Prof Madya Dr Zulkifli Hasan
Prof Madya Dr Zulkifli HasanDean of Fakulti Syariah dan Undang-undang

The collapse of long established industry players that assume to be immune or “too big to fail” such as Bear Stearns, Lehman Brothers and others is a clear indication of a systemic economic failure. This tension leads to numerous debates on the cause of the meltdown and the primary cause of the crisis. While Michael Spence claims that securities and derivatives like collateralized debt obligations (CDOs) and Credit Default Swaps (CDS) are the main factors, Sachs and Stiglitz blame the credit markets deregulation as the root cause of the crisis. A renowned Islamic economist, Chapra views that the most important cause of current financial crisis was due to excessive and imprudent lending by banks and a so called founding father of modern Islamic economic, Siddiqi affirms that the crisis is rooted in a moral failure that leads to exploitation and corruption.

In short, high level of debt, excessive speculation, return of capital is higher than the rate of economic growth, lack of risk sharing, excessive financialisation of the economy and over concentration on production of goods rather than production of knowledge are the root causes of the crisis.

Global financial crisis has witnessed the failure of conventional finance markets to prevent the economic instability and inefficiency. In this regard, Islamic finance tends to offer very promising solution as IFIs has showed very strong resilience to the current financial turmoil. Despite considerable growth and relatively stable, the IFSB reported that the size of global Islamic finance industry has not changed much over the last year with the total Islamic banking assets only increased from USD 1.4 trillion to USD 1.5 trillion, the volume of ṣukuk outstanding increased (USD 318.5 billion), but Islamic funds’ assets decreased (USD 56 billion), takaful contributions increased slightly (USD 25 billion). This raises the question of whether adherence to Islamic finance principles would have prevented the future crisis.

To be clear, although Islamic finance is conceived to be inherently stable; in reality it is actually not immune from the financial crisis as it is part of the global financial system. Studies show that the adherence to Islamic finance per se does not guarantee that this sector is safe from any economic crisis. In fact, Islamic finance will face significant challenges when it reaches to certain degree of complexity and sophistication of financial products and instrument such as derivatives that have been always the hallmarks of its conventional counterparts.

Several studies affirm that no significant difference in terms of the effect of the financial crisis on the soundness of Islamic finance and conventional banking system. Islamic finance industry is not entirely crisis-proof and financial crisis does have an impact on the Islamic banking performance. In fact, it is also found that Islamic financial institutions are more sensitive to the changes in interest rates as compared to the conventional banks.

Lack of concern towards excessive debt is a good example to illustrate the recent trend of Islamic finance practices. Although, there may not be any issues arising in using debt as appropriate Shari’ah compliant instruments can be used to create it and even some scholars claimed that there is nothing wrong with creating debt, the ethics derived from the text and context indicate that we should strive to keep the levels of debt to a minimum. In term of economic perspective, a key obstacle to recovery, growth and prosperity in the advanced economies is too much debt and too little equity in the economy. Raghuram Rajan in his book ‘Fault Lines, How Hidden Fracture Still Threaten the World Economy’ and another important piece by Atif Mian and Amir Sufi, ‘House of Debt: How They  (And You) Caused the Great Recession and How We can Prevent It from Happening Again’ clearly prove with comprehensive data and figures that the root cause of the crisis is excessive debt.

The key role of the IFIs in this aspect is therefore to ensure that it would be able to achieve a level of resilience that would ensure its sustainability. On this point, the mechanism that would protect the industry from the worst effects of any credit crisis is stern adherence to the core ethical principles of Islamic finance such as strict rules of conduct for all market participants, prohibition of interest and speculative behavior, risk sharing, money as potential capital, sanctity of contracts and Shari’ah approved transactions. This can be further materialized via strengthening the corporate governance practice in IFIs so as to promote transparency, accountability, fairness and equality.

Islamic finance concept is grounded on ethics, values and norms. On top of its commercial orientation, Islamic finance assumes a moral based value preposition that requires the decision-making process to not purely based on efficiency and equity but must have social and ethical dimensions. As a matter of fact, internalization of the value-based practices would enhance the potential role of Islamic finance in contributing toward financial stability and adherence to the pillars of contract in Islamic finance alone will surely not prevent financial crisis to happen in the future.

In light of this, Larry Beeferman and Allan Wain in their 156-page epic paper ‘Getting Real About Islamic Finance’ brilliantly analyses the important aspects of financialisation, real economy and real asset in Islamic finance. It becomes more interesting when Ashby Monk in his article ‘How Islamic Finance Can Save the Global Economy’ highlights the need to shrink the distance between the financial and the real economies.

In conclusion thereof, Islamic finance is clearly not immune from the crisis. Islamic finance must learn from the history and take lesson from previous financial crisis. The foregoing discussion seems to suggest that the current Islamic finance practices needs to have certain transformation and adjustment that would help to prevent a crisis in the future. We do not want to hear that the only lesson that Islamic financial institutions have learned is that they never learn. In other words, has Islamic finance learned something from the previous financial crisis?