Sample Essay

Though there are arguments suggesting, a high level of inherent risk for the Islamic banks, these arguments have had no empirical support. However, the shareholders of Islamic banks ought to exercise an effective control on the bank operations due to lack of any deposit insurance, whereas, conventional banks generally are protected by some kind of deposit insurance, such as Federal Deposit Insurance Corporation in the USA (Cihak and Hesse, 2008). On the other hand, it is quite clear that certain specific features of the Islamic banks make them less risky compared to the conventional banks. These features include the ability of the Islamic banks to pass through a loss to the investment depositors (e.g. Mudaraba deposits).

Islamic banks have their own inherent risks; however, they are not directly affected by the current financial crisis. The opinion of some of the experts in the field of Islamic Banking is summarized below (Al-Hamzani, 2008).

Islamic banks are not involved in trading of debt securities due to prohibition of interest in Islam. One of the major causes for the current financial crisis is the use of MBS. These derivatives are issued based on subprime mortgages that earn interest. Islamic banking is distinguished by the fact that it is prohibited from buying debt securities under Islamic Sharia’a law; therefore, Islamic banks are safer from the direct effect of the global financial crisis. Second Islamic banking distances itself from investing in projects with excessive uncertainty due to the prohibition of Gharar. MBS and other securities are packaged and repackaged to sell in tranches with a high rating though they were issued based on subprime loans. Therefore, there was a high amount of risk associated with these derivatives. Thus, the prohibition of interest and Gharar provides a protection wall to the Islamic banks and inherently they were able to avoid the direct brunt of financial crisis. Whatever negative effect we see on the Gulf countries is more of a psychological nature. Islamic banks will be affected to a certain degree as they are part of the wider global financial system and consequently will be affected by all global financial dealings, even if only in an indirect manner.

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