Islamic Banking - a way out of the crisis?

slamic Banking seemed to be significantly more resilient to the crisis then Western banks. Will this make it a good alternative to get out of the crisis?

The world-scale economic crisis of 2008-2009 had a widespread effect on both internal economics of separate countries and international economics at large. Most of the countries faced economic regression, financial breakdowns and bankruptcies. Yet, the Islamic banking system as used in some Muslim countries showed strengths that protected these systems, to some extent, from a similar breakdown as experienced in Western states.

The crisis occurred first in the US, basically due to an overproduction of housing goods. It appeared in Europe a year later, yet some would claim that reasons and signs of crisis appeared in Europe earlier than they did in the US.   This crisis did not only affect the developed countries though. As the US and Europe, the other regions of the world suffered economically in this period. However, one region in particular, that is, the Middle East, shows some curiosities about how its financial system – or at least part of it – reacted to the crisis.

Many Middle Eastern countries use the Islamic banking and financial system either in parallel with the conventional banking system (Bahrain, Malaysia, Pakistan, United Arab Emirates), or, in a few cases, uniquely that (Iran and Sudan). The Islamic banking system shows key differences from the conventional system in its principles. While the conventional system is based on debts, its Islamic counterpart, compliant with the Shari’a, is based on the moral principle of justice and risk sharing, and applies the prohibition of interest. This mode of banking seemed more resilient to crisis and less damaged than the classical Western-type banking, which raises the question whether or not the Islamic banking can be a way out of the crisis.

The fact that it uses interest-free and profit-and-loss-sharing financing formulas make it more accessible for people, especially for those of lower-income who would otherwise be unable to bear the burden of the interest on a loan in order to buy a home or start a new business. It is not only more accessible, but more secure also: for the clients it is due to the shared risk that might have the ability to encourage them to turn to banks, and for the banks because shared profit of a project can seem less risky than an unsecured interest on a loan, that a client would eventually prove to be unable to produce. The ban on interest can curb inflationary pressures in the economy. Moreover, the shift to profit-sharing could increase the volume of investments and helps job creation.

Yet, challenges are numerous: one concerns Islamic banking on the whole, and that is the absence of a uniform religious guidance and that of a clear regulatory system and standards, which is still to be developed. Moreover, there is a lack of general understanding of Islamic finance, which would certainly not contribute to its popularity on the overall level.

In addition, it is also important to question what attitude one should expect from the part of the banks: this may probably be negative, for banks in general might see a lower profit and a higher level of responsibilities if applying the Shari’a compliant system. Added to that is the possible negative political response to a system that declares itself overtly Islamic and has as its base the principles of the Shari’a. This may have negative effects on its public image due to the negatively altered vision of Islam, its association with terrorism and the growing xenophobia.

To address these challenges, several steps ought to be taken. In order to raise public support, banks could eventually distribute information in booklets to their customers to inform them about the new possibilities. Yet, this depends on the willingness of banks to include Islamic services in their ranks, and it might also be hindered by the lack of trust from the part of the customers.

To address possible political problems, it might be a solution to use different terminology, that is, instead of using the notion of Islamic banking and the terms related to it. One would also consider not implementing the grassroots principles of Shari’a on which the economic system itself is actually based, but to only use the ones concerning economics, so as to adapt the system to the needs and to the existing culture.