The launching of the Islamic Interbank Benchmark Rate (IIBR) by Thomson Reuters in Bahrain last week is the latest manifestation of how the technical architecture of the global Islamic financial industry is maturing. To many the pace of maturity remains frustratingly slow, especially in the Middle East and North Africa, while Asia is galloping ahead, which has resulted in a lob-sided West Asia and East Asia fault line.
The search for a purely Shariah-compliant benchmark for pricing Islamic financial transactions and products is not new, whether it applies to Commodity Murabaha deals or Islamic mortgages. Malaysia has tried to set profit rates for its Islamic banking sector devoid from the benchmarks of LIBOR (London Interbank Offered Rate) or KLIBOR (Kuala Lumpur Offered Interbank Rate).
In reality, the debate even amongst Islamic bankers has been whether a purely Islamic benchmark is really necessary. After all they argue that the use of LIBOR and its ilk merely serve as a benchmark and are not involved in the actual transaction.
According to Rushdi Siddiqui, global head of Islamic finance, Thomson Reuters, the delinking from conventional performance benchmarks started more than a dozen years ago in the Islamic finance industry, but this launch of "the world's first Islamic finance benchmark rate" is designed to provide an objective and dedicated indicator for the average expected return on Shariah-compliant short-term interbank funding.
IIBR uses the contributed rates of 16 Islamic banks and the Islamic sections of conventional banks "to provide a reliable and much-needed alternative for pricing Islamic instruments to the conventional interest-based benchmarks used for mainstream banking sector."
Only two Saudi banks are on the contributors list, namely Alinma Bank (an Islamic bank) and National Commercial Bank (a conventional bank). The list does not include Al-Rajhi Bank, the world's largest Islamic bank in terms of assets and balance sheet.
The criteria of IIBR require that participating banks must supply to all points on the curve; they must quote every day from Sunday to Thursday, and as Sunday is not a working day (say) in Malaysia, Friday's rate will be used; and contributors will be permitted to maintain the same rates for one additional day.
The calculation method is based on contributions being ranked highest to lowest; the upper and lower quartiles are disregarded; the fixing is calculated from the mean average of the two mid-quartiles; the output rate is calculated to five (5) decimal places; and the rounding convention is the same as standard Thomson Reuters.
The benchmark's ongoing implementation and integrity will be overseen by an Islamic Benchmark Committee of over 20 Islamic finance institutions, chaired by Nasser Saidi, chief economist of the Dubai International Financial Center (DIFC), and a Shariah Committee consisting of four Shariah scholars, namely, Sheikh Yusuf Talal Delorenzo (chairman); Abdul Rahim Sultan Al-Olama; Mohammad Daud Bakar; and Sheikh Muddassir Siddiqui.
While Nasser Saidi maintains that "the establishment of the IIBR marks an important milestone in the maturation of Islamic money markets by providing an international reference rate for interbank transactions," some Islamic bankers are more cautious about the feasibility of IIBR in practice.
"Conventional money markets have relied on LIBOR, which by definition does not comply with Shariah conventions. Islamic markets will be able to rely on the IIBR and it will become an international reference rate for both conventional and Shariah-compliant transactions. Our aim is to provide an IIBR that is reliable, timely, representative of market conditions, transparent in its construction and accepted as the market reference. Islamic money and financial markets are coming of age and becoming part of the mainstream," added Saidi.
But, Badlisyah Abdul Ghani, CEO of CIMB Islamic Bank, one of the participating banks in setting the IIBR, confirms that he is personally "not entirely convinced with the feasibility of having an IIBR which is separate from the conventional market. The percentile (e.g. 1 percent, 10 percent, etc) are just numbers. There is no such thing as Islamic mathematics! There is only mathematics. Islamic financial institutions use the benchmark rates such as LIBOR, KLIBOR, etc, as reference rates in the calculation on returns under various Islamic financial transactions. There is no Shariah reasoning for not using LIBOR because it is just a number referenced to determine a return rate under trade contracts."
This is where Thomson Reuters' collaborative approach comes in. Industry challenges, stressed Siddiqui, are best solved by industry players working towards a common objective. The simplicity and robustness of the new benchmark's methodology, governance, and transparency, combined with the endorsement of many respected Islamic financial institutions and scholars, will result in a reliable and realistic benchmark that better measures cost of funding for Islamic financial institutions, he maintained.
CIMB Islamic Bank, for instance is committed to see through this initiative to make it a success and feasible exercise unless proven otherwise, because it is a member of the Association of Islamic Banks in Malaysia (AIBM), which has agreed to support the IIBR initiative, whose other multilateral sponsors include the Jeddah-based Islamic Development Bank (IDB); the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI); the Bahrain Association of Banks (BAB); and the Dubai-based Hawkamah Institute for Corporate Governance.
Abdul Ghani has other concerns about IIBR - in that it may be heavily Middle East-centric and reflect largely Middle East pricing. "In general, it would be fine if the rate can reflect only one common rate globally. For a start it will probably reflect just Middle East pricing as most contributors predominantly come from there. When more contributors from the rest of Asia (particularly Malaysia and Indonesia), Europe and America come on board later, this rate will converge to neutral. This, I believe was somewhat similar to how LIBOR started in those early days," he explained.
According to the promoters, the IIBR harnesses Thomson Reuters global benchmark fixings infrastructure which is used to compile over 100 fixings around the world. Rates for Shariah-compliant US dollar (USD) funding will be contributed by the 16-member panel in the morning of each business day to Thomson Reuters systems and will be published daily on Thomson Reuters terminals. The efficacy of how the benchmark works, according to Abdul Ghani, depends on how close the IIBR is to the particular market. "If the IIBR yield curve is 3 percent and the particular market is trading around 1 percent, then creditability is questionable," he added.
The new benchmark, says Thomson Reuters, can 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 Shariah-compliant fixed income instruments. It can also be used for the pricing and benchmarking of corporate finance and investment assets.
Islamic bankers are not duly worried about the constraints of the IIBR in that it will only set the daily rates for Shariah-compliant US dollar (USD) funding and not other major currencies as well. The consensus is that a benchmark will have to start somewhere and starting with a US dollar one is fine, as long as other yield curves for other currencies are also developed as and when the need arises.
"My only concern at this juncture is whether having this initiative done in a new market that has yet to achieve efficiency would bring about a meaningful result and impact on the young modern era Islamic financial market," explained CIMB Islamic's Abdul Ghani.
In London, LIBOR is set daily in the morning by the top six banks, whereas the IIBR process comprises a whole range of banks (from very small to fairly large ones) and a number of professional bodies. Abdul Ghani warns that IIBR contributors must give out a rate that is reflective of the real market not entirely based on their market position because if based on their position, the result can be somewhat skewed.
"Later," he explained, "the pioneering contributors will be expanded to include more contributors from center such as Europe, US and Asia. The idea behind the initiative is to just start something instead of simply discussing the theory. As much as I am not fully convinced, I am game for anything that may be able to help contribute to a more robust Islamic financial market. If it does not work, then at least we would have explored it. If it works, then the industry would be for the better."
The challenge of IIBR is whether it can facilitate cross-border transactions and funding given the diverse nature of the level of development of the Islamic finance markets in the Middle East, GCC, Malaysia and the rest of Asia. Unless the rate is reflective of all the centers that partake in the initiative, Islamic banks maintain that it is going to be very difficult to say whether IIBR can facilitate cross border transactions and funding.
Abdul Ghani is bullish about IIBR and urges the market to give it a chance. After all, he stressed, the aim of IIBR is to help enhance the robustness and integrity of the Islamic financial market.
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