Tariffs, weak confidence heighten risks for Islamic banks

Islamic banks in the country, which are already under strain from multiple challenges, are likely to face further difficulty amid political uncertainty, the fallout of US reciprocal tariffs and new financial reporting standards, Moody's Ratings said in a report released yesterday.

The global ratings agency said weak solvency of the banks, compounded by poor governance, is eroding depositor confidence, and this, in turn, will limit their growth.

"Still, regulators remain committed to developing the sector, and this will underpin its long-term growth," it added.

Moody's said Islamic banks in Bangladesh are highly exposed to the readymade garment industry, which makes up more than 80 percent of the country's exports and sends nearly a fifth of its products to the US.

The report said uncertainty over the new tariff remains, as the interpretation and implementation of any final agreements will dampen consumer and business sentiment and affect the entire RMG value chain and exports.

"We expect suppliers to the US to shoulder some of the tariff burdens. This diminishes borrowers' repayment capacity in a sector that is already challenged by rising production costs due to increases in wages and utility expenses," the report said.

Such pressures, it added, would squeeze exporters' revenues and raise credit risks for borrowers, in turn weakening the solvency of Islamic banks.

Moody's said the Islamic banking sector has also suffered from weak governance and a challenging operating environment, which has stemmed from a range of factors, including a slowdown in economic growth, political uncertainty, supply chain disruptions and a high inflation rate.

In addition, it said, the implementation of tighter rules for the classification of overdue loans in September last year led to a surge in non-performing investments, known as non-performing loans (NPLs) in conventional banks.

As of March 2025, overdue investments accounted for 37 percent of Islamic banks' portfolios, up from 10 percent in December 2023. By contrast, conventional banks recorded an overdue loan ratio of 25 percent.

"Some Islamic banks have reported losses in the first half of 2025, highlighting ongoing challenges and pressure on their profitability," the report noted.

The report said the introduction of International Financial Reporting Standard (IFRS) 9 from 2026, which requires earlier recognition of loan impairments, will deal another blow to the Islamic banks.

"While the new rules will enhance the management of credit risks across the banking system, banks will have to recognise asset impairments earlier than they currently do. This will strain their profitability in the initial years of adoption," Moody's said.

In addition, Islamic banks' weak solvency, exacerbated by poor governance in the recent past, will continue to undermine depositor confidence and limit their growth, it added.

According to Moody's, although the Bangladesh Bank (BB) restructured the boards of some Islamic lenders following the political changeover in August 2024, restoring public trust will take time.

Since September, banks with weaker governance have suffered deposit outflows, while remittance inflows to Islamic banks have also fallen, tightening liquidity and reducing their ability to lend.

Even so, the central bank remains supportive, said the report.

"We expect the sector's financing growth to accelerate in the next three to five years, with its share in the overall banking system expanding from 27 percent as of the end of March 2025," Moody's said.

To provide liquidity support to Islamic banks, the central bank has rolled out two schemes -- the Islamic Banks Liquidity Facility (IBLF) and the Mudarabah Liquidity Support (MLS).

From July 2022 to June 2023, BB supplied Tk 96,000 crore through the IBLF and Tk 200 crore via the MLS.

The amount of support through IBLF rose to Tk 190,000 crore in the July-June period of 2023-2024. Similarly, liquidity support via MLS during this period surged to Tk 1,300 crore, said Moody's in its report.

The amount of liquidity support provided in fiscal 2024 amounted to 3.8 percent of Bangladesh's GDP, or 22.1 percent of total Islamic banking assets, said the report.