Theory and Practice of Islamic Banking.

Theory and Practice of Islamic Banking.


Islamic banking refers to a system of banking or banking activity that is consistent with the principles of Islamic law (Sharia) and its practical application through the development of Islamic economics. Sharia prohibits the payment or acceptance of interest fees for the lending and accepting of money respectively, (Riba, usury) for specific terms, as well as investing in businesses that provide goods or services considered contrary to its principles (Haraam, forbidden). 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 apply these principles to private or semi-private commercial institutions within the Muslim community.

Classical Islamic banking

During the Islamic Golden Age, early forms of proto-capitalism and free markets were present in the Caliphate,  where an early market economy and an early form of mercantilism were developed between the 8th-12th centuries, which some refer to as “Islamic capitalism”.  A vigorous monetary economy was created on the basis of the expanding levels of circulation of a stable, high-value currency (the dinar) and the integration of monetary areas that were previously independent.

A number of innovative concepts and techniques were applied in early Islamic banking, including bills of exchange, the first forms of partnership (mufawada) such as limited partnerships (mudaraba), and the earliest forms of capital (al-mal), capital accumulation (nama al-mal),  cheques, promissory notes,  trusts (Waqf), startup companies,  transactional accounts, loaning, ledgers and assignments.  Organizational enterprises similar to corporations independent from the state also existed in the medieval Islamic world, while the agency institution was also introduced during that time.  Many of these early capitalist concepts were adopted and further advanced in medieval Europe from the 13th century onwards.


The word “Riba” means excess, increase or addition, which correctly interpreted according to Shariah terminology, implies any excess compensation without due consideration (consideration does not include time value of money). The definition of riba in classical Islamic jurisprudence was “surplus value without counterpart.” or “to ensure equivalency in real value” and that “numerical value was immaterial.” During this period, gold and silver currencies were the benchmark metals that defined the value of all other materials being traded. Applying interest to the benchmark itself (ex natura sua) made no logical sense as its value remained constant relative to all other materials: these metals could be added to but not created (from nothing).

Applying interest was acceptable under some circumstances. Currencies that were based on guarantees by a government to honor the stated value (i.e. fiat currency) or based on other materials such as paper or base metals were allowed to have interest applied to them.  When base metal currencies were first introduced in the Islamic world, no jurist ever thought that “paying a debt in a higher number of units of this fiat money was riba” as they were concerned with the real value of money (determined by weight only) rather than the numerical value. For example, it was acceptable for a loan of 1000 gold dinars to be paid back as 1050 dinars of equal aggregate weight (i.e., the value in terms of weight had to be same because all makes of coins did not carry exactly similar weight)

Modern Islamic banking

The first modern experiment with Islamic banking was undertaken in Egypt under cover without projecting an Islamic image—for fear of being seen as a manifestation of Islamic fundamentalism that was anathema to the political regime. The pioneering effort, led by Ahmad Elnaggar, took the form of a savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in 1963. This experiment lasted until 1967 (Ready 1981), by which time there were nine such banks in the country. This section requires expansion.

In 1972, the Mit Ghamr Savings project became part of Nasr Social Bank which, till date, is still in business in Egypt. In 1975, the Islamic Development Bank was set-up with the mission to provide funding to projects in the member countries. The first modern commercial Islamic bank, Dubai Islamic Bank, opened its doors in 1975. In the early years, the products offered were basic and strongly founded on conventional banking products, but in the last few years the industry is starting to see strong development in new products and services.

Islamic Banking is growing at a rate of 10-15% per year and with signs of consistent future growth.  Islamic banks have more than 300 institutions spread over 51 countries, including the United States through companies such as the Michigan-based University Bank, as well as an additional 250 mutual funds that comply with Islamic principles. It is estimated that over US$822 billion worldwide sharia-compliant assets are managed according to The Economist.  This represents approximately 0.5% of total world estimated assets as of 2005.  According to CIMB Group Holdings, Islamic finance is the fastest-growing segment of the global financial system and sales of Islamic bonds may rise by 24 percent to $25 billion in 2010.

