A common concern amongst customers of Islamic financial institutions is in with regards to the pricing or benchmarking of Shariah compliant products to the prevailing interest rate. For example, if the prevailing interest rate in the country is 2% and because of this a conventional financial institution is offering a car loan at 2% and an Islamic financial institution is offering car finance at 2% profit, this confuses many people and it is common to hear them say the following:
‘Islamic financial institutions just change the word Interest to Profit‘.
It is important to understand that Islamic financial institutions do not operate in an isolated environment but rather work in the same environment as their conventional counterparts hence the benchmarking or pricing of Shariah compliant products is bound to converge and be affected due to many factors. In an ideal situation Islamic financial institutions would not need to refer to the prevailing interest rate to price their products but they are not currently operating in an ideal environment.
According to Shariah scholars, benchmarking or pricing according to the prevailing interest rate does not mean that the product being offered by the Islamic financial institution is not Shariah compliant. What is important is that the product being offered is not based on an interest bearing loan but rather is based on a genuine Shariah compliant contract that meets all the relevant conditions as approved by the Islamic financial Institution’s Shariah board.
In his book ‘An introduction to Islamic Finance’, Sheikh Taqi Uthmani gives the example of two brothers, the first selling alcohol and the second selling soft drinks. If the second brother decides to sell his soft drinks at the same rate of profit as his brother selling alcoholic drinks, this does not mean that the profit the second brother earns is invalid from a Shariah perspective.
However, as mentioned previously, Shariah scholars are of the view it would be better for Islamic financial institutions to have their own benchmark for pricing and there have been attempts in recent years to come up with one but as far as I am aware, nothing has come into practice as of yet.
To read the previous post (#5) of this series, please click the link below: