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Islamic Finance as a Solution for Global Financial Crisis April 15, 2009

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by: Rhesa Yogaswara (rhesayogaswara@yahoo.com)

1. BACKGROUND

Nowadays, global financial crisis was caused by the implementation of capitalism system which there are some assumption in economic aspects should happened but it never happened. First, there was assumption that there would limit wants, but fact as long we have money, we tend to satisfy our desires. Second, capitalism claims that wealth distribution would be distribute fairly, but it never happened without government intervention.[1] Third, assumption that the market is always in perfect conditions, but in the fact, elite have a big influence that makes most bank like to finance a few big businesses than many small businesses. If we compare with socialism, it has been failed several years ago which socialism has failed to realize the efficiency and fairness.

In financial system, the fail of capitalism has been cause by several factors, such as the absence of Profit and Loss Sharing (PLS), the mind-boggling expansion in the size of derivatives, particularly Credit Default Swaps (CDS), “too big to fail” concept which tend to give an assurance to big banks, and bank has not undertaken the evaluation of loan applications. Which has led to unhealthy expansion in the overall volume of credit, to excessive leverage, and to an unsustainable rise in asset prices, and speculative investment.[2]

It is different with Islam which Islam has a balance system between materiel and spiritual needs in the way of life.[3] Islam use resources efficiently and fairness that should be implemented in every aspects, include in economic, financial system, corporation, and the detail in structure of financial system with realize the objective and moral dimension. In financial sector, Islam gives us the guidance for prohibited and suggested transaction and how Islamic financial system can be a solution for the stability of economic system nowadays.

 

2. SOURCES OF LAW

2.1. AL-QURAN

To find a solution for any problems, Islam has guided us the prohibition and suggestion in Al-Quran. In Muamalah, Islamic Law allows us for doing anything until there is a prohibition in Al-Quran. Several verses of the Quran mention and prohibit Riba (interest). In one of the earliest verses (30:39), earning through Riba is compared to the blessings and pleasure of Allah SWT through lending as an act of charity. This verse was followed by another verse (4:161), which severly condemned dealing in riba with a reminder that it was prohibited by earlier scriptures of the Jews and Chirstians as well. In the next set of verses (3:130-132), Muslim were told that avoiding riba was for their own welfare. Finally, the last revelation about riba came through verses (2:275-281) giving severe warning about riba and recommending to forgive riba due on loans but providing protection to the principal amounts.

 

2.2. AS-SUNNAH

Muslim scholar has agree that Sunnah (hadits shahih) is one of major source for syara’ law after Al-Quran. Its position is for ta’kid (lasing) Al-Quran, and the second is as explainer Al-Quran, and the third as Musyar (Syari’at creator). Including economic and finance, therefore ummat should pay attention in As-Sunnah for more detail in every single problem. Then we should refer to another source, such as Ijma, Qiyas, Ijtihad, Istishan, Maslahah, and other Ushl Fiqh methodologies.

 

3. PROHIBITED TRANSACTION IN ISLAM

Islam give solution in Finance and economic from global crisis. In each single transaction, there are four factors that made transaction prohibited. The first is a prohibition in the substance (zat), such as khamr, alcohol, pork, carcass, and blood. Second is prohibition of riba, which appear if uncertain contracts converted to be certain contracts. Third is avoidance of gharar, which appear if certain contracts converted to be uncertain contracts. Usually it happens in exchange transaction.   And the last is prohibition of gambling (maisir), usually it happens in zero sum game.[4]

 

4. AQAD FOR ISLAMIC TRANSACTION

In fiqih muamalah, aqad consist of tabarru’ dan tijarah. Aqad tabarru’ is for non-profit transaction for helping each other in goodness. And aqad tijarah is for commercial purposes which consist of natural uncertainty contracts (musyarakah, mudharabah, muwafadhah) and natural certainty contracts (murabahah, salam, istishna, ijarah).

 

5. FINANCIAL INSTRUMENT

The Islamic economic system has a set of core contracts, which serve as building blocks for designing more sophisticated and complex financial instrument. There is no established classification of contracts in the Islamic legal system as such, but from business and commercial point of view, one can group certain contracts according to their function and purpose in the economic and financial system. Contracts dealing with commercial and business transactions that can be classified into four categories.[5]

The first is transactional contracts, which deal with the real sector economic transactions that facilitate the exchange, sale, and trade of goods and services. Then, financial contracts which offer ways to create and extend credit, facilitate financing of transactional contracts, and provide channel for capital formation and resource mobilization between investors and entrepreneurs.

The third is intermediation contracts which facilitate an efficient and transparent execution of transactional and financial contracts. And the last is social welfare contracts which are between individual and the society to promote the well-being and welfare of the less privileged.

globalcrisis1

Figure 1. Financial Instrument in Islamic Financial System[1]

 

 

6. FINANCIAL INTERMEDIATION

Financial intermediaries not only channel resources from the capital-surplus agents (generally, households) to capital deficit ones (corporate sector); they also allow inter-temporal smoothing of households ’consumption and business” expenditure and thus allow both firms and households to share risk.[2]

The primary functions of a financial intermediary are asset transformation, conducting of orderly payment, brokerage and risk transformation. The others are the administrative function of accounting and payment system. In Islam, it has established historical record and has made significant contributions to economic development.[3]

There are several Islamic intermediation contracts, which consist of Mudharabah, Wikala, Amanah, Ariya, Wadia, Rahn, Kifala, Hawala, and Jo’ala. All of them have features that could be a solution in global financial crisis. First, profit and loss sharing that implies a direct concern for the profitability of the physical investment on the part of Islamic Bank. Islamic financial contracting encourages banks to focus on the long term in their relationships with their client. One of the most critical and distinguishing features of financial intermediation by Islamic banks as compared to  that by conventional banks is the inherent design by which the assets and liabilities side of the Islamic banks’s balance sheets are matched. And one of the distinct features of Islamic banking is the existence of a Shariah Board that comprises religious scholars and the influence this board exerts on the operations of an Islamic bank.

