Global financial crisis unthinkable under Islamic Banking

by Riyazi FAROOK

As the economy superpowers are on the brink of recession, the global financial industry declines into ever-deeper crisis, the collapse in the sub-prime market begins to have an impact on banking around the world, Now the credit crunch creates turmoil throughout the global economy. In recent years we had heard of the term `Credit Crunch', defined as "A severe shortage of money or credit", the slogan has now entered dictionaries.

The consequences of taking higher risks have led to unprecedented banking collapse around the world and have also emphasised the core differences between Islamic and conventional or interest based finance. Islamic banking institutions do take risks. But the clear distinction is that risk-sharing being a fundamental principle of Islamic banking, the more ethical and risk sharing method offered by the Islamic banking industry is emerging and attracting an increasing demand.

The global economic crisis sparked off by the US subprime mortgage meltdown would not have occurred if Islamic principles were applied in international financial markets, an Islamic scholar said.

The International Centre for Education in Islamic Finance (INCEIF) said the US subprime mortgage crisis would technically be unthinkable in the Islamic financial market sector because it would be against Shari'ah (Islamic Law) principles to sell a debt against a debt.

The rule is simple and clear, you can't sell unless you posses the asset, in Islamic trade. But the subprime mortgage crisis had seen trillions of dollars traded without the backing of assets which is not supposed to be traded according to Islamic principles. If such transactions had followed the Islamic finance model they would have been easily prevented and would have the global economic crisis by the use of Islamic Finance and Banking principles.

Islamic finance and banking industry

According to the Financial Times, over the past decade Islamic banking is estimated to have grown more than fivefold from around $150 billion in 1990 to $900 billion in 2008 and growing at the rate of 15 per cent to 20 per cent a year and are set to hit $2 trillion in 2010.

Global Islamic banking assets (based on the latest figures released by the Financial Times in 2008 November) grew by 27.6 per cent over the past year to reach over $800 billion from around 50 countries. Although this is relatively small compared with the $90,256 billion in total assets amassed by the top 1000 conventional banks around the world.

Analysing the $800 billion global market, the six states of the Gulf Cooperation Council-GCC (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE) offer the largest portion of the total but the non-GCC Middle East and North Africa (MENA) states are not far behind. While the overall total grew by 27.6 per cent to $800 billion in the listing, the GCC institutions expanded the most by a staggering 47.5 per cent to $262.7 billion and the non-GCC MENA institutions grew by 40.4 per cent to reach $248.3 billion.

Asia, led by Malaysia, Brunei, Pakistan, Bangladesh, Indonesia and Thailand, is the largest region in the world for Shari'ah-compliant assets, growing by 32.3 per cent to 119.3 billion. Australia, Europe and North America grew by 60.6 per cent to account for $35.1 billion with sub-Saharan African institutions contributing $4.7 billion in assets. Now Global banking giant such as America's Citigroup, Britain's HSBC and Germany's Deutsche Bank have also established Shari'ah-compliant banking units.

Financial crisis

US Federal Reserve increased the key interest rates from 1 per cent to 5.35 per cent between 2004 and 2006, the US housing market starts to experience the worst, with prices decreasing and a rise in mortgages due to the failure use of homeowners to make their payments.

These default rates on high risk sub-prime loans to consumers with poor or no credit histories have risen to record levels. Colossal losses in US financial markets led to a crunch on global credit markets and subsequent fall in international equity markets. The collapse in the sub-prime market begins to have an impact on banks around the world.

Federal Reserve signalled a warning that the US sub-prime crisis could cost up to $400 billion. The Federal Reserve slashes the key interest rate to by 0.5 per cent to 5.75 per cent at which it lends to banks, warning that the financial crisis could be a risk to economic growth. Not only the US Federal Reserve, the Bank of Canada and the Bank of Japan also begin to intervene.

It is the obvious sign that conventional banks are refusing to lend and do business with one another. To improve this situation the European Central Bank subsidised the financial market by 108.7 billion Euros to try to improve liquidity. UK high risk mortgage providers are set to pull out mortgages and increased the cost of borrowing for UK homeowners with poor credit histories.

In August 2007 French bank BNP Paribas produced quick climb in the cost of credit, and made global financial institutions recognise how serious the circumstances were. Investment bank BNP Paribas announced to the investors they would not be able to obtain money out of two of its main funds because it could cause difficulties in valuing the assets, owing to a "complete evaporation of liquidity" in the market.

In October 2007 major failures started to appear in the world's financial industry, Swiss banking giant UBS Bank has announced a loss of $3.4 billion from investments linked to sub-prime.

Following, American banking giant Citigroup posting a sub-prime loss of $40 billion. US investment bank Merrill Lynch revealed a $7.9 billion disclosure to bad debt.

A major bond insurer MBIA, announced a loss of $2.3 billion. After failing to search for a potential buyer, Lehman Brothers became the first major US investment bank to collapse since the beginning of the credit crisis. The US Federal Reserve pledged an $85 billion rescue package to the nation's largest insurance company AIG, to keep it away from liquidation.

Former Federal Reserve chief Alan Greenspan described the current financial crisis as "probably a once in a century type of event" and cautioned that this financial calamity will lead to the closure of major firms.

The US House of Representatives passed a $700 billion (œ394 billion) government plan to rescue the US financial sector a part of $900 billion (œ600 billion) economic stimulus package.

To be continued