Causs of global financial crisis and how Islam provides guidelines to prevent such a crisis

1. GOLOBAL FINANCIAL CRISIS REASONS AND ISLAMIC SOLUTIONS

2. WHEN DID IT BEGIN? Early signs appeared in 2007 Very reason was funding of external wars Bush administration spent >$ 5 trillion in 7 years of military expeditions It lead to increase in public debt of > $4.5 trillion between FY 2002-2008 This is a crisis of accumulated debts beyond the capacity of US financial system

4. Securitization

5. Debt securities trading

6. Credit derivatives

8. Crisis in services and production sectors Down sizing and closure of businesses Reducing employment and laying off workers Decline in demand for consumer goods More decrease in employment

9. Structural causes that aggravated the crisis 1-Large expansion in speculation transactions in financial markets Including conducted through internet They overshadowed the real transactions Real transactions affect the fluidity of capital and moving investments Speculation transactions are unproductive since they merely move capital from the losers to the winners.

10. 2-Emergence of many transactions merely for speculations on prices These transactions do not produce any added value to the market Huge amount of money and great human capacities are invested in them

11. 3- Culture of quick profits Without consideration to the long term results of the transactions Deficiency of laws, regulations and administrative oversight on the methods of creating new forms of transactions When there are no laws or regulations to control people’s behavior then why would they not extract maximum profits

12. 4-Shift of capital from service and production to financial institutions There was inflation of financial sector profits It led investors to believe that this is the way to make quick gain of wealth Layers of mere financial transactions accumulated and ballooned moving capital away from production sector This brought the theory of upside down pyramid- which is very unstable

13. Upside down pyramid

14. 5-Dependence on interest based loans This has been the foundation of funding in capitalist system It does not produce any added value by itself

15. 6-Securitization There was prevalence of securitization It led to culture of “strike and place the burden upon others” It created interconnection among the financial institutions. So all the institutions fell with the fall of first piece of domino

16. 7- Exchange and trade of debts Enormous investments were attracted to such transactions It does not result in any real increase in productions These are often quickly influenced by the media and political events These would not happen if interest was not adopted as the part of finance and re finance

17. 8-Investors trend towards being more cautious This led to increase in the processes of derivatives It inflated the size of mere financial swaps There was more interconnection among institutions Hence the retrogressive impact spread from one institution to the other

18. 9-Dependence upon public debt rather than taxes This led to inflation in the process of financial exchange at both levels: 1- Local 2- International

19. 10- Exorbitant rise in US military spending No doubt it increases labor and employment in defense sector However, it does not tend to improve the productive capacity of the economy Competitive capacity of US products in foreign markets diminished Deficit in the balance of trade accumulated This undermined the confidence in US economy

22. Ease the problem of diminishing demand for consumer goods

23. This will send signal to the factories not to cut productivity or to lay off workers

25. 4-Decrease the public debt Avoid increase in public debt Measures be taken to decrease public debt Taxes be imposed upon wealthy

26. 5- Dealing in derivatives Dealing in derivatives be immediately stopped Their remnants must be gradually dissolved, specially the credit derivatives

27. Long term solutions1- New legislations and oversight 1-New legislation to curb expansion of financing beyond the capacity of the debtor 2- This is specially needed in real estate and credit card market 3- Retail banks and finance companies must be forced to abide by strict standards 4- These institutions should be under strict Government oversight and be held accountable for any attempt to lure customers into contracts beyond their capacity

28. 2-Turning the financial markets to support goods production and services Ban or minimize the deals based on mere speculations: . Index related deals Contracts on differences Credit derivatives Short term deals Future deals Restricting choices as means of caution, in a way that is based or linked to an existing situation in assets or liabilities

29. Turning the financial markets Limiting or banning the currency trade on the internet and cancelling licenses for platform of currency speculations on the internet Platforms of goods and stock speculations on the internet should also be banned Generally, the financial markets be turned back to support services and goods production and not at investments and profits involving speculations

30. 3- Limiting Securitization Securitization of debts be banned Only taskik ( financial documentation) be used. In taskik, the financial documents represent real assets excepting debts and money.

31. 4- Legislation to ban circulation and trade in debts These processes do not create any added value. Strict restrictions be placed for discounting and rediscounting of debts

32. 5-Developing institutional funding from banks and non institutional funding from the markets This is to be bound by 2 main constraints: Establishing a direct connection with the real market of services and goods. This way the funding in the society does not go down the drain or transform into financial accumulations that turns away from the real market Giving preference to moral criteria in funding over the criteria for mere profit gains. It means funding be withheld from goods and services which are harmful to the society and environment.

