Few years ago the world faced a severe economic crisis which resulted in the great recession after 2002. Although the recession lasted for one year, still it left millions unemployed with bad debts and getting homeless. Although it has been two years, but the economists are finding it still very hard to cover up the consequences.Islamic banking emerged in 1970 with its unique and low risk joint ventures musharaka , Sukouk, Ijara, mudariba and takaful. Since then there has been no official or unofficial crisis reported in this sector. Instead it stands with $ 800 million portfolio and is expected to increase by 4 billion in 2015.
Today’s financial markets are based on a sophisticated financial system. The system is carefully examined and updated by financial specialists/professionals but the question is why they fail at first place. Well the answer lies in Islamic financial system. The Islamic system is based on Shariah laws for example things like interest fee on loaned money is strictly prohibited in this system. Furthermore, one can only make transactions with money in hand and investment on projects with excessive risk involvement is not allowed in Islam.
Now let’s see how Islamic system differs from conventional economic system. For example when a bank loans a company or an individual a interest rate and some security is taken on loan given. Later on if the company goes bankrupt there is nothing a bank can do except to sit back and wait for court orders. On the other hand an Islamic bank invests in the project and agrees to share profit and loss. So when a company is declared bankrupt, bank will extract its investment easily.
Another example for this system can be taken as e.g. an Islamic Musharaka transaction finances 90% of the project and keeps 90% of the ownership. Now monthly payment made by borrower increases his ownership whereas the bank covers up the cost by charging a fee each month when the payment is made. If we replace Islamic financing system with conventional system things would have been more different. To explain it in conventional way let’s take example of Lehman Brother. The company was a global financial service provider but resulted in Chapter 11 bankruptcy leaving thousands unemployed.
The failure resulted due to massive loss in stocks of clients of Lehman Inc. and devaluation of assets by CRA. Now an Islamic system won’t let this happen and this is due to low risk involvement in this system. A conventional economic system believes that funds would be provided to client on some security whereas an Islamic economic system believes that funds should be given to client by investing in the project and the return will be shared on agreed profit and loss by both the parties.The above two examples summarizes by saying that an Islamic financer has to go deeper in borrowers business because this will help him to minimize the risk of their borrower defaulting while investing into productive activities unlike conventional system where lending is done on interest basis.