Bangladesh Bank Needs an Islamic Finance Department

As of March 2024, Islamic banking in Bangladesh accounts for 26.23 per cent of total banking sector deposits and 28.24 per cent of total banking sector investments. Given the systemic importance of Islamic banking within the country’s financial system, ensuring the soundness and well-being of this sector is crucial for the stability of the economy. This necessity has become particularly evident in recent years, as failures in regulatory oversight and the collapse of governance in most Islamic banks have adversely affected not only the banking sector but also the entire economy. Following the July Revolution and the fall of the previous regime, Bangladesh Bank and the interim government have undertaken various steps to reform the banking sector. For instance, a task force for banking sector reform has been formed, and the boards of directors of several banks have been reconstituted, seven of which are full-fledged Islamic banks. The government is also planning to establish a banking commission. As the banking sector is currently recovering, the pace of recovery among Islamic banks has been described as a "miracle" in a recent talk show featuring Governor Dr. Ahsan H. Mansur, highlighting that Islamic banks can achieve remarkable success if good governance and trust are ensured.

The resilience of the Islamic banking sector in Bangladesh is repeatedly proven by its progress despite scepticism and opposition from various quarters since its inception. Hostility toward Islamic banking was particularly prevalent during the previous regime. For instance, a state minister for home affairs linked the largest Islamic bank in the country to terror financing. Although he later referred to it as a “slip of the tongue”, significant damage had already been done. A finance minister also criticised Islamic banking in Parliament, labelling it fraudulent and based on misconceptions. There were many other instances where Islamic banking was falsely criticised and mislabeled in public forums. Unfortunately, there was no effective mechanism to address such damaging claims against Islamic banking. Instead, individuals advocating for best practices in Islamic finance risked various repercussions. Such an environment laid the foundation for the takeover of the largest Islamic bank in Bangladesh at gunpoint and the subsequent takeover of several other Islamic banks by the same group.

The scepticism about Islamic finance is not unique to Bangladesh. However, a notable difference from several other countries with similar industry growth is the almost complete absence of engagement with lawmakers, policymakers, civil society, and other stakeholders to raise awareness about Islamic finance—what it is, the relevant issues, and how to govern it effectively. While central banks in several countries have facilitated these engagements and taken initiatives to develop their Islamic banking sectors, such experiences are almost non-existent in Bangladesh. Various sources have cited a lack of resources at Bangladesh Bank for the effective oversight of Islamic banking.

Bangladesh Bank, despite overseeing 48 institutions providing Islamic financial services, does not have a dedicated Islamic finance department. These institutions include 10 full-fledged Islamic banks, 30 conventional banks offering Islamic banking services through branches and windows, three full-fledged Islamic finance companies, and five conventional finance companies with Islamic windows. The number of institutions offering Islamic financial services is expected to grow, as several others have expressed interest in launching such services.

Over the years, the industry has observed that the absence of a dedicated department at Bangladesh Bank has resulted in inadequate coordination among departments related to Islamic banking, the formulation of regulations that do not sufficiently address Shariah compliance, shortcomings in the supervision of Islamic banking, and the operation of Islamic banking without clear economic objectives. Some regulations are such that they force Islamic banks to deviate from an ideal approach. It is worth noting that there are currently two dedicated departments in Bangladesh Bank that conduct onsite inspections of Islamic banks. Their primary focus is on the credit and investment operations of the Islamic banks, rather than on Shariah compliance issues. Additionally, there is a small Islamic banking cell in the Banking Regulation and Policy Department (BRPD), which is insufficient to address the needs of the industry.

As the Islamic banking sector has grown substantially and is likely to continue growing, extensive coordination is required among government agencies, industry players, and departments within Bangladesh Bank. Having a central reference point in the form of the Islamic finance department within Bangladesh Bank will greatly facilitate internal and external coordination. A dedicated department would also enable a stronger focus on developing robust and comprehensive regulatory and supervisory policies for Islamic banking. Furthermore, industry players will benefit from a single reference point for more effective regulation and supervision. A well-equipped Islamic finance department with staff possessing the necessary skills and expertise can make significant contributions to the development of Islamic finance in Bangladesh and globally.

