The Financial Sector Crisis and Islamic Banking

The international financial crisis began over a year ago, and has intensified over past few months. The International Monetary Fund has already warned that this credit crisis will result in losses of over trillion dollars and that it may worsen especially after the 150-year-old US financial giant Lehman Brothers been declared bankruptcy, not to mention the sale of financial services firm Merrill Lynch to the Bank of America.

Islamic banks are unaffected by the sub prime mortgage crisis; rather many non-Muslims are turning to Islamic banking as customers spooked by turmoil in the Western banking system feeling Islamic banks as a safe haven because these are immune against such crisis due to inherent business ethics within Islamic banking.

There are mainly two important reasons for insulation of Islamic banks under this current credit crisis as compared to the interest based banks and financial institutions. The first is liquidity problem due to inter banks lending, merger and resales of debted companies with their assets in the money markets. The second problem is realted to the rating the asset values mortgaed against debt finances by the credit rating agencies.

 

Principally Islamic banks are custodians and cannot tarnsfer public deposits to other banks without permission of the depositors. Inter bank liquidity transfer on debt finance basis is not permitted in Islam, which counters liquidity realted problems in the market.

Under Islamic banking, since equity finance does not mortgage assets to grant debt finance, but analyze cost projected yield on projects needing finance, the credit / equity finances remains unaffected with changes in assets values. There are so many internal and external factors affecting the asset values of stocks, bonds and securities which are prime components for credit rating system for Interest based lending; so it is not easy for the banks and even for credit rating agencies to evaluate the exact credit risk. The credit rating under Islamic Finance has nothing to do with up and rise in asset values, instead it depends on actual business. Thus there is no fear of sub prime mortgage under Islamic banking principles, and it thus reduces the throat cut competition in financial sector to get more credit shares. This principle in fact tends to provide stability in the financial market.

Islamic banking interestingly helps the weaker and even the weakest section of the society through various ultra modern financial products. Under Islamic banking credit in terms of equity finance, business finance, trade finance and leasing is provided by investors / banks to the borrowers with a condition that financial risk is borne by investors. This helps the poorer and vulnerable to get credit at no risk, but definitely requires other credibility like strong business proposal, sound projects, rational approach, skill and technical art to attract the financer. Under Islamic finance, genuine business proposals fetch credits with no risks and irrational projects finds difficult to get finances. This raises entrepreneurship skill within the economy helping inclusive growth because financial resources is well shared among haves and have nots with financial risk on financers and other risks on borrowers of funds.

The credit rating under Islamic banking and finance evaluates real term business potential and growth trends, instead of evaluating manipulated asset values which has caused recent damages to the credit market. Thus the regulators and credit rating agencies should now adopt principles of Islamic banking to safeguard the financial sector from any more turmoil.

14 Responses to "The Financial Sector Crisis and Islamic Banking"

  1. Guest   October 5, 2008 at 1:48 am

    and now one objective article, please

  2. Anonymous   October 5, 2008 at 9:01 am

    “financial resources is well shared among haves and have nots with financial risk on financers and other risks on borrowers of funds.”Exactly, risks on both parties. Islamic banking will experience loss due to downturn of markets. There is no hiding from economic chaos.

  3. Anonymous   October 6, 2008 at 5:35 am

    Why do you publish shit like this? It seriously detracts from your credibility. If Islamic banks were ethical them Islamic societies would be ethical…and they obviously aren’t.

  4. Anonymous   October 6, 2008 at 5:38 am

    This is the kind of stuff which useless idiots used to publish regularly during Communist times – to wit, anything which was anti-capitalist and anti-western must be wonderful.

  5. Anonymous   October 6, 2008 at 9:33 am

    Are the ethics described here going to strengthen terroists organizations funds?

  6. Syed Zahid Ahmad   October 7, 2008 at 10:47 am

    If anti Islmaic mentality does not like to my write ups and fearing that Islamic Banking may help financing Terrorism, I could only say that Islamic banking counters Terrorism.The experience of Islamic banks of Malaysia and Britain may be interesting; as in Malaysia, the Chinese businessmen are the biggest customers of Islamic banking; in Britain also, Islamic banks are not for Muslims alone. Stringent anti-money laundering measures are in place in these countries and have seen far less terrorist intrusions during the last decade. The Shariah principles require transparency in monetary routes. Every extended credit under Islamic Banking will need supportive document with managerial control of the fund to monitor the use of credits, which may not be available with debt finance under interest-based banking. All we have to put is a fairer and strict audit system to monitor the fund flows. The universal nature of banking through Islamic Banks prevents surreptitious routes for investments and mutual funds. The petro-dollars and SDRs have the potential for greater flows and these would also contribute to more dynamic commodity markets. With the financial muscle, the youth among the Muslims may look to better contribution to domestic GDP through better education and higher productivity.

  7. Anonymous   October 9, 2008 at 7:01 am

    I would encourage those who are against anthing labeled “Islamic” to be objective themselves and research Islamic banking before judging it.This article is a simple and well-written overview, but to truly understand Islamic banking as a system, you’d have to look its details up as well.

  8. Clara   October 9, 2008 at 7:17 am

    So many racist comment and no logical counter argument – so those who wrote these : and now one objective article, please”financial resources is well shared among haves and have nots with financial risk on financers and other risks on borrowers of funds.”Exactly, risks on both parties. Islamic banking will experience loss due to downturn of markets. There is no hiding from economic chaos.”Why do you publish shit like this? It seriously detracts from your credibility. If Islamic banks were ethical them Islamic societies would be ethical…and they obviously aren’t.” This is the kind of stuff which useless idiots used to publish regularly during Communist times – to wit, anything which was anti-capitalist and anti-western must be wonderful. “they shoul dstudy first and then open their mouths

  9. Nab   October 13, 2008 at 11:38 pm

    There are lot of comments without any intellectual support. Try to understand basics of Islamic Banking and its roots and judge the system. One system should not be bad as you people don’t like. If you people can counter author’s arguments intellectually,comment bravely.That will be respected. Otherwise please shut up.

  10. jay   October 20, 2008 at 1:32 am

    Islamic banking has it’s merits. And it seems to be more fair to borrowers (no hidden fees, fixed payment until the end of the loan). But I beilieve the Islamic banks aren’t immune to today’s crisis since they also share the risks of each investment (which is related to the real economy).

  11. Kainaat   October 24, 2008 at 10:52 pm

    bunch of racist red necks who didn’t even have the courage to put their names down.

  12. IQBAL   October 31, 2008 at 11:17 am

    regarding the fear that islamic finance will fund terrorist or terrorism is totally incorrect and unfounded. By the way all terrorist funds and drug money so far are being routed through conventional banks and not a single islamic bank is involved, so far. further the chances of financing terrorism through islamic finance is out of question because each financing is backed backed by real and tangible asset and not only papers. CDS which is one of the cause of recent crises was declared as weapon of mass financial destruction by no one else but Mr. Buffet (nothing to do with Islam!).chances of funding terrorist are more in conventional banks as they deals in paper (although asset based mortgages are also there)not backed by any tangible asset.however, despite all criticism and uncultured comments and remarks around the world about islam or islamic financing, islamic banks are growing at the pace of 15 to 20% and is destined to become the best and alternate financing sector which is based on ethics and morality.

  13. Jassim Almusallam   July 10, 2009 at 10:13 am

    People always in fight with the unkown. So all who did negative post here i can guarantee that they don’t know what is islamic banking.

    • Anonymous   September 22, 2009 at 7:41 pm

      I agree.