Islamic finance has enjoyed a steady and consistent horizontal as well as the vertical growth since the concept was put into practice some 40 years ago. Being able to undergo the implications of the global financial crisis and remain relatively positive in the midst of the crisis and eventually to emerge as more reasonable and efficient system have raised the profile of Islamic finance and underscored its capacity to bring stability to the global financial system.
There is a general agreement amongst economists, financial scholars and financial experts about the causes and the consequences of the global financial crisis. However, the search for the solution‟ to the crisis thus far has proved to be mission impossible‟ and remains the subject of an endless dispute. The governments should interfere in markets or should the solution be left for the market to find a solution Government bailouts of existing banking system neither present long term solution to the problem nor give assurance that similar crises will not happen in the future. On the other hand, the current global financial crisis has invalidated the argument promoted by free market advocates that “markets are efficient on their own” and market forces are capable of managing and correcting market inefficiencies should they arise.
World economies are yet to plan careful strategies on how to deal with the crisis, let alone to recover and overcome its hurtful result. The endeavour in this paper therefore is to extend the search for an alternative that is potentially capable of limiting, if not eliminating, the sources of such crises, and bringing stability to the market. Carrying out systemic analysis of the causes of the crisis and measuring these causes against the basic principles of the Islamic financial system reveals that such crisis could have been prevented should Islamic financial principles were common. The paper concludes that along with the enormous challenges that the crisis has created to the conventional financial system, it has presented the IFSI with abundance of opportunities to show its application.
1. Financial Crisis
“Financial crisis” broadly refers to disruptions in financial markets causing limitation to the flow of credit to families and businesses and as a result having unpleasant effect on the real economy of goods and services. The term is generally used to describe a variety of situations in which investors suddenly lose significant amount of their investments, and financial institutions suddenly lose significant proportion of their value. Financial crises include, among others, stock market crashes, financial bubbles, currency crises, and sovereign defaults.
2. Causes and consequences of financial crisis
Financial bubbles are generally linked to easy credit, excessive debt, speculation, greed, fraud, and corruption. Easy credit leads to lack of adequate market discipline, which in turn instigates excessive and imprudent lending. Chart 1 below presents a summary of the most frequently cited factors as being potential contributors to financial crisis.
3. The subprime three mortgage dilemma and the current global financial crisis
It is believed that every economic crisis is the product of cheap credit; low interest rates create demand for loans that cannot be repaid when interest rates subsequently rise. Banks driven by sense of invulnerability and the desire to capitalize on existing opportunities to maximize their returns adopted an easy approach to lending in order to have a bigger slice of selling more loans, thus making more money in fees and commissions. But as interest rates began to rise, new home affordability and the ability to repay existing loans have sharply decline.
4. Implications of the global financial crisis
The impact of the crisis was felt worldwide. Individuals, regardless of their location, have been directly or indirectly affected by the crisis as it has hit almost every sector of the world economy. World economies at large are yet to develop practical strategies on how to deal with the crisis reality.
were the first to feel the full impact of the crisis that they have initiated. which have created mass uncertainty, such as:
Sharp decline in global equity markets
* The failure or collapse of numerous global financial institutions
* Governments of a number of industrialized countries allocated in excess.
* Commodity and oil prices reached record highs followed by a fall
* Central banks reduced interest rates in coordinated efforts to increase liquidity and avoid recession and to restore some (confidence) in the financial markets.
5.. Islamic theory of finance and the global financial crisis
The current global financial crisis has accentuated the urgent need to get on one of the most fundamental reshape of the international financial system. The attitudes and the approaches expressed by the advocates and the opponents of both government interventions versus free market economies of thought thus far have failed to deliver a practicable long-term solution to the crisis .
Conclusions and Managerial Implications
Although it would be impractical to single out one factor as being the source of financial crisis, one can rightly argue that the main cause of financial crisis is attributed to a laxity of lending standards often adopted by conventional financial institutions – driven by greed and appetite for excessive returns, and facilitated by the absence of adequate and appropriate government regulatory control. This easy approach to lending when practiced over an extended period of time leads to excessive and, in all probabilities, risky lending environment that eventually works against the interests of both borrowers and lenders. The current global financial crisis, which was triggered by the US subprime mortgage crisis, was aggravated by the questionable tactics adopted by mortgage brokers who opted to sell their customers on subprime loans, and then by the complexity of products that have been created by intermediary players who sought to pass the entire risk of default to the final purchasers. Facilitated by financial globalization, the collapse of some US financial institutions associated with the subprime mortgage scheme activated systemic risk across national boundaries causing the current global financial meltdown.
This paper neither can claim to have suggested an easy way out of the current global financial crisis nor to have presented inclusive answers to the many questions it has raised. However, evidence at hand strongly suggests that Islamic finance is well endowed to deliver noteworthy contributions towards a more healthy and stable international economy. The paper has argued that an honest implementation of Islamic theory of finance is potentially capable of solving, and in all probability averting, such crises from happening simply because most, if not all, of the factors that have caused or contributed to the development and the spread of the crisis are not allowed under the rules and guidance of Shariah. The papers concluded by asserting that opportunities for Islamic finance are enormous, and so are the challenges. It also signals the transformation of Islamic financial paradigm into working policies and enabling institutions to be the most serious challenge facing the Islamic financial industry.
What role can managers and policy makers in Islamic finance industry make? Managers and the oversight boards in Islamic financial institutions need first to educate and inform their employees, clients and all stakeholders on the virtues and principles of Islamic finance. This should then permeate to the society if the government, through the ministry of education, introduce Islamic finance courses at different levels of education. The bottom up and top bottom approaches should complement each other. Regulatory authorities should have a common framework universally applicable to all Muslim countries. This will then form a bulwark of operational infrastructure to lay a firm foundation of spreading and practicing Islamic finance to the global stage. The regulatory authorities, experts in Sharia‟h law and teachings need to address the issues of intermediation, risk management and financial engineering within the framework of Islamic finance. Islamic finance Policy makers must also strive to transform Islamic finance model into working policies and build enabling institutions to overcome the challenge of implementing Islamic finance at global stage.
Ph.D Research Scholar in Commerce
KSR Arts and Science College
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