Salaam alaikum wa rahmatullahi wa barakatuh,
Let’s say that I have taken a loan of $1,000,000 from someone for 30 years and decided to repay to him the same amount in future (because I don’t want to give him any interest, as it is prohibited). So, should I return to him the SAME amount or should I return to him the amount in which the amount of inflation is added?
Jazak Allah khair!
Wa alaykum salaam,
You will return the same amount in units back to him.
Allah knows best
Jazak Allah khair for your answer!
Another question please:
Will it not be unfair that I will the returning back the same amount of loan to the lender, while the purchasing power of that money is decreased/increased because of different factors like inflation? I mean, please correct me if I am wrong, that it is unfair to return the borrowed money to the lender more than the money borrowed or less than the money borrowed. It should be exactly the same. but i think it won’t be the same since inflation/deflation are around in our life.
Jazak Allah khair!
Inflation or the loss of purchasing power is a reality and a recognised concept in Shariah, thus, the indexation of wages and rental is justifiable. However, the indexation of cash loans to be repaid at a future date is a matter of debate.
Imam al-Sarakhsi (d.483 H), Imam al-Kāsānī (d.587 H) and others state that in the exchange of Ribawī commodities, discrepancy in value has been discarded and unrecognised due to the prophetic tradition (Naṣṣ) even though there may be actual discrepancy in value. Equality is thus stipulated in terms of actual quantity and units of the counter Ribawī commodities and not value. The primary prophetic tradition which discards value in Ribawī commodities is:
“Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt – like for like, equal for equal, and hand-to-hand; if these commodities differ then you may sell as you wish, provided that the exchange is hand-to-hand.” (Ṣaḥīḥ Muslim)
Thus, the different values and the purchasing powers of Ribawī commodities has been discarded and unrecognised in Shariah when they are exchanged among themselves. Therefore, indexation and the factoring in inflation in repaying financial obligations is a form of Ribā.
The Shariah scholars further argue that the prophetic traditions which prohibit Ribā clearly state that an exchange of homogeneous Ribā commodities must be equal and hand to hand. A difference in quality and value between the counter Ribawi commodities is permitted as long as the number and units of the commodities are equal on either side.
The major Islamic finance organisations as well as senior Shariah scholars have agreed that fiat money, which has no intrinsic value, follows the same rules as the bimetallic currency system. Thus, savings and loans of fiat currency cannot reap any increment above the sum of the loan irrespective of the value at the time of repayment.
Shariah scholars and economists conclude that indexation is not the answer. Rather, the focus should be on the source of inflation, in particular, price stability and fiscal discipline. If the concern is inflation, one should hedge against inflation by investing in Shariah compliant real asset investment vehicles such as gold and real estate as an example. The profit and loss sharing equity instruments in Shariah are another way to absorb the impact of inflation as the profit is shared in the agreed ratio whereas the losses are borne in the ratio of respective capitals.
Professor Zamir Iqbal (2011) enumerates the common arguments against indexations with the following:
The verse of Quran (2:275) secures only the principal amount of a loan and considers anything in excess of it as Riba. It is understood that this prohibition covers all transactions that may make any adjustments similar to al-riba, such as deferred exchange of currency, devaluation or revaluation, and change in the unit of currency at the time of repayment of loans. Since lending of money is a currency transaction that is treated as similar to exchange of a commodity, any compensation for the fall in the value of money is not justifiable.
Muslim scholars also argue that by virtue of inflation in the economy, an investor’s or lender’s purchasing power would be at stake irrespective of whether money is lent as a loan on a non-al-riba basis or is invested in a return-bearing security. In either case, the net loss to the lender is a real interest rate or real return. Even if money was not lent but was kept for consumption purposes, the same loss of purchasing power will occur. Therefore, it seems unreasonable to expect the borrower to bear all the loss, a loss that the lender would likely incur even if he or she had not made the loan.
It is argued that even if some form of indexation is allowed, it may not be in consonance with the notion of justice and therefore may not serve its intended purpose. While it is recognised that inflation is the loss of purchasing power and indexation is a compensation for such a loss, the problem is how to clearly identify and hold a certain party responsible for its share. There are several contributing factors leading to inflation, and the contributing magnitude of each factor and party cannot be determined. Therefore, it is unjust to ask one party to take the entire burden while others are burden-free. For example, if only the borrower is asked to compensate for the loss, which was caused by factors beyond the borrower’ s control (e.g., irresponsible policies of the government), it would imply that a person who is not responsible for inflicting the loss is made to compensate for it while the responsible party is not held responsible.
Fourth, some scholars have also discussed the practice of indexation by arguing that there is no perfect index that can fully capture the loss of the value. The constituents of the index representing the cost of living may not serve as a good proxy for the loss in purchasing power. Also, the cost of living index represents the consumption habits of an average person in an economy. Since the cost of living may differ from region to region and from city to city, it is not possible to measure it accurately. This inaccuracy can lead to an unjustified transfer of wealth from the borrower to the lender or vice versa. Similarly, inflation indices are based on a lag and therefore are not readily available to be used in daily financial transactions. All these factors make indexation less practical and prone to biases, which may open a back door for unjustified charges.
Allah knows best
jzk khyr - what an answer!
Just wanted to get your thoughts on the following, as discussion is always useful 
point 1) understood by who, and is this unanimous?
point 2) assumes funds are kept for consumption. High net worths (and evening middle class income earners) who are in a position to lend usually have investment opportunity cost, not consumption. So they forego a lot more more than inflationary losses. Opportunity cost loss is a lot higher. E.g. NASDAQ returned an average 10.8% average since 1978.
point 3) the lender isn’t ‘burden-free’ for the same reason mentioned above. If i lend £1k, i lend it not being able to spend it until it’s repaid, and potentially risking default.
point 4) seems unreasonable to say ‘it’s inaccurate so it’s unfair’, when the alternative unfairness (non-inflation adjusted loan repayments) is also arguably unfair. It’s lesser of 2 evils. Inflation, on average in the long term, is a reasonable representation for most of society. Although it’s not 100% accurate for all people at all times, it is sufficiently accurate.
Would love to hear your thoughts on the above!
Assalaamu alaykum,
They are the views of Professor Zamir Iqbal, you are welcome to get in touch with him for him to defend or advise further on your thoughts.
Regards
Sir, my name is Kashan and I am living in US for the past three years. I have a question similar to brother Ibrahim and I have struggled to find an answer for a long time now.
In US on average there is almost 2.5% inflation each year, we know that USD is not backed by commodity i.e. Gold or silver et, that used to retain its intrinsic value in the days of the prophet. Therefore, the USD (fiat currency) looses money each year.
I have $20,000 worth of emergency fund sitting in cash right now, meaning each year I loose 600 USD to inflation. I want to keep the cash liquid for my emergency needs such as an accident or unforeseen medical conditions etc and the best option that looks to me is to put that money into a savings account at bank of america that pays an interest of 1.5% even lesser than the average inflation in US., or let it devalue each year.
Would it be fair, if I do not have an emergency need in couple of years to let devalue that cash to almost $19000 in two years time frame. In other words would it still be considered RIBA , if I take interest to be able to get my money that I would original had without inflation?
Wa alaykum salaam,
According to most scholars, it would be interest.