SBP exempts Islamic banks from using interest-based benchmarks

KARACHI: The State Bank of Pakistan (SBP) has exempted Islamic banks from using the interest-based benchmarks for determining the pricing of some of their products. 

“It has been decided that the financing provided on the basis of participatory (Musharakah and Mudarabah) and Wakalah (Agency) modes by the Islamic banking institutions shall be exempted from the requirement of using KIBOR (Karachi Interbank Offer Rate) as benchmark rate,” said a circular, recently issued by the SBP. 

In 2004, the SBP advised all the banks to use KIBOR as the benchmark rate.

The government wants to promote the Islamic banking industry, which it said is at the evolutionary stage. 

The market share of Islamic banking assets and deposits in the overall banking industry stood at 11.4 percent and 13.2 percent, respectively by end June. The industry grew 7.4 percent during the quarter April to June 2016. Its assets reached to Rs1.745 trillion and deposits amounted to Rs1.461 trillion. 

The network of IBI consists of 22 Islamic banking institutions, six full-fledged Islamic banks and 16 conventional banks having standalone Islamic banking branches. Branch network of IBI was recorded at 2,146 branches (spread across 98 districts) by end June.

The central bank said Islamic banks, desirous to avail the exemption, need to take measures to mitigate equity investment risk in participatory mode-based products.

“For Mudarabah and Musharakah based products, IBIs shall ensure compliance with minimum Shariah requirements,” it said. “For Wakalah based products, IBIs should use Arabic version of AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) Shariah standard No 23 on agency as guideline in consultation with their Shariah board.”

The SBP also directed the banks to submit the details of Mudarabah, Musharakah and Wakalah-based products (new/revised) for delinking with KIBOR benchmark to the Islamic Banking Department. 

“IBIs shall comply with all other regulatory and Shariah related instructions issued by SBP from time to time,” it said.

“The above instructions shall be applicable with immediate effect. All other instructions on the subject shall remain the same.”

Reuters adds: Such sharia-compliant contracts are well-known but have traditionally been eclipsed by murabaha, a cost-plus-profit arrangement in Islamic finance.

Under murabaha contracts, one party agrees to purchase merchandise such as a commodity on behalf on another, which promises to buy it at an agreed mark-up.

That mark-up has been commonly set against a financial benchmark such as KIBOR or LIBOR for dollar-denominated deals.

This has been criticised by some religious scholars as not being sufficiently based on real economic activity, a key principle in Islamic finance.

The practice dates back to the beginnings of modern Islamic finance in the early 70’s, with scholars giving their blessings to what was deemed a temporary measure until alternatives could be developed.