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How Islamic financial markets are safe haven in conventional market crisis

Islamic law prohibits any forms of interest or gambling. Transactions that lack transparency are also banned

Larisa Yarovaya | The Conversation 

growth, investment, income, dividend, mutual fund, finance

Islamic finance is enjoying a surge in popularity, with 14% annual growth in recent years. And the in sharia-compliant and bonds is growing across the non-Muslim as well as Muslim world.

My recent research shows that there is good reason for this growth. In fact, Islamic were not rocked by the 2007-08 financial as much as conventional and can be considered a new safe haven for investors.

The popularity of Islamic financial instruments among Muslims is not surprising. Islamic law prohibits any forms of (riba) or (qimar). that lack transparency (gharar) are also banned. In finance, this means that the vast majority of assets and popular trading strategies (such as short-selling and speculation) are prohibited according to Islam.

To circumvent this problem Islamic banks issue sharia compliant bonds known as sukuk. Conventional bonds involve a contractual obligation to pay bondholders and principle on a certain date. When sukuk bonds are sold to investors the money is used to invest in an asset, of which the bondholders have partial ownership. Payments to sukuk bondholders them comes from whatever after-tax profit is made on the asset. When they reach maturity, the issuer is contractually obliged to buy the bond back at the value it was bought for.

The Quran prohibits and shutterstock.com

There are also sharia-compliant stocks, which must comply to risk-averse criteria such as a low to income ratio. Plus, the company should have limited engagement with activities that are considered sinful in Islam, such as alcohol and tobacco. So Islamic are attractive for Muslim investors, but also for non-Muslim investors, since these assets can be seen as more ethical.

Wider benefits

There are two popular beliefs that attract non-Muslim investors to choose sharia compliant assets. First, Islamic financial instruments can offer higher profits than non-Islamic assets. For example, for borrowers, high demand for ethical assets increases the marketability of sukuk in comparison to conventional bonds.

Second is the idea that are decoupled from conventional There is a belief that the move in opposite directions during crisis periods so when conventional decline, Islamic ones grow. So, Islamic offer an important way for investors to diversify their portfolios and protect themselves against downturns in conventional

As a result, Islamic finance is often placed in the category of alternative finance, with good potential for risk reduction. Myself and colleagues in the US, Saudi Arabia and Tunisia decided to put this idea to the test. After all, Islamic bonds are, generally speaking, not much different from traditional bonds in terms of their structure. And Islamic are often affected by the same global risk factors as conventional stock such as the crude oil price and the volatility index.

A safe haven

There have been a number of financial crises to rock stock over the years. The last two decades have seen the 1997 Asian financial crisis, 1998 Argentinian crisis, 2007-08 US and financial crisis to name a few. This causes significant volatility across markets, causing substantial loses for investors. They are therefore constantly searching for that are less influenced by crisis shocks.

In a recent study we compared Islamic indexes with their conventional counterparts during crisis periods in last two decades, across five regions: the US, UK, Canada, Japan, eurozone and the Asia-Pacific. We found that during turbulent periods the Islamic indexes decoupled from non-Islamic

There was limited spillover of the crisis shock from conventional indexes to Islamic ones and so they did provide an opportunity for risk reduction. For example, with Canada’s Islamic and conventional indexes, during tranquil periods the volatility spillover from conventional to Islamic index reaches close to 40%. But after the 9/11 terrorist attacks the Canadian Islamic index receive just 10% of volatility. This reflects the fact that volatility levels are quite similar during tranquil periods, but there is a separation when turbulence hits conventional

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These results are also true for the global financial crisis and the eurozone crisis. The behaviour of the net volatility spillovers between Islamic and conventional shows that the Islamic indexes move against conventional indexes during the turbulent periods.

Shariah compliant assets will not save investors entirely from loses – it does not act as a cushion against all financial shocks that affect the conventional And, in periods of economic stability, investors would not benefit much from investing in Islamic markets, as the correlation between Islamic and conventional is high during calm periods. But, nonetheless, Islamic have been less heated by global financial shocks and so can claim the status of a new safe haven, particularly from a non-Muslim investor’s perspective.


Larisa Yarovaya, Lecturer in Accounting and Finance, Anglia Ruskin University

This article was originally published on The Conversation. Read the original article.

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First Published: Mon, October 23 2017. 08:51 IST
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