The Islamic banks and financial institutions should get rid of this practice as soon as possible, because, firstly, it takes the rate of interest as an ideal for a halal business which is not desirable, and secondly because it does not advance the basic philosophy of Islamic economy having no impact on the system of distribution. Therefore, the Islamic banks and financial institutions should strive for developing their own benchmark. This can be done by creating their own inter-bank market based on Islamic principles. The purpose can be achieved by creating a common pool which invests in asset-backed instruments like musharakah, ijarah etc. If majority of the assets of the 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 periodical basis. These units may be negotiable and may be used for overnight financing as well. The banks having surplus liquidity can purchase these units and when they need liquidity, they can sell them. This arrangement may create inter-bank market and the value of the units may serve as an indicator for determining the profit in murabahah and leasing.

Islamic bank can and should have its own real sector return benchmark. However, in a country adopting dual financial system, where Islamic finance co-exists with conventional finance, low share of Islamic finance has forced Islamic bank to benchmark its price to interest rate. Real sector return index should be established.

Pricing is a main concern for Islamic financial instruments since it is new to the market and has yet to develop any suitable mechanism to determine its price. Currently, the London Interbank Offered Rate (LIBOR) is the most common benchmark adopted in determining the price of financial tools profit or rental-based return, which is undesirable under the Sharia law because it is an interest-based benchmark.

There are several challenges in setting the price for Islamic financial instruments include:

i) The absence of an Islamic benchmark rate due to a lack of agreement among the issuers. Hence, it has to depend on the conventional market benchmark rates (such as LIBOR or EURIBOR) to determine the pricing of the Islamic instruments.

ii) A relatively small number of participants lead to low liquidity, lack of market depth, and a lack of critical mass of issuances.

iii) The absence of a standard price validation mechanism to assist in distributing up-to-date news and upcoming related issues.

iv) The lack of a focused risk based pricing mechanism related to Islamic finance.

v) The lack of risk mitigation to manage and hedge the risk of fluctuations in the market value of instruments on account of movements in the benchmark rate.

vi) Only certain listed assets are to be accepted as guarantees.

The Islamic Interbank Benchmark Rate was developed few years ago. It's adoption in pricing involving Islamic financial transactions leaves much to be desired. 

See the attached fact sheet on IIBR for further details.

Umar A. Oseni this rate can be used for Islamic Financing products?

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