A comprehensive definition of Islamic banking and fi nance described by the State Bank of Pakistan goes as follows: “Islamic banking has been defi ned as banking in consonance with the ethos and value system of Islam and governed, in addition to the conventional good governance and risk management rules, by the principles laid down by Islamic Shariah.”
Islamic finance in more general terms is expected not to only avoid interest based transactions, but to also avoid unethical practices, and to participate actively in achieving the goals and objectives of an
Islamic society.
The emergence in Indonesia With the regulation Act No 7/1992 elaborated in government decree No 72/1992 concerning bank applying share base principle, the Indonesian government has implicitly permitted Shariah banking operation. The Act No 10/1998 was then issued as an amendment.
Bank Muamalat was established in 1999 as the country’s first Islamic bank. The industry grew by 85% in 2004 which triggered many conventional banks to open a Shariah window. (full story)
An overview
Indonesia is considered as the largest Muslim country in the world; 85% of its 240 million population is Muslim. This fact poses great opportunity for massive growth. In the past fi ve years, Indonesia experienced an encouraging average annual growth of 60% for the industry. In 2005, Indonesian Shariah banking recorded a profi t of US$23.8 million; a 47% increase from the previous year.
Through its central bank; Bank Indonesia (BI), the Indonesian government has initiated efforts to stimulate further growth. Various support schemes have commenced, legal support and law enforcement proposed and implemented, and policies issued. Flexibility in various commercial regulations and business conditions has been offered to foreign investors on stimulating the industry’s growth. However, despite various encouragement and offi cial support, the country’s Shariah banking industry remains in its infancy.
Although the industry’s outlook is promising in general, the accomplishments of the Indonesian Shariah banking industry still trails behind its neighbor Malaysia. In 2005, Malaysia recorded US$272 million in profit, and by the end of 2006, Malaysia seized a 12% market share of its total national banking assets. By the end of 2006, Indonesia only seized a 1.4% market share of its total national banking assets. Furthermore, the industry showed rather slow growth by the end of 2009, seizing only 2.8% market share of its total national banking assets.
From the retail side, in 2009, the total number of nationwide Shariah banking accounts in Indonesia totals only 4.5 million. To compare, the total number of nationwide conventional banking accounts is estimated to be 100 million. This shows Shariah banking accounts hold a humble market share of less than 5%.
Shariah banking development
The Shariah banking industry in Indonesia has recorded an encouraging growth rate since its fi rst introduction in 1993. According to BI, total Islamic banking assets grew by 35 times; from IDR1.79 trillion (US$204 million) in 2000 to IDR66.089 trillion (US$7.5 billion) at the end of 2009.
BI also reported that, in the past eight years, the industry’s average annual growth has been recorded at a rate of 53.32%. Between periods of 2008-2009, the industry’s assets grew by an average rate of 33.4% per year. This is well above a growth rate of 15% — 20% per year achieved by the Southeast Asian region’s Shariah banking industry within the same period.
Furthermore, in 2008 to 2009 there was a positive indication in the growth of the Shariah banking industry’s fi nancing provision; average annual growth of 22.8% was recorded. In its funds mobilization from public side, 37.7% average annual growth was achieved.
Over the past fi ve years, fi nancing to deposit ratio (FDR) of the industry reached 90%, implying that the industry has been actively supporting the real sector’s growth. From the profi tability side, Shariah banking
recorded a high growth rate between the periods of 2008-2009 with its return on equity of 25.22% per year.
The Indonesian Shariah banking industry has experienced an aggressive expansion process, nationwide. Its total network has reached 1,140 offi ces and 1,802 Shariah services are now made available in 32 provinces. The operation is supported by a wider network of ‘joint ATM’ stands and various sophisticated technology
which enables internet and banking mobile features.
Challenges
Despite the encouraging growth fi gures in the early years of Shariah banking in Indonesia, the industry is facing challenges which might have slowed down this growth.
According to BI, total assets of Shariah banks as of January 2010 were only around 2% of the total nationwide bank assets of IDR2.502 trillion (US$275.2 billion). BI claims that the industry seems to be struggling on meeting its target of growth, which is 5% share of the total assets.
Investors previously predicted a potential explosive growth in Indonesia based on the fact of a vast untapped banking potential and a large Muslims population. It was then expected that Southeast Asia’s largest economy would soon be the next huge growth market for the US$1 trillion industry.
