Home | Publications | Al Jamiat Volume 7 No. 4 | The Credit Crunch: What does it mean to you?

The Credit Crunch: What does it mean to you?

The buzzword in financial markets at the moment is “the credit crunch” and increasing talk of a global “financial crisis”. Indeed, there is a global financial crisis and many economies are indeed facing a credit crunch. In other words, there are many financial institutions that are struggling to remain liquid amid a crisis of confidence in the financial system. This has led to many financial institutions either closing down or being bought out, or seeking financial aid from governments. The widely touted “bail out” plans as advocated in many countries will seek to “inject fresh capital into the financial system.” As in any crisis, there is a rush to find solutions to the crisis. This article seeks to approach the financial crisis from a different angle: namely, by asking relevant and intelligent questions. The asking of the correct questions is often the first step toward understanding the problem, from which insightful solutions may emerge. In this light, we seek to ask and ponder over the answers to a few simple questions: What is the structure of the financial system, and is the current crises a structural fault? Would Islamic Banking be immune to such a crisis, and is it the answer? What are the implications of the worldwide bail out plans? What can we learn from our glorious Deen that can help us avoid becoming embroiled in such a crisis?

The dominant global financial system, particularly as it relates to banks is highly interconnected. That is why the banking credit crisis caused stock markets the world over to fall in response, thus leaving individuals short of credit and with greatly diminished unit trusts and retirement funds. The basis upon which this interconnected banking system operates is the fractional reserve banking system and debt, Interest bearing debt. Fractional reserve banking can be described as that system of banking which seeks to guarantee the deposits of depositors while only keeping a fraction of it available at any one time. It then makes sense that when more people want to withdraw their money than the bank has in reserve, it cannot meet its obligations, and needs to borrow from other banks, the reserve bank or simply shut down. It is not that the money is lost, but that it is tied up in loans that mature some time in the future. This can best be likened to a lottery or pyramid scheme of sorts, where it is hoped that there is enough money in the system at any one time to pay out on obligations, while using the rest of the money to earn a return purely for the benefit of the bank.

People allow banks this liberty because the banks undertake to pay them interest on their money. This system is susceptible to uncertainty and instability due to the fact that the bank only has on hand a fraction of its potential obligations. The system becomes even more tenuous when the money not held in reserve is lost due to debtors being unable to pay the bank back – this is, simplistically what has happened globally. Due to the globalised nature of the financial system, the lending of money across borders, many banks across the world were affected at the same time, triggering a crisis. Therefore, it is the system of fractional reserve banking that is, itself, inherently unstable, unjust and unfair. The default by creditors is simply an event occurring within a structurally defective system. The very nature of fractional reserve banking is that it will always need bail outs (as every pyramid scheme does).

Islamic banking as it is currently practiced is a fractional reserve banking system. This means a number of things. Firstly, the bank promises that your money will always be available for you to withdraw within a specified time frame, yet they go and use your money in investments and trade that could tie your money up for longer periods, hoping that the reserves that they keep in cash can cover expected demand for cash. They only keep a fraction of the cash deposited with them available as cash, and tie the rest up in a variety of investment activities. Secondly, Islamic Banks profess not to operate with interest, but rather to use profit and loss sharing systems of trade (PLS), and distribute a share of the profits to the depositors (who they claim are in a partnership with them). However, the depositors money is guaranteed – he is always entitled to withdraw the exact amount of money that he has put in – so, where is the risk? Basically, the structure of Islamic Banking is just as flawed as the structure of conventional banking, as it is being operated on a system of fractional reserve. Therefore, it is clear that Islamic Banking as it is currently practiced will be putting Muslims at risk in the same way as the conventional banking system has. The non-use of derivatives and the asset backed nature of the transaction do, admittedly, making it relatively safer, but by no means immune. Full reserve banking is the answer. However, in full reserve banking, no income can be earned, as the cash stays liquid with the bank vault, and the bank merely charges a fee for safekeeping and geographic access. This is the optimal solution to the “banking” needs of the Ummah. The need to earn a return is a separate need, and needs to be carried out in the correct structure. If the Ummah wants returns, they must be true investors, whose capital is at risk and to whom liquidity is not guaranteed. If the Ummah wants their money kept safe, they must be true depositors, and not expect returns, but rather safekeeping. The danger of Islamic Banking as it is currently practiced is that it acts as an unassuming funnel to channel control of the Ummah’s resources away from the Ummah and into the hands of the international conglomerates. Could it be that our money is being unwittingly taken away from us and being made subject to the vagaries of the international stock and debt markets? Instead of insulating the wealth of the Ummah from the results of a Haraam financial system, the current model of Islamic Banking will seemingly result in the safety and security of the Ummah being thrown to the wolves.

