June 2 (Reuters) - Bangladesh has developed a sizeable Islamic finance industry but a lack of sharia-compliant instruments such as sukuk is limiting further growth of the sector, a report by a standard-setting body found.
With a predominantly Muslim population of 160 million, Bangladesh has developed Islamic finance with only marginal regulatory adjustments; the industry has doubled in size in the past four years.
The central bank has a small short-term sukuk (Islamic bond) programme which issues six-month tenors to help Islamic banks manage their liquidity, but a wide range of tenors is not available and there are no corporate sukuk.
Sukuk would help to diversify funding sources and make up for the limited scope of the Islamic money market, but issuance of sukuk would require more specific rules, said the report by the Malaysia-based Islamic Financial Services Board (IFSB).
“The larger policy issue in Bangladesh is the adequacy and scope of the legal and regulatory framework in providing an appropriate enabling environment,” it said.
Islamic banks, which follow religious principles such as a ban on interest payments, now represent 18.9 percent of total bank deposits in Bangladesh, the report said. Bank deposits, excluding interbank deposits, totalled 6.33 trillion taka ($82 billion) in March this year, according to the central bank.
The banks include Islami Bank Bangladesh Limited (IBBL) , set up in 1983 as the country’s first Islamic bank and its largest privately owned commmercial bank.
But Islamic banks ran into liquidity constraints in 2010 when their combined advances-to-deposit ratio exceeded a ceiling set by the central bank, prompting the regulator to monitor their liquidity profiles to detect maturity mismatches.
This problem was addressed in 2011 when the central bank launched an Islamic interbank money market, but the dominant share of IBBL limits the market’s efficiency, the report said.
“Its relative size may impact on the effectiveness of the interbank market, and the central bank should take a further look at this issue.”
The central bank has set statutory liquidity requirements for Islamic banks at half of what is required for conventional banks, boosting their profitability but leaving the core issue of the money market’s depth unaddressed.
“This privilege has the critical flipside that the instruments of Islamic banks for their liquidity risk management are very limited. In cases of sizeable and unexpected deposit withdrawals, Islamic banks may face a liquidity crunch.”
The report also said a sharia-compliant lender-of-last- resort facility and Islamic deposit insurance should be developed by regulators.
The central bank, which did not respond to Reuters queries about its Islamic finance strategy, has said it plans to expand its short-term sukuk programme.
“Introduction of another similar instrument of three-month tenor for further facilitation is at the final stage,” central bank governor Atiur Rahman said in a speech in April.
The central bank is also developing an Islamic refinancing mechanism to increase Islamic bank lending to small and medium-sized businesses, and will encourage greater use of risk-sharing modes of finance, Rahman said. ($1 = 77.4250 Bangladesh takas) (Editing by Andrew Torchia)