There is no standard way of grouping Islamic Financial Institutions, but in terms of the services rendered, today’s Islamic Financial Institutions can be divided into the following forms of intermediation; Islamic windows, Islamic Investment Banks and Funds, Islamic Mortgage Companies, Takaful Companies, Mudharabah Companies, and Islamic Banking. The following figure is the Islamic Financial Intermediation in Islamic Banking.

globalcrisis2

Figure 2. Islamic Financial Intermediation[1]

 

7. ISLAMIC FINANCIAL SYSTEM

An Islamic Financial System have several components, such as banking system, financial markets, capital markets, and legal system. Further, in the Islamic banking system, there will be greater inter-dependence and closer relationship between investment and deposit yields, since Islamic banks can primarily accept investment deposits based on profit-sharing and can provide funds to enterprises on the same basis. Thus, productivity in the real sector determines the rate of return to the financial sector.[2]

Islamic scholar have pointed out the necessity of the existence of a stock market in the financial system of Islam in which transaction in primary capital instruments such as corporate stocks can take place. Market operations with Sharia rules must prevail for goods and services. Sharia has provided a network of ethical and moral rules of behavior for all participants in the market and requires that these norms and rules be internalized and adhered to by all.

For Islamic secondary markets to be able to transform an asset into a reliable source of cash for an economic unit whenever the latter needs it, they must be dealer markets, there is a set of position users who trade significant amounts of assets. Since debt is not permit, source of funds must be provided by central bank. Hence, given that debt instruments cannot exist, money market activities will have different characteristics from their counterparts in the conventional system.[3]

The challenge for Islamic money market and secondary market is the development of instruments that satisfy the liquidity, security and profitability needs of the markets while, at the same time, ensuring compliance with the rules of Sharia, provision of uncertain and variable rates of return on instruments with corresponding real asset backing. Therefore, Islamic system requires the active support of the government and the central bank in development, promotion, supervision and control.[4]

In the Islamic framework, although speculation is unlawful, professional speculators cannot exist, because most speculation is made possible only with funds borrowed based on interest, which is prohibited in Islam.[5] Then, the practice of short selling a stock is not compatible with the principles of Islam. An exchange is void unless the intention of buyer is for buying and seller is for selling, no one sells what he does not have.[6]

However, in those processes, there are many factors to support Islamic financial system such as Islamic Benchmark, accounting standards, financial engineering, risk management, regulations, and corporate governance to increase public trusty.

 

8. CONCLUSION

There are many factors in capitalism and socialism, which implies to global financial crisis. In Islamic system, there must be a balancing between material and spiritual. Similar with it, in Islamic finance that part of macroeconomics, has guided us to avoid prohibit and do the suggestion transactions as written in Al-Quran and As-Sunnah. In order to make Islamic financial can be a solution for global financial crisis.

There are some economy-wide benefits from the operation of an Islamic financial system. First, government expenditures that are fully rationalized. Second, revenues from taxation, and those derived from property legitimately placed within the government domain by the Shariah, can be raised to meet the expenditure needs of the government. The third, financial sector can be liberalized to allow the returns in this sector to reflect returns in the real economy. Fourth, equity markets can be developed to allow the financing of investment projects outside banking institutions. And finally, the structure of banking system could be such as to allow strong banking supervision and prudential regulation commensurate with the risks involved in various transactions.[7]

 

 

 

 

9. REFERENCE

Chapra, M. Umer, The Need for a New Economic System, Journal of the Islamic Economic Association, 1991

Chapra, M. Umer. The Global Financial Crisis: Can Islamic finance help. New Horizon Islamic Banking.

Iqbal, Zamir dan Abbas Mirakhor. An Introduction to Islamic Finance. John Wiley dan Sons (Asia) Pte Ltd. Singpore. 2007

Karim, Adiwarman. Bank Islam Analisis dan Keuangan, RajaGrafindo Persada, Jakarta, 2004.

 


[1] Iqbal, Zamir. 2007. pg 109

[2] Iqbal, Zamir. 2007. pg 127

[3] Iqbal, Zamir. 2007. pg 131

[4] Iqbal, Zamir. 2007. pg 132

[5] Iqbal, Zamir. 2007. pg 175

[6] Iqbal, Zamir. 2007. pg 176

[7] Iqbal, Zamir. 2007. pg 147


 

[1] Iqbal, Zamir, 2007. pg 79

[2] Iqbal, Zamir. 2007. pg 99

[3] Iqbal, Zamir. 2007. pg 100
 



[1] Chapra, M. Umer, The Need for a New Economic System, Journal of the Islamic Economic Association, 1991,pp.9-47

[2] Chpra, M. Umer. The Global Financial Crisis: Can Islamic finance help. New Horizon Islamic Banking

[3] Schuon, Frithjof. Understanding Islam, tr.D.D.Matheson. Allen and Unwin. London. 1963.

[4] Karim, Adiwarman. Bank Islam Analisis dan Keuangan, RajaGrafindo Persada, Jakarta, 2004.

[5] Iqbal, Zamir, Mirakhor Abbas. An Introduction to Islamic Finance. John Wiley & Sons. Singapore. 2007

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