The Sovereign Debt Crisis and Islamic Banking

By Lahem al-Nasser

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. 

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