The World Islamic Banking Conference, held annually in Bahrain since 1994, is internationally recognized as the largest and most significant gathering of Islamic banking and finance leaders in the world.

The Vatican has put forward the idea that “the principles of Islamic finance may represent a possible cure for ailing markets.


Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba (usury). Common terms used in Islamic banking include profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing (Ijarah).

In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, a bank might buy the item itself from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to pay the bank in installments. However, the bank’s profit cannot be made explicit and therefore there are no additional penalties for late payment. In order to protect itself against default, the bank asks for strict collateral. The goods or land is registered to the name of the buyer from the start of the transaction. This arrangement is called Murabaha. Another approach is EIjara wa EIqtina, which is similar to real estate leasing. Islamic banks handle loans for vehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor and then retaining ownership of the vehicle until the loan is paid).

An innovative approach applied by some banks for home loans, called Musharaka al-Mutanaqisa, allows for a floating rate in the form of rental. The bank and borrower form a partnership entity, both providing capital at an agreed percentage to purchase the property. The partnership entity then rents out the property to the borrower and charges rent. The bank and the borrower will then share the proceeds from this rent based on the current equity share of the partnership. At the same time, the borrower in the partnership entity also buys the bank’s share of the property at agreed installments until the full equity is transferred to the borrower and the partnership is ended. If default occurs, both the bank and the borrower receive a proportion of the proceeds from the sale of the property based on each party’s current equity. This method allows for floating rates according to the current market rate such as the BLR (base lending rate), especially in a dual-banking system like in Malaysia.

There are several other approaches used in business transactions. Islamic banks lend their money to companies by issuing floating rate interest loans. The floating rate of interest is pegged to the company’s individual rate of return. Thus the bank’s profit on the loan is equal to a certain percentage of the company’s profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is called Musharaka. Further, Mudaraba is venture capital funding of an entrepreneur who provides labor while financing is provided by the bank so that both profit and risk are shared. Such participatory arrangements between capital and labor reflect the Islamic view that the borrower must not bear all the risk/cost of a failure, resulting in a balanced distribution of income and not allowing lender to monopolize the economy.

Islamic banking is restricted to Islamically acceptable transactions, which exclude those involving alcohol, pork, gambling, etc. The aim of this is to engage in only ethical investing, and moral purchasing.

In theory, Islamic banking is an example of full-reserve banking, with banks achieving a 100% reserve ratio. However, in practice, this is not the case, and no examples of 100 per cent reserve banking are observed.

Islamic banks have grown recently in the Muslim world but are a very small share of the global banking system. Micro-lending institutions founded by Muslims, notably Grameen Bank, use conventional lending practices and are popular in some Muslim nations, especially Bangladesh, but some do not consider them true Islamic banking. However, Muhammad Yunus, the founder of Grameen Bank and microfinance banking, and other supporters of microfinance, argue that the lack of collateral and lack of excessive interest in micro-lending is consistent with the Islamic prohibition of usury (riba) 

Shariah Advisory Council/Consultant

Islamic banks and banking institutions that offer Islamic banking products and services (IBS banks) are required to establish a Shariah Supervisory Board (SSB) to advise them and to ensure that the operations and activities of the bank comply with Shariah principles. On the other hand, there are also those who believe that no form of banking can ever comply with the Shariah.[25]

In Malaysia, the National Shariah Advisory Council, which additionally set up at Bank Negara Malaysia (BNM), advises BNM on the Shariah aspects of the operations of these institutions and on their products and services. (See: Islamic banking in Malaysia). In Indonesia the Ulama Council serves a similar purpose.

A number of Shariah advisory firms (either standalone or subsidiaries of larger financial groups) have now emerged to offer Shariah advisory services to the institutions offering Islamic financial services. Issue of independence, impartiality and conflicts of interest have also been recently voiced. The WDIBF World Database for Islamic Banking and Finance has been developed to provide information about all the websites related to this type of banking.

