This document discusses how Islamic finance principles could help address global financial crises and lead to better outcomes. It summarizes that: 1) Islamic finance escaped the worst of the 2008 crisis due to prohibitions on interest, uncertainty, and risk-free returns. However, some Islamic banks failed by adopting conventional derivative products. 2) For Islamic finance to effectively contribute, it must strictly observe principles like prohibiting interest and risky transactions, ensuring risk and reward are linked to asset ownership, and using economic benchmarks not linked to interest rates. 3) The biggest challenges are avoiding imitation of conventional practices, developing its own benchmarks tied to real economic growth, and standardizing operations according to Islamic law. If done properly,

1. 11
GLOBAL CRISIS:GLOBAL CRISIS:
ISLAMIC FINANCE CANISLAMIC FINANCE CAN
LEAD TO BETTERMENTLEAD TO BETTERMENT
ByBy
Muhammad AyubMuhammad Ayub
Director Research and Training,Director Research and Training,
Riphah center of Islamic BusinessRiphah center of Islamic Business
Riphah University, IslamabadRiphah University, Islamabad

2. 22
In the Grip of Crises-In the Grip of Crises-
2008 onward2008 onward
 The most severe since 1930s’ great
depression;
 Alan Greenspan: ‘great tsunami’
 Started from the US - other parts of the
world - US Dollar and the huge size of
the American economy - also owing to
the ‘mighty’ US Dollar.
 Over $3 trillion of bailouts and liquidity
injections to abate the intensity

3. 33
More Advanced: More inMore Advanced: More in
gripgrip
 100s of institutions in USA, UK and100s of institutions in USA, UK and
Other developed world closed – notOther developed world closed – not
even single in countries like Pakistan –even single in countries like Pakistan –
had crossed all ethical and shariahhad crossed all ethical and shariah
based limits.based limits.
 Sovereign Debt problem – Europe, poorSovereign Debt problem – Europe, poor
indebted countriesindebted countries

4. CAUSES OF THE CRISIS
 Excessive ability to create money and credit
 ..carrying fixed charge; creating billions of
dollars by simply shuffling the papers and
transferring risk;
 Adding to wealth of already rich without creating
anything of value for use by the mankind.
 A large number of investment products, without
any underlying real assets by way of selling of
accounts receivable and derivatives.
 CDOs, interest rate swaps, interest rate futures,
forward rates agreement, Forex trade options,
warrants and options on futures contracts.
44

5. 55
ImplicationsImplications
 Increasing poverty and hunger forIncreasing poverty and hunger for
billions of human beingsbillions of human beings
 World Bank report, January 2010: 64World Bank report, January 2010: 64
million more people living in extrememillion more people living in extreme
poverty by the end of 2010 than wouldpoverty by the end of 2010 than would
have been the case without the crisis.have been the case without the crisis.
 Risk of “currency war” – collapse ofRisk of “currency war” – collapse of
the global payments system.the global payments system.

6. NEED FOR NEW F.
ARCHITECTURE
An ethical requirement– notAn ethical requirement– not
only Shariah injunction;only Shariah injunction;
comprehensive reforms to helpcomprehensive reforms to help
prevent chaos and spread ofprevent chaos and spread of
financial crisesfinancial crises
66

7. 77
I. F. Principles can helpI. F. Principles can help
 Strict moral guidelines for dealing with
money, prohibition of debt trading and
speculation;
 To provide checks for the factors that
distorted the system
 So, better ability to sustain in the hard
times.

8. 88
ISLAMIC BANKING
GROWING
 Even during the crisis; double digit growthEven during the crisis; double digit growth
last 20 years in terms of:last 20 years in terms of:
 Volume
 Scope and Assets
 Spreading worldwide
 Assets held by IFIs worldwide are estimated to
be over $1000 billion - figure may vary due to the
coverage of institutions;
 While the prospective market according to
Standard & Poor's is that of $4 trillion, the global
assets are expected to hit $1033 billion by the
end of 2010.

