global financial crisis risk mgt and social justice for islamic finance

7/30/2019 Global Financial Crisis Risk Mgt and Social Justice for Islamic Finance

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33ISRA Int rnational Journal of Islami Finan Vol. 1 Issu 1 2009

The Global Financial crisis,

risk ManaGeMenT and socialJusTice in islaMic Finance

M. Kabir Hassan Rasem N. Kayed

Abstract

The most salient values of the Islamic financial system are fairness and socio-economic justice. The exuberance of Islams uncompromising commitment to the well-being of humankind goes beyond its caring for existing generations to ensuring a sustainable future for generationsto come. This is evident by giving utmost priority to the environment and preserving earths valuableyet limitedendowments and resources, and by limiting public borrowings to available resourceshence freeing future generations from the burden of debt. The Islamic

system of production and finance based on profit-and-loss sharing (PLS) is more efficient and equitable in distribution of wealth and income. Allocation of funds under risk sharing will be based on theviability and expected profitability of the proposed entrepreneurial undertakings rather than on the creditworthiness of competing entrepreneurs. Furthermore, risk sharing offers both entrepreneursand investors incentives to be truly engaged in productive economic

activities, wherein entrepreneurs will be encouraged by the prospect of seeing their ideas transformed into business entities, and

financers will be obliged to assess the risk involved more cautiously,

T t w t t t e t ym f f mman sugg stions that improv th fo us an larit of this pap r. Th authorsa knowl g invaluabl itorial an r s ar h h lp b G offr Ng n .

M. Kabir Hassan is a Prof ssor at Univ rsit of N w Orl ans, Louisiana, USA. H t t tmhassan@uno. u.

Ras m N. Ka is a Prof ssor at Arab Am ri an Univ rsit , J nin, Pal stin . H t t tk_ras m@hotmail. om.


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T G F c , r M g m t s J t i m F

34 ISRA Int rnational Journal of Islami Finan Vol. 1 Issu 1 2009

and effectively monitor the use of funds by the entrepreneurs. Theappropriate implementation of such partnership contracts increases

the likelihood of business success, injects more discipline into the financial market by reducing excessive lending, and ultimately will have positive implications for the socio-economic well-being of

society at large.

Key words : Profit-an -loss sharing (PLS), Islami finan s st m,so io- onomi justi , risk manag m nt.

I. INTROdUcTION

i g m f M m t y t g t i m fg p t v t ft t y v t , v , of import i ologi s an so io- onomi v lopm ntal mo ls.Islam is r - stablishing its pr s n an its r l van on mor solig , m g t t m M m g t y t

g g p p f s , p t y t falings. Unlik th finan ial s st m, whi h is basi all fo us on

t m f p t f t v t , t i my t m p mp t m , t m

to promot ualit an fairn ss for th w ll-b ing of ommuniti san so i t at larg . Kri h n an Mirakhor (2009) mphasis th

m f t i m f y t m f i mf g t f t v ty f i m my tman at s so ial uit .

b g t t t t f g p f t i m t my,i m f t t t xp t t p t a or an with this fram of r f r n an to assum manifol rol s.In a ition to b ing omm r iall -ori nt institutions that un rtaklawful an l gitimat finan ial transa tions bas on int r st-fr

banking an risk-sharing finan ing, th rol of Islami bankingan finan (IBF) is xt n to a r ss th or asp ts of so ialan onomi justi . Islami banks provi finan ial pro u ts an

s rvi s that onform to Islami law, bas on a PLS stru tur rath r than a l n r-borrow r arrang m nt. Th l m nt of risk mbwithin th PLS ontra ts fin s th th or ti al justifi ations as w ll


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M. Kabir Hassan an Ras m N. Ka


t p t mp t f i m f t t p tint r st-bas finan .

c t v w f v t t t p t p f y t f t ft t y v t t p r lation to finan ial risk in finan ; i) tak no risk; ii) tak x ssivrisk; an iii) transf r risk. Islam r j ts all thr approa h s to alingw t t f w g g :i) Th on pt of no risk, no gain i tat s that an profit arn

m y t w f g f t wntails th inv stor to profit from th finan ial transa tion. Thus,

i m xp t t t g twt t m f p g t t f m t v t t t t t p ty q g t g ;

ii) x ssiv risk (ov r-l v raging, fo using on loan sal s g g q ty t f , v y mp

v tm t , t p p t g, q t /ov rsight among oth rs), b it inv stm nt bank or r tail bank,

p t t t v t y m t t g mw t t y p t i m; ,

iii) th risk transf r b l n ing institutions is m an unjust ant p t t t t t w

t t w t t v tm t , t g f m t m p f p t f mth us of fun s.

Inst a , Islam promot s risk sharing bas on PLS finan ing as am q t m f w t t t t

nhan onomi stabilit an xp it onomi maturit . Thultimat aim is to r alis so io- onomi justi , whi h is a on itionfor a hi ving prosp rit in this worl l lif an in th h r aft r.

Th primar obj tiv of this pap r is to xplor aus s anq f t g f , t t

manag m nt of risk in Islami finan . Th pap r argu s that Islamifinan has a built-in risk manag m nt m hanism that nabl s thg f y t m t p f m y m v

su h ris s. W also argu that so ial justi o s an shoul tak p ty i m f t t , q ty f m m m t f m f f g t i m


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finan ial s st m. In attaining su h an obj tiv , w hav in orporatan s nth sis ont mporar i as of chapra (2009), Wilson

(2990a, b), Si i i (2009), Ahm (2009). S if (2009), Lal in anMokhtar (2009), Hasan (2009), Ka an Hassan (2009), Kri h nan Mirakhor (2009), Khan an Moul (2009) Hassan an L wis(2007), Hassan an Ka (2009), an Hassan (2009 a, b, , ) inthis pap r. Th pap r on lu s b raising th in vitabl u stion of w t ibF, p t y i m f t t t ,

f , t t m t g t t t wt f f m t f t w t p f t M m m r alising so ial justi an onomi v lopm nt.