Apparently, investors would have to be satisfi ed to settle with a slower rate of gains. This slow growth is assumed to be the result of the implementation of several unwelcoming laws and regulations by the
government, also a lack of clear industry standards, for example, no proper guidelines on Islamic securities for instance.
The combined elements of a general upbeat economic outlook, high domestic interest rate, and the country’s fi rming currency have also appealed many foreign investors to the country’s assets.
Unfortunately, Indonesia is facing disappointments in the case of Sukuk. Several Sukuk sales and government issuances have shown discouraging results. Mohamad Safri Shahul Hamid, the deputy chief executive at Malaysia’s MIDF Amanah Investment Bank, believes that the regulators need to be more aggressive and active in opening up the market, initiating discussions and encouraging the introduction of various new products, especially retail and Sukuk.
Tax issues were also considered as one major hurdle of the industry’s growth. The double taxation system applied in several Shariah transactions subjected the customers to pay additional tax. Although the government has recently revised its tax regulation, the new regulation is viewed as ‘not retroactive’; and banks are still involved in a dispute with the directorate general of taxation.
Public awareness is one of serious issues holding back its growth. The need to educate Indonesian Muslims on Shariah fi nance is considered crucial. The other challenge to overcome is the characteristic of the Indonesian Muslim, which is less inclined to adhere to Islamic principles in many aspects including fi nance. Many analysts in Indonesia agree that although 80% to 85% of Indonesia’s population is Muslim, a signifi cant portion of them practice a more moderate form of Islam compared to Malaysia.
The World Bank argues that the industry’s growth is impeded by the lack of regulation instruments to supervise and regulate the industry, which is also lacking in appropriate framework, and low public awareness and limited market coverage. From the operational side, the industry’s growth seems to be held back by ineffi ciencies of institutional structures to support effi cient operations, incapability to comply with international fi nancial standards, and harsh competition from conventional banks.
BI support
The government through BI as the regulator is expected to facilitate the structures on various issues related to the Shariah banking industry, before the industry could be expected to leap for growth in the future. Only with the right support from regulators level, a more impressive growth can be achieved.
To strengthen the Shariah banking network, BI issued in 2009 the regulation on the conversion of conventional banks to Shariah banks; Regulation No 11/15/PBI/2009. The regulation came into force on the 29th April 2009, with the aim to stimulate the conversion of conventional banks to Shariah banks.
The regulators’ role in supporting the industry’s growth is vital. Mulya Siregar, then deputy director of BI, in his speech at a seminar on Islamic Banking in 2009 claims that, without the full support of government regulations, the growth would only be around 43%, while with the support, it could grow by a maximum of 81% for asset ownership.
Prospects for growth
The Shariah banking market is predicted to grow at a compound annual growth rate (CAGR) of around 52% from 2008 to 2010. The reasons behind this are the large Muslim population, current conditions of a relatively low penetration of Shariah banking, and the improvements in regulatory framework. As an effort to support the industry’s development, BI issued a blueprint aimed at strengthening the industry by 2015.
BI’s grand strategy to boost the industry’s growth will be focusing on three major actions; increasing the effi ciency of Islamic banking, integrating Islamic banking into the Islamic fi nancial industry, and conforming to global Islamic banking products.
BI believes that a recent revival of the Islamic religion in the country, supported with by its grand strategy, will popularize various Shariah banking products; eventually resulting in concrete growth in the future. Based on the rising popularity of Shariah banking within the country, BI predicts an increase in demand for Shariah fi nancing, which will offer a CAGR growth of more than 51% from 2008 to 2010.
Despite various challenges faced, the industry’s growth potential in the country has apparently attracted foreign banks. HSBC launched its Shariah window called HSBC Amanah, which is now operating in the
country. Only recently, Malaysia entered the market in 2010 with CIMB Niaga Syariah. It is also predicted that in the near future there will be more foreign banks from Malaysia and Bahrain entering the market by
establishing its Shariah branches in Indonesia. This fact implies there is a massive potential market for growth within the country.
Drs Rizqullah, MBA
President director
Bank BNI Syariah
Email: rizqullah57@yahoo.com
Rizqullah has been involved in Islamic banking and economic activities since 2002. He was involved in several Islamic economic and banking organizations and is lecturing on Islamic economic and finance at several postgraduate programs with Trisakti University and Universitas Islam Negeri Jakarta
Source : www.islamicfinancenews.com
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