Thoughts on Economics 1
Thoughts on Economics
Vol. 25, No. 01 & 02
Islamic Banking in Bangladesh: Current Status, Challenges and Policy Options
Md. Golzare Nabi1
Dr. Md. Aminul Islama
Dr. Rosni Bakarb
Asma Akterc
Abstract
In tandem with the global rapid expansion of Islamic banking, Bangladesh has experienced phenomenal growth in Islamic banking following strong public demand for the system. Since its inception in 1983, Islamic banking industry has recorded robust performance and the industry now accounted for more than twenty percent market share of the entire banking industry in Bangladesh. Though Islamic banking industry in Bangladesh has achieved more than 20 percent annual growth, the industry has immense potentials for further expansion as Bangladesh is a Muslim majority country with a vibrant economy of 6 percent real economic growth over the last decade. To reap the full potentials of Islamic banking, it is imperative to assess the present status of Islamic banking industry in Bangladesh. Given this, the present paper investigated the present status of Islamic banking industry and it also assessed its comparative performance with overall banking industry.To attain the objectives of the paper, required information/data have been collected from the secondary sources and financial ratio analysis approach has been applied. Finally, the paper shed light on challenges faced by the Islamic banking industry and prescribed policy options to meet the challenges.
JEL Classification:G10, G21, G28
Keywords: Islamic banking, challenges, policy options
1. Introduction
With a timid beginning in 1960s, the Islamic financial industry hasnow gained popularity in both Muslim and non-Muslim countries attracting customers of all faith due to its resilience and less risky character.In tandem with the global rapid expansion of Islamic banking, Bangladesh has experienced phenomenal growth inIslamic banking following strong public demand for the system. Since inception in 1983 Islamic banks have recorded robust performance;at presentthey accounted for more than twenty percent market share of the entire banking industry in Bangladesh.Though Islamic banking industry in Bangladesh has achieved more than 20 percent annual growth, the industry has immense potentials for further expansion as Bangladesh is a Muslim majority country with a vibrant economy of 6 percent real economic growth over the last decade.To reap the full potentials of Islamic banking, it is imperative to access the present status of Islamic banking industry in Bangladesh, review further potentials and design proper policy options. Given this, the present paper investigated the present status of Islamic banking industry and it also assessedits comparative performance with overall banking industry.Finally, the paper shed light on challenges faced by the Islamic banking industry and prescribed policy options to meet the challenges.
The objective of the present paper are two-fold: first, to review present status and challenges of Islamic banking in Bangladesh and second, to put forward policy options to build a sound Islamic finance architecture capable for meeting up the growing demand of Islamic financial products. To attain the objectives of the paper, the required information/data have been collected from secondary sources. The secondary sources included different reports of Bangladesh Bank, Islamic Banks and other national and international Research Organizations, and scholarly articles published in domestic and International Journal. Financial ratios have been used to assess the status of Islamic banks and make comparison with the conventional banks.
The remaining part of the paper has been organized into the following chapters. Chapter 2 is devoted to review of literatures and chapter 3 focuses onglobal experiencesin Islamic finance. Chapter 4 analyses current status of Islamic banking in Bangladesh.A comparative analysis of performance between Islamic banking and overall banking industry in Bangladesh has been made in chapter 5. Chapter 6 shed lights on challenges of Islamic banking in Bangladesh while chapter 7 provides policy options and conclusions.
2. Literature Review:
Though Islamic banking has made significant progress in Bangladesh during the last three decade, there is dearth of quality studies/papers addressing key issues of Islamic banking in Bangladesh. Most of the studies done in the context of Islamic banking in Bangladesh have so far focused on performance of banks and legal issues based either on few samples or narrower perspective or short time span.As there is research gap in Bangladesh Islamic banking, an in-depth and comprehensive research is required oncurrent status of Islamic banking in Bangladesh for proper dissemination of information among regulators, managers, investors and general customers.
