An Introduction to Islamic Finance: Theory and Practice

137

CHAPTER

7

The Stability of the Islamic Financial System

Financial Engineering

1

T

he fi nancial crisis that began in August 2007 is considered by many to be
the worst since the Second World War. Representing the collapse of tril-
lions of dollars of fi ctitious credit derivatives and the meltdown of uncon-
trolled credit growth, the scope of this crisis and its intensity have kept
increasing and could potentially continue on a downward path for some
time to come.
The crisis has crippled the fi nancial system of many advanced coun-
tries, and has claimed as victims long - established banking institutions that
were deemed “too big to fail.” Large bailouts by governments and mas-
sive liquidity injections by central banks may have served only to fan the
fl ames. Capital markets have frozen and stock markets around the world
have crashed, wiping out trillions of dollars in share value and in retirement
investment accounts. The level of economic uncertainty is unprecedented
over the last 80 years.
While the full impact of the crisis cannot yet be calculated, it has slowed
down economic growth in many industrialized countries, increased unem-
ployment to levels not seen in 25 years, triggered food riots and energy
protests in many vulnerable countries, imposed extraordinary fi scal costs
with unprecedented government bailouts and fi scal stimuli, and perhaps
threatened the lives of more than 100 million people around the world.
Notwithstanding its far - reaching and devastating consequences, the crisis
has made the quest for fi nancial stability a pressing and fundamental issue.

WHAT IS FINANCIAL STABILITY?

Financial instability has been a recurrent phenomenon in contemporary eco-
nomic history, affecting countries to varying degrees and resulting in mas-
sive unemployment and lost economic output. The most enduring crisis was
the Great Depression of 1929–33. Eminent economists who lived through

An Introduction to Islamic Finance: Theory and Practice, Second Edition

by Zamir Iqbal and Abbas Mirakhor

Copyright © 2011 John Wiley & Sons (Asia) Pte. Ltd.