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When benchmark rates change: the case of Islamic banks

Simon Archer (Henley Business School, ICMA Centre, University of Reading, Henley-on-Thames, UK)
Rifaat Ahmed Abdel Karim (Henley Business School, ICMA Centre, University of Reading, Henley-on-Thames, UK)

Journal of Financial Regulation and Compliance

ISSN: 1358-1988

Article publication date: 26 April 2019

Issue publication date: 23 May 2019

594

Abstract

Purpose

This paper aims to examine the issue that arises in the context of benchmark rate (or interest rate) changes made for reasons of monetary policy in a jurisdiction with a significant presence of Islamic banks. Changes, especially increases, in the prevailing interest rate made by central banks raise issues of asset-liability management for banks, which typically have longer maturities on the asset side than on the liabilities side, resulting in exposure to interest rate risk for conventional banks, and what is known as rate of return (RoR) risk for Islamic banks, which for reasons of compliance with Islamic religious law (Shari’ah) do not use interest in their operations. Islamic banks use various financial instruments which reflect the cost of funds by means of contracts of sale on credit or of leasing or forms of partnership, which allow them to earn returns on their funds and to pay returns to customers who deposit funds with them.

Design/methodology/approach

The methodology of this study consisted of a descriptive analysis of the relevant characteristics of Islamic banks and their economic and regulatory environments, illustrated by a case study approach applied to two jurisdictions, namely, Sudan and Malaysia.

Findings

In jurisdictions where Islamic banks represent a significant share of the market for financial services, if the contracts used in Islamic financing allow for periodic adjustments of the profit rate or lease rental, this could result in a significant impediment to the full implementation of monetary policy and hence to the maintenance of financial stability.

Originality/value

This study is (to the best of authors’ knowledge) the first thorough analysis in the literature of the issues arising from the exposure of Islamic banks to RoR risk and has clear implications for regulatory and central bank policy.

Keywords

Citation

Archer, S. and Abdel Karim, R.A. (2019), "When benchmark rates change: the case of Islamic banks", Journal of Financial Regulation and Compliance, Vol. 27 No. 2, pp. 197-214. https://doi.org/10.1108/JFRC-11-2017-0104

Publisher

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Emerald Publishing Limited

Copyright © 2019, Emerald Publishing Limited

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