The Need for Regulatory Framework for Islamic Banks and

Islamic Financial Institutions in Bangladesh

Md. Abdul Awwal Sarker

Introduction
With the beginning of the 21
st
century, the world is actively considering to prepare a formal
regulatory framework for the Islamic banking and financial institutions to capture the entire
modalities of the modern financial architecture. To this end, necessary processing work has
already been started in many countries of the world. Policy research and building of
institutional framework with appropriate legal foundations are the basic task of this move. The
establishment of ccounting and uditing !rgani"ation of the Islamic #inancial Institutions
$!I#I%, Islamic #inancial &ervices 'oard $I#&'%, International ssociation of Islamic 'anks
$II'%, a group of Islamic banking and financial research and training academies including
universities of high standards are the signal to search the lost Islamic wisdom and apply those
to the present times. (urrently, about )** Islamic banks and financial institutions $I#Is% have
been functioning in line with Islamic &hariah with total combined assets e+ceeding ,& -)**
billion in more than .* countries. This rapid growth has gained considerable attention in
international financial circles where various market participants have recogni"ed their
promising potentials. To tap the potentials of the emerging Islamic markets and funds, a number
of global financial institutions have established Islamic banking &hariah compatible services in
several countries.
Islamic Banking in Bangladesh
'angladesh is the third largest /uslim country in the world with around 1)* million
populations of which 0* percent are /uslim. The hope and aspiration of the people to run
banking system on the basis of Islamic principle came into reality after the !I(
recommendation at its #oreign /inisters meeting in 1012 at &enegal to develop separate
banking system of their own. fter . years of that declaration in 102), 'angladesh established
first Islamic bank. t present, in 'angladesh, out of 32 banks, 4 full fledged Islamic 'anks and
21 Islamic 'anking branches of 1* conventional banks, have been working in the private sector
on the basis of Islamic &hariah. longside, one non5bank Islamic financial institution named
6Islamic #inance and Investment 7imited8 $I#I7% has also been operating in the system as
Islamic 9'#I since 2**1. Islamic banks and non5bank financial institutions in 'angladesh
since their inception have been gaining popularity in spite of some problems in their operation.
:owever, the purpose of this paper is to briefly highlight the development of Islamic banking
and non5banking financial institutions in 'angladesh, necessity of enactment of the Islamic
financial laws and to put forward some suggestions for the policy makers of the monetary
authorities.
Islamic Banking Branches in Conventional Banks
!ne of the important developments in Islamic banking in last few years has been the entry of
some conventional banks in the market and their use of Islamic modes of financing through
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;eputy <eneral /anager and (hief, Islamic =conomics ;ivision > =+ternal =conomics ;ivision, ?esearch ;epartment,
'angladesh 'ank, :ead !ffice, ;haka. !pinions e+pressed in the Paper are the author8s own and do not reflect the view of
'angladesh 'ank or <overnment.
their Islamic branches, windows or units. It necessitates and encourages the globali"ation of
Islamic banking, which includes some of the giants in the banking and finance industry.
'angladesh was not indifferent to this turning move. Presently, 1* conventional banks have
opened 21 Islamic banking branches alongside their interest based branches. These
conventional banks should focus on the safeguards that ensure the Islamic nature of these
branches such as separation and compliance with &hariah. &eparation of Islamic banking
branches includes separation of capital, accounts, staff employed and office. :owever, the most
important thing is compliance with &hariah.
Islamic Non-bank Financial Institutions in Bangladesh
9on5bank #inancial Institutions $9'#Is% represent one of the most important segments of
financial system and play very important role in mobili"ing and channeling resources in
'angladesh. The 9'#Is comprise investment and finance companies, leasing companies etc.
The 9'#Is numbering 20 as of &eptember 2**4 $starting from IP;( in 1021% are regulated by
the #inancial Institutions ct, 100) and the regulations made there under.
