Islamic Finance Growing in Bangladesh Despite Structural Issues

The Bangladeshi Islamic finance industry is likely to continue growing over the medium term, driven by rising public demand, new branch openings, and supportive government policies, says Fitch Ratings. Many conventional banks are focusing on Islamic products, either by opening new Islamic branches or windows or by converting into full-fledged Islamic banks. Islamic capital markets remain nascent, but the government started issuing domestic sovereign Sukuk in 2020, with its fourth auction in April 2022. This supports fiscal funding diversification and enables Islamic banks and takaful firms to invest their liquidity. Structural issues include underdeveloped regulations and a weak banking sector.

More lax prudential requirements have supported Islamic banking growth and motivated conventional banks to provide Islamic products. The regulator, Bangladesh Bank, has set the statutory liquidity ratio limit for Islamic banks (5.5%) much lower than for conventional banks (13%). Islamic banks also benefit from higher prudential limits, such as an advance-deposit ratio of 92% in contrast to 87% for conventional banks. We estimate the Bangladeshi Islamic finance industry to be over USD58 billion at end-1H22.

Bangladesh’s positive economic growth prospects (real GDP growth 2023F: 5%), due to rising private consumption, exports of ready-made garments, government spending, and investment, should support Islamic and conventional banking performance over the medium term.

The Islamic finance industry faces long-standing challenges, including Islamic banks’ limited branches and digital banking networks in rural areas – where 61% of the Bangladeshi population resided in 2021, according to the World Bank. The Islamic finance regulatory framework is underdeveloped, with a lack of Sukuk investment options and Islamic derivatives or hedging instruments, low awareness of Islamic products, lack of standardization, inadequate fintech usage, lack of incentives for Sukuk issuers, and under-skilled human capital.

Part of the Islamic liquidity-management infrastructure exists for Islamic banks, who can deploy and receive interbank placements from both Islamic banks and conventional banks, and invest in short-term government Sukuk in the form of Bangladesh Government Islamic Investment Bonds. However, no Islamic repurchase agreement or Islamic lender-of-last-resort facilities exists with the central bank. Potential remains to expand the range of Islamic liquidity-management products.

The Bangladeshi financial sector is also underdeveloped in general. The banking sector’s asset quality, capitalization, governance, and regulatory quality are weak, especially for public-sector banks. Banking penetration remains very low. About 47% of Bangladesh’s adult population didn’t have a bank account in 2021, and 8% of adults cited religious reasons for not having them, according to the World Bank. Insurance and takaful penetration was also very low at 0.5% in 2021. While a challenge, it underpins the high long-term growth potential for Islamic finance in Bangladesh, which has the fourth-largest Muslim population in the world.

Islamic banking has a domestic market share of 28.5% of total industry loans and advances at end-1H22 (June 2021: 28%). Islamic banks’ global market share was 2.7% – higher than Indonesia (1.9%), Pakistan (1.3%), Egypt (1.3%), and Jordan (0.9%), based on Islamic Financial Services Board’s latest available data. The outstanding Sukuk volume was about USD 1.7 billion. The takaful segment’s end-2020 domestic market share of 14.4% placed it seventh-largest globally, ahead of Oman (13.9%), Pakistan (12.6%), Bahrain (12%), and the UAE (10.2%).

Several initiatives could support Islamic finance development. In August 2022, the Bangladesh Securities and Exchange Commission released regulations on forming a Shariah Advisory Council, which should help in the push for standardization and support of Sukuk issuance. In September 2022, Bangladesh Bank issued a policy on green bond financing for banks and financial institutions, which covers Islamic securities. Standards issued by Accounting and Auditing Organization for Islamic Financial Institutions are partially adopted in Bangladesh.