Islamic Financial Instruments

Author(s): Rodney Wilson

Source: Arab Law Quarterly, Vol. 6, No. 2 (1991), pp. 205-214
Published by: BRILL
Stable URL: http://www.jstor.org/stable/3381836
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 ISLAMICFINANCIALINSTRUMENTS
Dr RodneyWilson*

INTRODUCTION

This paperaimsto reviewrecentdevelopments in financialinstrumentsinternationally

and examine the relevanceof this experiencefor Islamic finance. What financial
instrumentshaveprovedthe mostsuccessfulin termsof clientappealandefficiencyin
financialintermediation?Is there a trade-offbetweenpopularityand suitabilityfor
modernfinancialtransactions?Does the needfor a marketin financialinstrumentsto
functioneffectivelyconflictwith equityand distributionalconsiderations? Is a finan-
cial marketwith a "humanface"possible,and can a moraldimensionbe introduced
when designingnew financialinstruments?Clearlymany of these questionsare of
vital concernto protagonistsof and practitionersin Islamicfinance.

The Issue of Definition

It is perhapsan obviousstartingpoint to definewhat exactlyis meant by the term
"financialinstruments".Instrumentsare often equatedwith securities,and an im-
portantcharacteristicis consideredto be theirtradability.This does not merelymean
the fact that they are purchasedwhen first issued,or repurchasedon redemption.It
also usuallyimpliesthat the instrumentsare tradableon secondarymarkets.Bonds,
for example,areperhapsthe mostuniversallyrecogliisedtypeof financialinstruments,
as most purchasersacquiresuch securitiesin orderto tradethem in secondarymar-
kets,and only a smallproportionof marketparticipantswill be seeldngto hold bonds
until maturity.
With the processof securitisationof financialmarketsin recent years, there has
been an enormousincreasein both the value and varietyof financialinstruments
available.Certificatesof deposit are a case in point, as this has enabledbanks and
otherfinancialintermediariesto tradetheirdepositsamongsteach otherin secondary-
markets.The possibilityof such asset tradinghas given banks a useful additional
sourceof liquiditywhich can be drawnuponif unforeseenliabilitiesarise,such as a
suddenspate of depositwithdrawals.Althoughoriginallyenvisagedas a methodof
meetingwith contingencies,certificatesof depositsare now regardedby many as a
ritaltool of liquiditymanagement.

*Readerin Economics,Universityof Durham.

 ARAB LAW QUARTERLY
206
Financialinnovationhas resultedin the emergenceof
significantmarketsin in-
strumentssuch as futuresandoptions.Thesearenow tradedin
most majorfinancial
centres,and are regardedas importanttools for risk
management.Such instruments
are by naturemuchmoredifficultto evaluatein terrns
of theirworthovertime and
yield, but the adventof computerisedportfolio
managementsystemshas facilitated
the trackingof such securities.

The Borderline for Financial Ittstrllments

The questionmust of coursebe askedif all securitiesare
financialinstruments,or if
the lattertermshas a morerestrictedmeaning.Thereis
clearlya riskwithbonds,but
it is a measurableriskas long as thereis no default.
Thereis short-termuncertainty
overfutureassetvalues,but no long-terrndoubtover
ultimateworthor even return.
Informationflows are near perfect,and marketsare usually
efficient.Optionsand
filturesare clearlymorerisky,and certificatesof depositin
some respectsless risky,
but all representone class of financialproduct.
Equitiesor quotedcompanystockareclearlyin a different
is much less perfect,and risk harderto quantify category,as information
precisely.Formulatradingcan of
coursebe used,andtriggermechanismsfor buyingand
sellingarenow common,but
judgmentis muchmorelikelyto be involved.Ultimatelyit is
the performance of the
publiccompaniesthemselveswhichwilldetermine
profitability, andthisis affectedby
thequalityof their managementsand workforces.
Shareceriificatesare in any case
titlesto property,with mostof the rightsandsome,but
not all, of the obligationsthat
thisinvolvesin the case of quotedcompanies.Despite
theirtradability,it is doubtful
thatequitiescan reallybe regardedas financial
instrumentsin the purestsenseof the
term.
Unit trustsaresometimesregardedas a typeof financial
instrument,as they arean
indirectmeans of acquiringequities, with less risk
because of the spread of
shareholdings usuallyinvolved,and lowertransactionscosts than those
building up the sameportfoliothroughthe directpurchaseof the incurredby
isthe lowerlevel of riskand the fact that they underlyingshares.It
representintermediateassetsbetween
thefinanceandthe underlyingpropertythatmakesthem
havemoreof the character-
isticsof a financialinstrurnent.The samecouldbe said
of the sharesof investment
companies whose main purposeis to placefimdswith other
companies.With such
companies the nsks aregreaterhowever,as theycanborrowunlike
value unittrusts,andthe
of theirsharesdoes not necessarilyreflectthat of the
compariiesin whichthey
placetheirown shareholder's inds.

