Prof. Dr. Erhan Akkas

This book explores the causes of the current economic crisis, evaluates the foundational principles of capitalism that contribute to crises, and investigates how an Islamic economic and banking system could play a role in fostering global stability.

It includes insightful chapters covering theoretical and empirical analysis carried out by budding and prominent researchers in the field of Islamic economics. The book assesses the resilience of the Islamic economic system and Islamic financial institutions in the face of economic and financial crises, with a particular focus on Organisation of Islamic Cooperation (OIC) member countries. Furthermore, the effects of these crises on income and wealth distribution are discussed.

The book compares Islamic and conventional economics in response to economic crises, both across countries and financial institutions and provides a brief analysis of financial crises from a theoretical point of view, examining various approaches. It discusses how the Islamic financial system could serve to mitigate the occurrence of a financial crisis, since the prohibition of Riba, Maysir, and Gharar transactions offers a solution to financial crisis from speculative bubbles and crash. It also discusses some of the challenges facing the Islamic finance industry.

The first chapter provides a brief analysis of financial crises from a theoretical point of view. It examines approaches that regard financial crises as a disturbing factor of a generally stable real economy. It also examines behavioural finance since many theories suggest that financial crises sometimes appear to be driven by irrational factors and behaviours. The prohibition of Riba, Maysir, and Gharar transactions offers a solution to the financial crisis from speculative bubbles and crash. The principle of equity financing in Islamic economics is a solution to the financial crisis from the sovereign default.

The second chapter analyses the institutions as rules and organizations in Islamic economics and financial framework to deal with economics and financial crisis. It explains that Islamic economic and financial system has a role for markets, but the asset and goods markets are closely synchronized with real economy-based commodity and fund flows.

Islamic economics framework avoids the situation of glut and deflation with careful evaluation of investment projects with wide risk sharing. Islamic rules and norms of trade emphasize on commitment in contracts which is strengthened through rules regarding necessity of assuming ownership, possession, and risk before entering in trade contracts.

Avoidance of excessive non-asset-based leverage reduces the risk of both firms and investors. Prohibition of speculative trades and a check on artificial liquidity and leverage-based trading helps in checking asset price bubbles. Rewards are matched to risk, and the risk has to be borne by all capital providers with prohibition of Riba.

Finally, the ‘beyond-market stabilizers’ help in wealth and income redistribution irrespective of the phase of business cycle. Thus, Islamic economics framework is more resilient to avert crisis and deal with it through its set of commercial and social finance institutions and business ethics.

The third chapter assesses the effects of the global economic crisis on income and wealth distribution within countries while exploring Islamic finance solutions for achieving greater equity. Given the inherent flaws in the current economic system, Islamic finance and economics propose various alternatives to address disparities. Specifically, Waqf based on microfinance emerges as a prominent solution, aiming to enhance overall societal well-being and alleviate poverty. Additionally, FinTech within Islamic finance offers another avenue for ensuring fair distribution, facilitating easier donations such as Sadqa and Zakat, as well as executing transactions like Mudarabah and Murabaha.

The fourth chapter notes that the general acceptance of Minsky’s hypothesis, which states that financial crises are not the results of mistakes or external forces but a natural path of how the current economic system works, was a big hit in the economics literature after the 2008 Financial Crisis. With the creation of vast amounts of debt by printing un-backed money and financial innovations, it is now easier to increase the risk and transfer it to the counterparty. This system makes excessive borrowing a profitable but riskless process for those posing the risk.

Since Ponzi borrowing became the inevitable outcome of the system, it is also impossible to avoid financial crises. Furthermore, putting the economic agents who create and transfer the risk in the centre of the system makes the failure of those agents accompany the failure of the whole system. Therefore, the “Too Big to Fail” concept becomes unquestionable but causes “socializing private losses while maximizing private gain.” This chapter posits that the primary cause of the 2008 crisis is excessive debt, and it discusses how the interplay of supply and demand factors inherent in the current system inevitably leads to excessive debt.

The fifth chapter explores the relationship between Islamic equity investing and conventional equity investing. The findings show that conventional and Islamic stocks can mutually diversify each other in the event of excessive and widespread volatility.

This sixth chapter predicts the economic crisis in Organization of Islamic Cooperation (OIC) countries using machine learning. It uses debt to gross domestic product (GDP) ratio as a proxy for the economic crisis. This study considers the panel dataset from 57 OIC countries covering the period 1970–2020 for model training and testing and develops five machine learning models to compare their prediction accuracy.

Results suggest that Random Forest Classifier outperforms other models with 83.8% accuracy. Additionally, variable importance shows that total reserves are the most influential variable for debt crisis prediction and contribute 13.25% to the model. The results of this study offer significant implications for the policymakers to predict the economic crisis and make strategic decisions to prevent or lower the effect of economic crisis.

The seventh chapter states that US dollar has recently become unreliable and risky to use for any country that wishes to preserve its sovereignty, rather than obey US orders. The three countries forming the geo-strategic ECO partnership, Turkiye, Iran, and Pakistan, are increasingly using each other’s currencies for trade. The unique system of conditional currency convertibility based on a range of commodities, devised by Grondona in the 1950s, offers an economically and politically attractive approach to stabilizing exchange rates, using traded primary commodities to stabilize the real value of their currencies.

Islamic scholars have judged this system to be Shariah-compliant, making it particularly suitable for the three members of ECO. This chapter illustrates the system by simulating how it could have operated in terms of the Lira, Rial, and Rupee over the years 2018 through 2021, using past commodity market and exchange-rate data. These simulations show how each country’s reserves of selected basic, storable, traded commodities would rise and fall over the trade cycle, causing a corresponding counter-cyclical variation in the national money supply on a scale decided in advance to be appropriate.

This would help to reduce inflation and stabilize mutual exchange rates in a way which can be made progressively stricter and can be adopted by many other countries, leading to a wide group of countries ending their dependence on ‘fiat’ money, which is a major underlying goal of Islamic economics.

This eighth chapter investigates whether Islamic banks are more resilient to uncertainties than their counterparts. Gulf Cooperation Council (GCC) countries are included in the sample, namely Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE), which are heavily dependent on oil revenues and therefore affected by the current global and local crisis. Therefore, it would make sense to analyse hydrocarbon-based rentier economies which are directly affected by uncertainties and have a large amount of global Islamic finance assets. From this point of view, this chapter aims to analyse how rentier economies’ governance indices impact the financial stability and performance of Islamic banks and conventional banks. In addition, this chapter argues that Islamic banks respond to uncertainties similarly to conventional banks.

Finally, the last chapter highlights that geopolitical risk significantly affects oil prices, affecting the public sector. Furthermore, geopolitical risk might have a negative effect on Saudi Arabia’s high foreign reserves retained via high oil prices.

Therefore, oil prices are a major concern in terms of geopolitical risk. Examining the relationship between these three variables in an oil-exporting state to comprehend the magnitude of the impact of changes in oil prices and geopolitical risk on inflation is instructive. Overall, the book is a useful guide for researchers and advanced students of Islamic Economics and Finance.