Islamic Banking in Bangladesh - Essay Example

Research Paper on "Islamic Banking in Bangladesh An way to the light". Executive Summary The prime objective of this report is tofind out the overall situation, performance of Islamic (shariah based) Banking in the banking Industry as well as in Bangladesh and how Islamic Banking system can be "An Way to the Light" for the development of a country. More elaborately this report will show the importance of Islamic Banking, development model for a country through Islamic banking. 1) In the introduction I discussed about how I have conducted this report and what the elements of this report are. 2) Then I give an overview of Islamic Banking & Conventional Banking, difference between Islamic Banking & Conventional banking system and philosophy, principles. 3) In the next part I discussed about the Islamic Banking in Bangladesh and try to show the situation of Islamic Baking through situation analysis. All the data for this analysis has collected from secondary sources. 4) Then I have tried to identify the strength, weakness by SWOT analysis. 5) In the major findings I have identified some major problem for the Islamic Banking system & Islamic Banks. 6) Finally in the recommendation side I gave some suggestions. At last I have made conclusion according to my findings. I hope that authority will consider my model and suggestions and apply them. And by implementing those suggestion Islamic Banking system will climb up and comes popular in future. Table of Contents Page No: Executive Summary i Introduction 01-02 Islamic & Conventional Banking (overview) 02-06 Situation/ Market analysis 07_08 SWOT analysis 08_09 Major Findings 09 Recommendation & Conclusion 09-10 Refrences -- Appendices/Annexure -- Objectives of the Study: The primary objective of this report is to comply with the requirement of my course. But the objective behind this study is something broader. Objectives of the study are summarized in the following manner: Identify Islamic and Conventional Banking. To identify situation of Islamic banking system in Bangladesh. To apply the literature knowledge in the practical field. Scope of the Study: The report will cover About the Islamic banking system, situation of Islamic Banking. Islamic / Shariah based Banking System. Operation of Islamic Banking.. The main focus of the report is the Islamic Banking system; which is indicated a way to the light. Methodology: Research type: It is an exploratory research. Source of data: In this report all-necessary information to prepare are collected from secondary data. Secondary data: I need much information for the report, which we get from secondary data. These are: Annual Report of different banks. Different types of brochures of EXIM Bank Ltd. Books and Journals (Details are available at Bibliography). Research approach: As the research is based on secondary data Traditional Research approach has used as (Query from Internet, Journals, Books etc). Analysis & reporting: I have used different types of statistical tools and computer software for analyzing and reporting my gathered information, such as - Microsoft Excel, Microsoft Word, SPSS. Limitations of the Study: The study had to be completed under certain constraints, which barred it to be more effective. Some of these constraints are listed: Every organization has their own secrecy that is not revealed to others. Another limitation of this study is Banks policy of not disclosing come data and information for various reasons, which could be very much useful. No contacted method used because research conducted based on secondary data. Despite the limitations, I have tried my best to prepare the report. If you find any mistakes please consider it cordially. Islamic Banking: Islamic banking has been defined as banking in consonance with the ethos and value system of Islam and governed, in addition to the good governance and risk management rules, by the principles laid down by Islamic Shariah. Interest free banking is a narrow concept denoting a number of banking instruments or operations, which avoid interest. Conventional Banking: The banking system deal with interest and do not follow the rules of shariah is known as Conventional banking. Usually the conventional banking system deals with the interest factor and in most of the cases we can see that it does not work in a partnership basis with its client. Islamic Banking Vs. Conventional Banking. Conventional Banks Islamic Banks 1. The functions and operating modes of conventional banks are based on fully manmade principles. 1. The functions and operating modes of Islamic banks are based on the principles of Islamic Shariah. 2. The investor is assured of a predetermined rate of interest. 2. In contrast, it promotes risk sharing between provider of capital and the user of funds. 