g lobal f inancial c rises & muslim world
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Making of the Crisis
1
GLOBAL FINANCIAL CRISES &
MUSLIM WORLD
A CRITICAL ANALYSIS
Making of the Crisis
2
Banks/financial institutions engaged in sub-prime lending (with adjustable interest rates)
Loans packaged as Mortgage Backed Securities (MBS) / Collateralized Debt Obligations (CDO)
Investors (investment banks, hedge and pension funds, municipalities, schools, etc.) bought these securities
Investors bought Credit Default Swaps (CDS) to hedge credit risks
Issuers of CDS (Investment banks & Insurance companies) took on the risk of default
From the Mortgage Crisis to the Global Economic & Financial Crisis
3
Banks adopted an easy approach to lending in order to have a bigger slice of the pie
Loan volume gained greater priority over loan quality
Several factors that have contributed directly or indirectly to the occurrence and the spread of the
current credit crisis:Derivatives and excessive leveraging of US
financial institutions
Complexity of credit derivative products
Poor enforcement of inadequate regulatory systems and lax on lending standards
The model worked while borrowers were making payments.
When they stopped, the system, literally, caved in.
The Current Global Financial Crisis:The Deepest since World War II
4
Current disruptions in financial markets causing constraint to the flow of credit to families and
businesses
Adverse effect on the real economy in terms of recession and high unemployment rates
Investors unexpectedly lose substantial amount of their investments
Financial institutions suddenly lose significant proportion of their value
5
Global Financial Crisis:Impacts on OIC Countries
Major Impacts
6
Major Impacts of the Current Global Economic & Financial Crisis
Slowdown in economic growth
Fall in export demand and commodity prices
Sharp drops in private capital inflows
Interruption in flows of ODA and remittances
Deterioration in current account balances
Increase in unemployment and poverty
Slowdown in Economic Growth
7
From October 2008 to July 2009, IMF revised down its projections for economic growth of 2009 many times.
World: From 3.0% to -1.4%Advanced Economies: From 0.5% to -3.8%Developing Countries: From 6.1% to 1.5%
October 2008November 2008
January 2009April 2009
July 2009
Slowdown in Economic Growth
8
Average growth for OIC countries is expected to decelerate to 1.5% in 2009, compared to 5.1% in 2008.
Members in Europe & Central Asia are expected to suffer deep contraction by 3%.
Growth in East Asian members is projected to decelerate significantly, from 5.5% in 2008 to 0.8% in
2009.The other regions are expected to record growth rates
around 3%.
Fall in Export Demand and Commodity Prices
9
Decline in the volume of global exports in 2009
WTO: -9%IMF: -11%
“The largest contraction since World War II”
Exports of developing countries to decline by 6.4%
The most affected
Open Economies
Exporters of a small range of products
Dependants on markets of major economies, mainly the US and EU
Sharp decline in commodity prices
Manufactures and food prices to fall back to 2007 levelsPrices of oil and non-oil primary commodities to roll back to
2005 levels
Exporters are to suffer while importers, especially the LIFDCs, are to benefit
Sharp Drops in Private Capital Inflows
10
Private capital flows to developing countries declined by about $500 billion in 2008.
A further $630 billion is expected for 2009.
Global FDI flows reached a record high level of $1.9 trillion in 2007.
Estimated to have fallen by 15% in 2008 due to tighter credit conditions and falling corporate profits.
Decline in developed countries by 25%
Increase in developing countries by 7% (20% in 2007)
Projections signal for a more remarkable decline in 2009.
Interruption in Flows of Official Development Assistance (ODA)
11
Global Financial & Economic Crisis
Negative impacts on flows of ODA to low-income countries, particularly the LDCs.
Threat for achievements in MDGs
European aid, providing over half of global aid flows, accounted for 0.40% of GNI in 2008 (+ €4 billion over 2007)
+ €20 billion needed over the next 2 years to meet the target
Since December 2008, many European countries have announced cuts to their 2009 aid budgets.
Interruption in Flows of Remittances
12
In 2008, developing countries received $305 billion of remittances.
