Tuesday, September 23, 2008

Islamic Finance, Interest, and Efficiency: An Analytical Overview


اقتصادنا، كتاباً من أية الله العظمى سيد الشهيد محمد باقر الصدر

Riba, Efficiency, and Prudential Regulation: Preliminary Thoughts

By Mohammad Fadel
University of Toronto, Faculty of Law

Wisconsin International Law Journal (forthcoming 2008)
Islamic Law and Law of the Muslim World Paper

ABSTRACT: Recent years have witnessed the rapid growth 'Islamic Finance.' Islamic finance distinguishes itself from conventional finance through its adherence to the doctrines of peculiar Islamic commercial prohibitions, most famously the prohibition against riba. Although riba is commonly equated with interest, Islamic law does not condemn all types of interest. It is the ambiguous relationship of riba to interest that explains the paradoxical nature of Islamic finance: even as it condemns lending with interest, it endorses transactions that replicate the economics of interest-based lending, giving rise to the phenomenon of shari'a arbitrage. Islamic finance is thus a systematic strategy to exploit unresolved tensions within Islamic law regarding riba. This paper explores the legal puzzles that arise out of the various doctrines of riba in Islamic law and suggests that riba-based prohibitions can only be understood against a background rule that generally privileged market pricing mechanisms. From the perspective of contractual freedom, it is possible to break down riba into two sets of doctrines: ex ante prohibitions and ex post prohibitions. Only prohibitions that deal with bankrupt debtors should be understood as categorical, while the ex ante riba-based prohibitions are best understood as prophylactic or prudential measures that function as price-fixing measure in times of scarcity which tend to reinforce a baseline distribution of entitlements guaranteed by the system of zakat, a tax-and-transfer system that guaranteed all individuals a year's worth of provisions. Because the prohibition against interest-based lending is also a type of ex ante restriction on market pricing mechanisms, it follows that it should also be viewed as a prudential rule rather than a categorical one, thereby vitiating the need to engage in complex restructuring of conventional financial instruments to assure their consistency with Islamic law.

Mohammad Fadel is professor at the University of Toronto at the Faculty of Law. He earned a B.A. in government and foreign affairs, a Ph.D. in Near Eastern Languages and Civilizations at the University of Chicago, and a J.D. from the University of Virginia. He is a past articles development editor at the Virginia Law Review and John M. Olin Law and Economics Scholar at the University of Virginia. He also served as a law clerk for Judge Paul V. Niemeyer of the United States Court of Appeals, 4th Circuit.


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