How Islam responds to lending money and inflation

How Islam responds to lending money and inflation

Dr Mohammad Akram Nadwi
Oxford

Question:
How is Islam’s prohibition of interest (riba) justified considering economic realities such as inflation? If I lend ₹100 to a friend today and he pays me back ten years later, the ₹100 I receive is decreased in value as a result of inflation. Additionally, I will lose access to my money for the duration of the loan and there is a risk that my money will not be returned. Interest appears to solve these issues, so why is it still prohibited?

Answer:
Islam prohibits interest due to its exploitative nature and unjust enrichment. However, your concern about inflation is valid, and Islamic finance addresses this issue differently.
Islam encourages fairness and the protection of value in lending. A key principle is that when money is lent, it is not just the amount that matters, but also its real value. If you lend ₹100 today and over ten years, inflation reduces its purchasing power, you are Islamically entitled to be repaid an amount that reflects the original value you lent, not just the same ₹100.
This is not interest, but rather a return of the real value of the loan, and this ensures fairness for both parties. Risk-sharing and alternative contracts like profit-sharing (mudarabah), leasing (ijarah), or sale-based modes (murabaha) are also used in Islamic finance to address risk and compensation without resorting to interest.
In summary, Islam prohibits fixed interest, but it does not require you to lose value due to inflation. You may agree to be repaid in a way that preserves the real purchasing power of your loan, as long as it is mutually agreed upon from the start.