Original Question: In calculating loans, Islamic banks do use interbank rates (e.g: libor) to determine the risk premium of a financing method (diminishing musharaka/Murabaha etc). Is the use of these rates even permissible since they are essentially interest rates charged between banks?

Yes it is true that Islamic banks do use these interbank rates on top of the spread which is dependent on the client’s business and overall market risk. Yet the use of interbank rate is considered permissible as it constitutes a measurement of how much the bank should charge as a return rather than the actual interest rate. Think a taxi ride, if a new taxi is launched, their base charge needs to be pegged to an already present benchmark. Unfortunately also, there are no available alternatives in the market.

The news of LIBOR being discontinued in Dec 2021, does bring a much needed boost to ongoing efforts by AAOIFI and IIFM to work out alternatives. Until then, it is permissible despite not being ideal. For more information on this, one could read up on Ethica’s Handbook of Islamic Finance page 152.