Islamic banking is a system build to avoid some shortcomings and loopholes of the conventional banking system, the major one being interest charging by banks. It has so far survive for some forty plus years, despite pessimism of those who initially saw it as a fail project and not sustainable.Today there are hundreds of Islamic Banks spread all around the world, that are operating according to Islamic business contracts.While recognition of the system has come from major western institutions such as the World Bank, International Monetary Fund, investment banks like Goldman Sachs, universities such as Harvard University, Oxford, Cambridge, just to mention a few.There is more than $2 trillion under Islamic finance with the system growing at double digit rate over the last three decades.
Islamic banking system came in for a test during the last global financial crisis of 2007/8 when the whole foundation of global financial system was shaken. Banks such as US Lehman Brothers and Wachovia, were wiped out of the banking landscape. In Nigeria, banks like Intercontinental bank, Oceanic bank, BankPHB were declared insolvent and sold to new owners or taken over by the government. Banks that remain after the crisis were left with bigger holes in their balance sheets to the extent that governments around the world had to intervene to serve them. Trillions Dollars of tax payers money were spent in bailing out those banks from an injury that was clearly self inflicting. According to many commentators the major causes of the crisis were accumulated interest-dominated debt, greed inherent in the system, speculative investment, lax regulation on the part of central banks, absence of a moral restrainer, etc.
As the Economist of London (Sep 7th 2013) put it, referring to the causes of the crisis: "The most obvious is the financiers themselves—especially the irrationally exuberant Anglo-Saxon sort, who claimed to have found a way to banish risk when in fact they had simply lost track of it." Then there was reckless financial engineering, where all kind of financial products were developed and put into the market without regulators doing the thorough assessment of the products expected of them. This go contrary to what obtains in the sciences, where before any new discovery (product, system, etc) is put to public use, they must undergo thorough test to determine their applicability. In the US, financial engineers turned highly risky mortgages into (theoretically) low risk products and sell same to the naive public - the subprime lending debacles. Products such as credit default swaps that were meant to spread risks concentrated it in fewer places.
At the heart of the uniqueness of the Islamic banking system is the prohibition of interest and its replacement with profit and loss sharing. This single act allow flexibility at time of crisis and period of growth, as it act as shock absorber. In period of crisis, depositors and investors share lost/less profit, while at period of growth higher profit is shared. But, in the conventional system, interest rate does not adjust during period of crisis and growth, as it remains fixed in respective of performance of the venture. Islamic banks are restricted on moral ground on where to invest their money. For example, they cannot invest in gambling, highly risky ventures, speculative activities, prostitution, etc. Islamic banks are not allowed to put investors money in the kind of derivatives that accelerated the last global financial crisis.
According to a 2010 study by two IMF staffs (Hasan and Dridi) Islamic banks performed better during the crisis when compared to their conventional counterpart.There are many other studies that found similar results using different methods (Wasiuzzaman and Gunasegavan, 2013; Shafique, et al, 2012; Abdullahi, 2011). Here in Nigeria, one of the root causes of our banking crisis was the highly risky and speculative investments of Nigerian banks, after Charles Soludo's banking consolidation that resulted in banks dolling out money to oil importers, as well as loans dedicated to buying unsecured equities on the floor of Nigerian stock exchange. By December 2010, all these loans turned out to be the non performing loans bought by the government funded Asset Management corporation of Nigeria. Today it is a history matter, as we know that the greed, corruption and reckless investment decisions of Nigerian banks managers were responsible for the crisis and its aftermath that is still with us today as i finish writing this article.
Abdullahi, S. I. (2011). "Risk Management and Corporate Governance in Islamic Finance: A
Comparative Analysis". Available at SSRN: http://ssrn.com/abstract=2804312
- Hasan, M. and Dridi, J. (2010), "The Effects of the Global Crisis on Islamic and Conventional
- Banks: A Comparative Study", IMF Working paper, WP/10/201
- Wasiuzzaman, S., Gunasegavan, U. N. (2013) "Comparative study of the performance of Islamic and conventional banks: The case of Malaysia", Humanomics, Vol. 29 Iss: 1, pp.43 - 60
- Shafique, A, Faheem, M. A. and Abdullah, I. (2012), " Impact of global financial crisis on the Islamic banking system", Arabian Journal of Business and Management Review (OMAN Chapter) Vol. 1, No.9; April 2012