Sovereign investment Sukuk in Bangladesh

Bangladesh issued first sovereign investment Sukuk for raising funds aiming at implementing a project titled 'Safe Water Supply for the Whole Country' on  December 28, 2020. The maiden Sukuk was over-subscribed by nearly four times, signaling that investing in such Sukuk is a new potential avenue for the financial markets of Bangladesh. Likewise, the growing share of Islamic banking in Bangladesh, the huge oversubscription of this maiden Sukuk reflected investors' interest in Islamic financial products of capital market. Besides, the issuance of such Sukuk provides a scope for the government of Bangladesh to explore financing prospects in Shari-ah-compliant projects.

Moreover, current huge excess liquidity with Islamic banks is exerting adverse effects since the Islamic banks cannot invest in interest-bearing government securities because of non-Shari ah-compliance issues. The newly issued Sukuk also offers an avenue of investing the excess liquid assets into such Shari-ah-compliant securities. Against this backdrop, this paper explains the structure of the maiden Sukuk in order to delve further scopes of developing such types of Sukuk in the country, considering huge excess liquidity in Islamic banking sector.

It is to be noted that Sukuk is the plural of Arabic word sakk. In Arabic language, the word Sukuk means 'legal instrument', 'deed' or 'check'. In Islamic financial concept, Sukuk refers to Shariah-compliant financing instruments, which differ from conventional bonds in terms of structure, rate, legal rights and the underlying contracts, among others. Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) defines Sukuk as the certificates of equal value representing undivided shares in ownership of tangible assets, usufructs and services, or equity of a given project or equity of a special investment activity.

NEWLY ISSUED Sukuk AND ITS STRUCTURE: The government planned to raise Tk 80 billion through issuing Sukuk for implementation of a five-year 'Safe Water Supply to the Whole Country' project which began in January, 2021. Three parties, which are originator, special purpose vehicle (SPV) and investors, are involved in the operations of the Sukuk. Bangladesh Bank (BB) acting  as a SPV on behalf of Ministry of Finance, the originator of the Shariah-compliant Sukuk, arranged first auction of Tk 40 billion ijarah Sukuk on December 28, 2020 with a 5-year maturity period. The first auction got response from 37 institutions - both conventional and Shari-ah-compliant financial institutions and two individuals - and was over-subscribed to Tk 151.53 billion. There are two tranches, with Tk 40 billion in each tranche. The BB will arrange the next auction for the remaining tranche of Tk 40 billion on  June 28, 2021.

The underlying contract of such Sukuk is based on ijarah in nature. The existing and future asset including usufruct under the project "Safe Water Supply to the Whole Country' of the government are the Sukuk asset to be leased to the Sukuk investors. Rental rates of the Sukuk will be transferred to the investors in the form of coupon payments. According to the guidelines on the investment criteria of the new Sukuk, investors will receive 4.69 per cent as rental rate on their investment in such Sukuk, which will be paid by the BB on behalf of the government on a half-yearly basis. The BB has fixed the rate based on the latest rate on Bangladesh Government Islamic Investment Bond (GIIB) which paid 3.69 per cent as profit in 2019 and accordingly, the BB added just 1.0 per cent to the rate of the maiden Sukuk. A single investor must invest at least Tk 10,000 in such Sukuk, without any upper limit. The Department of Public Health Engineering (DPHE) is implementing the project funded by the Sukuk issuance and is going to complete the project by 30 June 2025.

IMPLICATION OF THE NEWLY ISSUED SUKUK: The overwhelming response for that Sukuk may be attributed to existence of excess liquidity surplus of Islamic banks. Since Islamic banks cannot invest their excess funds in interest bearing securities and since there are only limited available Shariah-compliant securities, Sukuk has given a scope to assist the Islamic banks in managing their liquidity to some extent. Not only such Sukuk is mopping up the excess liquid assets from the Islamic banks, but also government is implementing its project by introducing such Sukuk, which will, in fact, help resource mobilisation and fiscal management. 