Th pap r is ivi into fiv s tions. S tion 2 anal s s ani m f y t m t f m g m t ts st m. S tion 3 xamin s risk manag m nt from a so ial w lfarangl b mphasising th importan of uit in Islami finan .An Islami finan ial s st m is mor pro- uit than pro- bt unlika W st rnriba -bas s st m. S tion 4 xamin s th impli ations of th global finan ial risis for th Islami finan ial in ustr . S tion 5

on lu s th pap r.

II. cAUSeS ANd cONSeqUeNceS OF THe GLOBALFinancial crisis

F g y t y t, x v sp ulation, gr , frau , an orruption. eas r it l a s to la k

f q t m t p , w t t g t x v impru nt l n ing.

T m t f q t f f :a) compl x rivativ s an x ssiv l v raging of US finan ial

t t t v v m w f t t t bankrupt i s an brought oth rs to th g of ollaps . Finan ialg t t ty t f f y t m w t a ross national boun ari s. Goo an poor- ualit mortgag s

w t g t t p g t frisk sol to int rm iari s. Th s mortgag -ba k s uriti sw t y v t t t t m


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mark t. This r l as ash to xt n n w loans an mak mormon . Th mo l work w ll whil borrow rs w r making

th ir pa m nts. Wh n pa m nts stopp , th mo l, lit rall ,av in. b) Ass t-liabilit mismat h. This is a tuall a isparit b tw n a

banks posits an its long-t rm ass ts whi h r sult in inabilitof banks to r n w th short-t rm bt th us to finan long-t m v tm t m tg g t v t y t g

bank runs.) R gulator failur . Insuffi i nt r gulations mak banks l ss

transpar nt an l ss a ountabl to stak hol rs (Al xan r 2008). Banks will op rat without suffi i nt li ui it to m t

ontra tual obligations. Banks a opt lax l n ing b s llingmor loans to arn f s an ommissions. chapra (2009) pointsout that loan volum gain gr at r priorit ov r loan ualit . As

t t t g t , w m ff ty t to r pa xisting loans sharpl plumm t . ex ssiv r gulationst t q t t p t w

t t t g w p t suppl .

) Frau , orruption an gr . extr m onomi gr ov rri s basi thi al onsi ration in inv stm nts. enti ing positorst g m g m t v tm t t t gm p t g f m t t g f t w tan r al onomi a tivit is just a harbing r to finan ial risis.sp t , t mp t t m

g t v g x v t g tavailing r it to unworth /subprim borrow rs (Spi g l onlin ,2008).

) contagion. This aris s wh n th ollaps of on bank u to la k f q ty, m g t m y t

institutions an thr at ns th stabilit of finan ial mark ts.f) Mon suppl . Un ontroll printing of pap r mon not ba k

y mm ty g w y f t(Ras m an Ka , 2009; Hassan, 2009a, b, , ).

Th iffi nt r spons of various W st rn gov rnm nts was rushan impru nt pur has of toxi bank ass ts worth in x ss of US$1


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trillion to stav off ollaps of troubl finan ial institutions. Thommon vi w h l b th majorit of Islami finan ial s holars an

p t t t t t g f ty of fail moralit (Si i i, 2008). Fail moralit , arguabl , is th pro u t an th aus of gr , xploitation an orruption. This

t f p w t f t t p twinv stm nt originators an inv stors (Loun , 2008).

III. THe ISLAMIc FINANcIAL SySTeMand risk ManaGeMenT

Justi in Islam is not just anoth r i iom for fairn ss an impartialit ,an th PLS ontra ts ar not m r l th or ti al alt rnativ s to thint r st-bas finan ial in ustr that ominat s th global finan iallan s ap . Int grating th on pt of PLS with th th m of so io-

onomi justi ompris s th orn rston for buil ing an thi al,highl valu an prosp rous so i t . O ou who b li v ! Stan outfirml for justi , as witn ss s to Allah, v n against ours lv s, or

our par nts, or our kin, an wh th r it b (against) ri h or poor, for Allah an b st prot t both (Th Hol qurn, 4:35).1

A. The Concept of Justice in Islamic Finance

Th importan of justi as a human valu is mphasis in thfollowing qurani v rs : B just, that is los st to awar n ss of Go (5:8). Th Hol qurn (57:25) also stipulat s that a humanso i t without justi will ultimat l h a towar s lin an

stru tion. Justi an onl thriv an flourish if th r is a s t of moral valu s whi h v r on a pts an faithfull ompli s with.A finan ial s st m an promot justi b satisf ing at l ast twomoral valu -bas on itions. First, th finan i r/l n r shoul

t w t t t t f is not born b th ntr pr n ur/borrow r. This is on of th t n ts

1 cit v rs s from Th Hol quran ar r f r n a or ing to th hapt rs ( surah )numb r follow b th v rs s (ayah ) numb r. Thus th r f r n (Th Hol quran,4: 35), for instan , r f rs to V rs 35 of chapt r 4.


