Professor Dr Mohammad Kabir Hassan is a Bangladeshi-American Professor of Finance at the Department of Economics and Finance, University of New Orleans. He is the winner of the 2016 Islamic Development Bank (IDB) Prize in Islamic Banking and Finance. In a recent interview with Prothom Alo, he speaks at length about economic issues and financial systems
Islamic Economics, Banking and Finance
What makes Islamic finance an appealing option for investors?
Islamic finance focuses on adhering to Shariah standards, thus providing financial services and products both to Muslim investors looking to invest only in Shariah-compliant assets and secular investors looking to invest in ethically-based assets. The essential purpose of Islamic finance is to achieve the objectives set forth in Shariah law: maintaining high ethical values, creating wealth to be equally distributed in the community, and protecting religion, life, lineage, intellect, and wealth. This stands in stark contrast to conventional finance, which focuses purely on profit maximization.
Usury (riba), gambling (maisir), and ambiguity (gharar) are prohibited by Shariah law. Because of these high standards of business practice, the market share of the Islamic Finance industry has grown substantially and rapidly. The principles of Islamic finance advocate fairness in payoffs and reward structures and embrace socio-economic justice amongst all. There is a growing movement to invest in assets that contribute to society and are managed in an ethical manner which is evidenced by the increasing market share of Islamic Finance on an international scale.
There are eight banks in Bangladesh which run the entire operations under the sector of Islamic banking, abiding to Shariah law. Seven of them are listed as actively engaging in corporate social responsibility initiatives that help the vast underprivileged population in the country. One study shows that the aggregate spending is about USD 52 million annually which is high. However, more significant impact can be made through the implementation of a joint CSR strategy among the institutions.
Extensive continuation of high donations in a few sectors proves to be more impactful that distinctly smaller and more occasional donations across several sectors. Especially with the turmoil from the pandemic, the disparity of socio-economic situations has widened. This is coupled with lower liquidity and cash flow in the economy of Bangladesh. The Islamic banks joining together can really tackle the issue.
Yes, there is a healthy debate on the issue of riba, on the question of whether riba’s mention in the Quran is the same as the interest we find in modern day financial systems. This is a theological debate, and this debate will continue. What I try to find is the economic meaning of riba and how it affects an economy. My reading of this debate is that those who oppose Islamic finance do so on an incomplete understanding of what is described in the Holy Quran and the Hadith and Islamic jurisprudence. I must say that this group is in the minority.
But there is also criticism of current Islamic banking practices. We hear about the similarities of Islamic banking and western banking operations. Can you shed light on this issue?
Yes, in many ways the current practices of Islamic banking are very similar to the western banking system, but these practices are not illegal from Islamic Shariah perspectives. Here we are in the debate again on “form versus substance”, a kind of micro vs macro analysis of interest-free banking system. In form wise, Islamic banking practices are legal, but substance wise, they are very similar to conventional banking operations. And it will be like this because the western banking model is not suitable for actualisation of Islamic finance.
Islamic finance is not only about banking as we see in many countries. Banking, in its very nature, is short-term, regardless of Islamic or western. Islamic finance contains banking, capital markets, insurance, social finance, zakat, waqf and charitable sectors. Islamic finance is about sharing risk, not transferring between debtors and creditors. We need to establish non-banking financial institutions to bring forth the essence of Islamic finance, which is not possible through only Islamic banking operations. Despite this fact, even Islamic banking operations are asset-based lending, so it puts a break on excessive debt creation, which does not help economic growth in the long run.
The Islamic finance industry started in 1983 through the establishment of the first Islamic bank in Bangladesh, Islamic Bank Bangladesh Limited. Islamic banking is about 25% of the total banking sector in Bangladesh with an annual growth rate of 14%, greater ROE and lower non-performing loans compared to conventional banking system.
According to IFSB (2020), at end of December 2019, eight full-fledged Islamic banks and 17 conventional banks with Islamic banking branches/ windows (with two of the conventional banks having both Islamic banking branches and windows) are providing Islamic financial services in Bangladesh. Three conventional banks (presently providing Islamic financial services through Islamic banking branches/windows) have licenses for operating full-fledged Islamic banking.
In terms of deposits and investments, at the end of December 2019, the Islamic banking industry in Bangladesh has accounted for one-fourth the share of the entire banking industry. The total banking system deposit of Bangladesh grew at 12.57% while the total loans grew at 10.23% from 2018 to 2019. Non-performing loans (NPLs) decreased significantly in 2019. The strenuous effort of the Bangladesh Bank has made it possible to reduce the NPL level and ensure deposit and loans and advances (investment) growth of the Islamic banking industry.
In terms of assets, Bangladesh ranks at 11 in global Islamic banking ranking. Financial inclusion is a built-in concept of Islamic finance and Bangladesh has become a role model in Islamic financial inclusion in the world. With more than 25% of the country’s private banking sector, 35% of the world’s Islamic banking customers and 50% of the global Islamic microcredit, Bangladesh is a dominant player in the global Islamic finance industry. Islamic banks contribute 28% of their investment funds to small and medium scale industries (SME). Bangladesh Bank has introduced a Shariah based refinancing scheme to the agro-based and SME industry.
