Separate Benchmark for Islamic BanksWhat is Banking System?A
Bank is a financial institution and a financial intermediary that
accepts deposits and channels those deposits into lending
activities, either directly or through capital deficits markets. A
bank connects customers that have capital deficits to customers
with capital surpluses.Due to their critical status within
thefinancial systemand the economygenerally, banks arehighly
regulatedin most countries. Most banks operate under a system known
asfractional reserve bankingwhere they hold only a smallreserveof
the funds deposited and lend out the rest for profit. They are
generally subject tominimum capital requirementswhich are based on
an international set of capital standards, known as the Basel
Accords.
Types of Banks:Banks activities can be divided intoRetail
Banking, dealing directly with individuals and small
businesses;Business Banking, providing services to mid-market
business; corporate banking, directed at large business
entities;Private banking, providing wealth management services
tohigh net worth individualsand families;Investment banking,
relating to activities on thefinancial markets.
Other Types of Banks:Central Banksare normally government-owned
and charged with quasi-regulatory responsibilities, such as
supervising commercial banks, or controlling the cashinterest rate.
They generally provide liquidity to the banking system and act as
thelender of last resortin event of a crisis.Islamic Banksadhere to
the concepts ofIslamic law. This form of banking revolves around
several well-established principles based on Islamic canons. All
banking activities must avoid interest, a concept that is forbidden
in Islam. Instead, the bank earns profit (markup) and fees on the
financing facilities that it extends to customers. Most banks are
profit-making, private enterprises. However, some are owned by
government, or arenon-profit organizations.
Islamic Banks in Pakistan1) Dawood Islamic Bank Limited2) Dubai
Islamic Bank Pakistan limited3) Meezan Bank Premier Islamic Bank In
Pakistan4) AlBaraka Islamic Bank5) BankIslami Pakistan Limited6)
Emirates Global Islamic Bank
What is Islamic Banking?Islamic banking refers to a system of
banking or banking activity that is consistent with the principles
of the Shari'ah (Islamic rulings) and its practical application
through the development of Islamic economics. The principles which
emphasize moral and ethical values in all dealings have wide
universal appeal. Shari'ah prohibits the payment or acceptance of
interest charges (riba) for the lending and accepting of money, as
well as carrying out trade and other activities that provide goods
or services considered contrary to its principles. While these
principles were used as the basis for a flourishing economy in
earlier times, it is only in the late 20th century that a number of
Islamic banks were formed to provide an alternative basis to
Muslims although Islamic banking is not restricted to
Muslims.Islamic banking has the same purpose as conventional
banking except that it operates in accordance with the rules of
Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions).
Islamic banking activities must be practiced consistent with the
Shariah and its practical application through the development of
Islamic economics. Many of these principles upon which Islamic
banking is based are commonly accepted all over the world, for
centuries rather than decades. These principles are not new but
arguably, their original state has been altered over the
centuries.
It is evident that Islamic finance was practiced predominantly
in the Muslim world throughout the middle Ages, fostering trade and
business activities. In Spain and the Mediterranean and Baltic
States, Islamic merchants became indispensable middlemen for
trading activities. It is claimed that many concepts, techniques,
and instruments of Islamic finance were later adopted by European
financiers and businessmen.The revival of Islamic banking coincided
with the world-wide celebration of the advent of the 15th Century
of Islamic calendar (Hijra) in 1976. At the same time financial
resources of Muslims particularly those of the oil producing
countries, received a boost due to rationalization of the oil
prices, which had hitherto been under the control of foreign oil
Corporations. Disenchantment with the value neutral capitalist and
socialist financial systems led not only Muslims but also others to
look for ethical values in their financial dealings and in the West
some financial organizations have opted for ethical operations.
Origin of Islamic BankThe origin of the modern Islamic bank can
be traced back to the very birth of Islam when the Prophet himself
acted as an agent for his wife's trading operations. Islamic
partnerships (mudarabah) dominated the business world for centuries
and the concept of interest found very little application in
day-to-day transactions.Such partnerships performed an important
economic function. They combined the three most important factors
of production, namely: capital, labour and entrepreneurship, the
latter two functions usually combined in one person. The
capital-owner contributed the money and the partner managed the
business. Each shared in a pre-determined share of the profits. If
there was a loss, the capital-provider lost his money and the
manager lost his time and labour. Islamic Banking PrinciplesThe
Shariah prohibits the payment of charges for the renting of money
(riba, which in the definition of Islamic scholars covers any
excess in financial dealings, usury or interest) for specific
terms, as well as investing in businesses that provide goods or
services considered contrary to its principles (Haram, forbidden).