Instrumentsof Trade
Oftenpaperswhich are used to facilitateinternational
transactionsare regardedas
financial
instruments,especiallywhen thereis a marketfor the paper
risk
factoris limitedwithin naxTowly itself,and the
determinedparameters.Perhapsthe best ex-
ampleof such instrumentsare bills of exchange,which
historicallywereone of the
mostimportantmeansof financingbothexportsandimports.A bill
of exchangeis a
 ISLAMIC FINANCIAL
INSTRU1ZENTS
207
promiseto paya specifiedsumat a
iimeperiodis usuallysetin filturetime,ratherlikea
advance to postZatedcheque.The
tradedgoodsin question,and coincideapproximately
the bill is writtenby the withthedeliveryofthe
exporter. importerin favourof the
Onreceiptof thebillthe
exporter caneither
cashequivalent, or elsesellit at a discount, holdit to maturity, andthencollectthe
obnouslybepreferable andobt cashimmediately,
Eomthe whichsvill
willreflectboththeiimeperiodpointoflrieW of liquidity. Theamountofthediscount
to
eliated if the exporterhas thematurity andtheriskof default.The
lattercanbe
bill "accepted", whichmeansthat the acceptor
guarantees thepaymentin theeventof
service,as didthe specialistacceptingdefault.Mostmajorbanksprondethistypeof
A chargeis of coursemade housesin the Londonmarket.
vices for acceptances, butthebankswhichprovide
keeprecordsof goodandbad suchser-
risks,and are
individual exportersto ensurethat importers usuallyin a strongerpositionthan
made in writingthebillsin thefirst honourthe cotments they
instance. Once have
become verytradablefinancial billsof exchangeareaccepted
instruments, whosemarketvaluewill be they
maturity dateandinterestratesin related to
involveno interestelementin alternative markets, thoughtthebillsof exchange
Likeothertradablefinancial themselves.
exchange viewthemas somewhat instruments) participants in the marketfor billsof
represent
themeansofpayment. detached Eom theunderlying goodsforwhichthey
though Thisis lessthecasewith
cheapter to arrange, relatedirectlyto theexportsand documentary creditswhich
ments
canonlybe effectedwhenthe importsthemselves. Pay-
thatthegoodshavebeen necessary
evidence shippingdocuments areproduced as
paperis muchmoreclosely dispatched
the orforwarded. Thereis a sensein which
makes connectedto the realphysical
documentary creditsa muchlessperfect transaciions,
butthis
of
less
easilyquantifiable risksinvolved.Indeed instrument, asthereareso
manytypes
credits
as financialinstruments. manywouldnotregard
documentary

