Bangladesh’s bet on Islamic banks merger: A turning point or a temporary fix?

Bangladesh is undertaking one of the most ambitious restructurings in its financial history: the merger of five Islamic banks—First Security Islami, Global Islami, Union, Social Islami, and EXIM—into a single state-backed bridge bank. A committee led by a deputy governor of Bangladesh Bank has been assigned to work on the merger plan, and they expect to complete the work by mid-November. 

The merger decision highlights the determination of the government and central bank to manage and address a systemic collapse of the banking system that may have otherwise followed if these banks were liquidated. 

They deemed liquidation more costly than the merger. The merger also aims to protect depositors, safeguard the jobs of bank employees, and stabilise the sector. This bold step could set a new benchmark for reforming Bangladesh's banking industry if implemented with strong governance, regulatory discipline, professionalism, and transparency. That said, significant challenges lie ahead.

In the initial phase, some depositors are likely to withdraw funds to meet overdue needs, temporarily straining the liquidity of the merged bank. There is also a lingering lack of trust due to months of withdrawal restrictions. This trust deficit is reflected in the deposits of these five banks, which fell by 14% between September 2023 and May 2025—from Tk1.58 lakh crore to Tk1.36 lakh crore—impacting the entire Islamic banking sector as well.

As of June 2025, the share of Islamic banks in total banking sector deposits had slipped by 1.17% year-on-year, whereas traditionally, the deposit growth of Islamic banks has generally outpaced that of their conventional counterparts. 

Yet, the merger provides an opportunity to rebuild trust, provided the new entity allows on-demand withdrawals and provides uninterrupted services. However, to manage a possible strain on liquidity, there are proposals for continuing to limit deposit withdrawals and for large depositors to convert their deposits into shares of the merged bank. 

Operationally, the merger will be complex. Integrating core banking systems, reconciling organisational cultures, and rationalising overlapping branch networks will take time and may face resistance. Still, redeploying branches to unserved areas presents an opportunity to expand access to Islamic banking. Some reports citing the Bangladesh Bank say that the merger will be completed within two years, although the claim seems too optimistic.

With Tk2.2 lakh crore in assets, the merged entity is set to become the largest bank in Bangladesh. However, its significant non-performing loans (NPLs) must be noted, which will pose a considerable burden. An asset quality review reveals that Union Bank's NPL ratio stands at 98%, First Security's at 96%, Global Islami's at 95%, while Social Islami and EXIM fare somewhat better at 62% and 48%, respectively. 

Collectively, they represent Tk1.47 lakh crore or 77% of the outstanding investments. Across the whole banking sector, NPLs have also grown sharply, reaching Tk4.2 lakh crore (about 24% of total lending) in March 2025.

The fiscal costs are also considerable. Initially, an estimated Tk35,200 crore in fresh capital will be needed. Around Tk20,200 crore is expected to come from budget allocation, and Tk15,000 crore from institutional contributions and large deposit conversions. In a country with a tax-to-GDP ratio of only 6.6%, the opportunity cost of budgetary support is high.

Still, policymakers appear to have come to an understanding that ensuring the stability of the banking sector justifies the forgone benefits of investing in education, healthcare, infrastructure, and other essential sectors. No disclosures on the economic benefit analysis of this budgetary allocation have been made to the public.

Nonetheless, the government's takeover is planned to be temporary, and once the merger is complete, it is expected to be reprivatised. History offers a cautionary tale regarding state-owned banks. The existing ones have largely suffered from NPLs, necessitating repeated recapitalisation. Between 2009 and 2024, over Tk2.5 lakh crore in capital support was provided to them.

Yet, as of June 2025, four of them held Tk1.46 lakh crore in classified loans, with over 90% considered bad or loss with little chance of recovery. Janata Bank's default rate is 76%, Agrani Bank's 40%, Rupali Bank's 44%, and Sonali Bank's 20%.

Operationally, the merger will be complex. Integrating core banking systems, reconciling organisational cultures, and rationalising overlapping branch networks will take time and may face resistance. Still, redeploying branches to unserved areas presents an opportunity to expand access to Islamic banking. Some reports citing the Bangladesh Bank say that the merger will be completed within two years, although the claim seems too optimistic.

Avoiding a repeat of such a scenario for the state-backed new Islamic bank requires learning from past mistakes. Professional management, insulated from political interference, will be essential. Asset recovery must be systematic and enforced, while accountability must be ensured if success is not delivered. Regulatory independence will also be crucial.

The Bank Resolution Ordinance 2025 and proposed amendments to the Bangladesh Bank Ordinance will provide the regulator with more powers. Yet their exercise must also be effective. However, plans to appoint central bank officials as administrators risk blurring boundaries and creating moral hazards.

A successful merger will represent a turning point for the Islamic banking industry. Ensuring Shariah compliance throughout the merger process is equally critical, but there currently appears to be a deficiency in this regard. 

Going forward, prudential requirements should be tailored to the unique risks of Islamic banking. Through appropriate regulations, Islamic banking must be encouraged to return to its core principles of risk-sharing and responsible financial intermediation, rather than drifting into a risk transfer and debt-based system.

Boards and management should also be held to higher standards of accountability, while Shariah governance, compliance, and competence must become ingrained in their DNA. For too long, auditors and Shariah committee reports have provided hollow claims of a "true and fair view" and compliance. Stakeholders deserve an accurate representation of reality from them, not fiction.

The merger of five struggling Islamic banks into one united entity is a bold experiment. If managed properly, it can buy time to bring discipline, restore confidence, and ultimately reshape Bangladesh's banking system, offering a pathway for replicating the same for other troubled banks, finance companies, and insurance companies.

Yet the risks are real. Success will depend on whether policymakers and bankers can align ambition with execution, and whether this bridge leads to genuine reform rather than another cycle of crisis and bailout. Bangladesh cannot afford to have another "too-big-to-fail" bank on permanent life support. 

Sketch: TBS

Mezbah Uddin Ahmed is a research fellow at the ISRA Institute of INCEIF University in Malaysia. He can be contacted at mezbah-isra@inceif.edu.my

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.