Converting into Islamic bank: Issues and challenges

Many conventional banks in the country have shown interest to introduce Islamic banking. Some of them have already applied to the central bank for their conversion into Islamic banks. The Bangladesh Bank (BB), which is the main regulatory authority in the country, has not yet given any permission to any of these banks. Newspaper sources confirm that the BB has decided not to allow any new Islamic bank or Islamic windows of conventional banks or such conversion permission until formation of a central Sharia Supervisory Council (SSC). Currently, there is no central SSC to regulate or monitor Islamic banks in the country.
Islamic banking is becoming more popular day by day in the country. According to the BB, growth of deposits is more in Islamic banks than in conventional ones. In 2013, deposit growth of Islamic banks was 25.83 per cent compared to 20.58 per cent in conventional banks.  
The reason for increasing trend of Islamic banking in Bangladesh or anywhere else in the world may well be attributed to its intrinsic value, uniqueness of distinctive banking, ethical and sustainability aspects. There is still a scope for further growth of Islamic banking in Bangladesh because the Muslims of this country are predominantly pious and prefer to satisfy their banking needs in a Shariah-complaint way. Therefore, such conversion permission should be considered positively and the government should create supervisory and regulatory framework for facilitating such conversion.
Although we have not seen any conversion in the country yet, there are such examples existing in other countries in the world.  The first conversion case took place when the National Bank of Sharjah became the Sharjah Islami Bank in 2002. So far, the world has witnessed eight significant conversion cases: the Middle East Bank into the Emirates Islamic Bank (UAE), the Dubai Bank into the Dubai Islamic Bank (UAE), the NCB (Saudi Arabia), only retail banking, the Khyber Bank (Pakistan), the Industrial Development Bank into the Jordan Dubai Islamic Bank (Jordan), the National Bank of Development into an Islamic bank by the ADIB (Egypt) and the Kuwait International Bank. Many banks are also in the process of being converted into Islamic.  
At present, the BB controls, guides and supervises this sector by incorporating some Islamic banking provisions in the amended Banking Companies Act, 1991. Apart from this, the BB issued guidelines for conducting Islamic banking in Bangladesh through a circular on November 09, 2009. But the guidelines lack any guidance with regard to conversion to Islamic banking.  The issue of developing a supervisory and regulatory framework for Islamic banks in the country is the pressing need now. The government should act on this issue while taking into consideration emerging issues like conversion from conventional banking to Islamic banks.  A proper conversion guideline should be in place for facilitating such a transformation and of course in line with the practice of international standards.
During their conversion into Islamic, the banks face some challenges. These originate from the basic principles on which the Islamic banks run its operation, that is, providing banking services without taking resort to interest as it is prohibited in Islam. It may be felt from a layman's perspective that the services we get from Islamic banks are of those we also get from the conventional banks and the differences between the both are not distinguishable from each other. But a closer look at various issues will help clear the confusion.  A look at the balance-sheet of both Islamic banks and conventional banks can clarify the matter.
It is clearly evident from the tables that there is a difference between Islamic banks and conventional banks in terms of operational aspects. On the liability side of conventional banks, it accepts demand and savings deposits, issues term certificates such as certificate of deposits (CD), and has capital. On the asset side, there is much more diversity and options in the form of marketable securities, trading accounts, lending to corporations and to consumers. On the liability of the Islamic banks, it accepts demand deposits and various investment accounts while the asset side comprises financing assets where tangible goods and commodities are purchased and sold to customers, investment assets, fee-based services and non-banking assets.
The differences outlined above occur due to the fact that Islamic banks act as sorts of investment banks which collect deposits from depositors  on Profit and Loss (PLS) basis and invest these deposits along with its own funds through various Shariah-complaint  instruments.

If put simply, depositors will deposit money in the banks for investment.  Banks will invest this money and share the profit or loss within the guidelines of Shariah.  Therefore, the bank as a financial intermediary, in modern setting, will have PLS arrangements with both the depositors and with the users of the bank funds. This uniqueness of Islamic banking causes many challenges for any bank converting into an Islamic one among which the main three challenges are:
Firstly, dealing with interest income the banks have earned so far. Conventional banks normally receive interest from borrowers and pay interest to the depositors. The difference between these two is normally the main source of bank income. As Islamic banks do not accept interest, the dealing with this income and the interest they have received and paid before the transformation is one of the challenges.  