Hassan, M. Kabir (1999) explained the basic elements of interest- free banking in details and its practical experience in a developing Muslim majority country, Bangladesh. The paper analyzed the performance of ‘Islami Bank Bangladesh Limited (IBBL)’, the first Islami Bank in Bangladesh based on growths in deposits, investment, profit, international trade, remittances and expansion of branch net work during the period of 1983-94. The paper also made comparison of IBBL’s performances with those of other private banks during the same period. The key recommendations made in the paper included diversification of lending portfolios into long term financing under Musharaka and Mudaraba, selection of customers based on quality and genuineness of projects, imparting knowledge of Islamic banking among customers and creation of interest free money market instruments by central bank.
Sarker, Md. A. A. (1999) evaluated performances of Islamic banks in Bangladesh during the period of 1988-97. The paper used five efficiency test criteria (mainly financial ratios) to measure the performance of Islamic banks. The paper reported that only Islamic Bank Bangladesh Limited, the first Islamic Bank in Bangladesh maintained positive growth trend in deposits, advances and profits during the period under report. Investments under Musharaka, ideal partnership mode was below 3% of total investments and no investment was made under Mudaraba, another ideal mode during the period under report.
Alam, M. N. (2000) attempted to analyze growth trends of deposits and investments of the first and large Islami Bank in Bangladesh ‘Islami Bank Bangladesh Limited (IBBL)’ during 1983-94. The paper found that the IBBL mobilized deposits mainly under AL-Wadia and Mudaraba modes. The paper revealed that the bank made investments mainly under Murabaha, Musharaka, Bai-Muajjal, Hire Purchase, and Quard E Hasana mode of investments. Among different mode of operations, the bank concentrates on the Murabaha, Bai-Muajjal and other related mode of investments. Musharaka and Quard E Hasana modes recorded below 3% of the total investment and no investment has been made under Mudaraba.
Ahmad, A. U. F., & Hassan, M. K. (2007) examined current legal and regulatory issues of Islamic banking in Bangladesh. The paper pointed out that there is a lack of a well-defined regulatory and supervisory framework for Islamic banks for their effective functioning in line with the tenets of Shariah. The other major issues included absence of an interbank Islamic money market, presence of a discriminatory legal reserve requirement for Islamic and conventional banking, prevalence of a restrictive environment in the capital market, and the lack of legal support and protection of Bangladesh Bank to avoid the associated risks of Islamic banks. The paper suggested that Islamic banks in Bangladesh should have an independent banking act that controls, guides, and supervises their functions and provide legal support to the parties concerned.
Mamun, Dr. Muhammad Z (2008)shed light on the prospect and growth potentials of Islamic banks in Bangladesh as perceived by Islamic and conventional bankers. The paper investigated the factors that motivate banks to adopt Islamic banking methods, the reasons which attract consumers towards Islamic banks and the factors responsible for hindering growth of Islamic banks. The paper identified adherence to the rules of Shariah as the foremost factor to customers in choosing Islamic banking services. The paper pointed out opinions of conventional bankers that the preferential treatments that Islamic banks receive from central bank contribute to their profitability and this factor plays a crucial role in motivating some conventional banks to offer Islamic banking as a parallel service. The paper found that lack of supportive legal framework works as the primary factor in hindering growth of Islamic banking in Bangladesh.
Mahmud, Abdullah Al & Islam M. Muzahidul (2010) paper focuses on the comprehensive comparison about the performance of conventional and Islamic banking system operation in Bangladesh during 2000-2005. Some commonly used measures such as general business measures, profitability ratios, management soundness and social profitability have been applied to derive the objectives of the paper. The paper found that though both conventional and Islamic banking have contributed a lot to the economy of Bangladesh, there are two major functional differences. Firstly, the conventional banks follow borrowing and lending mechanisms while the Islamic banks abide by trading and investment mechanisms. Secondly, the conventional banks provide and receive interest for deposit and advance but Islamic banks neither accepts nor pays interest in any of its activities and run business based on profit as a pricing tool instead of interest. The study reported better performance of Islamic banks as compared to that of conventional banks.
