Regulation and-supervision-of-islamic-banks-and-financial-institutions-bangladesh-perspective

Thoughts on Economics Vol. 22, No. 03

Regulation and Supervision of Islamic Banks and Financial Institutions: Bangladesh Perspective

Abdul Awwal Sarker1

The role of a central bank is very crucial in guiding, supervising and controlling the Islamic banks and financial institutions for smooth development of the sector. This paper presents an explanation of the role of Bangladesh Bank (Central Bank of Bangladesh) in accomplishing the above task. There are seven full-fledged Islamic banks, one non-bank Islamic financial institution and 22 Islamic banking branches of ten conventional banks operating in Bangladesh in tandem in line with the glorious Islamic Shari'ah. Alongside, one Islamic mutual fund, Government Islamic Investment Bond and Islami Bank Mudaraba Perpetual Bond is also playing important role in mobilizing the financial resources on Islamic line in the stock exchanges of the country. The rules, provisions etc, of the above instruments have been discussed. Above all, role of Bangladesh Bank has been critically examined relating to the regulation and supervision of the Islamic banking system of the country and some suggestions have been proposed for enhancement of the capacity of the central bank in achieving its objectives.

I. Introduction

The second half of the twentieth century witnessed a major shifting of thinking in devising financial and banking policy and framework on the basis of Islamic Shariah. This new thought was institutionalized at the end of the third quarter of the century and emerged as a new paradigm of banking called Islamic banking. The establishment of the Islamic Development Bank (IDB) in 1975 in Jeddah, KSA gave an accelerating momentum to the Islamic Banking movement worldwide. Since the establishment of IDB, a number of Islamic Banking and financial institutions have been established all over the world irrespective of Muslim and non-Muslim countries. Over the past few decades, the Islamic financial industry has rapidly expanded worldwide. Currently, about 300 Islamic banks and financial institutions (IFIs) have been functioning in line with Islamic Shariah with total combined assets exceeding US $2 trillion in more than 75 countries. This rapid growth has gained

1 General Manager, Bangladesh Bank Training Academy, Mirpur, Dhaka. Opinions expressed in the Paper are personal to the author and do not reflect in any way, the view of Bangladesh Bank or Government.

60 Regulation and Supervision of Islamic Banks……………….

considerable attention in international financial circles where various market participants have recognized their promising potentials.

To tap the potentials of the emerging Islamic markets and funds, a number of global financial institutions, including but not limited to, the world giants such as Kleinwort Benson, Chemical Bank, ABN Amro (Netherlands), Citibank(USA), ANZ (Australia) Grindlays, J.P.Morgan, Goldman Sachs(USA), Bankers Trust, Chase Manhattan, Hong Kong and Shanghai Banking Corporation (UK), Deutche Bank (Germany), Societe Generale (France), BNP--Paribus, and Union Bank of Switzerland(UBS)--have established Islamic banking Shariah compatible services in several countries. Additionally, many conventional commercial banks, in many Muslim countries, have been offering Islamic banking services. These include among others, Bank Misr in Egypt, National Commercial bank, Saudi American Bank and Saudi-British Bank in Saudi Arabia. In Malaysia, almost all commercial banks are offering Islamic banking services through their windows after the interest free banking scheme was launched in 1993, in order to allow conventional banks to offer Islamic banking services. Bangladesh is also not indifferent in this move.

II. Genesis of Islamic Banking in Bangladesh

Bangladesh is the third largest Muslim country in the world with around 130 million populations of which 90 percent are Muslim. The hope and aspiration of the people to run banking system on the basis of Islamic principle came into reality after the OIC recommendation at its Foreign Ministers meeting in 1978 at Senegal to develop separate banking system of their own. After 5 years of that declaration, Bangladesh established her first Islamic bank “Islami Bank Bangladesh Limited” in 1983. At present, in Bangladesh, out of 47 banks, 7 full fledged Islamic Banks and 22 Islamic Banking branches of 10 conventional banks, have been working in the private sector on the basis of Islamic Shariah. Alongside, one non-bank Islamic financial institution named ‘Islamic Finance and Investment Limited’ (IFIL) has also been operating in the system as Islamic NBFI since 2001. Islamic banks and non-bank financial institutions in Bangladesh since their inception have been gaining popularity in spite of some problems in their operation.

At present, 7 full-fledged Islamic banks viz. (1) Islami Bank Bangladesh Limited (IBBL:1983), 2) The ICB Islamic Bank Limited (the-then Al-Baraka Bank Limited and Oriental Bank Limited)2 (OBBL:1987), (3) Al-Arafah

2 Formerly known as Al-Baraka Bank Bangladesh Limited.

Thoughts on Economics 61

Islami Bank Limited (AIBL:1995) ; (4) Social Investment Bank Limited (SIBL:1995); 5) Shahjalal Islami Bank Limited (SJIBL:2001); (6) Export Import Bank of Bangladesh Limited (EXIM Bank:2004)3 and (7) First Security Islami Bank Limited (FSIBL: 2009) and 22 Islamic banking branches of 10 conventional banks4 have been operating in Bangladesh in line with the Islamic Shariah. The first Islamic bank, Islami Bank Bangladesh Limited (IBBL) was established in March, 1983 to conduct banking activities on the basis of the basic tenets of Islamic Shariah. Later, The Al-Baraka Bank Limited (currently ICB Islamic bank Limited) was established as the second interest-free Islamic bank in Bangladesh in March, 1987. The third and fourth Islamic banks of Bangladesh namely Al-Arafah Islami Bank Ltd. and Social Investment Bank Ltd. started their business in Bangladesh from September 27, 1995 and November 25, 1995 respectively. In the year 2001, the fifth private sector Islamic bank "Shahjalal Islami Bank Limited" started her banking operation. The sixth Islamic bank is the Export Import Bank of Bangladesh Limited. This traditional bank has converted her banking policies and principles in line with Islamic Shariah in 2004 and started operation as an Islamic bank. The seventh Islamic bank converted in 2009 to resume operation in line with the glorious Islamic Shari'ah. The only foreign Islamic bank "Shamil Bank of Bahrain EC (Islamic Bankers)" which is the largest Islamic bank in the world opened a branch in Dhaka in August, 1997 (later on, after several stage of mergers, this bank is renamed now as Bank Alfalah Limited operating in Bangladesh as an interest based bank having one Islamic banking branch in Dhaka). Besides, 22 Islamic banking branches of 10 traditional banks have been operating in the country on Islamic Shariah basis from 18th December, 1995 alongside the Islamic banks. These conventional banks have also established their own Shariah Supervisory Councils to guide their activities conforming to Islamic principles.

3 Export Import Bank of Bangladesh Limited (EXIM Bank) was a traditional commercial bank. It was converted as a full-fledged Islamic bank on 1stJuly 2004 after the approval of Bangladesh Bank.4 The ten conventional banks are: Prime Bank Limited, Dhaka Bank Limited, South East Bank Limited, Jamuna Bank Limited, The Premier Bank Limited, Arab Bangladesh Bank Limited, The City Bank Limited, Standard Chartered Bank, Bank Alfalah Limited and HSBC Limited (Amanah Branch).


III. Islamic Banking Branches in Conventional Banks

One of the important developments in Islamic banking in last few years has been the entry of some conventional banks in the market and their use of Islamic modes of financing through their Islamic branches, windows or units. It necessitates and encourages the globalization of Islamic banking, which includes some of the giants in the banking and finance industry. Bangladesh was not indifferent to this turning move. Presently, 10 conventional banks have opened 22 Islamic banking branches alongside their interest based branches. These conventional banks should focus on the safeguards that ensure the Islamic nature of these branches such as separation and compliance with Shariah. Separation of Islamic banking branches includes separation of capital, accounts, staff employed and office. However, the most important thing is compliance with the dictates of Shariah. There should be strong Shariah supervisory boards in order to prepare the model agreement, to approve the structure of every new operation and lay down the basic guidelines for each and every mode of financing. There must be also some Shariah scholars employed to monitor the compliance with Shariah in daily basis. Besides, there should be an annual review of the transaction carried out during the year. The staff of the banks should also go through training program in order to understand the basic Islamic principles and the philosophy governing commercial transactions in order to implement it in their day-to-day work.

IV. Development of Islamic Non-Bank Financial Institutions in Bangladesh

Non-bank Financial Institutions (NBFIs) represent one of the most important segments of financial system and play very important role in mobilizing and channeling resources in Bangladesh. The NBFIs comprise investment and finance companies, leasing companies etc. The NBFIs numbering 29 as of October 2007 (starting from IPDC in 1981) are regulated by the Financial Institutions Act, 1993 and the regulations made there under.5 Out of 29 non-bank financial institutions, two NBFIs called ‘Islamic Finance and Investment Limited’ and Hajj Finance Company Limited have been functioning in line with the Islamic Shariah since 19 April 2001.6

5 Bangladesh Bank, Annual Report 2005-06.6 Islamic Finance and Investment Limited (IFIL) 2001: A Short Introduction of Islamic Finance and Investment Limited, Dhaka, 2001.


