G Model

QUAECO-1139; No. of Pages 10 ARTICLE IN PRESS

The Quarterly Review of Economics and Finance xxx (2018) xxx–xxx

Contents lists available at ScienceDirect

The Quarterly Review of Economics and Finance

journal homepage: www.elsevier.com/locate/qref

Interbank offered rates in Islamic countries: Is the Islamic benchmark

different from the conventional benchmarks?
Salem Nechi ∗ , Houcem Eddine Smaoui
College of Business and Economics, Qatar University, Doha, 2713, Qatar

a r t i c l e i n f o a b s t r a c t

Article history: Motivated by the size and the growth of the global Islamic financial services industry, 17 Islamic Banks
Received 16 October 2017 in six Islamic countries, in conjunction with Thompson Reuters, developed an Islamic Interbank Bench-
Received in revised form 24 April 2018 mark Rate (IIBR, hereafter) to address the Sharia compliance requirements of Islamic banks in the money
Accepted 6 May 2018
market. This paper examines to what extent this newly introduced monetary tool differs from the con-
Available online xxx
ventional interbank rates used in the countries of contributing banks to the IIBR. We use cointegration
analysis, Granger causality tests and Vector Autoregressive Models to investigate the dynamics and the
JEL classification:
inter-temporal linkages between the Islamic and conventional interbank benchmarks in five countries
C32
G0
from Gulf Cooperation Council (GCC, hereafter) region. Results show that the IIBR exhibits a long-run rela-
G15 tionship with the conventional rates and fails to be independently determined. Our findings advocate
G28 also that market conditions such as oil prices and inflation do not contribute to the dynamics between
the IIBR and the conventional interest-based interbank benchmarks.
Keywords: © 2018 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved.
Islamic finance
Islamic interbank benchmark rate
Conventional interbank rates
Cointegration
Granger causality
Vector autoregression model

1. Introduction
A rule of thumb in Islamic finance is the rejection of all interest-
based tools and instruments as they violate Sharia guidelines. In
many Middle Eastern and Asian countries, Islamic finance has
evolved into being an integral part of the mainstream financial
services landscape. According to the 2017 Islamic Financial Ser-
vices Industry Stability Report (Islamic Financial Services Industry
Stability Report, 2017), in 2016, the share of Islamic banking in
total domestic banking services exceeded 15% in 12 countries. For
instance, in 2016, the share of Islamic banking in total banking
assets was 100% in Sudan and Iran, 57% in Brunei, 51% in Saudi
Arabia, 30% in Kuwait, around 20% in Qatar and Malaysia, and 15%
in Jordan. Moreover, countries like Malaysia and Indonesia have
set national targets for Islamic banking and finance aiming market
share of 40% in 2023 for the former and 15% in 2020 for the later.
At the regional level, the Gulf Cooperation Council (GCC, hereafter)
∗ Corresponding author.
E-mail addresses: snechi@qu.edu.qa (S. Nechi), hsmaoui@qu.edu.qa
(H.E. Smaoui).
countries constitute the largest domicile for Islamic financial assets
with market share of 42.3% of the global Islamic finance indus-
try and services in 20161 . In addition to the increasing interest
in Islamic finance in most Muslim countries, there has been also
a significant interest in Islamic finance among many non-Muslim
countries such as UK, Hong Kong, South Africa and Luxembourg2 .
The development of Islamic finance sector was accompanied the
development of various Islamic financial products (Islamic banking
assets, Sukuk, Islamic funds, takaful, etc.) consistent with Sharia
rules, which enabled Islamic banks to attract and secure a signif-
icant market segment of investors seeking interest-free financial
securities. In some circumstances, however, Islamic banks are con-
strained to engage in financial and monetary practices that are
1
From 2010 to 2014, liquid wealth in the Gulf Cooperation Council (GCC) coun-
tries grew at an average of 17.5% per annum, doubling from USD 1.1 trillion to USD
2.2 trillion (Diemers and Khalil, 2015). Given the dominance of the Islamic culture
in these countries, we would expect that an important part of the newly generated
assets would integrate Islamic finance markets.
2
There are nine Muslim countries, which constitute the core markets of Islamic
finance with 93% of industry assets in 2015: Bahrain, Qatar, Indonesia, Saudi
Arabia, Malaysia, UAE, Turkey, Kuwait and Pakistan (World Islamic Banking
Competitiveness Report, 2016).

https://doi.org/10.1016/j.qref.2018.05.003
1062-9769/© 2018 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved.

