TITLE:
Conventional Banks Risk Diversification: A Case for Islamic Finance
AUTHORS:
Issam Tlemsani, Robin Matthews
KEYWORDS:
Financial Risk, Crisis, Islamic Finance, Financial Stability
JOURNAL NAME:
Theoretical Economics Letters,
Vol.9 No.6,
August
27,
2019
ABSTRACT: This paper challenges the idea that the conventional
financial sector either innovates or diversifies risk. To understand
diversification of risk and the true nature of innovation in finance, this
paper distinguishes between risk spreading and risk sharing. Risk spreading
characterises conventional finance and risk sharing characterises Islamic
finance. We argue that the case for Islamic
type financing in the sense of risk sharing is a safer approach and overwhelming for governments, regulators and for financial
institutions that consider themselves innovators in an historic sense, contributors to society rather than greedy acquisitors of personal
wealth. Effectively, innovation according to the originate and distribution
model of banking amounts to (a) a wealth transfer from the rest of the world to
people in financial sectors, mostly in developed economies and/or (b) asset
depreciation/default. We are describing a situation rather like that described
by the story told to children about the emperor having no clothes. In
the story, an
emperor, suffering from an excess of pride or insecurity, is manipulated by an
exploitive tailor into believing he has been supplied with magnificent robes
that only the privileged and enlightened can see. No one dares to believe their
own eyes that tell them unequivocally that the emperor is naked, except a
child, who blurts out: “why is the
emperor naked?” Why is there not a similar response to the nakedness of the
financial sector, when its contribution, nationally and internationally has
been so massively negative? We argue that one of the reasons is that we,
meaning governments, regulators, bankers and the rest of us, are mostly divided
into three groups; those who understand the mathematics of finance but not
financial institutions, those who understand financial institutions but not the
mathematics of finance and those who understand neither. The purpose of this paper is to examine conventional
finance risk diversification and compare it to the Islamic finance risk sharing
approach. The findings of this paper demonstrate that the Islamic finance risk
sharing approach is safer.