The
Moral Acceptabilityof
Financial Instruments
There
hasbeenvirtuallyno
relaiion questioning concerning ethicalor distributional
to thefinancialinstruments issuesin
major which aretraded in internatonal
Westerneconomies.Mattersof markets andthe
simply
notbeenaddressed. fess, eqliityandjusiicein
It is implicitlyassumedLhat exchangehave
kets
aretrainedprofessionals the
whoknowhowto lookafterparticipants in suchmar-
actions
involveintermediaries whoarebuyingandsellingon themselves. Most-trans-
and
otherfinancialinstitutions. behalfofbusiness clients
with Themarketsareof a wholesale
ie ordinarycitizenare nature,and the links
finance remoteandindirect.The feeling
specialistsis thatsuchmarkets of economistsand
etomental arebestsubjectto minimal
orofficialinterveniion might regulation,as gov-
extremes onlyreducemarketefficiency
mightkillthe market. andif takento
Isthis
lackof concernfor the
between moralityof the marketjustified?
specialistdealersandfinancial Do transaciions
scruiiny
as thosebetweenprivate insiituiionsneedto be subjectto the same
individualsordoesthecorporate natureof thepar-
 ARAB LAW QUARTERLY
208
ticipantsmeanthat differentconsiderationsshouldapply?
How
individualclients and shareholdersshouldinstitutionsbuying accountableto their
and selling financial
instrumentsbe in any case?
In any marketsituaiionthere are alwaysuneven
outcomesin the sense of there
beingwinnersandlosers,but the questionis how greata
gainis sociallyacceptable,
andthe extentto whichlosersshouldbe penalised?It is
not clearthatthe stateshould
attemptto preventtheseoutcomeswhicharepartof the
incentivemechanism,though
it maywish to limitextremescenarios.Clearlyin a
marketin whichonly insiituiions
with considerableresourcesparticipate,thereis less
worryaboutdistributionalcri-
teria.Neverthelessa seriesof errorsin decision-making
can drivean insiituiionmto
insolvencyand ultimatebankruptcy,whichwill inevitably
resultin loss of employee
incomeandevenunemployment. Therewill alsobe lossesforclientsof the insiinltion,
and shareholdersmay unwitiinglysee theirassets
become
this to be acceptedas an unavoidableoutcomeof market suddenlyvalueless.Is all
forces?

Justice and Equity

Thereareno easysoluiionsto the moraldilemmaswhich
arisein dealingsin financial
markets.Religiousteachingcan providesome pdance,
and despitevaryingview-
pointson manyissuesfiom dose withdifferentbeliefs,there
appearsto be almostuni-
versalconcernwith the &ndamentalissuesof jusiiceand
equity.The latterdoes not
meanequality,however,but ratherthat the dipty of
"losers"shouldbe protectedX
andthat everyonehas the rightto a certainbasic
materialprovision.Forthe success-
fill,the stressis noton the limitationof materialwealth,
but ratherthatthe "winners"
shouldrecopse and dischargetheirsocialresponsibilities
in a propermanner.
As far as marketconductis concerned,the stressis on
honestandfairdealings,as
anyfraudis clearlymorallyreprehensible. The latterdoesnot merelyreferto cheating
onpayments,but also knowinglyprovidingfalse
informationin orderto deceive.
There is of coursea distinciionbetweenthis andwitholding
informaiion,one beingan
entirely negaiiveact,andthe latterthefailureto actin a positive
fashion.Ofieneconb
mists can pointto a conflictbetweenequityandefficiencyin
iions. pcular marketsitua-
The probabilityof a trade<ffbetweenjusiiceand
efficiencyis muchless likely.
Indeed one can facilitatethe other. Full disclosureof
informaiionis
important &ctorin reducingbothriskandtransaciionscosts,andcan certly an
be regardedas a
prerequisite for marketeffeciency

TheIslamic View of Acceptable Trading

Behaviour
Islamic
scholarsviewtradingas botha necessaryandpotentially
aciivity. productiveeconomic
Tradingis highlyregardedas an occupation,andindeedthe
took
an activeinterestin tradematters)both as a pariicipant Prophethimself
and as an arbitratorof
what
was fair and just. Becauseof this involvementin
commerce,the Prophetwas
well
awareof the dubiouspracticesthat could occur in trade
fi*omfirst-handex-
perience
of dealingsin Mecca and Medina.The concernwith
accurateweightand
 ISLAMIC FINANCIAL INSTRUMENTS 209

measuresfor tradedcommoditiescan be interpretedin a moderncontextin termsof

filll disclosureandthe necessityto providecomprehensiveinformationto tradingpart-
ners.
The highestmoralstandardsshouldbe expectedfromtraders,with no exploitative
behaviourtowardsthose who are in a weakerbargainingpositionbecauseof a lackof
resources.There is of coursean emphasison honestyin all dealings,but the trader's
responsibilitygoes well beyondthis. If tradingis viewed as productiveand socially
desirable,then speculativebehaviouris clearlyprecluded.The latter is virtuallyby
definition both unproductiveand socially undesirablebecause of its potentially
exploitativenature.Speculationcanbe bothdeliberateandunintentional,but because
of the moralunambiguityof the latter,practiceswhich might result in speculation
shouldbe avoided.
It is for this reason that forward,filturesand optionsdealingare viewed as pb
tentiallycorruptingby modernspecialistsin Islamicfinance.Such transactionsmay
be promptedby the desireto hedgeor gainfromarbitrage,whichis admittedlyquite
differentfrom speculation.The problem,however,is that it is the speculatorswho
providethe liquidityin the marketfor such activitiesto be effective.Those who par-
iicipatein hedgingor arbitrageare thereforeindirectlybenefitingfrom, and to some
extent encouragmg,specuatlon.
* .

