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What is Islamic Banking

Islamic banking refers to a system of banking or banking activity that is


consistent with the principles of the Shari'ah (Islamic rulings) and its practical
application through the development of Islamic economics. The principles which
emphasise moral and ethical values in all dealings have wide universal appeal.
Shari'ah prohibits the payment or acceptance of interest charges (riba) for the
lending and accepting of money, as well as carrying out trade and other activities
that provide goods or services considered contrary to its principles. While these
principles were used as the basis for a flourishing economy in earlier times, it is
only in the late 20th century that a number of Islamic banks were formed to provide
an alternative basis to Muslims although Islamic banking is not restricted to
Muslims.

Islamic banking has the same purpose as conventional banking except that it
operates in accordance with the rules of Shari�ah, known as Fiqh al-Muamalat
(Islamic rules on transactions). Islamic banking activities must be practiced
consistent with the Shari�ah and its practical application through the development
of Islamic economics. Many of these principles upon which Islamic banking is based
are commonly accepted all over the world, for centuries rather than decades. These
principles are not new but arguably, their original state has been altered over the
centuries.

The principle source of the Shari�ah is The Qur�an followed by the recorded sayings
and actions of Prophet Muhammad (pbuh) � the Hadith. Where solutions to problems
cannot be found in these two sources, rulings are made based on the consensus of a
community leaned scholars, independent reasoning of an Islamic scholar and custom,
so long as such rulings to not deviate from the fundamental teachings in The
Qur�an.

It is evident that Islamic finance was practiced predominantly in the Muslim world
throughout the Middle Ages, fostering trade and business activities. In Spain and
the Mediterranean and Baltic States, Islamic merchants became indispensable
middlemen for trading activities. It is claimed that many concepts, techniques, and
instruments of Islamic finance were later adopted by European financiers and
businessmen.

Origin

The origin of the modern Islamic bank can be traced back to the very birth of Islam
when the Prophet himself acted as an agent for his wife's trading operations.
Islamic partnerships (mudarabah) dominated the business world for centuries and the
concept of interest found very little application in day-to-day transactions.

Such partnerships performed an important economic function. They combined the three
most important factors of production, namely: capital, labour and entrepreneurship,
the latter two functions usually combined in one person. The capital-owner
contributed the money and the partner managed the business. Each shared in a pre-
determined share of the profits. If there was a loss, the capital-provider lost his
money and the manager lost his time and labour.

Islamic Banks in the 20th Century

When, in the1960s, Muslim thinkers began to explore ways and means of organising
commercial banking on an interest-free basis, economists dismissed their work as
wishful thinking.

But, in 1963, in Mit Ghamr, in Egypt, the first Islamic interest-free bank came
into being. Mt Ghamr was a rural area and the people were religious. They did not
place their savings in any bank, knowing that interest was forbidden in Islam. In
these circumstances, the task was not only to respect Islamic values concerning
interest, but also to educate the people about the use of banking.

The following types of accounts were accepted:

a) Savings accounts
b) Investment accounts
c) Zakat accounts

No interest was paid on savings accounts, but withdrawals could be made on demand.
Small, short-term, interest-free loans for productive purposes could be made. Funds
in investment accounts were subject to restricted withdrawals and invested on the
basis of profit- sharing. The zakat account attracted the official amount of zakat.

The Mit Ghamr project was successful, as deposits increased from 1963 to 1966. The
bank was cautious, rejecting about 60% of loan applications and the default ratio
was zero in economically good times. But project was eventually abandoned for
political reasons. Nevertheless, it had shown that commercial banking could be
organised on a non-interest basis.

lslamic banks in Bangladesh:


