Managing non-performing murabaha finance and Islamic banking in Bangladesh during Covid-19

The Islamic financial system is based upon commercial transactions known as fiqh al-mu'amalat. Fiqh al-mu'amalat considers issues of social justice, equity, and fairness in all business transactions, promotes entrepreneurship, protects property rights, and emphasises transparency of contractual obligations according to the divine law of Allah SWT and his last messenger Hazrat Muhammad (PBUH).  

It is based on Shariah-approved products which do not involve riba (interest/usury), gharar (uncertainty), maisir (gambling), and non-halal (prohibited) activities.  Although Islam has allowed profits, pre-determined, fixed amount of returns is not allowed. Risk of loss and variability of profits must be faced to get returns.

Islamic banking started with the simple profit and loss sharing accounts, and Islamic savings and investment products, but it is now flourishing as Islamic bonds (Sukuk) have been introduced in the market. The main products of Islamic banks are now based on profit and loss sharing principle (Mudarabah), partnerships or joint ventures (Musharakah), sale on contract (Muajjal), leasing contract (Ijarah) and trade with markup (Murabaha).

The Islamic banking industry of Bangladesh has been experiencing an impressive growth due to strong public demand and support from the Bangladesh Bank as well as the government. The Bangladesh Securities and Exchange Commission has issued the Bangladesh Securities and Exchange Commission (Investment Sukuk) Rules 2019, which will help Islamic banks manage liquidity as well as promote Sukuk (Islamic bonds)-based Islamic capital market.

By the end of December 2019, Bangladesh's eight full-fledged Islamic banks have been operating with 1,273 branches out of a total of 10,578 branches of the whole banking industry. In addition, 19 Islamic banking branches of nine conventional commercial banks (including two foreign Banks – HSBC Limited and Bank Alfalah Limited) and 88 Islamic banking windows of nine conventional commercial banks (including one foreign bank – Standard Chartered Bank Limited) are providing Islamic financial services in Bangladesh.

Now, the Islamic banking industry in Bangladesh faces exceptional challenges driven by the global Covid-19 pandemic. The present crisis is an economic crisis that will in turn affect the financial system. The economic shutdown resulting from the pandemic across countries has caused a huge impact on various industries, which are cutting down production and jobs due to diminishing demand and cash flow constraints.

The Islamic finance industry has not been spared. Before the pandemic, there has been a steady growth in demand for Shariah-compliant products and services and the Islamic banking industry in Bangladesh holds almost one-fourth share of the entire banking industry in terms of deposits and investments in 2019. Total investments (loans in conventional sense) in the Islamic banking sector and the conventional banking sector stood at Tk10,587,073 million, out of which Islamic banks' share was 24.82 percent (Tk2,627,519.94 million) at the end of December 2019, according to the Bangladesh Bank.

The analysis of mode-wise investment revealed that the highest investment was made through Bai-Murabaha mode (44.60 percent), followed by Bai-Muajjal (23.95 percent), Ijara and Ijara-bil-Bai (23.62 percent), others (4.87 percent), Musharaka (1.38 percent), Bai-Istisna (1.16 percent), Mudaraba (0.32 percent), Quard with Security (0.05 percent), Bai-Salam (0.03 percent), and HPSM (0.02 percent), at the end December 2019. 

Though the amount of non-performing loans/investment (NPL/NPI) in Bangladesh showed its least growth since 2014 as it grew only by 0.42 percent year-on-year, the entire banking sector has been burdened with the NPL/NPI for long. As of December last year, Tk943.31 billion (Tk94,331 crore) was classified as nonperforming loans, according to a Bangladesh Bank report.

The ratio of gross nonperforming loans to the total outstanding loans of the banking sector stood at 9.32 percent but in the Islamic banking sector, it was 4.82 percent at the end of December 2019, according to the Central Shariah Board for Islamic banks of Bangladesh. It is obvious that Islamic banks have a lower ratio of classified investment/loan compared to the overall banking sector.   

By analysing the data, it is evident that Islamic banks' NPI is simply half (5 percent) in terms of investment comparison with conventional banks (10 percent). This is because in Islamic finance mode, monitoring of proper utilisation of fund is well-ensured than in conventional banks.

Now, given the global recession and outlook, the Islamic banking industry, together with the rest of the world, is staring on a long road to recovery ahead, facing challenges that are unprecedented. In response to the threat of Covid-19, the Bangladesh Bank has announced various types of payment moratoriums, deferments and suspensions.

For instance, BRPD Circulars no 13, dated 15/06/2020, reveals the central bank directed that the classification category of all loan contracts will be the same as it was on 01/01/2020 or better. All term loan contracts' (including short-term agriculture and small loans) tenor will be increased by nine months from the existing maturity date.  A fresh repayment schedule starting from October 2020 to the extended tenor (existing tenor + nine months) will be effective.

This also impacts Islamic finance transactions. For example, "A", being a client of an Islamic bank "B", has enjoyed Murabaha Islamic Investment facility and has an outstanding repayment of Tk50. This comprises Tk40 as cost price and Tk10 as profit.  The repayment of outstanding amount will be made at Tk10 per year and in the third year, the central bank issued a circular on moratorium for a certain period.

It is pertinent to mention here that a contractual buying and selling at a mark-up profit is called Murabaha. In Murabaha, the client requests the bank to purchase certain goods for him. The bank purchases the goods as per specification and requirement of the client.

The client receives the goods on payment of the price, which includes mark-up profit as per contract. In the light of BRPD circular no 13, how should Islamic banks/financial institutions treat Murabaha transactions in which there is a moratorium on repayment obligations which are imposed by the central bank? As there are strict principles governing Murabaha transactions against usury/interest, if a contractual repayment obligation period is extended, can the remaining amount of deferred profit still be claimed?

And what about a claim for an increase in profit, due to the extension of the repayment period? Is this allowed? Can an Islamic bank claim more than the pre-fixed sale price, even if the payments were to be delayed with the asset becoming "non-performing"?

The Shariah is an essential component of Islamic banks' operations. From an Islamic perspective, the notion of "moratorium" is mentioned in the Holy Quran. Allah SWT in Surah Al-Baqra (2:280) instructs creditors to be patient with the debtors who are having a hard financial time, and grant them time until it is easy for them to repay: "And if the debtor is in straitened circumstance, let him have respite until the time of ease; and whatever you remit by way of charity, it is better for you, if only you know."

In Islamic finance, if the transaction has been carried out on credit resulting in a receivable (e.g. using Murabaha), Islamic banks cannot charge an extra amount for extending the date of payment. In the case of Murabaha, this means that they cannot charge extra for deferring Murabaha payments, as this would mean increasing the mark-up retrospectively.

Thus, once the sale price (cost + profit) is fixed for Murabaha financing, an Islamic bank cannot claim more than the pre-fixed sale price, even if the payments were to be delayed with the asset becoming "non-performing". In terms of rescheduling, refinancing, or reclassification, Islamic banks should therefore bear in mind that Shariah rules and principles do not allow them to refinance debts on the basis of re-negotiated higher markup rates. However, debt rescheduling or restructuring arrangements (without an increase in the amount of the debt) are allowed.

It is appreciable that all Islamic Banks in Bangladesh are already sticking to Murabaha principle according to advices of their respective Shariah Boards by truly complying with the aforesaid divine verse as well as the guidelines of Central Bank though their income has decreased.

Imran Ahmed Bhuiyan is Deputy Attorney General, Bangladesh.