Bangladesh’s Islamic banks face higher asset risks with lower loss buffers than conventional peers’ : Moody’s Research

Bangladesh’s Islamic banks face higher asset risks with lower loss buffers than conventional peers’ : Moody’s Research

Singapore, November 01, 2021 :

Islamic banks in Bangladesh have higher asset risks than conventional private banks because
they have rapidly increased corporate exposures, while loss buffers are lower.

Islamic banks also have weaker capitalization than conventional banks because of higher
financing growth when compared to conventional peers and structurally weaker profitability
Bangladeshi Islamic banks’ new corporate exposures are untested through economic cycles, raising
the risk of asset quality deterioration during economic downturns.

At the same time, Islamic banks have weaker loss buffers than conventional peers’ to withstand a worsening in asset quality, says Moody’s Investors Service in a new report.

“Rapid growth in Islamic financing for corporates in a highly fragmented market could be due to poor underwriting standards. Corporate financing increased to 75 per cent of total Islamic financing as of the end of March 2021 from 52 per cent five years earlier, while the proportion for conventional banks reduced to 71 per cent from 75 per cent during the period,” says Tengfu Li, a Moody’s Analyst.

Islamic banks have weaker income buffers against financing losses.

This is because their profitability is structurally weaker, suppressed by higher funding costs and excess liquidity due to a prohibition on holding conventional interest-bearing government bonds and a lack of Shariah-compliant liquid instruments.

Funding costs are higher for Islamic banks than their conventional peers because of their greater
reliance on costlier term deposits. The profitability gap between Islamic banks and their conventional peers will widen if the former’s asset quality worsens to a greater degree when existing support measures for borrowers expire.

Meanwhile, capitalization at Islamic banks will lag further behind conventional peers as financing
growth accelerates. Given their weaker profitability, Islamic banks’ internal capital generation is
inferior compared with conventional counterparts.

In addition, Islamic financing is growing faster than conventional bank loans. As a result, the capitalization gap between Islamic banks and their conventional peers will widen as growth in financing will outpace internal capital generation.