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!ut of 20 non5bank
financial institutions, one 9'#I called Islamic Finance and Investment Limited has been
functioning in line with the Islamic &hariah since 10 pril 2**1.
)
Till 2**4, it had opened three
branches. The business performance showed by the I#I7 in the 9'#I sector of the country
during the last five years is commendable. With a very limited resource base in the beginning in
2**1, it had e+celled in mobili"ing deposits and deploying funds. ;eposit recorded a
substantial increase from Tk. 1.*4 crore in 2**1 to Tk. 1*..12 crores in 2**. and investment
from Tk. ).30 crores in 2**1 to Tk. 14).30 crores in 2**..
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This phenomenal growth of this
Islamic 9'#I indicates a growing acceptance of her activities. Therefore, the development of
Islamic banks and Islamic 9'#Is and their growing acceptance in the country in view, it is
necessarily felt that without regulatory standards, this promising sector be in struck in future.
To ensure the right direction and sustainable position of the Islamic banking and financial
sector in the country, importance of Islamic law on finance has been emphasi"ed.
Section II: The Status o Islamic la! on Finance
!ne of the important determinants of financial development is adaptability of law to changing
conditions. daptability underscores the formalism of laws and the ability of legal traditions to
evolve. &pecifically, legal systems that adapt efficiently to the contracting needs of the
economy foster development of the financial system. The @uestion of adaptability of the law to
changing circumstances is vital to the development of Islamic financial system. !ver the
centuries, Islamic law has evolved to a body of Aa highly sophisticated system of rules, covering
the whole field of what the contemporary world perceives as lawA. Islamic laws and rulings
regarding human activities can be divided broadly into twoB devotional matters $ibadat% and
dealings or transactions $muamalat%. The rules and principles of nominate contracts are applied
to new concepts and problems and by the process of analogy, applicable solutions are arrived
at. The most common method of creating financial contracts has been by far the combination of
traditional nominating contracts to create new contracts. nother method of creating new
contracts in the Islamic financial sector is to adopt and adapt conventional productsCcontracts
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'angladesh 'ank, nnual ?eport 2**.5*4.
)
Islamic #inance and Investment 7imited $I#I7% 2**1B &hort Introduction of Islamic #inance and Investment
7imited, ;haka, 2**1.
3
Islamic #inance and Investment 7imited $I#I7%, nnual ?eport 2**.
2
that meet the &hariah criteria. The conventional contracts or products can be modified by
removing the undesirable components to make them comply with the &hariah principles.
A!!lication of the Islamic "egal Infrastructure
s pointed out, most /uslim countries have adopted one of the Western legal systems. The
absence of a comprehensive legal system for a long time resulted in the lack of legal
infrastructure institutions that can support the use of Islamic commercial law during
contemporary times. With the advent of Islamic finance, Islamic financial contracts are being
used, but this is being done in an alien legal environment. =ven if individuals agree to use
Islamic contracts, the laws and courts may not be there to interpret and enforce the form of
these contracts. &uccessful application of Islamic law in contemporary financial transactions
re@uires various supporting legal infrastructure institutions.
To ensure the growth of the Islamic financial industry, there is a need to have dispute settlement
institutions or Islamic courts that understand the form of the contracts so that these can be
interpreted and enforced accordingly. While the whole court system can not be e+pected to
change, a solution is to have special Islamic bench that deals with, among others, financial
transactions. In this regard, /alaysia has adopted several steps to build some legal
infrastructure institutions for Islamic financial industry. t the highest level, the :igh (ourt in
/alaysia has dedicated high court Dudges to oversee litigations related to Islamic banking and
finance. #urthermore, to complement the court system, the Euala 7umpur regional (entre for
rbitration has been enhanced to deal with disputes on Islamic banking and finance for both
domestic and international cases. To ensure the efficient functioning of the Islamic financial
sector, the (entral 'ank of /alaysia has also set up a 7aw ?eview (ommittee to assess the
common law based legislations and to assimilate the &hariah principles.
