A Benchmark Pricing Strategy for Islamic Banks

Document Type : Original Article

Author

Faculty of Economics and Political Sciences, Shahid Beheshti University, Tehran, Iran

Abstract

This paper aims to present a pricing strategy for Islamic banking products. It will demonstrate that the exchange of Shari’ah compatible products in competitive capital markets results in a price that will allocate financial resources efficiently and will serve as a robust substitute to London Interbank Offered Rate (LIBOR) and similar interest based benchmarks in dual banking systems. This rate will be observable and measurable in the capital market and efficiently allocate capital funds, serve as evaluator for investment projects, and restore a stable equilibrium in the financial markets. Further, this rate will facilitate interbank transactions and contribute to the development of interbank financial markets. It will also serve as a pricing mechanism for financial products exchanged between the Central Banks and commercial banks. Consequently, it will facilitate implementation of growth stimulating or inflation combatting policies. The paper presents a model of benchmark pricing for Islamic banking products which are linked to the performance of the real sector of the economy. A model of complete and competitive financial market in which products are exchanged by Shariah rules is presented and it is shown that the rate of return which is determined at long run equilibrium of this market equals both to cost of capital and at the same time to marginal time preference rate of the clients.

Keywords

References

Ahmed, E. R., Islam, M. A., Alabdullah, T. T. Y., & Amran, A. (2018). Proposed the Pricing Model as an Alternative Islamic Benchmark, Benchmarking: An International Journal, 25(8): 2892-2912.
Ahmed, S. U., Rahman, A., Ahmed, S.P., Ullah, W.  (2014). Pricing Linkage between Islamic Banking and Conventional Banking: The case of Bangladesh, International Journal of Finance and Banking Studies, 3(4): 84-97.
Abdul Kader, R. & Yap Kok L. (2009).  The Impact of Interest Rate Changes on Islamic Bank Financing International Review of Business Research Papers, 5(3): 189-201.
Abdul Rahman, R., & Dean, F. (2013). Challenges and Solutions in Islamic Microfinance. Humanomics, 29(4): 293–306.
Akhatova, M., Zainal, M.P. & Ibrahim, M.H. (2016). Banking Models and Monetary Transmission Mechanisms in Malaysia: Are Islamic Banks Different?, Economy Papers: Journal of Applied Economies and Policy, 35(2): 169-183.
Aysan, A.F., Disli, M. & Ozturk, H. (2018). Bank Lending Channel in a Dual Banking Ssystem: Why Are Islamic Banks so Responsive?, The World Economies, 41(3): 674-698.
Ali, M. & Choudry, W. A.N. (2014). Islamic Finance Benchmark: A Possible Solution Revisited, Journal of Islamic Business and Management, 4 (2). 115-126.
Azmi Omar, Azman, M. N., Ahamed, K. M., Turkhan, A. A. M., M. Shabri, A. M. (2010). An Islamic Pricing Benchmark, ISRA research paper, 17.
Bank for International Settlements (2013). Towards Better Reference Rate Practices: A Central Bank Perspective, March.
Bohm-Bawerk, E., V.  (1890). Capital and Interest, Translated by William Smart, London Macmillan and CO. 
Bernhardsen, T. (2005). The Neutral Real Interest Rate, Norges Bank, Staff Memo.
Brazilia, D. & Mekean, H. (2021) White Paper on Global Benchmark Rate Reforms and Implications of IBOR Transition for Islamic Finance, International Islamic Financial Market, Retrieved from Regulationtomorrow.com.
Brousseau, V., Chailloux, A. B. & Durre, A. C. J. (2013). Fixing the Fixings: What Road to a More Representative Money Market Benchmark?. IMF Working Paper No. 13/131, Available at SSRN: https://ssrn.com/abstract=2280637.
Cowen, T. (2015). What’s the Natural Rate of Interest in Economics History, Marginal Revolution, https://marginalrevolution.com/marginalrevolution/2015/11/whats-the-natural-rate-of-interest.html.
Cultural Section of the society of Teachers (2002). Pul wa Nezamhaye Puli [Money and Monetary Systems], Islamic Propagation of the Islamic Seminary of Qom, Qom Iran.
Duffie, D. & Stein, J.C. (2015). Reforming LIBOR and Other Financial Market Benchmarks. Journal of Economic Perspectives, 29 (2), Financial Times International edition (14 September).
Fisher, I. (1930). The Theory of Interest, New York the Macmillan Company.
Fitri, M.R. (2007). Pricing of Murabaha and Ijarah Product in Malaysia, Master Thesis, International Islamic University Malaysia, Kuala  Lumpur 
Friedman, M. (1963). Price Theory, Chicago, Aldine Publishing Co.