While these principles were used as the basis for a flourishing
economy in earlier times, it is only in the late 20th century that
a number of Islamic banks were formed to apply these principles to
private or semi-private commercial institutions within the Muslim
community."While a basic tenant of Islamic banking - the outlawing
of riba, a term that encompasses not only the concept of usury, but
also that of interest - has seldom been recognized as applicable
beyond the Islamic world, many of its guiding principles have. The
majority of these principles are based on simple morality and
common sense, which form the bases of many religions, including
Islam."The universal nature of these principles is immediately
apparent even at a cursory glance of non-Muslim literature. Usury
was prohibited in both the Old and New Testaments of the Bible,
while Shakespeare and many other writers, particularly those
writing in the 19th century, have attacked the barbarity of the
practice. Much of the morality championed by Victorian writers such
as Dickens - ranging from the equitable distribution of wealth
through to man's fundamental right to work - is clearly present in
modern Islamic society. "Although the western media frequently
suggest that Islamic banking in its present form is a recent
phenomenon, in fact, the basic practices and principles date back
to the early part of the seventh century." (Islamic Finance: A
Euromoney Publication, 1997)Basis of Islamic BankingIn order to be
Islamic, the banking system has to avoid interest. Consequently,
much of the literature on the theory of Islamic banking has grown
out of a concern as to how the monetary and banking system would
function if interest were abolished by law.Another Islamic
principle is that there should be no reward without risk-bearing.
This principle is applicable to both labour and capital. As no
payment is allowed to labour unless it is applied to work, so no
reward for capital should be allowed unless it is exposed to
business risks.Consider two persons, one of whom has capital but no
special skills in business, while the other has managerial skills
but possesses no capital. They can co-operate in either of two
ways:1. Debt-financing (the western loan system). The businessman
borrows the capital from the capital-owner and invests it in his
trade. The capital-owner is to get back his principal and an
additional amount on the basis of a fixed rate, called the interest
rate, as his compensation for parting with liquidity for a fixed
period. The claim of the lender for repayment of the principal plus
the payment of the interest becomes viable only after the expiry of
this period. This payment is due irrespective of whether the
businessman has made a profit using the borrowed money. In the
event of a loss, the borrower has to repay the principal amount of
the loan, as well as the accrued interest, from his own resources,
while the capital-owner loses nothing. Islam views this as an
unjust transaction.2. Mudarabah (the Islamic way, or PLS). The two
persons co-operate with each other on the basis of partnership,
where the capital-owner provides the capital and the other party
puts his management skills into the business. The capital-owner is
not involved in the actual day-to-day operation of the business,
but is free to stipulate certain conditions that he may deem
necessary to ensure the best use of his funds. After the expiry of
the period, which may be the termination of the contract or such
time that returns are obtained from the business, the capital-owner
gets back his principal amount together with a pre-agreed share of
the profit.The ratio in which the total profits of the enterprise
are distributed between the capital-owner and the manager of the
enterprise is determined and mutually agreed at the time of
entering the contract, before the beginning of the project. In the
event of loss, the capital-owner bears all the loss and the
principal is reduced by the amount of the loss. It is the risk of
loss that entitles the capital-owner to a share in the profits. The
manager bears no financial loss, because he has lost his time and
his work has been wasted. This is, in essence, the principle of
mudarabah.Rules of PermissibilityMuslims believe that all things
have been provided by God, and the benefits derived from them, are
essentially for mans use, and so are permissible except what is
expressly prohibited in The Quran or Hadith. When guidance is not
clearly given in the Quran there are several other sources of law.
For example, guidance can be sought from Fiqh, which means
understanding and is the science of jurisprudence: the science of
human intelligence, debate and discussion
Financing Modes of Islamic BanksIslamic financing in its first
stages used only the partnership modes of musharakah and mudarabah.
