Written by Mohammad Abdul Hannan, Head of Islamic Finance Wing, IDLC Finance Limited

In recent times, non-interest banking and finance, universally known as Islamic finance, has grown at an unprecedented rate. It is expected that Islamic finance will continue to grow in countries with large Muslim populations, where it has already been dominant in several jurisdictions.

Islamic finance refers to financial activity that adheres to shariah (Islamic law) and its practical implementation through the development of Islamic sustainable economics. That means Islamic finance is based on Shariah principles on sociopolitical and economic matters. And the ultimate goal of Shariahbased Islamic finance is to create economic freedom that is fair and balanced for everyone.

Bangladesh is home to the fourth-largest Muslim population in the world. In recent years, Bangladesh has been opening itself to Islamic finance with the hope of establishing a sustainable economy.

According to the Refinitiv Islamic Finance Development Indicator (IFDI) 2021, a composite weighted index that measures the overall development and health of the Islamic finance industry, Bangladesh positioned itself in 14th place out of 135 countries around the world. Also, the Islamic Finance Development Report 2021 demonstrates that Bangladesh is among the top ten countries holding the highest Islamic finance assets. Up to 2020, the Islamic financial assets of Bangladesh stood at USD 50 billion, which is 10.75% of the current gross domestic product (GDP) of Bangladesh.

The Emergence of Islamic Finance

The Islamic financial system was founded around 1,400 years ago and is comprised of a comprehensive framework that is clearly specified. The spread of Islam has resulted in stronger economic ties between Asia, Africa, and Europe. Muslims pioneered essential financial concepts such as transactional accounts. In business and commerce throughout mediaeval times, the Islamic methods of partnership financing known as Mudarabah and Musharakah were predominant. But as time went on, industrialisation and formalised commercial banking spread to Muslim communities, making it impossible for Muslims at the time to reject the conventional financial system since there was no practical alternative available.

 In the 19th century, the Muslim world began to realise that the existing system of banking and finance was founded on elements that are forbidden in Islam (Riba/ interest, Gharar/uncertainty and Qimar/speculative transactions) and that there should be an ethical alternative that is in accordance with Shariah principles. This realisation led to the creation of the modern Islamic financial system that is in accordance with the Shariah principles. Basically, Islamic finance came back into the modern world in the 1960s, and since 1975, several new interest-free banks have been established. Although most of these financial institutions were established in Muslim nations, Islamic finance began to form in Western Europe in the early 1980s.

Global Islamic Finance Industry Landscape

Despite the worldwide pandemic, the global Islamic financial services industry (IFSI) continued to rise in 2020 and was estimated to be valued at USD 2.70 trillion in that year, marking a growth of 10.7% year-onyear in assets in USD terms [2019: USD 2.44 trillion], according to the Islamic Financial Services Industry Stability Report 2021. In addition, the report indicates that the Islamic banking and Islamic capital markets sectors contributed to the growth in the worldwide IFSI’s overall value, but Takaful (Islamic insurance) contributions suffered a minor decrease. Even though the COVID-19 pandemic caused lockdowns and more uncertainty, which hurt economies in many places, the IFSI grew overall in 2020.

It was depicted in the Islamic Financial Services Industry Stability Report 2021 that in 2020, the members of the Gulf Cooperation Council (GCC) continued to be the leading domicile for assets related to Islamic finance. The market share of Islamic finance in the area increased from 45.9% in 2019 to 48.9% in 2020. With a 24.9% share of all IFSI assets worldwide, the Middle East and South Asia (MESA) region came in second, maintaining its position from the previous year. The South-East Asia (SEA) region’s share decreased slightly from 23.8% in 2019 to 20.3% in 2020, while the Africa region’s participation remained low at 1.7%. The remaining 4.3% of all IFSI assets were in other regions, which included Turkey, the United Kingdom, and Commonwealth of Independent States (CIS) countries.

* Sukuk outstanding and Islamic funds data are for full-year 2020; Islamic banking data are as of 3Q20, and Takaful data are as of end-2019.

