Steps to regaining trust in Islamic Banking in Bangladesh

Illustration: TBS

Islamic banking, a system that has operated in Bangladesh for over four decades, holds immense potential. However, its development has been hampered by the failure to adhere to key governance principles. 

While conventional banks are facing their own challenges, Islamic banks are in an even more precarious position, as news reports frequently highlight their weaknesses. The Shariah governance system, which is supposed to strengthen the resilience of Islamic banks, is struggling to live up to its promise. 

After the July Revolution, reforms in the banking sector are underway. These reforms must take into account the unique requirements of Islamic banking, especially with regard to Shariah compliance and governance.

Bangladesh Bank's proactive role is essential

The first step in this reform journey should start at the very heart of the financial regulatory system—Bangladesh Bank. 

Despite Islamic Banking's presence in Bangladesh for over 40 years and its significant impact on the economy, Bangladesh Bank has yet to establish such a department. This absence has resulted in inadequate coordination among departments related to Islamic banking, formulation of regulations that do not adequately address Shariah compliance, hindered necessary supervision of Islamic banking, and operation of Islamic banking without any clear economic objectives. 

In contrast, central banks in countries like Malaysia, Indonesia, and Bahrain have long had such departments, which play a crucial role in developing their respective Islamic banking sectors, formulating necessary regulations, and implementing effective supervision with clear economic objectives.

The establishment of a specialised department for Islamic banking within Bangladesh Bank is long overdue. This department should be led by professionals who are well-versed in Islamic finance, which is essential given Bangladesh's dual banking system, where conventional banks dominate.

Currently, Bangladesh Bank has more than 30 officials who are qualified in Islamic banking. While their efforts have yielded some results, this is far from enough to meet the growing demands of the sector. 

Establishing a dedicated department would not only centralise these efforts but also ensure that regulations, risk management, and governance align with international standards. To further support this department, an advisory committee made up of Islamic finance experts—possibly with international experience—could enhance its capacity and effectiveness.

Revising regulations: Aligning with global standards

One of the most pressing issues facing Islamic banks in Bangladesh is the outdated nature of the existing regulations. These regulations do not align with international standards, creating significant risks for the sector. Key areas such as Shariah-based product descriptions, governance, risk management, and financial reporting need urgent revisions.

Internationally, Islamic banking regulations have evolved to address both religious and economic concerns. 

For Bangladesh to stay competitive and grow its Islamic banking sector, it must update its regulations. This will not only boost investor confidence but also attract international financial institutions that are hesitant to enter a market with regulatory uncertainties.

To enhance its effectiveness, the Bangladesh Bank needs to develop comprehensive guidelines based on international standards. Additionally, it is important to appoint qualified individuals to these committees and ensure their professional and ethical independence.

The Shariah committees within Islamic banks play a crucial role in maintaining the integrity of the governance system. However, these committees have failed to deliver on their promises, as evidenced by their role in recent scandals. These committees consistently issue "no objection" reports, even when there are clear governance failures. This calls into question their independence and effectiveness.

For example, these committees need to provide opinions on matters such as profit and loss calculations of investments, financial reporting, and the use of technology. Their opinions must consider not only Shariah compliance but also the economic and social consequences of the bank's operations. 

To make well-informed decisions, specialised education, experience, and expertise are crucial, which the traditional Shariah or madrasah education and curriculum in Bangladesh do not provide. 

In Bangladesh, the curriculum for madrasa-educated scholars, even those who have studied fiqh or Islamic law, lacks the theories and practical aspects of the modern global economic system. This situation noticeably impacts the Shariah compliance of various Islamic banks in Bangladesh. So, policymakers and authorities in madrassas should urgently consider the need to reform the curriculum and include the necessary qualifications and skills for worldly matters.

Learning from the world 

Countries like Malaysia and Bahrain, which are leaders in Islamic finance, offer valuable lessons for Bangladesh. In these countries, members of Shariah committees often hold advanced degrees not only in Islamic studies but also in economics, finance, and law from prestigious universities around the world. 

For example, Sheikh Nizam Yaquby, a leading figure in global Islamic banking, holds a degree in economics and comparative religion from McGill University and a PhD in Islamic law from the University of Wales. 

Similarly, the chairman of Malaysia's central bank's Shariah Advisory Council holds both Islamic and secular qualifications, making him well-versed in the complexities of modern Islamic finance.

Bangladesh Bank must also ensure that board members of Islamic banks possess a sufficient understanding of Shariah principles within the context of Islamic banking. The Islamic Financial Services Board (IFSB), a key standard-setter for Islamic finance, has established the responsibilities of the board of directors. 

Bangladesh Bank must ensure that board members of Islamic banks are familiar with these responsibilities. Malaysia's central bank serves as a model, implementing initiatives to enhance Shariah knowledge among board members, which Bangladesh could adopt to improve the governance effectiveness of its Islamic banks.

Transparency is key. To address the lack of trust surrounding Islamic banks, effective measures should be implemented. Simply ensuring Shariah compliance is not enough; Islamic banks must also take proactive steps to assure the public about their adherence to Shariah principles. This can be achieved through transparency and disclosures regarding their Shariah control systems and Shariah-based decisions. 

Islamic banks should disclose their Shariah control systems and decisions to the public, offering assurance that they are adhering to both religious and economic guidelines. One potential solution is the introduction of external Shariah audits and rating systems, which are already mandatory in countries such as Oman, Pakistan, and Bahrain.

Reforms are also needed in the Islamic capital market and insurance sectors, as these areas complement the Islamic banking system. The Islamic capital market and insurance sectors are vital components that complement the banking system. There is a growing demand for Islamic investment products, particularly for retirement planning and short-term investments. Addressing this demand through comprehensive reform will not only benefit consumers but also contribute to the broader socio economic goals of Islamic finance. 

The reform of Bangladesh's Islamic banking sector requires immediate and focused interventions. It is imperative to establish a dedicated department within Bangladesh Bank, update regulations, strengthen Shariah committees, enhance board awareness, and restore public confidence. 

By leveraging lessons from global best practices, Bangladesh can construct a more robust and Shariah-compliant financial system that effectively serves its populace.

Sketch: TBS

Professor Dr Mohammad Omar Farooq is the Head of the Department of Economics at United International University and an expert in Islamic Finance. 

Mezbah Uddin Ahmed is a Research Fellow at INCEIF University, Malaysia, under the Central Bank of Malaysia. 

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.