Challenges to Islamic Banking Business
Challenges to Islamic Banking Business

Comprehensive Picture of Islamic Banking in Bangladesh that is

Quite Ahead of Pakistan in its social responsibility role

Muhammad Arif

Muhammad Arif
Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), Former Head of FSCD SBP, Former Head of Research ArifHabib Investments and Member IFSB Task Force for development of Islamic Money Market, Former Member of Access to Justice Fund Supreme Court of Pakistan.

 Bangladesh is a Muslim country while remaining part of Pakistan till 1971. However being a Muslim country they still stand with Pakistan as a brotherly country.

It is interesting to say that like Pakistan Islamic banks in Bangladesh are homogenous; however, they are not financially healthy when liquidity measurements are concerned. This indicates that working capital management of Islamic banks in Bangladesh is not at the optimum level if conventional parameters are considered. Therefore, it is critical for the Islamic banks to manage their working capital efficiently and they should increase the amount of working capital as much as possible.

On the basis of working capital management, no significant difference has been found among the Islamic banks. From the evaluation of capital structure efficiency, the results revealed that most of the Islamic Banks in Bangladesh are practicing debt-based financing rather than equity-based financing. Thus, the leverage attributes for an Islamic bank are the same as those for a conventional bank. In addition to capital structure, there is no significant difference among the Islamic banks in Bangladesh. In case of capital budgeting efficiency, most of the Islamic banks somehow utilize their fixed assets to generate income, but inefficiently as the fixed asset turn over ratios are not up to the mark while considering conventional benchmark. It indicates that Islamic banks in Bangladesh are facing capital budgeting problem.

Additionally, since the Islamic banks are homogenous in Bangladesh, there is not any significant difference among the Islamic banks. The findings of overall Islamic bank financial management’s operating efficiency suggest that most of the Islamic banks in Bangladesh are facing high-operating cost due to the inefficiency of managerial skills and inefficient utilization of resources. However, based on the return on equity, it is suggested the resource management of the banks are both efficient and effective and the earnings of Islamic banks are higher as compared to their equity position. Similarly, no significance difference has been found among the Islamic banks.

However immediate attention from the respective authorities, including practitioners and policy makers are indeed vital. In that aspect, establishing an independent regulatory authority to supervise and monitor the activities of Islamic should be prioritized in the government agenda. This would ensure and create more congenial infrastructure for the smooth functioning of IFM practices of Islamic banks in Bangladesh. For Islamic banking – it may be reasonably good to argue that the Islamic banks in Bangladesh are homogenous; however, they are not financially healthy when liquidity measurements are

First of all, the financial sector in Bangladesh is classified into three broad categories based on regulation:

  1. Formal sector
  2. Semi-formal sector and
  3. Informal sector.

Among this financial sector, banking sector, which is the major part of formal financial sector dominants other types of financial institutions in the industry. Due to its significant effect in the economy of Bangladesh, banking industry is highly regulated and monitored by the Bangladesh Bank (BB), the central bank of Bangladesh. Though Bangladesh inherited an interest-based banking system since its independence, the first Islamic bank, Islami Bank Bangladesh Limited (IBBL), was established in 1983. In 2017, out of 57 banks in Bangladesh, eight private commercial banks (PCBs) operated as full-fledged Islamic banks and 16 conventional banks (including three foreign commercial banks-FCBs) were involved in Islamic banking activities through window Islamic banking. The Islamic banks have continued to show strong growth since its inception, as reflected by the increasing market share of the Islamic banking sector in terms of assets, financing and deposits compared to the total banking system. A brief analysis on the performance of Islamic banks is given in Table 2. It is evident from the Table 2 that, total deposits of the Islamic banks and Islamic banking branches and windows of the conventional banks stood at BDT 1857.3 billion at the end of December 2016 which accounted for 20.79 percent of total deposits (BDT 8933.92 billion). Total credit of the Islamic banks and the Islamic banking branches and windows of the conventional banks stood at BDT 1647.0 billion at the end of December 2016 which accounted for 24.44 percent of total credit (BDT 6739.3 billion) of the banking system in Bangladesh. Islamic banks in Bangladesh receive deposit under two principals: a) Al-Wadeeah or current account and b) Mudaraba or savings account. Under Mudaraba, most Islamic banks have the following deposit scheme:

  1. Mudaraba Savings Deposits (MSD)
  2. Mudaraba Short Notice Deposits (MSND) and
  3. Mudaraba Term Deposits (MTD)

One of the uniqness of Islamic banking system is that Islamic banks do not directly deal with money rather they run business with money. The funds of Islamic banks in Bangladesh are mainly invested in the following modes:

  1. Mudaraba;
  2. Musharaka;
  3. Bai-Murabaha (Murabaha to the purchase orders);
  4. Bai-Muajjal;
  5. Salam and parallel Salam;
  6. Istisna and parallel Istisna;
  7. Ijara;
  8. IjarahMuntahiaBittamleek (Hire Purchase);
  9. Hire Purchase MusharakaMutanaqisa (HPMM);
  10. Direct Investment;
  11. Investment Auctioning;
  12. Quard and
  13. Quard Hassan.

Challenges of institutional aspects are as follows:

  1. Islamic banks suffer from the lack of institutional support. Building a proper institutional set up is most serious challenge for the Islamic finance.
  2. Lack of appropriate legal framework and supportive policies
  3. Lack of effective supervisory framework
  4. Lack of Accounting Standards Boards for Islamic finance practicing companies
  5. Lack of equity institutions
  6. Establishment of organized secondary financial markets
  7. Necessity to have a market for short term placements of funds

Moulana Taqi Usmani (1998) has highlighted the problems of Islamic banking and identified three types of important challenges; i) capital budgeting, ii) financing and iii) working capital management. On the other hand, Akkas (2008) categorized challenges into two ways; i) macro operational challenges and ii) micro operational challenges.