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of Islami finan : no risk, no gain. Th l n r, in an att mptt v v t m z y t w , w

ar full an ff tiv l monitor th us of fun s b th borrow r.T w t m g p t fmark t. S on , an uitabl shar of finan ial r sour s mobilis

y f t t t m v t t passuag in ualiti s of in om an w alth. Th shar of uit anPLS in busin ss s o s not rul out bt finan ing. Although btf g p , t t t f w

onsumption an unpro u tiv sp ulation. Islami finan allowst f t f g y t g f

b m ans of sal s an l as -bas mo ls (chapra, 2009).F t t ff t v f g v i m f

t f w g f t m t f f ft t t mp y w t f t s : i) Th ass t b ing sol or l as must b r al, not imaginar

or notional. This liminat s a larg numb r of rivativ st t , w m y v v g m g y t p tw m mp t f ff y t p p

part .ii) Th s ll r or l ssor must own an poss ss th goo b ing sol

or l as . This m ans that th s ll r b ars a part of th risk an r war of th l as . This avoi s short sal s an ass t-pri -

lin swings. In sum, this bt finan ing an onl xpan int p w t t f t my t t g x vr it xpansion.

iii) Th transa tion must b a g nuin tra transa tion with fullint ntion of giving an taking liv r . This will motivat th

t v t g t t v t xplosion of th volum an valu of transa tions.

iv) d bt annot b sol , an thus th risk asso iat with it must b born b th finan r him/h rs lf. d bt annot outsiz thr al onom . Th finan ing of th r al s tor will h lp xpan

mplo m nt, s lf- mplo m nt opportuniti s an pro u tion of n -bas goo s an s rvi s.

T f t t t my y v m m f t t p t v v


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transa tions ar g n rall z ro-sum gam s with a rar positivontribution to th onom . Th r stri tions on th numb r an

v m f v t v t t w t t mm y p t v t t v t ptwhi h ulminat in finan ial risis (chapra, 2009).

J t m t t v t m t t t that isa vantag subprim borrow rs (usuall th small, poor an low r mi l lass) ar abl to g t a uat r it to r alisth ir r ams of hom own rship an putting up mi ro nt rpris s.T t m t t t t m t t t twhi h an provi r it to th v r poor on a human int r st-fr

basis (qar asan ). This oul b a hi v if mi ro r it firms art g t w t zakh waqf t t t , w m y

t t f f g f t w g f zakh. Thm f t m y p t g t g t w t

mm t t t v g g tsmall borrow rs (chapra, 2009).

T i m f y t m m m t v ty fr u n of finan ial ris s b inj ting gr at r is iplin into thf y t m, g t xp t t g wt f t

my, g t t t t f t gw t g f , f y, y m t g t g t p m f

subprim mortgag through provision of r it at affor abl t rms.i m f t t t m y t g vsmall fra tion of int rnational finan . Th us of uit an PLS

t v y m w t f t f g t g l as is pr pon rant. Th Sharah on itions for bt r ation ar

mv t y f g t t g m(iyal). T p t y to ina uat un rstan ing of th obj tiv s of Islami finan ,non-availabilit of train p rsonn l an abs n of an ffi i nti m f y t m t t m f ym ty, m zan information as mm tr . Th s st m shoul gain mom ntum

p y p v t f g p m t g t t stabilit of th global finan ial s st m (chapra, 2009).


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B. Risk Management in Islamic Finance

r m g m t t t p t g w ft t t t f , q t f t t ppa tions ith r to ontain th m or mitigat th m. Th finition

t t m t f m f m y t t w t loss (own rship risk). It th r for stablish s a los r lationship

b tw n risk manag m nt an risk sharing. L n ing is a m ansf t f g w p, t t v g t mlaim for int r st r turn on mon apital. In trust ontra ts wh r

f g v v m y p t , g tw t an borrow r is a must.

S if (2009) xplains th ss n of risk manag m nt. On on, t m y v v p t , t t , t m y

involv h ging. Risk manag m nt an b p rform throughavoi an of risk ass ts or shifting of risk to thir parti s. Thisis th mo of op ration for onv ntional banking. Th pa kaging

f t t g f t v v x gutiliti s. From th Islami finan p rsp tiv , short sal s, futur s,

pt w p f p t t g f mshifting. Th us of th s ompl x rivativ s was partl thg n sis of th urr nt risis. From th Islami finan p rsp tiv ,t y gharar -stri k n transa tions an shoul b prohibit .

T t y f t f w t t tprin ipl s an obj tiv s of risk manag m nt; it is most lik lt t M m w t t w t y f t

t t t p v y t v t p m tth Islami law of ontra ts. In Islami finan , risk manag m nt

v v p t f t gutiliti s whil avoi ing wast an amag . Av rsion to amag s(in lu ing finan ial loss s an onomi wast ) tak s pr nov r g n ration of utiliti s. Un r risk sharing, th borrow r anl n r shoul shar risk. In banking, th borrow r unjustl b ars allt t w t t v tm t v f t fix int r st in om . Shifting risk to thir parti s b n fits th

v f m t t t p q t finan ial mark t, just as savings ma hav n gativ ma ro- onomiupshots (as oppos to sp n ing) on output an mplo m nt, but,


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ironi all , th sam saving is b n fi ial to th in ivi ual. How v r,wh n th in om - arning ass t is th subj t matt r of th sal

t t t f x p , t m f i m t frisk to th li nt. This risk shifting, as a ompon nt of th ov rallrisk manag m nt strat g in Islami finan , is a win-win strat gas oppos to a win-los strat g in banking (S if, 2009).

