Indexation of Bank Deposits & Advances​

Under a system of indexation the liability of a borrower to the banking system would be adjusted in money terms to reflect the change in the value of money, as measured by a price index, during the period the borrowing remained outstanding. Lending by banks on this basis would enable them to compensate the depositors for the change in the value of money. Indexation may constitute a favourable factor for the growth of savings in an inflationary situation by preserving the real value of money savings. But indexation on the side of bank advances is likely to create a number of problems. It is well known that inflation affects profitability in various sectors in different ways. Recent experience in a number of developed and developing countries showed that profits in the commerce sector boomed in an inflationary situation while profits in the industrial sector did not rise in consonance with the rise in the general price level. Indexation of bank advances under such circumstances can greatly hurt productive activity. Agricultural sector is also likely to suffer because agricultural prices are often controlled by the Government or determined by international demand and supply factors. If the increase in the prices of agricultural products is less than the rise in the general price level, indexation, of banks advances will place the agricultural sector in a disadvantageous position compared tc sectors where price rise is equal to or more than the rise in the general price level.

Under the Shari'ah, currency transactions are not treated differently from commodity transactions in as far as lending and borrowing are concerned. The basic principle is that the same quantity (units) should be returned as was borrowed even though the price of the commodity may have changed in the meantime. For example, if one maund of wheat has been borrowed, the borrower will have to return one maund of wheat even though the price of one maund wheat may have risen from Rs. 30.00 to Rs. 50.00 per maund or fallen to Rs. 15.00. Similarly, if the borrowing consisted of a specified amount of money, say, Rs. 1,000, the borrower will have to repay the same amount of money even if the value of rupee in terms of other goods and services may have changed during the period.

Source: Money and Banking in Islam, Ziauddin Ahmed; Munawar Iqabal; M. Fahim Khan. Republished with permission.