Pricing Islamic finance contracts by decoupling from interest-based benchmarks

Purpose This study aims to evaluate theoretically and empirically interbank and real-economy-based benchmark alternatives in the post-LIBOR scenario. Design/methodology/approach The study uses extensive data from 1970 to 2024 to empirically evaluate forecasted nominal GDP growth rate against interest rate in 27 OIC member countries using the autoregressive integrated moving average forecasting model, equivalence of means test, variance ratio test and Pearson’s correlation. For asset price indices, the study takes monthly data from 11 countries during 2015–2024. Findings The forecasted nominal GDP growth rate is positive in all 27 OIC countries and sufficiently decouples from the interest rate. Furthermore, the returns on Islamic equity market indices have more downside risk and volatility as compared to the interest rate. Among the benchmark alternatives in a post-LIBOR scenario, a real macroeconomy-based benchmark rate is suitable to decouple from the interest-based benchmarks that are currently used in practice. Practical implications The Islamic finance industry has been in search of a distinct pricing benchmark that is directly linked with the real economy and decouples from interest-based pricing. The comprehensive empirical evidence provides a path to transition and achieve the aim of having a distinct, stable and positive rate benchmark, which simultaneously captures the real economy and financial market reality. Originality/value The paper is a first comprehensive attempt to evaluate interbank, real-economy-based macro- and micro-benchmark alternatives simultaneously. The empirical evidence of 27 countries and multiple global markets covers GCC, East Asia, South Asia and Africa for the first time, to the best of the authors’ knowledge, in a single study.