Therefore, the development of Islamic banks and Islamic NBFIs and their growing acceptance in the country in view, it is necessarily felt that without regulatory standards, this promising sector be in struck in future. To ensure the right direction and sustainable position of the Islamic banking and financial sector in the country, importance of Islamic law on finance and enactment of those has been emphasized. Thus, the following discussions have been divided into four sections. Section II highlights the status of Islamic law on finance while Section III deals exclusively with the role of Bangladesh government and Bangladesh Bank and issued Islamic bonds and financial instruments in formalizing the Islamic financial system in the country. Section IV concludes with remarks and recommendations.

SECTION II

I. The Status of Islamic Law on Finance7

Given the principle of permissibility, Islamic commercial law can evolve within the limits imposed by Shariah. Recent history of the growth of the Islamic financial sector based on new rulings of Shariah scholars is an indicator of the adaptability of Islamic law to changed situations. While Islamic law can evolve, other elements of the legal infrastructure like laws and statutes and dispute settlement institutions also need to be strengthened. The adaptability features of Islamic law along with the strengthening the legal infrastructure is vital components of the development of the Islamic financial sector.

One of the important determinants of financial development is adaptability of law to changing conditions. Adaptability underscores the formalism of laws and the ability of legal traditions to evolve. Specifically, legal systems that adapt efficiently to the contracting needs of the economy foster development of the financial system. The question of adaptability of the law to changing circumstances is vital to the development of Islamic financial system. Issues like legal formalism, dynamism, and the efficiency with which laws can adapt to changing circumstances will determine to a large extent how this sector will grow in the future.

Islamic law started with the advent of Islam. The overall goal of the Islamic law is to promote welfare (masalih) of mankind. This goal in broad general terms implies, among others, to ensure growth (tazkiyah) and justice (qist) and

7 This section has been heavily drawn from Ahmed Habib: Islamic Law, Adaptability and Financial Development, Islamic Research and Training Institute, Islamic Development Bank.


in specific terms relates to maqasid al Shariah implying the protection of religion, life, reason, progeny and property. Thus, the objective of Islamic commercial law would be to ensure one or several of these goals. For example, the goal of prohibition of riba or interest is to ensure justice and equity.

II. Adaptability of Islamic Commercial Law

Over the centuries, Islamic law has evolved to a body of 'a highly sophisticated system of rules, covering the whole field of what the contemporary world perceives as law’. Islamic laws and rulings regarding human activities can be divided broadly into two: devotional matters (fiqh-ul-ibadah) and dealings or transactions (fiqh-ul-muamalah). The rules and principles of nominate contracts are applied to new concepts and problems and by the process of analogy, applicable solutions are arrived at. The most common method of creating financial contracts has been by far the combination of traditional nominating contracts to create new contracts. Examples of these include the contemporary financial murabahah (or murabahah to the purchase orderer) a widely used instrument by Islamic financial institutions. The original sale contract (murabahah) is used with several other concepts (promise, guarantee) to produce a financing tool. Similarly, traditional ijarah contract is used with a sale or gift contract to form a financing instrument called ‘ijarah wa iqtina’ or ‘ijarah muntahia bit-tamleek’. ‘Musharaka Mutanakissa’ or diminishing musharakah associates musharakah contract with that of a sale for financing purposes. Similarly, contemporary sukuk is a composite of multiple transactions/contracts.

III. Adapting Conventional Financial Products

Another method of creating new contracts in the Islamic financial sector is to adopt and adapt conventional financial instruments/products/contracts that meet the Shariah criteria. The conventional contracts or products can be modified by removing the undesirable components to make them comply with the Shariah principles. For example, equity based mutual funds have been adopted by Islamic financial institutions by adapting the stocks that can be included in these funds. Investments in stocks are allowed if they fulfill certain business and financial criteria derived from Shariah and fiqh. Accordingly, investment in companies that deal with forbidden goods/services like alcohol and tobacco, gambling, pornography, interest based financing institutions, etc. is not allowed. The financial filter developed on the basis of Islamic shariah is being used to weed out firms that have unwarranted dealings with interest-based transactions.


IV. Prudential Regulations and Supervision Issues

The International Monetary Fund (IMF)8 in a study named "Islamic Banking: Issues in Prudential Regulations and Supervision" highlighted various techniques for banking supervision in an Islamic framework and for smooth development of Islamic banking. They recommended that "an appropriate regulatory framework for banking supervision in an Islamic environment should be designed to ensure that:

Legal foundations for the supervision of Islamic bank are in place;

Investment and other risks are adequately dealt with, taking into account that financing through the PLS modes adds an element of complexity to the already difficult task of investment banking and

Adequate information is necessary for supervisory authorities to exercise a more effective prudential supervision and to enable the public to make reasonably informed investment decisions. Greater stress on these issues, particularly during the licensing process is likely to strengthen financial system surveillance in countries where Islamic banking is followed.

To implement the above recommendations report places some ways and means which are:

a. In order to provide the legal foundations for the supervision of Islamic banks it is necessary that either the general banking laws or specific laws performing to Islamic banks define in detail the nature of these banks and their specific operating relationship with the central bank and other conventional banks, if applicable.

b. Management of operational risks in Islamic banks could usefully be addressed through an appropriate rating system (CAMEL rating is a measure of the relative soundness of a bank and is calculated on a 1-5 scale, with one being a strong performance. The acronym stands for capital, assets, management, earnings and liquidity).

c. Information disclosure should be designed to reduce information asymmetries due to the unrestricted Mudaraba contract between an Islamic bank and its depositors and incentives for moral hazard due to the fact that capital value of and returns on investment deposits are not guaranteed.

8 Errico, Luca and Farahbaksh, Mitra (1998): "Islamic Banking: Issues in Prudential Regulations and Supervision", Washington D.C., The International Monetary Fund (IMF), WP/98/30.


d. An appropriate licensing process is just as necessary in an Islamic banking framework to enable supervisory authorities to ensure that new banks are sound and stable. Some basic elements of an appropriate licensing process are:

Transparency: Laws, regulations, criteria and requirements for a banking license should be published and applied in an even-handed way.

Set the ground rules: Requirement for a license should set rules for corporate governance; establish "suitability" standards for owners; establish "fit-and-proper" specifications for boards of directors and managers; determine whether commercial and industrial firms can own banks; define the organizational structure of the bank, including internal controls, internal and external audit functions and any provision necessary to present conflict of interests.

Capital requirements: Minimum levels and composition of initial capital should be set forth.

Specify activities: The scope of a bank's activities should be indicated, that is whether and to what extent the bank is allowed to take equity positions in non-financial enterprises, engage in securities, underwriting, licensing, factoring and other activities.

Business plan: The license application should include a feasibility study and a business plan detailing the bank's strategy to attain profitability and maintaining it over the initial period of operation.

V. Application of the Islamic Legal Infrastructure

As pointed out, most Muslim countries have adopted one of the Western legal systems. The absence of a comprehensive legal system for a long time resulted in the lack of legal infrastructure institutions that can support the use of Islamic commercial law during contemporary times. With the advent of Islamic finance, Islamic financial contracts are being used, but this is being done in an alien legal environment. Even if individuals agree to use Islamic contracts, the laws and courts may not be there to interpret and enforce the form of these contracts. Successful application of Islamic law in contemporary financial transactions requires various supporting legal infrastructure institutions. Some issues related to the development of Islamic law and legal


infrastructure institutions with respect to the financial sector are discussed below.

1. Good documentation of contracts is important determinant of growth and liquidity of markets in financial products. Standardized documentation creates more predictability and certainty about the characteristics of the financial contracts. Agents involved are better able to understand their rights and obligations under the contract and enhances the confidence to enter the market and transact.

2. The standardization of Shariah rules needs to take place at two levels. First, at the national level, the rules governing economic transactions can be standardized by a national Shariah body. This body will be responsible not only for issuing rulings but also codifying them for application. Examples of national level Shariah boards/authorities are those existing in Sudan and Malaysia. The harmonization of Shariah rules within national borders, however, will not solve the problems of global Islamic financial transactions. There is a need for an international body that can issue standardized rulings on economic transactions. Efforts by AAOIFI are given for this legal diversification. But as AAOIFI is an institution dealing with mainly accounting and auditing standards, there is need for a global Shariah body that can harmonize diverse bodies of knowledge to one standardized version that the Islamic financial industries around the world can use. Establishment of an international body to develop different Standards for Shariah Application in Finance Industry is inevitable.

3. As most Muslim countries have adopted either the common law or civil law framework, their legal systems do not have specific laws/statutes that support the unique features of Islamic financial products. For example, whereas Islamic banks main activity in trading (Murabaha) and investing in equities (Musharaka and Mudaraba), current banking law and regulations in most jurisdictions forbid commercial banks to undertake such activities. This calls for specific laws and statutes that can support and promote Islamic financial services industry. While in some countries separate Islamic Banking laws have been passed (e.g., Kuwait and Malaysia), in others Islamic banking is covered under a section of the existing banking law (e.g., Bangladesh and Indonesia). The implications of these Islamic banking/financial laws on the operations and growth of Islamic financial sector will depend on the type of legal system in place.