3. It aims at maximizing profit without any restriction. 3. It also aims at maximizing profit but subject to Shariah restrictions. 4. Lending money and getting it back with compounding interest is the fundamental function of the conventional banks. 4. Participation in partnership business is the fundamental function of the Islamic banks. So we have to understand our customer's business very well. 5. It can charge additional money (penalty and compounded interest) in case of defaulters. 5. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds is given to charity. Rebates are give for early settlement at the Bank's discretion. 6. Very often it results in the bank's own interest becoming prominent. It makes no effort to ensure growth with equity. 6. It gives due importance to the public interest. Its ultimate aim is to ensure growth with equity. 7. For interest-based commercial banks, borrowing from the money market is easier. 7. For the Islamic banks, it must be based on a Shariah approved underlying transaction. What is the philosophy of Islamic banking and finance Islamic Shariah prohibits 'interest' but it does not prohibit all gains on capital. It is only the increase stipulated or sought over the principal of a loan or debt that is prohibited. Islamic principles simply require that performance of capital should also be considered while rewarding the capital. "The prohibition of a risk free return and permission of trading, as enshrined in the Verse 2:275 of the Holy Quran, makes the financial activities in an Islamic set-up real asset-backed with ability to cause value addition"4. Islamic banking system is based on risk sharing, owning and handling of physical goods, involvement in the process of trading, leasing and construction contracts using various Islamic modes of finance. As such, Islamic banks deal with asset management for the purpose of income generation. They will have to prudently handle the unique risks involved in management of assets by adherence to best practices of corporate governance. Once the banks have stable stream of Halal income, depositors will also receive stable and Halal income. Along with the entitlement of profit, the liability of risk of loss on capital rests with the capital itself; no other factor can be made to bear the burden of the risk of loss. The following Four principles (discussed below) that make the Islamic banking unique. Riba: The Quran explicitly prohibits riba but does permit trade (al-Quran, 2: 185). It does not clearly mention whether riba is interest or usury. The lack of clarity led to a controversy among the Muslim scholars in the past. However, there now seems to be a general consensus that the term Riba includes any amount charged over and above the principal Gharar: It is speculation or gambling and is forbidden in Islam. Islam allows risk-taking in business transactions, but it prohibits speculative activity and gambling. Any transaction involving the element of speculation like buying shares at a low price and selling them at a higher price in the future is considered illegal. Zakat: It is a compulsory religious payment or tax on the wealth of the rich payable to the poor. It is a built-in mechanism in Islam for ensuring the redistribution of wealth and the protection of a fair standard of living for the poor. Islamic ethics of investment: In Islam, investment in production and consumption is guided by strict ethical codes. Muslims are not permitted to invest in production, distribution and consumption enterprises involved in alcohol, pork, gambling, illegal drugs, etc., even though these enterprises may be profitable. Providing financing for such activities is illegal in Islam. Financial Vehicles of Islamic Banking "The financial vehicles of Islamic banking are numerous, but the most commonly used are those with reference to wadi'ah (safekeeping), mudharabah (profit sharing), murabahah (cost plus), ijarah (leasing), qardh al-hassan (benevolent loan), and musharakah (joint venture)"1. 3.8.1 Wadi'ah (Safekeeping): The Wadi'ah is of two categories: The first category is the current account which, as in conventional banking, gives no return to depositors. It is essentially an arrangement between depositors and banks which allows depositors to withdraw their money at any time but permits the banks to use depositors' money in pursuit of their banking operations. The second category is the savings account, which is also operated on Wadi'ah basis. Mudharabah (Profit Sharing): The mudharabah represents investment accounts which are based on unrestricted contract. These accounts are term deposits that cannot be withdrawn prior to maturity without a penalty. A bank acting as an agent under a mudharabah contract is referred to a mudharib. Murabahah (Cost Plus): Murabahah means