There are numerous lessons that can be learned from Islamic finance/economics that are relevant to the recent financial crisis. In this context, the recent global financial crisis fronted numerous challenges to various organizations and countries. Consequently, lessons emerged on how organizations react to the ever-changing economic environment. Most institutions react to financial issues instantaneously just as they surface. In the Islamic context, numerous organizations have long-term or visionary measures meant to curb emerging economic challenges (Merkel, 2008). This paper discusses the lessons that can be drawn from Islamic finance/economics that are relevant to the recent financial crisis as indicated before. It addresses the reasons why the crisis happened and discusses how the particularities of the Islamic Financial System might have helped to decrease the magnitude of the crisis. This considers whether their response to different situations is long-term or short-lived. Since there are macro-environmental forces that dictate the magnitude of the financial crisis globally, it is important to discuss this claim in consideration of such issues. Various factors namely political, social, legal, technological, and fiscal/economical factors contributed significantly to the global financial crisis.
Reasons why the Financial Crisis Happened
There are numerous factors believed to have contributed to the 2007-08 housing market and financial crisis. These ranged from domestic to international factors or an interaction between the two. Including the Islamic community, the prospected factors directly and indirectly affected numerous countries in the context of financial instability, inflation, depression, and minimized global trade (Merkel, 2008). According to economists, the 2007/08 financial crisis remains the worst ever since the Great Depression of the 1930s. In this context, the crisis culminated into an absolute plunge of large financial institutions and a recession in stock markets globally. In fact, most governments were forced to bail out the affected banks. In other areas, the housing market similarly endured evictions, foreclosures, as well as lofty unemployment rates. Arguably, the crisis started in the United States and then spread across to all the other nations around the world. The countries, which did not have strong economic positions were the ones most affected by the concerned financial crisis. A number of reasons for this financial crisis can be linked to the macroeconomic rules which have been used over the past years. In the United States, it was believed that the financial crisis might have been caused by the inadequacy of the financial system. For instance, most people believed that natural weakness in the economic system was the main reason why there was a malfunction of the financial system. Under macroeconomic causes, a reduced rate of inflation and the provision of low-interest rates were the main contributing factors. Over the past years, there has been an unfamiliar high level of macroeconomic stability. In a number of the high-level economies, an increase in growth was associated with stable inflation. In this situation, the then stabilized inflation was regarded as the Great Balance (Allison, 2012). Conversely, low inflation was caused by a number of factors. There was a high rate of labor supply in the market at a cheaper cost. This was contributed to the fact that the previous communist nations were permitted to be members of the world trade.
The other cause of the financial crisis was the growing economic imbalances. Over the past years, many nations have been operating huge current account debits. This particular condition was more intense in the year 2000. This simultaneously happened when those nations producing oil and other upcoming countries were operating with huge current account surplus. This happened because a huge amount of the current account surplus was capitalized in the already developed countries (Allison, 2012). The prevailed high demand led to the increase in prices. Additionally, the government was able to realize low income from the sale of the bonds and low profits from the sale of the financial assets in the more advanced economies. Various families in the developed countries were able to speedily gather their debts. Additionally, the financial system was faced with a lot of risks though those who participated were not informed about what was going on. The failure of the government, central banks, and other responsible bodies to skillfully and adequately address the issues involved in the financial cycle was also another cause of the financial crisis (Merkel, 2008).
How the particularities of the Islamic Financial System might have helped to decrease the magnitude of the crisis
Various Islamic Financial Systems have demonstrated extensive visionary thoughts on fiscal issues. These issues possess significant impacts on economic realms. Additionally, they influence the ever-changing business environment. This shows how the system might have helped to decrease the magnitude of the crisis. Muslims decide rationally on political issues. Their management must consider political factors existing in the locality, region, or nation of operation in order to run a relevant, legal, futuristic, and meaningful business. Islamic government policies, Shariah, and political forces tend to affect the nature and orientation of any business in the region (IIBI, 2012).
Islamic Financial Systems might have introduced strategic management methods required to manage Islamic banking in the world. The designs made ensure that banks perform presently and also in the future. This can happen in three stages. The first stage is the strategic analysis of the economic environment. This involves the studying of society and the institution. Based on the findings of the study, a bank can determine available opportunities, the influence on society, the risks involved and the strengths and weaknesses of the financial institution. Strategic planning is then done based on these four factors. The plans could enable the financial institutions to attain their goals since the policies formulated could have been Shariah-compliant. This indicates how the particularities of the Islamic Financial System might have helped to decrease the magnitude of the crisis.
The second stage is the execution of the plans stage and involves the implementation of policies and plans made in the first stage. It involves a thorough analysis of the global economic policies and plans and the effect they will have in operations and in the balance sheet. In addition, this stage determines standards and procedures used in operations. The third stage is the examination stage in which performance is evaluated (Allison, 2012). This stage examines whether the plans have been effectively implemented and correct procedures have been applied (Chapra, 2012). Mistakes are corrected at this stage, and adjustments are made to ensure goals are attained. Islamic Financial Systems is based on the beliefs and pillars of the Islamic community. The fact that Muslims too are business people and need financial services gives a reason for the existence of Islamic banking. During the period of the financial crisis, the Islamic Financial Systems could have found ways of adapting and ensuring that various financial institutions make profits. The methods used by banks can range from the manipulation of interest rates for both loans and deposits. However, Islamic banks and products designed to meet the financial needs of Muslims have to find other ways. The system could have posed strategic management methods for the financial institutions to decrease the magnitude of the crisis.
Concurrently, the development of Islamic banking in the last two decades is among the major changes in the world’s economy. The financial sector experienced many changes and developments including the development of automated teller machines, internet banking and more recently, mobile banking. Islamic banking developed and brought new ideas such as Islamic socioeconomic, removal of interest rates due to “protective” shariah laws, and introduction of ethics in financial institutions. Islamic Financial Systems could have introduced new techniques and ways of investing to enable economic development (IIBI, 2012). It has significantly changed the political, social and economic landscape, in the whole world. Islamic Financial Systems has a principle that concerns interest rates, an activity considered inappropriate in Islam. The system could have also prohibited banks from charging interest on loans, which is a major contributor to the financial crisis.
Islamic Financial Systems maximizes the wealth of shareholders and benefits the society while it uses Islamic principles known as Shariah. Islamic Financial Systems is an economic system based on Islamic laws and Islamic provisions that manage the economy. Islamic financial system has pillars that could have guided the banking sectors in the world. These pillars are based on the Islamic banking principle, which gives guidelines, laws and rules known as Shariah. Shariah guides the entire society and deals with issues such as culture and economy (Chapra, 2012). Shariah can be traced in Quran, which is a Muslim’s holy book. The correct interpretations of these rules from the Quran guide the principles used in Islamic banking. This indicates how the particularities of the Islamic Financial System might have helped to decrease the magnitude of the crisis.
Allison, J. (2012). The Real Causes of the financial crisis. Web.
Chapra, U. (2012).The Global Financial Crisis: Can Islamic Finance Help?. Web.
IIBI (Institute of Islamic Banking and Insurance). (2012). Islamic Financial System. Web.
Merkel, D. (2008). What Caused the Financial Crisis of 2008?. Web.