Modern money and Islamic banking in the light of Islamic law of riba

Abstract

AbstractTheory of Islamic banking is based on neoclassical theory of money and banking which assumes that money is a neutral lubricant that facilitates exchange while bank is an intermediary institution that equates savings and investments in the economy. Endogenous money supply has demonstrated the fallacy of these assumptions by showing that it is not the deposits that create loans, rather the other way round. Unlike commodity money, modern money is credit, generated by the central and commercial banks in the process of advancing reserves and loans. When this correct version of money and banking is evaluated in the light of the correct understanding of riba, it becomes evident that modern money involves riba and this result is equally valid for Islamic banking. Genuine Islamic monetary and banking systems require commodity money, which may include gold and silver, such that its face value is equal to its intrinsic value and it does not represent credit. Riba is not merely a matter of eliminating the institution of interest from economic system, it is about eliminating credit‐based monetary or financial system because credit creation is as much riba as is charging interest.