The Refinitiv Islamic Finance Development Report 2021 postulates that the size of the Islamic finance industry is expected to grow from USD 3.37 trillion in 2020 to USD 4.94 trillion in 2025, representing an annual growth rate of 8% on average over the course of the next five years. The report shows the composition of Islamic finance asset distribution in 2020 was as follows: Islamic banking has the most assets, worth USD 2,349 billion, followed by Sukuk, Islamic funds, other Islamic finance investments, and Takaful, with USD 631 billion, USD 178 billion, USD 4 billion, and USD 62 billion, respectively.

Islamic Finance in Bangladesh

Bangladesh is one of the fastest-growing economies in the world. In line with other economic activities, Islamic finance in Bangladesh has also been witnessing robust growth.

According to a report issued by Fitch Ratings, a worldwide credit rating agency, the Islamic finance industry has the potential for considerable expansion in the medium term, owing to strong bottom-up public demand for Islamic products and the country’s good economic prospects. However, according to the same research, Bangladesh’s Islamic financial industry has been facing challenges due to long-standing restrictions.

Islamic Banking

In Bangladesh, Islamic finance started its inception through banking. The first Islamic bank in Bangladesh was established in the year 1983. According to January to March 2022 quarter data of Bangladesh Bank (BB), currently, 10 full-fledged Islamic banks have 1,679 branches out of 10,942 branches in the banking system. Furthermore, in Bangladesh, 41 Islamic banking branches of 9 conventional commercial banks and 434 Islamic banking windows of 13 conventional commercial banks provide Islamic financial services.

Total deposits of the Islamic banking sector were BDT 3,996.79 billion at the end of March 2022, which was 28.21% of the total deposits of the entire banking sector at that time. In comparison to March 2021, the deposits in Islamic banks grew by 11.71%. During the period from March 2017 to March 2022, the compound annual growth rate was 16% which was 10.75% in the entire banking sector.

On the other hand, total investments in the Islamic banking sector were found to be BDT 3,606.49 billion at the end of March 2022, which was 27.78% of the total loans and advances of the banking sector as a whole. It grew by 11.86% from the level of March 2021, and the compound annual growth rate was 15.29% during the period March 2017 to March 2022. 

In the case of remittance mobilisation, the Islamic banking sector accounted for 30.96% of the total remittances mobilised in the entire banking sector in the January-March 2022 quarter, which amounted to BDT 134.70 billion. Though the figure dropped by 14.39% from the January 2021-March 2021 quarter, the compound annual growth rate was 15.13% during the period March 2017 to March 2022.

Besides banks, 3 full-pledged non-bank financial institutions (NBFIs) are providing Islamic financial services in Bangladesh. Several other conventional NBFIs are showing an interest in providing Islamic financial products and services to their clients.

Islamic Capital Markets (ICM)

The Islamic capital market is an essential component of the Islamic financial system, and one of its primary functions is to provide individuals and businesses with access to various avenues for obtaining finance and opportunities for investment. The products that are traded in the Islamic capital market are Sukuk and Islamic equity.

Sukuk (Islamic Bond)

Bangladesh’s Islamic capital market is not as dynamic as its other Asian counterparts like Pakistan, Malaysia, and Indonesia. Despite this, the issue of Sukuk by the Bangladesh Bank in December 2020 is unquestionably a move in the right direction. To generate BDT 80 billion for the execution of a clean water supply scheme throughout the country, Bangladesh Bank, acting on behalf of the government, issued the country’s first sovereign investment Sukuk. Bangladesh Bank issued a second sovereign Sukuk (the third Sukuk auction) on behalf of the government to raise BDT 50 billion on December 29, 2021, for the implementation of the “Need-Based Infrastructure Development of Government Primary Schools Project (1st Phase).

The Bangladesh Securities and Exchange Commission (BSEC) granted Bangladesh Export-Import Company (Beximco) authority to issue the BDT 30 billion Beximco Green Sukuk Bond on July 8, 2021. The first Sukuk was traded on the country’s capital market on January 13, 2022, with the introduction of Beximco Green Sukuk Al Istisna’a.

Islamic Funds

An Islamic mutual fund operates similarly to a conventional fund, with the exception that the Islamic mutual fund only invests in Shariah-compliant investments. Shariah-compliant investments adhere to Islamic rules, meaning they are free of Gharar (speculation) and Riba (interest).

