Towards an interest-free Islamic economic system

A comparative and mathematically rigorous look at an Islamic financial system based on a variable-return scheme (VRS) verses one based on a fixed-return scheme (FRS) shows that under certain assumptions, such as risk aversion by investors, the Pareto-optimal contract occurs under a variable-return scheme. The reason: a VRS spreads risks far more equitably. In the contemporary world, FRS dominates, in the form of debt contracts. VRS monitoring costs are not prohibitive. In fat, the more effective the methods of monitoring are and the higher the degree of honesty of economic agents, the more superior the Islamic financial system stands to be.