Hedgingto avoid risk representsa form of insuranceprotection.There is an ex-

tensiveliteraturein Islamiceconomicsdealingwith insurancematters,and the views
of these writersmust be takeninto accountwhenconsideringthe legitimacyof hedg-
ing. Arbitragegainsaremadethroughthe exploitationof informationthat othermar-
ket pariicipantsdo not have available.Such an activitymay be deemedinherently
unfair,and counterto the emphasisin Islamicthinkingon marketbehaviouralready
mentionedon the need for filll disclosure.

Riba and Modern Finance

Undoubtedlythe best knowntenetof Islaic teachingon financeis the prohibitionof
nba or dealing in interest. Though knowledgeof this prohibitionis widespread
amongstparticipantsin internationalfinancialmarkets,the reasonsfor and con-
sequences of the Islamic position on interest remain poorly understood.Those
involvedin the design, marketingand dealingin financialinstrumentshave little
appreciationof the thinkingof Musliminvestors.
The objectionto interesttransactionsis becauseof the Koranicinjunctionsandthe
Shari'alaw, with the relevantpassagesandstatutesoftencited.Less emphasisis per-
hapsput on the rationalefor the prohibition,as if this was almostself-evident,but the
groundsof injusticeanddistributionof riskandrewardare appreciated,even by non-
Muslims.The immoralityof unproductiverewardsandreturnsfor time preferencesis
not as well comprehended,althoughthis challengesthe essenceof neoclassicaldistri-
butiontheorywith respectto the yield on capitaland much of the modernWestern
literaturein the field of finance.
o ARAB LAW QUARTERLY

Interest Returns and Zero Coupon Bondls

Bondsareregardedas the classicfinancialinstrumentbecauseof theirsimplicityand
tradability,but interestis both a directreturnand a determinantof capitalvalues.
Bonds are often acquiredand held for speculativepurposes,and their very desiF
invitessuch use. Henceconventionalbondsmust be consideredtotallyunacceptable
financialinstrumentsfrom the standpointof Islamicfinance.Can an Islamically
acceptablebondbe designed,andwouldsuchaninstrumenthaveanyof the character-
istics of a bond?Is there a need for such an instrumentin any case if sausfactory
Islamicalternativesare availablewhichcan servea similarpurpose?
It is of coursepossibleto have zero couponbondswhichby definitionyieldno in-
terest,and such instrumentsat first si«t wouldappearto be Islamicallyacceptable.
The difficultyis that such bondsare usuallyissuedat a discountto buyersto make
them attractivepurchasesin relationto alternativesecuritiesin the market.This,
someassert,resultsin the discountbeingrelatedto andperhapsevendeterrnined by
the interestreturnson compeiingsecurities.
This propositionrestson two assptions, however,whichneedto be challenged.
Ae firstconcernsde natureof the competinginstruments.1 he secondis the moral
conductof the investorsin theirinvestmentdecision-making. Zerocouponbondscan
be legiate instrumentsfor the Musliminvestorto buy andhold providedcertain
conditionsaremet.Theseconditionsarein somedegreedeterniinedby the be-haviour
of the bondholdersthemselves,both individuallyand collectively.
If the Musliminvestoris only preparedto hold zero couponbonds,and the alter-
nativeassetsaremudaraba,musharaka, andmurabahaholdings,thenthe discounton
the zero couponbondsis relatedto the returnson Islamicfinancialinstrumentsand
not those on ribabasedinstrumentssuch as conventionalbonds.To ensuresuch an
outcomethe zero couponbond sale may have to be restrictedto a certainclass of
buyers,such as the citizensof an exclusivelyMuslimcountry,Muslimbelieversonly
or thosewiAg to give an undertaking,regardlessof relgion,that they will not pur-
chaseinterestbasedsecurities.The placementof suchbondscouldalsobe restrictedto
the commercialbanksof a Muslimcountrywherefinancialdealingsarein accordance
with the Shan'alaw, or Islamlcfinancialinstitutionswhose own dealingsconform
with this law even in a non-Muslimenvironment.
AfteradvicefromMuslimjurists,the SaudiArabianMonetaryAgencydecidedto
issue securitiesof this type, whichprovidedthe local commercialbankswith usefi
liquidity,and at the sametime raisedfimdingfor the state.Similarissueshavebeen
madein a numberof otherMuslimcountries,andprovidedtheconditionsoutlinedare
fulfilled,therewouldseemto be no groundsfor objectingto such secllrities.