C. Risk Management and Sharah Screening

F m t s p t f v w, m g m t m t th prin ipl of blo king th m ans to vil. Risk manag m ntm t t g m mp w t t s t

g , w v t y m t f yt ty t t t p p v g y s .

T p f m g m t, w v v t f tf t xp w t m g t, mm t s

an banking. Sharah, how v r, provi s an a itional la r of s r ning ivi into two: a) n gativ Sharah s r ning whi h

x rib, gharar maysir -bas transa tions; an , b) p t v s g w t t mp t tt m t justi , thi s an a ountabilit (Lal in an Mokhtar, 2009).

A or ing to Mokhtar an Lal in (2009), n gativ Sharahg v tw t g : f t, f v tm t

ma . Unlik onv ntional finan ial mark ts, whi h ar fo us ont m y m t, i m f t t m t,w t t m t t t q t m f t v t t t

b un rtak n an also limits th xposur th inv stor oul fa .T z f t m y v t v m t t t

onomi a tivit . Sharah also r uir s ontra tual transpar nt m m gharar v maysir , mp x ty

t t w t v f gharar in transa tions. Ths on stag is wh n making isions on how to manag risk.F v t v t f f g t high, riskl ss r turn. It is iffi ult to fin a Sharah justifi ationfor allowing a high r turn a ompani b virtuall z ro risk. If

t t f w v v , q t f w t x g t t t , t p , t p f x g th aim of th x hang woul still hav to b answ r . Whil th


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g t v p y t g t g t m t, mp m t t q t t t v pp t m t m

on. On th oth r han , Mokhtar an Lal in (2009) xplain that th p t v , w t t mp m t t q t tapproa h to risk manag m nt, ar not pr s nt in mark ts.

S if (2009) urg s Islami finan ial pra tition rs not onl toavoi th onv ntional risk manag m nt strat gi s but also to r -ass rt th lost originalit of Islami finan ial ngin ring. Th rshoul b a r -awak ning an on rt ffort within th Islamifinan ial in ustr to r shap th valu s, prin ipl s, obj tiv san tools of risk manag m nt. Th pr s nt s lf-r gulator , s lf-r war ing an s lf-assur Islami s st m ma b r pla with an w r gulator strat g through th r ation of an xt rnal ju i ial

y t q fy t p f s pp v wt p p v f y p v

thi all viabl so io- onomi goals, growth-boosting v nturapital finan ing of low-in om groups, r pr s ntation of int r sts

of pov rt -stri k n Muslims an inv sting in mplo m nt-g n rating proj ts.

D. Nature and Management of Risksin Islamic Finance

T tw m m t y pp t f Islami finan : moral hazar an information as mm tr . Ini m f , t t f m z t a or to abs on ing btors. It is still an uphill task to

p g t t t w g y v in r pa m nt an thos who ar uns rupulous fault rs. P r

p g v mp pf t t m g t t t g t m t

moral hazar . Information as mm tr is pr val nt withmurabah mushrakah profit- sharing ontra ts sin th managing

mp y w y v t t t m m t t b shar with th positors. Rigorous au iting an mo rat th

information as mm tr probl m (Wilson, 2009a).T p p f m g m t i m mt t f t g y t m, t t t y t i m


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Finan ial S rvi s Boar (IFSB). Islami banks hav to managr it risk, li ui it risk, op rational risk, FOReX risk an rat -

of-r turn risk. Th rat -of-r turn risk is s non mous with int r st-rat risk for banking. Li ui it risks ar similar for Islami banks g t v t g t t t p t

f m w p t w t w t m y m(Wilson, 2009a).

d p t t m t , t v w irisk manag m nt iff rs from that of banking. Wilson (2009a)

t f w g f m g m t t t t tto th IBF. First is own rship risk. This risk is substantiall mitigat

murbaah f t mm ty mm t y t t tat th tim of pur has but first-pur has r risks r main v n aft r sal , as th li nt an pot ntiall su th bank. How v r, risksw t ijrah ar signifi antl gr at r sin th bank has a long r-t rm own rship of th ass t. S on is risk sharing of inv stm ntmurabah posits. Unlik banking, wh r int r st is guarantw t t w m p f t t, t v tm tmurabah posits (similar to tim an noti posits) ar notguarant , an it is onl th positor profit-an -loss sharingwhi h justifi s th r turn. How v r, th prin ipal inv st is notw tt , t m g t p f t g t t ga profit ualisation r s rv , whi h Islami banks must maintain.Th thir is opportunit ost of li ui it . This is mu h high r for i m t f g i m t tr asur bills an oth r int r st-b aring instrum nts. Th an

y vmurbaah v g t p t w t t i m ,whi h provi minimal r turns. Th fourth is FOReX risk. Islami

banks, just lik onv ntional banks, hol ass ts an liabiliti s in asingl urr n . cli nts an h g futur obligations using h gingm t f w t t , w t t vs . h w v , Sharah-bas ontra ts oul also b us b

pa ing a posit to s ur th pri /rat for a futur r al transa tion.h w v , t g f t pt p t t

ual to sp ulation (Wilson, 2009a).

