Thursday, November 4, 2010

The Hub of Islamo-Finance

Hossein Askari and Noureddine Krichene report on a country whose "achievements have been quite remarkable in developing market institutions and Islamic financial products, in boosting capital flows, and in establishing the country's dominant position in the world of Islamic finance" — Malaysia - gateway to Islamic finance. The authors answer the questions: "What is Islamic finance? What are its main foundations that make it supportive of financial stability, economic prosperity and social justice?"

We learn that Islamic finance "embrace[s] risk-sharing (profit and loss sharing) and ban risk shifting (debt that embodies interest), prohibit interest (riba), gambling, speculation, and any unjust appropriation of wealth, and make zakat (alms) a mandatory obligation for preserving an equitable distribution of income and social justice." Also, while "debt is not forbidden, it has to be interest free, and hence debt plays a negligible role in Islamic finance." In summary:
    In other words, in this example of a financial system, there is no debt financing by institutions, only equity financing; and there is no risk shifting, only risk sharing. Banks do not create money as under a fractional reserve system. Financial institutions serve their traditional role as intermediaries between savers and investors but with no debt on their balance sheets, no leveraging and no predetermined interest rate payments as an obligation.

    Because of the structure of Islamic finance outlined above, it has received increasing attention in the aftermath of the global financial crisis that broke out in August 2007. It is considered as a more stable financial system, capable of promoting sustained growth of income and employment. Prohibiting interest and interest-debt contracts, Islamic finance eliminates money creation and destruction by the banking system through the credit multiplier; it establishes one-to-one mapping of financial and real sectors of the economy. That is, it is based on real trade and production activities.

    The financial sector cannot expand beyond the real economy, and is immune to un-backed credit expansion and speculation that are characteristics of conventional finance and have destabilized even the most sophisticated and complex financial systems.

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Blogger Tertium Quid said...

Debt not equity? What a world!

7:02 AM  
Blogger The Western Confucian said...

Reading your comment, my first thought, "If that's Islamo-finance, is what we've got Judeo-finance?" Then, I read your fine post on the topic --

10:37 PM  

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