the Islamic banking industry has been growing at a faster rate than the
conventional banks, Shari'ahcompliant
banks still make up a smaller share (approximately one-fifth) of the total banking
sector. During the
third quarter of 2015, the share of total deposits and total investments of Islamic
banks accounted for 21.9% and
17.5% respectively among overall banking sector. Out of all the Islamic banks,
Islami Bank Bangladesh Limited
(IBBL) accounted for the biggest share of deposits (38.7%) followed by First
Security Islami Bank Ltd. (13.6%)
and Exim Bank Ltd. (13.4%). The key profitability indicators -- Return on Assets
(ROA) and Return on Equity
(ROE) -- reveal that Islamic banks' profitability was higher.
The ROA of 0.8%indicates an efficient use of assets whereas ROE of 11.50% indicated
higher earnings in
comparison to their equity position by the Shari'ah-compliant banks compared to
profitability ratios of
conventional banks in 2014. Islamic banks have enjoyed a lower non-performing loan
(NPL) ratio -- a measure
of asset quality in the loan portfolio-of 4.90% compared to 9.70% NPL ratio over
other banks in 2014. Since
Islamic banks historically contain fewer problem loans (except for one bank), they
could gain more robust net
profit, despite their relatively higher provisioning in 2014 than in 2013. A total
of seven out of eight Islamic
banks have been able to achieve the requirement of a minimum Capital Adequacy Ratio
(CAR) of 10 per cent in
2014.
Islamic banks maintain liquidity levels much above their Cash Reserve Ratio (CRR)
and Statutory Liquidity
Requirement (SLR) requirements of 6.5% and 5.5% respectively. Limited sources of
Shari'ah-compliant funds
allow Islamic banks to borrow funds either from the Islamic inter-bank money
market, which came into
existence in 2012, or from the Islamic Investment Bonds Fund issued by the
government.
BB amended Bangladesh Government Islamic Investment Bond (Islamic Bond) Policy,
2004 and this was a
noble development. This was carried out primarily to form a base for the Islamic
bond market and also to
convert excess liquid assets into investment through Islamic bonds. The maturity
period of Islamic bonds was
readjusted to three months and six months to assist the Islamic banks/financial
institutions (FIs) in managing
their funds smoothly. The profit of Islamic bonds will be equal to that of a three-
month fixed deposit scheme of
the issuing Islamic banks that will be inter-changeable among the eligible
individuals and institutions, and will
be used as an instrument for repo operations.
PRODUCTS OFFERED BY ISLAMIC BANKS: Islamic banks traditionally offer four
categories of financial
contracts: deposits, lending, treasury and trade finance. Islamic banks receive
deposits under two modes:
Wadiah and Mudarabah. The funds of Islamic banks are mainly invested in the
following modes: Mudaraba,
Musharaka, Quard, Bai-Murabaha, Bai-Muajjal, Salam and parallel Salam, Istisna and
parallel Istisna, Ijara,
Direct Investment, and Investment Auctioning etc.
According to BB, as of September 2015, Mudaraba Term Deposits are the most popular
followed by Mudaraba
Savings Deposits (MSD) and Special Scheme Deposits among different types of
deposits of the Islamic banking
industry. In case of investments, the highest investments were made through Bai-
Murabaha followed by BaiMuajjal
and Hire Purchase Musharaka Mutanaqisa (HPMM). The majority of the investments made
by Islamic
banks have been towards MSME (micro, small and medium enterprises), business and
trade sector.
The Islamic banking industry also collects and disburses remittances, accounting
and accounted for 33.6% share
of remittances collected by the entire banking industry at the end of the third
quarter of 2015. Among the
Islamic banks, Islami Bank Bangladesh Ltd. occupied the top position (80.2%) in
respect of remittance
collection at the end of September 2015.
Zakat collection and d
The banking landscape in Bangladesh consists of a mix of public, private and
foreign commercial banks. Bangladesh Bank is the central bank of the country,
established soon after the independence in 1971. As with any other central banks of
any
country, Bangladesh bank has the responsibility to control the monetary policies of
the
country, which also includes the control of all commercial banks that are
established
within the country. Islamic banking�s resurgence spread to Bangladesh in 1983 with
the
opening of Islamic Bank of Bangladesh Limited (IBBL).
Following the establishment of the first Islamic commercial bank in the country, an
ever-increasing number of investors were interested to open up other Islamic banks.
Recent statistical data shows that the growth of Islamic banking in Bangladesh is
steadily
progressing day by day, which is contrary to how conventional banks in general are
doing
at present. As of 2011, there are 46 banks working in the financial market of the
country
that includes six Islamic banks and nine foreign banks. Interestingly, Ahmed
et.al.,
(2006) and Ahmad and Hassan (2007) found that Islamic banks in Bangladesh have
shown relatively better performance in terms of loan recovery and various other
financial
measures as compared to its conventional counterpart.

