Abstract
The proposed alternative Islamic Rate of Return benchmark (IRR) is intended to address the issue of using backward-looking rates in Islamic finance that are challenging due to the Shariah principle of Gharar, which requires certainty on all fundamental contract terms. The IRR is designed to satisfy both economic and Shariahprinciples and aligns with free market principles by using general equilibrium theory to estimate a fair interest rate based on the opportunity cost (measured by EGR) and market supply-demand dynamics. It takes into account both economic fundamentals and risk considerations by combining two components: the EGR component and the risk premium component. Therefore, the IRR benchmark promotes responsible and sustainable financing or investment practices and supports the development of a robust and inclusive financial system that serves the needs of all stakeholders. However, for IRR to be a viable alternative to interest-based benchmarks, central banks and the banking industry must carefully examine, modify, engage stakeholders, and collaborate to ensure a seamless transition.
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