Middle-east Arab News Opinion | Asharq Al-awsat

The Sovereign Debt Crisis and Islamic Banking | ASHARQ AL-AWSAT English Archive 2005 -2017
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Riyadh, Asharq Al-Awsat- No sooner had the world begun to pick up the pieces in the wake of the US subprime mortgage crisis than another emerged, namely the sovereign debt crisis, which is something that I warned against in previous articles. I warned that the impact of this crisis on the economy and international stability would be greater than the previous crisis, since this crisis pertains to state debts, rather that individual or company debts. Until now the international financial system has yet to put in place laws to address state bankruptcy, despite the fact that this is something that has occurred on a number of occasions in the modern era. This is not the case with commercial debts, for there are laws which address civil institutions filing for bankruptcy and which reduce the effects of this. The sovereign debt crisis also represents such a threat because these debts are not just related to one country, but rather there are a number of countries who are expected to be unable to honor their financial commitments. This is something that will not stop with Greece, and international credit rating agencies have also downgraded Portugal’s credit rating by two levels, and Spain’s by one. What compounds the issue and exacerbates the magnitude of the sovereign debt crisis and its impact on the global economy is that this is something which is present within the largest monetary union in the world, namely the Euro zone, especially since the Euro today is the second most utilized currency in international transactions after the US dollar. This means that the crisis will reflect negatively on countries in the European Union, the largest economic bloc in the world. Therefore the panic that is spreading across the international markets is justified, especially as stock markets and energy values have plummeted around the globe, which is something whose influence nobody can escape.

To say that the Islamic banking industry will not be affected by this crisis is, in my point of view, a clear and glaring inaccuracy. The Islamic banking industry does not operate independently from international markets, and so it is not immune to international financial fluctuations. We witnessed how the US subprime mortgage crisis affected the [Islamic banking] industry and its institutes, and here we must distinguish between direct and indirect impact in order to ensure that we do not misread reports issued by credit rating agencies, such as the one which claims that Greece’s financial crisis will not have any direct impact upon Islamic banking. This means that Islamic banking has no assets that are directly connected to the sovereign debt crisis since assets such as securities and other debt instruments that are prohibited under Islamic Shariaa law. However this report did not mention the indirect impact this crisis will have on Islamic banking, which is bound to be substantial due to the crisis’s effect upon economic factors that are stimulating the Islamic financial industry. One of the key fields which is stimulating the Islamic banking industry’s development and which will be immensely affected by the sovereign debt crisis is the oil industry. Oil prices are expected to fall due to fears of a fall in demand as a result of the sovereign debt crisis, and this would lead to the oil industry losing financial liquidity. Another key factor which the Islamic banking industry’s development relies upon heavily is its investments in the stock market and real estate markets. These investments constitute the bulk of Islamic financial investment assets, and are particularly vulnerable to currency fluctuations due to the absence of effective financial hedging [in Islamic banking] which could limit this.

Therefore now that the Islamic banking industry has developed and matured, it must carefully study such crises and find ways of countering their effects and avoiding them. In addition to this, the Islamic banking industry should exert effort to establish a central bank for Islamic banking; a bank that would pursue common objectives and interests of all Islamic banking institutions, such as examining the possibility of creating a financial hedging system to offset currency fluctuations by linking Islamic financial institutes’ reserves to gold. This central bank would also regulate short-term investment, act to rescue failing Islamic financial institutes, and set up a common market for investment, which would lead to the establishment of joint criteria within the Islamic banking industry. This proposed central bank for the Islamic banking industry would also pursue any other common objectives that are of interest to all parties involved in this industry. Some might say that the things that I am calling for already exist within the parameters of central banks, and I would answer, yes, I am aware of this, but what can we do if central banks in the Arab world are not aware of their role, or are not performing this as they should? The only option is then to rise to the challenge and take the initiative. Every hour that we delay places the Islamic banking industry at greater risk, and impedes its progress even further.