The most befitting thing for me to do is address myself to the practical aspects of an Islamic financial market. I wish to do this by posing four important questions with a view to understanding the benefits and problems of an Islamic financial market in its various ramifications. I will not hesitate to make my own observations and to suggest solutions wherever 1 can.

The first question that arises is about the crucial differences between an Islamic and a conventional securities market. This question is of significant importance because it has a great bearing on the two key functions of an effective securities market-resources mobilisation and liquidity generation. There are two differences which we must particularly bear in mind:

a) While the conventional securities market bas a mix of both interest-based instruments and equities, with a preponderance of the former, the Islamic securities market can have only equity-based or profit-and-loss sharing instruments. There is no possibility of resources to interest-based instruments, except in the transitional phase. However, equity, as understood in the conventional sense, is mainly open-ended. It need not be so in the Islamic market; it can also be closed-ended. Closed-ended securities can be either long, medium or short-term.

b) There is no predetermined positive rate of return on equity based or profit-and-loss sharing securities. While the principal is known, the return, unlike interest, is unknown; it may be either positive or negative. By making the financiers share in the risks of business, Islam seeks to establish justice between the financiers and the entrepreneurs.

The second question is about the impact that these two differences are likely to have on the possibility of developing a primary as well as a secondary market for equity-based instruments. The primary market performs the function of enabling entrepreneurs mobilise resources for investment while the secondary market makes it possible for investors to generate liquidity when they need it.

As far as the primary market is concerned, the preponderance of equity-based instruments in the Islamic securities market should tend to have a positive effect on both the entrepreneur and the financier. Interest has to be paid in good and bad times. Dividends can, however, be reduced in bad times, and in extreme situations, even passed. So the burden of finance by equity is less. There is no doubt that in good times, the entrepreneur will have to pay a higher dividend to the financier but it is precisely in such times that the burden of higher dividends can be borne. The firm would be insuring itself to some extent against a strain, which in difficult conditions can be serious, at the cost of an increased payment in conditions when it would be easy to meet it. It is in this sense that the riskiness of its position would be diminished. Thus the promotion of equity financing should have a favourable effect on entrepreneurs and help promote venture capital. It should also have a favourable effect on savers. They will get a handsome reward when profits are good by their willingness to get little or no return when conditions are bad. In an interest-based system the savers get a relatively paltry return even when businesses are doing extremely well because of the assurance of get~ the same return if businesses do not do so well.

The dependence of business on equity for mobilising resources may tend to create a business preference for issuing stocks and shares along with long and medium-term mudarabah, musharakah and ijarah (leasing) certificates. This is because resources in this case become committed for a longer period, thus relieving business of uncertainties and headaches associated with the frequent raising of finance. This should help them in achieving better long-term planning. Commercial banks and non-bank financial institutions would however, prefer to make available mainly short-term financing even though they would be willing to provide medium and long-term financing because of the relatively higher prospective return on these. Where the balance will be struck is difficult to say. It is almost likely that an equilibrium may be ultimately established at a point where the supply of corporate shares as well as investment and unit trust shares rises substantially in an Islamic economy and~ short-term financing is sought and provided for mainly bridge-financing, overcoming seasonal variations in the need for funds and taking advantage of unexpected business opportunities. This implies that the nature of banking in an- Islamic economy will have to undergo a revolutionary change after the transitional phase is over.

Joint stock companies, and investment and unit trusts will, along with other non-bank financial institutions and commercial banks, hence play an important role in the Islamic financial markets. It would in fact be advisable for Muslim countries to encourage the formation of these institutions and to induce the existing corporations to reduce their loan financed capital by increasing their share subscriptions.

Joint-stock companies have the advantage of limited liability, divisibility and easy transferability of shares because of the absence of delectus personae. The shares of companies which are doing relatively well tend to be highly liquid. It is however not possible for an individual to achieve the desired diversification in his investments by purchasing the shares of joint-stock companies unless he has an adequately large amount of financing available. If he seeks to have a greater diversification with smaller resources, investment and unit trusts and financial institutions offer a greater advantage. Moreover, the possibility of getting a positive return on the diversified portfolios of such institutions would tend to make their shares less risky and the ease of selling or redemption would also make them relatively more liquid.

In addition to shares of joint-stock companies and investment and unit trusts, profit-and-loss sharing investment certificates of varying risks and maturities could play an important role in an Islamic securities market for mobilising funds for investment. These may include mudarabah, musharakah and murabahah certificates, leasing certificates and deposit certificates.

In short, Islamic financial markets should be able to satisfy investors of varying attitudes towards risk - risk takers as well as risk averters. The rate of return would of course be unknown for all investments (except murabahah and leasing). Nevertheless, the likelihood of its being positive, though low, may be much higher in some investments than in others. Thus the mobilisation of surplus funds for investment should not be a problem in an Islamic financial market.

As far as secondary market is concerned, it is very likely that open-ended and medium and long-term instruments may tend to be more liquid in an Islamic financial market than short-term instruments. This is because the price of securities depends on the capital as well as the prospective income. Whereas in the case of medium and long-term instruments, the past performance of the company and the future prospects are importance and can enable the determination of a price by market forces, in the case of short-term mudarabah and musharakah instruments income would be unknown while past performance and future prospects may be of little relevance. Income on short-term instruments is determined by immediate factors and it would require substantial research on the part of the buyers to know the nature of the project or the consignment in which the company is using the funds and the prospects of income. Since the issuing company may know this better than anyone else. It may be the only agency able to redeem short-term securities. Hence short-term mudarabah and musharakah may in general have to be held by the investor until maturity if not redeemed by the issuing company. In contrast with this, short-term murabahah and leasing instruments may tend to be relatively more liquid because the rate of return on these would be known. Nevertheless, since there are risks associated even with these methods of financing if the conditions laid down by the Shari’ah are abided by, even these instruments may, in general, tend to be less liquid than short-term interest-based instruments. Hence investors who are not sure of their liquidity may have to seek the longer than the shorter end of the securities market.