Later it was realized that, to avoid moral hazards, yet compete
successfully with conventional banks, it was necessary to use all
permissible Islamic modes and so trade-based and leasing techniques
were developed.The general rule is that all financial arrangements
that the contracting parties agree to use are lawful, as long as
they do not include an element of interest. Equity-holding and
commodity and asset-trading are an integral part of Islamic
financing.
The two basic categories of financing are: 1)
profit-and-loss-sharing (PLS), also called participatory modes,
i.e., musharakah and mudarabah and 2) Purchase and hire of goods or
assets and services on a fixed-return basis, i.e., murabaha,
istisna'a, salam and leasing.Legitimate modes include financing
trade, industry or budget deficits through domestic or foreign
sources. Islamic banks may design diversified investment portfolios
and instruments that generate profit with the required liquidity.
To maximise its profits, a bank needs to look for investments that
yield the highest return, minimize risks and provide adequate
liquidity. At the same time, it is necessary for the bank's
liabilities and assets to be matched.A pyramid of financial assets
can be built based on liquidity and profitability, which are the
criteria of prudent banking. At the top would be high-risk and
less-liquid assets, such as long-term investments out of its own
equity or from deposits of its risk-accepting account-holders. At
the bottom of the pyramid would be the least risky and most highly
liquid assets, based on murabaha (leasing) or short-term (even
overnight) Mudarabah Certificates (PLS).Musharakah and mudarabah
can be used for short, medium and long-term project-financing,
import-financing, export financing, working capital financing and
financing of single transactions. Diminishing musharakah can be
used for large fixed assets such as houses, transport, machinery,
etc. Murabaha can be used for purchases of goods needed by the
bank's clients. Salam is useful for financing farmers, trading
commodities for the public and private sectors and other purchases
of measurable and countable things. But it must be kept in mind
that buyback and rollover modes may not be used, because they are
seen as a back door to interest.With Islamic financing, the need to
assess clients' acceptability is more important than it is for
conventional banks. The bank needs to be vigilant and prudent by
concentrating on the client's integrity as well as his status
regarding property and particularly his willingness to comply with
Shari'ah-compliant contracts.Islamic banks, while functioning
within the Shari'ah, can perform the crucial task of resource
mobilization and efficient allocation on the basis of both PLS and
non-PLS modes. Sharing modes can be used for short, medium and
long-term financing, import financing, pre-shipment export
financing, working capital financing and financing of single
transactions. To ensure the maximum use of Islamic finance in the
development of the economy, it is necessary to create an
environment that can induce financiers to earmark more funds for
musharakah- or mudarabah-based financing of productive units,
particularly those of small enterprises.The non-PLS modes
acceptable to the Shari'ah not only complement the PLS modes, but
also provide flexibility of choice to meet the needs of different
sectors and economic agents in the society. Trade-based modes, such
as murabaha, having less risk and better liquidity options, have
several advantages over other techniques, but may not be as
fruitful in reducing income inequalities and generation of capital
goods as participatory techniques are.Ijarah-based financing, that
requires Islamic banks to purchase and maintain the assets and
afterwards dispose of them according to Shari'ah rules, requires
the banks to engage in activities beyond financial intermediation
and are very much conducive to the formation of fixed assets and
medium- and long-term investments.On the basis of the above, it can
be said that supply and demand of capital in an interest-free
environment have the additional benefit of providing a greater
supply of risk-based capital. There is also a more efficient
allocation of resources and an active role for banks and financial
institutions to play, as required in the asset-based Islamic theory
of finance.Islamic banks can not only survive without interest, but
are also helpful in achieving the objective of distributive justice
by increasing the supply of risk capital in the economy and
facilitating capital formation and the growth of fixed assets and
real-sector business activities.Salam (forward purchase with
prepayment of price) has a vast potential to finance productive
activities in crucial sectors, particularly agriculture, agro-based
industries and the rural economy as a whole. It also provides an
incentive to enhance production, as the seller will spare no effort
to produce at least the quantity needed for settlement of the loan
taken by him as the advance price of the goods. Salam can also lead
to creating a stable commodities market, especially of seasonal
commodities, and therefore to stability of their prices. It enables
savers to direct their savings to investment outlets, without