Bai’ al-inah (sale and buy-back agreement)

The financier sells an asset to the customer on a deferred-payment basis, and then the asset is immediately repurchased by the financier for cash at a discount. The buying back agreement allows the bank to assume ownership over the asset in order to protect against default without explicitly charging interest in the event of late payments or insolvency. Some scholars believe that this is not compliant with Shariah principles.

Bai’ bithaman ajil (deferred payment sale)

This concept refers to the sale of goods on a deferred payment basis at a price, which includes a profit margin agreed to by both parties. This is similar to Murabahah, except that the debtor makes only a single installment on the maturity date of the loan. By the application of a discount rate, an Islamic bank can collect the market rate of interest

Bai muajjal (credit sale)

Literally bai muajjal means a credit sale. Technically, it is a financing technique adopted by Islamic banks that takes the form of murabaha muajjal. It is a contract in which the bank earns a profit margin on the purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. It has to expressly mention cost of the commodity and the margin of profit is mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price. (Deferred-payment sale)


Musharakah (joint venture with capital)is an arrangement or agreement between two or more partners,whereby each partner provides funds to be used in a venture. Profits made are shared between the partners according to the invested capital. In case of loss, each partner loses the capital in the same ratio.If the Bank is providing capital, same conditions apply. It is this financial risk, according to the Shariah, that justifies the bank’s claim to part of the profit. All the parnters may or may not participate in carrying out the business. The partner(s) who is/are also working, gets greater profit ratio as compared to the sleeping partner. The Difference between Musharaka and Madharaba is that, in Musharaka, each partner participates with some capital, whereas in Madharaba, there is a capital provider, ie. a financial institution and an entrepreneur, who has zero financial participation. Note that Musharaka and Madharaba are commonly overlapping.


“Mudarabah” is a special kind of partnership where one partner gives money to another for investing it in a commercial enterprise. The investment comes from the first partner who is called “rabb-ul-mal”, while the management and work is an exclusive responsibility of the other, who is called “mudarib”.

The Mudarabah (Profit Sharing) is a contract, with one party providing 100 percent of the capital and the other party providing its specialist knowledge to invest the capital and manage the investment project. Profits generated are shared between the parties according to a pre-agreed ratio. Compared to Musharaka, in a Mudaraba only the lender of the money has to take losses.


This concept refers to the sale of goods at a price, which includes a profit margin agreed to by both parties. The purchase and selling price, other costs, and the profit margin must be clearly stated at the time of the sale agreement. The bank is compensated for the time value of its money in the form of the profit margin. This is a fixed-income loan for the purchase of a real asset (such as real estate or a vehicle), with a fixed rate of profit determined by the profit margin. The bank is not compensated for the time value of money outside of the contracted term (i.e., the bank cannot charge additional profit on late payments); however, the asset remains as a mortgage with the bank until the default is settled.

This type of transaction is similar to rent-to-own arrangements for furniture or appliances that are very common in North American stores.


Musawamah is the negotiation of a selling price between two parties without reference by the seller to either costs or asking price. While the seller may or may not have full knowledge of the cost of the item being negotiated, they are under no obligation to reveal these costs as part of the negotiation process. This difference in obligation by the seller is the key distinction between Murabaha and Musawamah with all other rules as described in Murabaha remaining the same. Musawamah is the most common type of trading negotiation seen in Islamic commerce.

Bai salam

Bai salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are goods and cannot be gold, silver, or currencies based on these metals. Barring this, Bai Salam covers almost everything that is capable of being definitely described as to quantity, quality, and workmanship.

1)  Describe the role of Islamic Banking in Bangladesh.

Islamic banks can provide efficient banking services to the nation if they are supported with appropriate banking laws, and regulations. This will help them introducing PLS modes of operations, which are very much conducive to economic development. It would be better if Islamic banks had the opportunity to work as a sole system in an economy. That would provide Islamic banking system to fully utilize its potentials. Studies show that Islamic banks cannot operate with its full efficiency level if it operates under a conventional banking framework, their efficiency goes down in a number of dimensions. The deterioration is not because of Islamic bank’s own mechanical deficiencies. Rather it is the efficiency-blunt operations of the conventional banking system that puts obstructions to efficient operation of Islamic banks. This does not mean that the survival of Islamic banks operating within the conventional banking framework is altogether threatened. Evidences from Bangladesh indicate that Islamic banks can survive even within a conventional banking framework by which over from PLS to trade related modes of financing.

