Thesis Report

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Chapter-1: Introduction

1.1 IntroductionIslamic banking and finance is a creation of modern age. Capitalism argues, capital- one of the key factors of production, deserves fixed return whereas the entrepreneurs have to bear all the risks. The conflict of opinions with the Islamic values starts from this very basic point. As the conventional banking systems follow the philosophy of capitalism and interest which is forbidden according to Islamic Shariah, the Muslims made the first move toward the Islamic financial system was observed in the second half of 20th century when the Muslim world got liberation from colonial powers. Conference of Foreign Ministers of Muslim countries (1973) can be marked as a landmark of the growth and popularity of Islamic Financial Institutions (IFIs). Soon after this conference, Bangladesh signed the Charter of Islamic Development Bank August 1974. Analyzing the demand and feasibility of Islamic banking, Islami Bank Bangladesh Limited, the first Islamic bank of Bangladesh was established in March 19833. Currently eight Shariah based Islamic banks are operating in Bangladesh with their significant contributions to the banking industry and to the financial system of the country

1.2 Objectives of the ResearchThe key objectives of the study are: To review the distinctive concepts of Islamic banking To evaluate the current practice and performances of the Islamic banks of Bangladesh To evaluate the potentials and future prospects of Islamic banking systems in Bangladesh

1.3 MethodologyThis is a secondary data based report. Information has been collected from various secondary sources like journal articles, annual reports of different banks, books and different websites. All the existing Islamic banks of Bangladesh are included in this study. The first two objectives of the research are subject to be achieved through the secondary data review and the qualitative discussion. Current Islamic banking practices and the performances of different Islamic banks are measured and analyzed from the financial statements of the banks and information from different relevant websites. Statistical analysis tool SPSS and MS Excel had been used for analysis and graphical presentations.

1.4 Review of LiteratureA significant level of development had been observed in Islamic banking research since the last decade. The western analysts and economists demonstrated their emphasis on the interest-free business transactions. These western economists discovered the connection between the interest rates and some key macroeconomic instabilities like- unemployment, inflation or negative growth (Bernante andGertler, 1990; Fisher, 1933; Greenwald and Stiglitz, 1988; Hayek, 1933 & 1939; Minsky, 1977; Smith, 1904; Wicksell, 1935). In different parts of the world, Islamic banking researches had been mostly conducted by Muslims and a small portion by the non-Muslims. The works of Erol and El-Bdour (1989) and Erol et al (1990) revealed three key selection criteria for Islamic banks: fast and efficient services, reputation and confidentiality. According to their findings, religious motivation was not a prime criterion. On the contrary, Metawa and Almossawi (1998) and Naser et al (1999) found loyalty to Islamic belief the primary criterion for selecting Islamic banks in countries like Bahrain and Jordan. Similarly, some other scholars discovered same findings in their studies in Indonesia, Kuwait and Malaysia (Kader 1993 & 1995; Osman et al, 2009; Othman and Owen, 2001 & 2002; Wakhid and Efrita, 2007). A study on a large number of respondents by Dusuki and Abdullah (2006) discovered that Islamic bankers should not only rely on promoting the Islamic factors but also the necessary service quality. The three most important factors found in their study were competence, friendliness and customer service quality. Hanif & Iqbal (2010) categorized Islamic modes of financing objectively in two heads; Sharia compliant and Sharia based. Later, Hanif (2011) discussed these terms used for modes of financing briefly. He explained Sharia compliant products as the modes of financing where return of financier is predetermined and fixed but within Sharia constraints. The tools which are relatively harmonizing the operations of Islamic financial system with conventional banking includes Murabaha (cost plus profit sale), Ijara (a rental arrangement), Bai Salam (spot payment for future delivery), Bai Muajjal (sale on deferred payment), Istasna (order to manufacture) and Diminishing Musharaka (house financing) are all Sharia compliant products. Sharia based transactions means the financing modes adopted by IFIs on profit and loss sharing basis including Musharaka (partnership in capital) and Mudaraba (partnership of capital and skill). Under Sharia based modes of financing returns of financier are not fixed in advance rather it depends upon the outcome of the project. However loss is to be shared according to capital contribution. Following the rule of substance over form one can conclude that the major difference between conventional and Islamic financing is Sharia based modes of financing.

