Islamic Finance and its Contribution to Solving the Current Financial Crisis

Abstract

As a result of the global financial crisis and its effects on the world economy, there is an increasing awareness and exploration of more vigorous frameworks and types of financial tools and intermediations. With its emphasis on asset-backed transactions, Islamic finance can contribute to overcoming the challenges and difficulties created by the current credit crisis. At its core, Islamic finance is concerned with the deployment of capital in genuine commercial activities that will benefit the whole world. So far, the techniques used in Islamic finance, if applied and executed properly, have created a much closer relationship among the customer, the financier, and the asset. In both principle and practice, Islamic finance prohibits the creation of debt through direct lending and borrowing, thus prohibiting excessive leverage, which is a root cause of the financial crisis. This paper highlights the strengths of Islamic finance in the context of the current financial and economic crisis. This paper examines whether Islamic finance could help to provide an alternative approach to the problems that led to the crisis that would prevent the repetition of a similar crisis in the future. Keywords: Islamic finance; Islamic financial system; financial crisis; profit-loss sharing; risk management. JEL Classification Code: G01; G21; G32, Z12.