Potential Role of Islamic Finance in Preventing Financial Crises: A Discourse Based on Three Financial Crises

Abstract

The Capitalist system has undergone numerous crises in its history. The Financial Crisis of 2007-2008 shook the International Financial architecture raising questions as to what was inherently wrong with the system. Islamic Finance offered solutions to the problems confronting the financial system. This study analyzes three crises; Black Wednesday 1992-the currency crisis that shook Britain; East Asian Currency Crisis and the Financial Crisis of 2007-2008.The causative factors of these crises have been isolated and studied under the light of Islamic Finance principles. This is a theoretical and analytical paper and is unique in analyzing the Black Wednesday Currency Crisis in the light of Islamic Finance principles. The study shows that the underlying causative factors of the three crises are in violation of the principles of Islamic Finance. The main causative factor behind the Currency Crises is shown to be the ability to carry out a Speculative attack which is possible due to the facility of short sales. The study shows that short sales are contrary to the teachings of Islamic Finance. Likewise, the role of speculation in the 2007-2008 crisis is also highlighted along with the other causative factors. The study concludes that if the causative factors isolated in the three crises, which are in violation of the rules of Islamic Jurisprudence and still persist in the system, are removed from the International Financial Architecture then this system would be given great stability and the chances of a further crisis would significantly diminish.