a sale of an item on mutually agreed profit. Technically, it is a contract of sale in which the seller declared his cost and profit. Islamic banks have adopted this as a mode of financing. As a financing technique, it involved a request by the client to the bank to purchase certain goods for him. The bank does that for a definite profit over the cost, calculated either on a percentage of cost basis or as a fixed amount. This vehicle is used mostly to assist short-term trade transactions. Ijara (Leasing): Ijara, also known as ijara waqtina (lease and purchase), is a leasing contract whereby a party leases an asset for a specified rent and term. The owner of the asset (the bank) bears all risks associated with ownership. Qardh al-hassan (Benevolent Loan): This is a loan extended on a goodwill basis, wherein the debtor is required to repay only the amount borrowed. However, the debtor may, at his discretion, pay an extra amount beyond the principal amount of the loan (without promising it) as a token of appreciation to the creditor. Muslims consider this type of loan to be the only type that does not violate the prohibition on riba because none is promised or paid. Musharakah (Joint Venture): The Rising Importance of Sukuk Musharakah is a form of an equity participation contract under which a bank and its client contribute jointly to finance a project. It is done through the issuance of "Participation Securities," commonly referred to as sukuk or Islamic bonds. The sukuk is becoming so lucrative that many banks are rushing to set up shariah compliant operation. Reasons to Establish Islamic Banking System in a Country To control inflation To do justice to the depositors To increase the investment To decrease the income discrimination To ensure proper supply & distribution of goods / wealth To increase the financial development of poor's To stabile of the price climb The Genesis of Islamic Banking in Bangladesh At birth, Bangladesh inherited an interest based banking system, which was introduced here earlier when the country was a part of British Colony. Since its inception Bangladesh saw a new trend in banking both at home and abroad. Islamic banking was successfully tries in Egypt During the seventies, Islamic Development Bank (IDB) and a number of Islamic banks at national levels were established in the Islamic world. At home, the Islamic groups were vigorously working for adoption of Islam as the complete code of life. They found Islamic banking in ready form of immediate introduction. Two professional bodies "Islamic Economics Research Bureau" (IERB) and "Bangladesh Islamic Bankers Association" (BIBA) were taking practical steps for imparting training on Islamic Economics and banking to a group of bankers and arranging some national and international seminars/workshops to mobilize local and foreign people and attract investors to come forward to establish Islamic bank in Bangladesh. Their professional and right-thought activities were reinforces by a number of Muslim entrepreneurs working under the aegis of Muslim Businessman Society (MBS). The body concentrated mainly in mobilizing equity capital for the emerging Islamic bank. Due to continuous and dedicated work of the above groups and individuals and active support from the Government, Islamic banking could be a popular form of banking in Bangladesh day by day. Lists of Islamic Bank In Bangladesh there are five Banks whose follow the shariah rules in their overall banking system. These are: 1.0 Arab Bangladesh Bank Limited 2.0 Shahjalal Islamic Bank Limited 3.0 Islamic Bangladesh Bank Limited 4.0 Al-Baraka Bank Limited 5.0 EXIM Bank Limited Comparative Consolidated Balance Sheets: Interpretation11 (Consolidated Balance Sheet given to annexure-1): The Balance Sheet footing of the Islamic Banking Industry increased during the past quarter. The total assets portfolio in the Islamic Banking Sector expanded by 15% to BDT.135, 641 million in March 2007 from BTD.118, 183 million in December 2006. Financings constituted 52% of the total assets and stood at BDT.69, 993 million in March 2007 as compared to BDT.65, 137 million at the end of December 2006, showing an increase of 7%. There was a substantial increase in "Balances with other banks". Balances held by Islamic Banking Institutions at the other Banks increased by 35% to BDT.22, 192 million from BDT.16,383 million. Deposits increased by 11 % to BDT. 93, 068 million as at the end of March 2007 from BDT. 83, 742 million at end December 2006. Industry Progress and Market Share (See annexure-2)12 From the table and the graph we can see that: The progress in the banking industry and market share is good enough. The market share is increasing than last years. In the banking Industry the total asset increase at 0.3%. In the banking Industry the total