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. After the Mit Ghamar Model, Naser Social Bank was in the process of establishment. 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 9MBS). 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 established in early eighties.

Islamic banks have been operating in Bangladesh for about one and half decade alongside with the traditional banks. Out of over 39 banks only five banks (including one foreign Islamic bank) and two Islamic banking branches of a traditional bank, Prime Bank Limited (PBL) have been working on Islamic principles. Like any other traditional commercial banks, they do mobilize deposits and produce loans. But their modes of operation, based on shariah, is different from the other traditional commercial banks. However, the five Islamic banks operating in Bangladesh are :

Islami Bank Bangladesh Limited (IBBL)

Al Baraka Bank Bangladesh Limited (Al-Baraka)

Al-Arafah Islami Bank Limited (Al-Arafah)

Social Investment Bank Limited (SIBL)  and

Faysal Islamic Bank of Bahrain EC (FIBB)

Besides the five Islamic banks , as mentioned, Prime bank Limited has opened two islamic banking branches on 18 December, 1995 and 17th December 1997 respectively while Dhaka Bank Limited has strated operation with an Islamic Counter hand to hand at its Principal office Conjuction with conventional banking operations since inception

of the bank on July. 1999.

1 Islami Bank Bangladesh Limited

Islami Bank Bangladesh Ltd., which was incorporated on 14th March, 1983, went into operation on 30th March, 1983 and introduced a full package of banking services in August 1983, Islami Bank Bangladesh Limited is considered to be first interest-bank in South East Asia. IBBL is a public limited company with limited liability under the companies Act, 1913, it is a joint venture multinational bank with sixty four percent of equity being contributed by the foreign sources. Regarding shareholding structure of the bank, the local shareholders hold shares in the ratio of thirty six to sixty four. In December, 1997 the number of its shareholders stood at 6863, its shares are quoted in the two stock markets of the country namely Dhaka Stock Exchange (DSE) and Chittagong Stock Exchange (CSE), Being in high demand the shares are presently sold at three time higher than the face value. Authorized capital of this bank is Tk. 500 million. At present IBBL has a paid-up capital of Taka 317.98 million and Reserve Fund to Taka 930.17 million.

The Bank is managed by 23-member Board of Directors elected by the shareholders, An Extensive committee consisting of 8 Directors and a Management Committee consisting of the top Executives of the Bank also oversee the day-to-day function of the Bank. A representative from the Shariah Council also

take part in the above committee. Powers and functions are suitably distributed amongst these bodies. The bank has also a 10 -member Shariah council consisting of Fuquah, Islamic Economists and a Lawyer. The council gives decision on Islamic issues, which are generally followed in the Bank. The Council conducts audits the operation of Bank branches each year on selective basis and put forward report identify the

deviations and suggestions for purification of the banking transactions. Besides these committees and Council, types of activities for improvement of the Bank’s overall position.

2 Al-Baraka Bank Bangladesh Ltd.

The second Islamic Bank of the country, Al-Baraka Bank Bangladesh Limited commenced banking business as a scheduled Islamic banks on May, 20, 1987. The Bank is also incorporated under the companies Act of 1913 with registered office in Dhaka it is a joint venture Bank of Al-Baraka investment and Development Company 9ABIDCO) of Jeddah, Saudi Arabia, a renowned financial and business house in the world, Islamic Development Bank, a group of eminent Bangladeshi entrepreneurs and the government of Bangladesh. The authorized capital of the Bank is Tk.600 million dividend into 600,000 ordinary shares of Taka 1,000,00 each . Initially, the paid-up capital of the bank was Taka 150,00 million. To increase the capital of the Bank from Taka 150 million to Taka 300.00 million, the Bank offered right shares at 1.1 ratio to the shareholder on August 01.1992. Consequently, the paid up capital of the bank now stands at Taka 259.553 million shares by the different groups. The Bank has been conducting its all banking operations with 32 branches spreader all over the country. The Bank is managed by a 15-member board of Directs elected by the Shareholders. Since the Board of Al-Baraka Bank cannot meet frequently, the day-to-day affairs of the bank are managed by an Executive Council of 7 Directors. Like IBBL it has a Shariah Council which gives decision on shariah issues.