33. 6-Individual’s right of ownership is a fundamental right It is improper for an individual to cede this right or right to freely benefit from it. Only exception to this rule is if individual wants to give it up voluntarily Contractual increase in debts and loans for deferred payment is unjust. It is not compatible with the requirement of rights to property and entitlement. Debts should not be susceptible to increase. No added value is generated from them.

34. Islamic Banks and current crisis of debts Islamic banks were less affected because: They do not buy financial papers based on debts They do not deal with usurious debts

35. Setbacks for Islamic Banks in this crisis Islamic banks which dealt with traditional banks through goods Murabihah have billions of dollars to be paid by the latter Banks that dealt in Tawarruq (securitization) with their clients and holders of credit cards also have lot of inflated debts to be paid by ailing clients Banks that invested in global stock markets are also affected Islamic banks are affected by the financial difficulties of their clients (falling income etc)

37. Avoidance of usurious loans

38. Avoidance of loans that takes away finance from real market of production and exchange

40. 3-Re evaluate certain financial dealings adopted by some Islamic banks Dealings which separate finance from real market and avoid relying on the production of an added value Avoid dealings which rely on accumulation of debts not accompanied by movement in services or goods These dealings widen the gap between the real market and the financial market. This leads to financial instability.

41. 4-Transactions of Tawarruq and Murabaha for local and international commodities These represent debts not based on real exchange of goods but on overlapping contracts They result in illusory financial accumulations They do not reflect the true identity and goal of Islamic finance Islamic finance, hence, would fail to maintain its moral purity and fail to apply its moral standards to the measures it follows

42. 5-Financial markets in Muslim countries must be reviewed Financial speculations should be limited and restrictions should be laid down on their different types Transactions that do not involve real investment should be banned Systems in some Muslim markets do not allow many derivatives which is one of the most important causes of the crisis

43. 6-Views,opinions and some practices be revised Short term sale Derivatives and dealings on the same day Markets of caution Mudawalat (speculations) via the internet using currency These practices create mentality of quick profits with spirit of selfishness and speculations

44. 7-Principles of Islamic finance should be presented to the world This is part and parcel of true image of Islam This message is directed to all mankind This is a message of mercy to the world Implementation of these principles guarantee elimination of oppression They guarantee justice and human rights. These rights include reaping the fruits of one’s property, protection against encroachment upon personal property.

45. 8-Re evaluation of financial documents from Sharia perspective is needed Attempts are to be made to perfect their (documents) rules We need to lay down the organizational and jurisprudential regulations These regulations should ensure that they will not slip into forms of securitization that dominated the Western financial markets

46. 9-Firm stance against selling debts There must not be any selling of debts There should be no discounting and rescheduling the debts even under false names

47. Islam’s Guidance There hath come to you from Allah a (new) Light and a perspicuous Book. Wherewith Allah guides all who seek His good pleasure to ways of peace and safety and leads them out of darkness by His Will unto the light guides them to a Path that is Straight. Surah Al Maidah 5:15,16

48. Contrast of financial systems Conventional Finance Islamic Finance Interest and interests based transactions Deposits and loans Banks create and destroy money Interest is forbidden and so no interest based transactions Equity shares and ownership of real assets in investment projects Banks do not create or destroy money

49. Contrast of financial systems Conventional Finance Islamic Finance Asset-liability mismatch, illiquid Money multiplier depends on reserve ratio, very high; infinite with securitization Speculation, a casino, debt trading No asset-liability mismatch, liquid Money multiplier depends on the savings ratio, very low No speculation, no debt trading

50. Contrast of financial systems Conventional Finance Islamic Finance Interest rate not related to real economy, high price distortion Social inequality: inflation tax, redistributive issues, food riots Highly cyclical: booms and busts, uncertainties, unpredictable growth Profit rate determined by real economy, no price distortion Social equality: no inflation tax, no redistribution Stable economic growth, predictable

51. Contrast of Financial Systems Conventional Finance Islamic Finance Massie bankruptcies, contagions, bailouts Interest rate policy, highly destabilizing No systemic bankruptcies, no bailouts No interest policy, money aggregates are used, highly stable