- February 11, 2022
- Posted by: Bastion team
- Category: World News
Islamic finance providers have been slow to make the transition away from LIBOR, as the replacement benchmark rates pose challenges in the context of Sharia compliance
The phase-out of the London Inter-Bank Offered Rate (LIBOR) as a benchmark interest rate has been complicated for banks around the world, but particularly in Islamic finance markets.
Publication of LIBOR rates stopped at the end of 2021, apart from a few tenors of dollar LIBOR that will run until mid-2023. Supervisory guidance from regulatory bodies in the US and the UK called for no new LIBOR contracts after 2021, to facilitate the transition.
Rates such as the Secured Overnight Financing Rate (SOFR) and Sterling Overnight Index Average (SONIA) were brought in to replace the previous benchmark. Unlike LIBOR, these are backward-looking risk-free rates (RFRs), based on past transactions rather than estimates of future borrowing costs.
For banks in general, the move to RFRs poses operational and legal risks, as bank processes and systems have been built to quote interest rates payable at the end of a borrowing period upfront. This has led to, among other things, a lack of clarity on how to account for derivatives, hedging and futures instruments.
Islamic finance institutions (as well as parties looking to structure and raise funding through Islamic finance products), however, face an additional and unique complication: They have to unpack the implications of RFRs in the context of Sharia principles,…