Summary |
Conventional banks are exposed to credit and interest-rate risk and may face problems of liquidity. In order to maintain their payments, rediscounting and borrowing from the central bank become pillars for their smooth operation. Central banks create money out of thin air and support a rapid expansion of credit that exposes banks to systemic risks, in the form of a general collapse of asset prices or widespread default in subprime markets.
In Islamic finance, banks do not have or cause any asset-liability mismatch and are thus not dependent or central bank financing. In conventional finance, instability is not contained. What starts as a crisis in one country becomes global through the transmission of interest rates, hedging and speculating using interest-rate swaps, capital flows, and cross-border acquisition of toxic assets and credit default swaps. The flow of debt across borders facilitates the transmission of financial instability across countries. Equity flows, on the other hand, are more long-term and stable.
The authors make a convincing case for the world to shed its reliance on debt, interest and leveraging, and revamp the global financial system to rely more heavily on equity and risk sharing, the foundation of an Islamic financial system.
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