Mahal & Rahman (2013) made a comparative analysis between conventional and Islamic banks of Bangladesh. They discussed the distinctions of product or serviceand the distinctions in terms of business efficiency between Islamic Banks and Conventional Banks. Their key findings on the product or service differences are about the principles of business, variation in goals, variations in deposit etc. The conventional banks of Bangladesh deal with man-made principles or principles provided by Bangladesh Bank. But Islamic banks follow Shariah based principles under the supervision of BB. Conventional banks currently focusing on the CSR activities but Islamic banks are focusing on the IT development though they also consider the CSR issues. Conventional deposit schemes are like the fixed deposit, savings or short notice deposit and current deposit. The Islamic banks offer through Al-Wadeeah principle and Mudaraba principle. These researchers also discussed the distinctions in terms of business efficiency. Profitability of conventional banks depends on loans and investments both; whereas Islamic banks depends on only investments sectors. Conventional banks have to maintain more SLR (19%) than the Islamic banks (10.5%). Islamic banks do not collect deposits through conventional methods rather on the basis of profit & loss sharing notion.

Chapter-2: Banking Industry of Bangladesh

2.1 Overview of BanksAfter the independence, banking industry in Bangladesh started its journey with 6 nationalized commercialized banks, 2 State owned specialized banks and 3 Foreign Banks. In the 1980's banking industry achieved significant expansion with the entrance of private banks. Now, banks in Bangladesh are primarily of two types:Scheduled Banks: The banks which get license to operate under Bank Company Act, 1991 (Amended in 2003) are termed as Scheduled BanksNon-Scheduled Banks:The banks which are established for special and definite objective and operate under the acts that are enacted for meeting up those objectives, are termed as Non-Scheduled Banks. These banks cannot perform all functions of scheduled banks.There are56 scheduled banksin Bangladesh who operate under full control and supervision of Bangladesh Bank which is empowered to do so through Bangladesh Bank Order, 1972 and Bank Company Act, 1991. Scheduled Banks are classified into following types: State Owned Commercial Banks (SOCBs): There are5 SOCBswhich are fully or majorly owned by the Government of Bangladesh. Specialized Banks (SDBs):3 specialized banksare now operating which were established for specific objectives like agricultural or industrial development. These banks are also fully or majorly owned by the Government of Bangladesh. Private Commercial Banks (PCBs): There are39 private commercial bankswhich are majorly owned by the private entities. PCBs can be categorized into two groups: Conventional PCBs:31 conventional PCBsare now operating in the industry. They perform the banking functions in conventional fashion i.e interest based operations. Islami Shariah based PCBs: There are8 Islami Shariah based PCBsin Bangladesh and they execute banking activities according to Islami Shariah based principles i.e. Profit-Loss Sharing (PLS) mode. Foreign Commercial Banks (FCBs): 9FCBsare operating in Bangladesh as the branches of the banks which are incorporated in abroad.

There are now4 non-scheduled banksin Bangladesh which are: Ansar VDP Unnayan Bank, Karmashangosthan Bank, Probashi Kollyan Bank, Jubilee Bank

2.2 Overview of Non-banksNon-Bank Financial Institutions (FIs) are those types of financial institutions which are regulated under Financial Institution Act, 1993 and controlled by Bangladesh Bank. Now,31 FIsare operating in Bangladesh while the maiden one was established in 1981. Out of the total, 2 is fully government owned, 1 is the subsidiary of a SOCB, 13 were initiated by private domestic initiative and 15 were initiated by joint venture initiative. Major sources of funds of FIs are Term Deposit (at least six months tenure), Credit Facility from Banks and other FIs, Call Money as well as bonds and Securities.

The major difference between banks and FIs are as follows: FIs cannot issue cheques, pay-orders or demand drafts. FIs cannot receive demand deposits, FIs cannot be involved in foreign exchange financing, FIs can conduct their business operations with diversified financing modes like syndicated financing, bridge financing, lease financing, securitization instruments, private placement of equity etc.

