its application especially in Islamic perspectives. Thus, there are more research on Islamic negotiable instrument are needed in order to accommodates Muslim in dealing their business operations.

In conclusion, the application of negotiable instrument can be accepted in commercial and business transaction instead of money application. However, people especially Muslim should aware with the conditions of the instrument either it follows the Shari’ah rulings or not.

----------------------- [1] McConnell Brue, “Economic:Fifth Edition”, (McGraw-Hill Irwin,2002), p.244

[2] Shovlin H.P, “Bills of Exchange and Other Negotiable Instruments: A Handbook of Effective Practice”. (Woodhead Faulkner, 1988), p. 5

[3] Surah al-Baqarah 2:275 [4] Surah al-Nisa’ 4:29 [5] Shovlin H.P, “Bills of Exchange and Other Negotiable Instruments: A Handbook of Effective Practice”. (Woodhead Faulkner, 1988), p.10 [6] Shovlin H.P, “Bills of Exchange and Other Negotiable Instruments: A Handbook of Effective Practice”. (Woodhead Faulkner, 1988), p.14

[7] McConnell Brue, “Economic:Fifth Edition”, (McGraw-Hill Irwin,2002), p. G-2