Article of Rifki Ismal as cited hereunder.
The Islamic finance market in Indonesia has been growing rapidly, albeit from a small base, and remains far behind Malaysia in significance in the financial system overall. Malaysia has over 20% of the financial system in Islamic financial institutions, while Indonesia has just under 3.5% market share. A recent report by Rifki Ismal (from the Directorate of Islamic Banking at Bank Indonesia), “Islamic Banking in Indonesia: Lessons Learned,” which was presented at the UNCTAD Multi-Year Expert Meeting on Services, Development and Trade: The Regulatory and Institutional Dimension held April 6-8, 2011 provides an interesting overview of the banking market in Indonesia, and specifically on the differences between the product mix between equity- and debt-based products. (full story)
The Islamic finance market in Indonesia has been growing rapidly, albeit from a small base, and remains far behind Malaysia in significance in the financial system overall. Malaysia has over 20% of the financial system in Islamic financial institutions, while Indonesia has just under 3.5% market share. A recent report by Rifki Ismal (from the Directorate of Islamic Banking at Bank Indonesia), “Islamic Banking in Indonesia: Lessons Learned,” which was presented at the UNCTAD Multi-Year Expert Meeting on Services, Development and Trade: The Regulatory and Institutional Dimension held April 6-8, 2011 provides an interesting overview of the banking market in Indonesia, and specifically on the differences between the product mix between equity- and debt-based products. (full story)
The Islamic banking market is different in Indonesia than in many markets because there are far fewer products used compared to the GCC and Malaysia. According to Mr. Ismal, this limited product development is due to restricting contracts to those that are “all confirmed with Sharia”. He notes that “Indonesia does not implement debatable contracts such as bay al dayn, bay al innah, tawarruq, bay al arbun and bay al wafa”. Of these contracts deemed debatable, bay al dayn and bay al innah are nearly exclusively used in Malaysia. The product that has attracted the most attention is tawarruq, which was deemed non-Shari’ah-compliant by the OIC Fiqh Academy in the way it is currently practiced.
According to the report, the contracts used in Indonesia are mudaraba and musharaka (equity-based products) and murabaha, salam and istisna’a (debt-based products). These products are useful in many aspects of Islamic finance, but limit the variety of products that can be offered by banks. This is not necessarily always detrimental because it can check the growth of controversial products (e.g. Shari’ah-compliant credit cards). However, there are limitations by imposing limitations on the products because they will have a more difficult time competing with conventional financial institutions. The conventional banks–with a wider variety of products–can address customers needs in more different economic situations than Islamic banks.
The one bit of data in the product mix in Indonesia compared to other countries is the relative shares in equity-based and debt-based products. According to the report, roughly 1/3rd of the financing is equity-based means (mudaraba and musharaka). I don’t know how to explain this difference. One thing that really is striking is the lack of Islamic investment banks:
“However, almost all of Islamic banks in Indonesia are retail banks which extend financing directly to real sector. The Islamic banking industry from other countries contains some investment banks which seek profit from trading Islamic securities in Islamic money market, Islamic capital market and Islamic stock market. The ideal practices of Islamic banks should directly extend funds to the real sector and seek profit directly from the robust performance of the real sector.”
On the one hand, shifting the focus away from investment banks should lower the share of debt-based products because most Islamic investment banking (e.g. sukuk) creates Shari’ah-compliant alternatives to debt. However, the focus on retail banking seems out of line with a high rate of equity-based financing because it would appear to be even more costly to monitor these products (to limit losses from the well documented problems aligning incentives between the customer and the bank).
Just as the product breakdown differs between Indonesia and the rest of the world, so does the institutional setting. Most Islamic financial institutions around the world are (relatively) large institutions. Even the numerous smaller players are small mostly in comparison to other commercial banks. Indonesia, however, has the commercial banks (11 full Islamic banks and 23 Islamic banking windows, according to the report) in addition to many more (151) Islamic rural banks, which are much smaller institutions than the commercial banks and, in addition to providing localized banking services in rural areas also provide Islamic microfinance. They are much different than the typical Islamic financial institution worldwide, which may provide some explanation for the differences in product types used in Indonesia.
There were many other interesting ideas presented in the paper presented at the UNCTAD conference, but the difference in breakdown of product mix was the most stark to me. There are no firm estimates for product mix in other countries, but the general rule of thumb is that between 90 and 95% of the products used elsewhere are debt-based, with the remainder being equity-based (and possibly a few non-financial products like qard).
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