Indexation of financial obligations
Indexation of financial obligations is the adjustment of the liability of the borrowers in money terms to reflect the change in the value of money during the period the loan, this value is measured using a price index. The concept of indexation in conventional finance is often used to make a provision for a floating rate in the agreements, in relation to any future inflationary pressures. Applying new rates to the remaining period allows not to affect the liability already accrued.
In the Islamic framework, transactions of loan or debt should involve equality. If a measurable good is lent, it is necessary to return the same quantity, irrespective of any increase or decrease in its price. And the borrower should pay the same coins or currency, irrespective of any increase or decrease which has occurred in the currency. In addition, the difference in value due to a time element is not prohibited in Islam except when the time-value of money is a predetermined quantity calculable at a predetermined rate. In fact, the Shari’ah makes difference between the valuation of a credit period based on the value of the goods or their usufruct and the conventional concepts of opportunity cost or the time-value of money.
Therefore, indexation could be neither a substitute for interest nor it could control the vagaries of inflation. In fact, while the intrinsic characteristics of money do not change during an inflationary period, the relative characteristics, such as the future value of money in terms of its exchange value, are continuously changing. Therefore, indexation in Islam excludes the functions of measurement of value of money without providing a remedy for its failings, and the function of standardizing value of money for deferred payment. The Islamic banks would receive from their borrowers the same rate of return as they will have to pay to their depositors, both being based on the rate of inflation. This would mean that no profit will be left for the banks themselves.
Regarding the impact of change in the purchasing power of any currency on a debt, the Islamic Fiqh Academy considers that it is not permitted to attach fixed debts, whatever their source, to currency fluctuation. Fixed debt should be repaid in the same currency and not by its counter value. Therefore, the Academy approved that the parties may agree on the day of settlement for the settlement of the debt in a currency other than the one specified for the debt, provided the rate of exchange applied is that applicable on the settlement date. No part of the subject of the currency exchange should remain outstanding. The parties may also agree, at the time of contracting, to the settlement of the deferred cost in a single payment or in instalments, and to have it in a specific currency, in a variety of currencies or against a given amount of gold. And a debt contracted in a specific currency should not be recorded against the debtor in its counter value in gold or other currencies.
Therefore, Islamic banks are not allowed to link any debt or receivable for the purpose of indexation. However, they are allowed to stipulate a floating or variable rate in certain financial products. In fact, in order to settle pecuniary liabilities in the context of an inflationary situation. In fact, banks can enter into Musharakah, Mudarabah and diminishing Musharakah transactions wherein their return can automatically be adjusted with an inflationary situation. The rental rate for a short duration can be fixed or variable. Accordingly Islamic banks can charge rental in Ijarah at a higher rate, if already provided in the agreement, for any remaining period of the lease. However the rentals for a particular period, once accrued, cannot be indexed.
In the Islamic framework, transactions of loan or debt should involve equality. If a measurable good is lent, it is necessary to return the same quantity, irrespective of any increase or decrease in its price. And the borrower should pay the same coins or currency, irrespective of any increase or decrease which has occurred in the currency. In addition, the difference in value due to a time element is not prohibited in Islam except when the time-value of money is a predetermined quantity calculable at a predetermined rate. In fact, the Shari’ah makes difference between the valuation of a credit period based on the value of the goods or their usufruct and the conventional concepts of opportunity cost or the time-value of money.
Therefore, indexation could be neither a substitute for interest nor it could control the vagaries of inflation. In fact, while the intrinsic characteristics of money do not change during an inflationary period, the relative characteristics, such as the future value of money in terms of its exchange value, are continuously changing. Therefore, indexation in Islam excludes the functions of measurement of value of money without providing a remedy for its failings, and the function of standardizing value of money for deferred payment. The Islamic banks would receive from their borrowers the same rate of return as they will have to pay to their depositors, both being based on the rate of inflation. This would mean that no profit will be left for the banks themselves.
Regarding the impact of change in the purchasing power of any currency on a debt, the Islamic Fiqh Academy considers that it is not permitted to attach fixed debts, whatever their source, to currency fluctuation. Fixed debt should be repaid in the same currency and not by its counter value. Therefore, the Academy approved that the parties may agree on the day of settlement for the settlement of the debt in a currency other than the one specified for the debt, provided the rate of exchange applied is that applicable on the settlement date. No part of the subject of the currency exchange should remain outstanding. The parties may also agree, at the time of contracting, to the settlement of the deferred cost in a single payment or in instalments, and to have it in a specific currency, in a variety of currencies or against a given amount of gold. And a debt contracted in a specific currency should not be recorded against the debtor in its counter value in gold or other currencies.
Therefore, Islamic banks are not allowed to link any debt or receivable for the purpose of indexation. However, they are allowed to stipulate a floating or variable rate in certain financial products. In fact, in order to settle pecuniary liabilities in the context of an inflationary situation. In fact, banks can enter into Musharakah, Mudarabah and diminishing Musharakah transactions wherein their return can automatically be adjusted with an inflationary situation. The rental rate for a short duration can be fixed or variable. Accordingly Islamic banks can charge rental in Ijarah at a higher rate, if already provided in the agreement, for any remaining period of the lease. However the rentals for a particular period, once accrued, cannot be indexed.
