Index-linked-saving certificates: These are on sale intermittently and for a term of 3 or 5 years. At the end of the term one can cash them or renew them for another term. The purpose is to keep the purchasing power of the money as when it was put in. This is done by adding the rate of inflation, RPI, to the amount at the end of the term. To make them attractive the government add a predetermined amount 0.25% – 0.5% on top. This addition is clearly Riba and I dispose of it. Example: If I purchased bonds for £100 in 2015 and cashed them in 2020 and assuming RPI of under 2%, I’ll get approximately £110 So numerically I get more but the purchasing power of £110 will be in 2020 exactly the same as the purchasing power was of my original £100 I gave them in 2015 So to me it’s like investing in a currency that is not affected by inflation, say the Swiss frank as opposed to a weaker currency that is devalued by inflation. Is this permissible?
In the Name of Allah, the Most Gracious, the Most Merciful.
As-salāmu ‘alaykum wa-rahmatullāhi wa-barakātuh.
The NS&I index-linked saving certificates are not Shariah compliant.
The Fiqh (jurisprudence of the answer):
The NS&I index linked savings are in the ruling of Qarḍ (loan). In addition to earning interest, each year the investment’s value moves in line with a measure of inflation called the Retail Prices Index (RPI). The indexation of financial obligations has been debated by contemporary Shariah scholars as well as economists without any consensus on the issue.
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 impact of 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 Riba 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 commodity money. 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. 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:
1) The verses of Quran (2:275) secure only the principal amount of a loan and consider 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.
2) 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.
3) 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.
4) 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.
And Allah Ta’ālā Alone Knows Best
Mufti Faraz Adam,
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