Contemporary and Social Issues

Thoughts on The Banking Crisis in the West

The economic crisis of the 21st century has been the worst since the Great Depression of the 1930s, but what were the main factors behind it and what was the true extent of this downturn?
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‘Absolute ownership of everything belongs to God alone.’

—The Holy Qur’an, 3:190

‘All ownership is subject to the moral obligation that in all wealth all sections of society have a right to share.’

—The Holy Qur’an, 51:20

‘Whatever Allah has given to His Messenger as spoils from the people of the towns, it is for Allah and for the Messenger and for the near of kin and the orphans and the needy and the wayfarer, in order that it may not circulate only among those of you who are rich.’

—The Holy Qur’an, 59:8

The economic crisis in the early decade of the 21st century was the result of many factors; some economic, some political, some social, and some cultural. Economic cycles have existed throughout history; in days gone by they were related to the agrarian cycle; today they are related to the business cycle. Therefore, an economic downturn is not surprising in itself. What has been surprising has been the extent of the downturn – the worst global crisis since the Great Depression of the 1930s. Interestingly, some of the causes are similar.

Economic causes included an unprecedented increase in petroleum prices, although one should not forget that the primary beneficiaries of such increases are the oil companies. Thus, OPEC benefits as much as Shell, Exxon, Texaco, etc. Europe and the USA may pay more for imported petroleum but gain as their multinational oil companies share in record profits.

Financial institutions took advantage of a general feeling of euphoria in the 1990s and early 2000s. As governments cut back on public expenditure, taxes were reduced to make the general public happy. This increased disposable incomes and fuelled a growth in consumer spending. Unfortunately, unlike the past, personal savings or disposable income was no longer a check on spending, since financial institutions were willing to provide unlimited consumer finance. Consumer finance, the most risky of financing, was covered by fixed rates on loans, fixed rates on deposits, and the mechanics of both formal and informal deposit protection.

Over the last twenty-five years, the state has been taking a step back from involvement in economic activity in the west. This is because of a new, more laissez-faire model in North America and Europe, which favours lower taxes, less social welfare, less public sector activity and more business involvement in the economy. Private-public partnerships were in vogue, and as a result the state withdrew from what had been its traditional responsibilities, such as health, education, and welfare. Unfortunately, it also withdrew from actively regulating the private sector. There were many examples of this in the US and Europe in the new millennium, and these examples could have predicted a more serious global problem.

As governments withdrew from regulation, the private sector became free to feed its greed without check. Commercial bank spreads reached record levels; financial institutions took greater risks to feed money-hungry shareholders; technology provided new opportunities through complex new financial products and avenues to circumvent regulation; higher disposable incomes and cheap credit fuelled speculative booms in property and financial assets. Moral hazard, adverse selection and debt, encouraged excessive risk taking without adequate checks and balances, such as the expansion of consumer credit all over the world. Misplaced confidence in the regulators (who had withdrawn from an active role) encouraged excessive interest and holding of risk assets.

The debt markets boomed as more and more people wanted to participate in this superficial growth, to increase personal wealth. To ensure that all could participate, financial institutions removed traditional checks and balances, and accepted compromises on the quality of assets, since profits were guaranteed through fixed returns. Well-known economists came under the influence of the boom; others, however, were more conservative and warned of future disaster.

In all this, the multilateral agencies, especially the International Monetary Fund (IMF), reinforced the move towards less governmental influence and more private sector power. And in their desire not to be left behind, developing countries embraced the laissez-faire dogma of the IMF at the expense of all common sense and rationality, simply because it was the philosophy of the day.

Could it have been avoided? Unfortunately, predetermined biases in both the West and the East do not permit their countries from looking seriously at Islamic financial and economic principles. Countries with avowed Islamic systems, such as Pakistan, have also fallen foul of the global crisis because their behavior was no different from that of North America or Western Europe. The key Islamic principles would have been:

a. Focus on real as opposed to financial assets, which would have limited the growth of financial markets and especially leverage, and linked it to real variables in the economy.

b. Risk sharing, which would have automatically checked the uncontrolled expansion of risk assets without proper examination and evaluation.

c. Ownership status, which would have restricted debt financing and checked an uncontrolled growth in the property markets.

d. Product conformity, which would have checked the growth in risky consumer products.

e. Profit sharing, which would have ensured that returns to institutions were not guaranteed but reflected prevailing economic conditions.

The five points above would suggest that a conventional interest-rate based financial system can neither ensure adequate returns, nor protect investors, nor guarantee continuity. In fact, the substitution of equity for conventional debt, and profit for interest, automatically ensures more rigorous checks and balances, as well as greater fairness and transparency.

In conclusion, it is the author’s considered opinion that the withdrawal of the state from its primary role of regulation and creating a level playing field was the core reason for market failure. Government ownership through public goods, such as health, education and welfare, as well as regulation of services such as transportation and utilities, is a necessity. It is also the author’s opinion, that when Hazrat Khalifatul Masih IIra, the second worldwide head of the Ahmadiyya Muslim Community,  rejected capitalism (for its excesses and greed) and communism (for the absence of an incentive structure), he captured the essence of the welfare state, where equality was reflected in opportunity, and the state had a critical role in ensuring the equality of opportunities. This, to my mind, is the essence of the verses in Chapters 59:8 and 4:33 of the Holy Qur’an, as well as Chapter 16:72.

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About the Author: Dr Bashir Ahmad Khan is Founding Dean and Professor of the School of Business and Management at Information Technology University in Lahore, Pakistan. He has previously been associated with the Lahore University of Management Sciences as well as Forman Christian College in Lahore. He holds a DPhil and MSc from Oxford University. His research interests are in the area of governance of higher education institutions and creating non-interest based financial institutions. He also works as a consultant. The views expressed here are the author’s alone and do not reflect the views of any other person or institution.

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