2.3 Overview of Islamic Banks

Operational Style of Scheduled banksNumbers of Banks

Full-fledged Islamic banking operationPartial Islamic banking operation Total full-fledged or partial banking operation 8 15

23

Types of Islamic BankBranches/Windows

Full-fledged Islamic banks (8)Convention banks with partial Islamic Banking (8)Conventional banks with partial Islamic window (7) Total 843 19

25

887

List of Islamic banks:

Name of Banks Year of incorporation

1. Islami Bank Bangladesh Limited (IBBL)2. ICB Islamic Bank Limited (ICBIBL)3. Al-Arafah Islami Bank Limited (AAIBL)4. Social Islami Bank Limited (SIBL)5. Export Import Bank of Bangladesh Limited (EXIM)6. First Security Islami Bank Ltd. (FSIB)7. Shahjalal Islami Bank Limited (SJIBL)8. Union Bank Limited (UBL)19831987199519951999199920012013

Portion of Islamic banks in banking industry:

Chapter-3: Evolution of the Islamic banking in Bangladesh

Peoples initiative In the early twentieth century, after the formation of East Bengal and Assam province, centering Dhaka as its capital, the socio-economic development of East Bengal was in a new spur. At that time an initiative was taken to setup and manage interest-free banks in different areas of Bangladesh including Jessore and Cox's Bazar. But those initiatives could not get solid foundation on the backdrop of then socio-economic and political circumstances. Although individual efforts and organizational initiatives continued, however, introduction of Shariah-based banking remained a dream for a long time.

State-level initiatives or interventions After independence, a number of initiatives were taken up from different stages to establish an Islamic bank from the state level. The Bangladesh government signed the IDB Charter in 1974. Member countries, through the signing of the charter, were committed to reconstructing their banking system in consonance withthe Islamic principles.The definition of Islamic banks was approved in the Dakar conference of OIC member countries in Senegal in 1978. Member Countries of the OIC also approved a set of recommendations for gradual transformation of their banking system into Islamic. Bangladesh actively participated in the conference and qualifiedtobecome a partner in implementing the recommendations.

Bangladesh Banks supportiverole From the very inception, the Bangladesh Bank has been playing a highly active and positive role in implementing theprinciplesand procedures of Islamic banks in the country. On 4 April 1981, Ministry of Finance issued a letter to Bangladesh Bank, directing all state-owned banks of the country, on the experimental basis, to open separate Islamic banking counter in all of their branches in towns and villages and to keep separate ledgers for them.In November 1980, A. S. M. Fakhrul Ahsan, the research director of Bangladesh Bank, was deputed to the Middle Eastern countries to see for himself the activities of Islamic banks and Islamic financial institutions operating there. In January 1981, he submitted a comprehensive report with a set of recommendations to initiate the process of settingup Islamic banks in Bangladesh.Later, on 18-19 March 1981, on the initiative of BIBM a two-day seminar on Islamic banking was organized in Dhaka. The then first deputy Governor of Bangladesh Bank M. Khalid Khan inaugurated the seminar as chief guest, where recommendations were taken upto set up Islamic banks in both public and private sectors.On June 9-11, 1981, a senior official of the Bangladesh Bank took part in an international seminar held in Geneva, Switzerland on Islamic Banking and Insurance. On 16 October, 1982, at the 4th Bankers meeting of the Bangladesh Bank, chaired by the then-governor Nurul Islam, decision was taken to introduce Islamic banking in all branches of six state-owned commercial and two specialized banks at metropolitan and district headquarters level as soon as possible.In the light of the decision of Bangladesh Bank and for creation of suitable manpower for Islamic Banking, a one-month long full-time residential course was held on 6 October 1981 at Sonali Bank Staff College. A total of 37 officers from Bangladesh Bank, all state-owned banks, BIBM and then-proposed 'Dhaka International Islamic Bank Limited (now, the Islami Bank Bangladesh Limited) took part in the course. The then Principal of Sonali Bank Staff College M. Azizul Haq played a vital role inthe successful implementation of the course. The opening ceremony was presided over by M. Khaled, the then Chairman and Managing Director of Pubali Bank.While the training course was underway, M. Khaled was appointed second deputy governor of Bangladesh Bank. He was the special guest at the closing ceremony of the training program as the Deputy Governor of Bangladesh Bank.

Other InitiativesFrom 1979 to 1982, a number of public and private institutions in the country took part in the preparatory work for the establishment of Islamic banks. At the time, a `Working Group for the Islamic banking in Bangladesh was constituted under the leadership of M. Khaled. He also led the reorganizing process of the group and subsequently it came to be known as Bangladesh Islamic Bankers Association (BIBA).At that time, several national and international seminars and training courses on Islamic banking were organized by Bangladesh Institute of Bank Management (BIBM), Islamic Economics Research Bureau, Baitus Sarf Islamic Research Institute, Chittagong where, senior bankers, economists and professionals of the country took part. In the meantime, more than 300 bank officials were trained.