As at the end of March 2017, 8 full-fledged Islamic


banks are operating with 1048 branches out of total 9680 branches of the banking
industry; in addition,
19 Islamic banking branches of 9 conventional commercial banks and 25 Islamic
banking windows of 8
conventional commercial banks are also providing Islamic financial services in
Bangladesh. At the end
of the January-March 2017 quarter, deposits, investments and the investment deposit
ratio of Islamic
banking industry grew by 1.37%, 4.82% and 3.40% respectively while surplus
liquidity and remittances
collection declined by 26.08% and 27.37% respectively compared to the previous
quarter. Islamic
Banking Industry accounted for more than one-fifth share of the entire banking
industry in terms of
deposits and investments at the end of the quarter under review.
Highlights on Islamic Banking Sector in Bangladesh, January-March 2017
? Total Deposits in Islamic banking industry reached at Tk. 190257.70 crores at the
end of JanuaryMarch
2017 quarter, which increased by Tk. 2562.80 crores or by 1.37% compared to
previous
quarter and by Tk. 2438.55 crores or by 14.60% compared to corresponding quarter of
the last year.
? Total Investments (Loans in conventional sense) in Islamic banking sector stood
at Tk. 177093.67
crores at the end of January-March 2017 quarter, which went up by Tk. 8136.19
crores or by 4.82%
and by Tk. 27707.80 crores or by 18.55% compared to previous quarter and same
quarter of the
preceding year respectively.
? Investment-Deposit Ratio (Credit-Deposit Ratio in conventional sense) reached at
0.93 in JanuaryMarch
2017 quarter which was 0.90 at the previous quarter of this year and 0.90 at the
end of March
2016.
? Surplus Liquidity of Islamic banking industry stood at Tk. 8031.62 crores at the
end of JanuaryMarch
2017 quarter, which was lower by Tk. 2833.75 crores (26.08%) and Tk. 1669.80 crores
(17.21%) compared to the previous quarter and corresponding quarter of the
preceding year
respectively.
? Total Remittances mobilized by the Islamic banking sector stood at Tk. 6660.16
crores at the end
of January-March 2017 quarter, which was lower by Tk. 2509.47 crores or by 27.37%
and Tk.
1842.39 crores or by 21.67% compared to previous quarter and same quarter of the
preceding year
respectively.
? The Number of Branches of Islamic banking sector including Islamic
branches/windows of
conventional commercial banks stood at 1092 at the end of the quarter under review
which was 1090
during the previous quarter and 1012 during the same quarter of the last year.
? Total Manpower in Islamic banking sector was 30047 in number at the end of the
quarter under
review which was greater by 871 persons than that of the last quarter and by 1506
persons compared
to the same quarter of the last year

Mobilization of Deposits
Total deposits of Islamic banking industry stood at Tk. 190257.70 crores at the end
of the quarter
January-March 2017, which was higher by 2562.80 crores (1.37%) and by Tk. 24238.55
crores or by
14.60% respectively as compared to the previous quarter and the corresponding
quarter of the preceding
year. Among total deposits, demand deposit was Tk. 21680.90 crores and time deposit
was Tk.
168576.80 crores. The share of total deposits of Islami banks accounted for 22.38%
among all banks
during the period under review.
Total deposits of the eight full-fledged
Islamic banks accounted for 95.24% of
deposits of the Islamic banking industry.
Deposits of 8 full-fledged Islamic banks
stood at Tk. 181207.99 crores as on end
March 2017.
Among Islamic banks, Islami Bank
Bangladesh Limited accounted for the
biggest share of deposits (35.97%) [chart-
1], followed by First Security Islami Bank
Ltd.(14.27%), Exim Bank Ltd. (12.08%),
Al-Arafah Islami Bank Ltd. (11.95%),
Social Islami Bank Ltd. (9.29%), Shahjalal Islami Bank Ltd. (6.88%), Union Bank
Limited (4.24%),
Islami banking branches (2.78%), Islami banking windows (1.98%) and ICB Islamic
Bank Limited
(0.57%).
IBBL
35.97%
ICB
0.57% SIBL
9.29%
AL-Arafah
11.95%
EXIM
12.08%
SJIBL
6.88%
FSIBL
14.27%
Union
4.24%
Islami Banking
Branches
2.78%
Islami Banking
Windows
1.98%
Chart 1: Share of Deposits of all Islamic Banks
(January-March 2017)
5
Types of Deposits
Among different types of
deposits of the Islamic
Banking industry, Mudaraba
Term Deposits secured the
highest position (47.02%)
[chart-2] followed by
Mudaraba Savings Deposits
(MSD) (18.67%), Other
deposits (16.89%),
Mudaraba Special Savings
pension/profit) Deposits
(8.92%), Al-Wadeeah
Current Account Deposits
(4.20%), Mudaraba Special Notice Deposits (3.25%), Mudaraba Savings Bond (0.86%)
and Mudaraba
Hajj Deposits (0.19%) etc.
Investments
Total amount of investments in Islamic Banking industry reached at Tk. 177093.67
crores at the end of
the quarter January-March 2017. During the quarter under review, investments
increased by 4.82% and
18.55% respectively as compared to the previous quarter and the corresponding
quarter of the preceding
year. The share of total Investment of
Islamic banks accounted for 24.10% among
all banks.
Among total investments of Islami banks,
95.47% were made by 8 full-fledged
Islamic banks, 2.71% by the scheduled
banks� Islamic banking branches and the
rest 1.82% by the scheduled banks� Islamic
banking windows. As in the case of
investments, Islami Bank Bangladesh Ltd.
attained the highest share in investments
which was 35.58% at the end of the quarter
January-March 2017, (chart-3). The share of
investments made by other Islamic banks
included First Security Islami Bank Ltd (13.37%), EXIM Bank Ltd. (12.38%), Al
Arafah Islami Bank
Ltd. (11.91%), Social Islami Bank Ltd (10.02%), Shahjalal Islami Bank (7.30%),
Union Bank (4.38%),
Islami banking branches (2.71%), Islami banking windows (1.82%) and ICB Islami Bank
Ltd (0.54%).
Mudaraba Savings
Deposits
18.67%
Mudaraba Special
Notice Deposits
3.25%
Mudaraba Term
Deposits
47.02%
Mudaraba Hajj
Deposits
0.19%
Mudaraba Special
Savings
(Pension/Profit
Deposits)
8.92%
Mudaraba Savings
Bond
0.86%
Al-Wadeea current
Account Deposits
4.20%
Other Deposits
16.89%
Chart 2: Types of Deposits held by Islamic Banks
(January-March 2017)
IBBL
35.58%
ICB
0.54%
SIBL
10.02%
AL-Arafah
11.91% EXIM
12.38%
SJIBL
7.30%
FSIBL
13.37%
Union
4.38%
Islami Banking
Branches
2.71%
Islami Banking
Windows
1.82%
Chart 3: Share of Investments made by Islamic
Banks (January-March 2017)
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Bai-Salam
0.50% Mudaraba
0.40%
Musharaka
1.46%
Bai-Murabaha
48.57%
Bai-Muajjal
19.87%
Bai-Istisnaa
0.22%
HPSM
16.65%
Ijara & Ijara-bil-Bai
7.24%
Quard with Security
1.31%
Others
3.78%
Chart 5: Mode-wise Investment of Islamic Banks
(January-March 2017)
Sector-wise Investments
After analyzing the sector-wise
investment, it can be observed that
investment in the MSME (Micro,
Small and Medium Enterprises)
sector was the highest among all
sectors which stood at 28.09%
(chart-4) at the end of the quarter
January-March 2017. The next
position was occupied by Trade &
Business sector (27.81%) followed
by Industrial sector (25.12%),
Others (8.61%), Real Estate
(6.44%), Agriculture (1.71%),
Transportation (1.50%), Electricity,
Gas and Water supply (0.62%) and
Poverty Alleviation (0.10%).
Mode-wise Investments
The analysis of mode-wise
investment revealed that the
highest investments was made
through Bai-Murabaha mode
(48.57%) at the end of the quarter
January-March 2017, [chart-5]
followed by Bai-Muajjal
(19.87%), HPSM (16.65%), Ijara
& Ijara-bil-Bai (7.24%), others
(3.78%), Musharaka (1.46%),
Quard with Security (1.31%), BaiSalam
(0.50%), Mudaraba
(0.40%) and Bai-Istisna (0.22%).
Investment situation in the Agricultural sector
Islamic Banking Industry has made tangible contributions in sectors and sub-sectors
of agricultural and
rural investment programs. During January-March 2017quarter, investments in
agricultural sector made
by Islamic banking Industry reached at Tk. 958.16 crores which was higher by Tk.
79.27 crores and by
Tk. 319.51 crores than the previous quarter and the same quarter of the preceding
year respectively

