Islamic finance shows banks the way forward

Published on Friday 26 September 2008 10:14

THE spectacular collapse of Lehman's, the problems at AIG and the takeover of HBoS by Lloyds TSB have led to central banks injecting liquidity into the markets and governments bailing out certain institutions, often at taxpayers' expense.

The question is: are taxpayers and governments subsidising flawed institutions or indeed propping up an inherently flawed financial system which survives merely on the basis of confidence?

Although HBoS had taken steps recently to ensure it was adequately capitalised from regulators' perspective, nonetheless the market lost confidence in the bank and its share price plummeted.

It is of no surprise to see concerned leaders around the world address the issue of how to prevent such a disastrous situation happening again. Perhaps Islamic finance presents a solution.

Islamic finance has seen astounding growth with two new Islamic banks and a takaful (Islamic insurance) firm receiving authorisation in the UK.

Islamic finance is an industry based on principles of equity and financial justice.

Would such a banking catastrophe have occurred if Islamic finance principles had been followed? The answer is almost certainly no.

Islamic principles prevent selling something you do not own. Practical implications include limitations on the use of derivatives and short-selling is generally not accepted – the dangers of which were exposed last week. Pure speculation and gambling are prohibited.

Contract certainty and clarity is another key principle – contracts must be clear with no link to uncertain future events.

Islamic banks do not invest in conventional interest-related instruments, and did not have exposure to 'toxic' American sub-prime mortgages.

Now is the opportune time to apply principles inherent in Islamic finance to mainstream banking to help provide a more stable economy.

&#149 Nadeem Haq is executive manager of the Islamic Finance Council UK