Introduction 11
By 1988, this challenge was met when academic research, using modern
analytical fi nancial and economic theory, showed that:
■ (^) A modern fi nancial system can be designed without the need for an
ex ante, determined, positive, nominal fi xed-interest rate. Indeed, it was
shown that there was no satisfactory explanation for the existence of
such a rate.
■ (^) Moreover, it was shown that not having such an interest rate (that is, the
absence of a debt contract) did not necessarily mean that there would be
zero return on capital.
■ (^) The basic proposition of Islamic fi nance was that the return on capital
would be determined ex post, and that the magnitude of that return was
determined on the basis of the return to the economic activity in which
the funds were employed.
■ (^) It was the expected return that determined investment.
■ (^) It was also the expected rate of return, and income, which determined
savings. Therefore, there was no justifi cation for assuming that in such
a system there would be no savings and investment.
■ (^) It was shown that in such a system there would be positive growth.
■ (^) Monetary policy in such a system would function as in the conven-
tional system, its effi cacy depending on the availability of instruments
designed to manage liquidity.
■ (^) Finally, it was shown that, in an open-economy macroeconomic model
without an ex ante fi xed-interest rate, but with returns to investment
determined ex post, there was no justifi cation to assume that there would
be a one-way capital fl ight.
Therefore, the system which prohibited a fi xed ex ante interest rate and
allowed the rate of return on capital to be determined ex post, based on the
returns to the economic activity in which the funds were employed, was
theoretically viable.
In demonstrating the analytical viability of such a system, the research
also clearly differentiated it from the conventional system in which, based
on debt contracts, risks and rewards were shared asymmetrically, with the
Sanctity of contracts and the preservation of property rights: Islam
upholds contractual obligations and the disclosure of information as a
sacred duty. This feature is intended to reduce the risk of asymmetric
information and moral hazard. Islam places great importance on the
preservation of property rights, defi nes a balance between the rights
of individuals, society and the state, and strongly prohibits encroach-
ment on anyone’s property rights.