Islamic Banking Thriving in Bangladesh

Islamic banking has witnessed impressive growth in Bangladesh in recent years amid strong public demand for interest-free financial transactions and a profit-loss sharing mechanism.

Both deposits and investments under Islamic banking have increased massively over time, indicating a phenomenal growth and expansion of the system across the country.

According to Bangladesh Bank data, the total Islamic banking deposits have increased from Tk 1,57,492 crore in 2015 and Tk 1,13,360 crore in 2013 to Tk 4,21,375 crore at the end of September 2022. The share of Islamic banks in the country’s total bank deposits was 26.8 percent in September 2022.

The total investment – loans and advances – under Islamic banking reached Tk 3,86,221 crore at the end of September 2022, up from Tk 1,35,061 crore at the end of September 2015 and Tk 97,530 crore at the end of December 2013.

However, Ahsan H Mansur, executive director of the Policy Research Institute of Bangladesh, told the New Age that the recent loan anomalies in Islamic banks have hurt Shariah banking as well as the entire banking sector.

He said it was unacceptable to hand over control of most Shariah banks to a single business group that was playing with people’s religious sentiments. Despite the exposure of such irregularities, we haven’t seen any effective action against the wrongdoers, he added.

Mansur stressed that the BB must take them to task and ensure effective monitoring of the Shariah banks to save the depositors and the banks.

According to Zahid Hussain, former chief economist at the World Bank’s Dhaka office, Islamic banking has been growing over the years because Bangladesh is a Muslim-majority country and the general population is religious and considers receiving or giving interest a sin. They, therefore, feel comfortable doing business with Islamic banks, which they believe offer interest-free services.

A growing number of depositors and businesses who have no other option are doing business with Sharia-based banks to avoid the sin, Zahid said.

He also noted that the performance of Islamic banks had deteriorated following the takeover of several Sharia banks by a business group. The recent news of the loan irregularities had adversely affected the confidence of depositors, he added. The central bank should strengthen its supervision to curb irregularities in Islamic banks and restore depositors’ confidence, he said.

According to a report by US-based Fitch Ratings, Islamic finance in Bangladesh is likely to continue to grow in the medium term, driven by rising public demand, new branch openings, and supportive government policies.

Many conventional banks are focusing on Islamic financial products, either by opening new Islamic branches or windows or by converting into full-fledged Islamic banks, the report said.

Bangladesh entered the Shariah banking era with the establishment of Islami Bank Bangladesh Limited in 1983. The success of IBBL has influenced the opening of other Shariah-based banks and Islamic financial institutions in the country.

There are currently 10 full-fledged Islamic banks operating in Bangladesh with 1,605 branches – out of a total of 10,974 bank branches – across the country. The banks are Islami Bank Bangladesh, ICB Islamic Bank, Al-Arafah Islami Bank, Social Islami Bank, Shahjalal Islami Bank Limited, Export Import Bank of Bangladesh, First Security Islami Bank, and Union Bank Bangladesh.

In addition, 23 Islamic banking branches of 11 conventional commercial banks and 511 Islamic banking windows of 13 conventional commercial banks also provide Islamic financial services in Bangladesh. The Islamic banking method of providing interest-free loans usually serves the purpose of financial inclusion as it empowers poor people.

According to economists, the main reason for the popularity of Islamic banking is that many people want to avoid receiving or paying interest as it is prohibited in Islam. Islamic banks refrain from accepting or paying interest on any transaction because any kind of predetermined or fixed rate of return on investments or deposits is considered riba or interest.

Although riba or interest is prohibited in Shariah-based banking, it is acceptable to make a profit on investments where the investor takes a well-calculated risk. Islamic banks make loans, which are considered investments.

Islamic banks invest their deposits in Shariah-compliant instruments to generate profits, which can be reinvested on a cyclical basis. The profits or losses are shared between the bank and its depositors. As a result, a large number of people find it safe, convenient, and profitable to keep their money in Sharia-compliant banks, economists say.

The system has also become attractive and profitable for conventional banks because of their lower statutory liquidity ratio – SLR – and higher investment deposit ratio – IDR, BB officials said. Several banks have therefore opened Shariah-compliant branches and/or windows to provide Islamic banking services, they said.

On the other hand, conventional banks charge interest on loans to creditors and pay a certain percentage of interest to depositors.

However, the activities of Islamic banks in Bangladesh are controversial with many people arguing that the banks do not fully comply with Shariah laws. Some of the forms of Islamic banking include mudaraba (profit and loss sharing), musharaka (joint venture), Murabaha (selling loans at a profit), and ijara (leasing).

