BNM Council Permits Adoption of Risk-Free Rate as an Alternative Rate
At a recent meeting, the Shariah Advisory Council of BNM has ruled that the adoption of risk-free rate as an alternative benchmark rate to LIBOR, or as a fallback benchmark replacement rate after the permanent cessation of LIBOR, is permissible. This ruling comes into effect immediately upon publication on March 22, 2021 and applies to certain Islamic financial institutions. This ruling enables the orderly transition to alternative risk-free rate (including backward-looking term risk-free rate) by Islamic financial institutions before reliable and widely used forward-looking risk-free rate term rates become available.
This ruling is based on the following justification:
- The compounding methodology is merely an arithmetic method in determining the term rate which does not affect compliance of the transactions with Shariah requirements.
- Uncertainty from the adoption of average risk-free rate or backward-looking term rate at the point of payment is mitigated via proper determination and disclosure of the ceiling price and formula to derive the periodic payment amount to the customer at the inception of the contract.
In transitioning to the alternative risk-free rate, the Shariah Committee of each Islamic financial institution needs to determine the appropriateness of invoking the deemed consent mechanism to signify customer consent on the incorporation of the fallback provision in the contract’s terms and conditions.
Keywords: Asia Pacific, Malaysia, Banking, LIBOR, Fallback Provisions, Benchmark Reforms, Shariah Advisory Council, Islamic Financial Institutions, Risk-Free Rates, Islamic Banking, BNM
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