Please cite this article in press as: Nechi, S., & Smaoui, H.E. Interbank offered rates in Islamic countries: Is the Islamic benchmark different
from the conventional benchmarks? The Quarterly Review of Economics and Finance (2018), https://doi.org/10.1016/j.qref.2018.05.003
G Model
QUAECO-1139; No. of Pages 10 ARTICLE IN PRESS
2 S. Nechi, H.E. Smaoui / The Quarterly Review of Economics and Finance xxx (2018) xxx–xxx
not necessarily Sharia-compliant. The use of conventional inter-
bank rates when operating in the money markets is an example.3
Nevertheless, to preserve the authenticity of Islamic finance prod-
ucts and services, Islamic finance institutions felt the need to
distinguish themselves from conventional banks, by developing a
Sharia-compliant interbank benchmark rate.
In 2011, 17 Islamic banks from six countries (5 from the United
Arab UAE, 4 from Bahrain, 3 from Qatar, 2 from Saudi Arabia, 2 from
Kuwait, and 1 from Pakistan) in conjunction with Thomson Reuters
launched an Islamic interbank benchmark rate, IIBR, in US dollars
(Thomson Reuters, 2011a; Thomson Reuters, 2011b)4 . The IIBR rep-
resents an average expected cost of short-term interbank market
funding for the Islamic banking industry that can be used as a base
in the pricing of interbank market transactions, retail and corporate
Islamic financial products, and Sukuk and other fixed income struc-
tures (Global Islamic Finance Report, 2017)5 . The benefit of having
this Sharia-compliant interest-free instrument denominated in US
dollars is to promote uniformity across all contributors, render
the Islamic financial products more globally integrated, and help
countries attracting Islamic Investment Funds, thereby promot-
ing Islamic capital markets. Moreover, with the recent tremendous
growth of the Islamic financial services industry and the heightened
interest in the Islamic financial markets and products worldwide,
the use of the IIBR is expected to gradually increase.6 This would
generate increased interest in the determinants and/or the factors
driving the IIBR.
Most studies examining the relationship between Islamic and
conventional banking systems conclude that most of the Islamic
financial instruments and products are driven by the same market
conditions as their conventional counterparts (Ayub, 2007; Bacha,
2008; Chong & Liu, 2009; Kaleem & Isa, 2003; Khan, 2010; Cevik
& Charap, 2011; Ito, 2013; Saraç & Zeren, 2014; among others).
Our study contributes to this strand of literature by examining the
causal relationship and long-term co-movement between the IIBR
and the conventional interbank rates (IBORs) in five (GCC) coun-
tries (Bahrain, Kuwait, Qatar, Saudi Arabia, and United Arab UAE).
Specifically, we investigate to what extent the newly introduced
Islamic interbank rate, IIBR, differs from its conventional coun-
terparts, IBORs, in countries where both Islamic and conventional
banks compete, the GCC region in particular. Surprisingly, the ques-
tions of whether the IIBR is independently determined and whether
its characteristics and market conditions are unique were not suf-
ficiently addressed in the literature, a void that this study attempts
to fill.
Azad, Azmat, Chazi, and Ahsan (2018) attempt to explain
why the efforts to have an Islamic benchmark have failed. They
show that the IIBR fails to decouple from the London Interbank
Offered Rate (LIBOR, hereafter), which is an interest-based bench-
mark and hence it cannot distinguish itself as a Sharia-compliant
(i.e., interest-free) monetary tool. While their study investigates
whether the IIBR will distinguish itself from the LIBOR, our focus
3
Many Sharia scholars allowed the use of LIBOR for pricing goods and their
usufruct in trading or leasing based on Islamic finance contracts (JIBM Discussion
Forum).
4
The list of contributing banks is: Abu Dhabi Islamic Bank (UAE), Qatar Islamic
Bank (Qatar), Ahli United Bank (Kuwait), Sharjah Islamic Bank (UAE), Al Baraka
Bank (Pakistan), Dubai Islamic Bank (UAE), Al Hilal Bank (UAE), Ithmaar Bank
(Bahrain), Alinma Bank (Saudi Arabia), Kuwait Finance House (Kuwait), Al Salam
Bank (Bahrain), Masraf Al Rayan (Qatar), Bahrain Islamic Bank (Bahrain), National
Commercial Bank (Al Ahli) (Saudi Arabia), Barwa Bank (Qatar), Noor Islamic Bank
(UAE), National Bank of Kuwait (Kuwait).
5
More on the administration of the IIBR can be found at the IIBR fact sheet pre-
pared by Thomson Reuters.
6 8
According to the Global Islamic Finance Report (2017), the Islamic finance ser-
vices industry stood at US$2.93 trillion at the end of 2016 and the size of the industry
grows by at least 10% annually.
Please cite this article in press as: Nechi, S., & Smaoui, H.E. Interbank offered rates in Islamic countries: Is the Islamic benchmark different
from the conventional benchmarks? The Quarterly Review of Economics and Finance (2018), https://doi.org/10.1016/j.qref.2018.05.003
is on the relationship between the IIBR and conventional rates
in the contributing banks’ countries. Although the Islamic finance
industry has grown rapidly in the last decade or so, the share of
Islamic assets in global assets markets remains insignificant and the
dynamics of the Islamic finance industry are not visible7 . Since the
global Islamic finance services industry still constitutes a very small
portion of the overall financial system, we argue that it is more
appropriate to compare the IIBR with the conventional interbank
rates in markets where Islamic finance is indigenously significant.
We believe that focusing on the relationship between the IIBR
and conventional interbank rates in countries of the contributing
banks is an interesting question, because of the increasing com-
petition between Islamic and conventional finance institutions in
these countries. Our focus on the GCC countries is motivated by
the fact that 16 out of the 17 contributing banks are located in
this region and the share of GCC countries in total Islamic assets of
the MENA region reached 42% in 2017 (Islamic Financial Services
Industry Stability Report, 2017)8 .
In the present study, we examine the empirical behavior of
the IIBR and conventional interbank rates in five GCC countries
(Bahrain, Kuwait, Qatar, Saudi Arabia, and United Arab UAE), using
daily data from April 15, 2012, to May 26, 2016. Our methodology
is based on four tools: (i) Correlation Analysis, (ii) Cointegration
tests between the IIBR and conventional interbank rates in the
selected countries, (iii) Granger Causality tests and, (iv) Vector Error
Correction Model (VECM) approach to identify any inter-temporal
linkages or dynamic relationship between the IIBR and conven-
tional interbank rates and other macroeconomic variables.
By way of review, the evidence in this paper shows that there is a
long-run relationship between the IIBR and the conventional inter-
bank rates in three out of the five countries of contributing banks
(Bahrain, Saudi Arabia, and UAE), implying that the IIBR is driven
by the same market conditions as the conventional interbank rates
in these countries. Moreover, the Granger causality tests indicate
that the conventional interbank rates Granger-cause the IIBR, indi-
cating that the determination of IIBR is influenced by past values of
conventional interbank rates. However, the IIBR does not Granger-
cause the conventional interbank rates, except in UAE. Finally, our
VAR models indicate that, overall, there is a dynamic relationship
between the IIBR and the conventional interbank rates.
The remainder of the paper is organized as follows. Section 2
provides a brief review of the literature on Islamic and conven-
tional benchmarks. Section 3 describes our research methodology.
Section 4 provides descriptive statistics and the preliminaries of
our data. Section 5 discusses our empirical results and Section 6
concludes and provides policy recommendations.
2. Review of related literature
The literature on Islamic benchmarks and their relationship with
conventional benchmarks is still nascent. The focus of this literature
is on whether Islamic benchmarks were able to distinguish them-
selves from or converge to conventional benchmarks. For instance,
Kaleem and Isa (2003) investigated the relationship between term
deposit rates for various maturities for both Islamic and conven-
tional banks using Granger causality test. Their results show that
Islamic banks take into account the conventional deposit rates
when determining their term deposit profit rates. Subsequently,
using Malaysian data, Bacha (2008) shows that the Islamic money
market profit rates/yields are highly correlated with conventional
7
Islamic financial Services Industry Stability Report 2017.
The importance of Islamic finance is also significant in other countries. We
exclude these countries, however, because none of the panel banks contributing
to the IIBR is located in these countries.
G Model
QUAECO-1139; No. of Pages 10 ARTICLE IN PRESS
S. Nechi, H.E. Smaoui / The Quarterly Review of Economics and Finance xxx (2018) xxx–xxx
money market rates. He concludes that this finding is not surpris-
ing since Islamic banks have adopted the commercial conventional
banking model, and hence should bear the interest rate risk.
In the same vein, Chong and Liu (2009) investigate the relation-
ship between Islamic investment rates and conventional deposit
rates in Malaysia. Their results show that only a negligible por-
tion of Islamic bank financing is strictly profit and loss sharing
(PLS) based and that the Islamic deposit rates are not interest-free,
but closely pegged to conventional deposit rates. Cevik and Charap
(2011) study the co-movement and causal relationship between
the profit rates on Islamic PLS rates and conventional bank deposit
rates in Malaysia and Turkey. Their findings suggest that PLS profit
rates are cointegrated with conventional bank deposit rates, and
hence exhibit a long-term relationship with them. Moreover, the
time-varying volatility of PLS profit rates is highly and significantly
correlated with that of the conventional bank deposit rates. Their
results also show that conventional bank deposit rates Granger
cause PLS profit rates. The study of Ergeç and Arslan (2012) confirms
the long-run cointegration relationship between Islamic and con-
ventional banks’ rates in Turkey over the period 2005–2009. They
conclude that Islamic banks profit rates in Turkey are influenced by
conventional interest rates.
Soon after, Ito (2013) investigated the nexus between Islamic
and conventional banks’ rates using daily data from Malaysia over
the period from 2005 to 2012. His findings support the hypoth-
esis of a two-way causality between Islamic rates of return and
conventional interest rates. More recently, Saraç and Zeren (2014)
examine the long-term relationship between Islamic banks’ deposit
rates and conventional banks’ term-deposit rates in Turkey using
the Maki cointegration test with multiple break, Granger causality
test, and frequency domain causality tests. Their results indicate
that Islamic banks’ deposit rates and conventional banks’ term-
deposit rates are significantly cointegrated. In addition, Granger
causality test confirms the common proposition that conventional
deposit rates Granger-cause Islamic banks’ profit rates.
Ajmi, Shawkat Hammoudeh, Nguyenc, and Sarafraziba (2014)
investigate the links between the Islamic and global conventional
stock markets using the heteroscedasticity-robust linear Granger
causality and nonlinear Granger causality tests. Their results point
to the existence of a significant linear and nonlinear causal-
ity between the Islamic and conventional stock markets. They,
therefore, reject the hypothesis of decoupling the Islamic mar-
ket from their conventional counterparts. In their footstep, Alaoui,
Dewandaru, Rosly, and Masih (2015) examine the impact of the
LIBOR on the Islamic Dubai Financial Market (DFM)-UAE return.
Using both the discrete and continuous Wavelet technique, they
report that the two markets DFM-UAE, and (GCC and Saudi) exhibit
long-term conversion to the same level of risk and volatility with
the Global Sukuk index.
Finally, Azad et al. (2018) use the standard Johansen cointegra-
tion method to investigate the long-term relationship between the
IIBR and the LIBOR and Engle’s (2002) dynamic conditional corre-
lation to test the short-term dynamic relationship. The dynamics
between the two series are investigated to examine the stability
of the spread between the two benchmarks, referred to as ‘Islamic
premium’. Their results indicate that there are both long-term and
short-term dynamics between the two rates, suggesting that the
IIBR failed to decouple from the conventional benchmark.
Overall, previous studies on the relationship between Islamic
and conventional bank rates, including the IIBR, support the
hypothesis that the Islamic benchmarks failed to decouple from the
conventional counterparts and remain pegged to them. This study
extends this strand of literature by investigating to what extent
the IIBR differs from the conventional interbank rates, with a focus
on the countries of the IIBR panel contributing banks. Against this
backdrop, we aim to test the following hypotheses:
Please cite this article in press as: Nechi, S., & Smaoui, H.E. Interbank offered rates in Islamic countries: Is the Islamic benchmark different
from the conventional benchmarks? The Quarterly Review of Economics and Finance (2018), https://doi.org/10.1016/j.qref.2018.05.003
3
H1. The IIBR converges to and comoves with the conventional
interbank benchmarks.
H2. Conventional interbank rates lead the IIBR.
3. Research methodology
We use various analytical tools to investigate the relationship
of the IIBR with the interbank funding rates in five GCC countries
(Bahrain, Kuwait, Qatar, Saudi Arabia, and UAE). In particular, the
nature and extent of association between the IIBR and the conven-
tional interbank rates in these countries are investigated using four
techniques.
First, we calculate the Pearson, Kendall, and Spearman coef-
ficients of correlation to measure the strength of a relationship
between the IIBR and the conventional interbank rates in the
Islamic countries in our sample. It is important to note that,
although the coefficients of correlation can signal the existence
of linear relationship between the IIBR and the conventional
interbank rates, they might be misleading if the series are non-
stationary.
Second, cointegration analysis is used to study the existence of
a long-term relationship between the IIBR and the conventional
rates. More specifically, we use the Maximum likelihood cointe-
gration methodology developed by Johansen (1988) and Johansen
and Juselius (1990), which uses two tests, namely: trace test
and maximum eigenvalue test9 . If a long-run relationship exists
between the IIBR and any of conventional interbank rates, then
the difference between the two is constant and they appear to
be moving closely together. Prior to the cointegration analysis, we
investigate whether the series are non-stationary using the Aug-
mented Dickey-Fuller (ADF) test. The most important source of
non-stationarity is the unit root. In order to resolve the unit root
problem, the data set should be differenced (Wei, 2006).
Third, we employ the Granger causality test to investigate
whether a causality exists between the IIBR and the conventional
benchmarks. Our decision to perform a Granger causality test is
motivated by the availability of high-frequency time series data
and our interest to investigate the ability to predict future values
of the IIBR using prior values of the conventional interbank rates.
Fourth, we investigate the relationship between IIBR and the
conventional interbank rates using the Vector Autoregression
(VAR) model. VAR models can provide evidence about the rela-
tionships between variables. If our variables are non-stationarity,
the relationship is investigated using the Error Correction Model
(VECM), which is a framework that involves specifying and esti-
mating a VAR model for integrated multivariate time series. The
time paths of cointegrated variables are influenced by the extent of
any deviation from long-run equilibrium. In case of disequilibrium
(due to an innovation or shock), some of the variables must respond
to the change to return to the long-run equilibrium. The main pur-
pose of the VECM model is to concentrate on the short run dynamics
and, at the same time, ensuring their consistency with the long run
solution. For the series that are non-stationary and not integrated,
we use a VAR in difference model.
We conduct multiple two-equation VAR (VAR in difference, or
VECM) models. For each of the VAR models, the first equation corre-
sponds to the IIBR equation, while the second equation corresponds
to one of the conventional interbank rates.
9
Note that Johansen’s procedure has its limitations as it assumes the cointegrating
vector to remain constant throughout the period of study. However, the long run
relationships between the underlying variables have a high possibility to change
or vary due to reasons such as technological advancements, economic or financial
crisis, change in the taste and behavior of people and changes in policies.
G Model
QUAECO-1139; No. of Pages 10 ARTICLE IN PRESS
4 S. Nechi, H.E. Smaoui / The Quarterly Review of Economics and Finance xxx (2018) xxx–xxx

