Benchmarking in Islamic Finance: Issues and Challenges Essay

In Islam, fixing the price of commodities is not allowed as the increase of the price is caused by practice of supply and demand in the market. Hence in this case, benchmarking for the products is not allowed. It is can be reflected from of the Hadith of Prophet Muhammad S. A. W. Narrated by Anas Ibn Malik, â€Å"The people said: Apostle of Allah, prices has shot up, so fix prices for us. Thereupon the Apostle of Allah (PBUH) said: â€Å"Verily, Allah S. W. T. determines the climate of economic affluence and gloom. I do not want to take any action to fix the prices because I do not want, later in hereafter, any among you to demand for the return of your property and blood from me because of my tyranny (in fixing the prices). † In the above hadith, the practice of fixing price is clearly condemned by Prophet Muhammad S. A. W. The Prophet S. A. W declared the act of fixing price as injustice towards the seller if the price is fluctuated due to the normal market forces. But the second school of taught disagree with not fixing the price. They argued that the fluctuation in the price of commodities at the time of Prophet Muhammad S.  A. W was due the normal market forces i. e. supply and demand of the commodity in the market. But nowadays the prices fluctuate more due to seller’s speculation rather than supply and demand of the product. In this case the price of the commodities should be fixed by the authorities. Hence benchmarking in this case is allowable by the Scholars. In financial industry, several different methods of pricing business loans have appeared over the years including cost-plus loan pricing, price leadership loan pricing, below-prime loan pricing, and costumer profitability analysis. Many business loans today are priced directly of money market interest rates, with narrow profit margins reflecting intense competition for the best business customers. Some of the profit/interest rates used in the market is as follows: (1) Overnight Policy Rate (OPR); (2) London Interbank Offered Rate (LIBOR); (3) Kuala Lumpur Interbank Offered Rate (KLIBOR); (4) Cost of fund (COF); and (5) Base Financing/Lending Rate (BFR/BLR). Issues: Islamic Finance has been established to save Muslim world from the effects of Riba. But the problem that has been seen is the benchmarking system of Conventional Banking practiced by Islamic Banks. Islamic Finance that has been mentioned by some authors as â€Å"Ethical Finance† which is the system of justice for the community and free from Riba, gharar and Mysir cannot practice the conventional benchmarking for its products. It has also been known that Islamic Finance deals in assets backed financing rather than debt based financing. Hence a proper Islamic based benchmarking system needs to be developed and implemented to overcome the issue of using conventional benchmarking for Islamic banking products. According to Sheikh Taqi Usmani, Islamic banks and financial institutions should get rid of such practice as soon as possible. He argued that using interest rate as a benchmark for halal products is not desirable and it does not reflect the basic philosophy of Islamic economy and hence making no impact on the system of distribution. It is also been said that the current benchmarking system does not make IFIs products haram. According to Taqi Usmani, ‘’If all the pillars of sale is valid from Shariah point of view, just mere use of interest rate as a benchmark cannot invalidate whole sale’’. According to Sheikh Yusuf DeLorenzo (2009) ’A benchmark is no more than a number, and therefore non-objectionable from a Shariah perspective. If it is used to determine the rate of repayment on a loan, then it is the interest bearing loan that will be haram. LIBOR as a mere benchmark has nothing to do with actual transaction or more specifically with the creation of revenue or return’’. Alternative Models for Islamic Benchmarking: There are different models being suggest by the scholars such as Rate of Profit Mechanism Model proposed by Abd al Hamed al-Ghazalie According to him, this can be achieved by analyzing the rate of profits in the money market. He proposes that it is a more rational way that promotes justice for all and fits the nature of economics. â€Å"According to Sheikh Muhammad Taqi Usmani, the purpose can be achieved by creating a common pool which invests in asset-backed instruments like musharakah, ijarah, etc. If the majority of the assets pool is in tangible form, like leased property or equipment and 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 ay be negotiable and may be used for overnight financing as well. 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 also. † Another model is presented by Dr. Aznan Hassan. According to him there should be different OPR for Islamic Banks that should be develo ped by Bank Negara Malaysia. But it can create the problem of hedging. If the conventional market rate is more favourable people will go for it and if the market rate of Islamic market is better people will opt for it. In the end the conventional market will be on safe side as the Islamic market is very small and the rate will tend to be higher as compare to conventional market. There are few others model that were suggested by the scholars such as Tobin’s Q Theory and Rate of Dividend of Islamic Bank Deposits and Investment Accounts Model etc that also gives the alternative ways of Islamic benchmarking. These models sounds good in theory but the problems can only be realized if such systems are implemented. Discussion/Conclusion: Some scholars argued that the conventional benchmarking is still allowed and it does not make the transaction haram. But IFIs still benchmark their products based on conventional loans. Profit rates are then decided on the bases of this benchmarking. Hence it is considered as back door to riba. Copying non Muslims is prohibited by the Prophet Muhammad S. A. W. It can be reflected for the Hadith, Narrated by al-Bukhaari (1865) from Ibn „Abbaas, who said: „? The Prophet (saws) came to Madinah and saw the Jews fasting on the day of Ashoora. He said, â€Å"What is this? † They said, â€Å"This is a good day, this is the day when Allah saved the Children of Israel from their enemy and Moosa fasted on this day. † He (the Prophet Muhammad) said, â€Å"We are closer to Moosa than you. † Hence the Prophet S. A. W fasted on this day and told the people to fast. This is the Sunnah that is proven from the prophet S. A. W, as he said, â€Å"If I am still alive next year, I will certainly fast the ninth (Narrated by Muslim, 1134). So to differentiate from jews, Prophet S. A. W recommended fasting on both 9th and 10th of Muharram. Similarly, riba is the practice of non Muslims hence it should not be benchmarked. Every Islamic Financial transaction should be different than what is nowadays practiced in the market. Although different models have been proposed by the scholars but the problem lies in implementing it. Such practices are going on from the long time but there is no one to step forward for implementing such system. It is because such system cannot work under capitalistic economic system as dual benchmarking will give rise to hedging and IFIs will suffer from it. Secondly, Islamic economy is based on real economy hence the risk is higher which will lead to higher Islamic benchmark rate as compare to conventional counterparts. Hence borrowers will prefer conventional system for loaning as compare to IFIs because interest rate charged by the conventional financial institutes will be less as compare to IFIs. Islamic benchmarking system can be failed under current economic system because the current economic system principles are different than Islamic economics principles. There could be no other solution but to shift from current economic system to Islamic economic system. It can only be possible if the entire Muslim countries unite and work on serious course for implementing Islamic economic system in Muslim community. After implementation of Islamic economic system, Islamic benchmarking will be possible and could be used by both conventional and Islamic financial institutes.