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Interest Based Financial Intermediation: Analysis and Solutions

Author

Listed:
  • Shaikh, Salman

Abstract

Interest is prohibited in all monotheist religions. Apart from religion, interest is also regarded as unjust price of money capital by pioneer secular philosophers as well as some renowned economists. However, it is argued by some economists that modern day, market driven interest rate in a competitive financial market is different from usury and that the interest based financial intermediation has served a useful purpose in allocation of resources as well as in allocation of risk, given the interpersonal differences in risk preferences that exist in any society. Hence, there is a need to delineate clearly whether Islamic economics distinguishes between usury and interest. Secondly, there is also a need to reassess the economic merits and demerits of modern day competitive financial markets fueled by interest based financial intermediation. This paper tries to serve this need and presents a brief review of literature on the issue and examines the economic rationale usually presented for legitimizing interest as the price of capital. The paper analyzes the impact of interest based financial intermediation on macroeconomic variables as well as on development goals by highlighting few glaring facts and statistics and empirical evidence documented in past studies. The paper concludes with delineating the role of capital in an Islamic economy and how it can be valued in an Islamic economy without compensating it with fixed payoffs and the paper also assesses how economic and financial decisions will be altered in this new interest-free framework.

Suggested Citation

  • Shaikh, Salman, 2012. "Interest Based Financial Intermediation: Analysis and Solutions," MPRA Paper 42500, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:42500
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    References listed on IDEAS

    as
    1. Haque, Nadeem ul & Mirakhor, Abbas, 1999. "The Design of Instruments For Government Finance in An Islamic Economy," MPRA Paper 56028, University Library of Munich, Germany.
    2. Easterly, William, 2002. "How Did Heavily Indebted Poor Countries Become Heavily Indebted? Reviewing Two Decades of Debt Relief," World Development, Elsevier, vol. 30(10), pages 1677-1696, October.
    3. Abbas Mirakhor, 1996. "Cost Of Capital And Investment In A Non-Interest Economy," Islamic Economic Studies, The Islamic Research and Training Institute (IRTI), vol. 4, pages 35-47.
    4. Arshad Zaman & Asad Zaman, 2001. "Interest And The Modern Economy," Islamic Economic Studies, The Islamic Research and Training Institute (IRTI), vol. 8, pages 61-74.
    5. Hanif, M. Nadim & Sheikh, Salman, 2009. "Central banking and monetary management in islamic financial environment," MPRA Paper 22907, University Library of Munich, Germany, revised 25 May 2010.
    6. Betsy Jane Clary, 2011. "Institutional Usury and the Banks," Review of Social Economy, Taylor & Francis Journals, vol. 69(4), pages 419-438, December.
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    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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