Towards an interest-free Islamic economic system : a theoretical analysis of prohibiting debt financing

The author addresses the concept of Riba in Islamic law. References are made to al-Qur'an and to the Sunnah. Riba is seen to be a harmful institution. Instead of engaging in interest, it is possible to utilize the concepts of Shirakah (partnership) and Mudarabah (trust financing). The system in which returns are not pre-set, the variable return scheme (VRS), is shown to be a better framework than is the fixed rate arrangement FRS. Behind the reasoning for this finding are the postulates that investors steer away from risk and that information is symmetrical. It is believed that fixed rates are used in response to the moral hazard associated with variable return arrangements. Game theory analysis shows that the variable return scheme requires that dead weight loss be produced by spending on oversight expenses. The author looks at the models of economies without interest set up by other thinkers and compares his vision with theirs.