The basic VECM model for two integrated variables X and Y has
the following general equation:

  
k 
k
Xt = a0 + ˛ Xt−1 − ˇYt−1 + aj Xt−j + bj Yt−j + ε1t (1)
j=1 j=1

  
k

k

Yt = c0 +  Xt−1 − ˇYt−1 + cj Xt−j + j Yt−j + ε2t (2)

j=1 j=1

where ε1t and ε2t are white noise disturbance terms that might
be correlated, and a0 , c0 , ˛, ˇ, , aj , bj , j ; j = 1, 2, . . . are param-
eters. By assumption, X t , Y t , ε1t and ε2t are stationary, I(0).
It follows that the linear combination (Xt−1 − ˇYt−1 ) is also sta- Fig. 1. Islamic Interbank Rate: Different Maturities.
tionary, implying that the two variables are cointegrated with the
cointegrating vector (1, −ˇ). For our purposes, Xt and Yt represent Table 1
the IIBR and a conventional interbank rate, IBOR, in one of the coun- Summary Statistics for IIBR (%).
tries of our sample, respectively. The IIBR and the IBOR change IIBR1 M IIBR3 M IIBR6 M IIBR1Y
in response to stochastic shocks (captured by ε1t and ε2t ) and in
Mean 0.3726 0.5547 0.7378 1.0621
response to the previous period’s deviation from long-term equi-
Median 0.3514 0.5200 0.6867 1.0033
librium. Note that ˛ and  can be interpreted as speed of adjustment Maximum 0.6000 0.8500 1.1933 1.5383
parameters. A large value of ˛ implies a greater response of the IIBR Minimum 0.2375 0.3300 0.4525 0.6525
to the previous period’s deviation from the long-run equilibrium Std. Dev. 0.0692 0.1259 0.1761 0.2117
and vis versa. Skewness 0.4778 0.4541 0.6200 0.4178
Kurtosis 2.2363 1.9240 2.1882 1.8562
For series that are non-stationary and not integrated, we esti- Jarque-Bera 65.2752 86.4996 95.8228 87.5297
mate VAR in difference, which has the following general equation: Probability 0.0000 0.0000 0.0000 0.0000
Observations 1047 1047 1047 1047

k

k
Y1t = ␣1 + ␤1j Y1t−j + ␦1j Y2t−j + u1t (3)
j=1 j=1 (1Y) maturities.10 The rationale for considering different maturi-
ties is to investigate whether the behavior of this newly developed

k 
k
rate (i.e., IIBR) is correlated with its maturity type. For any secu-
Y2t = ␣2 + ␤2j Y1t−j + ␦2j Y2t−j + u2t (4) rity (bond, equity, mortgage, etc.), longer maturities are associated
j=1 j=1 with high risks making them more volatile, leading investors to
claim higher compensation for taking extra risk. Interest rates in
For our purposes, Y1t will be the change in IIBR while Y 2t will
general and conventional interbank funding rates, in particular, are
be the change in one of the conventional interbank rates that is non-
governed by this relationship.
stationary and not integrated with the IIBR. Y it−j (i = 1, 2) is the
The data for IIBR spans the period from April 15, 2012, to May
jth-lagged variable of Y it . It is assumed that each of the error terms
26, 2016.11 All rates were taken from Eikon Thompson Reuters
u1t and u2t does not exhibit serial correlations and autocorrelations.
database.12 As the focus of this study is on the IIBR, data for all
We estimate also VECM and VAR models with exogenous vari-
other variables were adjusted to match dates where the IIBR data
ables. An augmented VAR model with exogenous variables has the
is available. In other words, we synchronized data according to
following form:
the availability of the IIBR values. Given that all the contributing

J

J

K banks to the IIBR in our sample are from the GCC region, the loss of
Y1t = ␣1 + ␤1j Y1t−j + ␦1j Y2t−j + 1k Xk + u1t (5) observations in IBORs due to this synchronization is not significant.
j=1 j=1 k=1
Fig. 1 below displays the different maturities of the IIBR. As can be
seen, the IIBR maturities, although different in level, have similar

J

J

K behavior.
Y2t = ␣2 + ␤2j Y1t−j + ␦2j Y2t−j + 2k Xk + u2t (6) Table 1 below presents summary statistics of the different matu-
j=1 j=1 k=1 rities of the IIBR. As expected, longer maturities are associated with
higher rates. The standard deviation of the maturities seems to
where Xk refers to the exogenous variables we consider, oil price follow the standard risk-return trade-off; that is, higher levels of
and inflation. risk (6-month and one-year maturities) are associated with higher
potential returns and lower levels of risk are associated with lower
4. Data and preliminaries potential returns.
Table 2 presents summary statistics for the conventional inter-
Our data set includes daily rates of the IIBR, conventional inter- bank rates in the five GCC countries and the IIBR. Except for Kuwait,
bank rates in five GCC countries: Bahrain (BHIBOR), Kuwait (KIBOR),
Qatar (QIBOR), Saudi Arabia (SAIBOR), and United Arab Emirate-
sUAE (AEIBOR). Note that one of the contributing banks, Al Baraka 10
While data for IIBR and BIBOR and QIBOR is available for other maturities
Bank, is located in Pakistan. We decided not to include Pakistan in (Overnight, ON, Spot Week, SW, 2 and 9 months), ON and SW maturities are not
our analysis because Al Barak Bank is a branch of the Al Baraka Bank- available for Saudi Arabia, 2M and 9M maturities are not available for Kuwait, Saudi
ing Group based in Bahrain, which implies that the rates reported by Arabia, and the UAE.
11
Although the IIBR was launched on November 22, 2011, we did not consider
the bank during the setting process of the IIBR might be influenced the data prior to April 15, 2012, because of a mistake in reporting prior to that date
by the main office in Bahrain. Our analysis is applied for one- (Azad et al., 2018).
month (1 M), three-month (3 M), six-month (6 M), and one-year 12
For Qatar, data is available starting June 10, 2013.