4. As the laws and their implementation are codified under the civil law regime, it would be difficult to have Islamic financing if new laws are not enacted as the existing rules and regulations are geared towards conventional banking practices. The Islamic banking law enacted by the legislature will form the legal foundation for Islamic banking and financial dealings. The Islamic banking laws passed in civil law country like Indonesia, however, are worded in general terms and lack details of the different Islamic modes of financing. Examples of such omissions include the prohibition of trading and taking equity positions and the absence of resolution of the double taxation in Islamic financial transactions (e.g. in case of ijarah). While Bank Indonesia is trying to fill some of the gaps through some regulations, these may not hold in the courts of law. Such uncertainty in the laws related to Islamic banking will have Islamic banks at a disadvantageous position compared to the conventional banks. Thus, there is a need for detailed codification of the law that would include the Islamic principles for financial transactions and the administrative procedures for carrying out these activities.

5. Islamic contracts and transactions under the common law regime may have problems of interpretation as no precedents on these activities may exist. Promulgation of law in this system may not be as effective as in case of civil law regime as the judges may deviate from the statute if the statute is incompatible with the precedents. Common law regimes, however, provide more predictable results under legal documentation relative to the civil law system. While in the civil law system, the courts will interpret the contracts on the basis of reasonableness and fairness, the Common law system will consider the provisions in a legal document more weight irrespective of other considerations like materiality or fairness. As the sanctity of the contract is greater in the common law system, there may be lower legal risk involved for Islamic baking instruments under this regime.

6. Lack of Islamic courts in most Muslim countries that can enforce Islamic contracts increases the legal risks of using these contracts. As such, partners in transactions avoid using Islamic law as they want to avoid the impracticalities or the uncertainty of applying classical Islamic law. In an environment with no Islamic courts, Islamic financial contracts include choice-of-law and dispute settlement clauses. In such cases, two approaches can be taken. The first is to use Shariah as the governing law as the Islamic financial contracts' legitimacy should be judged by the principles of Shariah. To ensure such settlements the


contracts would include a clause indicating Islamic law to be used for settlement of disputes. The second approach is to use the law of the country to settle disputes. In the former approach, the contracts should be shielded from the legal environment and disputes settled through commercial arbitration.

To ensure the growth of the Islamic financial industry, there is a need to have dispute settlement institutions or Islamic courts that understand the form of the contracts so that these can be interpreted and enforced accordingly. While the whole court system can not be expected to change, a solution is to have special Islamic bench that deals with, among others, financial transactions. In this regard, Malaysia has adopted several steps to build some legal infrastructure institutions for Islamic financial industry. At the highest level, the High Court in Malaysia has dedicated high court judges to oversee litigations related to Islamic banking and finance. Furthermore, to complement the court system, the Kuala Lumpur regional Centre for Arbitration has been enhanced to deal with disputes on Islamic banking and finance for both domestic and international cases. To ensure the efficient functioning of the Islamic financial sector, the Central Bank of Malaysia has also set up a Law Review Committee to assess the common law based legislations and to assimilate the Shariah principles.

SECTION III

I. Role of the Bangladesh Government and Bangladesh Bank

The objectives of the monetary policy are to secure stability in the value of money and regulate the banking system prudently. Bangladesh Bank issued license in 1983 for establishment of first Islamic bank in Bangladesh “Islami Bank Bangladesh Limited”. The Bangladesh Government also participated in establishing first Islami Bank by taking 5% share in the paid up capital. From the very beginning, considering lack of Islamic financial markets and instruments in the country, Bangladesh Bank granted some preferential provisions for smooth development of Islamic banking in Bangladesh. Among the preferential provisions, the following are important:

1) Islamic banks in Bangladesh have been allowed to maintain their Statutory Liquidity Requirement (SLR) at 11.50% of the total deposit liabilities while it is frequently fixed and re-fixed around 15% to 20% for the conventional banks. This discriminating provision had facilitated the Islamic banks to hold more liquid funds for more investment and thereby generate more profit.


2) Under indirect monetary policy regime, Islamic banks were allowed to fix their profit-sharing ratios and mark-ups independently commensurate with their own policy and banking environment. This freeness in fixing PLS ratios and Mark-up rates had provided scope for the Islamic banks to follow the Shariah principles independently for realizing goals of Islamic Shariah.

3) Islamic banks could reimburse 10% of their proportionate administrative cost on a part of their balances held with the Bangladesh Bank. This facility has given some scope for enhancement of their profit base.

II. Relationship between Central Bank and Islamic Bank

A study regarding "The Relationship between Central Banks and Islamic Banks” prepared by IAIB9 was submitted to the third Expert Level Meeting on Islamic Banking Studies (Dhaka, 1989) . The recommendations adopted by the meeting include:

The provision of financial assistance by the Central Banks in the form of Mudaraba deposits with the Islamic banks and by way of providing refinance to the Islamic banks under Mudaraba/Musharaka or any other Islamic mode of finance;

Refinance facilities on the basis of PLS;

Opening of current accounts at the Central Banks with occasional overdrawing facilities free of any charge and participation in the bank's clearing house;

Regulation and Supervision of Islamic banks as applicable in interest-based banking in respect of permission for establishing banks or opening share capital, appointment of directors and auditors, foreign exchange regulations etc.;

Lower liquidity requirements on the deposits accepted by Islamic banks till such time as appropriate Islamic financial instruments which can be counted towards liquidity requirements become available;

For inspection of the Islamic banks, the Central Bank's personnel may be adequately trained in Shariah-based banking operations and

9 International Association of Islamic Banks (IAIB) 1989: Study Report, "The Relationship between Central Banks and Islamic Banks” submitted to the third Expert Level Meeting on Islamic Banking Studies held in Dhaka, 1989 .


the central banking authorities may consider preparing separate guidelines for inspection, keeping in view the special character of Islamic banks.

III. Role of Bangladesh Bank in Promoting Islamic Banking in Bangladesh

Unlike Bangladesh, in most Muslim countries a special law is passed prior to the establishment of an Islamic bank, which specifies the rules and regulations for the institution willing to engage in banking business based on Islamic principles. In Malaysia for example, the Islamic Banking Act 1983 was passed by Parliament prior to the establishment of the Bank Islam Malaysia Berhad in 1983 and this law applies to any Islamic banking institutions wishing to operate in Malaysia. However, despite having their own laws, Islamic Banks in most Muslim countries have to conform to other laws and regulations. Similarly, in the case of disputes or legal actions between banks and their customers, matters are referred to civil courts. For instance, the commercial transactions of Islamic Banks in Malaysia come within the jurisdiction of the civil court. Therefore, any legal proceedings between Islamic Banks and their customers are to be handled by the normal civil court.

Though there is no complete Islamic Banking Act till date for controlling, guiding and supervising the Islamic banks in Bangladesh, some Islamic banking provisions have already been incorporated in the amended Banking Companies Act, 1991 (Act No. 14 of 1991). Bangladesh Bank did not set up any separate Department at its Head Office to control, guide and supervise the operation of the Islamic banks. Inspection and supervision of the Islamic banks operation are being scrutinized by the Bangladesh Bank as per the general guidelines framed for the conventional banks. So, ensuring of the implementation of Shariah principles in the Islamic banks are being conducted by their own Shariah Councils. The role of Bangladesh Bank in controlling, guiding and supervising the Islamic Banks in Bangladesh in accordance with Islamic Shariah is very minimal. In observing the Shariah implementation status of the Islamic banks, Bangladesh Bank examines only the report of the respective banks' Shariah Councils. However, the inspectors and supervisors of Bangladesh Bank are not equally familiar with the technicalities of the different operational methodologies of the Islamic banking. This is because of the fact that there is no separate Department to look into this important matter and any concerted effort to devise separate inspection and supervision guidelines for the Islamic banks.


IV. Measures Adopted by Bangladesh Bank

Regarding the suggestions put forwarded by the study report of the IMF, Bangladesh Bank has already been complying with the following guidelines:

a. Some legal provisions have been incorporated in the amended Bank Companies Act, 1991.

b. For analysis of the operational risks of the Islamic banks, CAMEL rating framework is being used by the concerned Department of Bangladesh Bank.

c. Information is being disclosed by the Islamic banks as per the same format designed for the conventional banks. A workshop was held in Bangladesh Bank in 1995 on "Islamic Banking Inspection Methodology" to devise separate inspection methodology for the Islamic banks. However, follow-up research work is going on this issue in the Bangladesh Bank.

d. Regarding licensing procedures, Bangladesh Bank is pursuing some prudential techniques. But, this will be sounder if she follows the guidelines recently submitted by the Islamic Banking Focus Group.

V. Rapid Expansion of Islamic Banks in Bangladesh and Role of Bangladesh Bank, ICB And IBBL

In view of the rapid expansion of Islamic banks in Bangladesh, Bangladesh Bank issued a letter10 to the Islamic banks to carefully address and examine the upcoming problems in due time. To help actualize those, Bangladesh Bank identified the following problems and accordingly advised all Islamic banks on 5th March, 1997 to take appropriate measures on them through mutual discussion and co-operation:

a. Development of an Inter-Bank Islamic Money Market.

b. Constitution of Central Shariah Supervisory Board.

c. Preparation of draft Islamic Banking Act.

d. Establishment of Islamic Insurance Company.

e. Development of New Financial Products in line with Islamic Shariah.