.slamic Certificates of Deposit

II1Westernfinancialmarkets,especiallyin ti IJnitedStates,certificatesof deposit
haveassumeda Fowing significancein recentyears.Theycanbebotha usefultoolfor
liquiditymanagementanda saferalternativeto bondholdings.As the interestrateson
 ISLAMIC FINANCIAL INSTRUMENTS 211

suchceriificates is relatedto thoseprevailing in themarketgenerally, thevalueof the

ceriificatesdoesnot varyappreciably fi*omthe redemption price.
Assuchcertificates arenbabased,theyareclearlyunacceptable instruments fiom
theIslamicpointof view It should,however, be possibleto havecertificates
basedsn
mudaraba depositswhichcouldbe tradable atthesecondary marketlevel.Unlikecon-
ventionalcertificates of deposit)the marketvalueof the certificatemightvaryap
preciably fromtheredempeon price,as thereturnson theunderlying depositswould
onlybeknownretrospectively ratherthanin advance. Furtherrnore,thereturnswould
dependeitherontheprofitsof theIslamicbankissuingthecertificates, orontheprofits
on theunderlying investments wherethecertificates werebasedon a specifiedinvest-
mentaccount.
Islamicceriificates of depositwouldtherefore involvea riskelement,whichcould
onlybe assessedthroughsuchdevicesas raiionalor adapiiveexpectanons, although
eventhesewouldbefarfromcert approaches foresiimatinglikelyreturns.Never-
thelessif theceriificates areredeemable withina specifiedtimeperiod,thislirnitsthe
risksinvolved,asin thecaseof bonds.Inpractice, returnswouldbedetermined at the
microlevelof the individual Islamicbankor Muslimbusiness,as it is theirprofits
whicharethe keyfactor.
Incontrastthereturnon conventional bondsandcertaintypesofcertificate deposit
dependsmoreon government monetarypolicyandbudgetary developments at the
macroeconomic level.Theproblemwiththisis thatsuchfactorsareoutsidethecon-
trol of the banksissuingthe certificates of depositors. Fortunately in the case of
Islamiccertificates of depositthis wouldnot be the case andthereforethe issuers
musthaveresponsibility towardspurchasers andholdersof theirsecuriiies.
The Islamicbanksportfoliois of coursea movein thedirecionof Islamiccertifi-
catesof deposit.Thisschemewaslaunched bytheIslamicDevelopment Bankin 1987,
andthemajority of commercial Islamicbankshaveagreedto pariicipate. TheIslamic
Development BankhassoldIslamicsecurities to thecommercial Islac banks,thus
acquiring addiiional privatefinancing. Thebanksfortheirparthaveacquired sound
liquidinstruments whichcanpotentially be resoldto otherIslamicbanksforcashor
alternauvely totheIslc Development BankInpraciice therehasbeenlittletrading,as
the amountsinvolvedare modestby internaiional standards, but moreaciierity is
likelyas the schemeexpands.Returnsarebasedon theIslc Development Banks
profitsfromtradefinancing, its mostsuccessfillaciivity.