Please cite this article in press as: Nechi, S., & Smaoui, H.E. Interbank offered rates in Islamic countries: Is the Islamic benchmark different
from the conventional benchmarks? The Quarterly Review of Economics and Finance (2018), https://doi.org/10.1016/j.qref.2018.05.003
G Model
QUAECO-1139; No. of Pages 10 ARTICLE IN PRESS
S. Nechi, H.E. Smaoui / The Quarterly Review of Economics and Finance xxx (2018) xxx–xxx 5

Table 2
IIBR vs. Conventional Interbank Rates.

Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability Observations

IIBR1 M 0.3726 0.3514 0.6000 0.2375 0.0692 0.4778 2.2363 65.2752 0.0000 1047
BH1 M 0.8553 0.8000 1.3500 0.7500 0.1520 2.1344 6.3471 1246.9300 0.0000 1017
KW1 M 3.0954 3.0984 5.0336 2.1815 0.8014 0.6270 2.4674 83.1338 0.0000 1075
QR1 M 0.2784 0.2639 0.4054 0.2445 0.0357 1.4596 4.0654 311.4430 0.0000 774
SA1 M 0.1936 0.1713 0.4961 0.1426 0.0773 2.5687 8.2594 2421.1440 0.0000 1075
AE1 M 0.1891 0.1429 0.4629 0.1214 0.0926 1.4751 3.5678 277.5675 0.0000 738
IIBR3 M 0.5547 0.5200 0.8500 0.3300 0.1259 0.4541 1.9240 86.4996 0.0000 1047
BH3 M 1.2105 1.1333 1.7900 1.0000 0.2022 1.6083 4.6903 559.4815 0.0000 1017
KW3 M 3.8017 3.7749 5.8725 2.6178 0.9060 0.4746 2.3668 58.3188 0.0000 1075
QR3 M 0.3285 0.3196 0.4691 0.2826 0.0339 1.0060 3.4347 136.6440 0.0000 774
SA6 M 0.2861 0.2660 0.5909 0.2213 0.0775 2.4783 8.0489 2242.2520 0.0000 1075
AE3 M 0.4831 0.4514 0.7114 0.3800 0.0957 0.8436 2.4268 97.6366 0.0000 738
IIBR6 M 0.7378 0.6867 1.1933 0.4525 0.1761 0.6200 2.1882 95.8228 0.0000 1047
BH6 M 1.4892 1.4667 1.9600 1.2500 0.1667 1.1844 4.1960 298.3913 0.0000 1017
KW6 M 4.5978 4.6625 6.7114 3.4904 0.8613 0.6162 2.7143 71.6765 0.0000 1075
QR6 M 0.3716 0.3663 0.5010 0.3271 0.0304 1.1403 3.9952 199.6645 0.0000 774
SA6 M 0.2861 0.2660 0.5909 0.2213 0.0775 2.4783 8.0489 2242.2520 0.0000 1075
AE6 M 0.8160 0.8129 1.1104 0.6771 0.1179 0.9039 2.7510 102.3919 0.0000 738
IIBR1Y 1.0621 1.0033 1.5383 0.6525 0.2117 0.4178 1.8562 87.5297 0.0000 1047
BH1Y 1.8405 1.8000 2.3000 1.6200 0.1480 1.5516 5.3272 637.5804 0.0000 1017
KW1Y 5.3888 5.3585 7.7393 4.1491 0.8873 0.8551 3.1746 132.3752 0.0000 1075
QR1Y 0.4339 0.4317 0.5438 0.3707 0.0345 0.3317 2.1047 40.0466 0.0000 774
SA1Y 0.3183 0.2940 0.6312 0.2573 0.0799 2.4940 8.0143 2240.6390 0.0000 1075
AE1Y 1.0010 0.9514 1.3496 0.8429 0.1384 0.8991 2.6768 102.6352 0.0000 738

the conventional rates in the contributing banks’ countries display Table 3

Correlation between IIBR and Conventional Interbank Rates.
some similarities with the IIBR in terms of means and standard
deviations, which may indicate a certain association between the IIBR Maturities IIBR1 M IIBR3 M IIBR6 M IIBR1Y
IIBR and the conventional rates in these countries. Pearson Correlation
In the next section, we investigate the possibility of association Bahrain 0.8911*** 0.8546*** 0.9177*** 0.8566***
between the IIBR and the conventional rates in the countries of con- Kuwait 0.4810*** 0.4057*** 0.4816*** 0.5908***
tributing banks by conducting correlation analysis, cointegration Qatar 0.8430*** 0.8428*** 0.8376*** 0.6110***
Saudi Arabia 0.8433*** 0.8487*** 0.8682*** 0.8777***
tests, and Granger causality tests.
UAE 0.8004*** 0.9163*** 0.9335*** 0.9102***
Surprisingly, the daily standard deviation of IBORs does not Average 0.7718 0.7736 0.8077 0.7693
seem to follow the standard risk-return trade-off. In fact, while the Azad et al. (2018) 0.8950 0.7960 0.8580 0.8590
higher levels of risk are associated with higher interbank rates (e.g., Kendall’s tau
Bahrain 0.6099*** 0.5707*** 0.6463*** 0.5087***
Kuwait and Bahrain), lower levels of risk are not associated with
Kuwait 0.0474 0.1127*** 0.1235*** 0.1426***
lower interbank rates (e.g., Qatar). As opposed to other countries Qatar 0.5989*** 0.6459*** 0.5866*** 0.3853***
in our sample, the money market seems to be more stable (e.g., Saudi Arabia 0.4148*** 0.5338*** 0.5095*** 0.5368***
less risky) in Qatar, despite the fact that it may not be the most UAE 0.5167*** 0.6709*** 0.7155*** 0.6224***
competitive (does not have the lowest mean). The goodness-of- Spearman’s rho
Bahrain 0.8442*** 0.7716 0.8324*** 0.6783***
fit tests of Jarque-Bera indicate that the data do not have skewness
Kuwait 0.1421*** 0.2105 0.2216*** 0.2412***
and kurtosis matching that of a normal distribution. Moreover, nor- Qatar 0.7953*** 0.8428 0.7863*** 0.5637***
mality tests strongly reject the null hypothesis of normality in the Saudi Arabia 0.5926*** 0.7312 0.6822*** 0.7334***
distribution of all maturities of IIBR and IBORs. UAE 0.7207*** 0.8682 0.8914*** 0.8076***

***, **, and * denote level of significance at 1%, 5%, and 10%, respectively.

5. Empirical results

5.1. Correlations analysis
Table 3 presents the correlation coefficients of all the maturities
of the IIBR with the corresponding maturities of the interbank rates
of the five GCC countries in our sample. We use three measures of
the correlation: Pearson, Kendall rank and Spearman rank.13 The
results show that all the maturities of the IIBR are positively and
significantly correlated with the corresponding maturities of the
conventional interbank rates. One exception is Kendall’s tau cor-
relation coefficient between the one-month maturities of the IIBR
and the interbank rate of Kuwait, KIBOR. Moreover, the Kendall and
Spearman coefficients indicate a very weak correlation between
13
Pearson correlation is used for normally distributed data while Kendall and
Spearman correlations are used for non-normal data. Both the Kendall’s tau and
Spearman rho methods are non-parametric (i.e., no restriction on the distribution
of the distribution).
the interbank rate in Kuwait and the IIBR. In addition, all the mea-
sures of correlation indicate that Bahrain interbank rates are the
most correlated with IIBR, followed by Qatar, UAE, Saudi Arabia,
and Kuwait, respectively.
It is interesting to note that, for all maturities, the average for
the correlation coefficients according to the Pearson measure are
higher than those obtained by Azad et al. (2018) for the correspond-
ing maturities between the IIBR and the LIBOR. For instance, while
the average correlation for the one-month maturity between the
IIBR and the five GCC countries in our sample is 0.77, it reaches
0.90 between the IIBR and LIBOR for the same maturity in Azad
et al. (2018). This might indicate that the IIBR is used more for
Islamic transactions in international markets than in local markets
of contributing banks.
Note also that the correlation does not change significantly
across the different maturities. Unreported results of the correla-
tion between the IBORs indicate that, on average, interbank rates
are more correlated with each other than with IIBR. This provides

Please cite this article in press as: Nechi, S., & Smaoui, H.E. Interbank offered rates in Islamic countries: Is the Islamic benchmark different
from the conventional benchmarks? The Quarterly Review of Economics and Finance (2018), https://doi.org/10.1016/j.qref.2018.05.003
G Model
QUAECO-1139; No. of Pages 10 ARTICLE IN PRESS
6 S. Nechi, H.E. Smaoui / The Quarterly Review of Economics and Finance xxx (2018) xxx–xxx

Table 4
Stationarity test, ADF Test.