Section III: "ole o the Bangladesh #overnment and Bangladesh Bank
'angladesh 'ank issued license in 102) for establishment of first Islamic bank in 'angladesh
FIslami 'ank 'angladesh 7imitedG. The 'angladesh <overnment also participated in
establishing first Islami 'ank by taking .H share in the paid up capital. #rom the very
beginning, considering lack of Islamic financial markets and instruments in the country,
'angladesh 'ank granted some preferential provisions for smooth development of Islamic
banking in 'angladesh. mong the preferential provisions, the following are importantB
1% Islamic banks in 'angladesh have been allowed to maintain their &tatutory 7i@uidity
?e@uirement $&7?% at 1*H of the total deposit liabilities while it is fre@uently fi+ed and re5
fi+ed around 1.H to 2*H for the conventional banks. This discriminating provision had
facilitated the Islamic banks to hold more li@uid funds for more investment and thereby generate
more profit.
2% ,nder indirect monetary policy regime, Islamic banks were allowed to fi+ their profit5sharing
ratios and mark5ups independently commensurate with their own policy and banking
environment. This freeness in fi+ing P7& ratios and /ark5up rates had provided scope for the
Islamic banks to follow the &hariah principles independently for reali"ing goals of Islamic
&hariah.
)% Islamic banks could reimburse 1*H of their proportionate administrative cost on a part of their
balances held with the 'angladesh 'ank. This facility has given some scope for enhancement of
their profit base.
)
Role of Bangladesh Bank in #romoting Islamic Banking in Bangladesh
Though there is no complete Islamic 'anking ct till date for controlling, guiding and
supervising the Islamic banks in 'angladesh, some Islamic banking provisions have already
been incorporated in the amended 'anking (ompanies ct, 1001 $ct 9o. 13 of 1001%.
'angladesh 'ank did not set up any separate ;epartment at its :ead !ffice to control, guide
and supervise the operation of the Islamic banks. Inspection and supervision of the Islamic
banks operation are being scrutini"ed by the 'angladesh 'ank as per the general guidelines
framed for the conventional banks. In view of the rapid e+pansion of Islamic banks in
'angladesh, 'angladesh 'ank issued a letter to the Islamic banks to carefully address and
e+amine the upcoming problems in due time. To help actuali"e those, 'angladesh 'ank
identified the following problems and accordingly advised all Islamic banks on .th /arch,
1001 to take appropriate measures on them through mutual discussion and co5operationB
1. ;evelopment of an Inter5'ank Islamic /oney /arket.
2. (onstitution of (entral &hariah &upervisory 'oard.
). Preparation of draft Islamic 'anking ct.
3. =stablishment of Islamic Insurance (ompany.
.. ;evelopment of 9ew #inancial Products in line with Islamic &hariah.
4. (onstitution of (onsortiumC&yndicate by the Islamic banks for large financing.
In !ctober, 2**3, 'angladesh 'ank has issued a /udaraba bond named F$o%ernment Islamic
In%estment BondG on behalf of the government as a first ever Islamic financial instrument in
'angladesh to facilitate the Islamic banks and financial institutions to invest their funds $to be
calculated as an outlet for maintaining &7?%. <overnment Islamic Investment 'ond has been
playing an important role in developing the Islamic financial instruments in 'angladesh.