Emergence of a real entity A number of local individuals as well as Islamic Development Bank (IDB) and various financial institutions began to extend their cooperation to establish Islamic banks in the country. With the commendableinitiative of Islamic Development Bank (IDB) Kuwait Finance House, Dubai Islamic Bank, Bahrain Islamic Bank, Islamic Investment and Exchange Corporation of Luxemburg, Al-Razi Company for Currency Exchange and Commerce of Saudi Arabia and three Ministry of Kuwait provided 70% capital for the establishment of an Islamic bank for the first time in Bangladesh.The remaining capital came from local entrepreneurs, where Bangladesh Governments share was five percent. On 13 March 1983, Islami Bank Bangladesh Limited was registered as the first shariah-based Bank in South-East Asia and began operation on 30 March of the year. Along the path of success of the countrys first Islamic bank, several Islamic banks were established in later years. In 1987 Al Baraka Bank, in 1995 Al-Arafah Islami Bank and Social Investment Bank and in 2001 Shahjalal Islami Bank were established. On 1 July 2004, Exim Bank and 1 January 2009 First Security Bank have transformed their activities to Islamic banking style. Shariah-based 'Union Bank' was established in 2013.

Chapter-4: Islamic banking system

4.1 Investment principles of Islamic banks There are different modes and mechanisms of investment under the Islamic Shariaah which are mainly categorized are under: 1. Bai Mechanism 2. Sharing or Partnership Mechanism 3. Ijara Mechanism

Islamic banks do not directly deal with money. They run business with money. The funds of Islamic banks are mainly invested in the following modes:1. Mudaraba2. Musharaka3. Bai-Murabaha4. Bai- Muazzal5. Salam and Parallel Salam 6. Istisna and parallel Istisna7. Izara8. Izara Muntahia Bittamleek (Hire purchase)9. Hire Purchase Musharaka mutanaqisa (HPMM)10. Direct investment11. Investment auctioning etc.12. Quard13. Quard Hassan etc

Mudaraba: Mudaraba refers to a contract between at least two parties in which the bank as the investor supplies the entire capital of the business. Hence, a relationship is formed in which banks act as the supplier of capital. The entrepreneur acts as the manager of capital only. When the venture ends, the manager of capital i.e. the entrepreneur pays the entire capital back to the bank, along with an agreed proportion of profit. If there is any loss, it is borne by the bank.

Musharaka: The word Musharaka stands for a partnership that shares both profit and loss. Such joint venture way of financing is designed to limited production or commercial activities of long duration. Under Musharaka, the bank and the customer jointly contribute capital as well managerial expertise and other essential services at agreed proportions. Profit or losses are shared according to the contract agreed upon.

Bai-Murabaha: The word Murabaha means a cost-plus profit/mark-up contract. In this system of financing the bank agrees to purchase for a client. The client will then repay the bank within a stated time period at an agreed upon profit margin. The mark-up price that the bank and the buyer agree to is mainly based on the market price of the commodity. Thus, under Bai-Murabaha mode of financing, the bank earns a profit without bearing any risk.

Bai-Salam: Bai-Salam means a sale in which an advance payment is made for a later delivery. Usually the seller is an individual or business and the buyer is the bank. Bai-Salam benefits both the banks and seller. The banks locks in the price at which the commodities will be purchased and upon delivery can profit for selling the commodities. On the other hand, by receiving advance payments for commodities, the seller can use the money for meeting various financing needs, particularly any working capital requirements.

Bai-Muajjal: Bai-Muajjal refers to a contract resembling credit sale. Under this type of contract, the seller sells certain specific goods to the buyer at an agreed fixed price payable at a certain fixed future date in lump sum or in fixed installments. The sold goods must be allowed under both Shariah and the law of the country. Under this type of financing, Islamic banks buy goods for those who need them and then, receive a fixed payment for the goods at a later date.

Ijarah: Ijara refers to leasing in Islamic finance. Leasing by Islamic banks is very similar to the leasing of conventional banks. It is argued that: The leasing agreement is based on profit sharing in which the bank buys the movable or immovable property and leases it to one of its client for an agreed sum by installments and for a limited period of time into a saving account held with the same bank. These installments are invested in Mudaraba investment for the customers account. The accumulated profit generated from the payments, and the payments themselves are invested in the banks investment ventures over the time period of lease, contributing to eventual purchase of the leased assets. The difference of Islamic banking lease with the traditional lease is that under Islamic banking leasing the risk related to leasing is shared between the lessee and lessor. There are various modes of leasing under Islamic banking, discussion of which does not fall under the specific purview of this report.

