The Underlying Cause of the Global Financial Crisis: An Islamic Perspective

Nauman Ejaz and Hayat Khan

Economic Papers, 2014, vol. 33, issue 1, 45-54

Abstract: type="main" xml:id="ecpa12060-abs-0001">

This article highlights that the primary architecture of the conventional financial system induces financial crises as it does not legally “tie the knot” between nominal and real transactions. This legal binding would require replacing interest-based mechanisms with an arrangement where nominal transactions are backed up by real transactions and a ban on securitisation of nominal assets that is based on the principles of risk transferring rather than risk sharing. The argument underlying our contention is that the extent of the negative impact of any crisis would be proportional to the gap between the nominal and real economy, and the mechanisms governing the distribution of risk. That is why, as advocated by proponents of Islamic Finance, the Islamic financial sector showed resilience during the global financial crisis (GFC). There is however no serious academic effort that formally presents the case of Islamic Finance. This article intends to fill this gap by taking stock of the literature on GFC and relates the discussion to the financial architecture proposed in Islamic finance.

Date: 2014
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