66 AN INTRODUCTION TO ISLAMIC FINANCE
LACK OF THEORY OF INTEREST
Islamic scholars advocating the elimination of interest from the economy
highlight the fact that there is no satisfactory theory of interest in the con-
ventional economic theory. This criticism is especially leveled against having
a fi xed rate of interest. Muslim writers see the existing theories of interest as
attempts to rationalize the existence of an institution that has become deeply
entrenched in modern economies and not as attempts to justify, based on
modern economic analysis, why the moneylender is entitled to a reward on the
money he lends.
Typical justifi cations for interest in any economy include the arguments
that interest is a reward for saving, a marginal productivity of capital, and
an inevitable consequence of the difference between the value of capital
goods today and their value after some time. With such arguments in mind,
the following points can be made:
■ (^) To the argument that interest is a reward for saving, Muslim scholars
respond that such payments could only be rationalized if savings were
used for investment to create additional capital and wealth: the mere act
of abstention from consumption should not entitle anybody to a return.
■ (^) The response from Muslim scholars to the argument that interest is jus-
tifi ed as marginal productivity of capital is that although the marginal
productivity of capital may enter as one factor into the determination
of the rate of interest, interest, per se, has no necessary relation with the
productivity of capital. Interest, they argue, is paid on money, not on
capital, and has to be paid irrespective of capital productivity. In distin-
guishing between interest as a charge for the use of money and a yield
from the investment of capital, they argue that it is an error of modern
theory to treat interest as the price of, or return on, capital. Money, they
argue, is not capital, it is only “potential capital,” which requires the
service of the entrepreneur to transform the potentiality into actuality;
the lender has nothing to do with the conversion of money into capital
or with using it productively.
■ (^) To the argument that interest arises as the time value of money, Mus-
lim scholars respond that this only explains its inevitability and not
its “rightness.” Even if the basis for time preference is the difference
between the value of commodities this year and the next, it seems more
reasonable to allow next year’s economic conditions to determine the
extent of the reward.
It is argued that when a person lends funds, the funds are used to cre-
ate either a debt or an asset (that is, through investment). In the fi rst case,
Islam considers that there is no justifi able reason why the lender should
receive a return simply through the act of lending per se. Nor is there a
justifi cation, either from the point of view of the smooth functioning of the