Islamic banks and financial institutions are actively participating to park their cash surpluses
and enhance their return on their investments. ?ecently, a Focus $rou! on Islamic Banking
has been constituted in 'angladesh 'ank to develop necessary guidelines to facilitate setting up
of Islamic bank, Islamic bank subsidiary or branches in 'angladesh. The group is yet to finali"e
their report. It is hoped that implementation of this guideline will pave the way to bring the
Islamic financial sector in close adherence to &hariah. ?ecently, 'angladesh 'ank has become
member to the Islamic Financial Ser%ices Board, based on /alaysia, the body established to
issue prudential and supervisory standards for the Islamic banking and finance industry. The
e+isting supervisory process and procedures will be redesigned to evolve in line with the best
international Islamic standards. ?egulatory and supervisory standards, which can specifically
address the uni@ue peculiarities of the Islamic banking operations, are necessary to promote
resilience and competitiveness of the Islamic banking sector. In this regard, the work of the
I#&' would act as a catalyst to the development of a stronger and robust supervision
framework in 'angladesh. In addition to that, a &om!etency $rou! on Islamic banking has
been constituted at the ;epartment of 'anking Inspection $;'I% to develop A&hariah
(ompliance (hecklistsA as a tool, for bank supervisors to carryout their supervisory functions.
Section I$: Concluding "emarks and "ecommendations
Promotion, regulation and supervision of the Islamic banks in accordance with the recent
guidelines, laws and regulations seem inade@uate since these are basically based on the
conventional wisdom and practices. These regulatory and supervisory systems, undoubtedly
helps to control their all5out operations with a view to reducing the possibility of their failure,
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promoting the public8s confidence in the banking system and ensuring its stability. 'ut, in case
of Islamic banks, in addition to those, &hariah implementation in the activities of the banks
must also be ensured by the regulators and supervisors. 7ack of enforcement and supervision in
line with Islamic &hariah may lead the Islamic banks into systemic &hariah distress. The
growing integration of financial markets on the eve of financial globali"ation, especially with
their sophisticated markets and their innovative instruments necessitates the development of
new Islamic financial architecture to cope with the challenges posed by them. :owever, to
ensure soundness of the financial and operational conditions of the Islamic banks, central banks
should develop specific rules and regulations. It is to be mentioned here that, 6while financial
soundness may be enough for retaining the confidence of clients of a conventional bank, in the
case of an Islamic bank, &hariah compliance is e@ually important. n Islamic bank could fail as
much due to non5compliance with the &hariah as for financial imprudence. Therefore it should
be ensured that all activities of an Islamic bank comply with &hariah principles8.
.

"ecommendations
. A!!ro!riate "egal Framework for Islamic Banks and Islamic Financial Institutions'
(entral banks or regulatory and supervisory authorities should develop appropriate and full5
fledged legal framework for controlling, guiding and supervising the Islamic banking and
Islamic 9'#I system. It is not sufficient to insert some words or sentences on Islamic banking
methodology in the 'ank companies ct.
(. Basel II) "egal and Regulatory Standards' 'asel II also re@uires Islamic banks to meet
legal and regulatory standards as specified in 'asel II. &ome opine that Islamic banks should
not be subDect to all regulatory measures specified by 'asel II, but they should be subDect to
regulations similar to corporations due to the participation of the investments depositors in the
risk of Islamic banks.
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There are several reasons for Islamic banks to comply with the 'asel II
regulations. Islamic banks are at the stage of growth and their si"es are normally small to
medium. In order for them to gain international recognition, 'asel II compliance becomes a
cornerstone. The standards developed by !I#I and I#&' should be added to the 'asel II,
then the regulatory framework prescribed by the 'asel (ommittee of 'anking &upervision will
bring standardi"ation for the Islamic banks.
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*. &entral Shariah Su!er%isory &ouncil at Bangladesh Bank' To advise 'angladesh 'ank
on &hariah matters and to formulate and implement uniform &hariah principlesCrulesCregulation
for all the Islamic 'anksC Islamic branches of conventional banksC Islamic subsidiary
companies operating in the country, it is necessary to constitute a (entral &hariah &upervisory
(ouncil $(&&(% at 'angladesh 'ank to be performed under the 'oard of ;irectors of
'angladesh 'ank.
+. A Se!arate ,Islamic Banking -e!artment, at Bangladesh Bank' separate AIslamic
'anking ;epartmentA may be established at 'angladesh 'ank to conduct comprehensive
.
l5Iarhi /abid li and I@bal /unawar $2**1%B Islamic 'ankingB nswers to &ome #re@uently sked Juestions, !ccasional
Paper 9o. 3, 2**1, Islamic ?esearch and Training Institute, I;'.
