Of course, in the absence of a sing

Of course, in the absence of a single, or representative, interest rate there would be an increase in the information costs to those wishing to place funds in investment deposits. Individuals would have to evaluate the relative performances of various banks in order to decide where to invest, instead of simply going into time and savings deposits with a known interest rate. However, the information costs can be significantly reduced if there is a secondary market in which investment deposit certificates are traded. This market would provide the necessary signals to the public on the current and expected performance of banks through the pricing of these investment deposit certificates.

As shown in a recent paper by Khan (1986), this system of investment deposits is quite closely related to proposals aimed at transforming the traditional banking system into an equity basis made frequently in a number of countries, including the United States(12). Since the nominal value of investment deposits is not guaranteed and will fluctuate according to the performance of the bank, any shocks to asset positions are absorbed by changes in the value of shares (deposits) held by the public. Therefore, an equity-based system of this type can respond more easily and rapidly in the face of a banking crisis. In the traditional banking system the bank is expected to guarantee the nominal value of the deposit, and a shock can cause a divergence between the real value of assets and liabilities. If the bank cannot absorb losses through its reserves and borrowings from the central bank, this divergence may well result in instability and possible collapse of the payments mechanism. With the value of deposits directly linked to the earnings, and therefore assets, of banks, such a possibility is excluded from the Islamic banking system(13).

2. Lending operations or banks
Unlike the equity-participation schemes advocated by Simons (1945) and others, which focus exclusively on the liability side of the balance sheets of banks, Islamic banks have also to apply the same principles of profit and loss sharing in their loan operations. The two methods that fully satisfy the requirements of Islamic law on the lending side are Mudarabah and Musharakah arrangements(14). Both these forms are essentially variants of partnership agreements in which risk and return are shared by the parties.

a. Mudarabah financing
In general terms, in this transaction surplus funds are made available by the owner to the entrepreneur to be invested in a productive economic activity in return for a predetermined percentage of the profits earned. During the lifetime of the project the lender is the sole owner of the project and the borrower is the manager. Profits are to be shared between the lender and the borrower, but in contrast to the case of investment deposits, there is an asymmetry insofar as losses are concerned, In a Mudarabah arrangement of financial losses have to be borne exclusively by the lender. The borrower, as such, loses only the time and effort invested in the venture(15).
In practice, under Mudarabah rules banks would provide loans to business enterprises, but instead of receiving a specific return, would be entitled to a proportion of the profits earned by the borrower, For the purpose of profit distribution, the