InstrumentsRelating to Islamic Trading

TradebetweenIslamicstatesandbetweenMuslimclientsandWestern countrieshas
beenincreasingly financedon themurabaha mark-upprinciple
in recentyears.Under
this systemthe Islamicfinancialinstituiionpurchasesthe importon behalfof the
Muslimclient,andthe latteragreesto repurchase the goodat a laterdatewiththe
priceadjustedupwardby a specifiedamount.This systempermitsthe importerto
obtaincreditwithoutinterestuntilthegoodin quesiionis received,or evensoldto a
localclient.It represents
an alternaiiveto financing
throughbillsof exchangewhich
212 ARABLAW QUARTERLY

wouldinvolveriba,andis in manywayssimilarto, butmoreacceptablethan,conven-

tionaldocumentarycredits.
The tradedgoodprovidesthe securityforthe financialtransactions, andthe Islamic
bankor financialinstitutionactuallytakes over the title to and ownership of the goods
inquestion.This meansit assumesa risk, and it is this which the
justifies mark-upor
reward.Such financinghas provedhighly attractive for Muslim businessmen, and
bothWesternandIslamicbanksoffersuchfacilities. Indeed, such trade funding repre-
sentsthe majorpartof the financingactivityof mostIslamicbanks,andaccountsfor
thebulkof short-termassetholdings.
Thoughthe goods are traded,the m2wrabaha instrumentsare not, unless the fi-
nancialtransactionswhen the fimdingis advancedand the mark-upis paid are
regarded as trading.If it is, thenit wouldbe categorisedas tradingat theprimarylevel.
Suchmurabahainstrumentsare not tradedbetweenthe Islamicfinancialinstitutions
themselves,as thereis no secondarymarketin the securities.Thereis no reasonon
religiousgounds why thereshouldbe not be such a development,and indeedsuch
instrumentscouldforma usefulbasisfor an Islamicinter-bankmarket,with all the
benefitswhichthat couldbringfor the pariicipantsinvolved.

Stock Exchange Development

Thediversityof sourcesof financeis quiterestrictedin the Islamicworldreflectingthe
limiteddevelopmentof capitalmarkets.Most businessfinanceis fromploughed-back
profits,andlong-tellllborrowingis usuallyfromcloserelativesor moredistantfamily
members.Commercialbankloansareonly soughtfortradefinancingandothershort-
terrnpurposes,partlybecausethereis a reluctanceto mortgagepropertyor provide
otherlong-termcollatoralwhichcouldultimatelyresultin the loss of familycontrol,
or even the eniirefamilybusiness.
For the same reasonsmall businessclients have been slow to approachIslamic
banksfor mudarabaand musharakafinancingeven thoughthese institutionswere
only tryingto be helpful,and had no desireto takeover the enterprisesthey were
funding.Islamicbankshave tendedto concentrateon murabahatradefinancingin
responseto the demandsof theirclients,andnot as a resultof anydeliberatematterof
policy.
If privatebusinessesin Moslemcountrieshavebeenreluctantto seekequityfinanc-
ing from Islamicbanks,they have been even more reluctantto raise filndingby
becomingpubliccompanieswith quotedshares.Equitymarketsareunderdeveloped
in mostIslamiccountries,but this reflectsculturalattitudesandthe stageof develop-
ment,ratherthanideologyor governmentpolicy.Kuwaitwasthe onlyMiddleEastern
coulltrywitha significantstockexchange,butmuchof the activitywasin the sharesof
banks,not directlyproductivebusinesses.In the FarEastMalaysiahasanincreasingly
importantstockexchange,andtransactionsaregrowingin Indonesia.It is perhapsthis
areaof the Islamicworldthat has the greatestfinancialpotential.
 ISLAMIC FINANCIAL INSTRUMENTS 213

