Islamic Finance and the New Financial System: An Ethical Approach to Preventing Future Financial Crises

Chapter 6Overview and History of Islamic Finance

Looking back at past financial crises, we can see how debt plays a significant role in building up to a crisis as well as the ensuing pain it causes once a crisis is sparked. A high level of debt, however, is not the cause of a crisis; it is merely a symptom of other problems in the financial system. Take, for example, the global financial crisis of 2008. The high level of debt consumers were taking on was not the problem; it was a symptom of the loose lending standards that had become prevalent in the United States and elsewhere. There were three other problems in the system that led to the unsustainable increase in the level of debt: low interest rates, which encouraged more borrowing; lax regulation and oversight, which led banks to take on more risk and engage in fraud; and financialization of the economy, leading to engineering of new and complex financial products, such as credit default swaps (CDSs). This financial engineering not only gave the industry, and the economy, a false sense of security, it also resulted in an overbloated financial industry that continued to play a bigger role in the economy while productive industries, such as manufacturing, play a lesser role.

So if rapidly rising debt is a symptom of the problem, what can be said today, six years after the worst financial crisis the world has seen since the Great Depression? According to the Bank for International Settlements (BIS), the amount of debt globally ...