BANKING - Islamic Finance Looks to Bank on Potential

Jakarta. When Alan Budikusuma and Susi Susanti, former badminton champions and Olympic gold medalists, started their own badminton equipment business in 2003, they did what most entrepreneurs do: They took out loans.

Everything went smoothly until last year, when the couple, who have been married for 13 years, saw interest rates hit 14 percent in the wake of the global financial crisis.

When they started Astindo Jaya Sport seven years earlier, rates were around 10 percent.

“We looked for other alternatives, and we found this Islamic banking financing scheme,” Alan said.

Susi said she and Alan, who are both Christian, turned to Islamic banks because they offered far more flexible financing-payment schemes compared to conventional banks.

“Instead of paying a fixed rate to the bank, we are allowed to adjust the payments in line with our profits,” Susi explained.

Such an arrangement is known as profit-sharing, or mudharabah. As part of this scheme, Islamic banks invest in businesses instead of simply lending them money.

The bank is then entitled to a share of the business’s profit, but must also bear a share of any losses it makes.

Profit sharing arrangements allow Islamic banks to circumvent charging interest, which is forbidden by Shariah law.

Another scheme, known as murabahah, would involve the Islamic bank buying assets from the business seeking a loan, and then selling back the assets later at a profit.

To comply with Shariah principles, Islamic banks also do not provide services to enterprises that engage in business activities that are considered forbidden by Islam, such as selling alcohol or supporting gambling.

By attracting customers like Alan and Susi, in addition to many Muslims in the world’s most populous Muslim country, Islamic banking has been on the rise in Indonesia, having grown 1,000 percent over the past seven years.

Yet analysts see this phenomenal growth as just the beginning.

Currently, Islamic banking is an underperformer in a lucrative market.

According to data from the Economist Intelligence Unit and Boston Consulting Group, Indonesia has 119 million potential customers for Islamic banking products, but has reached only 2.2 percent of them.

Malaysia has reached 19.9 percent and Brunei 36 percent of their own markets.

As of June, the total assets of Indonesia’s Shariah lenders constituted only 2.81 percent of all bank assets nationwide, which totaled Rp 2,678 trillion ($297.26 billion).

That percentage is still far below the 5 percent the central bank set as a target for the industry two years ago.

In an attempt to spur the massive growth they think the sector is capable of, lawmakers have attempted to craft a more favorable policy climate for Islamic banks.

A key obstacle for the banks — double taxation — was removed in April. Double taxation refers to the taxation of both sales in a murabahah scheme — firstly by the customer, and then by the bank back to the customer.

The banks argue the entire process should only be taxed once. But even with double taxation out of the way, the sector is still below the mark, unable to match the strong growth of conventional lenders.

Now analysts are blaming the slow growth on a lack of political will and a lack of public awareness.

To reinvigorate the sector’s growth, the analysts are pushing a so-called “asset conversion policy,” urging the government and state-owned enterprise to shift assets over to Islamic banks.

Some have even proposed fully converting an established state-owned lender into a Shariah bank.

Indonesia’s four state banks — Bank Mandiri, Bank Rakyat Indonesia, Bank Negara Indonesia and Bank Tabungan Negara — account for a third of domestic banking assets.

All four already offer Shariah services. Though Islamic banks have failed to seize a sizeable market share, their assets stood at Rp 75.2 trillion in June, up from Rp 7.8 trillion in 2003.

But Riawan Amin, chairman of the Islamic Banking Association of Indonesia (Asbisindo), called on fellow industry players to not flatter themselves, saying Islamic banking remained “a tiny player in the country’s financial sector.”

“We want size, not numbers,” he said on Tuesday at an awards ceremony for Shariah institutions and products.

Meanwhile, Mulya Siregar, director of Islamic banking at the central bank, said most people did not understand how the banks worked.

“That’s why we need more education,” he said, adding that a recent survey of 5,000 people found 40 percent believed Islamic banks were beneficial, but only 11 percent actually understood what they did.

Mulya said he believed Islamic banking assets could grow to Rp 97 trillion by the end of the year.

Source :  http://www.thejakartaglobe.com/business/islamic-finance-looks-to-bank-on-potential/394742 - Sept 5, 2010