Guide to equilibrium rate: Reality or mirage?

In-Depth Analysis

The advocates of interest claim that the presence of an interest mechanism in the world's economies has been a blessing since it has succeeded in achieving the optimal allocation of resources based on the 'equilibrium rate.' They also assert that replacing interest with profit cannot perform this function equally efficiently. The equilibrium rate is defined as the interest rate at which the supply of money meets its ultimate demand. This interest rate is applied by the apex banks of a country by way of a 'base rate' as a means of controlling the supply of money in an economy. The author was unable to locate any practical evidence in support of the equilibrium rate theory. In fact, he observed recurring instances to the contrary whereby there was a constant demand for funding from the SME sector which was denied to a large extent on account of an undesired risk paradigm. Some SMEs had pretty viable projects but unfortunately they could not see the light of the day due to a lack of funding, although the author's bank had excess liquidity and was forced to place it at meager overnight interest rates in the interbank market. Some lucky SMEs did get the bank's nod but the funds provided to them were inadequate and too loaded with rigorous conditions and at an exorbitant cost which significantly reduced the chances of exploiting the full potential of the projects. The biased measure of the credit rating mechanism in capitalist economies is also the reason why big businesses have grown bigger, assuming monopolistic powers, while the medium and small businesses have often been strangulated due to the denial of affordable credit. The varying rates on the different types of credit besides the influence by external factors such as regulatory bodies seldom allow the theoretical equilibrium to exist. The Islamic economic principles are defined to effectively eliminate all such anomalies through the fair allocation of capital resources on the basis of the viability of the project, its part or full ownership through the injection of risk capital and the sharing of the resultant profit or loss.