The Islamic banking sector in Bangladesh marked 35 years of its existence in March this year. Despite all sorts of scepticisms, the sector continues to grow at a faster rate than the conventional counterpart. It has already been a few years since the sector secured more than a one-fifth share of the total banking sector deposits and financing. Eight full-fledged Islamic banks along with 17 conventional banks with Islamic banking branches or windows are currently offering Islamic banking services. The performance indicators of the Islamic banks are also regularly reported to be better than the conventional banks.
Notwithstanding achieving this impressive progress, an Islamic Banking Act is yet to see the light in Bangladesh. There is no Shariah Governance Framework, and compliance with the Central Shariah Board for Islamic Banks (CSBIB) remains voluntary as they lack any enforcing authority. The external auditors and the central bank are also not required to involve themselves in ensuring Shariah compliance of the Islamic banks. Amid the limitations in the Shariah governance system, the Islamic banks continue to face criticisms as many fail to see them different from the conventional banks. Sometimes the criticisms are merely due to lack of understanding of Islamic banking concepts, but these are not always groundless. There is a dearth of initiatives that effectively address the criticisms or tries to overcome the misunderstandings.
Mudarabah is a partnership principle where the depositors act as the capital provider (rabb al-mal) and the Islamic bank acts as the manager of that capital (mudarib). The mudarabah principle entails that any profit generated from investment of the deposited money will be shared between the depositors and the Islamic bank at a pre-agreed profit sharing ratio, whereas any loss will be fully borne by the depositors.
As the critics argue, in reality, the mudarabah-based depositors do not bear any loss; rather they commonly receive a smooth rate of profit. The profit rate often is similar to the rate indicated by the Islamic bank at the time of deposit account opening. While there is truth in this, it must be looked through a proper perspective.
The profit smoothing is done to avoid displaced commercial risks. Islamic banks operate in a dual banking environment, and the direct competition with conventional banks puts commercial pressure on them to pay out profit at a competitive rate. A lower than the market rate or a real potential of capital loss (i.e. loss of deposited money) is not likely to attract many of the depositors. Moreover, directly participating in the investment’s profit-or-loss will incur additional monitoring costs for the depositors as well as will result in a higher risk of disputes between them and the Islamic bank.
Near to 95% of Islamic bank investments in Bangladesh are based on sale or rental based Islamic finance concepts. Shariah allows a fixed rate of return in these arrangements. This greatly contributes to maintaining a smooth profit rate for the depositors.
The Islamic banks also apply different techniques in smoothing the profit rate. If the investment does not generate the expected level of profit, then the Islamic bank can voluntarily forgo its share of the profit. If the investment makes a loss, then the Islamic bank can use shareholders’ capital to make good of the loss amount. The Islamic bank can also use a profit equalisation reserve, which is created by retaining part of the mudarabah profit at the good times to distribute in bad times. Even though not everyone appreciates these techniques, none of these are outside the parameters of Shariah.
Nonetheless, in moving forward, Islamic banks in Bangladesh can explore experiences of other countries such as Malaysia. The Islamic Financial Services Act (IFSA) 2013 of Malaysia separated a “deposit account” from an “investment account”. A deposit account guarantees repayment of the deposited money in full with or without a profit as agreed between the Islamic bank and the depositor at the time of account opening. Whereas, an investment account does not provide any such guarantee. The investment account holders fully bear the risk and reward associated with the investments of their money. Similarly, Islamic banks in Bangladesh can offer “investment accounts” along with regular “deposit accounts”. This will cater demands of all types of customers – those who wish to take investment risks and those who do not.
The Islamic banks may also consider launching investment account platforms and crowd funding platforms. These platforms will facilitate matching of investors with specifically identified ventures or projects that need financing. Investors will bear the actual risk and return. As the operational model of these platforms is different from the regular banking activities, these can be formed as subsidiary entities of the existing Islamic banks.
The writer is a Researcher at International Shari’ah Research Academy for Islamic Finance (ISRA), Malaysia and Fellow of ACCA. He can be contacted at: [email protected]