Abstract
The traditional view holds that the current worldwide monetary emergency was brought about by dark
monetary instruments utilized for hazard move. There was separate of bank borrower relationship,
educational issues brought about by absence of straightforwardness in resource market costs, especially
on the lookout for organized credit instruments. Such emergency would not have happened under an
Islamic monetary framework – because of the way that most, if not all, of the components that have
caused or added to the turn of events and the spread of the emergency are not permitted under the
principles and direction of Shariah. The current worldwide monetary emergency is generally seen as a
genuine trial of the strength of the Islamic monetary administrations industry and its capacity to
introduce itself as a more solid option in contrast to the traditional monetary framework.
Introduction
In spite of being a developing industry, Islamic finance has appreciated a consistent and steady even just
as the upward development since the idea was tried nearly 40 years prior. Having the option to bear the
ramifications of the worldwide monetary emergency and remain generally certain amidst the
emergency and at last to arise as more evenhanded and effective framework have raised the profile of
Islamic money and highlighted its ability to carry steadiness to the worldwide monetary framework.
Doing fundamental investigation of the reasons for the emergency and estimating these causes contrary
to the inherent standards of the Islamic monetary framework uncovers that such emergency might have
been forestalled should Islamic monetary standards were predominant. The paper infers that alongside
the gigantic difficulties that the emergency has made to the ordinary monetary framework, it has given
the Islamic finance bounty of freedoms to show its significance.
This research question is distributed into three parts. First part is introduction second part describe the
causes of financial crises and third part how Islamic theories and the working structure of Islamic banks
can mitigates the financial crises.
Literature Review
In literatures regarding financial crises 2008 and Islamic finance, the Islamic finance is a proper system
that are working under the shariah compliance with strict regulations. Financial crises 2008 happened
because of investor’s hunger and desire for too much return and government were not regulate that
properly. The market was collapse because of subprime loans and the broker who sell these subprime
loans to others to eradicate and transfer their own risk on to other shoulders. Islamic finance has an
ability to deliver significant contribution towards more stable economy. Islamic finance can proficient to
solve it because if the entire institutions worked under the guidelines of Islamic finance there are much
probability of averting the financial crises because all the activities that were done in the crises are not
permissible under the rules of shariah. (Hassan, 2018).
The important reasons for the financial crises is the extreme use of the real property loans and other
products to expand the lending of banks and then banks were failed to get back their loans from those
who already taken home loans. Weak supervision by the bank and government regulatory authority the
extreme use of debt leads the whole system into financial crises. The unethical conduct of managers and
investors can be considered as a significant reason for monetary emergencies as well. In Islamic finance
“Riba”, “Gharar” and “Maysir” are strictly prohibited in Islam just because of these rules and shariah
guidelines the Islamic banks were safe under the emergency period where despite all conventional
institutions were went to be bank corrupt and Islamic banks were not suffered from this. (MANASEER,
2017).
They have looked at six six different financial ratios of Islamic banks and conventional banks for four
consecutive years before and after the time span of financial crises. Islamic banks were performed
better than conventional institutions and their profitability ratios were greater than conventional
system. During analyzing the six different ratios were found that CAR, ROEA and E/TA of Islamic banks
had condensed through the crises and ROEA, ROAA and LA/TA of conventional banks reduced through
the crises. Islamic banks suffered during the financial crises 2008 in terms of lowering, Capital Adequacy
Ratio, Equity to Asset ratio and Return on Equity and Asset but four years record showed that Islamic
banks performed well under the financial crises. (Sat Paul Parashar, Jyothi Venkatesh, 2010).
The performance indicator like liquidity ratio and capital adequacy ratio of Islamic banks were far
improved than conventional banks through the time interval of financial crises. Result shows that there
was no difference in the liquidity ratio earlier and later the financial crises that mean the Islamic banks
had enough deposits and no withdrawals on that time. Capital adequacy ratio was stable and total
equity was greater than total assets which mean Islamic banks have an enough capacity to bear loss.
This happened because Islamic banks are more equity financed and profit and loss sharing relationship
with customers rather than debtor/creditor relationship like conventional banks. (Mosab I. Tabash, Raj
S. Dhankar, 2014).
Causes of financial crises
The main reasons of the financial crises are giving easily credit to borrower, lender-borrower greed,
fraud, corruption, lack of information and excessive lending without any checking criteria, rules and
regulations. It is difficult to point out only one factor of financial crises but the most important reason
was to be leniency of lending.
The question arises on this scenario that why commercial bank give loans to borrowers without checking
their credit history?
There are such main factors firstly their greed of earning more profit as compared to previous years and
other thing was getting more money from investors on the behalf of their mortgages of Collateralized
Debt Obligation (CDO’s).
Each monetary emergency is the result of modest credit; low financing costs encourage interest for
advances that can't be reimbursed when rate thusly rise. Lower financing costs in the United States
implied that home loans turned out to be more reasonable and in more interest. Banks, driven by
feeling of immunity and the craving to benefit from existing freedoms to boost their profits, received a
simple way to deal with loaning to have a greater cut of the pie by selling more credits, along these lines
getting more cash in charges and commissions.