deposit increase at 0.2%. In the banking Industry the total financing and investment increase at 0.1%. Deposits (See annexure-3)11 Interpretation Total Deposits have increased by 11% from BDT. 83,742 million to 93,068 million. Deposits by customers have increased by 13 % and by financial institutions by 1%. Modes of Financing (see annexure-4)11 Murabaha Financing is almost 40% of the total financing by the IBI's. Second most widely used mode of Finance is Ijarah Financing accounting for about 30% of the total financing. Ratio Analysis (see annexure-5)11 Earning and Profitability Ratios have improved as compared to the last quarter. The asset quality ratios reflect that the quality of financing has improved due to 1% decrease in Non Performing Portfolios coupled with 12% increase in provisions there against. . Strength Unified Islamic Shariah. Guidance of Al-Quran. High quality financial services in export and import trade business in this country. Skilled shariah board. Weaknesses: Right now its not a popular banking system to the world. Insufficient advertising. Limited investment policy. Not a good hand in network. Opportunities: To reach in market penetration through diversified products and banking network. To diversify online facility to more customer. To use of technology from entry level to top level. Can use Muslims positive sentiment about Islamic Banking. Threats: Growth of conventional banking. World runs through interest base banking system. The large threat for the Islamic Banking is terrorism. As it is an Islamic Shariah based bank the negative public sentiment work beside it. : Insufficient Legal protections: As in our country Islamic or shariah based banking is a new concept and there is a lacking of Unified Shariah Rule, it faces a greatest problem of insufficient legal protection. Terrorism: Now a day it is the major problem with the all Islamic banks of the world. There is a negative thinking already imposed with the Muslims and with their religious rulings. And as Islamic Banking system rules by the rule of Allah given in Al-Quran, a negative thinking also works with it. Economic slowdown and Political Situation of the Country: The political instability is the major problem for the banking industry. Because it reduce the overall flow of money within the country. As a result the growth of economy going down. As Islamic banking system concept for this country, people feel more unreliable to invest in Islamic banks, it causes negative reflection for the bank. Inadequate Track Record of Islamic Banking: As Islamic banking is comparatively new concept in this country it do not have a huge track record in the Banking Industry, so some time public got confused at the time of invest in these bank. As a new Concept Islamic banking system is facing some problem. Especially the Local Banks whose are performing the Islamic Banking system are the major sufferer. To avoid these problem Islamic Banks should take some steps which are given below: They should develop IBTC (Islamic Banking Training Center). They should provide training to their employee regularly. They should Increase follow up activity to stop defaulting culture of the borrower. Through providing better service they should Increase their reliability to minimize their problem of inadequate track record. To increase public awareness they should provide more advertisement. By maintaining more and more CSR (Corporate Social Responsibility) they should increase their public image. They should propose to the Central Bank to develop Islamic Inter-Bank money market. References: 1. Ali M. H (2001), A Hand Book of Islamic Banking and Foreign Exchange Operation, 3rd edition, Dhaka. 2. Bhattacharjee, D. and Kumar, S. Saha (1989), "An Evaluation of Performance of NCBs in Bangladesh", Bank Parikrama, Volume - XIV 3. Chakma P.B, Islam M.S, Karmaker S.S (December 1995), Managerial Performace of Islamic Bank: A Critical Review, Journal of Business Studies, Dhaka University, Volume- XVI No.2. 4. Devnath, R.M (2004), "Bangalir Bank Babyasha", 1st edition, Nabajug Paokashani, Dhaka. 5. The balance Sheet and Market Share is available at "www.bangladesh-bank.org". 6. www.EXIMbankbd.com 7. www.abbank.org. 8. www.shahjalalbank.com.bd. 9. www.islamibankbd.com. 10. www.reserve-bank.com/bdbank.ht. 11. Ahmed, Ejaj, 2008, "Islamic Banking & Financing: notun ekta rasta"; University press, Dhaka, Mohakhali. 12. The Daily New AGE, 15th march, 2008, "deshar Islamic banking market scenario dekho" Bokultola press, Samsu road, pg no.4, inner column no-4. **** Reference No. 2,3,12 available in Public Library of Bangladesh, available at: "http://www.publiclibrary.org.bd/". **** Reference No. 6,7,8,9,10 have used for identify the products (Financial Vehicles) in Islamic banking system. Appendices/ Annexure: Read More