Sub-Prime Crisis from Islamic Commercial Law Perspectives

Abstract:     
The current economic crisis stems from the US sub-prime crisis exacerbated by the practice of Credit Default Swap (CDS) – an insurance against default risk – whereby the buyer of CDS makes a series of payments to the seller in return for compensation if the debt instrument goes into default or rated downwards. This risk transfer mechanism had failed as seen by the collapse of the insurers themselves, resulting in a systemic effect that pulled down the most part of the US debt market. This type of failure must be avoided if Islamic finance is to be regarded as the alternative financial system. Towards this end, this paper begins with a review on the chronologies of the economic crisis and evaluates the events from the Islamic commercial laws (fiqh al-muamalat) perspectives, specifically on the issues on trading of debt (bai ad-dayn) and bai al kali’ bil-al kali’. An argument on the similarities of CDS to the now allowable practice of guarantee (kafalah) with fees – which is a departure from the classical view – is also established. At the end of this paper, several risk management suggestions are provided for the Islamic capital market. One of them is on the establishment of an aqilah-based common pool to mitigate the Sukuk default risk.

Number of Pages in PDF File: 47

Keywords: sub-prime crisis, CDS, Islamic commercial laws, risk management, debt trading

JEL Classification: D63, K00

working papers series