The second challenge involves dealing with deposits received by the banks before transformation. Islamic banks receive deposits mainly on the basis of mudarabah and therefore, banks will have to transform its deposits into mudarabah basis. It is to be mentioned here that all customers may not like the idea of mudarabah or Profit-or-Loss. Therefore, banks will have to give depositors a choice for withdrawal. However, giving choice for withdrawal is not easy as different deposits have different tenures before which withdrawal of such kind may incur loss to the depositors and banks also cannot force customers to withdraw deposits due to contractual obligation it made.   
The third challenge involves dealing with the loans given to customers on interest basis and arranging their transformation into equity-based investment. Like deposits, banks will face the same problem as different loan contracts may have different terms and banks cannot unilaterally force the customers to pay the debt before the due dates.
While dealing with these problems, banks may face legal and other challenges in terms of religious rulings.  Therefore, for dealing with these issues bank will have to form a Shariah Supervisory Committee and a Legal Advisory Committee which will guide banks throughout the transformation process and later period. Apart from facing these challenges, banks will have to take several other initiatives required for such conversion some of which are as follows:
n Restructuring the management in a manner suitable for its new activities. This will include establishment of new division, sections required for Islamic banking operations.
n Organising special training programme for senior management which will lead the whole transformation process. It is very vital because at the end of the day the senior management will provide leadership and supervision for the transformation process and later when a bank will operate as full-fledged Islamic bank. A general training for all level of staffs should be organised to familiarise them with the basic principles of Islamic transactions, investment structures and financing contracts. Specialised training should be organised at departmental level for smooth running of operational tasks.
n Preparing accounting standards conforming to guidelines of the regulatory authority and introducing necessary IT systems appropriate to the new banking syste  ms,
n Structuring various investment instruments, financing contracts and other documents under the supervision of the Shariah Supervisory Board, and   
n Formulating a post-transformation strategy that will include marketing strategy, resource planning, liquidity management, investment management  giving due consideration to the nature of the resources and investments of an Islamic bank.  
While banks face all these challenges, the regulatory authority also has some roles to play. Many countries in the world have already witnessed such conversion and put proper guidelines in place for streamlining the process of conversion and Bangladesh can learn from them. For example,   Pakistan, where a successful conversion took place and some more are taking place, formulated conversion criteria which Bangladesh can follow. Some of its criteria include the following:
n Submitting detailed conversion plan by the banks to the central bank which will include the timeframe for initiating and completing the conversion duly approved by the bank's Board of Directors and Shariah Supervisory Board. These will include:
a) Three years' business plan, which will cover expansion plan and profit projection,
b) Process for obtaining written consent from existing customers for conversion to Islamic banking products and services,
c) Methodology for conversion of existing assets and liabilities into Islamic modes in Shariah complaint manner,
d) Strategy for resolution of adverse findings of internal, external and statutory auditors specially regarding fraud, forgery, money laundering and terrorist financing (if any) before   conversion,
e) Plan for proper orientation and training of staffs and human resource planning, and
f) Any other requirements specified by the respective bank's Shariah Advisor for Shariah compliance of the whole conversion process.
From a humble beginning in the 1970s in Egypt, the Islamic banking industry has witnessed a significant development in terms of growth and size.  Currently, the global Islamic banking assets constitute 75 per cent of more than $1 trillion Islamic finance market. With 15 per cent -20 per cent growth annually, the Islamic banking has widened its horizons to all major parts of the world.  The Islamic banking is now operating in more than 75 countries of the world.  Standard & Poor estimates (2012) that over 2011-2015, the growth rate for Islamic banking will be about 20 per cent annually. Bangladesh, as a Muslim country, has a strong potential to be a part of this growth and granting permission for conversion into Islamic bank can accelerate this growth.   
The writer is working at a private bank in Bangladesh and has a post-graduate degree in Islamic banking, finance and management                      from the United Kingdom. akbar.chowdhury@yahoo.com