3 Al-Arafah Islami Bank Limited:

Al-Arafah Islami Bank Limited was incorporated in June 18, 1995 and started operation as 3rd Islamic

bank in the private sector banking in Bangladesh from September 27, 1995. The bank is having an Authorized capital of Tk. 1000 million and paid up capital of Tk. 207.6 million. It renders all types of commercial banking services within the stipulation laid down by banking Companies Act 1991 and directives as received from the Bangladesh Bank from time to time. Bank is managed by 23-member Board of Directors.

The Bank has a 7-member Shariah council consisting of Fuqaha, lawyers and Islamic Economists. The

Council gives its advice in order to ensure that the Bank does ntoinvolve any element which is not approved by Islamic Shariah. By August 1998 Al-Arafah Islami Bank opened 21 branches all within the


4 Social Investment Bank Limited (SIBL)

Social Investment bank Limited now social Islamic bank is a fourth Islamic Bank in Bangladesh. It was incorporated on 5th July, 1995 and launched its banking operations of 22nd November, 1995. It nature it is a venture bank of some renowned Islamic organizations of the world and the Government of Bangladesh. At the Operational level, the bank is committed to provide a linkage among the three sectors of the real economy: a) formal sector; b) non-formal sector; and c) Islamic voluntary sector. The authorized share capital of the bank is Taka 1000.00 million divided into one million shares of Taka 1000.00 each At the end of June 1998 the Paid-up capital of the bank stood at Taka 120.00 million. The bank is managed by a 24-member Board of Directors including three foreign directors and its sub-committee. The bank has also a 8-member Shariah Council consisting of Fuqaha, Islamic Economist and lawyer. The Council gives decision on Islamic issues which are generally followed in the bank. By June 1998 Social Investment Bank has opened seven branches all within the country.

5 Faysal Islamic Bank of Bahrain EC, Dhaka, Bangladesh

Faysal Islamic Bank of Bahrain EC, Dhaka has obtained permission to open its branch in Bangladesh on

6th March 1997. The bank started functioning with effect from 11th August 1997. The principal activities of

Bangladesh branch are to provide all kinds of commercial banking services to the customers. All functions of the bank are performed in strict adherence to the principles of Islamic Shariah. In order to ensure such conformity to Shariah, the bank’s operations are checked and monitored by its Religious Supervisory Board (RSB) to whom the management reports periodically. In case of new operations and activities, prior approval of the RSB is invariably by the Bank Management. The Bangladesh branch will also be monitoring by the same Shariah Board i.e. RSB.

6 Other Foreign Islamic Banks Branches Operating in Bangladesh

Besides the above branch of Faysal Islamic bank of Bahrain E.C., there are three more branches of three

Pakistani Banks have been operating in Bangladesh namely habib Bank Limited, National Bank of Pakistan and Muslim Commercial bank Limited. It may be mentioned that in Pakistan, as in evident in many papers that these banks are operating in accordance with Islamic Shariah. But, unfortunately, here, in Bangladesh, branches of these banks are operating as conventional banks, so their operations have been excluded from the purview of this study. Only the activities of Faysal Islamic bank of Bahrain EC isconsidered appropriate for this study.

