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Abstract

This paper shows how a risk management mechanism through selling debt can affect the value of the Islamic banks. The Islamic banks are able to maximize their value from the sale of murabahah on housing debt in order to manage their risk arising from fluctuations in interest rates. A tractable theoretical model is developed to maximize the Islamic banks’ values from the sale of housing debt financing in order to hedge against fluctuations in interest rates. Our findings show that Islamic banks could improve their earnings and rectify the problem in aligning their assets and liabilities through the benefits of debt selling. A rise in the market interest rates leads to an increase in the base financing rate and the mark-up rate in Islamic banks, since market interest rates serve as benchmarks in determining profits or mark-ups. If the Islamic banks engage in debt selling to decrease their risk exposure, their earnings or value may be amplified since they have the opportunity to undertake other positive NPV projects from the payoffs on the murabahah debt selling.

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