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Islamic Finance: A Therapy For Healing The Global Financial Crisis

2272 words - 10 pages

Islamic Finance: A Therapy for Healing the Global Financial Crisis

Miranti Kartika Dewi 1 *Researcher of Centre for Islamic Economics and Business ** Lecturer of Department of Accounting Faculty of Economics, University of Indonesia

Ilham Reza Ferdian * Student of Master of Science on Finance Programme Kuliyyah of Economics and Management Sciences International Islamic University Malaysia ** Fellow of PT. Bank Muamalat Indonesia

ABSTRACT Global financial crisis which hit many too-big-too-fail countries and financial institution in the world was mainly made happen by debt securitization. Derivative instruments resulted from this process obviously were not backed by real asset. When ...view middle of the document...

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Figure 1: Chronologies of the World’s Economy Crisis

Source: Sakti (2009), with some adaptations

Since current global financial crisis is frightened can bring prolonged period of economy downturn, it is very important to find ways to cure it. However, as always done by a doctor

                                                            
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Roy Davies and Glyn Davies (1996) in their book entitled “A History of Money from Ancient Times to the Present Day mentioned that until their book was launched, there were more than 20 crises happen in the world, and all of them are financial crises.

before giving medical treatment to his patients, it is important for us to firstly observe the ground of the problem.

ROOT OF THE CURRENT GLOBAL FINANCIAL CRISIS The Bank for International Settlement (BIS) has mentioned on its 2008 annual report that the root of almost all crises has been excessive and imprudent lending by banks. Furthermore, this factor also becomes important cause that makes this current crisis happen, which was boomed with defaults of subprime mortgages in the United States on 7th February 2007 (Sakti, 2009). The default was made happen by excessive and imprudent mortgage lending given by Washington Mutual to many high-risk home purchasers in the US. In return, the purchasers should pay certain amount of service fees to Mutual. This mortgage lending was then securitized by the Mutual and sold to mortgage guarantee institutions (Fannie Mae and Freddie Mac) to earn more funds. Furthermore, the guarantors pooled and packaged the mortgages into instrument called Mortgage backed Securities (MBS). This type of instrument later sold to the Wall Street. After that, the Wall Street re-packaged the MBS into another derivative instrument called as Collateralized Debt Obligations (CDOs) and sold them to some investment banks, e.g. Lehman Brothers (Karim, 2009). From this stage, the investment banks sold the instruments by mixing prime and subprime debt to pass the entire risk of default of even subprime debt from mortgage originators to the ultimate purchasers who would have normally been reluctant to bear such a risk. But do to this camouflage packaging; the buyers could not clearly see the inherent risk of the financial instrument they bought. As a result, the lending to subprime borrowers and speculators increased steeply (Chapra, 2008). Illustration of the root of the financial crises can be seen in the following figure.

Figure 6: Root of the Recent Global Financial Crises

Those unhealthy practices lead to nationalizations of a number of banks by the governments in the US, the UK, Europe and a number of other countries. In consequence, the creditors became uncertain with the situations and sought for protection against default by buying derivatives like Credit Default Swaps (CDSs). By owning these instruments, they pay a premium to hedge funds for the compensation they will receive in case the debtor defaults. Another...

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