Is making an "equivalent value" loan in accord with Islam?

Question

In much of the modern world, currency is defined according to a "floating exchange rate." To the best of my knowledge, such an innovation was unknown during the time of the prophet, where the economy directly revolved around gold and silver.

Whereas before, while under the gold standard, "a dollar" was defined by a particular weight of gold. Regardless of how the currency changed through time, or how the value of gold fluctuated in the economy at large, such a fixed currency maintained a solid value of exchange. That dollar would always be worth such-and-such amount of gold, period.

A floating currency, on the other hand, does not have such a guarantee. "A dollar" under a floating exchange is effectively only ever worth a dollar, whatever that may mean. Combined with the effects of inflation, this typically results in the dollar having less and less buying power with every passing year.

In other words, a dollar's worth of gold in 2012 would NOT be the same as a dollar's worth of gold in 2002.

This is very relevant when providing a loan; if the value of a dollar goes down as time goes on, the debtor has a strong motivation to not pay back an interest-free loan immediately, especially if the period of the loan is lengthy or undefined. The longer one waits to return the money, the cheaper it effectively becomes to pay back.

This is not good for the lender, who typically gets less value (despite the same dollar amount) in return than he had originally loaned out. In the non-Muslim world, this risk is often handled by charging interest on any loan; this not only offsets the effects of inflation (as well as providing a profit), but provides debtors with a motivation to pay back a loan as soon as possible so as not to accrue additional debt. Such an option is, of course, not appropriate in Islam as God has explicitly "permitted trade and has forbidden interest."

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It occurs to me that, with an interest-free loan, one could effectively mitigate this problem by providing a loan of "effective value" rather than of a particular dollar amount. For example, instead of loaning somebody $50, one could loan them "the cash equivalent of .915g of gold" (which as of the time of this post works out to roughly $50). That way, when the loan is repaid, the exact dollar amount returned would be based on whatever the price of gold is at that time, rather than a straight dollar-for-dollar return.

I realize that this transaction could be performed without stepping on any Islamic laws by simply loaning out the gold directly; arguably even by loaning out the gold and immediately buying it back for market price (and reversing the transaction when the debt is repaid), which would functionally be the same as the above proposal. Of course, most people typically don't deal with gold directly anymore (at least not in Canada), which makes this sort of transaction awkward at best.

So the question lies thus: Would performing such an "equivalent value" transaction be valid according to Islamic law? As Islamic finance in general has received significant study, especially in the wake of the interest-based economic system so favored by the modern world, I would be particularly interested in any scholarly opinions on the matter.

Answer 1

Question:

Is making an “equivalent value” loan in accord with Islam?

Answer:

It is not permissible for the one who borrows money from anyone to commit himself to repaying the loan based on the value of the currency at the time when the loan is repaid, rather he must repay the loan with the same value as it had at the time he took it.

...

In the event that inflation is expected at the time of signing the contract, the contract may be drawn up based on a currency or form of wealth other than that which is expected to fall, such as basing the contract on the following:

(a) Gold or silver

(b) A similar product

(c) A basket (group) of similar products

(d) Another, more stable currency

(e) A basket (group) of currencies

My personal thoughts:

I am assuming this means that you can do a contract on the day the loan is taken based on the weight of gold. If a loan of 10k is required, you work out the weight of gold 10k would get. For arguments sake, lets assume that is 1kg of gold. Then when paying the loan back many years later, you don't necessarily pay back 10k, you pay back whatever the cost of 1kg of gold is. So if in 2013 when you pay the loan back, 1kg of gold costs 50k, you pay back 50k.

I may have misunderstood the fatwa, so please read it carefully yourself.

Source:

islamqa.com.

Answer 2

As you and @oshirowanen mentioned, yes it is true and there is no problem if you agree to loan someone gold or any other kind of wealth instead and that person accepts it.
For example He wants 100$ and you say OK I'll give you 100$ worth gold(assuming 3g) but in cash and you should pay me back 3g gold. This is Halal but:

• The key thing you don't consider here is that maybe later 3g gold becomes less valuable and for example becomes 90$. So you don't define a fixed amount of interest.
• Riba is when you without any consideration just define an amount or a percent of interest for that loan.
• Riba is when you define a fixed interest and may never lose anything (e.g. due to the economic conditions of society) and that means others would turn into your slaves and work for you and they have to bear the risks.

Answer 3

Before I answer this, I want to mention something about precision. In the old days, metallurgy was less advanced than now (obviously). It's normal to expect variation -- for example, in the minting of coins, bullions, and other currency materials.

As to the meat of your question: you're really asking does Islam acknowledge the time-value of money? That is, that the value of money can change over time? And the answer is a resounding yes.

As we discussed in my Islamic finance class, Islam acknowledges and understands the time-value of money, and the depreciation of inflationary-economy-based cash. In the case of a loan specifically, the default is to pay back the exact amount borrowed, to the dollar. This is because Rasulullah (the apostle of Allah) said:

There is no loan that benefits the debtor.

I need not explain this much further; any benefit (especially lending $100 and being paid back $101) would classify as riba under this hadith (among other places).

However, what about the case of a long-term loan -- perhaps one that spans five, ten, twenty years? In this case, the value of money would change significantly.

In this case, we are told to seek the assistance of a qadi. In these kinds of situations, a qualified judge should give a ruling on how much the borrower should repay.

Source: Weekend course on Islamic Finance 101