Based on these important considerations, it is highly recommended that Bangladesh Bank consider establishing an Islamic finance department. Establishing a dedicated department would be crucial in addressing the current limitations in regulating and supervising Islamic banking. If compared with Malaysia, the establishment of such a department is already a few decades overdue. Bank Negara Malaysia (BNM) has a well-functioning Islamic finance department, which was established in 2000 to consolidate work related to Islamic finance that had previously been spread across various departments. The importance of this strategic move is reflected in the focused, sequenced, and orderly development of Malaysia’s Islamic financial sector. The Malaysian experience is particularly relevant, as both Bangladesh and Malaysia launched Islamic banking in 1983 and experienced similar industry growth in the early years. The central banks in several other countries, including Indonesia, Brunei, Pakistan, and Oman, have also established dedicated departments for Islamic banking.

The Islamic finance department at Bangladesh Bank may include a Shariah secretariat, which would lead the development of Shariah-related policies, provide sound Shariah research and analysis to support the roles of Bangladesh Bank in regard to Islamic banking, and assist in strategic and prudential policy formulation. It would also provide support to other units and the Shariah advisory committee (once formed) in making Shariah-based decisions. Additionally, the department may have a supervision and inspection unit, which would serve as the reference point for supervisory matters concerning Islamic banking. It may conduct Shariah review and audit the implementation of Islamic finance products by Islamic finance institutions. Furthermore, a regulation and reporting unit could be established for regulatory development, review, and the reporting framework for Islamic banking. An Islamic financial market unit could also be included to develop instruments for managing liquidity in Islamic banking.

The functions of the Islamic finance department may also include conducting analytical assessments and strategic benchmarking on emerging trends (customer, technology, global and market potentials) in Islamic finance based on local and global development to guide the department and Bangladesh Bank in setting strategic priorities or action plans for Islamic banking. The functions may also include formulation and implementation of relevant, practical, and robust regulatory, accounting, and relevant standards to ensure sustained financial stability of Islamic finance and cater to specificities of Islamic finance. The department may also coordinate with relevant parties to develop necessary information technology systems and requirements, develop new or enhance existing market structures and infrastructure aimed at promoting resilience and efficiency of the Islamic financial industry, and ideate and prototype growth and innovative solutions for Islamic finance. The department may also play a crucial role in introducing products of systemic importance, such as Islamic liquidity management instruments and Shariah-compliant facilities to manage liquidity supply. Finance companies that are under the purview of Bangladesh Bank may also be within the scope of this department for their Islamic financial activities.

Besides establishing an Islamic finance department, Bangladesh Bank would also need to develop internal policies, standard operating procedures, and governance processes. These internal matters will require continuous improvement and expansion to keep up with the growth of the Islamic banking industry. The other departments will continue to fulfil their respective roles in Islamic finance, seeking guidance from this new department as needed. Considering the extensive portfolio, a Deputy Governor with substantial relevant exposure can be dedicated to Islamic banking.

Bangladesh Bank currently has about 40 staff with qualifications in Islamic banking who can be prioritised in staffing the Islamic finance department. In the initial stage, the department could be supported by an advisory committee of Islamic finance experts to enhance its capacity. Some experts with international experience in Islamic banking, finance, and economics could be appointed for a few years. In the meantime, staff assigned to this department can receive training and development in various aspects of Islamic finance, such as Shariah, Islamic finance-related accounting, legal matters, and operational issues.

Given the systemic importance of Islamic banking in Bangladesh and the upcoming Financial Sector Assessment Program (FSAP) of the IMF, which is expected to evaluate the country's Islamic banking sector based on the Islamic Financial Services Board (IFSB) core principles, it is hoped that the current leadership will consider establishing an Islamic finance department at Bangladesh Bank. This department would ensure the implementation of IFSB standards and facilitate the focused and orderly development of Islamic banking regulation and supervision. A favourable FSAP report is vital for Bangladesh's economic growth, as it significantly influences the country's ability to attract foreign direct investment (FDI) and affects its global financial standing. Therefore, the establishment of an Islamic finance department within Bangladesh Bank is not only beneficial but also critical for Bangladesh.

Islamic Finance News published a version of this opinion on 8 October 2024.