Convergence of Islamic and Conventional Interbank Rates

Abstract

Financial Institutions' (FI) and banks' earnings on the trading portfolio are significantly influenced by the changing market conditions such as price of an asset, interest rates, market volatility, and market liquidity. Researchers to measure the risk related uncertainty of the FI's earnings use few Market Risk Measurement Models (MRM). Historic Back Simulation Model is one of the approaches that consider the return on all assets, as non-normal, as against the Risk Metric Model that considers the returns on assets is symmetric. This paper investigates the risk and return associated with Islamic interbank offered rates (IIBOR) in Malaysia using Back Simulation model and the results are compared with the conventional interbank offered rates (CIBOR). On application of the Back Simulation approach over the two different data sets (Yield Rates of IIBOR and CIBOR), it was found that during the de-peg period, the value losses and gains for Islamic trading portfolios were found to be significantly higher at the tail end horizon de-peg period. We also conducted independent sample "t" test to compare the mean losses and mean gains reported during these three time periods. We found that the CIBOR was active during crisis and peg periods IIBOR was active after de-pegging with higher losses and gains. These higher losses and gains of IIBOR are due to the active participation of money market players and experience gained in the last decade in Islamic finance. The IIBOR now provides the much-needed liquidity for Islamic finance products and this will further push up the growth of Islamic finance.