The implications of the worldwide bail out plan are simple: consolidation and government control. Essentially, the governments of the world are helping huge banks buy smaller ones, and themselves buying into the huge banks, resulting in the consolidation of control of the Western world’s savings in the hands of a few banks, owned by a few influential shareholders, and run by a few influential executives. Sure, the money belongs to the people on paper, but who will gain possession and control? Do we really own our wealth if we do not possess and control it? The results of consolidation could set in motion the process whereby 1% of the world’s population, controls the wealth of the other 99%. This is not at all far fetched – look at the control and distribution of wealth during the apartheid era. As Muslims, the worrying question is: Once the mega banks control our money, what will they use it for? Will they give loans to build schools in Palestine, or will they fund arms factories in Israel? Is the rate of interest worth the blood of our brothers? How much is our financial and physical safety worth? Will they fund schools and dams, or movie studios and music videos? Will our own money be used to kill our very own belief system? We do not have to look far – look at the state of the Middle East – billions of dollars of petroleum revenue have been invested in Western banks and stock exchanges, yet, how has it helped those countries? Or have Western economies been strengthened by the influx of Arab money?

So, what is the solution? Firstly, we need to create our own financial system based upon the principles, philosophy and ideals as embodied in the Shariah. This will have the effect of “de-coupling” the Ummah from the mainstream financial markets. When the crisis first emerged, many commentators stated that the economically powerful Asian nations were to an extent de-coupled from the Western economy, that is, they were not plugged into the vast financial network that was on the brink of collapse. Why? Because they had economies that depended on trade, not paper assets. They bought and sold physical things for which there was worldwide, everyday demand, and not merely contracts and paper. We need to understand that as things currently are, we are very plugged into this network. The pension funds and retirement annuities which we rely on for income in our old age are all invested in the stock markets and debt markets. Stock market crashes during this financial crisis have wiped out the savings of people about to retire all over the world. Why? Because of perception, speculation, a “crisis of confidence”. People invested all their hopes for the future in financial assets whose values could drop at the blink of an eye, based on nothing more than rumours and speculation. This sounds foolish, but many Muslims do this daily. When the Ulama warn people that the stock market is Haraam (for some of these very reasons), they argue and squeal. They need “big returns”, Shariah investments are too “slow”, etc. Ask these very same people what their savings currently stand at. So-called financial advisers peddle these investments to the Ummah, making all sorts of claims about returns and Shariah compliance – they are doing nothing more than usurping the wealth of the Ummah to be flung into a system of speculation and volatility. Perhaps, it is time to listen to the Ulama when they warn over certain things – do we need a crisis to listen?

Secondly, we need to invest in ourselves. We need to create Muslim owned and Muslim controlled investment houses that invest in real assets and businesses, fully in accordance with the Shariah. As an Ummah, let us buy properties and businesses, invest in schools and hospitals, etc. so that we may achieve a few noteworthy goals: we own and control those goods and services which are crucial to our existence and we can provide them at a fair price, we can create employment for Muslim professionals in a Halaal work environment, and where the Muslim Ummah can invest in and profit from. The time has come to move away from the stock market, retirement funds, equity funds, endowment policies, Islamic Banks, etc. and to invest in ourselves. There are a number of initiatives already taken off with the sole aim of moving the Ummah away from Haraam and disempowering investments and toward self sufficiency, and many Muslims are benefitting. Ask anyone who has had to endure missing Jumuah for the sake of “work”, any female who has had to travel away from home for her “company”, any parent who has had to constantly fight off the Haraam influences on their children from non-Muslim schools, any patient who had to forego purdah and pay huge costs at private hospitals, etc. and they will all attest to the need to invest in our own development and build a parallel economy. We owe it to our youth not to leave for them the legacy of staying up at night worrying about share prices and paying bonds and credit cards, and we owe it to our pious predecessors not to destroy the infrastructure that they put in place with the hope that we may one day be independent. But, most of all, we owe it to ourselves to save ourselves from sin and a great punishment.

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