Capital and Money Markets of Muslims: The Emerging Experience in Theory and Practice

Abstract

Capital market – or more precisely the primary capital market – is the fulcrum of capital formation whereby liquid funds are effectively mobilised, pooled and channelled through the financial system to finance the production of goods and services in the economy and, hence, effectively contribute to real economic growth. However, the long term commitment of funds in the production of goods and services tend to be thwarted by two major concerns on the supply side of funds (1) parting with liquidity and (2) exposure to various economic risks. An efficiently liquid capital market is, therefore, one which prudently resolves these two major problems through the structuring of appropriate capital market instruments and the placement of supportive financial and regulatory institutions. The worldwide phenomenal growth of secondary financial markets have thus flourished to cater the needed liquidity and risk management services through the free sale and purchase of capital and money market instruments. In particular, the trading of short term loans or debt instruments through money markets, with maturity less than one year, proves to be an important efficiency-enhancing arm to capital markets. Islamic finance is governed by the law of Shari’ah (Muslims’ law) which basically prohibits the interest rate as well as a kind of ‘structured’ uncertainty within financial contracts called gharar 1) . Depending on the maturity of financial assets, it will be shown that Islamic securities can be structured to act as either ‘capital market’ or ‘money market’ instruments. It is particularly interesting to see how Islamic capital and money market instruments have been structured with a view to issues of liquidity and risk management. Yet, currencies in whatever denomination are not legitimate objects of money market trade from Shari’ah perspective. For example, foreign exchange has to satisfy the hand-to-hand condition, which means that any deliberate delay or deference in the exchange of currency falls in the special category of prohibited usury called riba al-nasaa’ or the usury of deference 2) . This paper is about the experience of the newly emerging Islamic capital and money markets, and how they have been set out to integrate with global capital markets in accordance with Shari’ah-compliant solutions. At the outset, a brief background on the importance of money markets is given, followed by a comparative demonstration of conventional and Islamic financial markets. The structural properties of Islamic capital and money market instruments are then explained with reference to the emerging financial market experience in the Muslim world. In anticipation