A Benchmark Pricing Strategy for Islamic Banks

This paper aims to present a pricing strategy for Islamic banking products. It will demonstrate that the exchange of Shari’ah compatible products in competitive capital markets results in a price that will allocate financial resources efficiently and will serve as a robust substitute to London Interbank Offered Rate (LIBOR) and similar interest based benchmarks in dual banking systems. This rate will be observable and measurable in the capital market and efficiently allocate capital funds, serve as evaluator for investment projects, and restore a stable equilibrium in the financial markets. Further, this rate will facilitate interbank transactions and contribute to the development of interbank financial markets. It will also serve as a pricing mechanism for financial products exchanged between the Central Banks and commercial banks. Consequently, it will facilitate implementation of growth stimulating or inflation combatting policies. The paper presents a model of benchmark pricing for Islamic banking products which are linked to the performance of the real sector of the economy. A model of complete and competitive financial market in which products are exchanged by Shariah rules is presented and it is shown that the rate of return which is determined at long run equilibrium of this market equals both to cost of capital and at the same time to marginal time preference rate of the clients.