An Analysis of Productivity and Profitability of Islamic Banks in Bangladesh

Abstract

Commercial banks are the heart of the financial market as they mobilize scattered deposits of a country for investment in productive sectors. The banking industry has become a catalyst for growth and development of Industry and Commerce. Banking sector of the country has registered a high growth and achievements due to the promulgation of Banking Companies Ordinance in 1983 and Banking Companies Act 1991. The rapid growth in the number of private banks and competition among them brought in both quantitative and qualitative changes in their functioning and approach towards socioeconomic development of the country. At present there are 49 local commercial banks in Bangladesh; of which 7 are full-fledged Islamic Banks and 42 are conventional Banks. Islamic banks are the major constituents in the banking structure of the country and they have been playing an important role in the financial market in terms of deposit mobilization, investment and non investment services. Even some traditional banks have changed their business into Shari'ah based banking inspired by the success of Islamic banking in the country. The combined growth rate of deposits and investments of all Islamic Banks is over 30 percent as against 16 percent growth of deposits and 13 percent of advances (investments) of the banking sector as a whole. However, Islamic Banks in Bangladesh have been facing numerous problems and challenges despite their initial success. Growth brings new opportunities as well as problems. Now the financial market has become more competitive. It is alleged that there is discrimination between Islamic banks and traditional banks and there is no level playing field for Islamic banks in Bangladesh. Moreover, increased competition, absence of separate Islamic financial market and instruments, lack of separate legal framework and government patronage are the leading causes for low productivity and low profitability of Islamic banks in Bangladesh. It is urgently felt that the productivity and profitability performance of Islamic Banks in Bangladesh should be evaluated over a number of years to have a clear idea about their sustainability in the long run. With this end in view the present study has examined the productivity performance and operational efficiency of Islamic banks in Bangladesh so that corrective measures can be taken in time to enhance their level of efficiency and effectiveness. The beginning year of the study is 1997 and the ending year is 2006. In the beginning year of the study there were only four Islamic banks in Bangladesh, those are Islamic Bank Bangladesh Ltd (IBBL), Oriental Bank Ltd (OBL), Al Arafah Islamic Bank Ltd (AIBL), and Social Investment Bank Ltd (SIBL). These four Islamic banks have been selected for this study. The study has been based on both primary and secondary information. Financial tools like ratios and statistical tools like average, standard deviation, coefficient of variation, maxima, minima, simple and compound growth rate etc have been used along with productivity and profitability models. The study is divided into three parts and eight chapters. The first part contains concepts, ideology, growth and development of Islamic banking in Bangladesh along with methodology of the study. The second part contains the main corps of the study focusing on productivity and profitability performance of Islamic banks in Bangladesh. The third part contains only one chapter that is summary of main findings, conclusions and recommendations. In the recent past there has been increasing religious awareness throughout the Islamic world, which has demanded the reorganization of all social institutions according to Islamic principles, norms and values. An Important change is also taking place in the financial system of the Muslim countries including the banking sector. Much effort has been devoted to eliminate non-Islamic elements from the functioning of the banking system. Islam allowed business within Shari'ah guidelines but prohibited interest or usury. Thus a separate banking system is needed for the Muslims, which is totally free from interest and based on profit and loss sharing. The story of interest-free Islamic banking begins here though the concept of Islamic banking was originated at the time of Prophet Muhammad (SM). In Muslim communities, limited banking activity, such as acceptance of deposits, goes back to the time when Prophet Muhammad (SM) was still alive. People usually deposited their money with Prophet (SM) or with Hazrat Abu Bakar (RA). Prophet (SM) also introduced the system of Bait al-maal or public treasury for the collection and disbursement of revenues among the displaced Muhajirs and the poor and needy Ansars. However, from the early days of the Umayyad, the Bait al-maal started playing the role of an agricultural credit bank and also a commercial bank. Certain forms of banking activity including deposits in current account and use of cheques were known to the people of Baghdad, Damascus, Fez and Cordoba at about 1200 years back. Also, intercity money transfers were a known practice between cash depositors and practitioner Bankers who also used to be money exchangers at the same time. But the emergence of modern Islamic banks was the result of a widespread awareness and concern among scholars that there were increasing numbers of Muslims who were faithful to their religious beliefs refused to bank with the conventional interest-based commercial banks. These intellectuals came up with a banking system that was in conformity with the Islamic injunctions following the principle of profit and loss sharing. The history of interest-free modern banking could be divided into two parts. First, when it was an idea; second, when it became a reality. During seventies, eighties and nineties interest-free banking attracted much attention because of the emergence of young Muslim economists. Works specifically devoted to this subject began to appear in that period. Early eighties saw the institutional involvement. A series of conference, seminar, and symposia were held during seventies and eighties on different aspects of Islamic banking. That was the period of formulating conceptual framework for Islamic banking. While in Bangladesh two professional bodies namely Islamic Economics Research Bureau and Bangladesh Islamic Bankers' Association made significant contributions towards the introduction of Islamic banking in the country. Their professional and right-thought activities were streamlined by a number of enthusiastic businessmen in Bangladesh. At last, the long drawn struggle to establish an Islamic bank in Bangladesh became a reality with the establishment of Islami Bank Bangladesh Limited in March 1983 and that was the beginning of the new era- the era of Shari'ah based interest free PLS banking. At present there are seven Islamic banks in Bangladesh. Moreover, some other newly established traditional private banks have also set up some Islamic Banking branches along with their traditional banking. Islamic banks have occupied a large portion of the money market of the country and achieved significant advancement to evolve into a comprehensive Islamic banking system. One of the major objectives of Islamic banks in Bangladesh is to increase their number of branches and establish a banking network nationally and internationally for extension of banking services to their clients. In this context the growth in the number of branches have been examined and found that all the Islamic banks have been gradually increasing their branch network throughout the country and most of them have been growing more than the industry average. The growth trend in most of the variables like deposit, investment, spread, investment income, non investment income, total income, net profit, current assets, fixed assets, earning assets, total assets, was significant over the period in all the selected Islamic banks except in Oriental Bank Ltd. Thus with some exception, the growth in different variables of Islamic banks in Bangladesh is positive. Another parameter of testing the effectiveness and efficiency of a commercial bank is productivity performance. It is found that the amount of deposit, investment, investment income, non investment income, total income, spread, and net profit per branch and per employee had a fluctuating but growing trend in most of the Islamic banks. Contrarily, non investment expenses, manpower expenses, burden, and total expenses per branch and per employee had also a growing trend, which would have affected the profitability of Islamic banks in Bangladesh. But in some cases, as for example in OBL, the productivity performance was found to be negative. Like productivity, profitability is an indication of the efficiency with which the operation of an enterprise is carried on. The ultimate objective of a bank is to improve profitability by ameliorating efficiency and productivity. The more is the operational efficiency and effectiveness, the more is the productivity and consequently the more is the profitability. Considering all the indicators of profitability such as net profit as percent of total deposit, total income as percentage of total assets, net profit as percentage of spread, profit paid as percentage of total expenditure, and net profit to total investment, it is found that the profitability performance of AIBL was the highest followed by IBBL, and SIBL. However, the profitability performance of OBL was either negative or very low during the whole period of review. Thus, on the whole, the operational performance of most of the Islamic banks in Bangladesh is highly promising. But still there is ample potential for improving the profitability of Islamic banks in Bangladesh through better deployment of fund, reducing nonperforming assets, controlling of non investment expenses, improving transparency and accountability of the management, and increasing the competitive edge to compete successfully with the traditional banks working in the country.