According to Md Main Uddin, Professor, Department of Banking and Insurance, Dhaka University, the main reason for the growth of Islamic banking in the country is that a large number of people in the country are religious and are afraid of any transactions involving interest or riba.

Without any authentic assessment, people believe that Islamic banks are free from transactions involving interest, he said. Many of them don’t care about good or bad services or returns on their deposits, creating a strong customer base for Islamic banks, Main Uddin added.

As IBBL was the pioneer in the sector and had gained people’s trust, more and more people deposited their money with this bank, which managed to boost its growth over time, he continued. This is the reason why more banks have joined the system, attracted by the success of IBBL, he explained.

Besides, people get high returns on their deposits. At the same time, classified loans are very low in Islamic banks compared to conventional banks and this also motivated many customers to deposit their money in Shariah-based banks, Main Uddin also observed.

At the global level, Islamic banking started with the aim of conducting banking business by Islamic laws and principles all over the world. The world’s first interest-free bank, the Islamic Development Bank, was established in 1975, while the first modern commercial Islamic bank, the Dubai Islamic Bank, was established in 1975.

To provide a regulatory framework, the Accounting and Auditing Organisation for Islamic Financial Institutions – AAOIFI – was established in Bahrain in 1991. Over the next few years, more than 50 other non-interest banks were established, most of them in the Middle East.

The banking system was not confined to Islamic countries. The United Kingdom, China, the United States, and Germany also offer Islamic banking windows, demonstrating the continuing and growing appeal of Islamic finance. Australia’s first full-fledged Islamic bank received its license to operate in July 2022. Islamic banking was operating in 76 countries in 2021.

According to the Islamic Finance Development Indicator, the Islamic finance industry reached nearly $4.0 trillion in total assets in 2021, representing a 17 percent growth from 2020. The total global net profit reported by Islamic financial institutions in 2021 also tripled from 2020, signaling improved results, particularly for Islamic banks.

However, Islamic finance faces longstanding challenges. The regulatory framework for Islamic finance is underdeveloped, with a lack of Sukuk [shariah-compliant bonds] investment options and Islamic derivatives or hedging instruments, low awareness of Islamic products, lack of standardization, inadequate fintech usage, lack of incentives for Sukuk issuers, and under-skilled human capital,’ Fitch Ratings said.

Besides, there is also the lack of full-fledged shariah audits, fraudulent activities in Islamic banks, and a lack of intention of the management to be strict with shariah guidelines.

The Islamic banks should reduce their over-dependence on credit sale instruments, otherwise, they will fall into a risky position if market interest rates increase rapidly, the report suggested. Moreover, Islamic banks must adopt modern business practices in their operational activities to smoothen their services.

The government should amend existing financial laws and regulations to create a favorable environment for the smooth operation of Islamic banks, said the report. The Bangladesh Bank should develop some Islamic monetary and savings instruments and create a separate window for transactions with the Islamic banks, it further said.

In 2014, the number of depositors at Islamic banks in Bangladesh was 1.17 crore and the figure hit 2.85 crores at the end of September 2022. The Islamic banks accounted for a 37.63 percent share in the total remittances handled by the country’s entire banking sector during the July–September period in 2022.

The total number of jobs in the Islamic banks soared to 49,433 at the end of September 2022 from 27,662 in September 2015. The Bangladesh Bank issued the maiden sovereign investment sukuk on December 28, 2020, to raise Tk 8,000 crore for the implementation of a safe water supply project across the country.

The Bangladesh Government Islamic Investment Bond was introduced in 2004. It was the only approved shariah-compliant security other than the newly issued sukuk to maintain the SLR by the Islamic banks. Only Islamic banks can borrow from this fund in case of a liquidity shortage, which is mobilized through the selling of the BGIIB securities based on the mudaraba principle.

Although Islamic banking activities are growing in Bangladesh, the number of rural branches of full-fledged Islamic banks has not kept pace with the demand. They should also focus more on expanding their outreach to rural areas, according to a BB report.

To adequately address the shariah-compliance issues of the Islamic financial industry, the adoption of shariah standards at par with international accounting and auditing organizations will be useful.

In this regard, Islamic banks and conventional banks having Islamic banking branches and windows may take steps to become members of the Accounting and Auditing Organisation for Islamic Financial Institutions — AAOIFI, the BB in its latest report suggested.

The performance of Islamic banks could be further improved by upgrading the quality of their human resources by enhanced spending on research and training and preparing the manpower of this sector as Islamic bank professionals, it said.