 7 Islamic banking in Conventional Banks :

It is appropriate to mention that in the country two conventional banks have taken the initiative of limited Islamic banking activities within their present conventional set-up. These two banks are prime Bank Limited and Dhaka bank Limited. The first one has opened two Islamic banks are Prime Bank Limited and Dhaka Bank Limited. The first one has opened two Islamic banking branches one in Dhaka on 18th December 1997 respectively. The Dhaka Bank Limited had opened an Islamic banking deposit counter at its principal office. Dhaka in 1995 to attract the depositors willing to deposit their money in the interest-free account. But, due to the pressing demand of the customers linked with along with the traditional system. Prime Bank Ltd. Is the only bank in Bangladesh which is operating branches on both conventional interest-based banking and Islamic shari’ah based banking other traditional banks of the country are being induced by their successful operations to open full-fledged Islamic banking branches. However, at the operational side the operation of Islami banking branches of Prime Bank Limited are maintained separately from the conventional banking. A shariah Board has also been constituted in order to advise and provide guidance on Islamic banking operations. In order to avoid interest elements of conventional banking a separate set of Accounts are being maintained by the Bank for Islamic banking branches which is completely different from conventional banking branches.

Problems and Challenges of Islamic Banking in Bangladesh

1. Nature of the Problem and Challenges

The Islamic banks in the world have been facing a number of challenges. Side by side, the Islamic banking in Bangladesh is also facing numerous problems of challenges. First, they have not yet been successful in devising an interest-free mechanism to place their funds on a short-term basis. They face the same problem in financing consumer loans and government deficits. Second, the risk involved in profit-sharing seems to be so high that almost all of the Islamic banks in Bangladesh have resorted to those techniques of financing which bring them a fixed assured return. As a result, there is a lot of genuine criticism that these banks have not abolished interest but, they have, in fact, only changed the nomenclature of their transactions. Third, the Islamic banks do not have the legal support of the Central bank in Bangladesh, do not have the necessary expertise and trained manpower to appraise, monitor, evaluate an audit the projects that are required to finance. As a result, they cannot expand despite having huge excess financial liquidity. The implementation of an interest-free banking in Banking raises a number of questions and potential problems which can be seen from the macro and micro operational point of view. A partial list of the issues confronting Islamic banks in Bangladesh include:

