The transparency and structure demanded of Islamic finance that is attracting investors burned by the plethora of financial crises could well have provided warning signals of the impending debt turmoil.
The subprime crisis has seen an exodus from riskier asset classes, partly as investors veer away from sophisticated products like collateralized debt obligations.
According to the IMF following paper on the IMF website, Islam prohibits transactions based on Gharar (uncertainty in transactions), Maysir (gambling or the acquisition of wealth by chance instead of effort), and Riba (interest rate). These principles are beneficial for financial stability and consumer protection.
How Do Islamic Finance Protects Investors?
Investors say Islamic finance products demand greater transparency and accountability from company management, so it would be more obvious when companies are getting into debt problems.
Under Islamic finance, the lender is also an investor, so he remains an active participant through the life of the transaction and is in a position to rectify mistakes before the situation worsens, bankers say.
This appeal has added to an exponential growth in Islamic finance
Global bond and loan offerings issued according to Islamic guidelines have jumped 64 percent, to $5.5 billion so far this year, data from Thomson Financial show.
Islamic finance assets are growing at an annual pace of 20 percent and are set to hit $2 trillion in 2010 from the current $900 billion, fueled in part by a flood of petrodollars generated by the rise in energy prices.
Islamic finance principles stipulate that deals must be based on tangible assets and require tight controls on debt levels, features analysts say offer some protection to investors and ensure corporate accountability.
“At the core of the current subprime crisis is the securitization of subprime mortgages or debts, a concept that would generally not be acceptable from a Shariah perspective,” said Arshad Ismail, Dubai-based head of Islamic finance at HSBC Amanah.