This week in Bangladesh, a significant development took place in the realm of Islamic finance. On June 28, the central bank conducted the inaugural auction of a short-term sukuk, a nine-month financial instrument, raising Tk 5,500 crore to support rural infrastructure projects. This initiative has proven to be successful, indicating a positive trajectory for the program.
Despite the progress, a realization has emerged after over five years since the issuance of Bangladesh’s first sovereign sukuk in December 2020 to fund a national safe water project. While the sukuk mechanism has been effective, the envisioned market associated with it has not materialized. With over Tk 53,000 crore already raised and plans for an additional Tk 30,000 crore in the upcoming fiscal year, it is imperative to investigate why these efforts have not led to the establishment of a genuine Islamic capital market.
The underlying issue stems from the initial decision-making process. Each sovereign sukuk issued by Bangladesh follows a similar structure: the government transfers an existing public asset, such as a water network or schools, to the Bangladesh Bank, which serves as a holding entity. Subsequently, the BB leases the asset back to the government, with investors receiving fixed “rent” until the agreement concludes, at which point the government repurchases the asset at the original price.
Essentially, this arrangement resembles a sale-and-leaseback transaction, where the government sells an asset it already owns, leases it back, and commits to repurchasing it in the future. This model, known as asset-based sukuk, relies heavily on the government’s payment guarantees rather than investors having true ownership and sharing risks and returns associated with the asset, as seen in asset-backed sukuk structures.
In practice, Bangladesh has essentially repackaged conventional treasury bonds into Islamic financial instruments. Recent issuances have been priced between approximately 9.4% and 10.5%, aligning closely with traditional government securities, with the new nine-month sukuk offering a yield of 9.36%. The similarities are primarily cosmetic, indicating a structural issue rather than a religious compliance concern.
When governments opt for asset-based sukuk, they often choose the path of least resistance, adapting sukuk to fit existing financial frameworks, which involve holding entities, asset transfers, and repurchase clauses that mirror bond characteristics. Conversely, the more challenging route involves utilizing sukuk to finance genuinely new assets like infrastructure projects, enabling the instrument to function as intended. Unfortunately, the former approach is commonly favored, as witnessed in Bangladesh’s case.
However, relying on asset-based sukuk presents limitations. These instruments can only be issued if suitable public assets are available for repackaging, raising valuation and repurchase complications, necessitating extensive legal documentation, and constraining the frequency and volume of issuances needed to stimulate a robust market. While asset-based sukuk may address immediate funding needs, they fall short of creating enduring financial infrastructure.
In contrast, financing new assets would mitigate these challenges. Such sukuk structures could employ straightforward, standardized contracts without buy-back provisions, encounter fewer Shariah compliance obstacles, offer various maturities, and scale up considerably due to Bangladesh’s abundance of future development projects. This approach not only addresses immediate funding needs but also contributes to establishing a yield curve, a critical component for a well-functioning capital market.
The absence of a comprehensive yield curve in Bangladesh underscores the nation’s inadequate capital market framework, characterized by a small stock market relative to GDP and a nascent corporate bond market. Without a reliable benchmark for different time horizons, accurately pricing corporate loans, infrastructure ventures, pensions, or long-term savings becomes challenging.
The introduction of a nine-month sukuk is a positive step, as it fills a gap in the market by offering a previously unavailable maturity option. However, continuing to rely on the familiar asset-based model for this new instrument perpetuates the bond-like characteristics rather than embracing the intended sukuk principles. To establish a comprehensive yield curve, a continuous issuance of straightforward government sukuk across various maturities is essential, laying the foundation for a robust capital market, enhancing banking stability, facilitating Shariah-compliant tools for the central bank, and channeling household savings effectively.
It is evident that there is substantial demand for sukuk in Bangladesh, with auctions regularly oversubscribed despite offering lower returns compared to conventional instruments. Islamic banks hold a significant portion of banking assets and possess substantial untapped liquidity due to limitations on interest-bearing investments. Moreover, the appetite for Islamic pension products surpasses the current supply. The challenge lies not in the availability of funds but in the absence of a facilitating institution capable of transforming these resources into a thriving market ecosystem.
Implementing structural reforms is imperative. Instead of relying on ad hoc sale-and-leaseback arrangements for each project, Bangladesh should establish a permanent entity, such as a sovereign finance corporation, funded through revenue-generating assets. This corporation would enable the government to finance legitimate economic ventures using established Islamic contracts, issue suk
