Academic journal article Journal of Finance, Accounting and Management

Does Islamic Finance Prevent Financial Crises: A Global Perspective

Academic journal article Journal of Finance, Accounting and Management

Does Islamic Finance Prevent Financial Crises: A Global Perspective

Article excerpt

Introduction

Financial crises occurred repeatedly since the termination of Gold Standard regime which contributes towards a great depression in 1929-1930 ( Davis, 1996). Normally, it has been seen that financial crises frequently occurred in the period of Bretton Woods Agreements and in deeper volume. However, the latest financial crises had been triggered by mortgage crises in USA which suffered many financial institutions in trouble and mostly got bankrupt like Lehman Brothers. These crises had been called the worst one by economist because it causes severe effects on other economies like Greece and Portugal. These crises did not happened due to managerial faults however; it is mainly attributable to structure faults under different regulatory policies and mechanism. (Lietaer, et al., 2009).

Numerous factors are responsible for bringing financial crises; however they occur due to happening of either the mismanagement of financial liberalization and globalization, or severe fiscal imbalances, in developing countries .(Web Chapter)

Financial crises severely impact the economy through dampening of following ways:

* Financial sector and market downturn

* Market Weakness

* Equity blockage and bankruptcies

* Economic shortfalls like unemployment, inflation and workers layoff

* Decline in crude oil prices

* Loss of confidence in financial markets

* Currency and exchange rate fluctuations

Since the financial crises occurred repeatedly, economies still did not find any solution to control or prevent future financial crises. This financial instability prompts to posture new challenging regarding financial stability and constructing a stable financial system in future. However, Islamic Finance may be able to better solution in healing of financial crises. (Zerban, at,al, 2012)

Problem Statement

"Does Islamic finance prevent the financial crises ".

Research Questions

1) Does the Islamic Finance help in preventing the financial crises?

2) What are main root causes of financial crises from different school of thoughts?

3) Do policy reforms for repression from financial crises different for developed and developing economies?

Objectives and Potential Contributions

1) The main objective of this study is to investigate whether Islamic finance prevent financial crises or not?

2) Policy reforms would be provided from recovering of financial crises for both developed and developing economies.

Main Causes Of Financial Crises

Financial crises have been viewed under different school of thoughts. In this study, root causes of financial crises has been presented under economic and Islamic perspective in ensuing paragraphs

From Economic Perspective

Under economic perspective, financial crises have been caused due to following factors

* Boost up in Interest rate:

Due to adverse selection, credit rationing in which borrowers denied loans even they can pay high interest rate. High interest rate is an important element in bringing the financial crises because it will decrease the supply of loans. High interest rate leads to better chance that lender will lend even to bad credit risks and even a probable crumple in loan market

* Asset Market Effects on Balance Sheets:

Deterioration of balance sheet creates the adverse selection and moral hazard problem in financial markets and leads to financial crises if deterioration is significantly higher. Moreover, stock market crash translates the decline in net worth of companies that increases the moral hazards chances for borrowing companies to make riskier investments. Deflation also contributes to financial crises as it declines the net worth of companies.

* Increase in Uncertainty:

An increase in uncertainty due to stock market crash, recession and political instability makes the selection problems worse that leads to financial crises. …

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