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Liquidity challenges persist in once lucrative Islamic banks

Banking 2023-09-17, 10:59am


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Dhaka, Sept 16 – The Islamic banking sector in Bangladesh, a significant part of the country’s wider banking sector, continues to face liquidity challenges, according to Fitch Ratings, the global credit agency.

The situation however is improving, underpinned by central bank support in the form of the Islamic Bank Liquidity Facility and Mudarabah Liquidity Support and still-notable public demand for Islamic deposit products, Fitch said in a non-rating action commentary last week. 

Islamic banks held 25.3% of all domestic industry deposits at end-1H23, albeit down from 28.2% at end-1H22, it added.

Islamic banks in Bangladesh faced sizable customer deposit outflows in 2022-1H23 and lower liquidity buffers than conventional banks amid reports of loan irregularities.

Islamic banks’ excess liquidity, defined as total cash reserves minus required reserves with the central bank, declined significantly by 66.6% yoy (Tk 9.82 billion) at end-1H23, said Fitch.

However, excess liquidity has since improved, with a 12.7% quarterly rise.

In contrast, deposit growth is slowing. Islamic banks’ total deposits grew by only 3.8% yoy as of 1H23, a significant fall from the 12% yoy growth of 1H22, it added.

Bangladesh had the eighth-largest Islamic banking market globally at the end of 2022, with total assets of Tk 4,970.7 billion (US$45.3 billion), ahead of Indonesia, Bahrain, Pakistan, Egypt, Jordan, and Oman, based on data from the Islamic Financial Services Board. The market share, based on industry loans, is rising and reached 29.1% at end-1H23 (end-1H22: 28.5%).

However, the industry has significant untapped potential, as 62% of the Bangladeshi population does not have an account at a financial institution, whether conventional or Islamic, according to 2021 World Bank data. Bangladesh has the third-largest Muslim population globally, with sizable segments being sharia-sensitive, the credit rating company observed.

Many conventional banks are increasing their offering of Islamic products, either by opening new Islamic branches or windows or by converting into full-fledged Islamic banks. This is driven by customer demand and more lax prudential requirements.

Islamic branches and windows of conventional banks are expanding, with an 8.2% share of Islamic banking deposits as of end-1H23 (1H22: 7.1%), with the remaining 91.8% held by full-fledged Islamic banks, it said.

Islamic banks in Bangladesh can receive customer deposits based on either mudaraba (a profit-and-loss sharing contract) or wadiah (a safe-keeping contract). Mudaraba-based deposits accounted for more than 85% of customer deposits at Islamic banks at the end of 1H23.

Fitch has not observed Islamic banks passing on losses or not paying profits to depositors. Passing losses can increase reputational risk and may lead to customer deposit outflows.

The company also expected that Bangladesh Bank would not let depositors’ bear losses, as this would shake investor confidence in the banking system. Financing based on profit and loss (mudaraba and musharaka) was less than 1% of total financing.

The Islamic finance industry in Bangladesh continued to face key structural impediments. These include a lack of sukuk and other sharia-compliant investment options, gaps in human capital development, a lack of unified shariah rulings, and an Islamic finance regulatory framework that requires an update.

In general, the banking sector’s balance sheets, governance, and regulatory quality are weak. The central bank has taken steps to improve governance at public-sector banks, including the appointment of observers to bank boards, but progress has been slow, the company said. - UNB