Performance and prospects of Islamic banking in BD

Globally, Islamic finance has experienced rapid expansion over the past decade, growing at more than 10% annually. Today, Shari'ah-compliant financial assets are estimated at approximately US$2.0 trillion, covering bank and non-bank financial institutions, capital markets, money markets and insurance. A report by the International Monetary Fund (IMF) (2015) observes that out of all the sectors, the banking sector dominates Islamic finance sector making up about 80% of Islamic finance in 2013 followed by the Sukuk (Shari'ah-compliant bonds) market which accounts for 15% of the Islamic finance industry assets. Islamic banking assets have grown at a compound annual growth rate of 20.4% between 2007 and 2013. Islamic capital markets have also developed significantly over the past decade in terms of sophistication and size. Figure.1 shows the top 11 countries in terms of Islamic banking holding 54.8% of the global total Islamic banking assets (excluding Iran) in the first half of year 2014. Based on Islamic Financial Services Board (IFSB)'s report, Islamic banking assets in the Middle East and North Africa (MENA) countries (excluding the Gulf Cooperation council or GCC) make up 40% of total global Islamic banking assets, followed by the GCC (38%) and Asia (15%). Many European countries like the United Kingdom, Denmark, France, Switzerland and Luxembourg have also adopted Islamic finance.THE PRINCIPLES OF ISLAMIC BANKING: Broadly speaking, Islamic banking is a banking system where financial resources are mobilised and invested in accordance with principles of Islamic Shari'ah. Islamic finance is strictly equity-based and asset-backed. There are various concepts which underlie the functions of Islamic banking and sets it apart from conventional banking. The first and most important principle is that the charging and the receiving of interest (Riba) is strictly prohibited. However, there have been some doubts expressed by Islamic economic scholars as to whether the interest rates charged by modern financial institutions are equivalent to the Shari'ah concept of Riba. Another principle includes the sharing of profits and losses of an investment by both fund-providers and investors based on their capital share and effort. In contrast to conventional finance, there is no guaranteed rate of return. Finally, investors should be fully aware and conscious of the business to be invested in, its policies, the products it produces, the services it provides, and the impact that these have on society and the environment. One must work for profits, and simply lending money to someone who needs it does not count as work.


Under Islamic law, money must not be allowed to create more money. Any contract undertaken where 'Gharar' exists is null and void. Gharar is the ambiguity and uncertainty surrounding a contractual relationship, to the extent that it might provide an unfair advantage to one of the parties of a contract over the other. This ethical approach to banking avoids transactions involving usury, speculation, gambling, or industries contrary to Islamic values. Gharar also promotes risk sharing, connects the financial sector with the real economy, and emphasizes financial inclusion and social welfare.
DEVELOPMENTS AND PERFORMANCE OF ISLAMIC BANKING IN BANGLADESH: The Islamic banking industry has been playing a crucial role since its establishment in 1983, in mobilising deposits and financing key sectors of the economy in Bangladesh. The current status of the Islamic banking industry in Bangladesh is shown in Table 1.

Bangladesh Bank (BB), along with the Central Shari'ah Board and various Islamic banks, has prepared an integrated guideline for conducting Islamic banking business in November 2009 mostly on the basis of Banking Companies Act 1991, Companies Act 1994 and Prudential Regulations of Bangladesh Bank. BB has recently revised its policy and barred conventional banks from opening Islamic banking branches. The Islamic banking industry has continued to grow since 1983 at a steady pace as indicated by is increased market share, in terms of assets, financing and deposits of the total banking system (Figure2).


