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Saturday, 25 October 2008

Can Islamic finance be the cure?


Credit crunch, mortgage crises, Interest rates, debt, foreclosures, bankruptcy and mergers are all familiar words to hear nowadays. These are reflections and indications of the failure of the current financial system worldwide. A quick review to the current chaos witnessed in economies worldwide motivated some scholars and commentators to analyze the system more closely.
Looking closely at the causes and roots of the problem led some economists to question the role of Islamic financial systems and the ability of the Islamic financial systems to safeguard, cure and provide a way out of the current chaos.
One can say that the main cause of the problem started by credit expansion based on a certain credit rating system in American markets. The story began due to the expansion in lending in real estate.
The crises raised the issue of credit rating standards, credit expansion with no real assets and investments, accumulated interest rates and hence loans and many other defects in the current financial system. The chaos led some to compare current market rules and regulations with Islamic financial banking systems rules.
According to Sharia law interest rates are not permissible and so there are no accumulated loans. Thus, accumulated interest rates and current credit crises did not touch Islamic financial institutions as opposed to the current system. Under Sharia, Islamic banks are only custodians and liquidity transfer on a debt finance basis is not permitted in Islam. The credit rating under Islamic finance has nothing to do with rises in asset values but it depends on actual business. Islamic banking and finance evaluates real term business potential and growth trends, instead of evaluating manipulated asset values which has caused recent damage to credit markets. Thus, there is no fear of sub-prime mortgage and hence financial stability.
Business in Islam is based on capital and profit sharing and Islamic banks don’t give loans with interest rates. Instead they become shareholders. Islam prohibits interest but doesn’t prohibit gains on capital. This prohibition of a risk-free return and permission of trading marked the financial activities in an Islamic system of real assets backed with the ability to cause value addition.
Although Islamic financial banking systems had witnessed a considerable amount of attention and growth in the past five years particularly in western societies, the fact remains that Muslims are still hesitant to turn to such an unclear system that lacks many regulations and is still considered underdeveloped.
The current crisis might be a possible push for interested regulatory bodies and institutions to enhance and clarify rules and regulations so that people might turn to Islamic financial banking systems as a cure and a way out of the global crisis.

Doaa Khairy Mohsen, (PhD. MBA, BSc) is a business management consultant specialized in issues of organizational behavior, management reform, leadership and economic development in the MENA region, with particular interest in the Arab world and GCC Studies.
(Daily News Egypt)
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