waiting, for instance, until the harvesting time of agricultural
products or the time when they actually need industrial goods and
without being forced to spend their savings on consumption.Banks
might engage in fund and portfolio management through a number of
asset-managing and leasing and trading companies. Such companies
can exist on their own or can be an integral part of some big
companies or subsidiaries, as in the case of Universal Banking in
Europe. They would manage Investors Schemes to mobilize resources
on a mudarabah basis, and to some extent on an agency basis, and
use the funds so collected on a murabaha, leasing or
equity-participation basis. Subsidiaries can be created for
specific sectors or operations and would enter into genuine trade
and leasing transactions. Low-risk funds based on short-term
murabaha and leasing operations of the banks, in both local and
foreign currencies, would be best suited to risk-averse savers who
cannot afford the possible losses of PLS-based investments.Under
equity-based funds, banks can offer a type of equity exposure
through specified investment accounts where they identify possible
investment opportunities from existing or new business clients and
invite account-holders to subscribe. Instead of sharing in the
bank's profits, the investors share in the profit of the enterprise
in which the funds are placed and the bank takes a management fee
for its work. Banks can also offer open-ended multiple-equity funds
to be invested in stocks.The small and medium enterprises (SME)
sector has a great potential for expanding production capacity and
self-employment opportunities in developing countries. Islamic
banks may introduce SME-financing funds for various places.
Enhancing the role of the financial sector in the development of
the SME sub-sector can mitigate the serious problems of
unemployment and the low level of exports of such countries.
Problems faced by Islamic Banks in Pakistan:
There are many problems to Islamic banking in Pakistan as
compared to conventional banking system. There is no legal
framework, lack of professionals, no central bank, Benchmarking for
Islamic Banks, to educate the people about Islamic banking to
increase Islamic finance in the market, innovation and new
technology and experience. Fiqa problems educated scholars are
required to compete conventional banking in Pakistan
BenchmarkWhat Does Benchmark Mean? A standard against which the
performance of a security, mutual fund, or investment manager can
be measured. Generally, broad market and market-segment stock and
bond indexes are used for this purpose.Benchmark:Robert Demilio
(1995) defines Benchmarking as an improvement process used to
discover and incorporate best practice into your operation.
Benchmarking is the preferred process used to identify and
understand the elements (causes) of a superior or world class
performance in a particular work process.Xerox Corporation, which
is the pioneer of the techniques application in management
practice, defines it as the search for industry best practices
which lead to superior performance (Codling, S 1992). From above
two definitions key points identified are best practice and
superior performance. For instance Allah says in the Quran, Indeed
in the Messenger of Allah you have an excellent example (best
practice) to follow for whoever hopes in Allah and the Last Day and
remembers Allah much (best performance).So any Muslim wants to
worship Allah in the best possible manner should follow the sunnah
of the prophet (pbuh). For instance, if you want to be a best
husband, you need to look and follow the way prophet (pbuh) has
behaved with his wife. So a Muslim is expected to benchmark the
sunnah of prophet (pbuh) in each and every sphere of life to get
the best performance in both worlds, here and hereafter. The
Islamic BenchmarkDefinitionThe IIBR is defined as the profit rate
that an individual Contributor Panel bank would perceive to be
reasonable for Shariah compliant funding were it to do so by asking
for and then accepting inter-bank offers in reasonable market size,
just prior to 11.00 am Makkah local time (GMT + 3). The value dates
for settlement are T+0 for Overnight funds and T+2 for all other
tenors.BackgroundSince the establishment of the first Islamic
commercial bank in 1975, the Islamic finance industry has been
searching for an indigenous benchmark that can be applicable to
transactions compliant with Islamic law (Shariah compliant).As an
ethical financial system, Islamic finance prohibits interest and
shuns all interest-related transactions and instruments as these
are contradictory to the core principles of Islam. Despite this
prohibition, in the absence of a reliable Islamic interbank
benchmark, Islamic banks and financial institutions have continued
to utilize conventional interest based benchmarks to calculate
their cost of funding with no reference to either their assets risk
profile or the regional particularities of Islamic banks. The
Islamic Interbank Benchmark Rate (IIBR) serves to address some of
these concerns by developing a rate that is contributed by and is
indigenous to a global panel of Islamic banks and Islamic Banking
windows with fully segregated funds.
