Global Financial Crisis

QUESTION 5

Introduction

The global financial crisis has once again hit the conventional financial market since summer 2007. Indeed, the crisis has gone from bad to worse although there are signs of recovery in some countries. Some financial experts and economist like Michael Roberts (2009) has regarded the crisis as ‘The Great Recession' as comparison to ‘The Great Depression' in the early 1930s. Billions of bailouts have been made by the western superpowers like America and Britain but the financial system continues to go deep into recession. Some would say that the world needs a significant financial reform and some would argue that the existing financial system needs to be replaced with a more balanced and stable system like the Islamic finance.

In this report I intend to outline the main causes of the global financial crisis and discuss how Islamic finance viewpoints towards the crisis as it stresses on how Islamic finance can contribute towards the crisis resolution in relation to the causes.

The Causes of the Global Financial Crisis

The global financial crisis was caused by many factors especially the failure of the capitalism itself but in a lecture on 30th March 2010 by J. Harwood outlined that there were five main causes of the current global financial crisis.

To begin with, cheap and excessive credits were available for mortgages and housing loans during the housing boom period, which led to drop of property prices due to high interest rates on borrowings and more supply than demand on the property market resulted from sharp rose of repossessions by default activities of sub-prime borrowers.

Secondly, the policy mistakes made by the governments and central banks in 2008/2009 bear market for example the Federal Reserve has injected a huge amount of liquidity into the money markets after Bear Stearns a global investment bank and securities trading company collapsed in March 2008 and Lehman Brothers six months later (Turner 2009, p.67).

Thirdly, during the credit boom period a few years before the crisis, in which credits were easily obtained for mortgages, credit cards, car loans, personal loans etc that have loaded the consumers with excessive debt burden beyond their own capability of paying.

The fourth cause was the effect of credit or money creation. According to Hizb ut-Tahrir Britain (2009), the current chairman of Federal Reserve, Ben Bernanke had made a revelation about six years ago that the US government has the right to print the US dollars as much as they want using the ‘printing press' as a tool at no extra cost. The negative implication of uncontrolled money creation is that inflation will drastically rising up to the level of hyper inflation when too much paper or electronic money are available (Hizb ut-Tahrir 2009, p.9).

Fifth cause was the derivative markets as quoted by Warren Buffett, world greatest investor "Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." (Weinberg 2003, The Great Derivatives Smackdown: www.forbes.com). This statement is extremely true in terms of the damages and negative impact that derivatives markets have done on the conventional financial system.

Islamic Finance Perspective and Resolutions

Islamic Finance is based on the Shariah law and the basic principles are the prohibition to deal in interest (riba') in any case and ban on uncertainty (gharar). In Islamic banking system, giving and receiving interest are forbidden (haram) at all means therefore the depositors of the bank cannot demand or receive interest as this also apply to borrowers who cannot be charged interest by the bank (Gafoor 1999, p.5).

In Islamic finance point of views, the cheap and excessive credits of mortgages and housing loans have misled and trapped the public into getting onto the property ladder even if they cannot afford it. This is due to low security requirements set by the mortgage lenders in such a way that even the higher risk borrowers or sub-prime borrowers can be approved for mortgages. Under Islamic banking system people who qualify can apply for the zero interest mortgage of the Islamic home financing product that adopted the three principles of Islamic contract; murabaha, ijara and musharaka that focus on risk and profit sharing (Al-Haddad and El Diwany 2006, p.1). Moreover, one of the key principles in Islamic finance is obtaining a credit is not advisable, in which other options can be taken into considerations. In other words if one cannot afford to own a house he or she has the option of renting instead of buying. Furthermore, Islamic finance encourages people to be involved in productive economic and investment activities in accordance with Shariah law as these will generate the economic growth of the society as well as the country.

Similarly, Islamic finance has the same views towards the credit boom that has transformed more countries into indebted nation. In Islam one should not live beyond one's means which contradict with famous English idiom “live beyond one's means”. In most Islamic states, those who deserves like the poor, in specific debt or lost all their ownership can seek financial assistance from the Baitul Mal; a public treasury that has been responsible to collect states income and the allocation of those income into various social and economic purposes (Ebrahim 2004, p. 4).

Islamic finance is completely against the money creation factor. This is due to the fact that one of the main attributes of Islamic finance is based on asset-backed financing (Usmani 2007, p.18). Therefore, the use of paper money without the same equivalent unit like gold, silver or real asset is not recognised in Islam, hence Islamic finance is totally based on illiquid assets at all times (Usmani 2007, p.19).

Derivatives markets involved future, swap and options trading, therefore these types of derivatives are not permitted in Shariah because they are mainly used to make speculative gains as they have the component of uncertainty (gharar) and also similar to gambling in a way that profits can be gained by speculators who deliberately exposed themselves to risk (Mohammad n.d., Derivatives in Islamic Financial Market: www.mifmonthly.com).

Conclusions

The current global financial crisis has encouraged many experts including economist and financial specialist to explore a better solution in order to fix the existing crisis whilst Islamic financial system is not just the best solutions to the crisis in fact it also can be considered as the alternative financial system to replace the conventional financial system.

BOOKS:-

1. Cable, V (2010) The Storm The World Economic Crisis & What It Means, 1st ed. Great Britain: Atlantic Books.

2. Gafoor, A.L.M. Abdul (1999) Islamic Banking & Finance Another Approach, 1st ed. The Neatherlands: Apptec Publications.

3. Roberts, M (2009) The Great Recession, 1st ed. Great Britain:

4. Turner, G (2009) No Way To Run An Economy, 1st ed. Great Britain: Pluto Press.

5. Usmani, M.T (2007) An Introduction to Islamic Finance, 1st ed. Karachi, Pakistan: Maktaba Ma'ariful Qur'an.

WORLD WIDE WEB:-

1. Al-Haddad, H and El Diwany, T (2006) The Islamic Mortgage: Paradign Shift or Trojan Horse [WWW] Islamic Finance.com. Available from: http://www.islamic-finance.com/Islamic_mortgages.pdf [Accessed 04/04/10]

2. Aziz, Z.A (2009) Islamic Finance and Global Financial Stability [WWW] Available from: http://www.bis.org/review/r091130d.pdf [Accessed 26/03/10]

3. Ebrahim, A.F (2004) Islamic Economic Principles [WWW] Fatwa.co.za. Available from: http://www.fatwa.org.za/OtherIIslamicSections/IslamicEconomics/IslamicEconomicPrinciplesBook1.pdf [Accessed 04/04/10]

4. Illias, S (2008) Islamic Finance: Overview and Policy Concerns [WWW] Available from: http://www.scribd.com/doc/16653606/Islamic-Finance [Accessed 26/03/10]

5. Ozturk, I (2007) Global Financial Crisis Highlights Benefits of Islamic Finance [WWW] Available from: http://www.todayszaman.com/tz-web/yazarDetay.do?haberno=156567 [Accessed 26/03/10]

6. Weinbern, A (2003) The Great Derivatives Smackdown [WWW] Forbes.com. Available from: http://www.forbes.com/2003/05/09/cx_aw_0509derivatives.html [Accessed 03/04/10]

7. Mohammad, S (n.d.) Derivatives in Islamic Financial Market [WWW] MIF Monthly. Available from: http://www.mifmonthly.com/8_art.php [Accessed 03/04/10]

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