Friedman, M. (1968). The Role of Monetary Policy, American Economic Review, 58(1):1-17.
Freeman, M. C.  & Davidson, I. R. (1999). Estimating the Equity Premium, The Europian Journal of Finance, 5 (3). 
Gyntelberg, J. & Wooldridge, P. D. (2008). Interbank Rate Fixings During the Recent Turmoil, BIS Quarterly Review, March Available at SSRN: https://papers.ssrn.com › sol3 › papers.
Hershliefer, J. (1982). Price Theory and Applications, 2nd Ed. New Delhi, Prentice Hall of India.
Ismail, A. G. & Arshad, NC.  (2010). Pricing on the Islamic Banking Products, Malaysian Management Review.
Iqbal, Z., (1999) The Benchmark Issue in the Islamic Financial System. American Journal of Islamic Social Sciences, 16: 45–54.
Kader, R. A., & Leong, Y. K. (2009). The Impact of Interest Rate Changes on Islamic Bank Financing, International Review of Business Research Papers   5(3): 189–201.
Khan, M. S. & Mirakhor, A. (1989). The Financial System and Monetary Policy in an Islamic Economy, JKAU: Islamic Econ., 1, 39-57.
IOSCO. (2013). Principles of Financial Benchmarks: Final Report, Madrid, Spain: Available at   https://www.iosco.org/library/pubdocs/pdf/IOSCOPD415.pdf.
Al-Jallad, R. T. (2018). The Effect of Innovative Islamic Profit Rate Benchmark on Pricing Islamic Derivatives Securities. The Educational Review, 2(8): 427-431.
Lubik, B. T. A., & Matthes, C. (2015). Calculating the Natural Rate of Interest : A Comparison of Two Alternative Approaches, Richmond Fed Economic Brief (October), retrieved from https://econpapers.repec.org/article/fipfedreb/ (October), 1–6.
Lilian M. & Stenfors, A. (2021). Beyond LIBOR: Money Markets and the Illusion of Representativeness, Journal of Economic Issues, 4(2): 565-573.
Laubach, T., & Williams, J.C. (2016). Measuring the Natural Rate of Interest, Redux, Business Economics, 51: 257-267.
Mat Sari, N., Mirakhor, A. & Subky, K.H.M. (2017). Replacing the Interest Rate Mechanism in Monetary Policy, Case of Malaysia, Conference Proceedings: 1st International Colloquium on Islamic Banking and Islamic Finance Tarbiat Modares University, Tehran.
Mirakhor, A. & Alaa A. (2013). The Credit Crisis: An Islamic Perspective. The Global Islamic Finance Report (GIFR), London, Edbiz Consulting Limited.
Mirakhor, A., Krichene, N. & Shaukat, M. (2012). Unsustainability of the Regime of Interest-based Debt Financing. International Journal of Islamic Finance, 4 (2): 25-52.
Mirakhor, A. (2017). Benchmarks for Islamic Asset Pricing In Islamic Wealth Management: Theory and Practice. Ed. by Ariff, M. & Mohammad,S. Edward Elgar Publishing.
---------- (2011). Islamic Finance in a Multipolar World, The European Finance Review. October/November.
---------- (1996). Cost of Capital and Investment in a Non-Interest Economy, Islamic Economic Studies, 4(1): 35-47.
Modigliani, F. & Miller, M. (1958). Cost of Capital, Corporate Finance, and the Theory of Investment. The American Economic Review, 49(4): 655-669.
Modigliani, F. and Miller, M. (1966). Some Estimates of the Cost of Capital to the Electric Utility Industry 1954-1957. The American Economic Review, 56: 333-391.
Patinkin, Don (1962). Money Interest and Prices, 2nd Ed., New York, Harper and Row Publishers.
Rosly, S. A. (1999). Financing : Impacts on Islamic Banking Performance, Thunderbird International Business Review, 41: 461–480.
Sadr, S.K. (2016a). Money, Capital and the Islamic Property Rights Paradigm, Journal of Islamic Economics, Banking and Finance, 12(1): 1-32
Sadr, S.K. (2016b). The Economic System of the Early Islamic Period, New York, Palgrave Macmillan.
Schrimpf, A. & Sushko, V. (2019). Beyond LIBOR: A Primer on the New Reference Rates, BIS Quarterly Review, March.
Shaikh, S. A. (2019). Benchmark Rate in Project Valuation & Security Analysis in an Islamic Economy, Journal of Islamic Banking & Finance. 36(2): 37-47.
Toutounchian, I. (2009). Islamic Money and Banking: Integrating Money in Capital Theory, Singapur, Wiley & Sons.
Uhr, C. (1960). Economic Doctrines of Knut Wicksell. Berkeley: University of California Press.
Vaughan, L. & Finch, G. (2017). The Fix: How Bankers Lied, Cheated and Colluded to Rig the World’s Most Important Number, Wiley.
Zulkhibri, M. (2018). The Impact of Monetary Policy on Islamic Bank Financing: Bank-level Evidence from Malaysia, Journal of Economics, Finance and Administrative Science, 23 (46): 306-321.
International Journal of New Political Economy
Volume 4, Issue 1
2023
Pages 45-67

Files

History

  • Receive Date: 15 August 2022
  • Accept Date: 07 February 2023
  • First Publish Date: 07 February 2023
  • Publish Date: 01 January 2023

Share

How to cite

Statistics