You are on page 1of 4

Literature review on Global Financial Crisis: Islamic perspective

Many theories have been proposed to explain the cause of the global financial crisis. Generally, some scholars recognized most important cause. According to Chapra (2008), the factor excessive and imprudent lending by banks is contributed to the global financial crisis. One cannot blame banks for this because, like everyone else, they also wish to maximize their profits in a materialist cultural environment where maximization of income and wealth is the highest measure of human achievement.

Furthermore according to Siddiqi (2008), there are features of the crisis under a moral failure that leads to exploitation and corruption. This would be followed up by an explanation of riba and maisir that equates them to bank interest and gambling-like speculation based on risk shifting as distinct from risk sharing.

It will be argued that debt-finance coupled with speculative products whose intricacies defy understanding provide ample opportunities to greedy profitmaximizing agents to exploit the aspirations of ordinary investors and for goading home owners and consumers into living beyond their means and chasing untenable dreams. Siddiqi (2008) also mention elements of the implicit causes in financial crisis which are:

Firstly, factor of Casino Economics and Human Welfare and the alternative of casino economics are by risk sharing.

Secondly, Siddiqi (2008) also mentions credit without credibility. It means that over extended leverage, outstanding credits amounting to an ever-increasing multiple of existing capitals of the relevant institutions, is a direct result of financing through interest bearing debts. Debt financing of productive enterprise amounts to preferring risk shifting to risk sharing. This is immoral as well as counterproductive. The

environment in which productive enterprise takes place does not guarantee creation of additional wealth.

Thirdly, selling debts which some of debt financing has always been part of the financial markets. Even in peak of Islamic civilization trade credit, a form of debt financing, thrived. Islam has no problem with that as it fits in with prohibition of exchanging money now with a larger amount of money after a period of time. The problem starts with sale of debt, whether created by a money loan or owed as a price of goods sold on credit.

Fourthly, derivatives also involve excessive uncertainty. They facilitate managing certain market risks (related to prices, rates of exchange, etc.). Chance remains the basic element in the situation, however, expectations being based on pure speculation.

According to Mirakhor (2009), the current financial system is predominantly interest-based and debt-driven. He argued that a system dominated by interest-based debt contracts is inherently unstable.

Furthermore, Mirakhor (2009) explain about liquidity risk management that is important due to its role in maintaining institutional and systemic resilience in the face of shocks and, conversely, due to the system-wide contagion caused by liquidity shock to a single institution. Once the US financial crisis began, the panic spread worldwide. The resulting uncertainty and lack of liquidity made banks more averse to risk, as they were afraid of contagion. Furthermore, with the complexity and opacity of credit instruments, the interbank market froze, forcing financial institutions into deleveraging.

Then, Chapra (2008) explain more on credit problem. The more credit they extend, the higher will be their profit. It is high leverage which enables excessive lending. Excessive lending, however, leads to an unsustainable boom in asset prices followed by an artificial rise in consumption and speculative investment. The higher the leverage the more difficult it is to unwind it in a downturn. Unwinding gives rise to a vicious cycle of selling that feeds on itself and leads to a steep decline in asset prices followed by a serious financial crisis, particularly if it is also accompanied by overindulgence in short sales.

The subprime mortgage crisis is also a reflection of excessive lending. Securitization or the originate-to-distribute model of financing has played a crucial role in this. There is no doubt that securitization was a useful innovation. It provided lenders greater access to capital markets, lowered transactions costs, and allowed risks to be shared more widely.

According to Chapra (2008), the solution for global financial crisis according to the Islamic finance, it should, in its ideal form, help raise substantially the share of equity in businesses and of profit-and-loss sharing (PLS) in projects and ventures through the mudarabah and musharakah modes of financing.

Then Siddiqi (2008) explains about risk sharing that fits in a system that integrates risk management with value creation. The Islamic institutions of musharakah, and mudarabah, for example target value creation and are good ways of managing risk.

Muhamad Saiful Romli International Islamic University Malaysia 31 January 2011


Siddiqi, M.N. (2008). The current financial crisis and Islamic Economics, IIUM Journal of Economics and Management, 16(2):125-132.

Chapra, M. Umer (2008) The Global Financial Crisis: Can Islamic Finance Help Minimize The Severity And Frequency Of Such A Crisis In The Future? A paper presented at the Forum on the Global Financial Crisis held at the Islamic Development Bank. Mirakhor, A. (2009), Recent crisis: lessons for Islamic finance, New Horizon, No. 173, pp. 12-15.