Dr. Foyasal Khan: Islamic banking has witnessed impressive growth over the last four decades to become a well-established component of the banking industry. Currently, 10 full-fledged Islamic banks, 23 Islamic banking branches of 11 conventional commercial banks, and 550 Islamic banking windows of 13 conventional commercial banks are providing Islamic financial services in Bangladesh. Islamic banks represent more than 27 percent share of deposits and 28 percent share of investments of the total banking sector. The number of depositors at Islamic banks in Bangladesh has reached 2.85 crore in 2022 from 1.17 crore in 2014. Total deposits in the Islamic banking system reached BDT 4116.31 billion at the end of March 2023.

Islamic banks in Bangladesh receive deposits under two shari’ah principles: Al-Wadeeah and Mudaraba. Current accounts are operated based on Al-Wadeeah principle while saving accounts are based on Mudarabah principle. In the case of Islamic banking, depositors are the capital providers called Sahib Al-Maal while banks are users of the capital called Mudarib. Banks conduct the business independently maintaining shari’ah compliance. Profit, if any, is divisible between the Sahib Al-Maal and the Mudarib at a predetermined ratio, while loss, if any, is borne by the Sahib Al-Maal.

Distribution of Profits to Mudaraba Depositors

Two frameworks used in Islamic banks in Bangladesh for the distribution of profit to Mudaraba depositors are: weightage-based framework and income sharing ratio (ISR) based framework. The former was introduced in Bangladesh as early as in 1983 and the latter was introduced in 2008. In his 2012 booklet entitled “Profits Payout to Mudaraba Depositors”, M. Azizul Huq (1935-2020) who is widely regarded as one of the founders of Islamic banking in Bangladesh, convincingly argued that ISR-based framework is superior to Weightage-based framework. Let us now review the two options and see why we need to promote an ISR- based framework for a fair and equitable distribution of profits to Mudaraba depositors.

Weightage-Based Framework and Its Limitations

In the weightage-based framework, the bank’s management fee is recovered from the funded income with complete certainty and residues are distributed among different groups of Mudaraba depositors according to assigned weightage. As the bank (Mudarib) was kept outside this weightage schedule, any change in weightage schedule or deposit mix does not affect the management fee of the bank. In this framework, the head office officials exclusively handle profit calculation and Mudaraba depositors are informed only about the amount of profit paid into his account. As the profit determination is done at yearly intervals, throughout the entire accounting year, the bank depends on provisional rates which are changed from time to time. This creates an uncomfortable situation for the Mudaraba depositors. Thus, the weightage-based Framework is not a dependable mechanism as the framework enables an unscrupulous bank to unjustifiably promote its interest at the cost of the depositors.

ISR-Based Framework and Its Advantages

The ISR-based framework is fair to the depositors because if the bank decides to offer special benefit to any group it has to do it at the bank`s cost, not at the cost of other clients of the bank. The ISR-based framework offers a very simple process of one-tier calculation. The calculation can be done on a monthly basis and the rates can easily be updated throughout the year. Since the actual rate is available round the year, no provisional rate is used.

The Mudarabah depositors are better protected in the ISR-based framework because of transparency and full disclosure. At the end of any accounting period, every individual depositor is informed about the amount of income generated by his fund, the amount retained by the bank from this income as its management fee and the amount of income apportioned to him by applying the pre-agreed sharing ratio. The framework is transparent not only in terms of the underlying legal contract between bank and customer but also regular and timely in disclosing relevant profit and performance measures to make transactions fair and equitable.

ISR-based framework of return needs further promotion

Despite clear improvement in the ISR-based framework of return over the weightage-based framework, very few banks have adopted the ISR-based framework of return since 2008. It indicates that the present Islamic banking community either lacks awareness of ISR-based framework or is reluctant to adopt the framework as they do not want to reduce the profits of banks and share them with the depositors. In this situation, Bangladesh Bank (BB), being the regulator, needs to come forward to smooth the transition to the ISR-based system. Currently, the BB Guidelines for Islamic banking published in 2009 recognize the weightage-based framework as the only option for distributing profits to Mudaraba depositors. BB should revise the Guidelines with ISR-based framework of return and retain the weightage-based framework until the total Islamic banking adopts ISR-based framework. Islamic banks also need to be cordial and sincere in understanding the benefits of introducing ISR-based framework. For this, inter-bank and intra-bank discussions on the ISR-based framework need to be promoted. Furthermore, to discourage weightage-based framework, the BB may introduce regulations such as keeping the band of weightage as short as possible and introducing a cap on bank management fee. For example, any financial institution that limits its management fee within 10% and distributes 90% of its funded income to depositors may be given tax incentive. It is hoped that through these initiatives, we will be able to introduce a standardized and uniform profit distribution system for all the Islamic banks in the country.

Author: Dr. Foyasal Khan is an independent researcher and holds a PhD in Economics from International Islamic University Malaysia. He can be reached at foyasal.khan@gmail.com