Bangladesh's Islamic banking sector experienced a significant deterioration in financial health in 2025, with worsening capital adequacy, rising defaulted investments, declining profitability and mounting liquidity pressures, according to the latest Financial Stability Report published by Bangladesh Bank.
The report paints a concerning picture of the country's Shariah-based banks, many of which have struggled to meet regulatory requirements amid a sharp rise in non-performing investments and growing capital deficits. While Islamic banks continue to play a crucial role in mobilising deposits and financing key sectors of the economy, their overall financial position weakened considerably during the year.
Industry analysts warn that unless the sector's capital shortages and asset quality problems are addressed quickly, the ability of Islamic banks to support investment and economic growth could come under increasing strain.
Capital Adequacy Falls Into Negative Territory: One of the most alarming findings in the report is the sharp deterioration in capital adequacy among Islamic banks. According to Bangladesh Bank, the combined Capital to Risk-Weighted Assets Ratio (CRAR) and leverage ratio of Islamic banks fell significantly during 2025, pushing the sector into negative territory. By the end of December 2025, Islamic banks collectively failed to maintain the minimum regulatory requirements for CRAR, Capital Conservation Buffer (CCB) and leverage ratio.
The report showed that the sector recorded a capital shortfall of Tk 1,389.10 billion against the regulatory minimum capital requirement of Tk 326.81 billion. Out of the country's 10 full-fledged Islamic banks, only three were able to maintain the minimum Common Equity Tier-1 (CET-1) capital requirement. Meanwhile, only two banks successfully met the Capital Conservation Buffer requirement.
Banking experts say the figures highlight the severe pressure facing several Islamic banks, particularly those currently undergoing restructuring or merger processes. Speaking to The Daily Industry, banking analyst Dr. Zahid Hossain said the capital deficit reflects years of weak governance and poor credit discipline.
“Capital adequacy is the first line of defense for any bank. When capital falls below regulatory standards, the institution's ability to absorb losses becomes severely compromised. The deterioration in Islamic banks is largely linked to rising defaulted investments and inadequate provisioning,” he said.
Asset Quality Worsens Sharply: The report also revealed a significant deterioration in the quality of assets held by Islamic banks. Gross Non-Performing Investments (GNPI) rose to 56.15 percent by the end of December 2025, while Net Non-Performing Investments (NNPI) climbed to 29.18 percent.
Even after excluding five Islamic banks currently undergoing merger or restructuring processes, the sector's asset quality remained under severe stress. In that case, GNPI stood at 36.94 percent and NNPI at 29.61 percent.
The sharp rise in defaulted investments indicates that a substantial portion of financing extended by Islamic banks is no longer generating expected returns.
According to economists, high levels of non-performing investments reduce profitability, weaken liquidity and erode depositor confidence.
The Daily Industry spoke with economist Ahsan H. Mansur, who noted that resolving non-performing investments remains the biggest challenge facing the Islamic banking industry.
“The problem is not simply one of profitability; it is fundamentally about asset quality. When more than one-third of investments become non-performing, the capacity of banks to finance productive sectors of the economy becomes constrained,” he said.
Profitability Turns Negative: The worsening asset quality has had a direct impact on profitability. According to the report, Islamic banks collectively moved from a modest profit position in 2024 to significant losses in 2025. The Return on Assets (ROA), a key measure of profitability and efficiency, fell dramatically from positive 0.12 percent in 2024 to negative 23.90 percent in 2025.
Bangladesh Bank attributed the decline primarily to lower investment income and higher costs associated with funding and provisioning.
While six of the ten Islamic banks recorded ROA figures better than the sector average, the same number of banks still posted negative returns, underscoring the uneven performance across the industry.
Financial analysts say the negative profitability trend is particularly concerning because it limits banks' ability to build capital internally and support future business growth.
Liquidity Indicators Fail to Meet Regulatory Standards: The report also highlighted growing liquidity challenges across the Islamic banking sector. Several key liquidity indicators deteriorated further during 2025, with banks failing to meet minimum regulatory thresholds.
The Investment-to-Deposit Ratio (IDR) and Liquidity Coverage Ratio (LCR) both worsened and remained below required levels by year-end. The sector also failed to satisfy the Net Stable Funding Ratio (NSFR), another important measure designed to ensure long-term funding stability.
Liquidity pressure has become a growing concern for Islamic banks in recent years as deposit growth slowed while asset quality weakened.
Bankers say liquidity shortages can restrict lending capacity and reduce the ability of financial institutions to respond to unexpected market stress.
Growth Momentum Slows: In addition to weakening financial indicators, Islamic banks experienced slower growth across several major business segments. The report noted declines in the growth rates of investments, deposits, assets and shareholder equity during 2025 compared with the previous year. Despite these setbacks, Islamic banks maintained their significant presence within Bangladesh's financial system. As of December 2025, Islamic banks accounted for 26.01 percent of total banking sector investments, 19.17 percent of deposits and 20.83 percent of total banking assets. The figures demonstrate that although financial conditions have worsened, Islamic banking remains a major component of the country's banking industry.
Islamic Banking Continues to Expand Reach: Islamic banking has become increasingly popular in Bangladesh since its introduction in 1983, largely due to its profit-sharing model and prohibition of interest-based transactions.
By the end of 2025, Bangladesh had 10 full-fledged Islamic banks operating through approximately 1,700 branches nationwide. Five of these banks are currently undergoing merger or restructuring processes.
In addition, 17 conventional banks were operating 41 Islamic banking branches, while 21 conventional banks provided Islamic banking services through 919 Islamic banking windows.
The extensive branch network reflects the continuing demand for Shariah-compliant financial products among consumers and businesses.
Investment Financing Under Pressure: Economists warn that the deteriorating financial condition of Islamic banks could have broader implications for the economy. Islamic banks play a major role in financing trade, agriculture, small businesses and industrial activities. Any prolonged weakness in their balance sheets could reduce the availability of financing for productive sectors.
According to The Daily Industry's analysis, the twin challenges of capital shortages and rising defaulted investments have emerged as the most critical risks facing the sector.
Without stronger recovery of defaulted assets, improved governance and successful recapitalisation efforts, many banks may struggle to restore profitability and meet regulatory requirements.
Urgent Reforms Needed: Banking experts believe the ongoing restructuring and merger initiatives could help stabilise weaker institutions, but caution that structural reforms will be essential.
These reforms include strengthening risk management, improving corporate governance, enhancing regulatory oversight and accelerating the recovery of non-performing investments.
As Bangladesh prepares for greater financial sector reforms, the future of Islamic banking will largely depend on how effectively authorities and bank management address these long-standing vulnerabilities. For now, the latest Financial Stability Report suggests that while Islamic banks remain an important pillar of Bangladesh's banking system, the sector is facing one of the most challenging periods in its history, with capital deficits, mounting defaults and liquidity pressures threatening its long-term sustainability.
