124 AN INTRODUCTION TO ISLAMIC FINANCE
worthwhile considering the positive contributions the instrument would
make to the economy and to society.
Securitized “asset - linked securities” market In addition to the standard stock
market, there is another capital market that provides a platform for trad-
ing asset - linked securities. The notion in Islamic fi nance of binding capi-
tal closely and tightly to a real asset encourages the issuance of securities
against a portfolio of assets. For example, an asset fi nanced through ijarah
or istisna’ can be used as collateral to issue securities linked to the payoffs
and cash fl ows generated by the underlying assets. The assets of an Islamic
fi nancial intermediary based on ijarah or istisna’ have interesting features.
First, it provides a wide range of maturity structure; that is, from short - term
trade fi nancing to medium - term lease - based assets. A second and equally
important feature is that the risk profi les of such assets carry relatively low
credit risk because the payoffs are directly linked to the pre determined cash
fl ows. Finally, predetermined cash fl ows and fi xed maturities make these
securities a close substitute for fi xed - income securities which could be desir-
able to some investors. A portfolio of such assets could be securitized to
create a fi nancial security that can be traded on an organized capital market,
in both the primary and the secondary markets.
The securitization technique has been criticized in the conventional
system in the aftermath of the fi nancial crisis of 2007–08 where securi-
tized securities with complex embedded derivatives led to the meltdown.
A serious postmortem of the crisis will probably exonerate the process of
“securitization” as such and will put the blame elsewhere. The technique
of securitization by which a marketable security is developed that is backed
by the payoffs of the underlying asset has a number of merits. As will be
discussed below, a judicious application of securitization can lead to the
development of a vibrant market for “asset - linked” securities which can
play a critical role in the fi nancial system.
Securitization involves collecting homogenous assets with a known
stream of cash fl ows into a pool, or portfolio, which is independent of the
creditworthiness of the fi nancier. This pool of assets is used to issue securi-
ties, which can be marketed to different classes of investors ranging from
individuals to institutional investors. The securities are structured in such a
way that all payoffs in terms of risks and returns are “passed - through” to
the investors or the holders of the securities. The net result is that it is as if
the investor has the direct ownership of underlying assets, shares the returns
of the assets and, fi nally, is exposed to all the associated risks. These securi-
ties are, in turn, traded and negotiated freely on organized exchanges.
The process described above is readily and directly applicable to
the development of securitized securities in an Islamic fi nancial system. The
point of departure from the conventional system depends on the way the
returns and risks are shared with or passed on to the investors. A securitized
security in the conventional system is referred to as an asset - backed security
because, in most cases, the security owner is exposed to the credit risk of the