Islamic Finance and Economic Development: Risk, Regulation, and Corporate Governance

PART Two

Managing Systemic Risks

With hindsight, it seems that every 10 to 12 years an international financial crisis erupts. The East Asia crisis erupted in 1997, hit Thailand, and spread to many countries of the region and beyond. Following each crisis, 10 years are spent assessing and analyzeing what happened and living with the consequences of the measures taken to contain it. Reforms are pursued with the aim of avoiding a repeat episode of distress. In the meantime, the next crisis is already in the making, and soon it erupts where radar screens had not anticipated it. Unlike previous modern crises, the 2007–2008 crisis erupted in the world's financial center, not in emerging markets, and rapidly spread to its periphery with devastating effects. Thus the cycle of boom and bust resumes merrily, while humanity suffers great financial loss, grief, and tragedies. But efforts to stabilize the system, or at least to limit the most damaging effects of its volatility, cannot be abandoned, if not for the sake of maintaining growth, at least for limiting the human dramas that are the natural corollary of financial crises.

The risk of a systemic crisis affecting Islamic financial services (IFS) and the way to cope with it if it occurs have gained relevance in the wake of the 2008 worldwide financial tsunami that spread from the United States to the rest of the world.¹ The international financial crisis naturally prompts the question of whether IFS are robust and resilient or may be ...