India facing financial sector crisis: Jaswant Singh

Financial Crisis and Islamic Banking
Syed Zahid Ahmad

The international financial crisis began over a year ago, and has intensified during last few months. The International Monetary Fund has already warned that this credit crisis will result in losses of over trillion dollars and that it may worsen especially after the 150-year-old US financial giant Lehman Brothers been declared bankruptcy, not to mention the sale of financial services firm Merrill Lynch to the Bank of America.

Interestingly, Islamic banks are unaffected by the sub prime mortgage crisis; rather many non-Muslims are turning up to Islamic banking as the customers spooked by turmoil in the Western banking system are feeling Islamic banks as a safer haven because they are immune against such crisis due to inherent business ethics within Islamic banking.

There are mainly two important reasons for insulation of Islamic banks under this current credit crisis as compared to the interest based banks and financial institutions. The first is liquidity problem due to inter banks lending in the money markets, merger and resales of debted companies. The second problem is realted to rating of asset values by the credit rating agencies, mortgaed against debt finances under fluctuating price levels in the market. Principally Islamic banks acts as either custodians, advocates or managers for depositors and thus they cannot tarnsfer public deposits to other banks without permission of their depositors. Thus Inter bank liquidity transfer on debt finance basis is not permitted in Islam, which restrains liquidity realted problems in the market.

Since under Islamic banking, equity finance is not granted by mortgaging assets, but after analyzing the cost and projected yield, the credit / equity finances remains unaffected with changes in assets values. There are so many internal and external factors affecting the asset values of stocks, bonds and securities which are prime components for credit rating system for Interest based lending; so it is not easy task for the banks or even for credit rating agencies to evaluate the exact credit risks. The risk rating under Islamic Finance has nothing to do with fluctuation in asset values; instead it depends on actual business trend. Thus there is no fear of sub prime mortgage under Islamic banking principles; rather it counters the throat cut competition in financial sector to get more credit shares. This principle thus provides stability and insulation in the financial market.

Islamic banking interestingly helps the weaker and even the weakest section of the society through various ultra modern financial products. Under Islamic banking credits through Joint ventures, partnerships and leasing are provided by investors / banks to the borrowers with a condition that financial risk is to be borne by the investors, other risks be borne by borrower / manger of funds. This helps even the poor and vulnerable to get credit at no risk or cost, but definitely requires other credits in terms of strong business proposal, sound projections, rational planning, skilled hands and technical art to attract the financer. Under Islamic finance, comparatively better business proposals succeed in fetching credits while projects with poor economies find it difficult. This helps the economy boost inclusive growth as financial resources are well shared among haves and have nots with shouldering financial risk on financers and other risks on borrowers of funds.

The credit rating under Islamic banking and finance evaluates real term business potential and growth trends, instead of evaluating manipulated asset values which has caused recent damages to the credit market. Thus the regulators and credit rating agencies should now adopt principles of Islamic banking to safeguard the financial sector from any more turmoil.