Hasan (2009) points out that busin ss s an un rtak anumb r of m asur s to mitigat risk in a finan ial risis. Firstis th o um ntation of ontra ts. Firms shoul hav ualit


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m t t f mm t t g g m t wth ir li nts. This woul thwart th br ak own of r lationships an

p t t p t w y g m m tw p t t t t tt mpt t t g t obligations Th Hol qurn stablish s an xpli it imp rativ inthis r gar : O ou who b li v ! Wh n ou al with a h oth r intransa tions involving futur obligations, r u th m to writing.An l t a s rib raft our mutual obligations faithfull .An o

t t t w t g y t t f f t pwh th r it b small or big. Writing it is mor just in th sight of Allah,m t v , m x t p v t g among ou (Th Hol qurn, 2:282). Th s on m asur r lat sto mark t isruption. It is imp rativ that both Islami finan ial

t t t p t v g t y tt t v y t mm t t t x

f p v t t w t m t g t t t mmt p w t t t t f f f m

pt p t p v , t m t ,run h an in r as in inflation an int r st rat , among oth rs.

F x mp ,murabah waklah g m t m g ym f x tmurbaah . Th thir m asur on rns btv rsus uit . during an onomi boom, onv ntional as w ll

i m f m t m g y g t v profits an in r as turnov r. during onomi ownturns, su h

g y v g f m w p t y m p f m b om t hni all insolv nt. This is u to utt r failur to mat hass t-r lat ash flows with liabilit -r lat ash flows (maturitmat hing) an pursuing an aggr ssiv finan ing strat g . High

p f t t tt w t q ty f g w t t finan ial risk asso iat with l v rag . In Islami finan , uit -f gmurabah mushrakah p v g t f x tythan bt-bas , non-tra abl murbaah . Th fourth m asur isgov rning law an arbitration. Lu i in lusion of l gal juris i tion(gov rning law an Islami Sharah) of Islami finan ial agr m ntsis of n ssit , an onsi ration of non-Islami juris i tion is a

must. Making Sharah in g n ral th onl gov rning law oulintro u un rtaint , as th Sharah an b wi l int rpr t .


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i m g g t m t salam, arbn salam - parall l ontra ts oul b v lop . How v r, r gulations shoul

p t p t v t p t v t v t y ttra ing. This oul ushion Islami banks from mark t risk. Islami banks shoul x r is gr at aution with n w finan ial innovations.s t fy gharar t t

hara t risti s of all n w pro u ts su h as Islami h g fun s. Thcdo g t m t f gharar . Ass ts with iff r nt

t t t g t t t t t t p tf w t t ff t v t f f

ngin rs working for inv stm nt banks. Islami banking ontinu st f t g t m f v gfinan ing from posits rath r than from whol sal fun ing. ThiFsb t t w w t t b f i t tS ttl m nt (BIS) in ompiling its own risk manag m nt an

t v y p t p t b ii w t m t m tt t g t y g , ibF t t p y

an in r asing rol in th global finan ial s st m (Wilson, 2009a).A w ll- sign r gulator -pru ntial-sup rvisor institutional

f m w mp v g t v transa tions an all finan ial instrum nts an innovations. It woul

v f t t t p t g w t t y twithout a mar ation lin b tw n mon an apital mark ts.T t t m y g t gm t g t y

t ty t i m f y t m, g t t t t y t m promot s almost on -to-on int ra tion b tw n r al s tor anfinan a tiviti s. Su h a s st m shoul b unifi an uniform in

v g i m f t m t , f t t tt t t g t y t m t f

f i m f t t t t m t f g t Islami finan than in th onv tional finan ial s st m. That is

v g f t p t t m g t tntir Islami finan ial s st m. It shoul hav suffi i nt built-in

f x ty y m m t t y f t v t v minimis th risk of r gulator arbitrag , giv n th profit-s king

m t v t v g t f t v t fg g, t v v m t t fits rul s an stan ar s globall . This will r uir gov rnm nts in


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t w i m f p t t xt m t t t f g g t y g y f t v pm

f v g t t f i m t t t , t t instrum nts (Mirakhor & Kri h n , 2009).Si i i (2009) xplains that in ont mporar apitalism

th r is no los monitoring of borrow rs b l n rs. Sp ulators v mp x f p t t t p tf

uninform inv stors who rul th mark t. Th light ning sp of f v t p g t tw t p t msp ulators to th trim nt of th inv stors. To urb this probl m,

g t g t t p t t ty, t p y fth finan ial mark ts rath r than prot ting busin ss profits. Risk shifting an tra ing on bts shoul b r stri t . disillusionm ntw t t m p p y f G g w m t y t f t f y t y f m pp

busin ss an finan .

IV. RISK MANAGeMeNT ANdsocial JusTice in islaM

r g g m t w t p v f tfun s (finan i r) agr s to a shar of his/h r profits or r war s.If th us r of th fun s ( ntr pr n ur) o s not mak an profits,th finan i r g ts ba k th apital. Shoul th ntr pr n ur sustain

m , t , g t i m, b th finan i r. This is ontrar to apitalist so i ti s wh r th p y t f t fnot shar th risk. A s st m of pro u tion an finan bas on risk

g m ff t q t t t f win om for two prim r asons. First, allo ation of inv stabl fun swill b bas on xp t profitabilit /pro u tivit of th proj ts

q t , t p t t y t m w tth r itworthin ss an w alth of th proj t-sponsors. S on ,

y t m f g g t p v

w w t p t g t t g wtwhi h is l t rious to th busin ss nvironm nt (Si i i, 2009).Lik wis , Kuran (2002) argu s that an Islami bank op rating


