The Financial Market Instruments

A review of the balance sheet of the central bank as well as member banks will show the different financial instruments which comprise the “demand side” in the financial market. In order to obtain a complete picture of the financial market, the “supply side” will also be considered.

(a) The Central Bank



1. Central Deposits

1. Central Deposit Certificates

2. Loan Accounts with Member

2. Central Lending Certificates



3. Cash in Vault


The central bank holds central deposits and loan accounts with member banks which, in addition to cash in vault, constitute the central bank assets. On the Liability side, the public holds the central deposit and the central lending certificates.

Unlike the traditional process of money creation, issuing money by the central bank is not a liability that is offset by holding assets (government securities). In our case, this process increases the central bank deposits with member banks. Retiring money has the opposite effect of decreasing the central bank assets, with no offsetting liabilities.

(b) Member Banks

Assets                                                           Liabilities

  1. Cash                                                   1. Demand Deposits
  2.  Equity in Enterprises                         2. Specific Investment Deposits
  3.  Profit-Sharing Accounts                    3. Specific Investment Certificates, SICs.
  4. Leasing Accounts                               4. Profit-Sharing Deposits
  5. Profit-Sharing Certificates, PSCs
  6. Leasing Deposits
  7. Leasing Certificates, LCs
  8. General Investment Certificates, GICs

Member banks place their resources in equity (direct investment), in profit-sharing accounts, and in leasing accounts. That constitutes the Assets side.

On the Liability side, member banks open deposits for specific or general investment, for profit-sharing, and for leasing. The deposits are to be used for the purposes designated by their names. In addition, demand deposits are offered to those interested in checking accounts. Depositors can move their funds from one kind of deposits to another, within the time limits which could be specified for their deposits. Moreover, except for demand deposits, withdrawal requires a prior notice within a time limit. In addition, member banks issue specific and general investment certificates (SICs & GICs), profit-sharing certificates (PSCs), and leasing certificates (LCs). Each kind of certificate is issued for a variety of maturities that cover the spectrum of tastes of the savers. Each certificate pays out dividends whose amounts are not specified in advance.

The Financial Instruments

Savers in the present model have the following three investment alternatives: —

a. Corporate Stocks

A saver can directly buy stocks and become a stockholder. This affords him direct participation in the management of the company to the extent of his capital. If his savings are substantial, he can divide them into holdings in different companies. A proper diversification scheme can be applied in this respect.

In an economy where private enterprise has a significant degree of freedom, stocks would be easy to trade. To the extent this is true, stock prices should reflect a “market consensus” on the expectations of the future earnings of each respective enterprise.

(b) Member Bank Certificates

Member banks can offer four kinds of certificates;

  1. Specific Investment Certificates (SICs). These certificates would carry the name of an enterprise in which the value of the certificate would be invested. They would be exactly like stocks held by a member bank for a particular customer.

The advantages of holding stocks through a bank include the use of the bank’s expertise as well as its block-vote, as a representative of more than one stockholder. Small stockholders in particular would benefit from these advantages.

  1. General Investment Certificates (GICs). A GIC value would enter the general pool of member bank investment. Its holder would be entitled to an average rate of profit on all operations undertaken by the bank. It is the closest thing to holding a stock in the bank itself. In addition to the expertise and the blockvote power, the GIC provides a greater degree of diversification. This could mean lower risk for savers. GICs can be issued for different maturities ranging from 60 days to 5 or even 10 years, depending on the range of bank operations. They can be marketable, which would make them relatively liquid.
  2. Profit-Sharing Certificates (PSCs). A profit-sharing certificate involves investment in short-term operations. Its maturity varies from 60 days to one year. It offers diversification among short-term placements. All these characteristics could make it specially marketable and relatively attractive for savers who desire to stay closer to the higher edge of the liquidity spectrum.
  3. Leasing Certificates (LCs). A leasing certificate is similar to an SIC, except that it is a form of declining equity. Lease payments include profit plus capital depreciation. If both parts are refunded to the holder, net of bank costs, he recoups part of his capital as the term of the lease gets closer to maturity. It is possible to design LCs which entitle holders to dividends only during lease time. Meanwhile, capital repayments would be reinvested in other lease contracts. 

(c) Central Deposit Certificates (CDCs)

As mentioned above, a CDC gives its holder a share in the central bank deposits which are being invested with all member banks. This makes it the most diversified investment in the economy. In addition, since it involves two layers of financial intermediation, namely banks and the central bank, it should be the safest instrument available.

The central bank allocates its CDs among banks according to pro- fitability, liquidity, and risk. By using these traditional investment criteria, the central bank encourages investment efficiency in the economy, since only bank operating efficiently will obtain central deposits. This ultimately leads to high rates of economic activity in the economy, especially if the aggregate amount of CDs is significant.

Being relatively more familiar with member banks than individuals, the central bank can make a more reliable judgement on the perfor- mance of each. This further reduces the financial risk to the CDC holder. CDCs are easily tradable and would have a wide market. Moreover, since there are titles to CDs, they can be redeamed for their face value plus dividend through the central bank. This, however, could not be done instantly. Since CDs are investment rather than demand deposits, prior notice must be given to banks for withdrawal.

(d) Central Lending Certificates (CLCs)

As mentioned before, CLCs are titles to a fixed sum of money. The proceeds from their sale will be used by the central bank for loans to borrowers whose future income expectations warrant their solvency. Besides, the CLCs do not give any rate of return to their holder.

It may be suspected as to why people would want to hold “barren” assets, when a wide spectrum of financial assets are available. Altruistic reasons explain that. In addition, the central bank could guarantee the instant encashment of CLCs11. This makes them both safe and liquid. They are good substitutes for cash considering the cost of demand de- posits and of safe deposit boxes. However considering the fact, that a holder would have to pay Zakah (2.5%) on CLCs it would apear that people will hold them for very short periods. Only philanthropic motives could make the amount of CLCs significant.


Source: Money and Banking in Islam, Ziauddin Ahmed; Munawar Iqabal; M. Fahim Khan. Republished with permission.
Copy URL