Primary navigation:

QFINANCE Quick Links
QFINANCE Topics
QFINANCE Reference

Home > Capital Markets Best Practice > Islamic Finance and the Global Financial Crisis

Capital Markets Best Practice

Islamic Finance and the Global Financial Crisis

by Bilal Rasul

Executive Summary

  • The growth of Islamic financial institutions (IFIs) has been steady but the full potential for deposit-raising remains untapped.

  • The resilience of IFIs is a direct consequence of transactions being backed by real assets and prescribed financing contracts/agreements.

  • Disparity between the creation of wealth and underlying real assets is countered through socially and ethically responsible investments propagated by Islamic finance.

  • The report of the IFSB–IRTI Task Force on Islamic Finance and Global Financial Stability gives recommendations for keeping vigilant and creating global financial stability through IFIs.

  • The participatory/risk-sharing nature of Islamic finance is the mainstay of the system.

  • The projection and promotion of Islamic finance philosophy is the key to success.

  • Emphasis should be on the fiduciary responsibility of IFIs to market products that are authentic (shariah-compliant) so that wealth and the distribution of profits is equitable.

Islamic Finance

Islamic finance is a safe financial doctrine that promises justice and equity. The theme of Islamic finance is popular among those economies that are either interested in following the shariah tenets or are exploring alternative investment opportunities that have a sound basis and a promising potential.

The principles of Islamic finance fundamentally uphold the corporate governance and social responsibility philosophies: that is, accountability, transparency, and equitable distribution of wealth. They are derived from the shariah and the financial laws enabled by the Qur’an. The Qur’an, a complete code of life, is not just for the believers or for Muslims; it is for all mankind (linnaas):

“The month of Ramadan in which the Qur’an was revealed, a guidance for mankind, [a Book of] clear proofs of guidance and the criterion [distinguishing right from wrong]…” Sura Al-Baqarah, ayat 185. (English translation by the Nawawi Foundation, Chicago/Ibn Khaldun Foundation, London).

The stipulations of the Qur’an pertaining to the economic and financial system, too, are for the benefit of all mankind. Adherence to this conduct may not necessarily mean adhering to the faith—a misconception that needs to be addressed in the most benign manner.

Islamic finance is a subject that has reached out to a reasonable number of Muslims, as well as non-Muslims and financial planners. It is now accepted as an international form of financial intermediation. The growth of the industry, 20% annually, 1 has been the swiftest seen by any industry in the last few years. The innovation and product development have been dynamic.

In order to exploit the versatility of the corporate sector, an appropriate strategy is required to reveal the window of opportunity that exists for investors which, undoubtedly, would also launch Islamic finance to larger proportions. The practitioners and scholars of Islamic finance are expected to devise an unprejudiced approach for the purpose. Under the auspices of the Islamic Development Bank (IDB), the Task Force on Islamic Finance and Global Financial Stability was formed in October 2008, on the recommendation of the Forum of the Global Financial Crisis and its Impact on the Islamic Financial Industry, organized by the IDB Group. The Task Force was mandated to: (1) examine the conceptual aspects of Islamic finance and its role in enhancing financial stability; (2) conduct a stocktaking of the state of the Islamic financial services industry following the global financial crisis; and (3) examine the financial architecture of the Islamic financial industry amid the more challenging post-crisis environment.2 Since then the Task Force has thoroughly examined these areas and documented them in a report submitted to them by the three working groups. The report is a public document and can be accessed for a better understanding of the current stability issues that Islamic finance addresses, the state of the Islamic financial industry, and the challenges that lie ahead.

The events transpiring in the last two years leave little doubt that Islamic finance is the way forward and that the discipline should be explored. The role of the IFIs and Islamic regulatory organizations is critical in promoting an ethics-based financial system to provide the solution for the ailing conventional financial system.

Resilience through the Crisis

The resilience of the Islamic financial system has been put to the test at the evolutionary stage of its life. The incidence of default and financial instability in IFIs was significantly reduced due to the nature of Islamic finance, which is manifested in limited debt leverage, risk and profit sharing, and financial transactions backed by real assets, coupled with legislative restrictions on derivative-like products. Written contracts that emphasize the possession and ownership of real assets are a fundamental source of credibility for transactions and provide disclosure and transparency for investors to shariah standards. “The Islamic financial system is driven by trade and production and is intimately linked to the real sector (‘Main Street’ and not ‘Wall Street’).”3

Regulatory oversight, absence of governance, and pitiable rating structures failed the conventional financial system. Lapses in prudential standards and risk mitigating factors added to the tribulations. The hedging instruments that were designed to absorb the risk ended up manufacturing risk. By and large, however, the IFIs remained resilient.

Back to Table of contents

Further reading

Books:

  • Archer, Simon, and Rifaat Karim. Islamic Finance: The Regulatory Challenge. Singapore: Wiley, 2007.
  • Askari, Hossein, Zamir Iqbal, Abbas Mirakhor, and Noureddine Krichenne. The Stability of Islamic Finance: Creating a Resilient Financial Environment for a Secure Future. Singapore: Wiley, 2010.
  • Venardos, Angelo M. Current Issues in Islamic Banking and Finance. Singapore: World Scientific Publishing, 2010.

Article:

  • Tayyebi, Aziz. “Eclipsed by the crescent moon: Islamic finance provides some light in the global financial crisis.” Financial Services Review 90 (June 2009): 14–16.

Reports:

  • Ernst & Young. “Islamic funds and investments report 2009: Surviving and adapting in a downturn.” 2009.
  • Islamic Development Bank. “Report of the Task Force on Islamic Finance and Global Financial Stability.” April 2010.

Websites:

  • Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI): www.aaoifi.com
  • Islamic Financial Services Board (IFSB): www.ifsb.org

Back to top

Share this page

  • Facebook
  • Twitter
  • LinkedIn
  • Bookmark and Share