Corporate Social Responsibility


Islamic banks undertake and implement various types of social programs under
Corporate Social
Responsibility (CSR) activities. Sources of funds of Islamic banks available for
CSR activities include
Zakat, compensation charges (penal charges from defaulting investment clients) and
Sharia'h-permitted
other sources of earnings. These funds are spent among different types of
education, training, health and
charity-based organizations in Bangladesh. Islamic banks serve the deprived and
disadvantaged
segments of people, who, because of extreme poverty, remain outside the purview of
the conventional
banking system; the banks make financial transactions based on human necessities
and embark upon
productivity-oriented projects or activities to reduce the incidence of poverty.
Expenditure on CSR
activities increased by 48.00% in this quarter compared to the previous quarter. At
the end of JanuaryMarch
2017quarter, total expenditure on CSR activities of Islamic Banking Industry stood
at Tk.65.00
crores which was Tk. 43.92 crores and Tk. 33.52 crores during the previous quarter
and preceding
quarter of March 2017 respectively

OUTLOOK OF ISLAMIC BANKING IN THE CONTEXT OF BANGLADESH: The establishment of


Islamic
banks and adoption of Islamic banking windows by several conventional banks over
the years can be an
indicator of the high acceptability of this sector by the public. The potential of
this banking sector to grow is
tremendous and the reasons are various. One of the main reasons for the continual
rise in demand for Islamic
banking can be attributed to the rise in the Muslim population and their desire to
engage in financial transactions
that are in compliance with the rules of Shari'ah.
The principles of risk-sharing and the strong link of credit to collateral means
that Islamic banking is compatible
with the financing of cottage industries and start-ups, and can contribute to more
inclusive growth. Other
reasons include the superior performance of Islamic banks over conventional banks
as revealed by profitability,
liquidity and capital adequacy indicators