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Prohibition of Interest and Economic Rationality

Prohibition of Interest and Economic Rationality <jats:sec><jats:title>Abstract</jats:title><jats:p>This research evaluates three reasons against the use of interest. One reason is that interest is a tool of exploitation. It contradicts facts because nowadays ultimate borrowers are businessmen and ultimate lenders are salaried individuals, the former being financially better off than the latter. The second reason is that interest-based external financing leads to unfair distribution of profits. Although this reasoning is not wrong, it is not very appealing in positive economics. Having noted that risk aversion is applauded in both conventional and Islamic economics, this author has propounded a third reason which states that the risk of an investment is least when financed exclusively by equity. This reasoning is easily understandable to conventional economists and is proved mathematically in this article. Therefore it provides a sound economic footing for prohibition of interest.</jats:p> </jats:sec> http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Arab Law Quarterly Brill

Prohibition of Interest and Economic Rationality

Arab Law Quarterly , Volume 24 (3): 293 – Jan 1, 2010

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Publisher
Brill
Copyright
© 2010 Koninklijke Brill NV, Leiden, The Netherlands
ISSN
0268-0556
eISSN
1573-0255
DOI
10.1163/157302510X508346
Publisher site
See Article on Publisher Site

Abstract

<jats:sec><jats:title>Abstract</jats:title><jats:p>This research evaluates three reasons against the use of interest. One reason is that interest is a tool of exploitation. It contradicts facts because nowadays ultimate borrowers are businessmen and ultimate lenders are salaried individuals, the former being financially better off than the latter. The second reason is that interest-based external financing leads to unfair distribution of profits. Although this reasoning is not wrong, it is not very appealing in positive economics. Having noted that risk aversion is applauded in both conventional and Islamic economics, this author has propounded a third reason which states that the risk of an investment is least when financed exclusively by equity. This reasoning is easily understandable to conventional economists and is proved mathematically in this article. Therefore it provides a sound economic footing for prohibition of interest.</jats:p> </jats:sec>

Journal

Arab Law QuarterlyBrill

Published: Jan 1, 2010

Keywords: bank interest; debt equity ratio; risk aversion; economic rationality; portfolio theory; usury

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