4
:assan /.E., (howdhury /../., KIslamic 'anking ?egulations in 7ight of 'asel II.K, Proceedings of the #ifth :arvard
?esearch #orum on Islamic #inance, pril 12, 2**3
1
&arker $2**.%B Islamic 'anking in 'angladeshB chievements and (hallenges, Iournal of Islamic =conomics and
#inance, Lol. 1, 9o. 1, Iuly5;ecember 2**., a :alf5yearly Iournal of Islami 'ank Training and ?esearch cademy $I'T?%,
;haka, 'angladesh.
.
research in various fields of Islamic =conomics, finance and banking, to conduct field surveys
on different Islamic 'anking and finance issues from time to time, collect data from the field
levelCconcerned institutions and prepare papersCreports on the basis of dataCinformation
collected and surveys conducted, 6to inspect a sample of documents relating to operations, such
as contracts and accounting records to ensure compliance of the operations with the approved
models and Duridical rules, and to issue directives to officials of Islamic banks and Islamic non5
bank financial institutions, in the form of circulars, circular letters, and bulletins, drawing their
attention to common mistakes from a &hariah point of view and ways of avoiding them8.
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The
&hariah5based audit may also be done through this department. This department should have a
number of 6ulama8 in the field of Islamic Durisprudence, who are well versed in financial, legal
and accounting issues.
.. &a!acity Building #rograms for the Regulators and Su!er%isors' The most acute
problem is a general scarcity of @ualified people e@ually conversant with the present inspection
techni@ues and &hariah aspects of Islamic banking. This constraint in turn is a contributing
factor to other weaknesses such as reluctance to adopt proper guidelines and also to conduct
regulatory and supervisory functions in line with the &hariah prescriptions. Therefore, capacity
building programs for the regulators and supervisors of the central banks should be undertaken.
;ifferent training programs for the officers of supervision departments is often conducted
solely on5the5Dob in a less than systematic manner so that skills are ac@uired in a hit5or5miss
fashion. Inade@uacies in training and development affect the supervisor8s ability to build a
skilled, knowledgeable, and competent staff. In addition, off5the5Dob training should be
conducted in a systematic fashion. To have the knowledge on Islamic banking regulation and
supervision, central banks can get help of the Islamic ?esearch and Training Institute of Islamic
;evelopment 'ank as they have already e+celled in research in Islamic economics, banking
and finance and developed different training materials of effective banking supervision in line
with &hariah with the combination of intellectual resources of e+perts in fi@h al5muamalat and
financial sectors as well.

References
1. l5Iarhi and I@bal $2**1%B Islamic 'ankingB nswers to &ome #re@uently sked Juestions, !ccasional Paper
9o. 3, 2**1, Islamic ?esearch and Training Institute, I;', Ieddah.
2. 'angladesh 'ankB nnual ?eport 2**.5*4.
). :assan and (howdhury $2**3%B KIslamic 'anking ?egulations in 7ight of 'asel II.G Proceedings of the #ifth
:arvard ?esearch #orum on Islamic #inance, pril 12, 2**3.
3. Islamic #inance and Investment 7imited $I#I7% 2**1B &hort Introduction of Islamic #inance and Investment
7imited, ;haka, 2**1.
.. Islamic #inance and Investment 7imited $I#I7%B nnual ?eport 2**..
4. &arker $2**.%B Islamic 'anking in 'angladeshB chievements and (hallenges, Iournal of Islamic
=conomics and #inance, Lol. 1, 9o. 1, Iuly5;ecember 2**., a :alf5yearly Iournal of Islami 'ank Training
and ?esearch cademy $I'T?%, ;haka, 'angladesh.
2
l5Iarhi /abid li and I@bal /unawar $2**1%B op. cit.
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