Hire Purchase under Shirkatul Meelk: Under this mode of financing, Islamic banks share equity with the client in purchasing some assets. Both the bank and the client share the ownership and the share of benefit and loss in operating the asset. The portion of the asset owned by the bank is leased out to the client for use under specific conditions (like rent) and then, the client buys the banks portion upon agreed upon terms.

Qard: Qard refers to interest-free loan provided by Islamic banks to its clients. According to various authors the main aim of this loan is to help needy people in a society in order to, make them self-sufficient and to raise their income and standards of living.

4.2 Investment system for import/ export business as per Islamic Shariah

Import business The import business is broadly divided into following three categories 1. Import to Commercial goods 2. Import of raw materials for production purpose 3. Import of capital/ machineries

a) Import under the Bai-Murabaha system Bai-Murabaha is a contract between a buyer and a seller under which the seller sells certain specific goods permissible under Islamic Shariah and law of the land of the buyer at a price determined by charging agreed profit, margin or mark up over the cost price. In this case, the buyer either makes cash payment to receive the goods or is allowed to make payments by installments or on a fixed future date. The profit mark-up may be fixed in lump sum or in percentage over the cost price of the goods.

Some features of Bai-Murabaha system: The client(buyer) request the bank to purchase particular goods and promise to purchase the same from the bank at a price fixed by charging profit over the cost price. Under this mode there is no scope to increase the price once it is fixed. After buying the goods the bank has to bear all the risk until goods are actually delivered to the client. b) Import under the Bai-Muazzal system Under this mode of investment, a contract is made between the buyer and seller for buying and selling of goods approved by Islamic Shariah and law of the land on the stipulation to pay the agreed price at a specific future date or by fixed installments. Some features of Bai-Muazzal: most of the features of Bai- Murabaha and Bai- muazzal are alike except the following-

Bai-Muazzal sale is executed completely on deferred payment system The sale price is determined adding the profit with cost price. It is not necessary to disclose the cost price and profit markup separately to the clients. But in Bai-Murabaha, the cost price and the profit mark-up ratios are to be disclosed separately to the client.

c) Import under diminishing proprietorship method (hire purchase under shirkatul Meelk- HPSM) Capital machineries and other re-usable goods are imported under this mode. It combines three modes: rent (Izara)), partnership (shirkat) and buying and selling. Features: The bank and the client invest their capital jointly through a contract called partnership (shirkat) The bank leases its portion at a certain rent The bank sells its portion to the client on receipt of the price under this system.

d) Import under the Musharaka system Musharaka is a Shariah compliant mode of investment wherein the bank and the client jointly provide the capital. Here no prefixed profit is determined like in Bai-Murabaha or Bai-Muazzal. Profit, if any, is distributed as per agreement between the client and the bank while the loss, if any, is shared according to capital ratio. e) Import under Mudaraba system Under the Mudaraba mode of investment, the client or the businessman or capital user does not invest any capital. In this case, the bank alone invests all the required capital and the entrepreneur (the client) directly manages and looks after the business. Under this mode, the bank bears all the expenditures related to imports. In this case, the bank supervises the use of capital, system of business operation and income of the business etc. the client maintains all the registers, documents and accounts concerning buying & selling of the goods. In this case, profit, if any, is distributed between the bank and the client as per the agreed ratio and loss is fully borne by the bank.

Export business

a. Pre-shipment finance i. Back to back letter of credit(back to back L/C) Bank extends back to back L/C facilities to exporters to procure/import raw-materials for producing/ manufacturing exportable goods at pre-shipment stage under the mode of Bai-Muazzal. Initially, no financial facility from the bank is required when the back to back L/C is opened. But if the exporter fails to pay the L/C value at maturity or on due date, the bank provides financial facilities to the client under Bai-Mazzal mode.

ii. Bai-murabaha TR(trust receipt) To procure/purchase raw-materials for executing export order the bank provides investment facilities to the client under the mode of Murabaha TR. In this case, the bank obtains Trust Receipt signed by the client and handover the imported goods to the exporter.

