The development of an interest free benchmark for Islamic financial institutions of Pakistan

Abstract

The Islamic financial system has witnessed a rapid growth in its recognition, as an alternative to the conventional financial system, in the recent past. The number of Islamic financial institutions establishments, is also on a rise and depicts a very promising future for Islamic financial system. The magnitude of operations of Islamic financial institutions has reached global level and they are directly competing with and giving a very hard time to conventional institutions. Islamic financial system is still in its evolutionary stage and is facing a lot of criticism regarding its practices. The use of market interest rate, by the Islamic financial institutions, for pricing their products and services, is the biggest criticism on them as interest is forbidden in Islam. The challenge, currently faced by Islamic financial institutions is, how to counter this criticism. The issue of benchmarking encompasses the factors of price and profit. There is not an adequate volume of available literature that can provide an explanation of Islam’s stance on these issues, in reference to the current era of financial practices. This study is an attempt to enhance the body of knowledge regarding these issues and provides an answer to the biggest criticism on Islamic financial institutions. In persuasion of this objective, the study conducted, is a combination of qualitative and quantitative analysis. At the qualitative front, available literature is analyzed by conducting interviews with Islamic scholars and Islamic bankers in order to develop an understanding of Islam’s point of view on the issues of price and profit and whether the application of benchmarking is validated from the Shariah’s perspective or not. In the light of available literature and results from qualitative analysis, a solution is being extended, in the form of a quantitative model that can be used to establish, an interest free benchmark for Islamic financial institutions as an alternative to market interest rate.