Having said this, I must point out that even in the conventional market, the liquidity of short-term commercial papers is not necessarily assured and banks generally hold such instruments until maturity. There is however the market for treasury bills where short-term employment of funds is possible and the liquidity is assured. The conventional system also has the interbank market where banks can borrow if they wish to tide over their liquidity shortages or lend if they wish to profit from surplus funds available for a short-term period. The absence of the treasury bills market and the interbank market may pose difficulties unless a viable alternative is found.

While it may be possible for business firms, investment and unit trusts and non-bank financial institutions to remove their liquidity shortages by making an arrangement with banks within the framework of profit-and-loss sharing, what could be done by banks to get liquidity in case they need it? Considering the fact that the banks are exposed to a number of different types of risks, they may be expected to fall short of liquidity against their expectations. The banks could of course maintain a substantial amount of liquidity; this would reduce their profitability. Therefore some alternate arrangement must be made.

Hence the third question is related to the possibility of creating an alternative for the interest-based treasury bills market and interbank market? Development of a short-term treasury bills market may be difficult within the profit-and-loss sharing framework because the government need not necessarily use the funds mobilised through the sale of treasury bills to finance a profit-oriented project or consignment. The government could however issue treasury bills on the basis of the "normal" or "representative" rate of return in government enterprises or the economy as a whole. It is not certain whether the concept of a ‘normal’ or ‘representative’ rate of return would pass the test of the Shari'ah and be acceptable to most Fuqaha

Three alternatives to the interbank market may be considered to provide short-term liquidity to banks when they need it. First, banks could have an arrangement with other banks for mutual financing facilities, as is the usual practice of conventional banks, but within the profit-and-loss sharing framework. Second, there could be an inter-bank cooperative arrangement to extend reciprocal accommodation to each other on condition that the net use of this facility is zero over a given period. Third, the banks could create a common pool at the central bank to provide mutual accommodation.

Banks which have more frequent resources to each other for funds would be better off having a mutual profit and loss sharing arrangement. It would help them place surplus funds, arrange liquidity when they need it, and balance their short-term assets and liabilities. Along with the profit-and-loss sharing arrangement, banks could also resort to the second alternative of making a mutually cooperative arrangement with each other. This may have to be on the basis of mutual borrowings cancelling out mutual lendings. The disadvantage of both the above techniques is that they are essentially bilateral. The common pool at the central bank would have the characteristic of being multilateral and may have to be resorted to along with the other two alternatives if the bank wishes to be assured of having access to funds when they need them.

In a crisis situation, when all banks face a liquidity squeeze, or when the individual banks are unable to get enough assistance through resort to all the three alternatives indicated above, the central bank would be the only resource left and should ad as lender of last resort. This should of course be done within a disciplinary framework to ensure that this facility is not misused and to remedy the cause of the banks liquidity shortage.

It may be argued that all the three methods may he able to make a smaller overall contribution to the Islamic banks funds than is the case with conventional banks. This should in fact be healthy as it would make banks more reliant on their own resources and have access to other banks only when it is necessary. Excessive reliance on funding from other banks is generally recognised to be a weakness of the conventional banking system. This weakness gains limelight whenever there is a banking crisis. The limitation and discipline of the interbank market within the profit-and-loss sharing arrangement should exert a healthy influence on the entire financial system.

The problems however is that the interbank arrangement which has been suggested above is not possible in most Muslim countries except Iran and Pakistan because there are very few Islamic banks, generally only one or two, in those countries. These banks are moreover small in terms of their resources and may not be able to provide sufficient accommodation to other Islamic banks. Exchange controls, prevailing in most Muslim countries rule out the possibility of the Islamic banks being able to create any international arrangement for helping each other. Under these circumstances, the central bank remains the only hope for Islamic banks in case they are in difficulty. The central banks in Muslim countries should therefore provide the necessary assistance. If they do not do this, they will hurt the cause of Islamic banking because the failure of even one Islamic bank will be a great setback to the movement. While the central banks should be ready to provide such assistance, they should keep the Islamic banks under close examination to ensure that the management is sound and the banks are operating along healthy lines.

Given the importance of equity-based instruments in an Islamic economy, an efficient and well-regulated securities market would be of crucial importance. Share prices must reflect underlying economic conditions rather than speculative heat. Hence the fourth question is about how to create a 'sane' securities market. The proper regulation of joint-stock companies as well as investment and unit trusts, non-bank financial institutions and commercial banks would be crucial for realising efficiency and fairness in an. equity-based Islamic securities market. Every effort should be made to ensure that the relevant institutions release sufficient information, make adequate disclosures and that their directors or management do not manipulate share prices due to their insiders' knowledge. Directors of companies and management of trusts must not be allowed to levy a fixed initial or annual charge because their role is in the nature of mudaribs and a mudarib is not allowed a fixed remuneration by the Shari’ah. They should be allowed only a share in the profit as a reward for their services. If there is a loss they get no reward. The linking of the reward to performance should tend to have a salutary effect on the performance of directors of companies and the management of trusts.

The securities market should also be well regulated to ensure fairplay and to remove speculative transactions. Short sales and forward purchases against margin may have to be prohibited if speculative heat is to be removed. It would also be desirable to change the tax regulations in such a way that companies are encouraged to resort more and more to equity in place of interest-based financing. The present tax structure encourages interest-based financing by allowing interest paid to be tax deductible whereas dividends are taxable.