Islamic Liquid Investments: Sukuk, an alternative Islamic Tradable Debt Instruments

The capitalist banking system cannot operate without a liquid tradable debt market. The fundamental function of a banking system is to guarantee a payments and settlement system and provide liquidity to the market economy. Accepting deposits and extending loans is primary function of a banking system. A banker leverages its capital or net assets and makes profit from the difference in interest paid to depositors and the interest received from lending money. However, this process left the banker with illiquid loan portfolio in its balance sheet. To circumvent this issue, the banker maintains adequate investment grade highly liquid sovereign or corporate bonds that are tradable in secondary financial markets such as interbank money markets.

For Islamic banker, the maintenance of liquidity using conventional bonds is un-Islamic as the selling of bonds constitutes riba/interest in islam. In its simplest form, selling of debt by discounting is prohibited in Islam. In Islam, a debt should be exchanged without any beneficial considerations. Hence, selling or exchanging debt is counterproductive to Islamic banker as it will not yield return to them.

Nonetheless, the Islamic banker has devised instruments that do not defy the rules of Shariah and truly provide the functionality that investment portfolio of a traditional bank requires such as the provision of liquid assets, tradability of investments, and investment grade instruments etc. These instruments are so called sukuk.

Sukuk Certificates represent proportionate beneficial ownership in underlying physical or real assets. In essence they are asset backed securities. As they are asset backed their market value changes due to changes in the underlying asset and therefore they can be traded in secondary markets. Considering a pragmatic approach, these bonds behave like ordinary sovereign bonds. And they actually act similarly in repurchase agreements as any other repo instruments.

Consider for example Pakistan International Airlines Sukuk certificates. How do they act like highly liquid investment grade Islamic financial instrument for the purposes of liquidity management? The PIA has no net equity, in fact, it has negative equity. So, how do its underlying net assets have positive value? It seems that sukuk certificates are merely a renaming of government securities to make them feel Islamic and nothing else.