MANAMA -- Bahrain is counting on a new Islamic financial market to increase liquidity, attract inward investment and secure the tiny kingdom's place as the Persian Gulf's principal banking center, officials said Wednesday.

"The aim of the International Islamic Financial Market (IIFM) is to find new investment tools and solve the problem of liquidity affecting Islamic banks," Bahrain Monetary Agency (BMA) Deputy Director Khalid al-Bassam told AFP.

IIFM became operational Sunday after Bahrain's King Hamad issued a decree officially establishing the Manama-based market.

"The IIFM is set to open new horizons for investments and Islamic institutions, which are relatively limited because their banking system is based on Islamic Sharia Law," Bassam said.

Interest is banned under the Islamic banking system, as the religion forbids usury.

"Murabaha" is a classic practice of Islamic banking, under which a borrower has to pay an extra amount agreed in advance. This amount is regarded as a "reward" for the risk taken by the bank.

Islamic banks also take part in joint investments, sharing in the profits or the losses of a business venture.

Bassam said that in order to diversify their reduced activities, Islamic banks should raise capital through the issuance of Sharia-friendly bonds and find other ways of lending.

"Such tools could solve the problem of liquidity affecting these banks," he said, adding that the "Islamic banking sector is rapidly expanding and numerous investors want to capitalize on their funds according to Sharia law.

"If Islamic banks can offer the same services as conventional institutions, they will be able to capture a good part of the banking sector," Bassam said.

Last year, Bahrain began offering government Islamic bills worth 25 million dollars to help create investment opportunities. It has also offered five-year Islamic leasing bonds worth 100 million dollars.

The BMA will soon offer its third issue of Islamic bonds worth 80 million dollars, according to Bassam.

IIFM chief executive Abdul Rais Abdul Majid told AFP that the Islamic market was "created following the growth in demand for new tools for investments in Islamic banks," which number around 200 worldwide.

"The IIFM should create a favorable atmosphere that will encourage Islamic banks, as well as conventional ones, to find other investment tools," Majid said.

The IIFM board comprises officials representing the monetary authorities of Bahrain, Brunei, Indonesia, Malaysia, Sudan and the 53-member Islamic Development Bank (IDB).

Economists estimate that the Islamic finance market worldwide is worth an estimated 200 billion dollars and is growing at 15 percent a year.

There are around 20 Islamic banks and finance houses operating alongside 46 offshore banks and a further 20 commercial banks in Bahrain, which faces increasing competition from Dubai for its mantle as the region's banking hub.

The multibillion-dollar Dubai international financial center will launch in early 2003 with the aim of bridging the financial markets of the East and those of the West.