Alternative to kibor for Islamic banking A case study of Pakistan

Abstract

Existing practice of Islamic banks all over the world is not according to the theory proposed by Islamic banking at its inception – linking the banking system with the real side of economy. Additionally the profits of the Islamic banking system is calculated using Karachi Interbank Offering Rate (KIBOR), London Interbank Offering Rate (LIBOR) etc. as a benchmark – which is one of the major criticisms on Islamic banking because these returns are based on money market as well as on interest rate. This study proposes alternative models for Ijarah, Diminishing Musharakah and Murabaha for Islamic banks by linking them with prices determined in the commodity market rather than KIBOR. The house and car prices and rental data from different sectors of Islamabad was collected through a survey to check the feasibility of the proposed model. The results show that the proposed models for Ijarah and Diminishing Musharakah are also as much profitable as the existing models whereas the proposed model for the Murabaha is less profitable. The study recommends that the Islamic banks should adopt the proposed models because they are more consistent with the theory of Islamic banking and they should avoid using interest rate benchmarks for setting the profit rates.