Islamic banking at crossroads: Prospects and reform pathways in Bangladesh

Islamic banking in Bangladesh has evolved from a modest experiment into a defining pillar of the country’s financial landscape. What began with the establishment of Islami Bank Bangladesh Ltd. in 1983 has now expanded into a robust network of 10 full-fledged Islamic banks with 1699 branches, and 946 Islamic banking branches and windows operated by conventional lenders. Collectively, these institutions now command nearly one-third of Bangladesh’s total banking deposits, marking Islamic finance as no longer a niche concept but a mainstream financial reality.

This phenomenal rise reflects not only the faith-based preferences of a Muslim-majority population but also a growing demand of general mass towards Shariah-compliant financial solutions. However, as the industry matures, it faces a decisive crossroads — balancing expansion and credibility amid crises of governance, regulatory reform, and shifting depositor confidence.

The rapid growth of Islamic banking was initially propelled by public trust and religious motivation. But in recent years, the sector has faced mounting challenges that have eroded depositors’ confidence. A Bangladesh Bank (BB) report indicates that five Islamic banks — First Security Islami Bank, Social Islami Bank, Global Islami Bank, Union Bank, and EXIM Bank — together hold Tk 1.47 trillion in classified loans, equivalent to an alarming 77 percent of their total lending portfolio. The other Islamic banks are struggling for survival.  

Such figures reveal more than financial distress; they signify a breakdown in governance and Shariah compliance — two cornerstones of Islamic finance. The resulting erosion of trust has driven many devout clients, once loyal to Islamic banks, to seek refuge in conventional institutions offering Shariah-compliant windows or branches perceived as more transparent and professionally managed.

The government’s recent decision to merge the five troubled Islamic banks into a single state-owned entity is a critical step toward stabilising the financial system in Bangladesh. Yet, the move also exposes a moral and institutional crisis — the failure to uphold Islamic banking’s foundational values of justice, transparency, and trust.

As distressed Islamic banks struggle to regain footing, conventional banks have aggressively expanded their Islamic operations to capture the displaced clientele. According to central bank data, Islamic branches of conventional banks increased from 34 to 41, and Islamic windows from 730 to 919 between July 2024 and July 2025. Besides, three conventional lenders — NCC Bank, Trust Bank, and Bengal Commercial Bank — have even announced plans to convert into full-fledged Shariah-based institutions.

This competitive shift underscores a crucial reality — Islamic finance has become a mainstream necessity, commanding a significant share of deposits and investment appetite. The transformation also signals that labels alone no longer define credibility; rather, the market rewards genuine compliance, sound governance, and institutional trustworthiness.

Despite recent turmoil, Islamic banks still attract considerable deposits, reflecting resilience and renewed confidence following regulatory intervention. According to the Bangladesh Bank’s June 2025 Islamic Banking Report:

• Total Islamic deposits reached Tk 4.57 lakh crore, up 3.22 per cent from the previous quarter and 2.67 per cent year-on-year.

• Of this, Tk 3.97 lakh crore belonged to full-fledged Islamic banks, while Islamic branches and windows of conventional banks held Tk 25,333 crore and Tk 34,083 crore, respectively.

• Islamic banks accounted for 24.35 per cent of total deposits and 29.18 per cent of total investments across the entire banking sector.

• The total number of deposit accounts rose from 3.6 crore in March to 3.9 crore in June 2025.

These indicators show that despite governance failures in some institutions, the public’s faith in Islamic finance remains intact. Effective regulatory supervision, liquidity support, and board restructuring by the central bank have helped stabilise the sector and reestablish confidence. This migration of depositors toward conventional institutions offering Shariah-compliant products reflects a trust-driven transformation, not a decline in demand for Islamic banking itself. In fact, it reinforces the enduring strength of the Islamic finance model — one that, if properly reformed, could dominate the future of Bangladesh’s financial ecosystem.

Challenges to overcome

For Islamic banking in Bangladesh to realize its full potential, several systemic weaknesses must be addressed decisively:

Weak corporate governance: Political influence, nepotism, and lack of professional management undermine institutional integrity.

