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Charging the nominal inflation rate on loan

Published: 24/08/2011 10:36:00 AM GMT
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effects of inflation?

If the lending party does not charge the nominal inflation rate – albeit, only accurate to the best of the ability of the country setting the rate – he will not be able to insure that there will be no real profit or loss to either of the two parties. Refusing to charge an interest rate does not change the fact that one of them is still a making profit and the other is still making a loss on the loan. This is due to inflationary/deflationary pressures affecting the value of the transaction.

This means that the nature of the loan transaction is still inherently interest based, regardless of whether or not a nominal interest is charged.

Does this mean that all loans must be set in terms of a fixed commodity (e.g. gold)? Since doing so means that there will be no real profit or loss made on the loan since the value is pegged to a fixed commodity (e.g. gold).

Otherwise, wouldn’t setting interest rates at the national inflation rate be the best method to minimize the interest effects on loans? This is because if inflation rates are not taken into consideration, on average there will be a greater amount of interest paid on loans in a deflationary economy and rights not fulfilled to the lender in an economy experiencing inflation.

Answered by

Sheikh Sâmî al-Suwaylim, member of the Islamic Advisory Board of al-Rajhi Bank

A loan in Islamic finance is strictly a non-profit transaction. Any stipulated addition to the loan makes it a for-profit transaction, and thus one that contains interest (ribâ).

Accordingly, it is normal in a non-profit transaction that one party is sacrificing for the benefit of the other, whether due to inflation (where the loss would be born by the lender), deflation (where the loss would be born by the borrower), or otherwise.

Islamic law only allows a profit to be made in a transaction that creates value. This means that the transaction must be value-creating in and of itself, and therefore must involve the exchange of real goods and services.

And Allah knows best.

Source: Islam Today

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