The Credit Crisis: An Islamic Perspective.
Download as PPTX, PDF0 likes501 views
The document discusses the Islamic perspective on the credit crisis from several angles in 3 parts. It begins by defining key terms like debt financing and credit financing. It then contrasts Islamic risk sharing contracts with conventional debt contracts. Finally, it analyzes several economic theories for the causes of the credit crisis and argues that the fractional reserve banking system and financialization decoupled finance from the real economy and led to instability.
More Related Content
Similar to The Credit Crisis: An Islamic Perspective. (20)
More from Syed Anas Abdali (20)
The Credit Crisis: An Islamic Perspective.
- 1. THE CREDIT CRISIS: AN ISLAMIC PERSPECTIVE Presented by: Muhammad Saim Khan (9048) Syed Anas Abdali (8960) Zainab Shad (8957) Maria Shoaib (8698)
- 2. INTRODUCTION What is the “Credit Crisis” ? A credit crisis (also known as a credit squeeze) is a sudden reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks. Debt Financing: Debt financing means borrowing money and not giving up ownership. Debt financing often comes with strict conditions or covenants in addition to having to pay interest and principal at specified dates. Credit Financing: Credit is a contractual agreement in which a borrower receives something of value now and agrees to repay the lender at some date in the future, generally with interest. The term also refers to the borrowing capacity of an individual or company. Effects behind Credit Crisis: • Instability by debt financing • Sovereign debt crisis • Interest based fractional reserve banking system
- 3. DIFFERENCE BETWEEN DEBT AND EQUITY CONTRACT • Debt contract • Equity contract • Risk Sharing: It means that the premiums and losses of each member of a group of policyholders are allocated within the group based on a predetermined formula. E.g. Takaful Conditions • Risk Transferring: Risk transfer is a risk management and control strategy that involves the contractual shifting of a pure risk from one party to another. E.g. (Insurance Policy)
- 4. THE ISLAMIC VIEW OF FINANCE • Islam has prescribed ways of human conduct in Quran and Sunnah that help maintain the main objective which is unity . • Characteristics of operational requirement of Islamic finance include: Property rights Transparency, trust and faithfulness to terms and conditions of contracts Close relationship between the real and the financial sectors of the economy asset/liability risk matching Coordinated asset/liability maturity structure Asset/liability value matching • Exchange contracts must be used for transactions and their financing should not involve interest in any form
- 5. RISK SHARING • Islamic finance helps maintain equilibrium which generates high employment along with stability. • Risk sharing operates through : • Risk sharing based contracts of exchange and finance • Redistribution and transfer payment program • Risk sharing with future generation • Risks are shared through specialization and division of labor
- 6. OTHER PERSPETIVE ON THE CREDIT CRISIS ON: CONVENTIONAL VIEW • Macroeconomic Imbalance occurred because of Massive saving held by emerging market. • The last resort could provide balance of payment support but… • Thus, the banks stored large federal reserves bonds to avoid future occurrence. • This led to long term interest rate results in increase in the value of paper currency. • Which in turns to the creation of a assets bubble.
- 7. ALTERNATIVE PERSPECTIVES: KEYNES-CHICAGO PLAN-MINSKY • This perspective states that such crisis are unavoidable and are caused internally in a debt-dominated financial system. • There’s a conflict between putting the capital at risk with certain return which causes financial instability. • Fractional reserve banking-Fractional-reserve banking is the practice whereby a bank accepts deposits, makes loans or investments, and holds reserves that are equivalent to a fraction of its deposit liabilities. • Credit and debt creation is amplified during upswing phase of financial cycle leading to asset bubble and the bubble bursts during the downswing phase.
