Islamic Finance and Financial Crisis - How IFI's Survive?

Understanding Islamic Finance

In Islamic finance the financial transactions are based on Islamic principles. It prohibits the charging or paying of interest (riba) and promotes risk-sharing, asset-backing, and socially responsible investments. The Islamic banking and finance is gaining popularity from several decades, as it offers an equitable and ethical of conducting financial transactions.

The Role of Islamic Finance in Times of Crisis

The principles of Islamic finance provide remedies for the issues that led to the global financial crisis. For example, in times of crisis, conventional financial institutions often turn to governments for bailouts, resulting in inflation and increased burden on taxpayers. In contrast, Islamic finance emphasizes self-regulation, because every money is backed by an asset. This fact reduces the likelihood of government intervention during times of crisis.

Islamic Finance and Financial Crisis: Top 5 Reasons for the Resilience

The global financial crisis of 2008, also known as the Great Recession, had a severe impact on the world economy. The crisis was caused by several factors including excessive risk-taking, flawed regulations, and inadequate oversight in the financial sector. This led to a chain reaction of events that resulted in a global economic downturn. The COVID-19 pandemic also highlighted the fragility of the global financial system. As countries struggle to recover from the economic fallout, it is essential to consider alternative financial systems that can provide stability and resilience during times of crisis. Islamic finance has proven its resilience during previous financial crises, such as the:

• 2008 financial crisis and
• 1997 Asian financial crisis.

1. Shariah Justice:

The basic premise of a bank is the same throughout the world, but how they function can be completely different. In the case of Islamic finance, banks must abide by the rules of Shariah law. The bank is more than just a business that operates to make a profit in Islam, it is seen as a form of justice. Everyone is supposed to give and take under the same rules and interest does not play a role, as it is an unfair rule that only one side gets to benefit from.

Shariah prohibits usury, speculation, gambling, and unethical predatory practices. These things are, ironically, the very causes of what rots and eats away at the foundations of countries that operate under the rules of Western banks.

2. Relationships:

To fully understand the financial crisis and Islamic finance, we must consider a relationship. The citizens’ relationships with conventional banks are always in the form of a creditor to the debtor, unlike Islamic banks. Everything revolves around interest rates and creditworthiness. This prevents any real relationship with a bank, thus its lack of contribution to the communities around them. Islamic banking has to provide an equal service and maintain trust with the community to prosper.

3. Investments in the Bank:

When one deposits their money into a conventional bank with the intent to save and earn interest, that bank must pay back that money in the event of a financial collapse. This is the law under the FDIC minimum. Islamic banks do not have such a law, nor do they have the guaranteed interest for keeping said money in a savings account. This may seem bad for the customer, but it is also what allows their banking industry to prosper with confidence.

4. Treatment of Money:

Unlike conventional finance, Islamic finance does not see money as a commodity in itself to be sold or traded at a higher value than what it is printed at. Money is merely a tool to promote economic activity and freedom to exchange goods more efficiently, as money does. Islam sees valuable commodities, like gold, silver, and raw materials as money, but important food staples, like rice, wheat, and salt will not be tolerated.

5. Economic Development:

Instead of growing bank’s reserves through all the frauds, scams, and predatory practices that are common in conventional banks, Islamic banks grow their profits by investing in tangible businesses, according to the principles of Islamic economics. This creates more growth in the economy while turning a profit from the initial investment. It’s a win-win for banks and their stakeholders. Conventional banks are mostly looking for short-term returns on their investment, so it is rare to see banks make large investments with their own money in the West.

Tackling Global Financial Crises

So, during the financial crisis, Islamic financial institutions prospered because of all of these reasons. Public trust in conventional banks continues to fall, especially when Shariah lending practices have not improved with the public despite economic growth. When banks follow a law that is built around justice, they don’t invest all their resources into earning more from less; everyone prospers. The Centre for Islamic Banking and Finance in the UK has been instrumental in spreading Islamic finance education through its Islamic banking and finance courses and the diploma of Islamic banking and finance. These programs equip professionals with the understanding necessary to navigate the complexities of modern economic issues. They learn the practical ways Islamic finance can solve global financial crises through its inherent risk-sharing and real asset-backed system.