10 Bangladesh Bank (1997): Letter No. GOBI (PIED) IEC-1/97-20-25, Date: 05 March, 1997, Islamic Economics Cell, Research Department, Bangladesh Bank, Head Office, Dhaka.


f. Constitution of Consortium/Syndicate by the Islamic banks for large financing.

(i) Ibcf and Central Shariah Board in Bangladesh

In response to Bangladesh Bank's call, "Islamic Banks Consultative Forum (IBCF)" was constituted by the Islamic banks and banks having Islamic banking branches or windows in 1997 to take appropriate decision on the above identified areas. Later on, A Central Shariah Board of the Islamic Banks in Bangladesh has also been formed with the active participation and financial contribution of the said banks and banking branches. Membership to these forums is optional for the Islamic banks and financial institutions.

(ii) Government Islamic Investment Bond

In October, 2004, Bangladesh Bank has issued a Mudaraba bond named “Government Islamic Investment Bond” on behalf of the government as a first ever Islamic financial instrument in Bangladesh to facilitate the Islamic banks and financial institutions to invest their funds11 (to be calculated as an outlet for maintaining SLR). Government Islamic Investment Bond has been playing an important role in developing the Islamic financial instruments in Bangladesh. Islamic banks and financial institutions are actively participating to park their cash surpluses and enhance their return on their investments (for details of Government Islamic Investment Bond please see Annexure-I).

(iii) Focus Group on Islamic Banking

Recently, a Focus Group on Islamic Banking has been constituted in Bangladesh Bank to develop necessary guidelines to facilitate setting up of Islamic bank, Islamic bank subsidiary or branches in Bangladesh. Bangladesh Bank has issued Islamic Banking guidelines in September 2009 and thereby t is hoped now that implementation of this guideline will pave the way to bring the Islamic financial sector in close adherence to Shariah.

(iv) Member to the Islamic Financial Services Board, Malaysia

Recently, Bangladesh Bank has become member to the Islamic Financial Services Board, based on Malaysia, the body established to issue prudential and supervisory standards for the Islamic banking and finance industry. The existing supervisory process and procedures will be redesigned to evolve in line with the best international Islamic standards. Regulatory and supervisory standards, which can specifically address the unique peculiarities of the Islamic banking operations, are necessary to promote resilience and competitiveness of the Islamic banking sector. In this regard, the work of the

11 Detailed of Government Islamic Investment Bond is given at Annexure-1.


IFSB would act as a catalyst to the development of a stronger and robust supervision framework in Bangladesh.

(v) Working Group on Islamic Banking

In addition to that, a working Group on Islamic banking has been constituted at Bangladesh Bank to implement Strategy # 8 of Bangladesh Bank Strategic Plan 2010-2014. The working group has been working to develop Islamic monetary and liquidity instruments and supervision /inspection manual for BB supervisors.

(vi) ICB AMCL Islamic Mutual Fund

To facilitate the Islamic capital market in the country and to attract the investors who want to invest in Shariah-based financial products, the government owned Investment Company ‘Investment Corporation of Bangladesh (ICB) has introduced ‘ICB AMCL Islamic Mutual Fund’12 for Taka 100 million in 2005 with the approval of the Securities and Exchange Commission. ICB Capital Management Limited, a subsidiary of ICB is the sponsor and ICB is the Trustee & Custodian of the Fund. ICB AMCL13 is acting as the Asset Manager of the Fund. (for details of ‘ICB AMCL Islamic Mutual Fund’ please see Annexure-2).

(vii) IBBL Mudaraba Perpetual Bond (MPB)

Islami Bank Bangladesh Limited has issued a bond named Mudaraba Perpetual Bond (MPB) of Taka 3,000 million in October, 2007 which is the first of its kind with a view to serve multiple purposes like creating a vibrant bond market in Bangladesh, creating new avenues of investment for the prospective Islamic investors etc. From the viewpoint of the Islami Bank, the main purpose of the bond issue is to raise fund to maintain the capital adequacy requirement ratio of the Bank. As per the existing requirement of Bangladesh Bank, all commercial banks are required to maintain capital adequacy @10% of the risk weighted assets of the bank (previously 9%). With the government policy of encouraging the private sector to be the engine of economic growth, the private sector need for finance has increased significantly from the banking sector during the last two decades.

The purpose of the issuance of the MPB is to enhance the ability of the bank to make further investments by increasing the Capital Adequacy Ratio. One of the main objectives is to utilize the fund to be raised in prospective/profitable sectors. It is to be mentioned that through the issuance of the MPB, IBBL is

12 Detailed of ‘ICB AMCL Islamic Mutual Fund’is given at Annexure-2.13 AMCL stands for Asset Management Company Limited.


going to play a pioneering role in creating a bond market in Bangladesh, as this will be the first of its kind in the country. It is worthwhile to mention that, through the issuance of MPB, IBBL will be able to reduce its cost of fund substantially, which will ultimately be beneficial for the stakeholders. It is to be further mentioned that, the fund raised through issuance of MPB will be utilised in the profitable investment programs of the Bank to make the Bank more profitable. In addition to the income derived from deployment of Mudaraba fund, the bondholders will be entitled to get a rate of profit equivalent to 10% of the rate of dividend to be declared by the Islami Bank Bangladesh Limited. (for details of Mudaraba Perpetual Bond please see Annexure-3).

SECTION IV

I. Concluding Remarks and Recommendations

Promotion, regulation and supervision of the Islamic banks in accordance with the recent guidelines, laws and regulations seem inadequate since these are basically based on the conventional wisdom and practices. These regulatory and supervisory systems, undoubtedly helps to control their all-out operations with a view to reducing the possibility of their failure, promoting the public’s confidence in the banking system and ensuring its stability. But, in case of Islamic banks, in addition to those, Shariah implementation in the activities of the banks must also be ensured by the regulators and supervisors. Lack of enforcement and supervision in line with Islamic Shariah may lead the Islamic banks into systemic Shariah distress. The growing integration of financial markets on the eve of financial globalization, especially with their sophisticated markets and their innovative instruments necessitates the development of new Islamic financial architecture to cope with the challenges posed by them.

Inadequacies of existing rules, regulations and guidelines with respect to Islamic banks hinders the supervisory staffs and regulators to acquire proper understanding of this new areas of risk assessment. They have been applying core concepts of conventional supervision without differentiation to conventional and to Islamic banks. This way of similar supervision for conventional and Islamic banks can not be justified because it does not take into consideration of some peculiar characteristics of the Islamic banks. However, to ensure soundness of the financial and operational conditions of the Islamic banks, central banks should develop specific rules and regulations. It is to be mentioned here that, ‘while financial soundness may be enough for retaining the confidence of clients of a conventional bank, in the case of an


Islamic bank, Shariah compliance is equally important. An Islamic bank could fail as much due to non-compliance with the Shariah as for financial imprudence. Therefore it should be ensured that all activities of an Islamic bank comply with Shariah principles’.14

II. Recommendations

1. Appropriate Legal Framework for Islamic Banks and Islamic Financial Institutions: Central banks or regulatory and supervisory authorities should develop appropriate and full-fledged legal framework for controlling, guiding and supervising the Islamic banking and Islamic NBFI system. It is not sufficient to insert some words or sentences on Islamic banking methodology in the Bank companies Act.

2. Basel II, Legal and Regulatory Standards: Basel II also requires Islamic banks to meet legal and regulatory standards as specified in Basel II. Some opine that Islamic banks should not be subject to all regulatory measures specified by Basel II, but they should be subject to regulations similar to corporations due to the participation of the investments depositors in the risk of Islamic banks.15 There are several reasons for Islamic banks to comply with the Basel II regulations. Islamic banks are at the stage of growth and their sizes are normally small to medium. In order for them to gain international recognition, Basel II compliance becomes a cornerstone. The standards developed by AAOIFI and IFSB should be added to the Basel II, then the regulatory framework prescribed by the Basel Committee of Banking Supervision will bring standardization for the Islamic banks.16

3. Central Shariah Supervisory Council at Bangladesh Bank: To advise Bangladesh Bank on Shariah matters and to formulate and implement uniform Shariah principles/rules/regulation for all the Islamic Banks/ Islamic branches of conventional banks/ Islamic subsidiary companies operating in the country, it is necessary to constitute a Central Shariah Supervisory Council (CSSC) at Bangladesh Bank to be performed under

14 Al-Jarhi Mabid Ali and Iqbal Munawar (2001): Islamic Banking: Answers to Some Frequently Asked Questions, Occasional Paper No. 4, 2001, Islamic Research and Training Institute, IDB.15 Hassan M.K., Chowdhury M.A.M., "Islamic Banking Regulations in Light of Basel II.", Proceedings of the Fifth Harvard Research Forum on Islamic Finance, April 12, 200416 Sarker A A (2005): Islamic Banking in Bangladesh: Achievements and Challenges, Journal of Islamic Economics and Finance, Vol. 1, No. 1, July-December 2005, a Half-yearly Journal of Islami Bank Training and Research Academy (IBTRA), Dhaka, Bangladesh.


the Board of Directors of Bangladesh Bank. The broad functions of the Central Shariah Supervisory Council may be grouped as:

a) To study the rulings of Islamic Shariah previously issued by the Shariah councils of the Islamic banks and financial institutions in an attempt to make decisions identical;

b) To supervise the activities of the Islamic banks and financial institutions to ensure conformity with the rulings of the Islamic Shariah. In addition, it has to draw the attention of the concerned parties and Board of Directors of BB to any potential violation of these activities;

c) To issue legal religious opinions on banking and financial questions;

d) To study matters related to financial and banking operations in response to requests for advice from the Islamic banks and financial institutions;

e) To conduct Shariah audit and inspection of specific branches/offices of the Islamic banks and financial institutions with the help of the officers of DBI (Department of Banking Inspection) and submit inspection report with recommendations to the Board of Directors thereby ensuring Shariah compliance by the Islamic banks and financial institutions

f) To plan, design, conduct and manage different training courses, seminars, Symposia on Shariah and financial matters with the help of the Research Department and Bangladesh Bank Training Academy.

g) To assess the present status of Shariah compliance by the Islamic banks and financial institutions, identify problems and suggest remedies;

h) To collect, process and preserve data on Islamic economics, Banking and finance with the help of the Statistics Department;

i) To collect information/published data and books on Islamic banking with the help of Bank's Library.

