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Foreword ix Acknowledgments xiii Glossary of Arabic Terms xv Introduction 1 CHAPTER 1 The Nature of Capital and the Rate of Return 11 CHAPTER 2 The Origins of Financial Panics and Recessions 23 CHAPTER 3 Monetary Policy and Financial Crises 37 CHAPTER 4 The Internationalization of Financial Crises 45 CHAPTER 5 The Role of the Credit Multiplier in Financial Crises 61 CHAPTER 6 The Inherent Stability of Islamic Finance 75 CHAPTER 7 A Theoretical Model of the Inherent Stability of Islamic Finance 83 CHAPTER 8 Asset Pricing and Risk in Islamic Finance 93 CHAPTER 9 Islamic Financial Intermediation and Markets 113 CHAPTER 10 Risk Profi le of Islamic Financial Intermediaries 131 CHAPTER 11 Financial Engineering, Derivatives and Financial Stability 141 CHAPTER 12 Corporate Governance and Financial Crises 163 CHAPTER 13 The Performance of Islamic Financial Intermediaries and Products 183 Conclusion 209 Bibliography 217 Index 225

PROF. HOSSEIN ASKARI received all his university education, including a Ph.D. in economics, at MIT. He has taught at MIT, Tufts University, the University of Texas at Austin and is now the Iran Professor of International Business and International Affairs at the George Washington University. He served for two and a half years on the Executive Board of the IMF and was Special Advisor to the Minister of Finance of Saudi Arabia. In the mid-1980s he was the director of a multinational team that developed the first energy plan and energy planning models for Saudi Arabia. He has written extensively on economic development in the Middle East, international trade and finance, agricultural economics, oil economics, economic sanctions, and on Islamic economics and finance. DR. ZAMIR IQBAL works as Lead Investment Officer in the Treasury of the World Bank in Washington, D.C. He earned his Ph.D. in International Finance from the George Washington University, where he also serves as adjunct faculty of International Finance. He has extensive experience with capital markets, structured products, risk management, financial sector development, and financial modeling. His research interests include Islamic finance, financial engineering, structured finance and risk management. He is co-author of several books on Islamic banking and finance. DR. NOUREDDINE KRICHENE received his Ph.D. in economics, University of California, Los Angeles, 1980; joined the International Monetary Fund (IMF) in 1986; and held the position of advisor at the Islamic Development Bank. DR. ABBAS MIRAKHOR received his Ph.D. in Economics from Kansas State University in 1969. After teaching at various universities in the USA and in Iran he joined the staff of the Research Department of the IMF in 1984. He became an Executive Director of the IMF from 1990 until his retirement in 2008. He is the author of a number of articles and books on Islamic economics and finance. He is now the first holder of the INCEIF Chair in Islamic Finance.

The financial crisis that struck in 2007 crippled the global financial system and made financial stability a global priority. The crisis also exposed several vulnerabilities of the conventional financial system stemming from high leveraging, complexity of transactions and instruments, and disconnect between the real and financial sector. In this path-breaking book, the authors develop an analytical case for the inherent stability of an Islamic financial system, a system that is based on equity financing and risk sharing. Conventional banks are exposed to credit and interest-rate risk and may face problems of liquidity. In order to maintain their payments, rediscounting and borrowing from the central bank become pillars for their smooth operation. Central banks create money out of thin air and support a rapid expansion of credit that exposes banks to systemic risks, in the form of a general collapse of asset prices or widespread default in subprime markets. In Islamic finance, banks do not have or cause any asset212;liability mismatch and are thus not dependent on central bank financing. In conventional finance, instability is not contained. What starts as a crisis in one country becomes global through the transmission of interest rates, hedging and speculating using interestrate swaps, capital flows, and cross-border acquisition of toxic assets and credit default swaps. The flow of debt across borders facilitates the transmission of financial instability across countries. Equity flows, on the other hand, are more long-term and stable. The authors make a convincing case for the world to shed its reliance on debt, interest and leveraging, and revamp the global financial system to rely more heavily on equity and risk sharing, the foundation of an Islamic financial system.

This new book by a group of four Western-trained Islamic economists is greatly welcomed. It builds on and extends their earlier work on the topic and will become essential reading for all those with an interest in the economic implications of Islamic finance. The Stability of Islamic Finance develops themes that link Islamic finance to existing traditions in economics; that assess the stability properties of Islamic financial instruments, and that explain some of the key Islamic concepts in economists' terms. It will be an invaluable source for those who want to know more about the nature of the financial instruments that go to make up an Islamic financial system, and to understand how an Islamic financial system might work in a twenty-first century context. It is a provocative and insightful assessment of the economic properties of Islamic finance that deserves to be read and reflected on by Islamic and non-Islamic economists alike. Sir Andrew Crockett President, JPMorgan Chase International Former General Manager, The Bank for International Settlements (BIS) In recent years, Islamic finance has evolved from a tiny "cottage" industry to an increasingly important and respected component of global finance. The industry has developed common standards and practices, and has attracted the interest of issuers and investors outside the Muslim community. Yet, its economics and implications for financial stability are generally not well understood. The authors make an important contribution to our understanding of the industry by linking its foundations not only to the teachings of Islam, but also to classical Western economic thought. The authors also provide a convincing analysis of the structural weaknesses of conventional finance, and of the role of monetary policy in causing misallocation of resources and boom-and-bust cycles. In the process, they make a case for the inherent stability and efficiency of Islamic finance. The book is scholarly, insightful, original in scope and highly readable. Cesare Calari Managing Director, Wolfensohn Capital Partners Former Vice President, Finance, The World Bank The authors have written numerous books and articles on Islamic finance between them, and they bring a wealth of knowledge and experience to the topic. The Stability of Islamic Finance is an important contribution to the discussion of the Islamic finance industry as a whole and its place in broader efforts to reduce the volatility of global financial markets. Ms. Dr. Shamshad Akhtar Vice President, Middle East and North Africa, The World Bank The authors, whose academic credentials and practical experience are enviable, need to be heartily complimented for making another worthwhile contribution to the literature on Islamic economics and finance. They have convincingly shown in this valuable book how Islamic finance can help the international community avoid the severe financial crises of the kind in which it is currently embroiled. The timing of the book is perfect and those who read the book will not fail to realize that they have used their precious time in a highly productive manner. Dr. Umer Chapra Formerly Senior Economic Adviser, Saudi Arabian Monetary Agency Research Adviser, Islamic Research and Training Institute, Islamic Development Bank The Stability of Islamic Finance is not only timely but extremely relevant. At a time the world is asking questions on how we can avoid the next crisis and whether there are alternatives to the current system, which promotes increasingly damaging boom-bust cycles, the book provides answers to these and more. It gives us hope in that things can be better and we need not be held hostage to the present system which promotes greed, inequality, excessive consumption and the rapid deterioration of the environment. If policy makers are serious about addressing these issues and seek a change for the better, they should read The Stability of Islamic Finance. Sani Hamid Director, Wealth Management, Financial Alliance (Singapore) Former Director, Sovereign & International Public Finance Ratings, Standard & Poor217;s