Who should pay for Islamic Banks' bad investments?

While Islamic banking’s significant market share and systemic importance within the banking system are often highlighted as notable achievements, a troubling reality undermines this success: a substantial portion of investments in several Islamic banks are non-performing. To contain systemic risks and avoid destabilising the banking system, the central bank has merged five of the 10 full-fledged Islamic banks into the state-backed Sammilito Islami Bank. With a large volume of non-performing investments (NPIs), the Islamic banking sector’s urgent priorities include asset recovery, liquidity management, and restoring confidence.

The high level of NPIs in Islamic banking is troubling, given the strict Shariah compliance requirements. They are meant to demonstrate stronger governance and more disciplined practices than conventional banks. Yet, governance frameworks and Shariah requirements have often been treated as mere formalities rather than being meaningfully integrated. This has undermined the inherent strengths of Islamic banking principles in practice. The distress, therefore, lies not in the concept of Islamic banking itself but in its flawed implementation, which has become entrenched over time.

Accountability for high NPIs seems elusive, with responsibility diffused among different parties. Some attribute the crisis to networks involving powerful actors, actors with political interests, oligarchs, regulators, and insiders. Boards blame management, while management points to boards, state actors, and regulatory compromise. While such claims may provide context, they do not establish legal, fiduciary, or Shariah accountability, nor do they identify who made decisions, approved transactions, ignored warnings, or facilitated bad investments.

Broad attribution of responsibility risks obscuring real actors and the underlying problems. It fails to recognise deep-rooted governance weaknesses and deliberate misconduct. It also obscures the reality that various actors were complicit.

Without deliberate and transparent efforts to trace responsibility, accountability risks remaining rhetorical rather than real. Equally concerning is the implicit immunity enjoyed by those holding decision-making authority. Investment decisions were not anonymous. They were made, approved, executed, verified, reported, and audited by identifiable individuals. The absence of visible action to identify those responsible weakens confidence in the process.

At the same time, the role of the central bank, particularly in its capacity as a regulator and supervisor, warrants scrutiny regarding the timing, conditions, and effectiveness of its interventions. Moreover, statutory audit, internal audit, and Shariah audit do not appear to have operated as effective checks, raising concerns about the robustness of the control environment.

There is also a deeper ethical dimension concerning obedience to wrongful instructions. Acting under such instructions does not absolve responsibility. Islamic teachings do not permit obedience in wrongdoing. By failing to identify the real culprits, the burden ultimately shifts to depositors and the public. This diffusion of accountability is not only unjust; it undermines the moral and legal foundations of Islamic banking. From a Shariah perspective, such a shift is difficult to justify, as justice requires identifying those who have failed in their fiduciary duties.

This issue is particularly critical in the context of mudarabah deposits and bonds. Mudarabah is a trust-based arrangement in which Islamic banks serve as the mudarib (investment manager). Returns are shared between the bank and fund providers according to a pre-agreed ratio, while fund providers bear losses unless they arise from the mudarib’s failure in fiduciary duties.

This underscores the need to carefully distinguish between genuine business risk and losses arising from breaches of fiduciary duty. From a Shariah perspective, this distinction is essential. Where losses result from failure in fiduciary duties, the mudarib must bear them. This principle is grounded in the concepts of trust and accountability that underpin Islamic banking and are well-established in classical jurisprudence and contemporary Shariah standards.

However, while mudarabah historically involved individuals in institutional contexts such as Islamic banking, identifying the mudarib remains a subject of discussion. If the definition of the mudarib is confined to the institutional identity of Islamic banks, liability would be limited to their assets, which may be liquidated, either actually or constructively, to absorb losses. But given the scale of NPIs and the range of parties involved in their origination, identifying the bank solely as the mudarib may not be appropriate. The bank’s own assets are also not sufficient to absorb all losses. Assets funded by mudarabah funds would not be considered the bank’s assets in this context.

A broader interpretation of the mudarib may therefore be necessary. Those who exercised effective control over the banks, including controlling shareholders and those who made or influenced investment decisions, such as board members, board committees, and senior management, can be regarded as performing the mudarib function in substance. Extending personal liability to such individuals when fiduciary failure is established would more closely align with Shariah principles of accountability and broaden the scope of recovery to meet depositor claims. It would also reduce the burden on the state and strengthen accountability within the financial system. In this regard, it is pertinent to note that the Islamic Financial Services Act 2013 of Malaysia treats failure to comply with Shariah requirements as a serious offence, with significant penalties for those involved, which may include directors, officers, and Shariah committee members, of up to eight years’ imprisonment and a fine of 25 million ringgit (approximately Tk 76 crore), or both.

However, this also highlights the limitations of Bangladesh’s existing legal and regulatory framework. Without clear mechanisms to attribute personal responsibility beyond the institutional level, enforcement may not be possible. Meaningful reform is therefore required to allow individual responsibilities to be traced and enforced. In this context, the inclusion of personal liability provisions   (Section 53-58) in the newly enacted Bank Resolution Act, 2026, for the   fraudulent use of a bank’s assets or funds represents a step in the right  direction. This, however, should apply to all fraudulent   cases, not just to banks under resolution.

For Islamic banking to retain credibility, responsibility must be traced to where decisions were actually made. Key decision-makers cannot remain shielded behind the corporate veil. Accountability must be both institutional and personal. Similarly, Shariah supervisory committees, auditors, and rating agencies must be held accountable for any negligence and ensure that, going forward, their work becomes substantive rather than merely procedural.

At the same time, fairness requires recognising that not all actors bear equal responsibility. Some individuals engage in wilful misconduct for personal gain, such as additional benefits, promotions, or desired transfers, while others follow instructions from higher authorities, possibly due to fear of job loss or implicit or explicit threats. Generalised blame is therefore not appropriate for assigning responsibility.

Establishing accountability is essential to restoring discipline in a system built on trust. Without it, Islamic banking risks drifting towards a model in which profits are privatised while losses are socialised, similar to conventional banking, which is neither just nor Islamic. Unless the industry clearly identifies the mudarib, traces responsibility, rejects unjustified immunity, and embeds accountability in both law and practice, the proper establishment of Shariah principles will remain incomplete.

Mezbah Uddin Ahmed is a research fellow at the International Shari’ah Research Academy (ISRA) Institute of INCEIF University in Malaysia. He can be reached at mezbah.u.ahmed@gmail.com.

Views expressed in this article are the author's own. 

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