A big shift opens in islamic finance
Jakir Hossain, an employee of a renowned drug company, had a fixed deposit of Tk 10 lakh with an Islamic bank for several years.
When some banks struggled to return depositors’ funds in 2024 after the fall of the Awami League government and directors of the banks fled the country, he decided to withdraw his funds and keep them with a healthy conventional bank that has a shariah-based window.
He was not alone.
In the months after the 2024 mass uprising, the banking sector was revealed to have been hollowed out by years of corruption and plunder, with several Islamic banks among the worst affected. Directors fled the country, branches struggled to pay depositors, and panic withdrawals accelerated.
Two years later, the damage has deepened. Bangladesh Bank data shows deposits at full-fledged Islamic banks stayed roughly flat through most of 2024 and 2025, hovering close to Tk 4 lakh crore, before falling to about Tk 3.9 lakh crore by June 2026.
Year-on-year growth turned negative in late 2024 and hit minus 1.07 percent in June 2026. In that single month, deposits at full-fledged Islamic banks fell by roughly Tk 17,000 crore, coinciding with fresh protests and leadership disputes at Islami Bank Bangladesh, the country’s largest shariah-based lender.
Yet demand for Islamic finance has not disappeared. It has moved towards conventional banks that offer shariah-based services.
BB data shows conventional banks’ Islamic windows and branches held about Tk 37,000 crore in March 2024. By June 2026, that had more than doubled to roughly Tk 78,000 crore, growing in every quarter in between. Growth was still running at about 11 percent year-on-year in the final quarter, while full-fledged Islamic banks contracted by 5 percent.
“This steady growth in deposits of conventional banks can be primarily attributed to the unstable situation in the Islamic banking sector after the July 2024 uprising, which shifted the reliability and confidence of depositors more towards conventional banking,” the central bank said in its latest report on Islamic banking.
The shift shows that customers have not necessarily abandoned shariah-based finance. Instead, many are choosing institutions they consider safer while retaining their preference for Islamic banking.
A MODEL TESTED ONCE ALREADY
Bangladesh’s Islamic banking journey began in 1983 with Islami Bank Bangladesh, established with backing from the Islamic Development Bank. Al-Arafah Islami Bank, Social Islami Bank and Shahjalal Islami Bank followed in the early 2000s.
EXIM Bank and First Security Bank later converted from conventional operations, while Union Bank, Global Islami Bank and Standard Bank subsequently joined the full-fledged Islamic banking system.
Regulation also helped the sector expand. Islamic banks are required to hold far less in liquid reserves than conventional banks, 5.5 percent against 13 percent, allowing them to deploy a larger share of deposits.
Over the following decade, that advantage showed up in the numbers. Between 2016 and 2026, Islamic banking deposits grew roughly two-and-a-half times, while its financing book nearly quadrupled.
A decade of gathering deposits at a slightly slower pace than conventional banks while lending them out faster created a structural imbalance that made the sector more exposed when its underlying financing turned bad.
The model’s first major global test came in 2008. Islamic banks were largely insulated from the first-round effects of the global financial crisis because shariah rules prevented them from holding derivatives and some of the structured securities that triggered the crash, a 2010 study by the International Monetary Fund found.
But that resilience did not mean Islamic banks were immune to poor risk management. The IMF study also found that by the following year, banks with heavy real estate exposure and weaker risk-management practices saw profitability fall sharply.
The distinction between the principle and its practice has become central to Bangladesh’s experience.
“Internationally, Islamic banking is regarded as a resilient, sustainable, and risk-sharing financial system. However, we have not been able to demonstrate that in Bangladesh,” said Md Mahabbat Hossain, an associate professor at the Bangladesh Institute of Bank Management (BIBM).
For all latest news, follow The Daily Star's Google News channel. In practice, he said, much of Bangladesh’s Islamic banking does not involve genuine risk sharing.
For example, when a bank finances a customer, it purchases an asset and immediately sells it to the borrower. The entire transaction can be completed within seconds, meaning the bank bears virtually no risk. What follows is essentially the creation of debt, he said.
“Therefore, the main difference from conventional banking lies in the debt creation process. In terms of actual economic impact, genuine risk sharing remains very limited,” he said.
THE FALL OF ISLAMIC BANKS
By the mid-2010s, several of the largest shariah-based banks, including Islami Bank Bangladesh and First Security Islami Bank, had come under the effective control of the S Alam Group.
In 2022, reports surfaced that these banks had disbursed large loans to nine companies in violation of banking rules, with some loan applications using fake addresses. Bangladesh Bank appointed observers to Islami Bank Bangladesh and First Security Islami Bank.