9. In PakistanIn Pakistan
 Covering 6 % of the banks’ market;Covering 6 % of the banks’ market;
expected to rise to 12 % by 2012;expected to rise to 12 % by 2012;
 Islamic banksIslamic banks
 IBBsIBBs
 About 600 branches in all major towns of
the country
 MFIsMFIs
 Islamic FundsIslamic Funds 99

10. 1010
Crisis Impact on IFIsCrisis Impact on IFIs
 IFIs escaped due to general prohibition ofIFIs escaped due to general prohibition of
Gharar, Riba and risk-free return onGharar, Riba and risk-free return on
investments.investments.
 Dubai debt crisis of 2009 exposed the
weaknesses of ‘Islamic banking’ due to a
number of objectionable products adopted
by the IFIs.
 Derivatives – “Islamic” options and
swaps.

11. 1111
PRINCIPLES TO BE
FOLLOWED
 Avoiding:
 Riba: earning any return from loan and
debt contracts or selling debt contracts at
discount;
 Gharar – absolute risk / uncertainty about
the subject matter or the price in sales and
financial transactions;
 Gambling and chance-based games);
 Observing: General Prohibitions /unethical
practices

12. 1212
PRINCIPLES
 Risk & Reward - Owner of an asset has
both risk and reward;
 Forward trading with strict conditions of
delivery and settlement
 Possession / delivery - ensuring that
risks and liabilities pertaining to an asset
are properly taken by the owner;
 Public financing: disciplining the fiscal
behavior of the governments

13. Possibility of getting real
benchmarks for pricing of
goods, their usufruct and
the services, both in cash
/credit markets, - reflecting
real demand/supply scenario
and the strength of the
economy
1313

14. IFIs not allowed exposure to
CDOs, derivative products
and intra-financial
counterparty risk that
crippled the conventional
system;
1414

15. 1515
WHY IFIS FAILED TO AVAIL
OF THE OPPORTUNITY
Financial engineering to mimic the
conventional product – derivatives
and swaps that crippled the
conventional system – beneficial for
IFIs?
Permitting the haram contracts by use
of Wa’d
Separating risk from real economic
activities and making it traded
separately;

16. 1616
General Concerns aboutGeneral Concerns about
I. B.I. B.
 Does not reflect the ethos of Islamic
teachings - ; ‘Structured products’
 Strayed from the theoretical
foundation;
 Tawarruq - the predominant
instrument;
 LIBOR - benchmarks used as a
determinant of interest on non-
Shariah compliant assets, not only as
a pricing tool.

17. Can Islamic banking inCan Islamic banking in
present structure lead topresent structure lead to
betterment?betterment?
Not capable to play a
significant role in ensuring
health and stability of the
national and global financial
systems
PROBLEM OF OPERATION – NOT
OF THE SYSTEM
1717

18. Solution lies in:Solution lies in:
 Observing Shariah and Ethics:Observing Shariah and Ethics:
 Disciplining the creation of money;
 Limiting the self-interest with social
interest and the business ethics, and
 Transforming the corrupt financial system
to make it free of exploitation and games
of chance
 Thus enabling the mankind to optimally
use the resources for benefits at the
larger scale.
1818

19. To Avoid ConvergenceTo Avoid Convergence
with Conventionalwith Conventional
System:System:
 Islamic finance must avoid imitating
the practices of conventional
banking
To avoid
 The same fate as faced by the
capitalistic system.
1919

20. CHALLENGES
 Ensuring the real difference between the
two systems - the main key to the stable
and long-term growth;
 Changing approach of the practitioners
that all conventional products should
have alternatives;
 Developing benchmark based on real
performance of the economy- by linking
the money and credit expansion to the
growth of the real economy 2020

21. CHALLENGES
 Supply of trained human resources having
Shariah inspiration and confidence to operate
the system ;
 Standardization:Standardization: risk management, regulatory,
accounting and market standards - based on
AAOIFI Shariah Standards;
 Many practitioners -using the dubious
structures like that of Ba‘i al Inah and Tawarruq
- operating ‘Islamic’ hedge funds based on
options and derivatives do not really feel any
need for standardization 2121

22. To ConcludeTo Conclude
 Islamic bankingIslamic banking is in position to play crucial
role interrelating finance, economy,
community and society enabling the world
to avoid crises in future;
 To carry out operations according to the
fundamental principles of Islamic
economics and finance;
 To expand their role in the real sector;
 AAOIFI’s Standards must be applied for all
banks and areas. 2222

23. 2323
ThanksThanks