- 8. THE CHICAGO PLAN • The Chicago group proposed a reform of the US banking system known as “The Chicago Plan” • It was proposed but not implemented. • It stated that banks should hold 100% reserves against deposits. • It had the following benefits: • Better control of the business cycle • Elimination of bank runs • Reduction of net public and private debt
- 9. KEYNES PERSPECTIVE • Economist saw the credit creation ability of fractional reserve banking system the key reason behind financial instability. • Keynes argued that market capitalism is unstable by nature. • Consumers and businesses invest and save for different reasons and their coordinate approach is subject to uncertainty. • Equality of saving and investment cannot be assured which leads to unemployment and inflation. • He termed interest as “rent” and interest taker as “rentier”. • He particularly blamed the rent-rentier relationship and the lack of coordination for being unable to achieve full employment. • He also stated that compounding of interest leads to accumulation of wealth which tilts wealth towards the retier leading on unequal wealth/income distribution. • He termed the rentier class as the ‘Villan of the piece’ who cause unemployment and unequal distribution.
- 10. HYMAN MINSKY PERSPECTIVE • Hyman Minsky was a keen follower of Keynes who further worked on his thoughts. • He argued that the present debt-dominated capitalism system was itself responsible for the disturbances. • Debt was such a vital element of his hypothesis that he considered it “the theory of the impact of debt on system behavior.” • His hypothesis had two major prepositions: 1. The more the financial system tilts towards debt, the more fragile the system becomes. 2. Stability is destabilizing.
- 11. • He further stated that during stages of prosperity the businesses use internal sources or equity finance to finance their activities. He termed it “Hedge Finance”. This system is stable. • But as there are more opportunities for earning profits, entrepreneurs borrow to make riskier investments and as they keep borrowing, their structure tilts towards debt. He termed “Speculative Finance”. • Enterprises that borrow to pay off their previous debts were termed as “Ponzi units”. • This in turn leads to instability, unfair distribution and structural unemployment.
- 12. THE MINSKY MOMENT • Aftermanth of credit crisis, Minsky’s diagnoses and his explanations of possible turbulences were quite perceptive. • Minsky had warned about debt build up and deregulation. • He noticed that boom and bust in one asset market were followed by boom and bust in another asset market. • A Minsky moment is a sudden major collapse of asset values which is part of the credit cycle or business cycle. Such moments occur because long periods of prosperity and increasing value of investments lead to increasing speculation using borrowed money.
- 13. EMERGENCE OF “PAPER ECONOMY” & FINANCIALISATION • In 1980, Finance was dominating the real sector of the economy. • In 1984, Tobin sounded the alarm about the emergence of “paper economy”. “… we are throwing more and more of our resources into financial activities remote from production of goods and services” Paper economy: The paper economy is that part of the economy that involves legal claims and financial markets. Legal claims represent ownership or control of physical assets. Financial markets are used to exchange legal claims.
- 14. Characteristic of “Paper Economy” Finance is speculative (suppositional) rather than productive. Finance is focused on short-term projects, buying pieces of paper and trading them back and forth in rapid turnover. Finance decouples from real sector production. It extracts, rather than add, value from the real sector. It has only an illusory or, at best, a tenuous (insubstantial) virtual anchor in real assets.
- 15. • Financialisation: It is an increase in the size and importance of a country’s financial sector relative to its overall economy. Financialisation has occurred as countries have shifted away from industrial capitalism. • Decoupling: It takes place when two different asset classes that typically rise and fall together move in opposing directions, such as one increasing and the other decreasing. For example, stock and corporate bond returns generally move together. Stock markets are serving mostly the paper economy. The last five years, data shows of the total volume of USD 33 trillion annual trading in the US stock market as; • 0.8% was devoted to capital formation in real sector of economy every year on average of last five year. • Remaining 99.2% was devoted to pure finance activities, i.e., the paper economy.
- 16. THE CREDIT CRISIS AS MORAL FAILURE Moral Failure: A situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost. It arises when both the parties have incomplete information about each other. • LIBOR scandal • Commit of Economical and Financial Crime • Lack of Trust • Lack of Honesty • Lack of Transparency • Lack of Cooperation • Lack of consultation • Lack of Reciprocity