Deposit growth across Islamic banks fell from above 20 percent in 2021 to below 3 percent the following year. Excess liquidity in the sector also fell by more than 90 percent between late 2022 and early 2024.
BIBM’s Mahabbat said the banks struggled because of the robbery of funds by a group of people with the help of the state.
At one stage, bank management also helped them do so, he said. As irregularities occurred in lending, there was often no underlying asset to back the loans.
Syed Mahbubur Rahman, a former chairman of the Association of Bankers Bangladesh, said Islamic banks had remained relatively resilient during the 2008 crisis because of their underlying assets, but the problems in Bangladesh showed that banks had not followed those principles properly.
“They invested without following proper rules and regulations, so the banks fell into trouble,” he said.
A SECTOR HOLLOWED OUT
When the Awami League government fell in August 2024, the damage surfaced quickly.
BB cut special liquidity support to nine ailing lenders, including six Islamic banks -- Islami Bank Bangladesh, First Security Islami, Social Islami, Global Islami, Union Bank and ICB Islamic Bank.
The central bank later restructured the boards of 11 banks, six of them S Alam-dominated, while a government white paper devoted a full chapter to irregularities in the banking sector.
Five of the weakest lenders -- First Security Islami, Social Islami, Union Bank, Global Islami and EXIM Bank -- were eventually merged into Sammilito Islami Bank under the Bank Resolution Ordinance 2025.
Sammilito Islami began operations with Tk 35,000 crore in capital, including Tk 20,000 crore from the state and Tk 15,000 crore from depositors, becoming the country’s largest and only state-owned shariah-based commercial bank.
The bank is now trying to recover the assets left behind by the five lenders. BB recently said that the merged bank has filed nearly 10,000 lawsuits to recover defaulted loans and has also taken initiatives under an exit policy and alternative dispute resolution.
A comprehensive forensic audit into irregularities, corruption, loan fraud and asset misappropriation under the previous ownership and management is also nearing completion, the central bank said.
The bank’s board has been restructured with priority given to independent directors, while BB said operational integration of 780 branches and 1,500 business units is underway.
The latest steps come as depositors prepare to regain greater access to their funds. From September 1, individual depositors will be allowed to withdraw principal amounts from Al-Wadiah current accounts, Mudaraba savings accounts and Mudaraba term deposits as needed, beyond existing withdrawal limits.
BB has also said there will be no haircut on their profits.
TWO DIRECTIONS
The crisis facing full-fledged Islamic banks has created an opportunity for conventional banks.
At present, 17 conventional commercial banks provide Islamic banking through 49 dedicated branches, while 12 provide the service through 632 Islamic banking windows.
“This is a positive development because it will increase competition in the market, which is ultimately beneficial for customers,” Hossain said.
BB spokesperson Arief Hossain Khan said customers who remained committed to shariah banking had to look for alternatives after becoming disappointed with several Islamic banks.
“As people have disappointment regarding several Islamic banks, customers who prefer shariah banking opted for these conventional banks’ shariah branches or windows,” he said.
The conventional banks also moved aggressively to attract those customers, Arief said.
For instance, NCC Bank has announced that it will convert 20 conventional branches into full-fledged Islamic ones, resulting in a fivefold increase from its existing four dedicated Islamic branches.
But Arief does not expect their Islamic deposits to keep growing at the same pace indefinitely.
“Once the shariah-based banks rebound, people will move back to these banks,” he said.
“Especially when Sammilito Islami Bank rebounds, people will return to the bank as it is a state-owned bank.”
The demand for Islamic financial products is also visible beyond bank deposits.
Hossain recently tried to invest in a government-issued Sukuk but could not because he did not have a Sukuk Investor ID. He has since opened an account so he can invest next time.
Since the launch of government Sukuk in December 2020, total funds raised have exceeded Tk 53,000 crore. The first short-term Sukuk auction in June drew bids worth Tk 56,607 crore against an issuance target of Tk 5,500 crore, making it oversubscribed 10.29 times.
The numbers point to an industry dividing into two tracks.
Confidence in several full-fledged Islamic banks has fallen sharply, while demand for shariah-based finance has continued through conventional banks’ Islamic windows and branches, Sukuk and other Islamic financial institutions.
Regarding the profit-sharing philosophy of Islamic banking, Khan said customers who take profits should also be prepared to bear losses if banks incur them.
“Customers who love to do Islamic banking should have the concept that if they take profit, they should be prepared to bear losses if banks incur losses -- this is the main concept of Islamic banking,” he said.
“However, depositors are not prepared for that,” he added.
For BIBM’s Mahabbat, however, losses caused by mismanagement and irregularities should not be treated as normal business risks.
“What has happened in Bangladesh’s Islamic banking industry was not the result of business risk but of outright robbery by a group of individuals,” he said.