On the Significance of 'Trust' for Islāmic Financial Industry: Lessons from the Financial Crisis of 2007-8

Abstract

The notion of "trust" as social capital and an intangible asset has been discussed in the literature for some time but the financial crisis of 2007-8 has highlighted the significance of "trust" with respect to corporate governance, business ethics, confidence in leadership and policy-makers, and on financial system and the markets. In this paper we assessed the key triggers of the recent financial crises as it relates to issues of moral hazard and lack of transparency on the nature of financial instruments. We argue that this led to the lack of trust in financial systems. We provide analytical and descriptive quantitative evidence that Islāmic financial institutions undertake a sacred duty for their clients whose trust in them is invaluable. Any damage to this trust can have consequences not only for an individual institution, but can also have grave precautions for the industry as whole. The paper concludes that trust is vital to developing well-functioning financial systems. Moreover, transparency on the nature of Sharī‘ah compliant financial contracts should go hand in hand with developing financial literacy to ensure deepening trust in the financial system and its ability to support growth and economic development.

Keywords: Trust, moral hazard, social capital, Islāmic finance

JEL Classification: E58, E65, F53, G18, G28, N27, O55