Series Intercept Intercept + Trend None Intercept Intercept + Trend None

Level 1St Diff Level 1st Diff Level 1st Diff Level 1st Diff Level 1st Diff Level 1st Diff

ONE-MONTH SIX-MONTH
IIBR 0.1432 0.0000 0.5757 0.0000 0.5360 0.0000 0.5068 0.0000 0.9865 0.0000 0.4670 0.0000
BH 0.9998 0.0000 0.9980 0.0000 0.9898 0.0000 0.9175 0.0001 0.9553 0.0000 0.8727 0.0001
KW 0.8920 0.0000 0.7843 0.0000 0.9377 0.0000 0.8763 0.0000 0.4892 0.0000 0.9242 0.0000
QR 0.9977 0.0000 0.9941 0.0000 0.8636 0.0000 0.9568 0.0000 0.9987 0.0000 0.8283 0.0000
SA 0.9997 0.4163 1.0000 0.3310 0.9835 0.1498 0.9953 0.6970 0.9980 0.6206 0.9593 0.3584
AE 0.6487 0.0000 0.7701 0.0000 0.6749 0.0000 0.1090 0.0000 1.0000 0.0000 0.1682 0.0000

THREE-MONTH ONE-YEAR
IIBR 0.3036 0.0000 0.8427 0.0000 0.3747 0.0000 0.4653 0.0000 0.8817 0.0000 0.5666 0.0000
BH 0.9936 0.0000 0.9838 0.0000 0.9612 0.0000 0.9851 0.0000 0.9902 0.0000 0.8957 0.0000
KW 0.9256 0.0000 0.2412 0.0000 0.8915 0.0000 0.9710 0.0000 0.3301 0.0000 0.9313 0.0000
QR 0.9998 0.0000 0.9996 0.0000 0.8620 0.0000 0.9747 0.0000 0.9984 0.0000 0.7969 0.0000
SA 0.9977 0.4579 1.0000 0.4169 0.9685 0.1689 0.9991 0.3925 0.9998 0.3051 0.9694 0.1334
AE 0.0104 0.0000 0.9999 0.0000 0.0058 0.0000 0.0534 0.0000 0.9998 0.0000 0.0626 0.0000

Table 5
P-vales of the Cointegration Tests (H0 : no cointegration).

IIBR 1M 3M 6M 1Y

STATSTIC Trace Max. Eigen Trace Max. Eigen Trace Max. Eigen Trace Max. Eigen

BH One coint. Eqn 0.0033 0.0020 0.0015 0.0030 0.0351 0.0807 0.0536 0.0688
Two coint. Eqn(s) 0.6261 0.6261 0.1506 0.1506 0.1701 0.1701 0.3228 0.3228
KW One coint. Eqn 0.5815 0.7821 0.3521 0.4740 0.2707 0.3996 0.5642 0.5858
Two coint. Eqn(s) 0.1044 0.1044 0.2240 0.2240 0.1851 0.1851 0.4429 0.4429
QR One coint. Eqn 0.3238 0.6100 0.3092 0.2631 0.0783 0.0702 0.0130 0.0086
Two coint. Eqn(s) 0.1050 0.1050 0.6361 0.6361 0.4413 0.4413 0.6654 0.6654
SA One coint. Eqn 0.0029 0.0021 0.0108 0.0044 0.0152 0.0300 0.0021 0.0004
Two coint. Eqn(s) 0.4878 0.4878 0.6361 0.6361 0.1080 0.1080 0.7933 0.7933
AE One coint. Eqn 0.0003 0.0063 0.0000 0.0008 0.0000 0.0000 0.0000 0.0000
Two coint. Eqn(s) 0.0030 0.0030 0.0012 0.0012 0.0000 0.0000 0.0018 0.0018

an indication that conventional money markets in GCC countries
are more integrated than their Islamic counterparts. Finally, the
higher correlation coefficients of Pearson compared with Kendall
and Spearman coefficients suggest the possibility of the presence
of outlying data points in the tails of both Islamic and conventional
interbank rates. The high kurtosis reported in Table 2 supports this
observation.
5.2. Cointegration analysis
To ensure that our cointegration analysis is appropriate and
determine the degree of integration of the series, if any, we con-
ducted the unit root test with intercept, with intercept and trend,
and with no intercept and trend (none) for each of the interbank
benchmark rates (IIBR, BHIBOR, KIBOR, QIBOR, SAIBR, and EAIBR).
We also tested the first difference of each series for stationarity.
Table 4 below presents the results. Irrespective of the inclusion
of an intercept, intercept and trend, or none, the presence of unit
root in all series in level is confirmed. In fact, we cannot reject
non-stationarity for all maturities of all interbank benchmark rates
(Islamic and conventional). For the first difference, however, except
for SAIBOR, the null hypothesis of non-stationarity is rejected at
the one percent level indicating that the IIBR and the conventional
interbank rates are integrated of order one (i.e., may have a long-run
cointegration relationship). An additional test has been conducted
for the second difference of the SAIBOR led to the rejection of non-
stationarity at the
Next, we use Johansen cointegration procedure to analyze the
relationship between the different maturities of IIBR and the cor-
responding maturities of the conventional interbank rates in the
countries of our sample. Table 5 below reports the p-values for
the Trace and Maximum Eigenvalue tests. For Bahrain (BH), Saudi
(SA) and UAE we reject the null hypothesis of no cointegration
between the IIBR and conventional interbank rates at all maturi-
ties in these three countries.14 For Kuwait (KW), we do not reject
the null hypothesis of no cointegration for all maturities, while for
Qatar (QR) we reject the null only for the 6 M maturity (at the 10%
significance level) and for the 1Y maturity at the 1% significant level
according to the maximum Eigen method and at 5% significance
level based on the Trace method. These results suggest that there
is a long-term equilibrium relationship between the IIBR and the
conventional interbank rates in Bahrain, Saudi Arabia and UAE for
all maturities. The IIBR exhibits a long-term relationship with the
conventional interbank in Qatar for longer maturities only (6 M and
1Y). However, no long-term relationship exists between the IIBR
and the conventional interbank rate in Kuwait, indicating that the
IIBR is not affected by market conditions in Kuwait and act inde-
pendently from the KIBOR. Overall, the results of the cointegration
analysis support the argument that the IIBR is not independent of
interest-based interbank rates, indicating that the IIBR fails to prove
itself as a Sharia-compliant instrument. This finding is in line with
Azad et al. (2018), which suggest that the IIBR exhibits a long-run
relationship with the LIBOR. Saraç and Zeren (2014) find that term
deposit rates of all Islamic banks in Turkey are cointegrated with
those of conventional banks.
5.3. Pairwise granger causality tests
The next step in our analysis is to conduct causality tests
between the two types of interbank benchmarks. Table 6 inves-
tigates the Granger causality relationship between all maturities
14
For 1M and 3M maturities, the null hypothesis is rejected at 1% for all countries.
However, for the 6M and 1Y maturities, the null hypothesis is rejected at 1%, 5% or
10% depending on the country.

Please cite this article in press as: Nechi, S., & Smaoui, H.E. Interbank offered rates in Islamic countries: Is the Islamic benchmark different
from the conventional benchmarks? The Quarterly Review of Economics and Finance (2018), https://doi.org/10.1016/j.qref.2018.05.003
G Model
QUAECO-1139; No. of Pages 10 ARTICLE IN PRESS
S. Nechi, H.E. Smaoui / The Quarterly Review of Economics and Finance xxx (2018) xxx–xxx 7

Table 6
Granger Causality Tests for IIBR and Conventional Interbank Rates.

