How market rates affect Islamic banks

In-Depth Analysis

Article 40 concluded that the Islamic banks use Murabahah financing for shorter term transactions due to Murabahah being a fixed price sale contract where the profit element is immoveable. Explaining this point further, if an Islamic bank enters into a Murabahah transaction for longer term financing, say 10-15 years, it will be exposed to market rate risk. Ideally, Islamic banks should not be concerned with the rate prevalent in the market since it is the interest rate. However, it is important to note that the Islamic banks do not operate in isolation from the market and are part and parcel of a country's economy, and are governed by the same regulatory authority that supervises the conventional banks. This is the reason why the Central Bank of Sudan does not quote any official interest rate so as to ensure strict compliance of monetary policy and practices with Islamic Shariah principles. However, without any corruption from the central bank, Sudanese banks use the profit rate applied by the central bank on the Murabahah transactions it enters into with the licensed banks for liquidity management purposes as the national benchmark rate for the market. Let us assume that an Islamic bank provided a Murabahah facility to its clients for 15-20 years and several transactions with the same tenor were entered into when the market rate was low. A few years down the line, the market rate started to pick up and the Islamic bank found it difficult to cope up with customers' expectations to provide higher deposit rates. As a result, the Islamic bank's customers may consider switching to other banks in a position to provide a superior return on their deposits. The most transparent Murabahah transactions are found in Islamic banks where the cost and mark up are abundantly clear. Islamic banks have used the Murabahah structure fairly effectively as a means of deferred financing, albeit for a shorter term period owing to its nature being a fixed price (amount) contract, and that a longer term Murabahah transaction may expose the bank to the market rate.