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t m p y t t w w v tapital firm. It woul l n on a profit-an -loss sharing basis to

p p w t m y p m g , t t mp y tstablish ntr pr n urs with pl nt of ollat ral (Kuran, 2002).r t f t t , v v t f f t t

p t w y t t y t p v f f p tor organis pro u tion. Th bu rs of risk using rivativ s aravi sp ulators ngag in gambling a tivit . Unlik pro u rs,f w f t m w g t g

t ty f t m t m t g t g f , p t tli in instabilit . Risk transf r or shifting is l ss ffi i nt, unjust

q t p w t m t p y t p t w t t t f t

f t p w t , t v y ff t g t t tf m w t , g t tonfli t in th so i t . Risk shifting r uir s littl or no trust. Whilt t p t p t m t w g t , t t f t t

busin ss. Th xpansion of th r al onom through risk shiftingtrigg r prolif ration of int r st-b aring bts an sp ulation.T m g wt w p p y p t f p v tg , t g g m t m v m t

t rioration. R gulators oul hav prohibit risk shifting so thatf v f w m v t v pl n ing poli i s. Sin th int r st of th so i t li s in in r asm t t ty , p t w v t , m gan bu risks in or r to profit ngag in anti-so ial a tiviti s(Si i i, 2009).

i m m f p t p m t t typ f onom that sustains all m mb rs of th so i t . Lif -sustaining

a tivit is not ual to profit-making a tivit . It o s not allowm p t t t t p f t f f w t g f m t

ymm t y, m p t p t , xp t t f t w through outright frau . Si i i (2009) points out that mor work

t t f p t g v t p t t trights of all stak hol rs in a joint sto k nt rpris , in transpar n

in th flow of information, an in w lfar -ori nt mark t r gulationwhi h prot ts inv stors, labor onsum rs an th whol so i t .


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Khan an Moul (2009) argu that th pr s nt bt risis shoul b xamin as a fun am ntal u stion of so ial justi , a on pt

that is paramount in Islam. So ial justi in lu s thr asp ts,m y f q t t t f w t ; t p v t f f t t p t y; p t tof th w ak against onomi har ship. Th bt bur n, how v r,

g q ty tw p t t t m t t xp t t p t t p vth most basi s rvi s for th ir itiz ns. Striving for so ial justiinvolv s th struggl against pov rt an in ualit . Proph tMuamma (p a b upon him) sai , H who sl ps on a full

t m w g g g y t [t y] (Ibn Ab Sha bah).

Khan an Moul (2009) argu that so ial justi is so fo al toi m t t zakh (almsgiving), m aning to purif or l ans inArabi , is on of th fiv pillars of Islam. Th purpos of zakht p m t q ty y t t g w t f m t t t

poor. It also k ps w alth l ar of gr an s lfishn ss. Muslims g t m v t y t t , adaqah,

t p t p y f t w f p p(Khan an Moul , 2009). Th Hol qurn warns: W alth shoulnot onl ir ulat b tw n th ri h amongst ou (59:7). A or ingt i m t g , f t f t v t t

t, t t g f zakh. Through zakh, M m x t t t t p , t t t p t t

vuln rabl groups (orphans an trav l rs). Th Hol qurn stat s:T m y f t p t y, t w

t t m, t w t t , t fpt v t t , f t f a t

n trav l rs (9:60).Risk manag m nt an so ial justi in Islam is not onfin to

v mm t w t ty; t , t , xtto ov r r lationships b tw n iv rs ountri s. cont mporar

m p m p t w t tt t m g t t : p t w t

p t v t t g y t , w v wto shar th risk. This ontrav n s two fun am ntal prin ipl s of Islami finan . Islam abhors harging of int r st an omm n s


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sharing of finan ial risk. This s ks to avoi th on ntration of w t t t m xp t t f t w

borrow r. Th or b li f in Islami finan is that mon shoulnot in its lf b an arning ass t. Whil apitalism onsi rs mont p t , i m v w p t t t p t f w t t tis us in prolifi onomi a tivit . Mon is a m asur of valuan a m ans of x hang , an it is not a ommo it for sp ulation.T t m p t t p t t t v t p t

onomi a tivit tog th r with oth r m ans of pro u tion (lan ,labour an ntr pr n urship) (Khan an Moul , 2009).

Khan an Moul (2009) argu that int r st is onsi r anunjust an xploitativ instrum nt of finan ing sin th l n r

t w t t g y w g t w t w , p t f w , t f

positiv r turn. Th prohibition of int r st is th r for a m hanismto stablish justi b tw n th l n r an borrow r. Of parti ular

v t t w t t m y f p t aggravat b int r st harg s: O b li v rs! do not liv on usurthat is ompoun ov r an ov r again. Hav f ar of Allah so that

ou ma prosp r (Th Hol qurn, 3:130).h w v , t f t m t t t f y t m, w

t t t t f t t p t , proot in v r asp t of mo rn lif . Khan (2008) pru ntl stat sthat: Int r st annot b liminat without provi ing int r st-frloan fa ilit to loan s k rs just as illit ra annot b liminatwithout provi ing s hooling fa ilit to v r hil . H furth r

xplains that PLS arrang m nts ar not appropriat in all situations,p y w t g f p

int n for busin ss purpos s. This argum nt highlights th nt v v t p t f qar asan w t t f m f m

t t t f t M mummah.b g p t g t t t m t y p y

boun ari s nor subj t to tim onstraints, Islam full appr iat sm m t g t t t y w t t m

subj t to finan ial har ships an in onv ni n s. Islam th r for

p m t v g m g t w t fflimits. If bts ar in urr r sponsibl , th n prompt an fullr pa m nt is important. d bt is thus a s rious matt r an shoul


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not b un rtak n x pt in as s of r al n ssit . In urring bt tof x y xt v g t y t i m v

on mn x ss an wast . Th quran has, in v r strong wor s,m p t xt v g p g ty: e , t t w t f , f G t v w t f

p opl (Th Hol qurn, 7:31) (Khan an Moul , 2009).

