In Islamic point of View Interest and Indexation are interrelated?
S J Tubrazy
It is argued the interest charged and paid by the banks on the ground that since the value of money is decreasing constantly, the interest should be taken as a compensation for the erosion of the value of money during the period of borrowing. The financier, according to them, should have a right to claim at least the same amount in real terms as he had advanced to the borrower, but if his principal is repaid to him in the same numerical terms, he will not receive the same purchasing power as he had advanced to his debtor, because the inflation would have eroded a substantial part of the real value of money. Therefore the interest is paid to compensate the loss the financier has suffered through inflation.
This argument is without force because the rates of interest are though a major cause of inflation among other factors; they are not based on the rate of inflation. Had it been a compensation for inflation, the rate of interest should have always matched the rate of inflation, and obviously this is not the case. The rates of interest are determined by the demand and supply of money and not by the rate of inflation at the time of the contract. If at any given time both rates match each other, it may be by chance and not as a matter of principle. Therefore, the interest cannot be held as a compensation for the loss of purchasing power.
Some other quarters have taken the aspect of inflation from another angle. They do not claim that interest, as in vogue, is a compensation for the loss caused by inflation. However, they suggest that indexation of loans can be a suitable substitute for the present interest‑bearing loans. They argue that the’ financier should be compensated for the erosion of the value of money he had advanced to the borrower and, therefore, he can claim an additional amount matching the rate of inflation. Thus, according to them, indexation may be introduced into the banking system as an alternative for interest.
The concept of indexation of loans is to give the real value of the principal to the financier based on the rate of inflation, and therefore, there is no difference between depositors and borrowers in this respect. It means that the bank will receive from its borrowers the same rate as it will have to pay to its depositors, both being based on the same measure i.e. the rate of inflation. Thus, nothing will be left for the banks themselves, and no bank can be run without a profit.
In order to solve this problem, many suggestions have been proposed by different quarters, some of which are the following:
(a) That the loans should be indexed, meaning thereby, that the debtor must pay an additional amount equal to the increase in the rate of inflation during the period of borrowing.
(b) That the loans should be tied up with gold, and it should be presumed that the one who has loaned Rs.1,000 has actually loaned as much gold as could be purchased on that date for Rs.1,000 and must repay as much rupees as are sufficient to purchase that much of gold.
(c) That the loans should be tied up by a hard currency like dollar.
(d) That the loss of the value of money should be shared by both creditor and lender in equal proportion. If the value of money has declined at a ratio of 5 % , 2.5 % should be paid by the debtor and the rest should be borne by the creditor, because the inflation is a phenomenon beyond the control of either of them. Being a common suffering, both should share it.