2. Problems Related to Macro Operation of the Islamic Banks

1 Liquidity and Capital

2 Valuation of bank Assets

3 Financial Stability

4 The Ownership of Banks

5 Lack of Capital Market and Interest-free Financial Instruments

6 Insufficient Legal protection

7 Controlling and Supervision by the Central bank on the Basis of Islamic Shariah

8 Lack of Unified Shariah Rulings

9 Absence of Islamic Inter-Bank Money Market

10 New Banking Regulations

11 Accounting principles and Procedures

12 Shortage of Supportive and Link Institutions

13 Shortage of Skilled and Trained Manpower in Islamic Shariah banking

14 Lack of Co-operation among the Islamic Banks

15 Lack of Familiarity by International Financial and Non-financial Sector with Islamic Products and


16 Severe Competition in the Financial Sector

17 Economics slowdown and Political Situation of the Country

18 Inadequate Track Record of Islamic Banking

19 Absence of Infrastructure for International Islamic Trade Financing

20 Defaulting Culture of the Borrowers

21 Short-term Asset Concentration in the Islamic Banks

22 Lack of Course or paper on Islamic Economics, Banking and Finance at the Educational Institutions.

23 Lack of Uniform Operational procedure of Islamic Banking

24 Lack of Specialised Islamic Banks and Non-Bank financial Institutions

25 Lack of Consortium or Syndication of the Islamic Banks

26 Lack of Harmonization of Islamic financial Practices

27 Lack of Inter-country Study on the practical Operations of Islamic Banking

28 Lack of Secondary Securitisation Market

29 Lack of Coordinated Research Work on Islamic Economics, Banking and finance

30 Lack of Apex Training Institute for the Islamic Banks.

3. Problem Related to Micro Operation of the Islamic Banks :

1 Increased Cost of Information

2 Control over Cost of Funds.

3 Mark-up Financing and Corrupted Mark-up

4 Excess Resort to the Murabaha Mode of Financing

5 Utilization of Interest Rate of fixing the Profit Margin in Bai-Modes

6 Financing Social Concerns.

7 Lack of Positive Response to the Requirement of government Financing.

8 Failure of Islamic Banks to Finance High Return Projects.

9 Sacrifice of allocative Efficiency

10 Loss of Distributive Efficiency.

11 Depression of Profit.

12 Lack of Full-fledged Shariah Audit.

13 Fraud-Forgery or corruption in Islamic Banks.

14 Minimum Budget for Research and Development.

15 Working Environment.

16 Issuance of Letter of Guarantee (L/G)

17 Minimum Budget for Research and Development.

18 Lack of Shariah Manual or Guidelines.

19 Islamic Investment Risk Analysis and measurement Methodology.

20 Non-exemption of Stamp Duty for Purchasing Property by Banks.

21 Lack of Co-operation between Islamic Banks and Islamic NGOs for extending Microcredit.

22 Lack of Establishment of Links with other Training Institutes and Shariah Supervisory


23 Lack of Intention of the Management to be strict with Shariah Guidelines.

The above problems are some of the burning problems confronting the Islamic banks in Bangladesh. However it is

felt that much operational work and in-depth research work has to be undertaken to allow the Islamic banks to

flourish with highest quality and strength.

The Future of Islamic Banking in Bangladesh

1. Need for Re-organization of the Whole financial System

Review of the problems of Islamic banking in general and Islamic banks of Bangladesh in particular poses a challenging feature for the promotion and survival of Islamic banks in Bangladesh. The policy implication is not that Islamic banks should never be floated within the conventional banking framework. Rather it is the conventional banking system whose operational mechanism needs to be re-examined and converted into PLS system considering beneficial impact of the latter on the economy. However, as long as Islamic banks are to operate within the conventional banking framework, the recommendations under the following heads may be taken note of.

2. New banking philosophy for the Islamic Banks

There seems to be a gap between the ideals and actual practice of Islamic banks in Bangladesh. In their reports, booklets, bulletins and posters there banks express their commitment to striving for establishing a just society free from exploitation. Study shows that a little progress has been achieved so far in that direction. Though this failure is attributed mainly to the pervasive influence of conventional banking system itself, lack of vigilance of the promoters of Islamic banking in realizing the objective is no less to blame. There should be a thorough review of policies that have been pursued by these banks for about a decade and points of departure have to be identified to redesign their of action.

3. Future Policy and Strategy

The first action that deserves immediate attention is the promotion of the image of Islamic banks as PLS banks. Strategies have to be carefully devised so that the image of Islamic character and solvency as a bank is simultaneously promoted. To this end, Pilot schemes in some very selected areas should be started to test innovative ideas with profit-loss-sharing modes of financing as major component. Islamic banks should clearly demonstrate by their actions that their banking practices are guided by profitability criterion thereby establishing that only Islamic banking practices ensures efficient allocation of resources and provide true market signals through PLS modes. Islamic banks should continuously monitor and disseminate through various means the impact of their operations on the distribution of income primarily between the bank and the other two parties: the depositors and the entrepreneurs, and then on different income groups of the society. These presuppose establishment of a fully equipped research academy in each Islamic bank.

Stepping for Distributional Efficiency.

The task is more challenging for Islamic banks, as they have to promote their distributional efficiency from all dimensions together with profitability, Islamic banks, step by step, have to be converted into profit-loss-sharing banks by increasing their percentage share of investment financing though PLS modes. The Islamic banks, to do that, can be selective in choosing clients for financing under PLS modes. They should establish direct functional relationship between the income of the depositors and between the income the income of the bank and that of the entrepreneurs. The relationship improves with share of bank financing under PLS modes increases.

5. Promotion of Allocative Efficiency

The Islamic banks can improve their allocative efficiency be satisfying social welfare conditions in the following manner. First , they should allocate a reasonable portion of their investible funds in social priority sectors such as agriculture (including poultry and fishery), small and cottage industries and export-led industries like garment, shrimp cultivation. Secondly, when the percentage shares of allocation of investible funds are determined among the sectors of investment financing, profitability of projects should be the criterion for allocating investment funds. The criterion would be best satisfied if more and more projects were financed under PLS modes.