Shariah non-compliance: Inconsistent interpretations and weak internal monitoring erode confidence.

Limited product diversity: Over-reliance on Murabahah and Bai-Muajjal reduces competitiveness.

Liquidity and risk management gaps: Absence of robust Islamic money market instruments restricts short-term funding.

Public perception deficit: Scandals and loan irregularities have dented trust in Islamic institutions.

Lack of Islami banking literacy: Since Islamic Banking industry is expanding gradually, sufficient literacy on Islamic finance is absent here hampering to produce quality Islamic bankers. 

Without addressing these weaknesses, the sector risks being overtaken by conventional players who can more effectively embody the principles of transparency, discipline, and ethical finance.

Despite current turbulence, the long-term prospects of Islamic banking in Bangladesh remain promising—anchored in demographic demand, global trends, and Shariah-driven sustainability with special focus on the following arena:

Islamic microfinance and rural banking: A significant portion of Bangladesh’s rural population remains unbanked. Islamic microfinance models based on Qard Hasan (benevolent loans), Musharaka and Mudarabah partnerships can extend ethical finance to rural entrepreneurs, farmers, and women-led enterprises — fostering inclusive growth and reducing dependence on informal moneylenders.

Green and ethical financing: Shariah principles naturally align with sustainability and social responsibility. Islamic banks can lead in renewable energy projects, sustainable agriculture, and ethical business ventures, positioning themselves as pioneers of green finance in South Asia.

Digital Islamic banking: The rise of fintech offers a new frontier. Mobile-based Islamic banking platforms can reach the youth and diaspora customers, ensuring accessibility while maintaining Shariah compliance.

Sukuk and capital market development: Introducing sovereign and corporate Sukuk (Islamic bonds) can mobilise interest-free investments for infrastructure, housing, and industrial development. A vibrant Sukuk market would also improve liquidity and diversify funding sources.

Regional and international collaboration: Collaboration with established Islamic finance hubs such as Malaysia, Saudi Arabia, and the UAE can facilitate knowledge transfer in Shariah governance, liquidity management, and fintech innovation, enhancing Bangladesh’s competitiveness.

To restore credibility and ensure sustainable growth, a comprehensive reform framework is imperative:

Strengthen corporate governance: Leadership appointments must be merit-based, transparent, and free from political influence, ensuring professional management and accountability.

Mandate independent Shariah audits and disclosures: External Shariah audits should be compulsory, with findings published annually to promote transparency.

Ensure genuine conversions, prevent cosmetic Islamisation: Conventional banks seeking full conversion must submit comprehensive roadmaps covering product restructuring, liquidity management, and staff training.

Enhance public confidence: Joint campaigns by regulators and industry bodies should clarify depositor protection mechanisms and highlight reforms under implementation.

Human capital development: Expand Islamic finance education, certification programs, and research institutes to nurture skilled professionals in Shariah governance and risk management.

Bangladesh’s Islamic banking sector stands at a pivotal moment of reckoning. The ongoing merger of distressed banks may avert a systemic collapse but cannot alone restore moral integrity. The true revival of Islamic finance depends on a recommitment to its core ethical foundations — fairness, transparency, and trust.

If reforms succeed — if compliance, governance, and innovation align — Bangladesh can emerge as a regional hub for Islamic finance, serving not only its domestic Muslim majority but also neighboring South and Southeast Asian markets seeking ethical, inclusive financial systems.

The future of Islamic banking in Bangladesh, therefore, is not merely a question of institutional survival — it is a test of principle. Whether led by reformed Shariah-based banks or by conventional institutions embracing genuine compliance, the next phase of Islamic finance will be defined by credibility, competence, and conscience.

*The writer is an Islamic banking professional with extensive experience in Shariah governance, financial communications, and policy analysis. He currently serves as Head of Brand Communication in an Islamic Bank. E-mail: hasan.khairul@gmail.com

*The opinions expressed here are the author’s own.