One of the most striking times for the Islamic US home finance industry began in February 2007. The Federal Home Loan Mortgage Corporation (Freddie Mac) released a press release announcing that it would stop buying the most risky subprime mortgages and mortgage-backed securities. Two months after the announcement, a leading subprime mortgage lender applied for Chapter 11 bankruptcy protection. Three months after this bankruptcy filing, nationwide finance companies warned of “difficult conditions.” Manifestations of such difficult conditions appeared on the horizon of the financial market when established mortgage companies suddenly started applying for Chapter 11. Similar circumstances occurred in the UK when the Bank of England approved a grant to provide liquidity support to Northern Rock, the country’s fifth largest mortgage lender. Five months later, the British Treasury became the owner of Northern Rock.
Up to this point most people did not fully understand the severity of these “difficult conditions”. In late 2008, the Federal Reserve Bank of New York was authorized to lend AIG $ 85 billion. This was the beginning of the worst recession in the United States since the Great Depression. What followed was a chain reaction that led to an unprecedented global financial crisis as the world suffered from rising unemployment, rampant foreclosures and severe skepticism about financial instruments.
This led to another look at an unknown market segment that appeared to be comparatively more stable and, above all, far more ethical: the Islamic finance sector. From the financial centers in Malaysia to the Middle East, spanning more than seventy countries, Islamic funding in the United States rose from $ 5 billion in the 1980s to $ 1 trillion in 2010. This phenomenal growth was aroused the attention of global investors who want to secure their investments through more ethical and reliable financial instruments. When financial sector workers realized that these Sharia-compliant instruments avoided many of the worst effects of the global financial crisis, they became an attractive investment vehicle to support a more diverse portfolio. The Sharia-compliant financial sector has avoided investing in predatory lending and over-indebted financial instruments due to the strict ethical nature of the Sharia governance system. News and media reported on this old but unknown industry in the hope of learning from the mistakes of the conventional banking sector.
The concept of the modern Islamic financial services industry is based on the principles of Islamic jurisprudence dealing with financial transactions, a branch of Islamic jurisprudence called Fiqh Al Muamalat. Fiqh Al Muamalat is a framework under Islamic law that represents the behavior of Muslims in commercial or economic endeavors. Islamic financial products and decisions are based on specific Qur’an instructions that prohibit certain features of financial transaction models and related economic activities.
The Koran forbids interest, also called usury or riba. The underlying reasoning is that Islam views lending as a nonprofit to help another member of society in need. It is therefore strictly forbidden to benefit from a person’s need. In the traditional banking system, the risk of this transaction is transferred to the borrower when interest is charged on a loan while the lender benefits from the interest-based transaction. The difficulties that the borrower suffers should the transaction result in losses are not taken into account.
The Sharia law naturally prohibits unethical financial practices. It also promotes wealth distribution among all people to reduce poverty and inequality. This is reflected in the bans on activities such as excessive speculation, gambling and investments in products that are harmful to society under Islamic law (alcohol, pornography, etc.). The structure of Islamic financial products and services, particularly the ban on speculative transactions, has helped the industry escape most of the adverse effects of the global financial crisis. The governance model of Islamic financial institutions has been praised by institutions such as the International Monetary Fund and the World Bank as an ethical alternative. Economists have suggested that Islamic financial principles can be used to promote financial inclusion that improves quality of life in developing countries. Islamic financial principles can also contribute to financial stability and economic development worldwide.