South Asia and Europe & Central Asia are expected to witness sharper decline compared to other regions.
2007 2008Billion $ 73 80
Growth % 24.7 10.3
Remittances in OIC countries
2007 2008 200922 8 -(5 to 8)
Growth of Remittances (%)
OIC member countries like Tajikistan, Lebanon, Jordan, and Guyana, where remittances account for 20 to 40 percent of their GDPs, will be more affected than the
others.
Deterioration in Current Account Balances
13
Decline in global demand
Fall in oil & commodity prices
Credit crunch in export markets
Decline in Remittances
Slowdown in economic activity/growth
Decrease in imports(volume and import bill)
Current AccountBalance
Decrease in exports (volume and revenues) ( - )
( + )
In 2008, the combined current account balance of OIC countries was over +$400 billion.
In 2009, estimations indicate a deficit of around $35 billion; due mainly to declining oil revenues and growing deficits of Sub-
Saharan African members.
The number of OIC member countries with deficit was 30 in the last three years, but expected to grow to 43 in 2009, mainly from the
MENA region.
Increase in Unemployment and Poverty
14
ILO: Global unemployment could reach to 210-239
million in 2009 (2007=180 million)
Unemployment rate to 6.5% - 7.4% (2007=5.7%)
The increase originates mainly in;
• Developed Economies & the EU
• East Asia • Latin America & Caribbean • Central and South Eastern
Europe (non-EU) & CIS
Ratio of workers living on less than $2 a day:
• 2007 40.9% (1.2 billion)• 2009 46.8% (1.4 billion)
15
Islamic Financeas a Solution
The Global Economic & Financial Crisis:The Real Causes
16
The main, but not the only cause of the financial crisis, is attributed to a laxity of lending standards.
Absence of adequate and appropriate government regulatory control due to:
Inadequate market discipline in the financial system resulting from the absence of profit-and-
loss sharing (PLS)
The mind-boggling expansion in the size of derivatives, particularly credit default swaps
(CDSs)
The ‘too big to fail’ concept, which tends to give an assurance to big banks that central bank will
definitely come to their rescue and not allow them to fail.
Common Views on the Causes
17
Global financial crisis in reality is a crisis of failed morality
Cause of greed, exploitation and corruption
Failure in the relationship between investment originators and investors
Failure to communicate potential risks involved in these transactions with the investors (borrowers)
Implications for Islamic Banking
18
There is a potential role that Islamic banking is suited to assume in order to deliver noteworthy contributions
to the international financial system
Direct impact of the crisis on the Islamic banking sector was minimal due in part to the intrinsic principles
Islamic banks were not caught by toxic assets as interest is banned.
Lack of structured products and the reluctance of Islamic banks to exploit sophisticated
financial instruments
Lending under Islamic law is based on the concept of asset backing, where real estate is being the
preferred instrument to protect these investments.
Islamic Finance as a Solution
19
Advocates and the opponents of both schools of thought (government intervention and free market
economies) thus far have failed to deliver a viable long-term solution to the crisis.
Nobel Prize Winner, French economist Maurice Allais believes that the way out of such crises is best
achieved through structural reforms.
Given that the current crisis has clearly shown up the weaknesses of the conventional banking and finance
system,the resilience of the Islamic institutions to the current financial turmoil has led many analysts to come to a
conclusion that Islamic finance and banking system could provide the
solution to the weaknesses of the conventional financial system and could be a feasible alternative.