Further, Islamic banks of Bangladesh have to maintain their statutory liquidity ratio (SLR) with the BB, but the government securities to purchase for maintaining the SLR are mostly not Shariah-compliant. Currently, Islamic banks are required to maintain at least 5.5 per cent of their total demand and time liabilities, excluding inter-bank items, effective from February 1, 2014, which remained unchanged till date. On the other hand, conventional banks are required to maintain 13.0 per cent of their total demand and time liabilities. Lower requirement for the Islamic banks is because of the lack of available Shariah-compliant government securities for them, but may raise an issue of market perfection between Islamic and conventional banks. Issuance of more sovereign Sukuk instruments by which the banks will have broader space to maintain SLR will help rationalise the requirement for Islamic banks in future.   

However, in the financial sector, Bangladesh Government Islamic Investment Bond (GIIB), so far, is the only approved Shariah-compliant security other than the newly issued Sukuk in order to maintain the SLR by the Islamic banks. But the limitation of the GIIB is that the government cannot borrow money from GIIB fund as the fund must be used in the Shariah-compliant projects, and there is no mechanism to do so. Therefore, in return, the Islamic banks with liquidity shortfall borrow funds from this pool of GIIB which was collected earlier through selling of the GIIB securities. Here, mudarabah principle is the underlying contract followed for such financing by the security holders and Islamic banks avail this fund at a provisional rate of profit on its mudarabah short notice deposit accounts, with an adjustment after finalisation of accounts and rate of profit of the concerned Islamic banks. However, still a significant balance (= sale - financing) remained always idle in government account without incurring any benefit, indicating that there is a scope of financing this balance in Shariah-compliant ways. Table-1 shows the trend of sale, financing and net balance over the periods during FY10-FY20.

EXCESS LIQUIDITY OF ISLAMIC BANKS AND SCOPE FOR INVESTING IN SUKUK: Excess liquid assets of Islamic banks have been increasing gradually overtime with some ups and down as evident in Chart-1. At the end of Q4FY20, the total amount of excess liquid assets of Islamic banks hit a record Tk 183 billion, while conventional banks' excess liquid assets accumulated to Tk 1514 billion at the end of same quarter. Lower investment or financing in case of both Islamic and conventional banks reflected in slower private sector credit growth in the wake of Covid-19 situation expanded the excess liquid assets in the recent periods. However, while conventional banks have broader scopes of investing their excess liquid assets in treasury bills and bonds, Islamic banks have only two options -- GIIB or newly issued Sukuk.

Chart-2 also shows an overall positive relationship between deposits and excess liquid assets of Islamic banks over the years except 2016, 2017 and 2018. During 2016-2018, the Islamic banks had granted aggressive investments reflected in investment -- deposit ratios, which were close to 90 per cent or more. Since Islamic banks have excess liquidity experience with an absence of available sovereign Shariah-compliant securities, they have a tendency to make over-investments which sometimes remains a concern for bank's resilience against any adverse situation. The BB, at that time, took some special measures for Islamic banks to reduce the investment-deposit ratio. The excess liquid assets escalated again in 2019 to Tk 240.5 billion, while total deposits of Islamic banks also increased. This implies that innovative securities for Islamic financial system are critical to absorb the excess liquidity of Islamic banks.

LIQUIDITY INDICATORS OF ISLAMIC BANKS: Liquidity indicators indicate the capability of Islamic banking sector to its short-term financial obligations. Chart-3 shows that the liquid asset ratio calculated by taking liquid assets as numerator and total assets as denominator maintained always more than 20 per cent except in 2019H, reflecting available liquidity to meet expected and unexpected demands for cash. Liquid assets to short-term liabilities calculated by taking liquid assets as the numerator and short-term liabilities as the denominator show an upward trend and reached 98.1 per cent in 2019H, indicating available adequacy to meet short-term withdrawals of funds without facing liquidity problems.