iii. Bai-Salam Under the Bai-Salam mode of investment, payment is made in advance to purchase the goods and the supplier makes promise to delivers the goods at a future date. Investment under Bai-Salam mode is made to meet other expenses of the exporter excepting the manufacturing cost of exportable goods. The bank purchase a portion of goods under the Bai-Salam mode and makes advance payment for the same on the condition that the arrangements will be made by the exporter to export the goods purchased by the bank along with other goods of the exporter.

iv. Musharaka Pre-shipment investment may be made under Musharaka mode of investment if there is any pre-determined investment agreement.

b. Post-shipment finance Bank provides post-shipment facilities through negotiation (FBN) and purchase of export bills. It normally negotiates or purchases the export documents if the documents/bills prepared by the exporter are found in order/correct in all respect. The bank adjusts the liabilities against FBN/FBP after receiving the export proceeds and earns exchange income from this. This mode of investment is in compliance with the Islamic Shariah.

Chapter-5: Performance of Islamic banks

5.1 Current Performance of Islamic Banks Table: Net profits YearIBBL ICB AAIBL SIBL EXIM FSIB SJIBL UB Total Average

2009 2010 2011 2012 20133,403.55 (2,062.21) 858.99 431.52 1,682.99 326.84 1,070.57 - 5,712.25 816.044,485.48 (1,358.24) 1,816.14 640.10 3,458.02 548.60 2,072.34 - 11,662.44 1,666.064,624.59 (1,796.15) 1,992.87 1,032.46 2,017.72 579.94 1,168.65 - 9,620.08 1,374.305,616.75 (1,061.04) 1,694.14 1,465.22 2,083.08 762.29 1,744.45 - 12,304.89 1,757.845,055.36 (680.75) 1524.34 1252.13 1,885.61 776.48 1,305.92 87.34 11,206.43 1400.80

Here, we see that except the ICB, most of the Islamic banks shows remarkable increase in their profitability. Islami Bank Bangladesh Limited, the first Islamic bank of Bangladesh is leading in term of net profit since the last decade. On the other hand, ICB Islami Bank Limited shows net loss in almost all the years of the last ten years. This one is an exception. One reason behind this consistent negative figure in profitability is the change of ownership. The other banks show more or less gradual increase in their profitability or portray the upward trend in financial performance. Union Bank Limited, which is the latest incorporation, hasnt published any official financial statements yet.

Net profit (Average):

Figure: Profitably trend of Islamic banks

5.2 Growth of Islamic banksIslamic banking, a new genre of the Shariah-based banking system, has been able to prove its proficiency and augurits potentials in recent years with the average annual growth of 18 percent, despite the global recession and diverse challenges confronted byvarious banks in Bangladesh pursuing theconventional banking system. A dominant indicatorof the continued growth of the Islamic banking practices is that current assets of more than 500 Islamic financial institutions amounted to be about two trillion U.S. dollars. It is expected that the amount will exceed 5 trillion U.S. dollars in the next five years. Now, Islamic banking has 38 million customers across the globe. Of them, 13 million or 35 percent are in Bangladesh alone. Moreover, the biggest Shariah-based Islamic bank in Bangladesh contains 50 percent of the global microcredit.The Islamic banks have been making significant contributions to the process of poverty reduction, inclusive growth and economic development of the country. Public demand and market share of this approach are growing by degrees. With 18 percent market share, Islamic banking in Malaysia has achieved the fame of Shariah banking center (Hub) of the world. With a limited number of Islamic banking products, the United Kingdom and Singapore are striving to attract Islamic banking in emerging markets through simplification of the financial policies. With more than one-fifth market share of the country, one-third share of the global Islamic banking customers and fifty percent share of the global Islamic microcredit,Bangladesh has the potentialsto be an important center of Islamic banking on the global map with the help of competent leadership, incentives and appropriate branding.

Bangladesh is one of the emerging economies in South Asia. The Islamic banking set out its glorious journey in this country three decades ago. Now, this banking system covers one-fifth of the country's total banking. On the basis of asset value (size of assets) Bangladesh holds 12th position in the global Islamic bank ranking. Considering the financial inclusion or `the nature of distribution rather than `the size of assets, the position of Islamic banking in Bangladesh is quite encouraging.

