Islamic banking market in BD stagnant: Fitch

Liquidity challenges are still affecting Islamic banks in Bangladesh, which are more vulnerable than conventional ones, according to the latest report of an American credit-rating agency.
Fitch Ratings on Monday said the Islamic banking market share was sizeable but had been stagnant over the past two years, accounting for just over a quarter of the sector by industry deposits (end-2023: 25.3 per cent; end-2022: 25.8 per cent) and financing (end-2023: 28.9 per cent; end-2022: 29.2 per cent).
Islamic banks' liquidity-coverage ratio (LCR) tumbled to 58.7 per cent at end-Q323 (end-2022: 87.7 per cent; end-2021: 188.5 per cent), below the 100 per cent regulatory requirement and the 154.6 per cent industry average LCR.
"This is partly due to the flight of deposits, governance issues and more lax prudential requirements for Islamic banks. However, liquidity profiles are showing signs of improvement, with some stabilisation possible in 2024 and 2025," reads the report.
Fitch is monitoring several Islamic banks for their liquidity position, including ICB Islamic Bank Ltd (not rated).
The bank's cash balance fell by over 90 per cent (year on year), or YoY as of end-1Q24, based on its unaudited financial statements.
Local newspapers have reported that the ICB Bank has failed to pay depositors.
The bank reported in a media statement that it would honour its depositors in June.
Local dailies have also reported that the bank sought collateral-free liquidity support from the Bangladesh Bank (BB) in 1Q24, but this was not provided.
The ICB is the smallest Islamic bank in the country, with a 0.3-per cent sector share and, therefore, its negative performance is unlikely to materially affect the market share of the total Islamic banking sector.
As part of a financial sector safety net, customer deposits in Islamic banks are covered by a deposit insurance scheme that protects deposits up to Tk 100,000 ($852).
However, the scheme's efficacy is yet to be proven.
In general, Fitch regards Bangladesh's banking sector and its governance standards as "weak".
"The sector could be a source of contingent liability for the sovereign if credit stress intensifies."
Fitch downgraded Bangladesh to 'B+'/Stable on 27 May 2024, reflecting weaker external buffers.
There is a lack of precedents for default resolution for Islamic banks in Bangladesh and most key Islamic finance markets.
"It's yet to be seen how bankruptcy courts treat Islamic bank defaults compared to conventional bank defaults, whether mudaraba-based depositors - which are based on profit-and-loss sharing contracts - will have full recourse to banks, and if all depositors will be able to enforce their contractual rights in local courts."
Mudaraba-based deposits made up about 80 per cent of all Islamic banks' deposits at the end of 2023.
Bankruptcy regimes in Bangladesh and most countries with prevalent Islamic banking sectors are still in their early stages, also remaining largely untested and underdeveloped.
Islamic banks' excess liquidity - defined as total cash reserves minus required reserves with the central bank - rose by 43 per cent over 4Q23 (to Tk 111 billion).
However, excess liquidity fell by 13.7 per cent over the year 2023.
The deposit profile of the Islamic banking sector improved slightly from 2022-1H23, when it faced sizeable customer deposit outflows following loan irregularity reports.
In 2H22-1H23, Islamic banks received Tk 960 billion through the Islamic Bank Liquidity Facility (IBLF) and Tk 1.9 billion through the Mudaraba Liquidity Support from the BB.
In March 2024, the BB announced that conventional banks' Islamic banking branches and windows will be able to access short-term loans via BB's IBLF, which was previously only offered to Islamic banks.
However, the shortage of Islamic liquidity management instruments continues.
Government's sukuk bond could serve as collateral for Islamic repo and enable Islamic banks to seek central bank funding, but are in low supply.
The government started issuing sukuk in 2020, with the last issuance in 2022. No sukuk were issued in 2023.
The debt capital market in Bangladesh is underdeveloped, with sukuk even more nascent (end-1Q24: $1.5 billion outstanding).

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