How Islamic Banks Are Navigating Financial Strain to Maintain Dividend Payments

In a dramatic turn of events, cash-strapped Islamic banks under the S Alam Group in Bangladesh have distributed dividends for 2023 to their shareholders and directors, despite severe liquidity issues. This scenario unfolded thanks to emergency liquidity support from the Bangladesh Bank, which invoked its “lender of last resort” (LoR) facility to stabilize these banks.

The Role of the Lender of Last Resort

The lender of last resort is a crucial mechanism central banks use to provide emergency funding to financial institutions facing severe liquidity shortages. In late December 2023, the Bangladesh Bank extended Tk22,000 crore in liquidity support to seven banks, including five Islamic banks owned by the S Alam Group—Islami Bank Bangladesh, Social Islami Bank, First Security Islami Bank, Union Bank, and Global Islami Bank. This assistance was critical in preventing these institutions from collapsing due to a dire cash crunch.

The LoR facility offers temporary relief and restores confidence in troubled banks by ensuring they can meet their immediate liabilities. However, this emergency funding is supposed to be a stopgap measure, not a long-term solution. In this case, the liquidity support allowed these banks to declare and distribute bank dividends, which raised eyebrows given their precarious financial state.

Bank Dividends Amidst a Liquidity Crisis

Despite the severe liquidity issues and continuous failure to maintain the cash reserve ratio (CRR)—a mandatory reserve that banks must hold with the central bank—the Islamic banks managed to declare dividends ranging from 5-10% for the year 2023. This decision, approved under the governance of then-Bangladesh Bank Governor Abdur Rouf Talukder, sparked controversy. The central bank’s department initially rejected the idea of disbursing bank dividends to these banks but reversed its stance following verbal instructions from the governor.

In a significant turn of events, the Bangladesh Bank had to print Tk1 lakh crore in new money in 2023 to provide ongoing support to these banks. This not only highlights the extent of the liquidity crisis but also the central bank’s role in propping up the banking sector under extreme financial duress. This large-scale money printing contributed to a broader economic impact, including inflationary pressures and concerns about the long-term stability of the Bangladeshi currency.

Recent Developments

As of June 30, 2024, the Bangladesh Bank provided an additional Tk35,000 crore in liquidity support to these banks in a single day. Despite this, no financial penalties were imposed for the CRR shortfall, nor were any audits conducted to investigate the underlying causes of the liquidity crisis. The central bank’s actions have been defended by Rouf Talukder, who stated that such support was within his authority to prevent a banking sector collapse. This support aimed to maintain the appearance of financial stability, but the underlying issues remained unaddressed.

The lack of investigation into the causes of the liquidity crisis has been a point of contention. Critics argue that without a thorough audit, the systemic issues that led to the crisis remain unresolved. The absence of corrective measures raises concerns about the potential for recurring problems and the effectiveness of the central bank’s response.

The Underlying Issues

The origins of the liquidity crisis can be traced back to 2017 when S Alam Group took over several Islamic banks. Islami Bank Bangladesh and Social Islami Bank were among the first to fall under the group’s control. Over time, S Alam Group’s influence expanded, leading to six out of ten Islamic banks being under its purview. This consolidation of power, coupled with questionable management practices, contributed significantly to the current financial instability.

For instance, in 2017, Islami Bank Bangladesh, the largest private commercial bank in the country, was taken over by S Alam Group. Shortly after, in October 2017, shares of the bank were acquired by some little-known companies. Despite these transactions involving substantial sums of money, there was no investigation into the sources of these funds by authorities, including the Anti-Corruption Commission (ACC). This lack of scrutiny allowed for questionable practices to flourish.

Following the takeover of these two banks, S Alam Group’s influence grew, leading to the acquisition of a total of six out of ten Islamic banks. Family members and associates of the S Alam Group occupied key positions in these banks, creating a network of control that facilitated the misuse of these institutions. The appointment of Ahsanul Alam, the son of S Alam Group Chairman Saiful Alam Masood, as chairman of Islami Bank at just 28 years old, further exemplified the problematic practices within these banks. His appointment, seen by many as a reward rather than a merit-based decision, sparked criticism and led to the Bangladesh Bank issuing new guidelines on the qualifications required for bank directors.

Evidence of loan corruption also indicates misuse of the bank by the business conglomerate. For example, in 2022, loans totaling Tk2,700 crore were approved for three unknown companies, with Tk900 crore allocated to each without proper documentation. These companies, registered with fake addresses, highlighted the lax regulatory environment and the banks’ willingness to overlook red flags. Despite this, the Bangladesh Bank did not investigate these dubious transactions.

The Impact on Depositor Confidence

The decline in depositor confidence has been profound. From November 2023 to April 2024, Islamic banks witnessed a ninefold increase in loan growth compared to their deposits. Deposits in ten Islamic banks increased by Tk2,808 crore, while loans surged by Tk25,790 crore. This disparity underscores a growing mistrust among depositors and highlights the broader impact of the liquidity crisis on the banking sector.

Internationally, Islamic banks have faced a deterioration in their creditworthiness, with many foreign banks cutting off credit lines due to the banks’ poor reputation and failures in foreign payments. This has further strained the banks’ ability to operate effectively on a global scale. Foreign export-import companies have expressed frustration with Islamic banks, citing issues with obtaining Letter of Credit (LC) confirmations from foreign lenders due to payment failures and the banks’ poor reputation.

The decline in deposits at Islamic banks also reflects a lack of depositor confidence. The substantial growth in loan disbursements compared to deposits indicates a mismatch that jeopardizes the financial stability of these banks. The situation has led to increased scrutiny from both domestic and international stakeholders, raising concerns about the long-term sustainability of the Islamic banking sector in Bangladesh.

The ongoing saga of liquidity support and bank dividends in Bangladesh underscores the delicate balance central banks must maintain between stabilizing financial institutions and enforcing regulatory norms. While the lender of last resort facility has provided a necessary lifeline, the broader implications of these measures raise questions about long-term solutions and the health of the banking sector. As the situation evolves, continued scrutiny and reform will be essential to restore confidence and ensure the stability of the financial system.

Addressing the underlying issues, including regulatory failures and governance concerns, will be crucial in preventing future crises. The need for a robust regulatory framework and effective oversight mechanisms is paramount to safeguarding the interests of depositors and maintaining the integrity of the banking sector. As Bangladesh navigates these challenges, the lessons learned from this crisis will be vital in shaping a more resilient and transparent financial system.