Benchmark a major step for Islamic finance

Last month, the world’s first Islamic interbank benchmark rate (IIBR) was launched. It was the result of a collaborative approach taken by many Islamic financial institutions, industry associations and Sharia scholars over the course of 24 months to address a decades-old industry challenge:

how to decouple Islamic finance from a conventional western pricing benchmark (Libor) when an “Islamic” alternative was not available. The objective was to support and preserve Islamic finance authenticity.

The IIBR is an interbank benchmark that offers a reliable and realistic standard to better measure the cost of funding for Islamic financial institutions. As contributed pricing for Sharia-compliant funding, it represents the DNA of an Islamic banking industry that is today focused on commercial banking over investment banking.

IIBR brought together more than 20 Islamic finance institutions to create a proprietary Islamic pricing benchmark. It is a major indication to the world that Islamic finance has come of age and can be seen as a sustainable and rapidly developing feature of global financial markets.

The benchmark is designed to be used to price a number of Islamic instruments including common overnight to short-term treasury investment and financing instruments such as murabaha, wakala and mudaraba, retail financing instruments such as property and car finance, and sukuk and other Sharia-compliant fixed-income instruments. It can also be used for the pricing and benchmarking of corporate finance and investment assets.

We expect the benchmark to grow organically as industry use and acceptance increase. As the industry gets used to the idea of its own proprietary benchmark and its scope becomes more global, we expect to see banks use the rate to price their interbank liquidity placements.

As that gains traction, banks will start to use it for their corporate and retail banking facilities. The rate has reached its full potential when we see investment banks providing syndicated Islamic financing (loans) and debt (sukuk) issuance using the rate.

Since the launch of IIBR, it has received much attention around the world for the positive step that it is.

Understandably though, the significance of IIBR and what it means for the Islamic finance industry, indeed the very position of Sharia-finance in Islam and the wider world, means that it provokes strong opinion and debate.

And we must address the critics if we are to achieve the full potential of this initiative. After all, these commentators are important additional stakeholders.

All collaborations start with open minds and transparent dialogue, and so here I hope to address some of the key points raised.

What is the difference between IIBR and Libor – the London interbank offered rate? Put simply, IIBR measures expected profit while conventional benchmarks such as Libor measure interest rates.

The IIBR question for contributors explicitly refers to the cost of raising Sharia-compliant funding and is therefore based on returns generated by Islamic assets.

The IIBR rates represent the aggregate risk profile of Islamic financial institutions, by way of their assets on the balance sheet, and the geographies in which they operate. This is important for two reasons.

 

On an economic level, now more than ever, conditions in Europe or the US do not necessarily reflect the conditions in the Middle East funding market, although there will inevitably be a connection as global financial markets are always intertwined.

How is IIBR representative and reflective of global Islamic finance treasury funding costs?

This is only a beginning. At present, we have a strong base in GCC countries, we have three major Malaysian banks and are in conversations with others, and we have started conversations with banks in Turkey, Pakistan and other jurisdictions.

How will IIBR address cross-border funding costs?

The precondition for cross-border funding is establishing local rates, and we are starting a dialogue with more countries with established Islamic banking industries. The more important point is that a transparent process or methodology is in place for price contributions, and its integrity is overseen by our benchmark committee with rules that will punish banks, including expulsion, that violate the agreement they have signed.

Why are only murabaha contribution rates used?

Murabaha is the predominant form of funding for Islamic banks. However, the IIBR is instrument-neutral as decided by the Islamic benchmark committee, and in the future, when other instruments such as wakala or mudaraba become more widespread, a higher proportion of contributions could be derived from other rates.

Is IIBR only for Islamic financial institutions?

IIBR, like Islamic finance, is for all people and institutions for all times. As an accurate and transparent measure of market activity, it is suitable for a variety of uses in the modern financial markets of the world. With IIBR, conventional banks will now have more confidence in their counterparty Islamic banks because their rates will be benchmarked and publicly available.

http://www.thenational.ae/thenationalconversation/industry-insights/finance/benchmark-a-major-step-for-islamic-finance

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