Islamic banking in Bangladesh: From hybrid beginnings to a new ea of regulatory reform

Islamic banking has become a cornerstone of Bangladesh's economy. From a single institution in the 1980s, it has grown into a major segment with a significant share of deposits and investments, reflecting strong public confidence in Shariah-compliant finance.

Until recently, however, its regulatory foundation remained fragmented—relying on conventional laws, central bank guidelines, and decentralised governance. Bangladesh's banking sector now stands at a turning point. Recent reforms signal a shift from a loosely structured framework to a more codified, state-led regulatory regime, driven by Bangladesh Bank.

For decades, Islamic banking operated within a hybrid legal structure. While conventional banks were governed under the Bank Company Act, 1991, Islamic banks depended on supplementary guidance—most notably the Guidelines for Conducting Islamic Banking (2009).

These guidelines defined Shariah-compliant contracts, deposit and investment principles, and standards for accounting, reporting, and liquidity management. They helped bridge the gap between interest-based and profit-and-loss sharing (PLS) systems. However, the absence of a dedicated Islamic Banking Act left the sector without a fully codified legal identity. Regulatory clarity remained limited, particularly in dispute resolution, contract enforcement, and risk management.

Bangladesh Bank has followed a policy of regulatory parity, applying similar prudential standards—such as capital adequacy and risk management—to both Islamic and conventional banks. This has ensured stability and integration within the broader financial system.

At the same time, the central bank has introduced selective flexibility to accommodate Shariah principles, particularly in profit-sharing arrangements. While this dual approach has supported rapid growth, it has also created mismatches. PLS models require distinct regulatory treatment that conventional frameworks do not fully address.

Shariah governance has traditionally been decentralised, with each bank maintaining its own Shariah Supervisory Committee (SSC). These bodies approve products, ensure compliance, and conduct audits. However, differing interpretations have led to inconsistencies across banks.

To address this, Bangladesh Bank has introduced major reforms. In 2025, SSCs were made mandatory, with clear rules on their structure and accountability. Boards of directors are now directly responsible for Shariah compliance, supported by dedicated Shariah secretariats.

A landmark development is the establishment of a central Shariah Advisory Board (SAB) at Bangladesh Bank, effective from January 2026. This body is expected to standardise interpretations, resolve disputes, and guide product development—bringing long-awaited uniformity to the sector.

However, the recent legislative and policy actions mark a decisive shift toward a stronger regulatory framework. The Bank Resolution Ordinance, 2025 formally recognised Islamic banking as systemically important and strengthened the central bank's intervention powers.

A key example was the consolidation of five distressed Islamic banks into 'Sammilito Islami Bank PLC' in 2025. This intervention protected depositors and signalled a move from passive oversight to active regulation. Alongside a comprehensive Shariah Governance Framework, these steps reflect a transition from guideline-based oversight to a more enforceable and institutionalised system.

Consequently, liquidity management has long been a challenge due to the absence of Shariah-compliant instruments. Recent reforms have introduced Sukuk-based liquidity facilities, allowing banks to use Government Investment Sukuk as collateral for central bank support.

In addition, a developing Mudaraba-based interbank market—supported by digital platforms—is helping to create a self-sustaining liquidity ecosystem. These measures are reducing reliance on conventional benchmarks and strengthening operational independence.

Despite this progress, several key challenges remain in Islamic Banking sector. First, the absence of a comprehensive Islamic Banking Act continues to limit legal clarity and consistency. Second, governance concerns persist, including the independence of Shariah boards and variations in audit quality. Third, stronger oversight has exposed issues such as non-performing investments and related-party lending, requiring stricter enforcement. Finally, while liquidity tools have improved, further development of Islamic financial markets and diversified products is essential.

Future progress will depend on consolidating recent reforms. Key priorities include enacting a comprehensive Islamic Banking Act, strengthening the centralised Shariah supervisory system, expanding Islamic financial instruments and markets, enhancing regulatory capacity, and aligning with global standards such as AAOIFI and IFSB. Encouragingly, policymakers are moving in this direction, with plans to adopt international auditing standards and deepen governance reforms.

In fine, Islamic banking in Bangladesh is now a systemically important pillar of the financial sector. The shift from a fragmented, guideline-based model to a more codified regulatory framework marks a significant evolution. Bangladesh Bank's reforms—ranging from centralised Shariah oversight to liquidity innovations—have laid the foundation for a more resilient system.

The next challenge is to deepen these reforms and build a robust institutional structure for sustained growth. If this momentum continues, Bangladesh can strengthen its domestic sector and emerge as a leading hub for Shariah-compliant finance in the region.

The author is a Certified Shariah Advisor and Auditor of AAOIFI, an Islamic banker, and a financial sector analyst.