Islamic banking: Creating an enabling regulatory environment

Eight full-fledged Islamic banks are currently operating in the country. Moreover, 19 Islamic banking branches of nine commercial banks and 25 Islamic banking windows of eight commercial banks, are also providing Islamic financial services, according to Bangladesh Bank (BB) report of 2017.
Islamic banking covers 22.72 per cent of the country's banking sector in terms of deposits and investments. As of June 30, 2017 the total number of deposits and investments in Islamic banking was Tk19,94,249.0 million and Tk18,52,449.3 million respectively.
Although, Bangladesh Bank (BB) issued licence to the first Islamic bank way back in 1983, this sector still needs a lot of improvement in terms of regulatory and other supportive issues. Some provisions in regards to Islamic banking have been incorporated in the amended Banking Companies Act, 1991, but till now, no complete Islamic banking act has been enacted to control, guide and supervise the sector.
Apart from this, Bangladesh Bank issued a set of guidelines for conducting Islamic Banking operations in Bangladesh via a circular on November 9, 2009, which now requires to be updated.
According to Bangladesh Bank, "This guideline has been prepared mainly on the basis of Banking Companies Act 1991, Companies Act 1994 and Prudential Regulations of Bangladesh Bank. These guidelines should be treated as supplementary, not a substitute to the existing banking laws, rules and regulations. In case of any point not covered under these guidelines and in case of any contradictions thereof, the instructions issued under the Banking Companies Act and Companies Act will prevail".
Any dispute, if taken to the court, is settled under the existing laws which were enacted much before the introduction of Islamic banking and are largely suitable for conventional banking. The conventional banks can move to the Artha Rin Adalat, a specialised court for legal settlement of financial issues, but there is no separate section in regards to Islamic banking in the law of the land.
Inspection and supervision of the Islamic banks are being done in line with the general guidelines of the BB, which were actually adopted for conventional banks. The central bank does not even have a separate wing to deal with Islamic banking. In addition, the government borrows only from conventional banks through treasury bills and bonds to finance development projects as there is no regulation for Islamic banks to fund such projects. Islamic banks in Bangladesh have been sitting with excess liquidity as they are deprived of the opportunity to finance public projects.
Despite lacking proper regulatory and enabling environment and prudential regulations and guidelines, Islamic banking has become an important part of the country's banking sector. However, further growth of this industry as well as its successful contribution to promote systemic stability and economic development will depend on the adoption of international standards of best practices, and the creation of a proper enabling regulatory environment.
The article addresses some of the crucial issues and areas that are yet to be addressed to create the best industry practice of international standard and to meet the regulatory and supervisory challenges posed by the growth of this industry.
LEGAL FRAMEWORK FOR ISLAMIC BANKS: In view of the rapid expansion of Islamic banks in Bangladesh, it is high time for government to act on and promote a legal regulatory framework for Islamic banks in Bangladesh. Islamic Banking and Finance is an ideological discipline based on Shariah principles and Islamic banks were floated with the intention of eliminating the roles of interest, generating permissible (halal) activities, promoting profit loss sharing, establishing social equity and justice, upholding ethical values and maintaining sanctity of contract. While conventional banking and finance is governed by the laws of the land, Islamic banking and finance is governed by two sets of law, one divine Islamic law (Shariah) and man-made (conventional) laws.
It is obvious from the current practices that there are two different approaches followed by courtiers where Islamic banking operates parallel to conventional banking. First, it aims to replace the existing banking system with Islamic banking and the second approach is to set up individual Islamic banks parallel to conventional interest based banks. Pakistan, Iran and Sudan have taken the former while rest of the courtiers opted for the latter. Therefore, the legal frameworks of Islamic banks vary from country to country. For example, Malaysia, Turkey, Sudan, Yemen and United Arab Emirates have enacted Islamic banking laws parallel to those of conventional banking system.
On the other hand, countries like Saudi Arabia, Egypt, Qatar, Pakistan, Iran, Jordon and Bahrain have not enacted any new laws to accommodate Islamic banks, but instead Islamic banks are operated under the existing legislations that control conventional banks.
It is often assumed that two different systems within the same economy would create problems which should be addressed if the gap is to be bridged effectively. These problems include those based on legislative grounds and those faced in the process of judicial adjudication of disputes. It even includes those which can be resolved through alternative means of dispute resolution. Therefore, it is not an easy task for any government or regulatory body to create a legal framework overnight. Rather it is a complex issue and needs to be implemented gradually in phases.
Malaysia is a country where this effort has been successful due to gradual implementation of Islamic banking regulations which Bangladesh may consider. Malaysia started developing its Islamic banking and financial infrastructure in 1983 by introducing the Islamic Banking Act 1983. The main purpose of the law was to govern the operations of Islamic banks. In Islamic banking the depositor is a partner of the bank and shares profits or loss with the bank which contradicts the traditional banking principles Malaysia amended the Partnership Act 1932 on December 31, 1984.