Logic against Interest rateBenchmarking:Prophet (pbuh) has
forbidden copying non Muslims. He suggested fasting for two days on
Muharram while Jews fast for one day, only to differentiate
practice of Muslims from non Muslims. Riba is a practice of non
Muslims. So it should not be benchmarked. Every kinds of
transaction in Islamic finance should be able to differentiate from
the practice ofconventional finance.Dr, Zakir Naik, the most famous
Islamic scholar of time argued that Profit rate ofIslamic banking
products cannot be same for all the products. In a general day to
day sale transaction we can see that profit rate of sale of
computer and vegetable is not same. Therefore Islamic banks should
have a price index or profit index for different types ofproducts.
In a recent study by post graduate students of International
Islamic university Malaysia shows that using rental rate is better
than interest rate as because it is stable and linked with real
economy. They suggested that there should be different rental index
for different areas to fix rental rate to implement ijara contract
for home financing based on Musharakah Mutanaqisah Partnership
(MMP).
Impact of interest rate benchmarking on Islamic
banking:Benchmarking interest rate though does not invalidate
sharia rulings but it resembles like a conventional banking product
from the outfit. That is why some critics of Islamic banking say,
Islamic banking allows riba from the back door. Benchmarking
interest rate cannot completely differentiate between an Islamic
products and conventional products. Hence, stakeholders lose
confidence on Islamic branding. Mohammad Amin (2011) has shown how
interest rate benchmarking brings same result in fixed rate
mortgage and property finance using Murabaha (See Appendix A)The
Islamic Interbank Benchmark Rate ('IIBR')DefinitionThe Islamic
Interbank Benchmark Rate ('IIBR') is calculated by Thomson Reuters
based on a time tested methodology agreed upon in consultation with
the Islamic Benchmark Committee and approved by the Shariah
Committee.
The IIBR is defined as the profit rate that an individual
Contributor Panel bank would perceive to be reasonable for Shariah
compliant funding were it to do so by asking for and then accepting
inter-bank offers in reasonable market size, just prior to 11.00 am
Makkah local time (GMT + 3).The value dates for settlement are T+0
for Overnight funds and T+2 for all other tenors.
MethodologyA poll of approximately 16 pre-selected banks
contributed rates are snapped by Thomson Reuters contributions
technology (Thomson Reuters Spreadsheet Publisher or TRSP) at 10.45
AM on every business day (Sunday- Thursday).Banks are asked to
contribute rates between 9.00 AM- 10.44 AM Makkah local time (GMT
+3) as per the following question:What is the expected profit rate
that you would distribute for an interbank Shariah compliant
funding transaction, were you to do so by asking for and then
accepting inter-bank offers for a market amount of USD for the
tenors specified below?Over Night3 Months1 week6 Months1 Months9
Months2 Months12 MonthsThomson Reuters undertakes both automated
and manual audit and review procedures at this stage to ensure that
the rates contributed are genuine.The rates are ranked from highest
to lowest and the top and bottom quartiles (25%) of the rates are
excluded to ensure that outliers do not influence the distribution
(from 16 contributed rates, 8 rates are excluded 4 each of the
highest and lowest rates).The arithmetic mean (average) of the
remaining mid quartiles values is then calculated to produce the
IIBR, rounded to 5 decimal places.Criteria:In order to publish the
rate, certain conditions must be fulfilled; which include: A
minimum of 8 banks contributing to each tenor Banks must supply
rates to all points on the curve (all tenors) Banks must quote
every day Sun-Thurs (although as a fallback and to help reduce the
incidence of non fixing days a minimum number will be required (8)
A contributor will be permitted to maintain the same rates for one
additional day
Timing of Publication
Official Reference Time: The official reference time in relation
to the IIBR is Makkah time (GMT +3)Makkah is regarded as the
holiest city in Islam and is located in the Hejaz region of Saudi
Arabia, approximately 73 km inland from Jeddah.