4) A Separate 'Islamic Banking Department' at Bangladesh Bank: A separate 'Islamic Banking Department' may be established at Bangladesh Bank to conduct comprehensive research in various fields of Islamic Economics, finance and banking, to conduct field surveys on different Islamic Banking and finance issues from time to time, collect data from the field


level/concerned institutions and prepare papers/reports on the basis of data/information collected and surveys conducted, ‘to inspect a sample of documents relating to operations, such as contracts and accounting records to ensure compliance of the operations with the approved models and juridical rules, and to issue directives to officials of Islamic banks and Islamic non-bank financial institutions, in the form of circulars, circular letters, and bulletins, drawing their attention to common mistakes from a Shariah point of view and ways of avoiding them’.17 The Shariah-based audit may also be done through this department. This department should have a number of ‘ulama’ in the field of Islamic jurisprudence, who are well versed in financial, legal and accounting issues.

5) Capacity Building Programs for the Regulators and Supervisors: The most acute problem is a general scarcity of qualified people equally conversant with the present inspection techniques and Shariah aspects of Islamic banking. This constraint in turn is a contributing factor to other weaknesses such as reluctance to adopt proper guidelines and also to conduct regulatory and supervisory functions in line with the Shariah prescriptions. Therefore, capacity building programs for the regulators and supervisors of the central banks should be undertaken. Different training programs for the officers of supervision departments is often conducted solely on-the-job in a less than systematic manner so that skills are acquired in a hit-or-miss fashion. Inadequacies in training and development affect the supervisor’s ability to build a skilled, knowledgeable, and competent staff. In addition, off-the-job training should be conducted in a systematic fashion. To have the knowledge on Islamic banking regulation and supervision, central banks can get help of the Islamic Research and Training Institute of Islamic Development Bank as they have already excelled in research in Islamic economics, banking and finance and developed different training materials of effective banking supervision in line with Shariah with the combination of intellectual resources of experts in fiqh al-muamalah and financial sectors as well.

6) Separate Supervisory Institutions/Agencies: In most of the industrial countries of the west and in South Korea, there are separate institutions/supervisory agencies that jointly supervise the activities of banks and financial institutions through corporate leadership built upon the principles of delegation of power and co-ordination. They work simultaneously but there is clear delineation of the responsibilities. In the

17 Al-Jarhi Mabid Ali and Iqbal Munawar (2001): op. cit.


United States for example, there are as many as six separate agencies that supervise and control banks without conflicts. In Germany, the Federal Supervision Office (FSO) is a separate legal entity enjoying authority though it has close functional relationship with the Deutche Bundes Bank, central bank of the country. In Bangladesh, the central bank, Bangladesh Bank is the single organization that shoulders the entire responsibilities of bank and non-bank financial institution’s supervision irrespective of conventional and Islamic. In the context of heavy responsibilities, Bangladesh Bank may consider giving the supervisory responsibilities for Islamic banks and Islamic financial institutions upon a separate private supervisory institution.

7) Budget for R & D on Islamic Banking and Finance: Sufficient research and development budget may be allocated and or earmarked by the Islamic banks and Islamic NBFIs to carryout research work on Islamic banking and finance. They may also establish an Apex ‘Islamic Banking and Finance Research and Training Academy (IBFRTA) to this end an equivalent of Bangladesh Institute of Bank Management.

8) Research Journal on Islamic Banking and Finance: Quality research journals on Islamic banking and finance may be published incorporating empirical findings on the development of Islamic banking and finance activities in the country. This endeavor may fulfill the knowledge gap and disseminate the ideas among the financial sector participants to motivate them to converge towards the Islamic financial system.

REFERENCES

1. Ahmed Habib (2004): Islamic Law, Adaptability and Financial Development, Islamic Research and Training Institute, Islamic Development Bank.

2. Al-Jarhi Mabid Ali and Iqbal Munawar (2001): Islamic Banking: Answers to Some Frequently Asked Questions, Occasional Paper No. 4, 2001, Islamic Research and Training Institute, Islamic Development Bank (IDB), Jeddah, KSA.

3. Bangladesh Bank (2004): Circular and guidelines related to Government Islamic Investment Bond (GIIB).

4. Bangladesh Bank, Annual Report 2005-06.


5. Errico, Luca and Farahbaksh, Mitra (1998): "Islamic Banking: Issues in Prudential Regulations and Supervision", Washington D.C., The International Monetary Fund (IMF), WP/98/30.

6. Hassan M.K., Chowdhury M.A.M., "Islamic Banking Regulations in Light of Basel II.", Proceedings of the Fifth Harvard Research Forum on Islamic Finance, April 12, 2004

7. ICB Asset Management Company Ltd.: Brochure and Prospectus of ICB AMCL Islamic Mutual Fund and Annual Reports & Accounts FY 07, Dhaka.

8. International Association of Islamic Banks (IAIB) 1989: Study Report, "The Relationship between Central Banks and Islamic Banks” submitted to the third Expert Level Meeting on Islamic Banking Studies held in Dhaka, 1989 .

9. Islami Bank Bangladesh Limited: Information Memorandum on Private Placement of Mudaraba Perpetual Bond, 2007 and Prospectus on Repeat Public Offer of Mudaraba Perpetual Bond, 2007.

10. Islamic Finance and Investment Limited (IFIL) 2001: A Short Introduction of Islamic Finance and Investment Limited, Dhaka, 2001.

11. Islamic Finance and Investment Limited (IFIL), Annual Report 2005

12. Sarker A A (2005): Islamic Banking in Bangladesh: Achievements and Challenges, Journal of Islamic Economics and Finance, Vol. 1, No. 1, July-December 2005, a Half-yearly Journal of Islami Bank Training and Research Academy (IBTRA), Dhaka, Bangladesh.


ANNEXURE-I

Bangladesh Government Islamic Investment Bond (Islamic Bond)18

In Bangladesh, financial resource mobilization through issuance of Islamic financial instruments is at a nascent stage. Uptill 2004, no Islamic bank or financial institution has issued any Islamic financial instruments like bonds, debentures, mutual funds in the primary or secondary market for mobilizing financial resources. They were fully dependent on the deposited funds. However, after a long research and discussion, Bangladesh Bank has issued a Mudaraba Bond named as “Bangladesh Government Islamic Investment Bond (Islamic Bond)”in October, 2004 on behalf of the government to facilitate Islamic banks and financial institutions especially to invest their funds to be considered as liquid assets for meeting requirement of SLR. This bond is an approved security for the purpose of regulating the SLR as well as providing an outlet for investment or procurement of funds by the Shariah-based banks. This bond is also open for investment by any private individuals, companies or corporations.

The salient features of the Islamic Investment Bond are summed up below:

1. This Government Islamic Investment Bond (GIIB) will be governed by the Islamic Shariah i.e. the Islamic Bond will be governed on the principles of Mudaraba.

2. The GIIB mean the document of definite value issued in the name of their owners against funds they pay to the issuer or Bangladesh Bank.

3. Profit Sharing Ratios (PSRs) relating to the Bond may be determined separately for each deal. Bangladesh Bank will act as Mudarib.

4. Under the Rules, any individual, private or public companies, Islamic banks and financial institutions may purchase the bond. Any non-resident Bangladeshi may also invest in the bond from his/her NFCD account maintained with any bank in Bangladesh.

5. The minimum amount of investment may be Taka 1,00,000.00 (one hundred thousand and multiples thereof) and the rate of return to be given to the Investors are as follows:

18 Bangladesh Bank (2004): Circular and guidelines related to Government Islamic Investment Bond (GIIB).


a. For the period of investment of six months: PSR is 80:20 in which 80 % profit will be given to the bond holders and 20% will be retained by the Bangladesh Bank.

b. For the period of investment of one year: PSR is 90:10 in which 90 % profit will be given to the bond holders and 10% will be retained by the Bangladesh Bank.

c. For the period of investment of two years: PSR is 95:05 in which 95 % profit will be given to the bond holders and 5% will be retained by the Bangladesh Bank.