Null Hypothesis: 1M 3M 6M 1Y

F-Stat p-value F-Stat p-value F-Stat p-value F-Stat p-value

DBIBOR does not Granger Cause DIIBR 4.7995 0.0084 35.6568 0.0000 2.8992 0.0556 3.4296 0.0328
DIIBR does not Granger Cause DBIBOR 1.4944 0.2249 1.2885 0.2762 0.5118 0.5996 0.2700 0.7634
DKIBOR does not Granger Cause DIIBR 0.0312 0.9693 0.2513 0.7778 1.8513 0.1576 1.6490 0.1928
DIIBR does not Granger Cause DKIBOR 2.1241 0.1201 2.4036 0.0909 4.5150 0.0112 1.3444 0.2612
DQIBOR does not Granger Cause DIIBR 14.9320 0.0000 11.5437 0.0000 12.3009 0.0000 5.7431 0.0168
DIIBR does not Granger Cause QIBOR 1.7453 0.1753 4.1237 0.1166 7.0861 0.1971 5.0341 0.23 67
DSAIBOR does not Granger Cause DIIBR 4.1268 0.0164 0.6745 0.5096 0.7537 0.4709 2.3313 0.0422
DIIBR does not Granger Cause DSAIBOR 1.3944 0.2485 0.4231 0.6551 0.3829 0.6820 0.0979 0.9068
DAEIBOR does not Granger Cause DIIBR 11.2012 0.0000 34.2466 0.0000 40.5451 0.0000 16.7062 0.0000
DIIBR does not Granger Cause DAEIBOR 2.2205 0.1093 1.2746 0.2802 4.2494 0.0146 7.1922 0.0008

Table 7A
Output of the VECM Model.

BAHRAIN SAUDI ARABIA UAE

D(IIBR3 M) D(BIBOR3 M) D(IIBR3 M) D(SAIBOR3 M) D(IIBR3 M) D(AEIBOR3 M)

ECT −0.0160** −0.0082** −0.0006 0.0007*** −0.1331*** 0.0086

D(IIBR3 M(-1)) −0.4257*** 0.0049 −0.4395*** 0.0071 −0.3448*** 0.0115
D(IIBR3 M(-2)) −0.2714*** −0.0023 −0.2980*** 0.0107** −0.2486*** 0.0087

D(BIBOR3 M(-1)) 0.029 −0.2744***

D(BIBOR3 M(-2)) 0.0853 −0.0975***
D(SAIBOR3 M(-1)) 0.0295 0.4761***
D(SAIBOR3 M(-2)) 0.1884 0.1468***
D(AEIBOR3 M(-1)) 0.0955 0.0693**
D(AEIBOR3 M(-2)) 0.1496 0.0658**
CONSTANT −0.0002 0.0006 −0.0004 0.0005 ***
−0.0003 −0.0004**
R-squared 0.1914 0.0728 0.1961 0.4158 0.2241 0.019
Adj. R-squared 0.1870 0.0677 0.1919 0.4127 0.2200 0.0140
F-statistic 43.3090 14.3674 47.1734 137.6303 54.9795 3.7110

***, **, and * denote level of significance at 1%, 5%, and 10%, respectively.

considered in our study (1 M, 3 M, 6 M, and 1Y) of the IIBR and the
corresponding maturities of the conventional interbank rates. Note
that since the series are non-stationary, we conduct the Granger
causality tests on the first difference. For the conventional inter-
bank of Saudi Arabia, SAIBOR, we conducted the Granger causality
test on the second difference since it is I(2). We take into consider-
ation four (4) lags.
Overall, the results of the Granger causality test are consistent
with the results of the cointegration tests. In fact, the evidence
shows that, for the cointegrated variables, in particular, the IIBR
and the conventional interbank rates in Bahrain and UAE (BHI-
BOR and AEIBOR), for all maturities, changes in the conventional
interbank rates Granger-cause changes in the IIBR. For Saudi Ara-
bia, changes in conventional interbank rate Granger-cause changes
in the IIBR for the 1 M and 1Y maturities only. The results of the
Granger causality test for the IIBR and the conventional interbank
rate in Kuwait, KIBOR, confirms the findings of the cointegration
test, which concludes that, for all maturities, the two interbank
rates are not cointegrated. That is, changes in KIBOR does not
Granger cause changes in IIBR and vices versa.
It is interesting to note that while cointegration tests indicate
that the conventional interbank rate in Qatar is cointegrated with
the IIBR only for the longer maturities (6 M and 1Y), the Granger
causality tests indicate that, for all maturities, the QIRB Granger-
cause the IIBR.
Generally, the findings indicate that, at least, four out of the
five conventional benchmarks in contributing banks’ countries of
the IIBR can help predicting future values of the IIBR maturities,
suggesting that IBORs have a significant influence on the determi-
nation of the IIBR. This finding is consistent with the results of Saraç
and Zeren (2014) who investigated the direction of the causality
between the term deposit rates of Islamic and conventional banks
in Turkey. In fact, they find that conventional benchmarks Granger
cause the Islamic rates at 1% significance.
More importantly, the results advocate that changes in the IIBR
do not Granger-cause changes in conventional interbank rates,
except for the longer maturities, 6 M and 1Y, in UAE. In fact, we do
not reject the null hypothesis (H0 : DIIBR does not Granger Cause
DAEIBOR) at 5% and 1% significance levels, respectively. The past
values of the IIBR seem to be helpful in predicting the conven-
tional rates in UAE. This could be explained by the fact that UAE has
the biggest number of contributing banks to the IIBR (5 banks). In
addition, given that the UAE is home to a large number of Islamic
banks as well as Islamic window operations offered by conven-
tional banks, it is not surprising that the IIBR affects the fixing of
the conventional interbank rate in the UAE. A similar exception was
identified in the work of Saraç and Zeren (2014) who found a tem-
porary causality from an Islamic term-deposit rate (Kuveyt Türk
bank) to a conventional counterpart.
Ajmi et al. (2014) find evidence of bidirectional linear causality
between an Islamic benchmark, the Islamic Dow Jones Islamic Mar-
ket (DJIM) Index, the S&P stock market indices from the US, Europe
and Asia (SPUS, SPEU, and SPAS500), the US MOVE index, and the
US federal funds rate.15
5.4. VAR results
Table 7A below summarizes the output of two-equation VECM
models for the conventional interbank rates cointegrated with the
IIBR (BHIBOR, SAIBOR, and EAIBOR). The estimates are for the 3-
15
Their nonlinear causality analysis shows, however, a significant unidirectional
causality between the conventional benchmarks and the DJIM index.

Please cite this article in press as: Nechi, S., & Smaoui, H.E. Interbank offered rates in Islamic countries: Is the Islamic benchmark different
from the conventional benchmarks? The Quarterly Review of Economics and Finance (2018), https://doi.org/10.1016/j.qref.2018.05.003
G Model
QUAECO-1139; No. of Pages 10 ARTICLE IN PRESS
8 S. Nechi, H.E. Smaoui / The Quarterly Review of Economics and Finance xxx (2018) xxx–xxx

Fig. 2. Response Functions of IIBR, KIBOR and QIBOR to Innovations.

Table 7B dynamic relationship between them exists. Thus, past movements

Output for the VAR in Difference Model.
of the conventional interbank rates affect the IIBR.
DIIBR3 M DKW3 M DIIBR3 M DQR3 M VAR models also allow investigating the response of one variable
DIIBR3 M(-1) −0.43677 ***
0.0028 −0.42739 ***
−0.01691 to an impulse in another variable in a system that involves a number
(0.0312) (0.0176) (0.0401) (0.0324) of other variables as well. Broadly speaking, the impulse responses
DIIBR3 M(-2) −0.2875*** 0.019484 −0.2872*** 0.00446 are zero if one of the variables does not Granger-cause the other
(0.0310) (0.0174) (0.0398) (0.0321) variables taken as a group. An innovation in variable k has no effect
DKW3 M(-1) 0.002187 −0.18976***
on the other variables if the former variable does not Granger-cause
(0.0583) (0.0327)
DKW3 M(-2) −0.10652* 0.056993* the set of the remaining variables. Fig. 2 below shows the impulse
(0.0566) (0.0318) response functions of change of the three-month maturity of IIBR to
DQR3 M(-1) −0.10851** −0.26143*** the different innovations of one standard deviation in the change of
(0.0511) (0.0412)
conventional interbank rates in Kuwait and Qatar. The effect of the
DQR3 M(-2) −0.0995* 0.000549
(0.0502) (0.0405) innovations in the conventional interbank rates (KIBOR or QIBOR)
Constant −0.00021 0.000726 0.000299 0.000364 on the IIBR is immediate, small and lasts for a week. In fact, the effect
(0.0008) (0.0005) (0.0010) (0.0008) of the innovations in conventional rates on the IIBR starts the first
period (day) and vanishes within the 7th period (day). Moreover,
R-squared 0.1935 0.0453 0.1875 0.0698
the extent of the change in the IIBR is very small with a magni-
Adj. R-squared 0.1900 0.0412 0.1819 0.0634
F-statistic 55.4830 10.9731 33.7413 10.9752 tude of 0.002% at most. This result confirms our previous findings,
which suggest no long-term relationship between the IIBR and the
***, **, and * denote level of significance at 1%, 5%, and 10%, respectively.
conventional interbank rates in Kuwait and Qatar.
Note that although the F-statistics in Tables 7A and 7B indicate
that all equations are significant, the values of R2 suggest that the
month maturities.16 For all equations, the coefficients on the lags
estimated models cannot explain variation in the interbank rates
of the dependent variable are significant, indicating the existence
(less than 20%, except for UAE with 22%). This can happen because
of the short run causality. Moreover, given that the error correc-
the order of the model is inappropriately selected or we possibly
tion term (ECT) is negative and significant, we conclude that a long
omitted some important exogenous variables. To assess the former
run relationship exists between the IIBR and the corresponding
reason, we investigate the optimal lag length. Unreported results
conventional interbank rate.
indicate that, for all criteria, the optimal lag order of the model is
It is interesting to note that the coefficient of ECT is higher in UAE
at least 2. This means that the order of the VAR models we esti-
than any other country. This indicates that the response of Islamic
mated are appropriately selected. For the latter reason, we include
banks to a deviation from the long-run equilibrium is higher in UAE.
additional exogenous variables in the model, namely oil price and
Table 7B presents the output of the two VAR in difference mod-
inflation. Tables 8A and 8B report the output of the VECM and VAR
els for the conventional interbank rates that are not cointegrated
models with the oil price and inflation as exogenous variables17 .
with the IIBR, namely KIBOR and QIBOR. While, both the coefficients
As shown in Tables 8A and 8B, adding the oil price and infla-
of the lags of the dependent and independent variables are signif-
tion as exogenous variables in our VECM and VAR models did not
icant in the IIBR equations, only the lags of dependent variables
improve the results since, for each equation, the explanatory power
are significant for the conventional interbank rates equations. We
of the model either is the same or decreases. Note, however, that
conclude that although the IIBR is not cointegrated with the con-
while the oil price is found to be significant, inflation is not. One
ventional rates in Kuwait and Qatar (i.e., no long-run relationship), a

