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Global Financial Crisis:

The financial crisis of 20072008, also known as the global financial crisis and 2008 financial crisis, is considered by many economists to be the worst financial crisis since the Great Depression of the 1930. It resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. In many areas, the housing market also suffered, resulting in evictions, foreclosures and prolonged unemployment. The crisis played a significant role in the failure of key businesses, declines in consumer wealth estimated in trillions of US dollars, and a downturn in economic activity in many countries. After these financial crisis, economist agreed on a point that conventional financial system is failed to provide stability in the worlds economy and they are looking for an alternative. That alternative is Islamic Finance. Islamic finance is evolving in western countries at a very rapid pace because they know that Islamic finance is the only system which can give guarantee of no financial crisis in the future.

Emergence of Islamic Finance in the world:

Islamic finance has entered a bright new stage of development, emerging after the global financial crisis as a more equitable and efficient alternative to the Western approach. Let's see how. Interest in Islamic finance began in the 1970, mainly due to the accumulated petro-dollars in Arab countries. In a rather pragmatic approach, it was thought in the West that respecting Islamic principles regarding finance would attract wealthy Arab investors. The second major turning point in IF took place after the Sept. 11 attack on the US. It was declared at that time that Muslims were guilty unless they proved themselves innocent, and as a reaction to this uncertainty and discrimination, IF escaped from the West. The amount of capital which fled the West was over $200 billion. Moreover, as the epicenter of global economic growth shifted to Asia, IF concentrated its focus on these emerging and dynamic markets. The last, but most critical, stage has already started due to the collapse of the conventional finance system based on interest. Regardless of the religious values associated with IF, some people sought IF as merely a more efficient, equitable and even sustainable form of finance.

How Islamic Finance provides safeguard for financial crisis?

Islamic finance is based on the rules of Shariah which guarantee the social justice in the society. Some of the qualities of Islamic finance that provides safeguard against financial crisis are discussed below

1. Because interest-based transactions are prohibited, Islam encourages business and trade activities that generate fair and legitimate profit. In IF, there is therefore always a close link between financial flow and productivity. This intrinsic property of IF contributes towards insulating it from the potential risks resulting from excess leverage and speculative financial activities.

2. Another fundamental principle of IF is the risk and profit-sharing feature of IF transactions (such as Mudarabah or Musyarakah contracts). It is this profit and risksharing feature of IF transactions that requires a high level of disclosure and transparency in the IF system. These disclosures allow the market to assign the appropriate risk premiums to companies, thereby enhancing the potential for market discipline to take effect. These features, which are required by Shariah (Islamic law) injunctions, provide built-in checks and balances which serve to ensure the financial stability of the IF system.

3. This profit sharing rule of Islamic finance reduces risk for the banks and means they are less likely to become insolvent. However as the banks build up a profit equalization reserve, which can be used to finance pay-outs during difficult years, depositors benefit from some protection of their returns during economic downturns.

4. The most salient values of Islamic finance are fairness, socio-economic justice and its uncompromising commitment towards the well-being of future generations through the caring for the environment and preserving earths valuable resources. The philosophical reasoning underlying the principles of the Islamic financial system is the implementation of a financial system (wealth accumulation and wealth distribution) that is fair, just and unbiased towards the rich minority at the expense of the poor majority. The ultimate aim is to spread socio-economic justice amongst all people regardless of their whereabouts. The principles of Islamic finance advocate fairness in payoffs and reward structures and embrace socio-economic justice amongst all. Islam preaches moderation in all aspects of peoples lives, and commands them to live within their means.

5. In the absence of interest-based financial transactions under Islamic finance, financial relationships between financiers and borrowers are best understood within the framework of profit-and-loss sharing (PLS) contracts. The concept of PLS entails that when entering into a partnership (musharakah) contract, both parties share the risk (and returns) and have vested interest in seeing the partnership agreement come to a satisfactory ending.

6. Islamic financial institutions, in providing interest-free financial services and investment opportunities, are under religious and moral obligations to assume leading developmental role in promoting productivity and entrepreneurship. Sallah rightly argued: Being an Islamic institution with responsible mission, the [Islamic] bank must act with more developmental orientation. (Islamic financial, 128). While the prevailing objective of conventional banks in a capitalist market economy is maximizing profit by unjustly charging optimal interest rate, Islamic Financial Institutions are expected to demonstrate their true spirit and prove their viability as partners in development rather than instruments of exploitation.

7. Islamic finance is based on equity capital rather than debt. Lending transactions are based on the concept of assets backing. Consequently mortgage loans under such system would have been backed by solid asset structure that safeguards the banking industry against possible loan defaults. The enormity of loan defaults, should they occur within Islamic financial setting, will in no way threaten or compromise the health and proper functioning of the banking system. In the present crisis, trillions of dollars have been trading without backing of assets. One can strongly argue that the current financial crisis would have been prevented if such transactions were conducted in conformity with the Islamic finance model, where virtual money has no place in its accounting books.

8. Islam takes particular interest in fostering close relationship and trust between originators (financial institutions) of Islamic financial products and investors. This honest relationship suggests that a high level of transparency will be shared between the parties involved in a business transaction. Investors therefore will be compelled to open up to their financiers, who in turn will be inclined to authorize loans only to worthy borrowers based on genuine need and identifiable business activity. References: