Financial Crisis and Islamic Banking
The international financial crisis began over a year ago, and has intensified during last few months. The International Monetary Fund has already warned that this credit crisis will result in losses of over trillion dollars and that it may worsen especially after the 150 year old US financial giant Lehman Brothers been declared bankruptcy, not to mention the sale of financial services firm Merrill Lynch to the Bank of America.

Interestingly, Islamic banks are unaffected by the sub prime mortgage crisis; rather many non-Muslims are turning up to Islamic banking as the customers spooked by turmoil in the interest based banking system are feeling Islamic banks as a safer haven because they are immune against such crisis due to inherent business ethics within Islamic banking.

There are mainly two important reasons for insulation of Islamic banks under this current credit crisis as compared to the interest based banks and financial institutions. The first is security from liquidity problem due to inter banks lending in the money markets, merger and resales of debted companies. The second reason is rating of complete investment risks instead of mere credit risks. Principally Islamic banks acts as custodians, advocates or managers for depositors funds and thus they cannot transfer public deposits to other banks without permission of their depositors. Thus Inter bank liquidity transfer on debt finance basis is not permitted in Islam, which restrains liquidity related problems in the market.

Under Islamic banking, equity finance is not granted by mortgaging assets, but after analyzing the investment proposal, and the equity finances remains unaffected with changes in assets values. There are so many internal and external factors affecting the asset values of stocks, bonds and securities which are prime components for credit rating system used for Interest based lending; so it is not an easy task either for the banks or credit rating agencies to evaluate the exact credit risks. The rating of investment risks under Islamic Finance has no problem with fluctuation in asset values; instead it varies according to actual business trend. Thus there is no fear of sub prime mortgage under Islamic banking principles; rather it counters the throat cut competition in financial sector to get more credit shares. In a way Islamic Principles provides stability and insulation in the financial market.

Moreover Islamic banking interestingly helps the weaker and even the weakest section of the society through various ultra modern financial products. Under Islamic banking finances (through Joint ventures, partnerships and leasing) are provided by investors / banks to the borrowers with a condition that financial risk is to be borne by the investors, and other risks to be borne by borrower / manger of funds. This helps even the poor and vulnerable to get finance at no risk and cost, but definitely requires other credits like strong business proposal, sound projections, rational planning, skilled hands and technical art to attract the financer. Under Islamic finance, comparatively better business proposals succeed in fetching funds while projects with poor economies find it difficult. This helps the economy boost inclusive growth as financial resources are well shared among haves and have nots along with shouldering financial risk on financers and other risks on borrowers of funds.

The risk rating under Islamic banking and finance evaluates real term business potential and growth trends, instead of evaluating manipulated asset values which has caused recent damages to the credit market. Thus the regulators and credit rating agencies should now adopt principles of Islamic banking to safeguard the financial sector from any more turmoil.

Source: http://aicmeu.wordpress.com/2008/10/06/islamic-banking-restrains-financial-sector-crisis