Not specific rules and regulations about lending money and giving to borrowers is a major reason of
financial crises occurs not specific regulation was easy for borrowers to borrow money from bank and
bank did not think about the way when all the borrowers became bankrupt then what they will do.
(Wilson, 2009) Discusses sub-prime borrowers was also a major cause of financial crisis. Sub-prime
borrowers are characterized by default on mortgage obligations, previous credit, low income hence
inability to repay substantial mortgages and insufficient coverage of health insurance. All good and bad
mortgages were together and float into the financial market to getting money from that and when
banks have money they will again give loan to the borrowers to getting more profit. The model
functioned admirably while borrowers were making their installments. Be that as it may, nobody thinks
when installments halted, the model, in a real sense, collapsed.
Because of the financial crises the Europe and other countries suffered a lot of difficulties and due to the
global equity market decline, global financial institutions collapse, oil prices became decline, interest
rate were decreased to avoid recession. Some institutes were bankrupt due to financial crises for
example Lehman Brothers Holdings Inc.‟s (LEH), American International Group (AIG) etc.
The principles of Islamic finance show how it has potential as a reasonable option worldwide monetary
framework. Islamic finance is completely working under the shariah principles and guidelines for dealing
with money. All activities in Islamic finance are allowed except those which are forbidden by shariah due
to their destructive implications towards humanity. Muslims are stringently restricted from putting
resources into or managing in financial exercises that include interest, speculation and gambling, paying
little mind to their structure or shape or the guises that are frequently used to legitimize them.
Furthermore, Muslims are debilitate and prohibited from putting resources into organizations that are
illegal exercises. Islam not allowed to paying or receiving fixed rate of return. Due to receiving interest
from borrowers the poor become poorer and richer become richest. Islamic banking is working under
the profit and loss sharing principles. The idea of PLS involves that when going into musharakah contract
both parties share risk and return in a pre-decide ratio and exclude interest base earning system. Islamic
finance encourages interest free financial services and investment opportunities under the shariah
guidelines to generate profit. The objective of conventional banks is to maximize their profit by
maximizing interest rate while Islamic institutions demonstrate their true spirit and prove their viability
as partners in development rather than instruments of exploitation. Islamic financial institutions are
working under the principle of “no pain no gain” if you are not bear the risk than you have no right to
earn profit.
Can Islamic Finance handle shocks of financial crises?
Islamic institutions were also faces difficulties under the financial crises time tenure but it remained
resilience rather than as compared to conventional banks. It has been emphatically contended that if
worldwide financial practices stick to the standards of Islamic finance than we cannot suffer from
financial crises. Those factors that were the cause to occur financial crises are basically not allowed
under the shariah guidelines so if Islamic finance worked on that time we were not suffered from this
crisis.
Selling debt against debt is not allowed in Islam. You cannot sell your debt to another party or no even
sell the asset you cannot possess. The Islamic financial system not allowed short selling it encourages
real sale of asset and inspire justice and transparency. So due to these principles Collateralized Debt
Obligation process is prohibited in Islam.
Islamic finance allowed asset backed financing rather than lending borrowing transactions. So the
borrowers who taken home loans and then promises to pay back bank amount with interest this interest
factor is prohibited in Islam. Islamic banks allowed Diminishing Musharkah/Ijarah on this circumstance
where both parties can contribute their capital and then individual do ijarah agreement with bank and
give rental payments to bank.
Principles of Islamic Financial system
In Islamic financial system there is regulatory system to regulate the processes on daily basis and shariah
advisory board regulate and control the entire system and even they are checking either the current
working are according to shariah rules or not and on the other side there was no regulatory system and
no control on the time period of financial crises and banks gave loans to borrowers on easy terms and
conditions this process leads the economy to financial crises.
Islamic finance encourages the profit and loss sharing transactions such as mudarabah and musharakah
where all the terms and conditions are transparent to both parties if the bank did musharkah base
transactions with borrowers than risk will be shared between both parties and economy will save
ourselves from financial crises. Mudarabah and Musharakah are additionally seen as viable instruments
for overseeing risk, and both parties can share risk and profit on pre decided agreed ratio.
Conclusion
Financial crises occur due to laxity conditions of lending money to borrower and no proper rules and
regulations over the lending process so due to these processes it leads the whole system to financial
crises and many institutions who are working under the conventional system were collapsed and most
of them were bankrupt just because of their leniency over the lending system they upset the whole
economy. After the financial crises discussion raised there are some drawbacks on the conventional
system and we were unable to handle the shocks through this system then the researchers proposed
the Islamic financial system. The paper has argued that an honest implementation of Islamic theory of
finance is potentially capable of solving, and in all probability averting, such crises from happening
simply because most, if not all, of the factors that have caused or contributed to the development and
the spread of the crisis are not allowed under the rules and guidance of Shariah. The principle
motivation behind why the Islamic financial frameworks are superior to conventional framework on the
grounds that the system discourage interest rate and encourage profit and loss sharing. Islamic financial
systems are working under the shariah guidelines and those things that are harmful for the humanity
those things are already excluded from the system. Through this system we can save ourselves from
crises that will occur in the future and if they will rise than we can easily bear the shock of crises as well.