Articles on Islamic Economics

Critical Analysis of Arguments in Favor of Interest


Salman Ahmed Shaikh

Sometimes, arguments are made in favour of the justification of interest. These arguments are not potent from the perspective of economics. This section looks at some of these arguments and shows how they do not justify the institution of interest from even the economics standpoint.

  • Interest is the Price of Risk

Lending money for stipulated interest does not involve risk. The lender gets interest in any situation, no matter whether the borrower earns profit or loss. Even when the borrower takes a loan for meeting health expenses or buys essential food intake from the borrowed money, the borrower is required to pay interest. Even when the loans are provided to commercial businesses, the returns from enterprise in the real economy are uncertain. After taking the risk, businesses either earn profit or incur loss.

  • Share in the Profit of the Borrower

Interest cannot be regarded as the profit share in the business of the borrower. Not all borrowing is for commercial purposes. Even when borrowing is sought for commercial undertakings, the lender does not agree on sharing profits. Rather, the lender stipulates a pre-determined rate of increase demanded over the principal amount of loan. For sharing in the profit and loss of the business, the appropriate way of engagement is to provide investment funds on equity financing basis. In genuine equity financing, profit sharing ratio is agreed at the beginning. If the profit is earned, it is shared on the basis of profit sharing ratio. If there is a loss, it is shared on the basis of investment share.

  • Interest is a Rent on Money

It must be noted that the assets on which rent is charged are used and given back in the same existing condition after the use, such as homes or cars. On the other hand, money and other consumption goods are consumed.  When we borrow money, we consume it and then regenerate it to repay our liabilities. In a loan transaction, when the money is used by the borrower, it is consumed. The borrower has to regenerate it and the lender without taking any risk is entitled to receive the consumed money with interest. An example here would illustrate the difference between rentable and non-rentable goods. Can we borrow apples or mangoes on rent? The answer is ‘no’ since these are consumption goods. Thus, we can borrow a hammer, but not the nails based on the above classification between rentable and non-rentable goods.

1 reply »

  1. Thanks a lot for a useful feedback. Some observations are shared.

    Entrepreneurial risk is the dividing line between trade and lending for interest. A trader takes the risk that market price may turn out to be less than the cost or that he may remain unable to sell at all. Lending for interest avoids both these things. Plus, the subject of trade is fiat money that has no intrinsic value, so it cannot be traded at different face values across time periods. Reason why we discount present values is based on an implicit assumption that a parallel interest based system is operating and its legal basis is justified. In an interest free economy, time will become irrelevant for value. Even if things change in value overtime, it will not be a deterministic exponential function of time (as in compound interest), but based on changes in fundamental values of the assets because of real disturbances.

    For the second point, it is not necessary that all consumption goods have same features. Some are eatables while some are not. What is common feature among consumption goods is that their use require their destruction/consumption or non-usability after they are used. For example, eatables or money. Money has to be spent and parted away with to be of use. Then, it is regenerated by the borrower to repay the loan.

    Money is a means of payment. If means of payments are given exponential increase via interest, then they will be hoarded. Then, we are encouraging hoarding than spending. We are also creating a perpetual source of wealth concentration and by allowing interest on money, we are establishing a systematic source of rising income inequality.

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