Credit crunch opens doors for other possibilities: The Standard

Rudi Prenzlin

Monday, February 16, 2009

As strange as it may seem, there are financial institutions that are benefiting from the global financial meltdown.

Over the past few months, Islamic financial institutions have been reporting significant pick up in business.

Such institutions increasingly appeal to Muslim and non-Muslim customers alike.

To me, this shows that Adam Smith's invisible hand is alive and well, notwithstanding reports of its demise.

But why are Islamic institutions doing well? For that answer, let us focus on two main reasons behind the global credit crunch.

The first cause was the immense increase in the availability and active trading of derivatives.

In many cases, the paper held was not only highly leveraged but also unlikely to be secured by physical assets directly but by more paper.

As a result, banks increasingly held securities that were far removed from their core activities, with a corresponding increase in risk.

The second cause of the credit crunch was the lack of liquidity.

Up until September 2008, banks were quite content to lend to each other in the global interbank market. Almost overnight, the bankruptcy of the New York based bulge bracket investment bank Lehman Brothers - caused in no small measure by its overexposure to some of the complex derivative instruments - put an end to this in the middle of September 2008.

The resulting lack of liquidity in the interbank market, based on the extreme risk aversion of global banks that could no longer trust each other's balance sheets, had the unwanted outcome of also stopping the global economy in its tracks.

For more on this article, please click on the following link: Credit crunch opens doors for other possibilities: The Standard