Bangladesh has also issued short-term sukuk bonds to facilitate short-term liquidity management of Islamic banks. Islami Bank Bangladesh Limited also introduced the first corporate Mudaraba Perpetual Bond (MPB), which is very similar to sukuk except its perpetual tenure.
Islamic finance in Bangladesh promotes financial inclusion through promoting risk-sharing contracts such as murabaha, mudaraba and musharaka. Operating side by side of conventional banks, Islamic banks have become of systemic importance in the financial landscape of Bangladesh. But there is no Islamic banking or finance law in Bangladesh. Currently, Islamic banking is regulated by the Bangladesh Bank circulars. It is probably the right time for the government to develop and enact an Islamic Banking Law, and laws for other non-banking financial sectors in Bangladesh. I am willing to help the Bangladesh government and financial authorities to help develop such laws in Bangladesh.
Bangladesh has already become an important player in the global Islamic finance industry. But there is more to be done. First, it is very important that the Bangladesh Government make and enact regulations supporting this industry. Second, there are four gaps that need to be filled for sustainable growth of this industry.
• Communication: Misconceptions, misunderstandings and misplaced notions about Islamic Finance must be removed through awareness and advocacy programme.
• Trust: Social Business and Impact Investing should be emphasized to remove tensions among the stakeholders of the Islamic finance industry.
• Innovation: Balance between Macro and micro maqasid should be maintained, the so-called form versus substance (financial engineering).
• Talent: A new brand of scholars who are well versed in Islamic jurisprudence and secular financing techniques and mechanisms must be nurtured.
Impact investment is particularly well suited in frontier and beyond-frontier Muslim-majority markets; therefore, Islamic finance impact investing as a platform should be focused on these markets. Many such markets – for example, Bangladesh, Pakistan, Egypt, Morocco, Nigeria, and Kazakhstan – are compelling investment destinations based on their attractive demographics, economic growth, and non-correlated investment returns. At the same time, the social aspects of these markets need to be considered.
These aspects are also central to the motivations of many key investors (such as development finance institutions like the Islamic Development Bank Group, the International Finance Corporation, the European Bank for Reconstruction and Development, the Commonwealth Development Corporation, and the Overseas Private Investment Corporation) when deciding on investing in such markets.
How are regulations adapted to apply to Islamic finance and banking?
The most common international standards used when developing regulatory infrastructure is the Basel committee for banking supervision, but IFSB and AAOIFI are also frequently used. The advent of national Shariah boards and national Shariah compliance measures would serve to better fulfill the needs of Islamic finance. Strong regulatory systems are needed to encourage the growth of Islamic finance. This is especially important for Islamic banking and can be achieved by creating tax regulations that enhance the Islamic financial infrastructure, value equity over debt, and provide strong governance.
Bangladesh achieved GDP growth its percent trajectory of 6.0+ in the past two decades or so and reached its highest growth rate of 8.5% in FY2018-19. However, due to COVID-19, the GDP growth rate declined to 5.2% in FY2019-20. Still Bangladesh has projected 8.2% GDP growth at the end of FY2020-21. How realistic is this target?
It is true that Bangladesh attained a very steady growth trajectory in the past two decades. However, it is very hard to anticipate that the post COVID macroeconomic scenario will be the same as before since COVID is a new experience to the world economy and Bangladesh as well. In the absence of a vaccine or effective treatment, it has forced governments worldwide to implement large-scale containment measures. This has resulted in a global economic contraction. We can project if we categorically assess the macroeconomic identities that reflect GDP, for example, consumption, investment (both private and public), government expenditure and net export.
A recent Brac survey says, the COVID-19 pandemic has forced 95% of people across the country to suffer a loss in their income. If income reduces, consumption demand will fall. Although export earnings show a positive trend in the past three months (July-September, 2020), people are still struggling, due to job loss, to manage their basic needs, and private investment has been stalled due to uncertainty caused by the COVID outbreak. Even government investments, including mega projects like metro rails, are not progressing. Therefore, without accelerating all these macroeconomic parameters it would be hard to attain such a high percent (8.0+) of economic growth.
The government has declared several funding facilities for export-oriented industries, such as BDT 5,000 crore to pay the salaries and allowances to workers and employees of RMG sector. This increases the export development fund (EDF) from USD 3.5 billion to USD 5.0 billion at a reduced interest rate, pre-shipment credit refinance scheme of BDT 5000 crore through Bangladesh Bank. These measures have brought some positive results: export earnings the last three months (July-September 2020) are USD 989 crore which is 2.58% higher than the export of the same period in 2019.
Apart from this, a loan facility for BDT 300 billion (BDT 30,000 crore) has been created for affected large industries in the form of working capital loans and BDT 200 billion (BDT 20,000 crore) for cottage, micro, and medium enterprises at a subsidized interest rate. Since the fund is being provided by commercial banks (government contributes in interest subsidy), disbursement of these loanable funds depends on the loan portfolio decision of the commercial banks. This means banks will come forward to help affected industries after doing a strict cost-benefit analysis.