Muhamad, Abduh et.al., (2013) attempted to investigate the efficiency and performance of five major Islamic banks in Bangladesh. In the paper, ratio analysis and data envelopment analysis methods have been applied to measure the performance and efficiency of Islamicbanks with data collected from published annual reports during the period of 2006-2010. The paper foundthat the trend of allIslamic banks was on the rising stage during year 2006 to year 2010, suggesting that theIslamic banks have improved their efficiency over the study period. The paper also suggested further research applyingstochastic frontier approach with more variables, enhancing number of time period and making comparison between conventional and Islamic banking.
Sadekin, Md. Nazmus et.al., (2014) analyzed the performance, development and growth of selected five Islamic Banks in Bangladesh. Seven variables namely number of branches, number of employees, total deposits, total investments, total remittance, net Income and earnings per share during the time span of 2008 to 2012 has been used to derive results of the paper.Eight trend equations have been tested fordifferent activities of the Islamic banks. They found that the trend value of branches,employees, deposits and net income are positive in case of all the selected banks.The trend value of branches,employees, deposits and net income is positive in case of all the selected banks. Square of correlationcoefficient (r2) has also been tested for all trend equations. They revealed that the r2 of branches, deposits and net income is morethan 0.5 implying that the future of the Islamic Banks in Bangladesh is very bright.
Ibrahim, Md et.al., (2014) evaluated the performance of sixIslamic banks listed at both Dhaka Stock Exchange (DSE) & Chittagong Stock Exchange (CSE).Data have been collected from the annual reports of the selected banksand variables chosen for performance evaluation included deposit, investment, foreign remittance, earnings per share (EPS), dividend declaration, dividendpayout ratio, price earnings ratio (P/E) and net asset value (NAV).Analyzing these variables, the study concluded that Islamicbanks haveperformed well.
IFSB (2014) has attempted in a publication prepared on papers delivered at a seminar in Dhaka, Capital of Bangladesh to share the prospects and challenges, initiatives and experiences, in developing Islamic finance, with specific focus on the Bangladesh experience. The publication published by IFSB has six chapters covering different key issues relating to Islamic finance in Bangladesh and other countries.
3. Global Experience
Starting in Egypt in 1963, the Islamic finance industry has now come of age as a viable, resilient and suitable alternative in the global financial landscape. The finance industry began as a niche market mainly in retail banking and currently, it has been operating in 75 countries with 600 institutions offering wide range of Shairah complaint financial products ranging from commercial and investment banking to takaful (insurance), mutual funds and capital market products. The Islamic finance is not only flourishing in Muslim majority countries worldwide but it is also expanding fast in non-Muslim countries attracting both Muslim and non-Muslim customers. During the global financial crisis of 2007-2008, the conventional financial industry faced severe turmoil across the global but the Islamic finance industry showed much resilience compared to their conventional counterparts. This has created much enthusiasm among policy makers around the world that Islamic finance has solid ability to maintain financial stability.
The Islamic finance industry has experienced unprecedented progress in terms of geographical converge, offering diversified Islamic financial services and exponential growth. The total assets of global Islamic finance industry are estimated to be worth USD 1.87 trillion in 1H2014 from USD 1.50 billion in mid-1990s. The global Islamic financial industry comprising banking, sukuk, mutual funds, and takaful has witnessed robust growth with a compound annual growth rate (CAGR) of 17% between 2009 and 2013. The status of global Islamic financial industry is depicted in Table-3.1.
Table 3.1: Geographical Distribution of Islamic Finance Segments (2014)
(USD billion)
Region / Banking Assets / Sukuk Outstanding / Islamic Funds’ Assets / Takaful ContributionsAsia / 203.8 / 188.4 / 23.2 / 3.9
GCC / 564.2 / 95.5 / 33.5 / 9.0
MENA (exc. GCC) / 633.7 / 0.1 / 0.3 / 7.7
Sub-Saharan Africa / 20.1 / 1.3 / 1.8 / 0.6
Others / 54.4 / 9.4 / 17.0 / 0.3
Total / 1476.2 / 294.7 / 75.8 / 21.4
Source: Islamic Financial Services Industry Stability Report 2015, IFSB, Malaysia.
