WHY DID ISLAMIC BANKS SURVIVE THE 2008 FINANCIAL CRISIS?
2008 was the year in which Obama became the first black President of the United States, the UK experienced its largest earthquake in 25 years, and the year in which the world faced a global financial crisis — the effects of which are still felt today.
Triggered by the collapse of Lehman Brothers, many banks suffered large losses and asked for government help to avoid bankruptcy. Deregulation in the financial industry allowed banks to take on very risky activities using derivatives. In addition, there was a very high level of debt and loans, often in the form of mortgages, being offered to customers.
Interestingly, unlike conventional banks, Islamic banks managed to survive the crisis without much substantial impact.
In line with the principles of Sharia, Islamic banking is not reliant upon interest. Despite this, it is one of the fastest thriving segments of the global financial industry.
So why weren’t Islamic banks as negatively affected by the crisis as conventional banks?
The answer is simple: Islamic banks provide interest free services and prohibits executing unethical and high risk transactions. Also, the Islamic banking system avoids risky derivatives, and encourages transparency with customers. In addition, all cash flows (even for financing) are attached to buying and selling of real assets in the economy — this means that it is very difficult to create unsustainable levels of debt, as we see with conventional banking — where debt can be created without limit.
Conventional banks and Islamic banks both faced a different reality during the crisis, while conventional banks were at risk of bankruptcy due to unethical banking (risky derivatives and excessive lending at interest), Islamic banks were quite insulated as they avoided speculative and derivative elements, which resulted in little impact from the financial crisis in 2008.