The average growth of deposit in the banking sector in last five years (2009-2013) was 19% which was 20% for Islamic banks. During this period the average investment growth of countrys banking sector was 18%, which was 20% for Islamic banks. For the same period, the total assets in banking sector increased by 19%. In contrast, Islamic banks have achieved 21% growth. In the last five years, mentioned above, the average growth of equities in Islamic banks was 24%, which was 27% for the total banking sector of the country. A number of public banks have increased their capital in 2013, which has contributed to raise the equity index.

I. Deposits

Total deposit of the Islamic banks stood at Tk. 1,13,360 crore in December 2013, which was 18.00% of total deposits of the country and 29% deposits of the private commercial banks. Total deposits of the Islamic banks stood at Tk. 1,33,561 crore in June 2014.

ii. Number of depositorsIn March 2014, the customer deposits of Islamic banks in the country were 1 crore and 17 lakh, which was 17.92% of the total customer deposits. Until this period, country's total customer deposits for all private commercial banks were 2 crore and 78 lakh, of them 42.12% was in the Islamic banks.

iii. Investment

Total investment of the Islamic banks was Tk. 97,530 crore on December 2013, which was 21% of total investments in the country's banking sector and 30% investment of the private commercial banks. Islamic banks investment stood at Tk. 113,796 crore on June 2014.

iv. Classified Investment On December 2013, 8.90% investment of the country's banking sector was in classified, which was 4.2% for Islamic banks. At the same time, the amount of classified investments in Islamic banks, compared to equity was 39.9%, which was 20% lower than the country's banking sector.

v. Assets

On December 2013, the size of Islamic banks assets stood at Tk. 135,900 crore, which was 17 % of countrys banking assets and 27.40% of the total assets of private commercial banks. Total amount of assets of Islamic banks was Tk. 147,604 crore on June 2014.

Vi. Equity

By following the principles of capital adequacy rules set by the central bank, Islamic banks share in total equity was in a satisfactory level in the past years. Total equity of Islamic banks was Tk. 10,280 crore on December 2013. It is 15 percent equity of the country's banking sector and 23 percent equity share of private commercial banks. Total equity of the countrys Islamic banks stood at Tk. 11,382 crore in June 2014.

vii. Remittance

Hard-earned remittance by Bangladeshi expatriates is one of the main pillars of countrys overall economy. Islamic banks play a significant role in transferring it to beneficiaries. Bangladesh received a total of Tk. 57,044 crore in first 6 months (January-June) of 2014. Of the amount, Tk. 15,952 crore has come through the Islamic banks, which was 28% of the total remittance inflow in the country and 43% of PCBs.

viii. Import The amount of total imports in Bangladesh, during January-June of 2014, was Tk. 167,014 crore. Islamic banks imported over Tk. 34,952 crore; which was 21% of the total imports. The Islamic banks were at the forefront in importing various raw materials and essential goods including fertilizers, cotton, rice, wheat, etc.

ix. Export Total exports of the country, during January-June 2014 period, stood at Tk. 110,096 crore. The amount of Tk. 26,787 crore has been exported through the Islamic banks, which was 4% of total national exports. Islamic banks have been playing a leading role in drawing of foreign exchange through the export of various products including ready-made garments. x. Ratio (Capital Adequacy CAR), ROA, and ROE

Compared to 10 percent Capital Adequacy Ratio (CAR) set by the Central bank, country's banking sector CAR was 11.50% in December 2013. At that time, capital adequacy ratio of the Islamic banks was 12.16%. Total asset-based average net profit (Return on Asset-ROA) for the Islamic banks was Tk. 0.98 during 2012 and 2013. Total equity-based average net profit (Return on Equity-ROE) was Tk. 13.05 and the amount was Tk. 14.11 for the overall banking sector in the same period.

