Credit Crisis Draws Attention to the Virtue of Islamic Finance

Sources: Credit Crisis Gives Islamic Finance a Chance to Shine, Reuters; Turmoil Demonstrates Link With the World, Financial Times; Institute of Islamic Banking & Insurance

Although the credit crisis has proven that the Middle East is not detached from the world economy, Middle Eastern banks adhering to principles of Islamic finance remain virtually unscathed. In fact, the credit crisis has provided Islamic banks with a chance to play up the contrast between them and conventional banks.

The basic principle of Islamic banking is the prohibition of riba, or interest. In addition to discouraging interest-based banking, Islam also prohibits investments in sectors like liquor, pork, gambling, pornography and anything else that Islamic law deems haram, or unlawful.

Investors traumatized by the credit crisis could seek comfort from the stricter rules imposed on lending by Islamic law, which effectually bans some of the financing methods that proved unworkable during the U.S. mortgage crisis. Specifically, Islamic law requires transactions to be linked to assets, thus deterring the kind of complexities prevalent in conventional financing operations.

However, while the virtues of Islamic financing have recently been increasingly noticed, analysts say market commentators and intermediaries may be too zealous in promoting the merits of Islamic finance as a safe product.

Thus, while there is some debate on whether Islamic finance really provides a safer bet, most agree that the industry should make the most of the attention it is now receiving. The virtue of Islamic finance is currently drawing the interest of companies outside the Middle East. Accordingly, David Testa, chief executive of Gatehouse Bank (an Islamic bank in Britain) claims that “the current market condition has given Islamic finance a great opportunity to show what it can do—help to fill the liquidity gap. If Islamic banks step up to the mark, then they will gain attraction.”

Discussion: Do you think that companies affected by the credit crisis will consider pursuing principles of Islamic finance? Do you believe that Islamic banking is really less risky than conventional banking? Would the credit crisis have happened if Islamic finance principles were used in the United States? Even if it is less risky, does Islamic banking inhibit growth?