Publication Timings:The official publication time for the IIBR
is 11.00 AM (Makkah) The publication will follow the 1. Rate
contributions for the IIBR will be accepted from 9.00 AM- 10.44 AM
(Makkah) 2. The official snapping time will be 10.45 AM 3. An audit
period will follow from 10.45 AM -10.59 AM 4. The official rate for
that particular day will be published at 11.00 AM. Publication
Days: The IIBR is published every business day in the GCC: Sunday-
Thursday (provided minimum number of contributors is achieved
except for the two major Muslim festivals (Eid) and New Years Day
1st of January. For certainty, the IIBR will not be published on
the 1st Shawwal and 10th Dhul Hijjah, the exact dates of which are
determined by the official authorities in Saudi Arabia.
Contributory Panel:The Contributory Panel is the banks selected
in coordination with the Islamic Benchmark Committee to contribute
their rates in order for Thomson Reuters to calculate the IIBR.
The official Contributory Panel for the IIBR as of 22 November
2011 includes: a) Abu Dhabi Islamic Bank b) Ahli United Bank c) Al
Baraka Bank d) Al Hilal Bank e) Alinma Bank f) Al Salam Bank g)
Bahrain Islamic Bank h) Barwa Bank i) Dubai Islamic Bank j) Ithmaar
Bank k) Kuwait Finance House l) Masraf Al Rayan m) National
Commercial Bank (Al Ahli) n) Noor Islamic Bank o) National Bank of
Kuwait p) Qatar Islamic Bank q) Sharjah Islamic Bank Unless advised
otherwise, this Contributor panel remains current at the time of
viewing. A stringent and transparent governance framework advised
by the Islamic Benchmark Committee and approved by the Shariah
Committee regulates the selection, admission and exclusion of
Contributor panel banks.
Governance:The IIBR is governed by a stringent and transparent
governance framework, which includes the appointment of an
oversight body, the Islamic Benchmark Committee and the appointment
of a Shariah Committee to ensure that the benchmark is in
compliance with principles and laws of Islam. Islamic Benchmark
Committee Shariah CommitteeIslamic Benchmark Committee:The IIBR is
advised by the Islamic Benchmark Committee which meets at least
once annually for an Annual Review and under extraordinary
circumstances, can meet as called, to remove or include
contributors. The Committee members are appointed by a quorum
(quorate defined as at least 2 representative banks, Thomson
Reuters, AAOIFI and the Chairperson or the Vice Chairperson (where
the Chairperson is unable to attend)). New members may be nominated
by any of the existing members, Thomson Reuters or by the applicant
itself. The current members of the Islamic Benchmark Committee are:
1) Independent Members 2) Representative Bank Members
1) Independent Members a) Professor Abbas Mirakhorb) Mr. Ismail
Dadabhoyc) Accounting and Auditing Organisation for Islamic
Financial Institutions (AAOIFI) d) Association of Islamic Banking
Institutions Malaysia e) Bahrain Association of Banks f) Hawkamah
Institute for Corporate Governance g) Islamic Development Bank h)
Statistical, Economic and Social Research and Training Centre for
Islamic Countries (SESRIC) i) Thomson Reuters 2) Representative
bank members a) Abu Dhabi Islamic Bank b) Ahli United Bank c) Al
Baraka Bank d) Al Hilal Bank e) Alinma Bank f) Al Salam Bank g)
Bahrain Islamic Bank h) Bank Muamalat Malaysia Berhad i) Barwa Bank
j) CIMB Islamic Bank k) Dubai Islamic Bank l) Ithmaar Bank m)
Kuwait Finance House n) Masraf Al Rayan o) National Commercial Bank
(Al Ahli) p) Noor Islamic Bank q) Qatar Islamic Bank r) RHB Islamic
Bank s) Sharjah Islamic BankShariah Committee:A Sharia Board
certificates the Islamic financial products as being
Sharia-compliants. It thereby reviews the related contracts and
provides an opinion about whether those agreements would be
permissible under Islamic Law.
Duties of Sharia Committee:The duties of a Shariah Supervisory
Board or Shariah Committee are to advise and certify in form of a
legal opinion (fatwa) certain financial products of a financial
institution.A decision of a Shariah Board is made binding by
internal decision to the Islamic financial institution. Between the
institution and the client contracts are typically governed by non
Islamic law which raises the question of legal enforcement.
