Shariahnomics 2 – Islamic finance during the crisis

Posted in economics, institutions, micro by jrahman on March 18, 2013

I discussed the theory of Islamic finance in the last post on this subject.  Here is a nice summary of the difference between Islamic and conventional banks’ approaches to risk.

Risk Sharing and Risk Transfer

The above is from work done by Maher Hasan and Jemma Dridi, two IMF economists, on how Islamic banks performed during the global financial crisis (and the period leading up to it).  In a 2010 working paper, they use bank level data from 120 Islamic and conventional banks from eight countries* over the period 2007-10 to explore why Islamic banks might have performed differently during the crisis. 

They found that while Islamic banks were more profitable than conventional in the boom years leading up to the crisis, this was not driven by risk-taking.  Specifically:

Shariah principles precluded IBs from financing or investing in the kind of instruments [such as collateralized debt obligations and credit default swaps] that have adversely affected their conventional competitors and triggered the global financial crisis.  

However, in 2009, Islamic banks’ profitability suffered relative to conventional banks because of too much exposure to any one sector or borrower.

The authors also found that larger Islamic banks did better than smaller ones, policy implication being that “…developing the industry and increasing competition should be achieved through establishing large and well managed IBs that can compete with existing banks”.

In a follow up article, the authors highlighted challenges facing the industry and policymakers: need for appropriate institutional arrangements for the resolution of troubled financial institutions; lack of harmonized accounting and regulatory standards; and insufficient expertise.

I started this series before the Shahbag Awakening interest in the Islami Bank Bangladesh.  Whatever happens to that institution, there is a demand for Islamic banking and finance in Bangladesh.  Experiences and challenges elsewhere should be studied carefully by our policymakers.


*Bahrain, Jordan, Kuwait, Malaysia, Qatar, Saudi Arabia, Turkey, UAE.

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  1. shoronarthhi said, on March 18, 2013 at 10:12 am

    In practice though, the risk sharing distinction is probably overplayed, given the continued dependence on murabaha transactions in the sector, which the paper notes. (From what I understand, BIB too relies almost exclusively on murabaha.)

    Surprised at the CDO quote. Structured products are hot and happening in the sector – see sukuks.

    (Have to the read the rest of the article, but should have additional thoughts…)

    • jrahman said, on March 19, 2013 at 12:13 pm

      Yes, the risk sharing distinction may well be overplayed in practice. Also, the Fund article is a few years old. I wonder what the more recent data would show.

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