Islamic Theory of Finance and the Global Financial Crisis
20
Based on themes of Community Banking
Ethical and Socially Responsible Investments
Socio-economic justice
Wealth accumulation and wealth distribution that is fair
Supply of money therefore must be proportionate with the prospects of real growth
Islamic Theory of Finance and the Global Financial Crisis
21
Islam establishes a unique system that protects individual investors and financial institutions from
potential risks
Islamic finance is governed by Islamic principles
usury (riba)
gambling (maisir)
ambiguity (gharar)
income must be an outcome of productive economic activities based on the principles of
profit-and-loss-sharing contracts
Islamic Theory of Finance and the Global Financial Crisis
22
Financial approach of Muslims should be governed by major sets of rules:
Mu
slim
s a
re s
tric
tly
pro
hib
ited
fro
m
investi
ng
in
or
dealin
g
wit
h e
con
om
ic a
cti
vit
ies
that
involv
e in
tere
st,
u
ncert
ain
ty,
an
d
sp
ecu
lati
on Muslims are, not only
discouraged but also, forbidden from
investing in businesses that are engaged in
illicit (haram) activities
Islam prohibits paying or receiving any
predetermined fixed rate of return on borrowed/lent
money; Charging interest (riba) tends to drive the
poor into more poverty and create more wealth for the
wealthy
Trad
e, n
ot b
an
kin
g is
th
e p
rimary
fun
ctio
n o
f m
ark
ets
IslamicEconomics
Islamic Theory of Finance and the Global Financial Crisis
23
Absence of interest-based financial transactions under Islamic finance, financial relationships between
financiers and borrowers are best understood within the framework of profit-and-loss sharing (PLS)
contracts, where both parties share the risk (and returns)
Islamic finance advocate fairness in payoffs and reward structures and embrace socio-economic justice amongst
all
Principle of ‘no pain no gain’ embedded in the Islamic financial structure entails that no one has the right to rewards (profit) if they do not equally share the risk of
incurring loss
Islamic Theory of Finance and the Global Financial Crisis
24
“If global banking practices adhere to the principles of Islamic finance, which are based on
noble ideas of entrepreneurship and transparency, the current global crisis would
have been prevented.”
Islamic Theory of Finance and the Global Financial Crisis
25
Not to sell a debt against a debt: one can’t sell or lease unless he/she posses real assets
Islamic finance is based on equity rather than debt, and lending transactions are founded-on the concept of assets backing: mortgage loans under such system would have been backed by solid asset structure
Islam takes particular interest in fostering close relationship and trust between originators (financial
institutions) of Islamic financial products and investors
Potential investors are well versed about the prospects (opportunities and risks) that their investments are subject to when entering into new contracts - Risk
must be explicitly communicated !
Islamic Theory of Finance and the Global Financial Crisis
26
Honest implementation of Profit-and-Loss Sharing (PLS) transactions (such as Mudarabah and Musharakah contracts) in accordance with the spirit of Islamic principles entails full disclosure and transparency.
Islam regards the relationship between the lender (financial institution) and the borrower (investor) as a
partnership.
Risk sharing as apposed to risk taking is extended to include the prohibition of risk shifting as in CDS - risk
shifting is gambling.
Islamic finance provides a moral and practical option for those keen to invest in socially responsible and/or in
ethical investment portfolios.
Concluding Remarks
27
Current financial crisis demonstrates that Islamic finance is an effectual economic authority.
Today, investments through Islamic finance systems are acceptable in a significant number of countries –both
Islamic and others– such as Indonesia, Malaysia, Turkey, Japan, China, England, and the USA, and
continue to expand to many other countries as an alternative or complementary to the conventional
financial and banking system.Transformation of Islamic financial paradigm into
working policies and enabling institutions is a long-term evolutionary process.
Private and public sectors at country level and the cross-country coordination between member states of
the Organization of Islamic Conference (OIC) undoubtedly will play a crucial role.
Future of Islamic financing looks exceptionally promising, one should not be under the illusion that such transformation would happen without shrewd vision and hard work particularly in terms of human
capacity building and innovative financial engineering
Concluding Remarks
28
There is an urgent need for more integrated and concerted policy actions to recover from the crisis and improve the economic situation of the OIC community through, inter alia,
Designing sound financial systems at national level that would prevent the adverse impacts of future global financial crises
Promoting and encouraging financial systems based on Islamic principles such as equity-based financing and real activity-based transactions.
In such a system, the conventional financial instruments such as collateral debt obligations (CDOs) and credit default swaps (CDSs), which stand at the heart of the current crisis, are either not allowed or regulated very tightly.
Many researchers come to argue that the current global financial crisis could have been avoided if such a system had been in place.