Islamic finance in the era of deleveraging The clear and present danger to all financial activity, including Islamic finance, is the risk of contagion from an escalation of the Eurozone crisis. Islamic finance is closely intertwined with underlying economic activity and will be affected by the impact of slower global growth. Contagion from the Eurozone has already curtailed economic growth and capital inflows to many emerging economies where Islamic finance has taken root. Potential spillovers from an escalation of the Eurozone crisis could lower output in the Middle East and North Africa region by about 3¼ percent relative to baseline, the largest spillover effect for any region outside Europe. But Islamic finance has a window of opportunity in the current climate of deleveraging in the global financial system. With its strict prohibition on excessive leverage, Islamic finance has been spared the worst of the financial crisis. Islamic banks are well positioned to reach out to new customers who are in need of financing as many global institutions pull back on their lending due to the need to repair their balance sheets. Islamic finance should diversify into growth areas such as trade and infrastructure financing, where demand is still strong, especially in emerging economies. With a focus on supporting real productive activities, Islamic finance is naturally compatible with trade and infrastructure development. Tapping these sectors also brings about greater diversification benefits, especially for Islamic institutions which have been hurt by their significant lending exposure to the real estate sector.

At this point, it is worth noting that many developing countries, particularly emerging market economies, have actively participated in the world trade and global economy over the last two decades. The presence of emerging market countries, particularly the Asian economies, is growing, and their share in world trade has increased significantly. (b)  Secondly, the importance of non-bank financial institutions in the financial intermediation process has increased. The main examples of these institutions are securities firms, insurance companies and mutual funds. Therefore, we can say that the higher the level of international competition, the higher the economic growth, the higher the income level, the higher the quality of products and thus the higher the living standards the globalization process would bring. (3)  Globalization reorganized some concepts such as stabilization, risk-taking, supervision and regulation of banking systems, market discipline, public guaranty on deposit and moral hazard. As I mentioned earlier, parallel to the development of new financial instruments and markets and the resultant more complex and dynamic transactions, risk measurement and risk management techniques have changed dramatically. Financial institutions have increasingly been using internal rating and other risk measurement systems and models such as VAR, stress and back testing, and scenario analysis. As a result of these developments, every trading institution, including central banks, has become more exposed to changes all over the world economies and financial markets. Indeed, the recent Asian financial crisis revealed that the financial and economic stability of emerging market economies is extremely vital for global financial and economic stability.