Moreover, recently (April 1, 2020) the government/Bangladesh Bank decided on a policy to put a lending interest rate cap at 9.0 percent for banks for all types of loans and advances (except credit cards). This has created additional pressure on banks, particularly, to administer small, micro, and SME loans because of their higher administrative and monitoring costs.
The higher economic growth could not create adequate job opportunities in Bangladesh; although, the country has been in 6.0+ growth trajectory for the past two decades or so. The latest Labour Force Survey (LFS) [2016-17] of BBS shows the youth unemployment rate is 12.3%. I have categorically mentioned youth unemployment because currently the youth population dominates the total population of the country and the share of unemployed youth in total unemployment is 79.6%.
The LFS shows employment grew at an annual rate of 3.1% during 2003-10; however, the trend was reversed during the period of 2010-16 with job growth falling to 1.8 percent annually, below the 2.1 percent growth in labor force. Perhaps automation in the readymade garment industries (RMG) causes lower demand for unskilled labor. Since women are mostly employed in the RMG sector, female employment has been experiencing a declining trend since 2010. A recent government study [2019], conducted by the General Economics Division under the Ministry of Planning, has endorsed the fact that the country has made little progress in creating jobs in the industrial sector. Currently, 90% of the jobs are created in the informal sector in Bangladesh according to the ILO [World Employment and Social Outlook: Trends 2018].
Bangladesh Institute of Development Studies (BIDS) has estimated the unemployment rate among university graduates is 38.6 percent while LFS finds 46% of the unemployed people to be graduates. I think mismatches between education and industry demand, lack of collaborations between university and industry, could be reasons for such unemployment. Another reason for lower employment demand from the private sector is stagnant private investment for the past few years for various socio-political reasons. In the public sector, the government achieved half of the employment target, creating only 17.8 lakh jobs during 2016-2017 whereas, the target was 39 lakhs under its Seventh Five Year Plan (2016-2020).
Since most of the working population is employed in the informal sector, the COVID-19 outbreak has worsened the employment situation in Bangladesh. The Asian Development Bank has anticipated 1.4 million people will be jobless due to the pandemic. A recent World Bank survey says 76% of job losses are in Dhaka and 59% in Chattagram due to the pandemic. According to BGMEA (Bangladesh Garment Manufacturers and Exporters Association), around 70 thousand RMG workers have already been retrenched by 106 RMG factories. Apart from job loss, 82% of employees and workers have been earning less compared to the pre COVID time.
Many private firms including banks and FIs have reduced salaries and allowances to the employees. However, recently the government has created a special fund of BDT 2,000 crore to provide loans to small and young entrepreneurs through three specialised banks, Palli Sanchay Bank, Probashi Kalyan Bank, and Karmasangthan Bank and one lending institution Palli Karma Shahayak Foundation. Moreover, a special budgetary allocation for BDT 100 crore has been made to create self-employment opportunities for the poor.
The recent World Economic Outlook report has been a light for Bangladesh in what has been a difficult year globally. It is projected to lead South Asia with a GDP per capita of $1,888 – ever so slightly more so than India with a projection of $1,887 GDP per capita. This is a positive outlook of economic development in the developing world. However, it raises interest to the economic direction of other countries in the region, especially Pakistan and India. In the case for Pakistan, it has struggled mightily because of radical terrorism, relations with India and the US, and notorious corruption.
Bangladesh struggled economically after declaring independence from Pakistan but has taken a sharp turn at the start of this century. India is a global power and the definite regional power. Although its GDP per capita is projected to be slightly less than that of Bangladesh in 2020, its overall GDP is multiples above that of Bangladesh. The per capita figure can be attributed to India having a population of 1.38 billion people compared to Bangladesh’s 165 million people. India also has the fastest growing population (21% in last 15 years). With all this, Bangladesh has been closing the gap in the GDP per capita over the last decade. However, the IMF does not see this as sustained as COVID-19 has taken a hit on much of the world in 2020. Bangladesh is expected to grow 2020 GDP by 4% whereas India is expected to tumble 10%. Thus, Bangladesh is expected to continue its economic growth, but will not continue to lead India in terms of GDP per capita for the foreseeable future.
In hindsight, the economic progress of Bangladesh in the 21st century has many highlights, but also a few future contingencies that can set back future growth. The main contributor has been the advancement in the global garments industry which has also empowered women’s labour. Furthermore, the industry has helped lead Bangladesh to the upper 50 globally in gender parity rankings (whereas India and Pakistan rank much below). Bangladesh has emerged as a potential trading ally within the region as well as other continents expanding into the rest of Asia, North America, and Europe.
In light of all this, the country needs to address two glaring issues that can seriously hinder further development: a widening economic gap due to a significant population in extreme poverty and the corrupt and toxic bipartisan politics which sway money and power away from people of opposing parties. Complementing advancement in these issues with the continued growing economy, Bangladesh can, indeed, assert itself as a notable regional power and resourceful diplomatic companion.