Islamic finance and financial stability : a review of the literature

Abstract AR

This paper provides a critical review of the Islamic Economics (IEs) and Finance (IF) literature that have examined the stability of the Islamic Financial System (IFS) and its institutions vis-à-vis the conventional interest-based system.

The paper analyzes forty studies over the last thirty-year period (1983 – 2013).

Two sub-periods: pre-and post-subprime financial crisis are compared.

The pre-crisis period focuses on theoretical investigations while the post-crisis focuses on empirical research.

The results show that the crisis seems to have triggered more attention to the stability of IF.

Seventy five percent of the reviewed literature has been carried out in the post-crisis era; about five studies have been produced per year during the last five years (2008-2013) in contrast to less than one study per year in its antecedent period.

In addition, Z-score indicator has come out as the most commonly used proxy for measuring the stability of Islamic financial intermediaries.

The results also show that there is a significant divergence between the theory and practice of IF.

Theoretical studies claim the ‘superiority’ of the IFS based primarily on equity and participatory modes of financing, while empirical studies are not yet conclusive