Benchmarks for Islamic asset pricing

Benchmarks serve a critical role in financial markets for pricing the riskiness of a financial security, to indicate the relative value or opportunity cost of capital and to serve as a performance yardstick. The Islamic finance industry globally has yet to develop appropriate benchmarks and currently use LIBOR as the reference benchmark in determining expected rate of return in shariah-compliant securities. This chapter explains the significance and the critical role of LIBOR as a financial benchmark in current conventional banking and financial markets, and discusses the issues arising from the use of LIBOR as a compliant investment. A linkage between the concept of benchmarking and the doctrine of market price in Islam is established and contrasted from the perspective of wealth management in Islam. The risk of using an interest rate-based benchmark by Islamic financial institutions is highlighted and there is an urgent need to create an interest-free benchmark in place of LIBOR is explained.