232 AN INTRODUCTION TO ISLAMIC FINANCE
IFIs can be alleviated through the creation of an index that tracks the social
performance of companies whose activities are consistent with Shari’ah
principles. Given that the welfare of society is the prime objective of Islamic
law, it is essential that the discipline of Islamic fi nance establishes principles
that can gauge whether IFIs are contributing signifi cantly to this objective.
Though no such index exists currently, we believe that one can readily be
modeled on available ethical-investing indices.^3
PERFORMANCE IN CRISIS PERIOD
The fi nancial crisis of 2007–09 offered opportunities for the advocates of
Islamic fi nance to claim that Islamic fi nancial institutions are more resilient
to the stresses of fi nancial crises. Several studies were undertaken in support
of this claim. Some studies found that the primary reason why Islamic fi nan-
cial institutions and capital markets were not directly affected by the sub -
prime fi nancial crisis was that they did not have any direct exposure to toxic
assets and, therefore, were immune to the crisis during its early stages.
However, as the crisis led to economic recession and global slowdown,
Islamic fi nancial institutions also faced deteriorating business and decline
in profi t margins.
Several IFIs that had exposure to real estate developments in the Middle
East experienced an erosion of their asset values. Although this has yet
to show up as a liquidity crisis, it is feared that a lack of strict adherence to
marking assets to market may be disguising the problem, or at least delay-
ing their being brought to the surface. Similarly, it is too early to tell if
Islamic fi nancial institutions will indeed pass through some of the losses to
the depositors or if their equity capital will absorb some of the losses, as has
been done in the past. In addition, several IFIs have been building reserves
from previous years’ profi ts to use during less - profi table periods. The pic-
ture should become clearer shortly. Both Islamic and conventional banks are
facing problems with asset quality in the post - crisis period. For example, in
depressed capital markets, the Islamic banking sector is also facing a decline
of revenues derived from brokerage fees and trade fi nance - related fees.
Hasan and Dridi (2010) conducted a study for the IMF to assess the
impact of the crisis using bank - level data covering the period 2007–10 for
about 120 Islamic banks and conventional banks in eight countries (Bahrain
(including offshore), Jordan, Kuwait, Malaysia, Qatar, Saudi Arabia, Turkey,
and the UAE). The study used variables such as the changes in profi tability,
bank lending, bank assets, and external bank ratings to assess the impact.
The study shows that, in profi tability terms, Islamic banks fared better than
conventional banks in 2008 but this trend had leveled out in 2009 as the
crisis hit the real economy. In general, growth in the credit and assets of
the Islamic banks continued to be higher in all countries except the UAE. The
study concluded that, on average, Islamic banks showed stronger resilience
during the global fi nancial crisis. The other fi ndings of the study were: