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Prohibition of Interest and Economic Rationality

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This research evaluates three reasons against the use of interest. One reason is that interest is a tool of exploitation. It contradicts facts because nowadays ultimate borrowers are businessmen and ultimate lenders are salaried individuals, the former being financially better off than the latter. The second reason is that interest-based external financing leads to unfair distribution of profits. Although this reasoning is not wrong, it is not very appealing in positive economics. Having noted that risk aversion is applauded in both conventional and Islamic economics, this author has propounded a third reason which states that the risk of an investment is least when financed exclusively by equity. This reasoning is easily understandable to conventional economists and is proved mathematically in this article. Therefore it provides a sound economic footing for prohibition of interest.

Affiliations: 1: Department of Economics, Quaid-i-Azam University (QAU) Islamabad Pakistan


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