An Analysis of House Price Index as the Alternative Pricing Benchmark for Islamic Home Financing

Abstract

Currently, major interest rates, such as the Base Lending Rate (BLR) and Kuala Lumpur Interbank Offered Rate (KLIBOR), are widely used as reference rates by the Islamic financial institutions to benchmark a broad range of financial products and contracts. This study aims to compare the viability of alternative pricing mechanisms for the Islamic home financing products. By comparing the interest-based benchmark with the non-interest benchmark, this study attempts to highlight the sensitivity and fragility of the Islamic home financing product to financial market volatility. The study focuses on Malaysia as the case study and uses quarterly data frequency covering the period from 2001 to 2015. Specifically, the study compares the lending rate and Housing Price Index (HPI) with the economic growth as the indicator of economic activities. Through the correlation analysis, the study found that the non-interest benchmark shows better relationships with macroeconomic variable compared to the interest-based benchmark. It shows that these alternative benchmarks have the connection to the economic movements that lead to the stability of the non-interest financing instruments. The findings of this study would provide important insights on the viability of House Price Index as the alternative to the benchmark of the equity financing home financing product. This study contributes to the empirical evidence for the feasibility of adopting interest-free benchmark to price Islamic home financing product.