A financial crisis swept the US last month after the collapse of Lehman Brothers, the fourth-largest investment bank, and the financial woes of a number of Wall Street giants.

This triggered a domino effect across the world leaving conventional banks short of credit.

Western government have since pumped billions of dollars into their troubled banks to keep credit flowing and prevent a complete financial meltdown.

“In the current financial turmoil, it is interesting to note that Islamic financing may have prevented a majority of the mess created by the conventional banking and financial institutions,” Kuwait Finance House said in a recent report.

“The outlook for Islamic financing is bright and will likely take the lead in terms of providing funding for major projects as the conventional banking system reevaluates its business model.”

The rules of Islamic banking and finance read like a how-to guide on avoiding the kind of disaster that is currently gripping world markets.

Islam forbids Muslims from usury, receiving or paying interest on loans.

Transactions by Islamic banks must be backed by real assets — not shady repackaged subprime mortgages.

Shari`ah-compliant financing deals resemble lease-to-own arrangements, layaway plans, joint purchase and sale agreements, or partnerships.

Investors have a right to know how their funds are being used, and the sector is overseen by dedicated supervisory boards as well as the usual national regulatory authorities.

Boom

Experts, however, warn that the booming Islamic banking system could be hit if the financial turmoil worsens and real assets start to crumble.

“Islamic banks, especially in the Middle East, got heavily into private equity and real estate investments, and a lot of loans may be backed by properties,” notes Jennifer Chang, a partner at Pricewaterhouse Coopers in Kuala Lumpur.

“So if the property market goes down, there will be an impact,” she said.

“If a borrower is not able to pay then the bank will foreclose and the question is — can you sell the property in the market and at what value? These are issues which all banks can face.”

Abhishek Kumar, a senior research analyst at Financial Insights, a company under market research and analysis firm International Data Corp (IDC), shares the same concern but is more optimistic.

“We’re not really sure what the real extent of the impact is, and whether we’ve passed the worst of it or not, but the extent is not going to be as bad as in the mainstream sector.”

He predicts that many world countries would start taking a leaf out of the book of Islamic finance.

“More and more institutions will be interested in providing Islamic services to diversify their risk portfolio.”

Islamic finance is already one of the fastest growing sectors in the global financial industry.

The Islamic banking industry, which began almost three decades ago, has made substantial growth and attracted the attention of investors and bankers across the world.

Currently, there are nearly 300 Islamic banks and financial institutions worldwide whose assets are predicted to grow to $1 trillion by 2013.