Effect of Islamic Banks on Economic StabilityAs a follow-on to previous posts discussing Islamic banking, I'd mention a working paper by Ewa Karwowski (School of Oriental and African Studies, University of London) recently published by the Levy Economics Institute of Bard College.
In her paper, Karwowski examines the issue of whether the presence of Islamic banking in Malaysia contributes to macroeconomic stability in the country.
Karwowski's paper is quite technical, but it is possible to report her main conclusion in layman's language:
Contrary to the claims of Islamic scholars, Islamic banks channeling funds from companies to households play a destabilizing role in the economy as a whole. Credit granted to the household sector is used for housing purchases and therefore inflates this asset market, increasing the system's economic fragility and encouraging speculation.In other words, a pattern of overinvestment in housing (and consumer durables such as cars) tends to create bubbles that eventually collapse, leading to reduced and even negative economic growth just as in an economy like that of the US, in which the presence of Islamic banking is negligible.
Karwowski argues that the similarity she found between sources and uses of funds at Islamic banks and those at conventional banks, are due to the fact that the two types of banks operate in a single economic environment dominated by the conventional banks. This constrains the ability of Islamic banks to adopt idiosyncratic practices while still attracting customers.