V. THe IMPLIcATIONS OF THe cURReNTGlobal Financial crisis For

islaMic bankinG and Finance

T t f g v t t i m m t w p t t t t f ty f t

t f y t m w ff m t t t t f t wina uat mark t is iplin r sulting from la k of profit- sharingm f f g, f m xp f v t v fth poli of too big to fail. Oth rs argu that moral failur l to

xp t t pt , t y v xt vompl xit of pro u ts an sp ulation through risk shifting (Wilson,

2009b).T mp t f t g f f ibF

x m tw f t : t mm t mp t f t ibF, t p t t t t i m f t t

t g t m t v t w t y t t tint rnational finan ial s st m. Th ir t impa t of th risis ont i m g t w m m p t t t t

p p t t, t m xt t, m t t p t f t ifinan ial s tor. emmanu l Vollan , an anal st with th rating ag nStan ar & Poors, xplains,Islamic banks were not caught by toxicassets as Sharah law prohibits interest (Khalaf, 2009).

F t m , t f t t p t t ti m t xp t p t t f t m t t t t f m p t v t mm t t

t mp t f t t g g g f v

(Ambah, 2008). In his appraisal of th autious approa h a opt b Islami banking, Amr al-Faisal, a boar m mb r of dar al-Malal-Islami, omm nt , We are more conservative and sober in


20/26



our investments. That used to be considered a handicap. Now itsconsidered the height of wisdom. Successful banks have always been

conservative lenders (Ambah, 2008).a t g i m f t f t t f mp t f tg t , t mm t f t f m t v

y t f q ty v t t p g t t t m t G f st t w t t t t t t f t i m

t g m t t g g m t f t i m s tor in th r al stat in ustr (Ri ht r, 2008; Khalaf, 2009). Thfall in prop rt pri s in th Gulf Stat s is th r for a aus of major

on rn for Islami banking, giv n th ass t-bas natur of Islamif , w t t t p f t m t t p t t tinv stm nts (Singh, 2009). A or ing to Stan ar & Poors (S&P),t i m f t ff p v f ukk (an Islami finan ial rtifi at , similar to a bonin W st rn finan , that is suppos to ompl with th Sharah)issu in th ar 2008 to th sum of about $15.5 billion, ownfrom about $47.1 billion in 2007 (Khalaf, 2009; Mala sia l a s inIslami finan , 2009). d spit th str ngth an th soun n ss of t f m t f t i m ukk t y, t t tg f m t , y g , v g v mpon th Islami finan ial s rvi s in ustr (Islami ass ts in Gcc,Asia top $700b in 08, 2009).

As for th long-t rm impli ations, Stan ar & Poors b li v st t w t mm t f t f i m f t t tun rtain, th hav strong long-t rm prosp ts. Th r sili n of i m g t ty t v g t t f p

g y t mp t f t m p t g f i m g t ty f t g t g t g t t Islami t a hings into all asp ts of th finan ial in ustr . In his

tt mpt t xp t t m g f t i m f y t mt t m t y t p v t t f m m g g th int rnational finan ial mark t, chapra (2009) argu s that thIslami finan ial s st m is still in its infan . It is not full pr par

t t p t t m t p y g f t g t


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an stabilit of th int rnational finan ial s st m.2 i m t t v fy t f g y t p t

v p v fy t w x t g p t ih ging, rivativ s, an li ui it an risk-manag m nt instrum nts.h w v , t i m f y t m t g t t

xp t t t t y g wt p g v y t t f t t t v y p y t t t

finan ial mark t. contrar to this vi w, Loun (2008) argu s thatt mm t ty f t i m f t y , p t, [th in ustr ] from a subprim -lik m ss so far an won rs whatwill sav it wh n th in ustr grows up.

a t g t mp t f t t g f i m g t t , t t i m f v t y, t t t t t , against su h ris s. Ahm (2009) warns that Islami banks ar

pt t t m f t f t v t f y t m w ll monitor . Furth rmor , Islami finan ial institutions ar oft n

riti is for b ing run un r a onv ntional fram work (Ahm ,1992; Asuta ; 2008; IBF N t, 2009), an that th Islami finan ial

t y m f t cbs [ mm g y t m](Al-Ha a & el-diwan , 2008), an it is th r for lik l to suff r f m t m y t m p m f y t mm s st m (cBS). This is vi n b Islami banks avoi an of trul

ngaging in risk-sharing finan ial arrang m nts.Ahm (2009) i ntifi s thr fa tors that oul trigg r a finan ial

risis in th Islami finan ial s tor. At th institutional l v l, thi m g t y y t m t t m y t g , f g

v v g; t tt t t t f t m t fs st m. At th organisational l v l, x ssiv profit taking an risk taking is iffi ult to pr v nt unl ss th Boar of dir tors (BOd)an top manag m nt impos pru nt risk-manag m nt pra ti s.at t t m t v , t p g wt f mp x s -

mp t f v t t ukk , w v

2 This is partl u to a la k of prop r un rstan ing of th ultimat obj tiv sof Islami finan , th non-availabilit of train p rsonn l, an th abs n of

m f pp t t t t t t t m m t t w t ym ty, m z , p p / g t f t f t t,

lat s ttl m nt of finan ial obligations (chapra, 2009).


