Islamic Finance and Financial Stability- A Review of the Literature

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 authors have been able to analyze thirty-four investigations over a thirty-year period, from 1983 to 2013. The research aims to provide an account of the main findings and conclusions of the literature, discuss the robustness and comprehensiveness of these findings, and highlight some venues for future explorations. To meet these objectives the study utilizes an analytical “evaluative” framework as its main investigative tool. The results identified two main periods: pre- and post-subprime financial crisis eras. The pre-crisis era has been dominated by theoretical investigations, while the post-crisis era has been dominated by empirical studies. The results, also, show that there is a big divergence between the theory and practice of IF. Theoretical studies claim the “superiority” of an IFS based on pure “equity” and participatory modes of financing, while empirical studies provide mixing results. It is anticipated that the findings of the study will benefit academia, policy makers, industry players, and other stakeholders alike. Benefit in terms of understanding financial stability complexities and the difficulty in its measurement. More importantly, the paper highlights the contribution that the existence of Islamic financial institutions and the principles that govern their operations can make to enrich the diversity of the on-going discussion taking place in the prevailing conventional literature of Financial Stability (FS). © Author