Global financial crisis unthinkable under Islamic banking

by Riyazi FAROOK

Continued from last week...

Aftermath of Financial Crisis

Global: The World Bank predicted that global economic growth will slow down in 2009, as the financial crunch hits the wealthiest nations. Following this announcement global stock markets, including London's FTSE 100 index, experienced their major collapses since September 11, 2001.

International Monetary Fund (IMF) warns that the world economy development could decline to its lowest point ever since World War II to just 0.5 per cent this year. As the result of economy slowdown by the end of this year up to 51 million jobs will be lost worldwide creating a global unemployment crisis, International Labour Organisation (ILO) reported.

Extreme market volatility caused a loss of 600 million Euros to French savings bank Caisse d'Epargne during the financial market crisis. South Korea announced a $130 billion financial rescue package to stabilise its financial markets. The Dutch government funded 20 billion Euros ($26.8 billion) to protect the financial sector from the credit crisis.

Sweden's government also announced its financial rescue plan, with credit guarantees to banks and mortgage providers up to a level of 1.5 trillion kroner (œ117.2 billion; $205 billion). The government also announced it will set aside 15 billion kroner as a bank stabilisation fund.

United States of America; Obama took over the White House with 11 million Americans unemployed, More than half a million Americans' jobs were slashed last month, creating the worst year for US unemployment since the end of the Second World War and trillions of dollars were lost in stock market savings, Obama pledged that the economy was his first and greatest priority, as Obama presented are $838 billion stimulus package to Congress (it has just been passed by the US Senate) and the infusion of $350 billion left over from the bail-out package agreed in October, 2008.

The crisis had a significant domino effect on the US economy and, which in turn affected almost all stock markets worldwide. The interest rate has been cut hugely by the Federal Reserve from the 5.25 per cent where it stood in September 2007. The US Federal Reserve has slashed its key interest rate from 1 per cent to a range between 0.00 - 0.25 per cent as it battles the country's recession. Since 1954 it is the lowest the Central Bank's key rate - the target rate for banks to charge to lend to one another. Analysts said that the key interest rate is now virtually zero, however, whether it's zero or 0.25 per cent actually does not make a huge difference.

United Kingdom: While the pound is at a 23-year low against the dollar the Bank of England has cut interest rates to a record low of 1 per cent from 1.5 per cent in February, for the first time since the Bank of England was founded in 1694-the lowest level in its 315-year history. Ernst & Young, said that the Bank should not stop here, rates will be cut again. UK government thought once the interest rates are brought to zero, it would help the economy and avoid deflation.

According to figures released by the Office for National Statistics (ONS) the UK is on the brink of a recession. The UK economy failed to grow at all for the first time since 1992 between July and September, as economic growth was down by 0.5 per cent. Housing market in the UK has fallen to its lowest point in 30 years in March this year led to one of the UK's biggest nationalisations in which the UK government had to pump billions of pounds of taxpayers' money into three UK banks (Royal Bank of Scotland (RBS), Lloyds TSB and HBOS). Bank of England officially gave the figures in its latest bi-annual Financial Stability Report that globally financial institutions have already lost $2.8 trillion from the latest financial meltdown.

Scam or failure?

During the financial crisis, the FBI has arrested 406 people, including the well-respected Wall Street figure Bernard Madoff, a former chairman of Nasdaq has been charged with operating an alleged $50 billion (œ30 billion) "Ponzi scheme", World's biggest banks have become the victims of this biggest fraud in history stretched wider and deeper than anyone imagined. The financial model used by many investment banks including the American Investment Bank Lehman Brothers and British retail banks HBOS has been questioned about the financial model confidence and trust, two of the most invaluable principles, are at the lowest point following the bailout of Fannie Mae, Freddie Mac and AIG. The financial crisis is perhaps the worst since 1929 when Bank of America took over the collapsed Lehman Brothers, Bear Stearns and Merrill Lynch.

From Wall street and Canary Wharf in London, there have been growing accusations that state-backed banks paid and are preparing to pay out billions of pounds in bonuses to reward failure lavishly from taxpayers money even if bankers are legally entitled to enjoy bonuses there is a moral responsibility on some of these bankers, this will bring accusations that the taxpayer-funded bank is happy to reward failure lavishly.

How it could have been prevented and why it is unthinkable?

Islamic or conventional, in today's global volatile condition all types are affected. However, while the global financial crisis there are losses of more than $400 billion from conventional banks worldwide, losses in Islamic banks are virtually nil. Because the Islamic Finance and Banking have defining characteristics in the conventional finance world after the unprecedented crisis of the U.S. subprime mortgage market left financial institutions hundreds of billions of dollars of worthless credit instruments attached to home loans by complex structures.

Islamic banking and finance generally present a very low risk profile than conventional western finance. This presents a very meaningful way for both consumers and institutional investors and suggests that investment with Islamic financial institutions will grow dramatically as investors switch to more secure products in this environment. As the risk profile of Islamic banks is generally lower than that of conventional western banks, this opportunity offers a more solid option for both consumers and institutional investors, also proposes that Islamic Finance and Banking industry will create positive awareness and confidence among people to grow faster as they switch to more secure products in this environment. Unlike the western banks, who will continue to restrict their lending policies in the light of the current economic crisis Islamic banks posses a huge capital to finance wealthy individuals and corporate.

While the conventional financial system failing catastrophically, Islamic banking and finance system seems to take root, with 17 per cent of Qatari and 15 per cent of Malaysian banking assets and impressively, over 95 per cent of finance and banking transactions in Saudi Arabia comply with Shari'ah (Islamic law). Global banks have written down more than $400 billion while none of Malaysia's Islamic banks have been written down from the resulting global credit crunch. The Wall Street Journal, highlighted that the conventional financial system is facing ever-deeper crisis while Islamic banking playing a pivotal role in over $200 billion worth of projects in the Middle East and North Africa (MENA) region.

According to Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) senior Islamic financial products should be compliant with Islamic Shari'ah principle to avoid excessive gearing and speculation and the stricter rules imposed on lending by Islamic law prohibits the payment of interest and requires transactions to be linked to assets and require tight controls on debt levels - precisely what regulators of conventional finance are looking for the world over the current financial crisis.

Greater transparency, this is one of the key unique selling points of Islamic Finance and Banking, as the industry seeks to capitalise on the market wrecked with turmoil and many filled with gloom from failing of the conventional market. Liquidity risk is one of the key challenges for conventional finance industry which has been created by the ongoing financial crisis. Due to the fact that Shari'ah constrains the revenue generation from interest based sources, the conventional market is out of reach for Islamic financial institutions. Therefore, surplus liquidity cannot simply be capitalised to conventional financial institutions. However, it is permissible to exchange funds between Islamic banks, by the use of Mudarabah and Musharakah instruments. Islamic Development Bank, Bahrain Monetary Agency and Bank Negara Malaysia, a few of the most respected entities in Islamic Finance and Banking industry play key role in this area.

Concluded