Basel Committee on Banking Supervision (BCBS) developed a global liquidity indictor, the liquidity coverage ratio (LCR), to understand the capacity of high-quality liquid assets against possibility of cash outflows over the next 30 calendar days. BCBS developed another liquidity indicator, net stable funding ratio (NSFR), which is ratio of amount of available stable funding (ASF) to the amount of required stable funding (RSF), intending to encourage banks to develop access to medium- and long-term funding. According to BCBS guidelines, the ratio must be more than 100 per cent and Islamic banking sector of Bangladesh maintained the ratio well above 100 per cent during the reported periods, which indicates that Islamic banks have sufficient sources of funds over a one-year time horizon under the conditions of financial stress.

POSSIBLE UNDERLYING CONTRACTS: Sukuk can be developed based on different underlying Shariah-compliant contracts, such as partnership, lease, agency and sale contracts. In the context of Bangladesh's financing systems, the following three major contracts can be considered for issuing new Sukuk.

IJARAH Sukuk FOR MEDIUM- AND LONG-TERM GOVERNMENT FINANCING: This is one of the most common Sukuk issuance, especially for project finance. The newly issued Sukuk on safe water corresponds to ijarah contract. Ijarah Sukuk is a leasing structure coupled with a right available to the lessee to purchase the asset at the end of the lease period. The rental rates of return on those Sukuk can be fixed or floating depending on the agreement. The cash flow from the lease including rental payments and principal repayments are passed through to investors in the form of coupons and principal payments. Like the newly issued Sukuk, ijarah Sukuk provides an efficient medium to long-term mode of financing for Bangladesh economy. The major benefit of the ijarah contract is that government as a lessee can lease an asset only for a certain period of time, paying rent against the asset. Even the period is long, the Sukuk holders, on the other hand, can sell the certificates, if needed.

MUDARABAH Sukuk FOR INVESTING IN GOVERNMENT'S SHARIAH-COMPLIANT PROJECTS: This is an agreement made between two parties, where one party provides the capital (rab-al-maal) and the other is an entrepreneur (mudarib). The contract enables the entrepreneur to carry out business projects on a profit-sharing basis, according to pre-determined ratios agreed earlier. In the case of losses, the losses are borne by the provider of the funds only. Currently, GIIB certificates are being operated under mudarabah contract. Government can find the way to issue more mudarabah Sukuk in the market. However, unlike GIIB, it is important to find out how mudarabah fund can be utilised for government's Shariah-compliant projects.

MUSHARAKAH Sukuk FOR DEVELOPING PPP PROJECTS: This is very similar to the mudarabah contract and is widely used in equity financing. The structure of mush?rakah requires both parties to provide financing to the projects. In case of losses, both parties will lose in proportion to the size of their investment. Government's public private partnership (PPP) projects can be considered under musharakah Sukuk for raising required financing for infrastructure development.

CONCLUSION: The maiden Sukuk has drawn huge response from investors as it was over-subscribed, indicating that government can be benefitted further by introducing such types of Sukuk. To continue GDP growth rates to high levels as targeted by the government, the economy needs to implement huge infrastructure development projects in which policymakers need to consider on how Sukuk instruments can be used in government Shariah-compliant projects.

Excess liquidity of Islamic banking sector remains a concern and issuing Sukuk can help them purchase the Shariah-compliant securities for maintaining their SLR as well as for contributing to economic development of the country. At this stage, this note finds that asset backed Sukuk with ijarah, mudarabah or musharakah contracts can be initiated against other Shari-ah-compliant government projects.

Moreover, there is a need for supportive policies for encouraging the investment in Sukuk. For instance, current tax structure of a 5.0 per cent source tax on profit may discourage investors from parking their funds in Shariah-compliant securities. To make the Shari-ah-compliant securities more attractive, tax authority may take appropriate measures, treating Sukuk on how they can be exempted from taxes.

Dr Md Salim Al Mamun, Deputy General Manager, Chief Economist's Unit and Md. Gulzare Nabi, General Manager, Research Department in the Bangladesh Bank.

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