17
Unreported results show that the oil price and inflation series are stationary.
16
We conduct similar exercise for all maturities. Results are available upon Therefore, we estimate our VECM and VAR models with the two exogenous variables
request. the oil price and the inflation in levels.

Please cite this article in press as: Nechi, S., & Smaoui, H.E. Interbank offered rates in Islamic countries: Is the Islamic benchmark different
from the conventional benchmarks? The Quarterly Review of Economics and Finance (2018), https://doi.org/10.1016/j.qref.2018.05.003
G Model
QUAECO-1139; No. of Pages 10 ARTICLE IN PRESS
S. Nechi, H.E. Smaoui / The Quarterly Review of Economics and Finance xxx (2018) xxx–xxx 9

Table 8A
VECM with exogenous variables – oil price & Inflation.

BAHRAIN SAUDI ARABIA UAE

D(IIBR3 M) D(BH3 M) D(IIBR3 M) D(SA3 M) D(IIBR3 M) D(AE3 M)

ECT −0.0151 −0.0029 −0.0027 0.0017*** −0.1538*** 0.0007

(0.0106) (0.0058) (0.0038) (0.0006) (0.0282) (0.0068)
D(IIBR3 M(-1)) −0.4305*** 0.0117 −0.4425*** 0.0042 −0.3199*** 0.0228**
(0.0394) (0.0217) (0.0383) (0.0063) (0.0414) (0.0100)
D(IIBR3 M(-2)) −0.2333*** 0.0109 −0.2594*** 0.0104* −0.2088*** 0.0107
(0.0375) (0.0207) (0.0369) (0.0060) (0.0368) (0.0088)
D(BH3 M(-1)) 0.0146 −0.2711***
(0.0701) (0.0386)
D(BH3 M(-2)) 0.0647 −0.1028***
(0.0696) (0.0383)
OILPRICE 0.000012 −0.000050* −0.000037 −0.000029*** −0.000072* −0.000044***
(0.00005) (0.00003) (0.00004) (0.00001) (0.00004) (0.00001)
INFLATION 0.00307 0.07032* 0.00622* 0.0111 0.00511 0.08012
(0.0023) (0.0303) (0.00421) (0.0601) (0.0033) (0.0403)
D(SA3 M(-1)) 0.0268 0.4561***
(0.2222) (0.0364)
D(SA3 M(-2)) 0.1243 0.1573***
(0.2308) (0.0378)
D(AE3 M(-1)) −0.0130 −0.0005
(0.1675) (0.0403)
D(AE3 M(-2)) 0.1434 −0.0115
(0.1839) (0.0442)
Constant −0.0016 0.0049** 0.0018 0.0027*** 0.0047 0.0028***
(0.0038) (0.0021) (0.0035) (0.0006) (0.0032) (0.0008)
R-squared 0.1660 0.0739 0.1696 0.4120 0.1950 0.0428
Adj. R-squared 0.1588 0.0658 0.1627 0.4071 0.1883 0.0348
F-statistic 22.9594 9.1981 24.6751 84.6678 29.0681 5.3646

***, **, and * denote level of significance at 1%, 5%, and 10%, respectively.

Table 8B benchmarks in many countries. For instance, using a multivariate

VAR with exogenous variables – oil price & Inflation.
smooth transition autoregression (STVAR) framework, Milas and
KUWAIT QATAR Lekkos (2004) find significant asymmetries on the impact of the
common risk factors on the US and UK swap spreads. Based on a
DIIBR3 M DKW3 M DIIBR3 M DQR3 M
basic VAR model to analyze, He et al. (2007) suggest that although
DIIBR3 M(-1) −0.4392*** 0.0115 −0.4068*** −0.0049
US unexpected macroeconomic shocks still dominate Hong Kong
(0.0388) (0.0214) (0.0498) (0.0339)
DIIBR3 M(-2) −0.2449*** 0.0195 −0.2352*** 0.0248 money market interest rates (HIBOR), (China) Mainland shocks
(0.0373) (0.0206) (0.0468) (0.0318) have become more important in accounting for the unexpected
DKW3 M(-1) 0.0112 −0.1184*** fluctuations in HIBOR.
(0.0753) (0.0415)
DKW3 M(-2) −0.1152* 0.0553
(0.0694) (0.0382) 6. Conclusion and policy recommendations
Constant 0.0020 0.0017 0.0007 0.0016
(0.0032) (0.0018) (0.0032) (0.0022)
OILPRICE −0.000035 −0.000013 −0.000018 −0.000030
The IIBR was established in an attempt to allow for
(0.000039) (0.000022) (0.000043) (0.000029) Sharia-compliant lending practices that avoid interest-based and
INFLATION 0.0024 −0.0016 0.0011 −0.0047 excessive risk-taking activities and predatory lending on the part
(0.0003) (0.0007) (0.0101) (0.0032) of banks. One of the major aims of this research was to com-
DQR3 M(-1) −0.0859 −0.2863***
pare and contrast the behavior of the IIBR with the conventional
(0.067910) (0.046160)
DQR3 M(-2) −0.1247* −0.0407 (interest-based) interbank rates (IBORs) in five Islamic countries
(0.066400) (0.045130) where Islamic banking has a significant market share and host
R-squared 0.1663 0.0187 0.1472 0.0873 almost all contributing banks to the IIBR. Our methodology is based
Adj. R-squared 0.1603 0.0117 0.1374 0.0768
on four tools: (i) Correlation analysis; (ii) Cointegration analysis;
F-statistic 27.8367 2.6594 14.9517 8.2882
(iii) tests for Granger causality; and (iii) VAR approach to iden-
***
, **, and * denote level of significance at 1%, 5%, and 10%, respectively. tify any inter-temporal linkages between the IIBR and conventional
interbank rates.
Overall, our results suggest that the IIBR exhibits a long-term
reason why inflation is not significant is that, inherently, interest equilibrium relationship with the conventional interbank rates in
rates are assumed to take into account inflationary perspectives, Bahrain, Saudi Arabia, and UAE but not with conventional interbank
since the rate is somehow defined to compensate for inflation, at rates in Kuwait and Qatar. These findings imply that the IIBR is
least partially. not independently determined (at least in Bahrain, Saudi, and UAE)
Overall, dynamics in the other variables did not make a differ- rejecting the claim that it has unique characteristics and market
ence. That is, the exogenous variables did not affect the long-run conditions.
relationship between the IIBR and the conventional interbank rates At least three reasons can explain the failure of the IIBR to
in Bahrain, Saudi, and UAE nor the dynamic relationship between decouple from the conventional interbank rates. First, the panel
the IIBR and conventional interbank rates in Kuwait and Qatar. of contributing banks is not representative of all countries of the
This result is not in line with many studies that use VAR models core markets of Islamic finance. The examination of the panel banks
to investigate the impact of macroeconomic shocks on interbank of the contributing banks to the IIBR fixing shows that 16 out of