Proposed Alternative Islamic benchmarks: However some efforts
have been made to develop Islamic financial benchmark. The best
effort has been made by a group of the prominent academicians from
Islamic university Malaysia under supervision of ISRA (Islamic
Sharia Research Academy for Islamic Finance). In that research
paper named Islamic Pricing Benchmarking; authors have composed all
the previous proposals on Islamic benchmark. They found mainly five
proposals:
1. Rate of Profit Mechanism Model Proposed by Abd al Hamed
al-Ghazalie (1414 AH): According to him, this can be achieved by
analyzing the rate of profits in the money market. He proposes that
it is a more rational way that promotes justice for all and fits
the nature of economics.
2. Rate of Dividend of Islamic Bank Deposits and Investment
Accounts Model Suggestion by Muhammad Abdul Halim Umar (2000):
According to him, a benchmark can be created from the dividends
distributed by Islamic banks to their depositors. It will remove
uncertainty and doubt by replacing the interest rate with a rate of
profit. It will provide a mathematical index as compared to its
conventional counterpart.
3. The Creation of an Inter Islamic Banks Market Based on
Islamic According to Shaykh Muhammad Taqi Usmani, the purpose can
be achieved by creating a common pool which invests in asset-backed
instruments like musharakah, ijarah, etc. If the majority of the
asset pool is in tangible form, like leased property or equipment,
shares in business concerns etc. its units can be sold and
purchased on the basis of their net asset value determined on a
periodic basis. These units may be negotiable and may be used for
overnight financing as well. Banks having surplus liquidity can
purchase these units, and when they need liquidity they can sell
them. This arrangement may create an inter-bank market, and the
value of the units may serve as an indicator for determining the
profit in murabaha and leasing also.
4. Tobins Q Theory proposed by Abbas Mirakhor (1996). He
proposes a method by which, the cost of capital can be measured
without resort to a fixed and predetermined interest rate. The
suggested procedure is simple. It is based on the well known Tobins
q, and can be used in the private as well as the public sector to
obtain a benchmark in reference to which investment decisions can
be made.
5. A Benchmark That Fits both Islamic and Conventional Banks by
Aznan Hasan. According to him, in Malaysia there are various ways
to determine the interest rate based on different sectors; for
instance, KLIBOR, Interbank Money Market, BLR, BFR and Overnight
Policy Rate (OPR). It is possible to use the rate of OPR in line
with Shariah principles which suit both Islamic banks as well as
conventional banks. It is usually determined by BNM in order to
strengthen the monetary policy as well as to control the supply and
demand and fair circulation of funds in the money market. Then,
based on that rate, the banks will determine their own respective
interest rates that will be used to price all loans and financing.
Indeed, all the previously mentioned pricing rates are affected
directly by OPR, which is determined by BNM. After analyzing all
previously offered model for Islamic benchmark, ISRA research team
have tested two models based on CAPM (Capital Asset Pricing Model)
and APT (The Arbitrage Pricing Theory). After examining both models
with different theory of economics, they found some limitation of
CAPM model. With the objective of linking benchmark with real
economic performances, they proposed APT model for Islamic
benchmark. Their study recognized four macroeconomic variables as
having good return predictability for all the sectors: industry
production growth, to capture the overall economic growth; the
money supply changes (M2), to capture the monetary liquidity; the
ringgit exchange rate, to reflect the relative global
competitiveness; and the Kuala Lumpur Composite Index returns, to
reflect the overall market condition. A weighted average of the
sectors returns determined through the APT is suggested here as a
viable Islamic pricing benchmark rate for the market as a whole.
From the above discussion, it is seen that criticizing Islamic
finance for benchmarking interest rate is easy but in practice,
there are many limitations in findings an alternative of it. Many
researchers have been done on this issue, but still Islamic finance
is waiting for viable solution. There is no do doubt that Islamic
finance should get rid of this criticism as early as possible.
Hopefully, with the maturity of Islamic finance better suggestions
will come in future.Essentials Of Islamic Finance Page 1