Chapter-6: Problems and Challenges of Islamic Banking in Bangladesh

6.1 Nature of the Problem and ChallengesThe 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:

6.2 Problems Related to Macro Operation of the Islamic Banks1 Liquidity and Capital2 Valuation of bank Assets3 Financial Stability4 The Ownership of Banks5 Lack of Capital Market and Interest-free Financial Instruments6 Insufficient Legal protection7 Controlling and Supervision by the Central bank on the Basis of Islamic Shariah8 Lack of Unified Shariah Rulings9 Absence of Islamic Inter-Bank Money Market10 New Banking Regulations11 Accounting principles and Procedures12 Shortage of Supportive and Link Institutions13 Shortage of Skilled and Trained Manpower in Islamic Shariah banking14 Lack of Co-operation among the Islamic Banks15 Lack of Familiarity by International Financial and Non-financial Sector with Islamic Products and procedures.16 Severe Competition in the Financial Sector17 Economics slowdown and Political Situation of the Country18 Inadequate Track Record of Islamic Banking19 Absence of Infrastructure for International Islamic Trade Financing20 Defaulting Culture of the Borrowers21 Short-term Asset Concentration in the Islamic Banks22 Lack of Course or paper on Islamic Economics, Banking and Finance at the Educational Institutions.23 Lack of Uniform Operational procedure of Islamic Banking24 Lack of Specialized Islamic Banks and Non-Bank financial Institutions25 Lack of Consortium or Syndication of the Islamic Banks26 Lack of Harmonization of Islamic financial Practices27 Lack of Inter-country Study on the practical Operations of Islamic Banking28 Lack of Secondary Securitization Market29 Lack of Coordinated Research Work on Islamic Economics, Banking and finance30 Lack of Apex Training Institute for the Islamic Banks.

6.3 Problem Related to Micro Operation of the Islamic Banks:1 Increased Cost of Information2 Control over Cost of Funds.3 Mark-up Financing and Corrupted Mark-up4 Excess Resort to the Murabaha Mode of Financing5 Utilization of Interest Rate of fixing the Profit Margin in Bai-Modes6 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 Efficiency10 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 Bodies.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.

Chapter-7: The Future of Islamic Banking in Bangladesh

1. Need for Re-organization of the whole financial SystemReview 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 BanksThere 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 there of action.

3. Future Policy and StrategyThe 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 much 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.

4. Stepping for Distributional EfficiencyThe 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 EfficiencyThe 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 practicesIslamic 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 ResponsibilitiesGovernment 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 PlanAll 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 and Apex Research Academy and a Training Institute designed with modern tools. Books and other accessories.

Chapter-8: Findings, Recommendations& Conclusions

8.1 Findings & Recommendations1. Need for appropriate laws and regulations: 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 banks 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. Need for proper policy measure: 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. Need for separations: Having been considered the pro-efficiency character of Islamic banking and its beneficial impacts on the economy, government policy in Bangladesh should be in favor 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, therefore, that prudential regulations of these transactions should be different.

4. Need for separate standards and measures: 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 to 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 becoming a truly national invigorating force.

8.2Limitations of the studyFirst of limitation is that Data related to the year 2014 are not available. So the paper is mostly based on the data of the year 2013 and earlier. For the collection of information, websites, published articles in the journals, voluntary disclosures made by the companies, annual reports, sustainability reports or CSR related disclosures are analyzed.So the verifiability of the information was not properly confirmed.Besides many essential informations were not found for the specific topics and subjects.

Chapter-9: References

REFERENCES

1. Islamic Banking in Bangladesh: Progress and Potentials by Mohammad Abdul Mannan, Managing Director of Islami Bank Bangladesh Limited.2. Chapra, M. Umar (1000), Islam and Economic Challenge, Islamic Foundation, UK.3. Kahf, Monzer, (2002), Strategic Trends in the Islamic Banking and Finance Movement, Harvard University, USA, articles read at a seminar of Harvard Forum on Islamic Finance and Banking (April 6-7, 2002).4. Nienhaus, Volker (2011), Islamic Finance Ethics and Shari'ah Law in the crisis of the aftermath: Concept and Practice of Shari'ah Compliant Finance, in ethical perspectives, volume 18, Issue No. 4.5. Mannan, Mohammad Abdul (2007), Islamic banking system, Central Shari'ah Board for Islamic Banks of Bangladesh.6. World Islamic Banking Competitiveness Report 2013-14, Ernst & Young.7. Journal of Islamic banking and Finance, March 2014, by Salahuddin Yousuf, Md. Ariful Islam, Md. Rayhan Islam.8. Islamic Banking in Bangladesh: Performances, Problems & Prospects, by Abdul Awwal Sarkar.9. Prospects of Islamic banking in Bangladesh by Md. Maruf Ullah and Md. Shahnur Azad Chowdhury.10. Development of Islamic Banking in Bangladesh, April-June 014, Research Department, Bangladesh Bank.11. Financial Stability Report 2013, Issue 4, June 2014, Bangladesh Bank.12. Scheduled Bank Statistics, December 13 & March 14, Bangladesh Bank.