Equity Related Fmancial Instruments

It wouldbe stretchingdefinitionsconsiderablyto view equitiesor ordinarysharesas
financialinstruments.Despite theirtradability,they are inherentlyrisky assets,and
manyvariablesmust be takeninto accountin defiIiingand quantifyingthe natureof
the risks. In addition,they representpropertyrights rather than merely financial
certificates.Equitiesare acquiredandheld for theirown sakeratherthan as a means
or instrumentsto an end. These points have alreadybeen discussed,but they are
worthreiteratingin an Islamicconte2rt as M lslimsstressthe valueof risksharing,and
equityfinancinganangementscan makean importantcontributionto this goal.
Unit trust holdingshave moreof the characteristicsof financialinstrumentsthan
the underlyingequities.They are less risky,their value being based on a basketof
equities,and can alwaysbe sold backto the companywhichissues the units for cash.
In Islamiccountrieswhereequitymarketsare underdeveloped, this can be a definite
advantagefrom the perspectivesof liquidityand security,as a financialinstitution
such as a unit trust companyor a banlrissuingsuch paperwill be able to tradethe
underlyingassets by swapsor othermeansbecauseof its sheer size, but the private
investorcannotusuallytake such an approachwithoutincurnngheavy transactions
costs.In otherwords,the unit trustcan benefitfromeconomiesof scale,whichreduce
the dealingcosts in relationto the volumeand value of transactions.
In many Muslim countriesthe commercialbanks have marketedunit trusts in
recentyearsas a meansof extendingthe rangeoftheir financialproductsanddevelop
ing new lines of business.The strategyhavebeento concentrateon egistingcustomers
throughcross-sellingratherthan attractingnew clients.In SaudiArabiamost of the
leadingcommercialbankshave adoptedthis approach,whichhas beenespeciallysuc-
cessfill in the case of the NationalCommercialBank given its largecustomerbase.
The aim has been to attractfundsfromcustomerswho use theirlocalbankfor trans-
actionsbalances,and to a lesserextentsavings,but who placedinvestmentfunds in
overseasmarkets,usuallywith foreignbanks.
The unit trustconcepthas also receivedsome attentionfiom the IslamicDevelop
ment Bank in JP(128h which has exploredthe possibilityof offeringan Islamicunit
trust.This could attractadditionalcapitalto the bankfrom the Islamiccommercial
banksand other bodies,and extendits resourcebase. For the investorthe attraction
would be the fact that a majorIslamicinstitutionis administeringand offieringto
guaranteethe trust.The degreeof riskis much less with units basedon a spreadof
Islamicinvestmentsratherthan with individualinvestments.Such units would rep
resentattractivelong-terminstrumentswhichIslamicinvestorscouldholdwith a con-
siderabledegreeof confidence.

FUTURE
XEVELOPMENTS
There are severallikelyways forwardas far as Islaniicfinancialinstrumentsare con-
cerned. One is obviously to make increaseduse of existing Islamic financial in-
struments,such as zero couponbonds,paperfor tradefinanceandunitisedsecunties.
214 ARAB LAW QUARTERLY

Thereis a needto encouragesecondarymarketdevelopmentso thatinstrumentscan

be tradedeffectively.This will makeprimaryinstrumentsmore attractiveas pur-
chaserswillknowthattheycan alwaysobtaincashfor theirsecuritiesif theirliquidity
positionnecessitatesthis.The aimin otherwordsmustbe to promotemarketbreadth,
but also to ensurethat thereis sufficientdepthfor the marketto functionproperly.
Anotherobviousavenueforwardis to furtherdevelopthe instrumentsthemselves
by lookingat whatis availablein internationalmarkets,andassessingtheirsuitability
for the Islamicworld.In this case the innovationis in the application,but it may of
coursealso be possibleto designwholly new instrumentsfiom existingIslamicfi-
nancialproducts.It is possible,for example,to envisagea zero couponbond which
could be convertedinto equitiesundercertainpredefinedconditions.Islamicpre-
ferencesharescould also be developed.Muslim owned quotedand perhapseven
unquotedcompaniescould presumablyhave "rightsissues",as a meansof raising
freshcapital.
Thoughthe wholesubjectof Islamicfinancialinstrumentshas only recentlybeen
explored,it appearsthat thereare manySuitfill lineswhichareworthpursuing.The
scopefor developmentof Islamicfinancialproductsis enormous.Furtherrnore, it is
apparentthatsuchproductscanplaya majorrole,notonlyin facilitatingdevelopment
in Muslimcountries,but in promotingeconomicadvancemuchmorewidely

FURTHER READING

AhmedEl-Ashker,TheIslamicBusinessEnterpnse,CroomHelm,London,1987.
GilbertBeauge,Les Capitauxde l'Islam,Pressesdu CNRS,Paris,1990.
JulianFranks,John Boyd and WillardCharleton,CorporateFinance:Conceptsand
Applications,
KentPublishing,Boston,1985.
JohnGilbody,7theUK Monetaryand FinancialSystem,Routledge,London,1988.
ZubairIqbaland AbbasMirakhor,IslamicBanking,IMF OccasionalPaper,No. 49,
Washington,1987.
KV Peasnelland CWR Ward,BritishFinancialMarketsand Institutions,Preniice
Hall, New Jersey,1985.
RodneyWilson(ed.)IslamicFinancialMarkets,Routledge,London,1990.