Islamic Finance: A Critique and a Defense

 Money is not a commodity, but a medium of exchange and a unit of account. It has no intrinsic value, but only a nominal value that depends on its purchasing power. Interest is not a price for money, but a predetermined return on money that does not reflect the actual performance of the underlying asset or project. It creates an imbalance between the lender and the borrower, and it leads to inefficiency and injustice in the economy.

How so?

Interest creates an imbalance because it guarantees a fixed return to the lender regardless of the outcome of the investment, while the borrower bears all the risk and uncertainty. This creates a moral hazard problem, where the lender has no incentive to monitor or share the risk with the borrower, and the borrower may take excessive or speculative risks to meet the interest obligation. Interest also leads to inefficiency because it discourages productive investment and innovation, and encourages debt-financed consumption and speculation. It creates a mismatch between the maturity and liquidity of assets and liabilities, and it amplifies the business cycles and financial crises.

Islamic finance has a lot to offer to the world economy. It is based on ethical values and principles that promote social justice, human dignity, environmental sustainability, and economic development. It is based on risk-sharing and partnership that align the interests of all parties involved in financial transactions. It is based on real economic activities that link finance with the real sector. It is based on moderation and balance that avoid excesses and extremes in financial behavior.