6. GIIB may be used as collateral for availing loan or investment from any financial institutions. In this case, bond must be recorded in the Subsidiary General Ledger (SGL).

7. GIIB is qualified securities for the purpose of complying with the liquid assets requirement to be maintained by the banks and non-bank financial institutions. With regard to this, the Bangladesh Bank may provide the discount window facility for banks and financial institutions to buy or sell GIIB with Bangladesh Bank.

8. There is a provision in the Rules that the bond holders will get interim profit on the maturity date of the bond. This interim profit will be adjusted after finalization of the investment accounts. The interim provision of profit is based on the received monthly profit realized on the invested funds in the Islamic banks or financial institutions (as per Clause No. 7-b of the Rules). The interim profit rates will be given as follows:

a. For 6-month GIIB: 2% less from realized average rate of profit generated through financing of the Islamic investment bond proceeds.

b. For 1-year GIIB: 1.5% less from realized average rate of profit generated through financing of the Islamic investment bond proceeds.

c. For 2-year GIIB: 1% less from realized average rate of profit generated through financing of the Islamic investment bond proceeds.

9. The trading of the GIIB will be based on the interim profit rate derived from the investments of those with the Islamic banks. The interim profit rate will be reviewed on monthly basis.


10. The formula for calculation of the profit element to be paid to the bond investors is as follows:

= prt (k) / Y

Where:

= Profit payable to the bond investor;

p = Principal investment to the GIIB;

r = Rate of monthly profit received (in % per annum) from the investment of bond proceeds for 6 months bond;

t = bond period (number of days invested)

K= Profit sharing ratio to be applied to the Bond investor, and

Y= 365 days.

11. GIIB may not be a transferable instrument for more or less than its face (nominal) value. If it is returned to the Bangladesh Bank before maturity, then the bond-holder may be eligible to get only the principal amount invested. No profit will be allowed for the period before or after maturity of the bond, if not enchased on maturity.

Government Islamic Investment Bonds are playing an important role in developing the Islamic banking system of Bangladesh, whereby Islamic banks and financial institutions are actively participating to park their cash surpluses.

ANNEXURE-II

ICB AMCL Islamic Mutual Fund

Mutual Fund presently is one of the fastest growing sectors through out the world. In Bangladesh, ICB is the harbinger of mutual funds. Out of the total 13 mutual funds, ICB and its subsidiary alone floated 11 mutual funds in the market. These mutual funds are basically conventional fund which invest their funds both in equity and debt securities. Islam’s prohibition against paying and charging interest prevent Muslims from investing in securities that draw their income from those activities. In Islam interest is viewed as riba and usury because of its potential for exploitation of the borrower by the lender. In addition, the Islamic shariah law forbids any involvement in or ties to gambling, pornography, tobacco, weapons, alcohol etc. As the conventional funds invest and draw their income, among others, from the above mentioned companies and debt securities, ICB Asset Management Company Limited has


float the above fund to invest its funds according to the shariah law. It may be mentioned here that there are over 100 Islamic mutual funds in the global equity markets of which half originated in the Middle East.

The ICB AMCL Islamic Mutual Fund19 was established under a trust deed executed between the ICB Capital Management Limited (ICML) as ‘Sponsor’ and the Investment Corporation of Bangladesh (ICB) as ‘Trustee’. The Trust Deed was executed on July 15, 2004. The fund was registered with the Securities and Exchange Commission (SEC) on August 24, 2004 Securities and Exchange Commission (Mutual Fund) Rules, 2001. The fund was launched to provide interest free return to the investors by investing the funds only in Shariah Compliant instruments. ICB AMCL Islamic Mutual Fund is a closed-end mutual fund of 10 years tenure. The fund is listed with the Dhaka Stock Exchange limited (DSE) and Chittagong Stock Exchange Limited (CSE). The units of the fund are transferable and traded in both the Exchanges. As per Income Tax Ordinance 1984, income of the fund is tax-free upto certain level and investments qualify for tax credit. Investment activities of the fund started from mid of the FY 05. The fund declared dividend @12.00 per unit of Taka 100.00 each for 2006-07, which is much higher than the preceding year’s level.

Advantages in investing in ICB AMCL Islamic Mutual Fund: Generally investment in mutual funds enjoys some advantages compared to investment made directly in other securities of the capital market. Investors of this ICB AMCL Islamic Mutual Fund will be able to enjoy the following advantages:

a. As the fund will be invested in shariah compatible securities, there shall be no scope of haram earnings and as a result the income in the hand of the investors will totally be halal.

b. As the sale proceeds will be invested in the diversified portfolio, there will be a minimum risk in investment.

c. Diversified portfolio of the fund help the small investors access to the whole market which is difficult at individual level.

d. By channelizing small investors saving, this mutual fund will add liquidity to the market.

e. As the fund will be professionally managed under prudent guidelines, the fund is accepted to be able to achieve the target objectives.

19 ICB Asset Management Company Ltd.: Brochure and Prospectus of ICB AMCL Islamic Mutual Fund and Annual Reports & Accounts FY 07, Dhaka.


f. The investors can save a great deal in transaction cost as he/she has access to a larger number of securities by purchasing a single unit of mutual fund.

g. Investment in the fund would qualify for investment tax credit under section 44(2) of the Income Tax Ordinance 1984.

h. Management and operation of mutual funds are subject to prudential guidelines. SEC regularly monitors the performance of such funds. The laws governing mutual funds require exhaustive disclosure to the regulator and general public. As a result, the investors will be able to know the performance of the fund and accordingly they can be able to take convenient entry and exit options.

i. Income will be exempted from tax to a certain level in the hand of the individual investors.

Investment Policies: The scheme has been designed for a specific sectoral objective i.e. to provide interest free return to the investors by investing the fund only in shariah compliant instruments. Therefore, the fund shall invest both in listed and non-listed securities. While investing in securities the following criteria are to be observed: The basic business of the company should be in consistence with the shariah law. Although no universal consensus exists among contemporary shariah scholars on the prohibition of companies, most shariah boards have advised against investment in companies involved in the activities of: a) conventional banks, insurance and leasing companies; b) alcohol; c) pork related products, d) tobacco; e) weapons and defense; and f) entertainment (hotel, casinos/gambling, cinema, pornography, music etc.).

Screening of acceptable companies: After removing companies with unacceptable primary business activities, the fund may invest in the remaining companies if:

a. The total debt of the investee company is equal to or less than 33% of the trailing 12 month average market capitalization of the company.

b. The sum of cash or interest bearing securities of the investee companies is less than or equal to 33% of the trailing 12 month average market capitalization of the company.

c. The accounts receivable is less than or equal to 45% of the total assets of the company.

The fund may also invest in other shariah compliant instruments as and when they are available for investment. Specifically:


a. In Participation Term Certificates, Mudaraba Certificates, Musharaka, Murabaha, Term Finance Certificates and all other asset backed securities.

b. In contracts, securities or instruments of companies, organizations, and establishments issued on the principles of Bai’ Mu’ajjal, Bai’ Salam, Istisna’a, Mudaraba, Murabaha and Musharaka.

c. In the form of riba-free cash deposits with Islamic banks of financial institutions with the object of maintaining sufficient liquidity to meet the day to day requirement and to take advantage of suitable investment opportunities as and when they arise.

d. In other instruments that may be allowed by the Rules and confirmed as shariah compliant by the fund’s shariah advisor from time to time.

The fund will adopt a conservative strategy and will try to out-perform the index through market timing and security selection. A part of the fund will also be used to take advantage of the short term trading opportunities that may arise from time to time. The AMC will make the investment decisions based on best judgment supported by documents and analysis. The fund shall get the securities purchased or transferred in the name of the mutual fund.

Valuation Policy: the fund intends to determine its NAV per unit on the last business day of each week by dividing the value of the net asset of the fund (the value of total assets less total liabilities as per Rule 60 of the mutual fund rules, 2001) by the total number of units outstanding. Following the valuation criteria, the fund will use the following formula to derive NAV per unit:

Total NAV =VA – LT

NAV per unit = Total NAV/No. of units outstanding.

Where:

VA = Value of total assets of the fund as on date

LT = total liabilities of the fund as on date.

VA = Value of all securities in vault + Value of all securities placed in lien + Cash in hand and at bank + Value of all securities receivables + Receivables of proceeds of sale of investments + Dividend receivables, net of tax + Income receivables, net of tax + Issue expenses amortized as on date + Printing, publication and stationery expenses amortized as on date.

LT = Value of all securities payable + Payable against purchase of investment + Payable as brokerage and custodial charges + All other payable related to


printing, publication and stationery + Accrued deferred expenses with regard to management fee, trustee fee, annual fee, audit fee, and safe keeping fee.

Dividend Policy: The accounting year of the fund shall be July 01 to June 30 and the first year-end shall be June 30, 2005. The other policies related to dividend policy are: a) the fund shall distribute minimum 80 percent of the annual net income of the fund as dividend at the end of each accounting period after making provision for bad and doubtful investments. The fund shall create a Dividend Equalization Reserve (DER) by appropriation from the income of the fund. b) before declaration of the dividend, the asset management company shall make a provision in consultation with the auditors if market value of investments goes beyond the acquisition cost and the method of calculation of this provision will be incorporated in the notes of accounts. c) surpluses arising simply from the valuation of investments shall not be available for dividend. d) dividend warrants will be dispatched within 30 days from the declaration of such dividends. e) before registration for transfer of ownership, a transferee shall not possess the right to any dividend declared.

