The case against interest: Is it compelling?

Abstract The entire international financial system is now based on interest in spite of its prohibition by four of the world's major religions. However, the Muslim world is now trying to replace the conventional interest‐based system with one where there is greater reliance on profit‐and‐loss sharing (PLS) and where the debt is created not by pure lending and borrowing but by the sale or lease of real assets. The introduction of a new system raises the question of whether the case against interest is so compelling as to justify the difficulties and risks associated with it. This article is an attempt to answer this question. It argues that the main factor underlying the financial crises experienced by a large number of countries around the world over the last few decades is the excessive expansion of debt. The primary reason for this is the lack of adequate discipline in the financial system. The PLS system should help ensure greater discipline by making the bankers more careful in lending and the depositors more vigilant about the health of their banks. Asset‐based debt should further help by not allowing the debt to exceed the growth of the real economy. The introduction of such a discipline carries the potential of helping realize not only greater stability, but also greater efficiency and equity in the financial system. © 2007 Wiley Periodicals, Inc.