22/26



f t m t t f cdo Mbs, i m t w pw t y g p m t w pp w t t

on subprim cdOs.Ahm (2009) highlights th urg nt n to r at appropriatrul s, supporting institutions an in ntiv stru tur s at all l v ls. At th

t t t v , t t m t g t x v p f t an risk taking through: a) s paration of omm r ial an inv stm nt

banking; b) imposing r stri tions on x ssiv l v rag ; ) string ntapital r uir m nts; ) mor transpar n an a ountabilit ; )

s tting up inv stm nt rit ria to pr v nt x ss risk taking; f) tra ing ukks in w ll r gulat x hang s; an g) r uiring originators of ass ts to r tain som of th ass ts an th ir asso iat risks. At th

g t v , f t g t t t g t m t for goo gov rnan wh r upon th BOd shoul fin th risk-r turn param t rs, intro u pru nt risk-manag m nt ultur an

p t , t p y f m t , m t f t t t t m m t q

apital to ov r risk. At th instrum nts l v l, Islami finan shoulavoi an r v rs th tr n towar s th finan ial s st m. In parti ular:a) Islami banks shoul un rstan th in ntiv stru tur s an risksof iff r nt instrum nts; b) Sharah , g t t gat -k p rs of Islami finan , shoul approv an monitor Islami

p t t t f p t / t m t , ukks ; an ) Sharah boar s shoul provi Sharah gov rnang t s omplian risk (Ahm , 2009).

VI. cONcLUdING ReMARKS

Islami finan is b ing hampion as an i al alt rnativ to int r st- bas finan an an auth nti m ans to a van so io- onomi justi . It has b n strongl argu that if an Islami finan ial mo l

t t my t w g t , t t m m t tvalu s of PLS ontra ts whi h n ourag b tt r r sour allo ationan promot mor ff tiv risk manag m nt. How v r, whil th

PLS mo l ominat s th th or ti al lit ratur on IBF, th pra ti sof Islami finan ial institutions hav b n subj t to int ll tualt m v t t m f v g t


23/26



an s st mati all avoi PLS mo s (Ahm , 1992; Al-Ha a& el-diwan , 2008). This is a r fl tion of marginalisation of PLS

instrum nts in IBF, bringing th issu s of fairn ss an so ial justiinto s rious u stion.Whil is ussing th so io- onomi valu s un rlining th

i m f y t m, iq k , g t fi m f , g t f w g v t t ibF pt v : Profit-and-loss (PLS) sharing and risk sharing is preferred

alongside creating more value addition to the economy; Community banking: serving communities, not markets; Responsible finance, as it builds systematic checks on financial

providers and restrains consumer indebtedness; along withethical investment and corporate social responsibility (CSR)initiatives;

Alternative paradigm in terms of stability by linking financial services to the productive, real economy; and also it provides amoral compass for capitalism;

Fulfils aspirations in the sense that it widens the ownership baseof society, and offers success with authenticity. (Khan (2007,cited in Asutay, 2008, p. 1).

Asuta (2008) riti all xamin s th abov obj tiv s an pru ntlargu s that although th s valu s (th i als) fit w ll into th th man obj tiv s of Islami moral onom (IMe), th o not gaing w mp g t t t f t i m fs rvi s in ustr . H on lu that IBF has fail , or on littl ,to: i) uphol an promot its pr f r n for uit -bas PLSan risk-sharing finan ing as an alt rnativ to bt finan ing; ii)

provi tangibl so io- onomi v lopm nt at th ommunitl v l throughout Muslim-populat ountri s, vi n b th

xtr m l insignifi ant so ial l n ing (qar asan ) xt n bIslami finan ial institutions; iii) r n r m aningful ontributionst m t v m v pm t t gth r ation of a pro u tiv r al onom ; iv) positiv l aff t

p ty g t p t v f onom through partn rship PLS agr m nts, in or r to fulfil itsobj tiv of b ing a ommunit banking mo l; an , v) stablish


24/26



t f p f y g f v t t(pro u tiv ) onom onsi ring that th majorit of finan ial

transa tions arri out b Islami finan ial institutions ar bt- bas in natur as oppos to uit finan ing.Su h a on lusion l Asuta (2008) an oth rs to u stion th

f t i m f t y t mm tm t i m f t t t t w t t t t t

v t t t t v y t g t m v f m tso ial foun ations in pursuit of profits.

T f f ibF, v y t w g g p tw p m xp t t t p f m f ibF, t

y t m t y w t t t xt f t t t ibis s t to pla . d spit th fa t that Islami finan is pl rootin th omm r ial an valu -pro u ing onom , th fo us of thIslami prin ipl s of int r st-fr finan r mains, b ing issu s of fairn ss an so io- onomi justi , rath r than ffi i n bar l

fin uantitativ l in t rms of profit an rat of r turn. So ialw ll-b ing an not profits shoul b th rit rion for appraising th

ffi i n of risk manag m nt in Islami finan . L ssons from th p f f m y g p f ft pof risk manag m nt.

G v t f g t t t f p tw , t m g f g t i m f v

v p g m m t t w t t v mf i m f t v t g my m t y

banking an finan . Th irrational assumptions that first, Islamif p t y t m t t t q my

i m tt g, , i m my xist without an Islami so io-politi al fram work, hav no m rit

an go against th fun am ntals of rational thinking (Faroo , 2009).Th viabilit of Islami finan annot an shoul not b ju g int f t i m t t w t g , p t

, t m t t t mp m t t w w t w t t f mm v

aspirations.


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