The financial crisis faced the globe in 2007 and 2008, was originated from the United States sub-prime crisis and which is said to be the worst financial crisis since the great depression. It has later become a full-blown global economic crisis.
Due to the borderless nature of the global economy, the economic downturn in the US has been transmitted to the economies around the world. This crisis has inflicted heavy damaged on markets and institutions at the core of the global financial system, which is already over. Although many believe that the “worst is not over”, continuous deliberations are ongoing to diagnose the root of the crisis and find solutions to the current problems that the global economy is facing.
It may be mentioned here that once any crisis sets in, continuous efforts are undertaken to improve and strengthen the financial infrastructure so as to avoid such crisis from happening again in the future.
The recent past world economic crisis was unprecedented in its nature, which has badly damaged even the well-established financial institutions which is considered “too big to fail” (Citibank, Lehman Brothers and AIG, just to name a few).
On the contrary, the Islamic banking and financial institutions throughout the world are somewhat “sheltered” from the global financial shocks. Despite slowing down, the top ten Islamic banks continued to show encouraging performance by recording an average annual growth of around 30 percent for 2008 to onward. Especially, Islamic banks in the Gulf Cooperation Council countries continued to expand and recruit new workers. It is because of inherent strength of Islamic banking and financial system. Some of them are mentioned below:
Islamic banking and finance usually an equity-based financing which distributes risk and liability to both the lenders and borrowers so as to justify the return to both sides of the transacting parties.
The resilience of the Islamic financial institutions to the financial shocks, as well as their robust growth have led many quarters to conclude that Islamic banking had a solution to the financial ills and it can be a viable alternative to the financial system.
The economic crisis seems to highlight the weaknesses of the conventional banking and finance philosophy on which the global financial system is built upon.
The conventional system allows multiple debt creation on a particular asset without a real underlying transaction made possible by credit default swap. While, quite the contrary, Islamic finance requires that financial dealings must be backed by real assets and be in line with the Islamic law, Shariah.
Generally, the principles upon which Islamic banking system is built on ensure the element of certainty and stability in financial dealings. In particular, the requirements that the financial dealings must be free from interest, uncertainty, and gambling ensure that the elements of exploitation and excessive speculation are avoided.
To ensure fairness and justice, Islamic financial system deal with context, this must observe the concept of equal counter-value, which comprises of work effort, risk assumption, and product liability.
In Islamic financial system, there are various supervisory authorities that are committed to oversee the overall compliancy of the financial instruments, such as the Shariah supervisory board, as well as national regulatory authorities.
Financial dealings in this system is guided by the ultimate objective of achieving the ideals of equitable justice where priority is given to equity-based financing rather than debt-based financing. On the contrary, the conventional financial system largely focuses on debt-based financing, which results in concentration of wealth circulated largely among the deemed credit-worthy corporations and individuals.
In Islamic economy, priority is given to transactions that can benefit the society at large, rather than just the already wealthy corporations, so that wealth can be more widely circulated. So, the concept of equity-based financing along with its profit-sharing element is again another built-in stability aspect of Islamic financial system.
The joint-venture nature in most equity based financing such as Musharakah requires active participation from both the financier and the borrower to achieve the best outcome of a business venture. This equity-based financing distributes risk and liability to both the lenders and borrowers so as to justify the return to both sides of the transacting parties.
During the said crisis, Islamic financial system could influence the allocation of wealth and resources in the economy. While conventional banks worldwide had to nurse a loss of more than $400 billion from the credit crisis, when Islamic banks were virtually unscathed.
While, demand for Interest-free Finance due to the global credit crisis presents around $1 trillion Islamic finance industry with an opportunity to expand its appeal beyond Muslim investors, as a haven from speculative excess.
It is surprising that when big conventional financial banks and corporation were being bankrupt and some of them had to bail out, surprisingly, Islamic banks, such as Al-Rajhi Bank, Kuwait Finance House, Dubai Islamic Bank and Maybank Islamic, grow steadily during the crisis. It was because of Islamic banking’s merits and virtues, the demand for its products expanded not only in the Islamic countries, but also in the western countries, such as the US and the UK, Singapore and Thailand.
Therefore, in the light of the crisis, it is expected that there will be a large scale re-evaluation of the guiding principles of financial transactions globally. The Islamic economics model in general, and Islamic banking and finance in particular, are viable options as the search for more stable and safer global financial infrastructure continues.
From the above discussion, it can be concluded that the global economic crisis has not inflicted any damage for any Islamic banking and financial organization; rather it has presented about US$1 trillion Islamic finance industry with an opportunity to expand its appeal beyond Muslim investors, as a haven from speculative excess. Islamic financial institutions have already made in-roads in many developed countries like, the US and the UK, Thailand, Singapore, China, India and Australia. This discussion implies that there was a little chance of occurring global financial crisis if Islamic financial system would have been followed.
Economist Dr Rahman can be reached at, [email protected]