Problems related with macro operation are: liquidity and capital, valuation of banks assets, credit creation and monetary policy, financial stability, the ownership of banks, lack of capital market and financial instruments, insufficient legal protection. In contrast, problems related to micro operation of Islamic banks are increased cost of information, control over cost of funds, mark-up financing, excessive resort to the murabaha mode, utilization of interest rate for fixing the profit margin in murabaha sales, financing social concern, lack of positive response to the requirement of government financing. On top of that, there are few other issues that have hindered the growth of the IFM practices in most of the countries including Bangladesh. Firstly, in the era of globalization and rapid development, there is still a lack of sufficient infrastructures for Islamic trade financing on an international basis. This is significantly important as the international trade has gained momentum in most of the developing countries both in terms of import and export.

As a result of this, the Islamic banking requires competitive financial products and services to cater the growing demand of exporters/importers in a majority of the Muslim countries and, Bangladesh in particular. Secondly, the practices of Islamic banking and finance, and IFM in particular require conformity of both the national conventional laws and Shariah rules. Without the cooperation of these both institutions that implement these two types of laws in a country, achieving the expected growth in the esteemed sector would not be possible. However, it is observed that these two segments of the government in majority of the cases are in non-conformity, hence raising several issues and challenges to practically implement in the country.

Third, Islamic banking and finance is part of the financial sector of a country, hence, corporate sector plays an important role in this context. Similarly, there should be coexistence of both the Islamic banking and finance along with the corporate sector for sustainable development of an economy. However, it is understood that the corporate sector in Bangladesh is still rather poor, and no adequate supports are given to this industry in an aim to promote IFM in the country. Fourth, surprising enough, although the majority of the people in Bangladesh are Muslim and the country’s economy is booming in the recent decade as well as considerable size of the Islamic banking and finance industry, unfortunately, there is no Islamic capital market exist as of yet. However, countries like Malaysia have its own Islamic capital market (Oseni& Hassan, 2012). Fifth, since the history of Islamic banking and finance is not old and still in its beginning/growth stage in most of the Muslim countries including Bangladesh, there is a lack of professionals that are conversant with IFM. Due to the shortage of the professionals, the sector experienced significant turbulence in its growth path.

In a seminal work recently in Dhaka, one of the authority in a think tank reported that “To ensure true benefit from Islamic banking practices, we need to concentrate more on the concept and need to develop human resources with adequate knowledge of Islamic banking” (The Financial Express, 2018). Sixth, the successful and effective Islamic banking and finance practices requires that both the supplier and creditor of a loan contract uphold the rules and regulations prescribed for the financial transaction. However, a bitter truth is that, there are a mounting of loan defaulters, at least, 230,000 in Bangladesh as of 2018, reported by the country’s finance minister that dry out funds from the financial industry (Dhaka Tribune, 2018). This is also a great obstacle for the industry to perform efficiently and progress well in their operation. Lastly, as described initially, the Islamic banking and finance sector has a lack of supportive institutions and instruments, which is considered as an important determinant to promote IFM practices in the country.

Comparing it with Pakistan, Islamic Banking Industry in Bangladesh has made significant contributions in different sub-sectors of agricultural and rural investment programs. During October-December 2018 quarter, investments in agricultural sector made by Islamic banking industry reached at Tk. 2811.72 crores which was higher by Tk. 1982.36 crores than the previous quarter and Tk. 2048.33 crores compared to the same quarter of the preceding year. The share of total agricultural investment of Islamic banks accounted for 7% among all banks during the quarter under review whereas financing of Pakistan Islamic banking sector remained Rs 1511 billion with 0.3% in agriculture as of Dec 2018.

Further Islamic banks in Bangladesh undertake and implement various types of social programs under Corporate Social Responsibility (CSR) activities. Sources of funds of Islamic banks available for CSR activities include Zakat, compensation charges (penal charges from defaulting investment clients), and Sharia’h-permitted other sources of earnings. These funds are spent among different types of education, training, health, and charity-based organizations in Bangladesh. Islamic banks serve the deprived and disadvantaged segments of people, who, because of extreme poverty, remain outside the purview of the conventional banking system; the banks make financial transactions based on human necessities and embark upon productivity-oriented projects or activities to reduce the incidence of poverty. Expenditure on CSR activities during October-December quarter had been recorded Tk. 62.68 crores which was 85.30% higher than the Tk. 33.82 crores of July-September quarter of 2018. In Pakistan this segment is missing.

However, in the last couple of years a forum was created by the SBP in which all 22 banks pooled and collected funds to raise awareness about Islamic banking. The SBP also initiated a mass media campaign last year to raise awareness about the value proposition of Islamic finance. This move is highly controversial as SBP being custodian cannot deal with Islamic banks differently from conventional side. Advertisement remains the exclusive domain of Islamic Banks themselves. Thus in this respect SBP has indulged itself in unethical form of action.

Comparison of Islamic banking in Bangladesh with Pakistan as of Dec 2018.
  Bangladesh Pakistan
Deposits 237366 crore (US$ 28,098 billion) 2203 billion (US$ 15,563 billion)
Investments 230907 crore (US$ 27,333) 515 billion (US$ 3,638 billion)
No of Full Fledged Islamic Banks 8 5
Total No Of Islamic Bank branches 1241 2851
% of Islamic Banking sector among total banking sector  in deposits 23.50 15.5
% of Islamic Banking sector among total banking sector  in investments 24.04 19.4


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