Risk Management: Investment in securities market always bears risks. Investment in this fund also involves certain risk factors. The investors should carefully consider the following risks in evaluating the offer and also for taking a decision whether to invest or not:

a. the performance of the fund is directly related with the macroeconomic conditions particularly the capital market situation of Bangladesh

b. since the capital market of Bangladesh is highly volatile, there is no assurance of achieving the stated objective of the fund

c. due to small number of listed securities in both the stock exchanges, it may be difficult to invest the fund’s assets in a widely diversified portfolio as and when required to do so

d. as there is a limited scope of investment under shariah law in Bangladesh, it would be difficult for the fund manager to swap between asset classes if and when required

e. stock market trends show that the price of almost all the listed securities move in unpredictable direction which may affect the value of the fund. moreover, there is no guarantee that the market price of shares of the fund will fully reflect their underlying net asset values.

f. If the companies fail to provide expected dividend, this may affect the return of the fund.


g. For investing in pre-IPO placement securities i.e. in unlisted equity securities by the fund may involve liquidity risk.

h. Uncertainties like political and social instability may affect the value of the fund’s assets.

i. Adverse natural climatic condition may hamper the performance of the fund.

j. Due to inadequate supply of shariah compliant securities, full investment of the fund may require comparatively longer time which may affect the profitability of the fund.

k. As only the halal income shall be considered as income of the fund, this may lead to the lower income f the fund as compared with that of traditional mutual funds.

Shariah Compliance Auditor: The auditor of the fund will also act as shariah compliance auditor, and will complete shariah compliance audit of the fund for each accounting period within 30 days from the date of closing of Accounting Year, and will issue a shariah compliance audit report.

Procedure of Redemption/ winding up:

a. the mutual fund shall be redeemed on maturity on the expiry of the ten-year tenure of the fund from the date of first listing.

b. The fund may also be wound up on the happening of any event, which in the opinion of the trustee, requires the scheme to be wound up

c. The fund may also be wound up if the Commission so directs in the interest of the unit-holders.

ANNEXURE-III

Islami Bank Bangladesh Limited: Mudaraba Perpetual Bond (MPB)20

Islami Bank Bangladesh Limited has issued a bond named Mudaraba Perpetual Bond (MPB) of Tk. 3,000 million which is the first of its kind with a view to serve multiple purposes like creating a vibrant bond market in Bangladesh, creating new avenues of investment for the prospective investors etc. From the viewpoint of the Islami Bank, the main purpose of the bond issue is to raise fund to maintain the capital adequacy requirement ratio of the Bank. As per the existing requirement of Bangladesh Bank, all commercial

20 Islami Bank Bangladesh Limited: Information Memorandum on Private Placement of Mudaraba Perpetual Bond, 2007 and Prospectus on Repeat Public Offer of Mudaraba Perpetual Bond, 2007.


banks are required to maintain capital adequacy @ 10% of the risk weighted assets of the bank (previously 9%). With the government policy of encouraging the private sector to be the engine of economic growth, the private sector need for finance has increased significantly from the banking sector during the last two decades.

The purpose of the issuance of the MPB is to enhance the ability of the bank to make further investments by increasing the Capital Adequacy Ratio. One of the main objectives is to utilize the fund to be raised in prospective/profitable sectors. It is to be mentioned that through the issuance of the MPB, IBBL is going to play a pioneering role in creating a bond market in Bangladesh, as this will be the first of its kind in the country. Through the issuance of bond, IBBL is going to create an investment avenue for the prospective investors of the capital market. It is worthwhile to mention that, through the issuance of MPB, IBBL will be able to reduce its cost of fund substantially, which will ultimately be beneficial for the stakeholders. It is to be further mentioned that, the fund raised through issuance of MPB will be utilised in the profitable investment programs of the Bank to make the Bank more profitable. In addition to the income derived from deployment of Mudaraba fund, the bondholders will be entitled to get a rate of profit equivalent to 10% of the rate of dividend to be declared by the Islami Bank Bangladesh Limited.

Advantages for the Issuer

a. The issuer IBBL will issue a new financial product leading to improve financial deepening.

b. The issuer can access a new source of fund.

c. The reputation of IBBL will gradually be enhanced.

d. The issuance of bond will bolster the national effort to develop a bond market.

Benefits for the Investor

a. The investor of the bond will be able to invest in a Shari’ah compatible perpetual lucrative investment instrument.

b. Investment in bonds will enable the investors to diversify their Investments.


Major Features of the Issue

Name of the Bank Islami Bank Bangladesh Ltd.

Size of the issue Taka 1,500 million (private placement)

Unit Price Taka 1,000

Term Perpetual

Profit Distribution a) MPB will carry 1.25 weightage for distribution of Profit.

b) Not less than 65% of the income generated by deployment of MPB fund and

c) An additional rate of profit equivalent to 10% of the rate of dividend to be declared by the Islami Bank Bangladesh Limited every year. No portion of dividend will be distributed to the MPB holders.

Payment of Profit Annually

Market Lot 5 unit of MPB amount to Tk. 5,000.

Credit Rating MPB has been rated as A+ by Credit Rating Information and Services Limited (CRISL).

Trustee Investment Corporation of Bangladesh (ICB).

Manager to the Issue ICB Capital Management Limited (A subsidiary company of ICB).

Issuer Bank: The IBBL commenced its Shari’ah-based interest free Islamic banking operations in the year 1983 as a public limited company formed under Companies Act, 1913 with a mission to establish Islamic Banking through the introduction of a welfare oriented banking system and to ensure equity and justice in the field of all economic activities. The Bank’s corporate headquarter is situated in its own 18 storied modern building at 40, Dilkusha C/A, Dhaka, Bangladesh. The Bank has 8 (eight) Zonal offices and 176 Branches in the country as on 31-12-2006.

Placement Strategy: Considering the present situation prevailing in the capital market, the Bank intends to raise Tk.1,500 million through private placement with commercial banks, investment banks, financial institutions, insurance companies and individuals.

Trustee: Investment Corporation of Bangladesh (ICB) has been appointed as the Trustee to the MPB. ICB has applied to SEC for Registration to act as the trustee to this Bond, which is under active consideration of SEC. The role of Trustee is to protect the rights of investors.


Rights of the Investors: Unlike the interest based traditional Bond, MPB will be a subordinated equity instrument. However, MPB as a Mudaraba instrument will get priority over the shareholders in respect of getting profit and also refund of principal in case of liquidation of the bank. The Bondholders will however stand subordinated to the Depositors in respect of the payment of both profit and refund of principal. The MPB will be listed with both Bourses of the country and will remain freely transferable depending on the market demand subject to the consent of the SEC. However, the Bondholders will not be entitled to enjoy any rights and privilege as enjoyed by the shareholders except statutory requirements.

Claim of the Bondholders: The claim of the bondholders will come in the form of the securities provided by the issuer and the securities thereby constituted shall (subject as hereinafter provided) become enforceable in any of the following events:

a. If the Company is in default in the payment of any income, which ought to be paid in accordance with the terms and conditions, prescribed by the Information Memorandum of Mudaraba Perpetual Bond (MPB).

b. If the Company ceases to carry on its business, or threatens to do so without the consent of the Bond Holders.

c. If a court order is made or a special resolution passed for winding up of the Company.

d. If the Company defaults on the performance or observance of any of covenants, conditions or provisions binding upon the Islami Bank Bangladesh Ltd. for issuance of Mudaraba Perpetual Bond (MPB) and the Company fails to perform fully or rectify the breach of any covenants, conditions or provisions within 30 (thirty) days from the receipt of a written notice from the Trustee requiring it to do so.

e. If the company stops payment or has ceased or is unable to make the payments and it appears to the Trustee that the further pursuance by the company of his business will endanger the security hereby created.

It may be mentioned that IBBL has already agreed to create floating charge to the extent of Taka 3,000 (three thousand) million on the present and future assets of the Bank in favour of the Trustee in order to secure the interest of the Bond holders. In addition to that it will also provide corporate guarantee through which the Bond holders will have their claim on other assets, the provision of which will be clearly delineated in the respective deeds /


indenture. Moreover, at the time of liquidation, the Bondholders will get preference over the claim of the Stockholders.

Investors Protection: The Trustee is entrusted with the critical responsibility of monitoring and ensuring that the interest and rights of the bondholders are fully protected.

Unit Price: The unit price of the MPB will be Tk. 1,000 (Taka one thousand).

Market Lot: The Market Lot will consist of 5 unit of MPB amounting to Tk. 5,000.

Tenure of the Bond: The MPB will be perpetual in nature. Therefore, there will be no fixed maturity period for redemption.

