Can Islamic Banks Have Their Own Benchmark?

40 Pages Posted: 7 May 2017 Last revised: 10 Mar 2018

See all articles by A. S. M. Sohel Azad

A. S. M. Sohel Azad

Deakin University

Saad Azmat

Lahore University of Management Sciences (LUMS)

Abdelaziz Chazi

American University of Sharjah - School of Business & Management

Amirul Ahsan

Deakin University- Department of Finance

Date Written: February 16, 2018

Abstract

This paper attempts to answer whether Islamic banks can have their own benchmark rate. In so doing, the paper investigates the nature of the relationship Islamic interbank benchmark rate (IIBR) and its comparable conventional counterpart, London interbank offer rate (LIBOR). The dynamics of the two series are investigated to examine the stability of the spread between IIBR and LIBOR, referred to as ‘Islamic premium’ or ‘piety premium’. The findings suggest that there are both long-term and short-term dynamic relationships between the two rates providing significant evidence of their convergence and co-movement. Our results also show that the existence of the IIBR-LIBOR spread is a reflection of the cost of funding and profit potential of the participating IIBR rate-setters. We find that, in addition to the determinants of the credit spreads, fundamental news of the panel banks are dominant factors driving the ‘piety premium’. We argue that the Islamic banking industry is operating in a global context, where it is highly improbable that its rates can decouple from the global benchmarks. Given that Islamic banking products and their risk return profile are similar to conventional products, arbitrage activities force Islamic rates to converge with the global benchmark rates.

Keywords: IIBR; LIBOR; Islamic Premium; Structural Model

JEL Classification: G15

Suggested Citation

Azad, A. S. M. Sohel and Azmat, Saad and Chazi, Abdelaziz and Ahsan, Amirul, Can Islamic Banks Have Their Own Benchmark? (February 16, 2018). Emerging Markets Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2963000 or http://dx.doi.org/10.2139/ssrn.2963000

A. S. M. Sohel Azad (Contact Author)

Deakin University ( email )

221 Burwood Highway
Burwood
Melbourne, Victoria 3125
Australia

Saad Azmat

Lahore University of Management Sciences (LUMS) ( email )

D.H.A, Lahore Cantt
Lahore, Punjab 54792
Pakistan

Abdelaziz Chazi

American University of Sharjah - School of Business & Management ( email )

P.O. Box 26666
Sharjah
United Arab Emirates

Amirul Ahsan

Deakin University- Department of Finance ( email )

221 Burwood Highway
Burwood, Victoria 3125
Australia
+613 9244 6571 (Phone)

HOME PAGE: http://www.deakin.edu.au

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