Please cite this article in press as: Nechi, S., & Smaoui, H.E. Interbank offered rates in Islamic countries: Is the Islamic benchmark different
from the conventional benchmarks? The Quarterly Review of Economics and Finance (2018), https://doi.org/10.1016/j.qref.2018.05.003
G Model
QUAECO-1139; No. of Pages 10 ARTICLE IN PRESS
10 S. Nechi, H.E. Smaoui / The Quarterly Review of Economics and Finance xxx (2018) xxx–xxx
the 17 contributing banks are located in GCC countries. Although,
GCC countries are important markets for Islamic assets with Islamic
banks have significant market share, other countries that are part of
the core markets for Islamic finance do not have banks in the panel
of contributing banks. Including banks from Indonesia, Malaysia,
Turkey, Egypt, and Jordan would make the panel of contributing
banks more balanced and representative of the markets for Islamic
finance industry. Second, more integrated Islamic finance markets
with each other and with international financial markets would
empower Islamic banks, provide them with access to more asset
markets, and develop new products and services. Third, excluding
conventional banks with Islamic finance window operations from
the panel of contributing banks to IIBR fixing would minimize the
dependence of the IIBR to conventional interbank rates.
Since the IIBR failed to distinguish itself as a sharia-compliant
interbank rate, the challenges for Islamic banks continue, especially
those related to the authenticity of its transactions as interest-free
instruments. Given that the IIBR is subject to market conditions
similar to those driving the conventional interbank rates, what
Islamic banks can do to decouple the IIBR from the conventional
interbank rates? What factors can influence the IIBR but not the
IBORs that the administrators of the IIBR can use to make it a
sharia-compliant monetary tool?
Panel banks and administrators of the IIBR may need to reflect
on its setting and amend the process if needed. Any reform of the
IIBR, however, has to be carefully selected. Duffie and Stein (2015)
argue that the reform of the interbank benchmarks or other finan-
cial benchmarks, in general, need to satisfy two principles to be
successful. First, benchmarks should be based on the actual trans-
actions, not on the judgments submitted by market participants.
However, this principle is less likely to be satisfied in practice. For
instance, the fixing of IBORs is facing the problem that there are
few actual loan transactions between banks that could be used to
fix most of the IBORs. The IIBR fixing might be suffering from this
shortcoming, too. As suggested by Duffie and Stein (2015), Thom-
son Reuters and panel of contributor banks may consider a wider
set of unsecured bank borrowing transactions, not just those in the
interbank market, in the fixing of the IIBR.
Second Duffie and Stein (2015) encourage heavier use of alterna-
tive benchmark reference rates. This would reduce the possibility
of agglomeration of trade based on liquid high-volume markets
like those of the IBORs. In fact, massive agglomeration around a
single benchmark coupled with a weak fixing methodology can
be a source of manipulation of the benchmark. Given that the
IIBR is a relatively new benchmark, financial transactions in the
Islamic and international markets seem to be still agglomerated
around the conventional interbank benchmarks. Encouraging mar-
ket participants in the Islamic finance industry to use the IIBR as
an alternative tool together with a revised methodology would
increase the chance of its emergence as a Sharia-compliant instru-
ment.
A final remark is that despite its interdependence on the con-
ventional interbank benchmarks, the IIBR constitutes a milestone
for a new Islamic interbank benchmark that satisfies sharia require-
ments.
Please cite this article in press as: Nechi, S., & Smaoui, H.E. Interbank offered rates in Islamic countries: Is the Islamic benchmark different
from the conventional benchmarks? The Quarterly Review of Economics and Finance (2018), https://doi.org/10.1016/j.qref.2018.05.003
References
Ajmi, A. N., Shawkat Hammoudeh, S., Nguyenc, D. K., & Sarafraziba, S. (2014). How
strong are the causal relationships between Islamic stock markets and
conventional financial systems? Evidence from linear and nonlinear tests.
Journal of International Financial Markets, Institutions & Money, 28, 213–227.
Alaoui, A. O., Dewandaru, G., Rosly, S. A., & Masih, M. (2015). Linkages and
co-movement between international stock market returns : Case of Dow Jones
Islamic Dubai financial market index. Journal of International Financial Markets,
Institutions & Money, 36, 53–70.
Ayub, M. (2007). Understanding islamic finance. Chichester, UK: John Wiley and
Sons.
Azad, A. S. M. S., Azmat, S., Chazi, C., & Ahsan, A. (2018). Can islamic banks have their
own benchmark? Emerging markets review Retrieved. http://dx.doi.org/10.1016/
j.ememar.2018.02.002
Bacha, O. I. (2008). The islamic interbank money market and a dual banking
system: The Malaysian experience. International Journal of Islamic and Middle
Eastern Finance and Management, 1(3), 210–226.
Cevik, S., & Charap, J. (2011). The behavior of conventional and Islamic bank deposit
returns in Malaysia and Turkey. In IMF working papers series WP/11/156.
Chong, B. S., & Liu, M.-H. (2009). Islamic banking: Interest-free or interest-based?
Pacific-Basin Finance Journal, 17, 125–144.
Diemers, D., & Khalil, J. (2015). Retrieved from, GCC private banking study 2015:
Seizing the opportunities. Strategy& formerly booz & Company, https://www.
strategyand.pwc.com/media/file/GCC-private-banking-study-2015.pdf
Duffie, D., & Stein, J. C. (2015). Reforming LIBOR and other financial market
benchmarks. Journal of Economic Perspectives, 29(2), 191–212.
Engle, R. (2002). Dynamic conditional correlation: A simple class of multivariate
generalized autoregressive conditional heteroskedasticity models. Journal of
Business & Economic Statistics, 20(3), 339–350.
Ergeç, E. H., & Arslan, B. G. (2012). Impact of interest rates on Islamic and
conventional banks: The case of Turkey. Applied Economics, (45), 2381–2388.
Global Islamic Finance Report. (2017). Retrieved, Dubai Islamic Bank, http://www.
gifr.net/publications/gifr2017/intro.pdf
He, D., Leung, F., & Ng, P. (2007). How do macroeconomic developments in mainland
China affect Hong Kong’s short-term interest rates? HKMA Working Paper
17/2007. Retrieved http://www.hkma.gov.hk/media/eng/publication-and-
research/research/working-papers/HKMAWP07 17 full.pdf
Islamic Financial Services Industry Stability Report. (2017). Retrieved, Islamic
financial services board, https://www.ifsb.org/docs/
IFSB%20IFSI%20Stability%20Report%202017.pdf
Ito, T. (2013). Islamic rates of return and conventional interest rates in the
Malaysian deposit market. International Journal of Islamic and Middle Eastern
Finance and Management, 6(4), 290–303.
Johansen, S. (1988). Statistical analysis of cointegration vectors. Economic Dynamic
Control, 12, 231–254.
Johansen, R., & Juselius, K. (1990). Maximum likelihood estimation and inference
on cointegration– with applications to the demand for money. Oxford Bulletin
of Economics and Statistics, 52(2), 169–210.
Kaleem, A., & Isa, M. (2003). Causal relationship between Islamic and conventional
banking instruments. International Journal of Islamic Finance Services, 4(4), 1–8.
Khan, F. (2010). How ‘Islamic’ is Islamic Banking?, Journal of Economic Behavior?
Journal of Economic Behavior & Organizationn, 76, 805–820.
Milas, C., & Lekkos, I. (2004). ommon Risk Factors In The U. S. And Uk Interest Rate
Swap Markets: Evidence From A Nonlinear Vector Autoregression Approach.
Journal of Futures Markets, 24(3), 221–250.
Saraç, M., & Zeren, F. (2014). The dependency of Islamic bank rates on conventional
bank interest rates: Further evidence from Turkey. Applied Economics, 47(7),
669–679.
Thomson Reuters. (2011a). islamic interbank benchmark rate: Pulse of the islamic
Capital markets. Thomson Reuters. http://thomsonreuters.com/content/
financial/pdf/cross asset/iibr factsheet.pdf
Thomson Reuters. (2011b). Thomson reuters launches world’s first islamic interbank
rate. Business and economics banking and finance, http://ezproxy.aus.edu/
login?url=http://search.proquest.com/docview/906172454?accountid=16946
Wei, W. S. (2006). Time series analysis: Univariate and multivariate. Boston: Pearson.
World Islamic Banking Competitiveness Report 2016. Retrived http://www.ey.
com/Publication/vwLUAssets/ey-world-islamic-banking-competitiveness-
report-2016/%24FILE/ey-world-islamic-banking-competitiveness-report-
2016.pdf.