Islamic banking sector in Bangladesh continues to face liquidity challenges: Fitch

The Islamic banking sector in Bangladesh continues to face liquidity challenges, US credit rating agency Fitch Ratings Inc said recently.

"The Islamic banking sector in Bangladesh is a significant part of the country's wider banking sector but continues to face liquidity challenges," Fitch Ratings said on Tuesday (12 September).

"However, liquidity 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," it added.

According to Fitch Ratings, Islamic banks held 25.3% of all domestic industry deposits at end-1H23, albeit down from 28.2% at end-1H22.

"Islamic banks 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 (BDT9.82 billion) at end-1H23," it added.

"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," the rating agency said.

It said Islamic banks' vulnerability to short-term liquidity challenges is demonstrated by the fall in the liquidity coverage ratio (LCR) to 87.7% at end-2022 (end-2021: 188.5%), below the regulatory requirement of 100%.

Conventional banks had adequate liquidity profiles, with an industry average LCR of 154%.

Fitch Ratings said Bangladesh had the eighth-largest Islamic banking market globally at end-2022, with total assets of Tk4,970.7 billion ($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%)," it added.

It said 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," Fitch Ratings said. 

"Many conventional banks are increasing their offering of Islamic products, either through 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 added.

The rating agency further 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 end-1H23."

Fitch hasn't observed Islamic banks passing on losses or not paying profits to depositors.

"Passing losses can increase reputational risk and may lead to customer deposits outflows," it added.

Fitch also expects Bangladesh Bank would not let depositors' bare 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.

Green financing accounted for 3.7% (Tk157.18 billion, or $1.4 billion) of all financing provided by Islamic banks at end-1H23, it said.

"The Islamic finance industry in Bangladesh continues 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,"  Fitch Ratings said.

"The sukuk market is nascent, with outstanding volumes of Tk180 billion ($1.6 billion) as of end-1H23. The takaful sector accounted for 14% of Bangladesh's insurance market as of end-2022, ahead of Jordan (13%), Egypt (13%), the UAE (8%) and Tunisia (5%)," it further added.