Existence of an appropriate legal framework is a basic requirement for establishing sound financial institutions and markets. To ensure soundness in the Islamic banking industry, the government should develop a legal framework for Islamic banks and financial institutions in the country.
DEVELOPING EFFECTIVE SHARIAH GOVERNANCE FRAMEWORK FOR ISLAMIC BANKS: There is no independent Sharia supervisory council in Bangladesh Bank and it is the responsibility of the board of directors of respective banks to ensure that the activities of the banks and their products are Sharia compliant. The Board of the Islamic banks and conventional commercial banks having Islamic branches may form an independent Sharia Supervisory Committee with experienced and knowledgeable persons in Islamic Jurisprudence.
However, the Board shall be responsible for any lapses/irregularities on the part of the Sharia Supervisory Committee. Proper criteria for selection of members of the Sharia Supervisory Committee have also been included in the guideline. In compliance with the guideline, each bank has formed its own Sharia Supervisory Committee.
As per the guideline, the accounting standards for Islamic banks have been developed to comply with provisions of the Banking Companies Act 1991, International Financial Reporting Standard (IFRS), the Companies Act 1994, the Securities and Exchange Rules 1987, Dhaka and Chittagong Stock Exchanges? Listing Regulations, Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Islamic Sharia and other laws and rules applicable in Bangladesh.
While the above has been the existing framework for Sharia governance system for Islamic banks in the country, let us look at what other countries are doing in this regard. In Malaysia, the development of legal and regulatory framework for Islamic banks was supported by gradual introduction of various legislations. Malaysia first introduced its Islamic Banking Act (IBA) in 1983 and since then it has been supported by several other laws.
In order to harmonise the Sharia interpretations among various Islamic banks and financial institutions, Malaysia established Sharia Advisory Committee (SAC) at the Bank Negara Malaysia (BNM) which is the central bank and main regulatory authority for banks and financial institutions of Malaysia in 1997.
In Malaysia, it is a statutory requirement for all banks that offer Islamic banking to form Sharia Committee. In addition, an Islamic financial institution is required to have at least one officer, preferably a person with knowledge in Sharia, to serve as the secretariat to the Sharia Committee (SC).
The Sharia Committee as an independent body of the Islamic financial institution (IFI) reports to the Board of Directors of respective institutions. In Malaysia, all products of Islamic financial institutions are subject to approval from SAC. In case of any unresolved issues at the SC level of each institution, a licensed institution carrying on Islamic banking or Islamic financial business should refer it to the National Sharia Advisory Council and shall comply with directions on Islamic banking business and Islamic financial business issued by Bank Negara in consultation with the National Sharia Advisory Council.
In the light of international best practices and existing legal and regulatory framework in the country, Bangladesh Bank can initiate the process in the following manner:
n Bangladesh can form a Central Sharia Supervisory Board (CSSB) at Bangladesh Bank. The board should include at least three Sharia Scholars, one accountant, one lawyer and one experienced banker. This Board can be an Independent body and its role can be only advisory and not supervisory at any stage. A member who is sitting at the Sharia Supervisory Board (SSB) of an IFI cannot be a member of the CSSB.
n This board can advise and assist Bangladesh Bank in formulating Sharia- related policies for Islamic Banks in Bangladesh. All Islamic banking products should be approved CSSB. In this regard, Bangladesh Bank can take consent from the board and make it clear before approving any Islamic banking product. Like Malaysia, in case of any disputes among Sharia Scholars at the Sharia Supervisory Board (SSB) of any IFI or any deviation in practices among various SSB's, Bangladesh Bank can solve the matter by issuing rule in consultation with this Board. Bangladesh Bank can establish a separate Division for Islamic banks and issue all guidelines and supervise and monitor their operations through this division.
n The current practice of having a Sharia Supervisory Board (SSB) at each IFI can continue. However, the role and responsibilities of SSB can be specified and widened. Sharia Supervisory Board (SSB) can consist of prominent scholars who are highly qualified to issue Sharia interpretation on financial transactions and have considerable experience and knowledge of modern financial dealings and transactions.
n In order to promote harmonisation and adopt international best practices, Bangladesh can follow the standards set out by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and Islamic Financial Services Board (IFSB). The AAOIFI and IFSB are internationally recognised body for Islamic banking practitioners and the collective personal reasoning (Ijtihad) of the AAOIFI and IFSB are highly important for uniformed practices of Islamic banking globally. Many countries in the world have followed these standards and obliged their financial institutions to comply with these standards.
n Bangladesh bank can establish a separate department for Inspecting Islamic banks and their operations. However, instead of carrying out spot inspection like Pakistan, it can be made mandatory for all banks to submit internal Sharia Review Report periodically.

The author is working in a private bank in Bangladesh and has a post-graduate degree in Islamic Banking, Finance and Management from United Kingdom.
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