Islamic financial system shows inherent resistance to global crises

Published: December 17, 2012
Pakistan is a fast growing country with regards to Islamic finance. Starting from scratch in 2002, it is now about 8% of the local banking industry.

Pakistan is a fast growing country with regards to Islamic finance. Starting from scratch in 2002, it is now about 8% of the local banking industry.

KARACHI: Islamic finance is one of the fastest growing segments of the global financial industry. In 2008 the size of the global Islamic banking industry was estimated about $820 billion. Now it is closer to $1.35 trillion according to Global Islamic Finance Report (GIFR), and is expected to cross $1.6 trillion before the end of the current fiscal year.

The Islamic financial industry now comprises 430 Islamic banks and financial institutions and around 191 conventional banks having Islamic banking windows operating in more than 75 countries, according to the GIFR.

Pakistan is also a fast growing country with regards to Islamic finance and growth has been phenomenal. Starting from scratch in 2002, it is now about 8% of the local banking industry.

While Islamic banks play roles similar to conventional banks, fundamental differences exist. The central concept in Islamic banking and finance is justice, which is achieved mainly through the sharing of risk. Stakeholders are supposed to share profits and losses, and charging interest is prohibited.

There are also differences in terms of financial intermediation, the paper notes. While conventional intermediation is largely debt based, and allows for risk transfer, Islamic intermediation, by contrast, is asset based, and based on risk sharing. One key difference between conventional banks and Islamic banks is that the latter’s model does not allow investing in or financing the kind of instruments that have adversely affected their conventional competitors and triggered the global financial crisis. These include toxic assets, derivatives, and conventional financial institution securities.


Analysis done by the IMF suggests that Islamic banks fared differently, if not actually better than conventional banks during the global financial crisis. Factors related to the Islamic banking business model helped contain the adverse impact on their profitability. In particular, smaller investment portfolios, lower leverage, and adherence to Shariah principles—which precluded Islamic banks from financing or investing in the kind of instruments that have adversely affected their conventional competitors — helped contain the impact of the crisis when it hit in 2008.

The study used bank-level data covering 2007−10 for about 120 Islamic banks and conventional banks in eight countries — Bahrain, Jordan, Kuwait, Malaysia, Qatar, Saudi Arabia, Turkey, and the United Arab Emirates. These countries host most of the world’s Islamic banks (more than 80% of the industry, excluding Iran) but also have large conventional banking sectors. The key variables used to assess the impact were the changes in profitability, bank lending, bank assets, and external bank ratings.

While the study showed that Islamic banks were able to better withstand the initial impact of the crisis, the following year (2009), weaknesses in risk management practices in some Islamic banks led to a larger decline in profitability compared to that seen in conventional banks. The weak 2009 performance in some countries was associated with sectoral and name concentration—that is, too great a degree of exposure to any one sector or borrower. In some cases, the problem was made worse by exemptions from concentration limits, highlighting the importance of having a neutral regulatory framework for both types of banks.

Despite the higher profitability of Islamic banks during the pre-global crisis period (2005–07), their average profitability for 2008–09 was similar to that of conventional banks, indicating better cumulative profitability and suggesting that higher pre-crisis profitability was not driven by a strategy of greater risk taking. The analysis also showed that large Islamic banks fared better than small ones, perhaps as a result of better diversification, economies of scale, and stronger reputation.

Islamic banks contributed to financial and economic stability during the crisis, given that their credit and asset growth was at least twice as high as that of conventional banks. The IMF paper attributes this growth to their higher solvency and to the fact that many Islamic banks lent a larger part of their portfolio to the consumer sector, which was less affected by the crisis than other sectors in the countries studied.

However the post-crisis years have also shown where the Islamic banking sector is relatively weak. It lacks as efficient a structure for liquidity management as seen in conventional banking. The IMF report also recommended that the sector needs a stronger supervisory and legal infrastructure, including bank resolution.

The paper also recommended that Islamic banks and supervisors work together to develop the needed human capital, saying expertise in Islamic finance has not kept pace with the industry’s growth.

Published in The Express Tribune, December 17th, 2012.

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Reader Comments (9)

  • Zalim singh
    Dec 17, 2012 - 12:40PM

    Once the oil reserves are gone- everything will be back to normal. Barbaric banking will prevail.


  • Saleem
    Dec 17, 2012 - 6:45PM

    Is it really pure islamic banking and are any of the statistics given reliable. I suspect that the answer to both questions might be NO!Recommend

  • Raza
    Dec 17, 2012 - 9:27PM

    Perhaps you should actually do some research before airing your suspicions, which I ‘suspect’ are based on random guesswork. ‘Pure’/ideal Islamic banking is not in practice anywhere currently; however, the minimum necessary requirements of Islamic banking (i.e. removal of interest component) are being met in the current Islamic finance environment, which basically makes it Sharia-compliant. for further clarity, go read the Shariah regulations on Meezan Investments’; website. Pakistan like several other countries is seeing that level of Islamic banking; so basically this is good progress over the last 5 years, notwithstanding the lack of regulatory/govt support and lack of HR.


  • Umer
    Dec 17, 2012 - 9:38PM

    In a related development, the economies of the world that actually work have been so inspired by progress in Islamic banking, that they’re about to organize a UN summit to replace cars with camels instead.


    Dec 17, 2012 - 11:26PM

    @Mr Saleem
    I have no objections with the credibility of the data as Islamic Banking is one of the most fastest growing financial phenomena in the world.

    But one think I would like to point is that there is no centralized global regulation for Islamic banking like in conventional banking it is BASEL committee BIS and so on. Islamic Banks in each country are regulated by local boards which I think in this global world is not a very good idea, and by creating a central regulation board it would really help Islamic Banks reach new frontier
    and one more thing I think we should name it something else rather than Islamic Banking it is a Banking system we Muslims gave to the world it does not necessarily means Islamic Banking.


  • Cynical
    Dec 18, 2012 - 1:45AM

    Does Islamic Banking recognise the concept of ‘opportunity cost’ and ‘time value’ of money?


  • Sikandari
    Dec 18, 2012 - 1:58AM

    There is a centralized global regulation system for Islamic banking called AAOIFI. Moreover all other regualtions of conventional financial institutions also apply on Islamic Banks..


  • Shylock
    Dec 18, 2012 - 10:24AM

    The base of Islamic Banking is the Murabaha contract, and on close examination it is clear that the contract is an INTELLECTUALY DISHONESTcontract!


  • Umer
    Dec 19, 2012 - 11:54PM

    Haha. Don’t us Muslims love it when you feed our ego lol. Saudis are monitoring their women now haha. Worst nation on earth.Recommend

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