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Riba, Efficiency, and Prudential Regulation: Preliminary Thoughts

50 Pages Posted: 2 Apr 2008 Last revised: 7 Aug 2008

Mohammad Fadel

University of Toronto - Faculty of Law

Abstract

Recent years have witnessed the rapid growth 'Islamic Finance.' Islamic finance distinguishes itself from conventional finance through its adherence to the doctrines of peculiar Islamic commercial prohibitions, most famously the prohibition against riba. Although riba is commonly equated with interest, Islamic law does not condemn all types of interest. It is the ambiguous relationship of riba to interest that explains the paradoxical nature of Islamic finance: even as it condemns lending with interest, it endorses transactions that replicate the economics of interest-based lending, giving rise to the phenomenon of shari'a arbitrage. Islamic finance is thus a systematic strategy to exploit unresolved tensions within Islamic law regarding riba. This paper explores the legal puzzles that arise out of the various doctrines of riba in Islamic law and suggests that riba-based prohibitions can only be understood against a background rule that generally privileged market pricing mechanisms. From the perspective of contractual freedom, it is possible to break down riba into two sets of doctrines: ex ante prohibitions and ex post prohibitions. Only prohibitions that deal with bankrupt debtors should be understood as categorical, while the ex ante riba-based prohibitions are best understood as prophylactic or prudential measures that function as price-fixing measure in times of scarcity which tend to reinforce a baseline distribution of entitlements guaranteed by the system of zakat, a tax-and-transfer system that guaranteed all individuals a year's worth of provisions. Because the prohibition against interest-based lending is also a type of ex ante restriction on market pricing mechanisms, it follows that it should also be viewed as a prudential rule rather than a categorical one, thereby vitiating the need to engage in complex restructuring of conventional financial instruments to assure their consistency with Islamic law.

Keywords: islamic finance, islam, islamic law

Suggested Citation

Fadel, Mohammad, Riba, Efficiency, and Prudential Regulation: Preliminary Thoughts. Wisconsin International Law Journal, Forthcoming; Islamic Law and Law of the Muslim World Paper No. 08-18. Available at SSRN: https://ssrn.com/abstract=1115875

Mohammad Fadel (Contact Author)

University of Toronto - Faculty of Law ( email )

78 and 84 Queen's Park
Toronto, Ontario M5S 2C5
Canada

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