Rental index rate as an alternative to interest rate in Musharakah Mutanaqisah home financing: A simulation approach
International Journal of Islamic and Middle Eastern Finance and Management
ISSN: 1753-8394
Article publication date: 15 August 2016
Abstract
Purpose
This paper aims to propose a new pricing alternative called Rental Rate Index (RR-I) that captures the true value of property to be used by Islamic banks in Musharakah Mutanaqisah (MM) contract for home financing.
Design/methodology/approach
By formulating a profit rate based on Rental Index (RI) and House Price Index (HPI), the proposed rate eliminates conventional profit rate benchmarking, and, at the same time, suggests a fair, equitable and sustainable financing. This new RR-I (measured by RPI/HPI) enables computerization of the MM system in home financing to be easily implemented. A financial simulation is developed to demonstrate the feasibility of this newly proposed rate.
Findings
This newly proposed RR-I is found to be more stable, having less fluctuations, resilient to macroeconomic conditions and yet comparable to the conventional interest rates, without depending on them. It can also be regarded as a rate that is fair and sustainable to both the customer and the bank, as it measures the actual rate of return to both parties in MM contract.
Research limitations/implications
The paper confines one contract, namely, MM, as it is claimed to be more Shariah-compliant than others.
Practical implications
The finding also sheds some light on the recommendation by Bank Negara Malaysia, which is to consider RR that is more indicative of the actual rental price while taking into account the competitiveness of the product. (BNM, 2007).
Social implications
This paper wreaks customer patronage in selecting the contract of home financing.
Originality/value
This paper attempts to resolve the issue of benchmarking RR to the conventional interest rate in the MM contract. Studies conducted on this issue via simulation approach are meager.
Keywords
Acknowledgements
The authors wish to express gratitude to the International Research and Training Institute (IRTI), Islamic Development Bank in Jeddah, for funding this project. The authors also thank those who have contributed toward the successful completion of this project.
Citation
Yusof, R.B.M., Mahfudz, A.A., Che Mohamed Arif, A.S. and Ahmad, N.H. (2016), "Rental index rate as an alternative to interest rate in Musharakah Mutanaqisah home financing: A simulation approach", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 9 No. 3, pp. 397-416. https://doi.org/10.1108/IMEFM-11-2015-0141
Publisher
:Emerald Group Publishing Limited
Copyright © 2016, Emerald Group Publishing Limited