Islamic interbank benchmark rate

On November 22, 2011, Thomson Reuters launched what it claims to be the world’s first Islamic finance benchmark rate, designed to provide an objective and dedicated indicator for the average expected return on shari’a-compliant short-term interbank funding. The Islamic Interbank Benchmark Rate (IIBR), as Thomson Reuters would like to call it, uses the contributed rates of 16 Islamic banks and the Islamic sections of conventional banks to provide a reliable and much-needed alternative for pricing Islamic instruments to the conventional interest-based benchmarks used for mainstream finance. This is an interesting development that needs scrutiny from a shari’a and economic perspective.
Interbank lending and borrowing between conventional banks creates interest-based debt. In the case of Islamic banks, however, interbank deposits are based on, by and large, what is known as commodity murabaha. Although commodity murabaha has for some time been recognised as a shari’a compliant product, subject to some strict shari’a guidelines, the fact remains that such commodity murabaha based transactions and products are either priced in terms of LIBOR or a local interest-based benchmark. The question then arises: how will the newly launched IIBR be different from conventional interest rate benchmarks?
My feeling is that the financial behaviour of IIBR will be positively correlated with the benchmarks used for the participating banks’ existing products. My suspicion is that the IIBR will be only marginally different from the respective local interest-based benchmarks and the LIBOR. However, if the proposed IIBR is used by a sufficient number of participating banks, the individual banks’ portfolios will gradually change in favour of the IIBR-linked products. This in due time will create an Islamic benchmark different from the interest-based benchmarks. This will, however, happen only if Islamic banks “borrow” only from within the Islamic financial services industry. In other words, if segregation of Islamic funds is maintained on a systemic level and not on just institutional level, an Islamic benchmark like IIBR will be useful. This basically means that the countries where Islamic banks exist, conventional banks should not be allowed to offer Islamic financial services (similar to what Qatar has done recently). My own view is that the practice of commodity murabaha should be disallowed to “borrow” from or “lend” to conventional banks. Once, Islamic banks start conducting commodity murabaha amongst themselves only, a distinct Islamic market will emerge, which would maintain a separate benchmark for Islamic banks. This “valve” between Islamic banks and conventional banks would decrease the threat of arbitrage, which otherwise will always emerge if a separate and different Islamic benchmark is introduced in a market where an interest-based benchmark already prevails.
It is interesting to note that the IIBR uses data from16 participating banks, which also include some conventional banks offering Islamic financial services through Islamic windows. Inclusion of the conventional banks in the list of the founding participating banks, in my opinion, is the basic flaw of the newly launched benchmark. Involvement of the conventional banks in determining IIBR will necessarily retain conventional thinking on pricing of Islamic financial products. After all, very short term lending and borrowing by conventional banks is driven by making money from money, as short-term lending (e.g., overnight deposits) does not lead to any real investments, and the lenders get a return on purely financial investments.
A simpler solution is based on qard hasan (or interest-free loans) to borrow and lend on a short-term basis between Islamic banks. In a cooperative environment, Islamic banks with excess liquidity may decide to lend to other Islamic banks in need of short-term liquidity. Central banks must make it compulsory for Islamic banks to offer a certain percentage of their excess liquidity in an Islamic money market that would allow liquidity-deficit Islamic banks to borrow that money on an interest-free basis.
In case of Pakistan, for example, the State Bank of Pakistan can decide to issue a sukuk on its own buildings by way of selling the real estate assets to an independent fund, which would securitise these assets. The Islamic banks wishing to manage their excess liquidity should be allowed to buy such a sukuk to receive rental income. The trade in such a sukuk may also take place on the Karachi Stock Exchange allowing Islamic banks to invest or divest at their discretion. This will also allow Islamic banks to earn any capital gain arising from the secondary market trading. Alternatively, the Islamic banks may like to keep the sukuk either to maturity (which could be 30 to 90 days) or/and any intermediate redemption days, pre-announced by the central bank. In this context, the sukuk issued by the governments of Sudan and Bahrain should be studied to develop a comprehensive framework for development of a government-supported Islamic money market in Pakistan.

The writer is a Shari’a advisor to a number of banks and financial institutions and can be contacted at [email protected]