Profitability and Return on MPB: Islami Bank Bangladesh limited has been operating profitably since its inception. All Mudaraba Fund holders/ Mudaraba depositors of the Bank will share income which is derived from investment activities i.e. income from use of Mudaraba Funds. Income under this category will mean and include Profit, Dividend, Capital gain, Rent and any other income derived from investments. The Bank will invest the fund collected through the sale of MPB under Mudaraba Principles of Islamic Shariah, which is based on profit and loss sharing with the Depositors. Estimated Rate of Profit on MPB for 2006 based on the actual performance of the Bank for the last 5 (five) years is furnished below:

Sl.

No.

Particulars 2006 2005 2004 2003 2002

1 Profit on Mudaraba Savings Bond (8 years) at 1.25 weightage

10.85% 10.39% 8.81% 10.04% 10.79%

2 Dividend Declared 25% 25% 20% 20% 25%

3 10% of rate of dividend

2.50% 2.50% 2.00% 2.00% 2.50%

4 Rate of Profit on MPB (1 + 3)

13.35% 12.89% 10.81% 12.04% 13.29%

5 Remarks Based on Final Rate of Profit and entitlement will be based on record date / Book closure.

Procedure for calculation of profit on Mudaraba Deposits: We distribute Investment Income as per ratio between Mudaraba Deposit and Cost free Deposit. Then the share of Mudaraba Depositors can be distributed between Depositors and Management (Minimum 65.00%). We collect deposit product from the branches. After computation of product we convert product


into weighted product. Then we distribute share of Mudaraba deposit of Investment Income among the different types of Deposit. Then we get profit rate as per the following formula:

Rate of Profit P.A =Amount of total profit of any Deposit product

X 100Total Product of any Deposit

Since IBBL will distribute profit to the Bondholders from Gross Investment Income (before deducting any expenditure) so there is less possibility of incurring any loss by the Bondholders.

Special Feature of MPB: MPB will be treated as one of the components of Mudaraba Fund and shall be governed by the rule and principles of utilization & distribution of profit of such funds as in vogue in IBBL.

Security and enforcement:

01. The Bonds issued hereunder shall consist of series from 00,00,001 to 30,00,000 units of Tk. 1000 each aggregating to Tk. 3000 (Taka three thousand) million which are secured by creation of 1st charge/mortgage on fixed and floating/financial assets (investments, receivables etc.) to the extent of Tk. 3,000 million on the assets of IBBL.

02. In consideration of the Mudaraba Perpetual Bonds (MPB) aggregating Tk. 3,000 (three thousand) million the company has already agreed to create floating charge to the extent of Tk. 3,000 million on the present and future assets of the Bank in favour of the Trustee in order to secure the Bond holders.

03. The bond will be further secured by the corporate guarantee of IBBL.

04. The security thereby constituted shall (subject as hereinafter provided) become enforceable in any of the following events:

a) If the Company is in default in the payment of any income, which ought to be paid in accordance with the terms and conditions, prescribed by the Information Memorandum of Mudaraba Perpetual Bond (MPB).

b) If the Company ceases to carry on its business, or threatens to do so without the consent of the Bond Holders.

c) If a court order is made or a special resolution passed for winding up of the Company


d) If the Company defaults on the performance or observance of any of covenants, conditions or provisions binding upon the Islami Bank Bangladesh Ltd. for issuance of Mudaraba Perpetual Bond (MPB) and the Company fails to perform fully or rectify the breach of any covenants, conditions or provisions within 30 (thirty) days from the receipt of a written notice from the Trustee requiring it to do so.

e) If the company stops payment or has ceased or is unable to make the payments and it appears to the Trustee that the further pursuance by the company of his business will endanger the security hereby created.

05. At any time before the security hereby constituted becomes enforceable, the Trustee may upon the application in writing by the Company and at the expenses of Company but only if in the opinion of the Trustee the interest of the Bond Holders shall not be prejudiced, may do or concur in doing all or any of the acts in regard to the charged assets:

a) Sell, call in, collect or convert or concur in selling, calling in, collecting or converting all or any of the charged assets on such terms as may seem expedient with full power to make any such sale for fulfilling any obligation due to the Bondholder(s)

b) Retransfer, release, surrender or abandon on such terms as may seem expedient to the Trustee any of the charged assets which in the opinion of the Trustee is not required for the business of the company or purposes incidental thereto or which may have become unprofitable or source of loss or damage to the company.

c) Exchange any part or parts of the charged assets for any other assets suitable for the purpose of the company and upon such terms as may deem expedient and either with or without payment or receipt of money for quality or exchange.

d) Assent to the modification of any contracts or arrangement that may be subsisting in respect of any of the charged assets.

Transferability: As per approval of the Bangladesh Bank the Bond will have to be listed with the Stock Exchanges after obtaining necessary permission from the SEC and will be freely transferable like the existing shares being traded in the stock market through electronic device of CDBL. Moreover,


Islami Bank Bangladesh Limited will meet all the conditions to get the MPB listed with the Stock Exchanges. It may be mentioned here that Shares of Islami Bank Bangladesh Limited are already listed with Dhaka Stock Exchange (as one of the DSE 20 Blue Chip Companies) and Chittagong Stock Exchange (as one of the CSE best 30 Companies). Applications for the listing of the Bonds (MPB) in both DSE and CSE have already been made and the bourses have given their primary consent regarding listing of the same with the consent of SEC.

Credit Rating: Credit Rating Information and Services Limited (CRISL) has rated the Bond as “A+” which means that this category of securities are adjudged to be of good investment quality and offer adequate safety for timely repayment of financial obligations.

Lock In Provision: There is no provision of lock in period for the investors of bond (MPB).

Trust Deed: A Trust Deed has been executed between issuer IBBL and the Trustee (ICB). Bondholders are entitled to the benefits of and are bound by and deemed to have received notice of the provisions of the Trust Deed. The Trust Deed sets out the rights of the Bondholders and the responsibilities of the trustee.

Future Borrowings: The Bank shall be entitled, from time to time, to make further issue of bonds and other such instrument to the public, members of the Bank and/or to any other person(s) and/or to raise further funds and/or avail of further financial and/or guarantee facilities from financial institutions, banks and/or any other person(s) on the security of its properties with a notice to the Trustees but without any further approval from the bondholders.

Audited Accounts: The audited financial statement as on 31st December, 2006 represent true and fair financial position of the Bank and have been prepared in conformity with International Accounting Standards adopted in Bangladesh. It is worth mentioning that the Bank has not suffered any material adverse change in its business prospects or incurred any substantial or unusual loss or liability.

Risk Factors and Management Perception Regarding Risk: Islami Bank Bangladesh Limited is one of the most successful and leading banks among the Private Commercial Banks (PCBs) in Bangladesh. With a professional, dedicated and honest team of management having long experience, commendable knowledge and expertise in Islamic banking, the bank has achieved success among its peer group within a short span of time. With all its resources, the management of the bank firmly believes that the bank would be


able to encounter problems that may arise both at micro and macro economic levels. However, the prospective risk factors and the plan of the management to reduce such risks are given below:

Credit Risk: There is a risk that the issuer would fail to satisfy the terms of the obligation with respect to the timely payment of profit. This may result partial loss of money for the investors. Management perception: Very soon after its inception, IBBL has been enjoying various credit lines with a number of local and international financing institutions. In its entire operating history, it has not delayed any profit or principal repayment schedule, let alone non-payment. Considering the impeccable track record of IBBL in the repayment of debt obligations, it is expected that it would be able to maintain it in future as well because of its stringent and prudent financing and operating policy.

Liquidity Risk: The MPB will be listed in the Stock Exchanges and as such the Bondholders would be in a position to freely transfer the Bonds and obtain fund in case of needs. Management perception: The proposed bond issue is freely transferable. Hence, the investors can transfer their holdings, fully or partially whenever they want.

Industry Risk: Entrance of a new competitor like new bank or financial institution or expanding services of existing competitors may increase the market competitor and may adversely affect the profitability of the bank. Management perception: Financial institution is a fast growing industry in the country, which has witnessed a substantial growth rate. Over the years, IBBL has registered healthy growth in its banking business. The IBBL holds the highest market share of deposits and investments among Private Commercial Banks (PCBs). Among 48 banks, the growth rate of IBBL is much higher than the overall market growth. Being a first-generation Bank in the private sector, IBBL has been maintaining commendable growth of deposits and investments, which is much better than the growth trends in the industry mainly due to the huge customer participation. IBBL has the largest network of branches among Private Commercial Banks. Hence, it is expected that on the edge of its strategic planning, improved customer service, higher personnel skill and productivity and innovation, the bank be well poised to maintain its growth and profitability in future.

Income Tax: As per existing Income Tax policy, the bondholders will have to pay the income tax at the prevailing rate applicable for corporate & individual, as the case may be. However, since the MPB is a new product, therefore, to facilitate and encourage the investment in the MPB, IBBL has already applied to the chairman of National Board of Revenue (NBR) for the following tax benefits to the MPB holders:


a. Rebate by way of investment allowance for taxation purpose.

b. Profit earned on Mudaraba Perpetual Bond (MPB) as tax free income up to Tk. 25,000;

c. In case of income exceeding Tk. 25,000, the whole income shall be taxed at the rate of 10% at source and considered as the full and final discharge of the tax liability on the total income from MPB.

Date post:	25-May-2015
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