The Islamic banking sector has dominated the global Islamic financial industry with higher concentration in the MENA, GCC and Asian regions as they have larger Muslim population and vibrant emerging economies, mostly based on petro dollar.
The Islamic capital market, namely Sukūk, Islamic funds and indices continued to outpace most other asset classes in the global financial system. Both government and corporate sectors are increasingly using ‘sukuk’ as an important vehicle for international fund-raising and investment activities that generate significant cross-border flows. At present, there are four major global Islamic indices providers that cover the Islamic equity market- Dow Jones Islamic Market Indices, Standard and Poor Shariah Indices, MSCI global Islamic Indices and FTSE global Islamic Indices. Malaysia, Qatar, the UAE, Saudi Arabia and Indonesia have been at the forefront of growth in the sukuk primary market. The sukuk assets available in the secondary market have grown substantially since 2004 to reach USD 294.7 billion outstanding as at 1H2014.
Assets under management of Islamic funds grew to USD 75.8 billion from USD 29.2 billion in 2004, representing a CAGR of 10.8%. Despite relatively small market share as compared to its banking and capital market counterparts, the takaful industry has recorded robust double-digit growth rates in recent years. The industry’s contribution is to be estimated at USD 21.4 billion in 1H2014 with an average annual growth of 15% between 2008-13 periods.
3.1 Shares of Islamic Banking Market in Muslim Majority Countries
Although almost all 56 nations OIC countries have introduced Islamic finance, the Middle East, South-East Asia and South Asia Muslim majority countries have emerged as the leading Islamic financial Industry centers. Iran and Sudan have adopted fully Shariah-complaint financial systems. Based on 2012 data, among other major Muslim countries, Islamic banking market share of total banking industry in Kuwait is above 60% followed by Saudi Arabia (33%), Qatar, UAE, Malaysia and Bangladesh (20%) and Syria, Bahrain, Yemen and Jordan (10%). Countries having below 10% Islamic banking market share include Egypt, Turkey, Pakistan and Indonesia. List of Muslim majority countries having Islamic finance is shown in Table-3.2.
Table 3.2: Major Muslim countries offering Islamic Finance
Name of Regions / Name of CountriesMiddle East / Iran, Iraq, Kuwait, Saudi Arabia, Qatar, UAE, Bahrain, Oman, Lebanon, Jordan, Syria, Yemen, Turkey
South East Asia / Malaysia, Indonesia, Brunei
South Asia / Bangladesh, Pakistan, Afghanistan, Maldives
Middle Asia/Europe / Azerbaijan, Uzbekistan, Tajikistan,Kazakhstan, Albania, Cyprus
Africa / Sudan, Egypt, Libya, Nigeria, Tunisia, Morocco, Algeria, Senegal, Gambia, Djibouti, Niger, Guinea, Mauritania, Mali
Source: IFSB, MIFC and Islamic Finance Development Report 2013, ICD Thomson Reuters
Iran is the top among all Muslim majority countries in terms of share ofGlobal Islamic Banking Assets securing 39.70% assets followed by Saudia Arabia (13.70%), Malaysia (9.80%), UAE (9.10%) and Kuwait (9.0%).
Chart 3.1: Country Share of Global Islamic Banking Assets (2013)
Source: Islamic Financial Services Industry Stability Report 2015, IFSB, Malaysia.
3.2 Developments of Islamic finance in Western Countries and other Regions:
Though the Islamic finance industry has registered phenomenal growth in Muslim world due mainly to religious factor, the non-Muslim people of the western world and other jurisdiction have started to avail Islamic financial services motivated by commercial considerations. The resilience nature of the Islamic finance and its immense potentials for expansion in the future has drawn huge attention to non-Muslim customers within and beyond predominantly Muslim markets and jurisdictions. These countries have undertaken measures to bring changes to their legal and tax structure to facilitate the introduction of Islamic financial products into their markets.