The Role of Islamic Finance in Economic Stability and Social Justice

One of the most distinguishing times for the U.S. Islamic home financing industry began in February 2007. The Federal Home Loan Mortgage Corporation (Freddie Mac) sent out a press release announcing that it would no longer buy the most risky subprime mortgages and mortgage backed securities. Two months after the announcement, a leading subprime mortgage lender filed for Chapter 11 bankruptcy protection. Three months after that bankruptcy filing, nationwide financing entities warned of “difficult conditions” ahead. Manifestations of such difficult conditions appeared on the horizon of the financial market when once well-established mortgage companies suddenly began to file for Chapter 11. Similar circumstances reached the U.K. as the Bank of England cleared an authorization to provide liquidity sustain to Northern Rock, the country’s fifth largest mortgage lender. Five months later, Treasury of the United Kingdom became the owner of Northern Rock.

Up until that point, the gravity of these “difficult conditions” was not fully understood by most of the populace. Late in 2008, the Federal save Bank of New York was empowered to lend $85 billion to the AIG. This was the beginning of the most serious recession in the United States since the Great Depression. What followed was a chain reaction that led to an unheard of global financial crisis, as the world suffered from rising unemployment, rampant foreclosures, and harsh skepticism of financial instruments.

This led to a renewed spotlight on an unfamiliar market part that appeared comparatively more stable and, more importantly, far more ethical: the Islamic financing sector. From the financial centers in Malaysia to the Middle East, spanning across over seventy countries, Islamic finance in the U.S. increased from $5 billion in the 1980s to $1 trillion in 2010. This exceptional growth caught the attention of global investors who were seeking to safeguard their investments by more ethical and reliable financial instruments. When financial sector workers realized that these Shariah-compliant instruments avoided many of the worst effects of the global financial crisis, it became an attractive investment means to sustain a more different portfolio. The Shariah-compliant financial sector has avoided investment in predatory lending businesses and overly leveraged financial instruments due to the strict ethical character of the Shariah governance system. News and media outlets started to cover this ancient however unfamiliar industry in hopes of learning from the mistakes of the traditional banking sector.

The concept of the modern Islamic financial sets industry is rooted in the principles of Islamic legal jurisprudence that deals with financial transactions, a branch of Islamic jurisprudence called Fiqh Al Muamalat. Fiqh Al Muamalat is a framework under Islamic Law that charts the conduct of Muslims in commercial or economic endeavors. Islamic finance products and rulings are based on specific injunctions from the Quran that prohibit certain features of financial transaction models and related economic activities.

The Quran forbids interest, also called usury or riba. The inner reasoning is that Islam considers lending to be a charitable act to help another member of the society in his/her time of need – consequently, profiting from someone’s hardship is strictly banned. In the traditional banking system, when interest is charged on a loan, the risk of that transaction is transferred to the borrower while the lender gains profit from the interest-based transaction. There is no consideration for the hardships endured by the borrower in the event they undergo any loss from the transaction.

By its character, Shariah law prohibits unethical financial practices. It also contributes wealth dispensing among all people to reduce poverty and inequity. This is manifested in the prohibitions of activities such as excessive speculation, gambling, and investing in products that are unhealthy for society as deemed by Islamic law (alcohol, pornography, etc). The structure of Islamic financial products and sets, especially its prohibition in speculative transactions, has helped the industry escape most of the negative effects of the global financial crisis. The governance form of Islamic financial institutions has been praised as an ethical different by institutions such as the International Monetary Fund and the World Bank. Economic experts have suggested that Islamic financial principles can be leveraged to promote financial inclusion that uplift the quality of life in developing nations. Islamic financial principles can also contribute to financial stability and economic development around the world.

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