51106390 literature review on global financial crisis islamic finance perspective

7/28/2019 51106390 Literature Review on Global Financial Crisis Islamic Finance Perspective

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Literature review on Global Financial Crisis: Islamic perspective

Many theories have been proposed to explain the cause of the global financial

crisis. Generally, some scholars recognized most important cause. According to

Chapra (2008), the factor excessive and imprudent lending by banks is contributed to

the global financial crisis. One cannot blame banks for this because, like everyone

else, they also wish to maximize their profits in a materialist cultural environment

where maximization of income and wealth is the highest measure of human

achievement.

Furthermore according to Siddiqi (2008), there are features of the crisis under a

moral failure that leads to exploitation and corruption. This would be followed up by

an explanation ofriba and maisirthat equates them to bank interest and gambling-like

speculation based on risk shifting as distinct from risk sharing.

It will be argued that debt-finance coupled with speculative products whoseintricacies defy understanding provide ample opportunities to greedy profit-

maximizing agents to exploit the aspirations of ordinary investors and for goading

home owners and consumers into living beyond their means and chasing untenable

dreams. Siddiqi (2008) also mention elements of the implicit causes in financial crisis

which are:

Firstly, factor of Casino Economics and Human Welfare and the alternative of

casino economics are by risk sharing.

Secondly, Siddiqi (2008) also mentions credit without credibility. It means that

over extended leverage, outstanding credits amounting to an ever-increasing multiple

of existing capitals of the relevant institutions, is a direct result of financing through

interest bearing debts. Debt financing of productive enterprise amounts to preferring

risk shifting to risk sharing. This is immoral as well as counterproductive. The


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environment in which productive enterprise takes place does not guarantee creation of

additional wealth.

Thirdly, selling debts which some of debt financing has always been part of thefinancial markets. Even in peak of Islamic civilization trade credit, a form of debt

financing, thrived. Islam has no problem with that as it fits in with prohibition of

exchanging money now with a larger amount of money after a period of time. The

problem starts with sale of debt, whether created by a money loan or owed as a price

of goods sold on credit.

Fourthly, derivatives also involve excessive uncertainty. They facilitate

managing certain market risks (related to prices, rates of exchange, etc.). Chance

remains the basic element in the situation, however, expectations being based on pure

speculation.

According to Mirakhor (2009), the current financial system is predominantly

interest-based and debt-driven. He argued that a system dominated by interest-based

debt contracts is inherently unstable.

Furthermore,Mirakhor (2009) explain about liquidity risk management that is

important due to its role in maintaining institutional and systemic resilience in the face

of shocks and, conversely, due to the system-wide contagion caused by liquidity shock

to a single institution. Once the US financial crisis began, the panic spread worldwide.

The resulting uncertainty and lack of liquidity made banks more averse to risk, as they

were afraid of contagion. Furthermore, with the complexity and opacity of credit

instruments, the interbank market froze, forcing financial institutions into

deleveraging.


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Then, Chapra (2008) explain more on credit problem. The more credit they

extend, the higher will be their profit. It is high leverage which enables excessive

lending. Excessive lending, however, leads to an unsustainable boom in asset prices

followed by an artificial rise in consumption and speculative investment. The higherthe leverage the more difficult it is to unwind it in a downturn. Unwinding gives rise to

a vicious cycle of selling that feeds on itself and leads to a steep decline in asset prices

followed by a serious financial crisis, particularly if it is also accompanied by

overindulgence in short sales.

The subprime mortgage crisis is also a reflection of excessive lending.

Securitization or the originate-to-distribute model of financing has played a crucial

role in this. There is no doubt that securitization was a useful innovation. It provided

lenders greater access to capital markets, lowered transactions costs, and allowed risks

to be shared more widely.

According to Chapra (2008), the solution for global financial crisis according to

the Islamic finance, it should, in its ideal form, help raise substantially the share of

equity in businesses and of profit-and-loss sharing (PLS) in projects and ventures

through the mudarabah and musharakah modes of financing.

Then Siddiqi (2008) explains about risk sharing that fits in a system that

integrates risk management with value creation. The Islamic institutions of

musharakah, and mudarabah, for example target value creation and are good ways of

managing risk.

Muhamad Saifu l Romli

I nternational I slamic University M alaysia

31 January 2011


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BIBLIOGRAPHY

Siddiqi, M.N. (2008). The current financial crisis and Islamic Economics, IIUM

Journal of Economics and Management, 16(2):125-132.

Chapra, M. Umer (2008) The Global Financial Crisis: Can Islamic Finance Help

Minimize The Severity And Frequency Of Such A Crisis In The Future? A paper

presented at the Forum on the Global Financial Crisis held at the Islamic Development

Bank.

Mirakhor, A. (2009), Recent crisis: lessons for Islamic finance, New Horizon, No.

173, pp. 12-15.

51106390 literature review on global financial crisis islamic finance perspective

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