Islamic banks need benchmark profit rates

Islamic banks should shun conventional benchmark interest rates in favour of a profit rate derived from their activities, an Islamic banking economist said on Wednesday.

Islamic finance forbids interest-based lending but the conventional LIBOR (London Interbank Offered Rate) is routinely used to price sharia products in the absence of a benchmark Islamic rate.

Critics say this makes the $1 trillion industry a mere copy of traditional banking and exposes it to the volatility in conventional financial markets.

Iranian economist Iraj Toutounchian said Islamic banks should use a profit rate based on their businesses as interest is "a cancer cell and it ruins the whole body."

"Interest is not supposed to be present in any Islamic contracts. Interest and speculation produce instability," the 68-year old U.S-trained Iranian economist said in an interview.

Toutonchian has published books on Islamic money and banking and is regarded as an authority on the subject.

"Suppose we have 10 Islamic banks, each of which engage in say hundreds of, thousands of, different projects. The weighted average of the internal rate of return of these 10 banks which include thousands of activities will give you the benchmark."

Islamic banks can grant each other short-term interest-free loans to overcome any temporary shortage of funds, Toutounchian said.

Islamic banking requires that gains be based on real economic activity that benefits society rather than profiting select individuals.

Islamic financial contracts are often structured as leasing or sale and purchase transactions involving real assets such as metals, property or palm oil.

The industry has grown beyond traditional markets in the Middle East and Malaysia after the recent collapse of some top conventional banks and due to rising demand for ethical investments.

Toutounchian said Islamic finance activities had mushroomed in many countries recently but they were not sharia banking in its true form.

"Under the name of Islamic banking many steps have been taken, even in Japan, in the U.S., in European countries, they have started so-called Islamic banks," he said.

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"What they are really after is probably looking for Muslims' petrodollars."