6. Modern banking Policies and practices

Islamic banks, with a view to facing the growing competition either fellow-Islamic banks or the conventional banks which have launched Islamic banking practices, will have to adapts their functioning in line with modern business practices, though improvement and expansion of the range of dealing in the banking sector. Thus, it is necessary for them to provide comprehensive banking and investment services to clients and simultaneously to take advantage of modern technological breakthroughs in areas such as electronic communication , computerization etc.

7. Government and Central bank Responsibilities

Government should think actively for the promotion of Islamic banking in Bangladesh considering its pro-development role. It should amend existing financial laws, acts and regulations to create favorable environment conducive to smooth operation of Islamic banks. The bank Reforms Committee may be entrusted to draft an Islamic Banking Act. Government should also allow establishment of Islamic insurance and other subsidiary companies in order to facilitate their operation. Bangladesh Bank should develop some Islamic Monetary and Saving instruments and create separate window for transactions with the Islamic banks and a full-fledged Islamic banking Department for analyzing, supervising, monitoring and guiding purpose, thereby facilitating Islamic banks for their smooth development in Bangladesh.

8. Inter-Islamic Bank Co-operation and Perspective Plan

All Islamic banks should come forward to help each others and adopt a perspective plan say for 20 years for Islamization of the banking system of Bangladesh. To actualize this mission, they should set-up immediately andApex Research Adademy and a Training Institute designed with modern tools. Books and other accessories.

Conclusion and Implication

1. Islamic banks can provide efficient banking services to the nation if they are supported with appropriate banking laws, and regulations. This will help them introducing PLS modes of operations, which are very much conducive to economic development. It would be better if Islamic banks had the opportunity to work as a sole system in an economy. That would provide Islamic banking system to fully utilize its potentials. Studies show that Islamic banks can not operate with its full efficiency level if it operates under a conventional banking framework, their efficiency goes down in a number of dimensions. The deterioration is not because of Islamic bank’s own mechanical deficiencies. Rather it is the efficiency-blunt operations of the conventional banking system that puts obstructions to efficient operation of Islamic banks. This does not mean that the survival of Islamic banks operating within the

conventional banking framework is altogether threatens. Evidences from Bangladesh indicate that Islamic banks can survive even within a conventional banking framework by which over from PLS to trade related modes of financing.

2. Even under the conventional banking framework Islamic banks can operate with certain level of efficiency by applying in a reasonable percentage the PLS modes. The distinguishing features of Islamic banking. This has been possible in some countries of the Muslim world where the management of Islamic banks was cautious about possible impacts of every policy measure. Particularly, the management of these banks was judicious in selecting sectors or areas as major of their operations. Sudan Islamic banks is a typical example in this respect. Islamic banks in Bangladesh have much to learn from the experience of this successful Islamic bank.

3. Having been considered the pro-efficiency character of Islamic banking and its beneficial impacts on the economy, government policy in Bangladesh should be in favour of transforming conventional banking system into Islamic banking. It is reasonable to assume that risks involved in Mushraka or Mudaraba financing are different from those involved in trade-type financing. It follows, therefor, that prudential regulations of these transactions should be different.

4. Determination of profit and loss in profit/loss sharing arrangement and treatment of costs and reserves in such accounting is a pertinent issue to be addressed with utmost importance and priority. However, Islamic banking is a very critical institution to materialize the economic objectives of Islam. It should however, be noted that it is ot the whole of the Islamic framework. Compared to the conventional banks it is very much viable by itself, but the full impact of it can only be realized by supplementing it with corresponding reforms in other spheres of life in general, and in the monetary and fiscal fields in particular.

Finally, it may be mentioned that if the Islamic financial system, is to become truly liquid and efficient it must develop more standardized and universally (or at least widely) tradable financial instruments. The development of a secondary financial market for Islamic financial products is crucial if the industry is to achieve true comparison with the conventional system. It must also work hard to develop more transparency in financial reporting and accounting and ideally – a form of Islamic GAAP. Development if the whole sale and especially inter-bank and money markets, will be the key to Islamic finance growing outside its current little sphere of influence, and becominga truly national invigorating force.