An increasing number of conventional businesses are also going into the Shariah arena, even though there are already a number of full-fledged Islamic fund managers operating in the market. 

Besides the aforementioned shariah-compliant closed-end funds, there are currently 11 shariah-compliant open-end funds with a total paid-up capital of BDT 4115.6 million operating in Bangladesh.

Takaful (Islamic Insurance)

Takaful was initiated in Bangladesh in December, 1999. The first full-fledged Islamic insurance company in Bangladesh is Islami Insurance Bangladesh Ltd. At present, in Bangladesh, there are a total of 15 fully operational Islamic insurance companies (11 life and 4 non-life). According to the Islamic Financial Services Industry Stability Report 2021, the Takaful industry of Bangladesh represents a market share of 14.1% of the total insurance industry in 2019. In terms of market share, it is currently a small sector, but it has the potential to expand the national takaful market.

*Private limited company, data is not publicly available. **Could not retrieve data

Prospects of Islamic Finance in Bangladesh

Bangladesh’s future in Islamic banking and finance is promising, considering the country’s robust economic growth and favourable demographics. Some of the contributing factors have been discussed below.

Bangladesh is one of the largest Muslim-majority countries in the world, with 90.40% of its population followers of Islam. The growing preference for financial services designed in accordance with their belief system will undoubtedly boost the growth of Islamic financial products and services in Bangladesh.

Research published in the Indian Journal of Finance and Banking in the year 2022 has proven that Islamic banks in Bangladesh are performing better than conventional banks in terms of profitability, capital adequacy, asset quality, and management efficiency. This will give investors more confidence in the Islamic finance sector, and there will be more capital injection and transformation into shariah-compliant financial institutions as a result. In turn, it will help the Islamic finance sector flourish.

In recent times, we have observed that the Sukuk market is flourishing. Through restructuring our bond market, we will be able to attract international Sukuk investors to strengthen our position in foreign direct investment (FDI). Also, through the issuance of Sukuk, the country has the immense opportunity to finance different megaprojects in the public and private sectors.

Bangladesh is a country where yet a vast majority of the population needs to be brought under the umbrella of financial inclusion. In this particular aspect, mass penetration of Islamic microfinance can be a gamechanging phenomenon. Moreover, Islamic FinTechs have enormous business opportunities here as the median age of the population is 27.9 years, and they are highly adaptive to technology.

Challenges

Although the Islamic finance industry in Bangladesh represents remarkable growth and performance, it has some challenges to be solved. Some of the critical challenges the industry is currently facing have been discussed below.

Trust issues and misconceptions regarding Islamic financial products and services pose major challenges for Islamic financial institutions. Mass awareness programmes need to be conducted to eliminate the knowledge and communication gaps.

Out of the USD 50 billion Islamic finance market, Islamic banking alone possesses a market cap of USD 48 billion, which indicates that the Islamic capital market, the Islamic insurance (Takaful) market and other areas of Islamic finance have not flourished to the extent that Islamic banking products and services have flourished.

Excess liquidity in the Islamic banking sector stood at BDT 299.99 billion by the end of March 2022. As Islamic banks cannot invest in conventional investment vehicles and there is a minimal number of shariahcompliant instruments, excess liquidity has become a common scenario in this sector. The development of a functional Islamic capital market and the initiation of more Sukuk-based finance projects in public and private sectors can help the Islamic banks control their excess liquidity.

In Bangladesh, Islamic banking products are skewed more toward asset-based financing or debt financing, i.e., Murabahah, Ijarah, and Salam modes of financing. But the true spirit of Islamic finance is inherent in equity-based instruments like Mudharabah and Musharakah. So, to ensure greater compliance with shariah, Islamic banks need to focus more on profit/ loss sharing modes of investments than mark-up modes of investments.

There is a shortage of quality certificate courses, academic programs, professional development programmes, etc., in the field of Islamic finance in Bangladesh. Inconsistencies are often observed in the opinions of different scholars. So, there is an urgent need for proper standardisation.

Finally, to reap the utmost benefit from any particular industry, a proper regulatory and legal framework is a must. Some aspects of Islamic finance still have a need for central guidelines and standards.

The writer is working as Deputy General Manager at IDLC Finance Limited and he can be reached at hannan@idlc.com.