Although the Islamic banking industry has been growing at a faster rate than the conventional banks, Shari'ah-compliant banks still make up a smaller share (approximately one-fifth) of the total banking sector. During the third quarter of 2015, the share of total deposits and total investments of Islamic banks accounted for 21.9% and 17.5% respectively among overall banking sector. Out of all the Islamic banks, Islami Bank Bangladesh Limited (IBBL) accounted for the biggest share of deposits (38.7%) followed by First Security Islami Bank Ltd. (13.6%) and Exim Bank Ltd. (13.4%). The key profitability indicators -- Return on Assets (ROA) and Return on Equity (ROE) -- reveal that Islamic banks' profitability was higher.
The ROA of 0.8%indicates an efficient use of assets whereas ROE of 11.50% indicated higher earnings in comparison to their equity position by the Shari'ah-compliant banks compared to profitability ratios of conventional banks in 2014. Islamic banks have enjoyed a lower non-performing loan (NPL) ratio -- a measure of asset quality in the loan portfolio-of 4.90% compared to 9.70% NPL ratio over other banks in 2014. Since Islamic banks historically contain fewer problem loans (except for one bank), they could gain more robust net profit, despite their relatively higher provisioning in 2014 than in 2013. A total of seven out of eight Islamic banks have been able to achieve the requirement of a minimum Capital Adequacy Ratio (CAR) of 10 per cent in 2014.
Islamic banks maintain liquidity levels much above their Cash Reserve Ratio (CRR) and Statutory Liquidity Requirement (SLR) requirements of 6.5% and 5.5% respectively. Limited sources of Shari'ah-compliant funds allow Islamic banks to borrow funds either from the Islamic inter-bank money market, which came into existence in 2012, or from the Islamic Investment Bonds Fund issued by the government.
BB amended Bangladesh Government Islamic Investment Bond (Islamic Bond) Policy, 2004 and this was a noble development. This was carried out primarily to form a base for the Islamic bond market and also to convert excess liquid assets into investment through Islamic bonds. The maturity period of Islamic bonds was readjusted to three months and six months to assist the Islamic banks/financial institutions (FIs) in managing their funds smoothly. The profit of Islamic bonds will be equal to that of a three-month fixed deposit scheme of the issuing Islamic banks that will be inter-changeable among the eligible individuals and institutions, and will be used as an instrument for repo operations.
PRODUCTS OFFERED BY ISLAMIC BANKS: Islamic banks traditionally offer four categories of financial contracts: deposits, lending, treasury and trade finance. Islamic banks receive deposits under two modes: Wadiah and Mudarabah. The funds of Islamic banks are mainly invested in the following modes: Mudaraba, Musharaka, Quard, Bai-Murabaha, Bai-Muajjal, Salam and parallel Salam, Istisna and parallel Istisna, Ijara, Direct Investment, and Investment Auctioning etc.
According to BB, as of September 2015, Mudaraba Term Deposits are the most popular followed by Mudaraba Savings Deposits (MSD) and Special Scheme Deposits among different types of deposits of the Islamic banking industry. In case of investments, the highest investments were made through Bai-Murabaha followed by Bai-Muajjal and Hire Purchase Musharaka Mutanaqisa (HPMM). The majority of the investments made by Islamic banks have been towards MSME (micro, small and medium enterprises), business and trade sector.
The Islamic banking industry also collects and disburses remittances, accounting and accounted for 33.6% share of remittances collected by the entire banking industry at the end of the third quarter of 2015. Among the Islamic banks, Islami Bank Bangladesh Ltd. occupied the top position (80.2%) in respect of remittance collection at the end of September 2015.
Zakat collection and distribution is also carried out by Islamic banks as part of their corporate social responsibility (CSR).
OUTLOOK OF ISLAMIC BANKING IN THE CONTEXT OF BANGLADESH: The establishment of Islamic banks and adoption of Islamic banking windows by several conventional banks over the years can be an indicator of the high acceptability of this sector by the public. The potential of this banking sector to grow is tremendous and the reasons are various. One of the main reasons for the continual rise in demand for Islamic banking can be attributed to the rise in the Muslim population and their desire to engage in financial transactions that are in compliance with the rules of Shari'ah.
The principles of risk-sharing and the strong link of credit to collateral means that Islamic banking is compatible with the financing of cottage industries and start-ups, and can contribute to more inclusive growth. Other reasons include the superior performance of Islamic banks over conventional banks as revealed by profitability, liquidity and capital adequacy indicators.
From the perspective of financial system stability, Islamic banks are less vulnerable to risk than conventional banks. Experts on Islamic banking suggest that the core values of Islamic banking can help introduce greater discipline into the system and, thereby, substantially reduce financial instability. Others note that during the financial crisis of 2008-09, Islamic banks performed better than conventional banks. They are able to pass the negative shocks on the asset side (Musharaka accounts) to the investment depositors (Mudaraba accounts). Others emphasise that Islamic banks are more prudent taking up fewer risks and therefore providing a stable and competitive return to investors, assigning responsibility for negligence or misconduct (operational risk) to shareholders, and making access to liquidity more difficult. It needs to be taken into account that Islamic banks operate very differently from conventional banks making it necessary to adopt an elaborate legal, tax and regulatory system that caters to the needs of Islamic finance. Banks believe that the introduction of an independent banking act would enable this sector to thrive. Two relevant variables, acting as impediments to growth of the Islamic banking sector, are: lack of supportive and link institutions and absence of an inter-bank money market in the country. Anti-money laundering and Financing of Terrorism (AML/CFT) risks that may be associated with Islamic finance, need to be mitigated. The risks associated with Islamic finance are not generally well understood compared to conventional banks. Therefore, national regulators should work together along with task forces to seek a greater understanding of the money laundering (ML)/terrorist-financing (TF) risks that may apply to Islamic finance.
The writer is a Senior Research Associate at Policy Research Institute (PRI) of Bangladesh and can be reached at [email protected]