Sharia-compliant financial products gain traction in Indonesia

 

As the most populous Muslim country in the word, Indonesia is developing itself as a centre for sharia-compliant banking, seeking to turn this speciality from a niche activity to a major sector growth driver. The authorities have applied new laws and regulations for Islamic finance they hope will boost the penetration rate beyond the current levels. The government is looking to triple the segment’s current market share to 15% of sector assets. The country has 13 commercial Islamic banks, 21 Islamic windows within conventional banks and 168 rural Islamic banks that accounted for 5.78% of total banking assets as of 2017, up from 5.34% a year earlier. That same year also saw a 0.28-percentage-point decrease in the non-performing loan ratio to 3.87%, while the asset base grew from Rp356.5tn ($25.3bn) to Rp424.18tn ($30.1bn). According to an assessment from Bank Indonesia, the central bank, published in an Islamic Financial Services Board report in 2017, the Islamic banking industry has continued to consolidate, strengthening its capacity.

Global Pattern

However, both asset quality and the capital adequacy ratio (CAR), which stood at 17.91% of risk-weighted assets in early 2018, lag behind the industry average, and competition with the conventional lenders for deposits leads to higher rates. “Sharia-compliant banks often have to look for higher-risk and higher-return borrowers,’’ Herwin Bustaman, director of sharia banking for Bank Permata, told OBG. However, these challenges are not unique to Indonesia. Around the world Islamic banks struggle to match the performance results of their conventional counterparts, many of whom are much larger with greater economies of scale. Islamic banks’ lower solvency ratios in Indonesia are consistent with global trends. For example, the UAE, which is a key market for Islamic finance and one in which the CAR for Islamic banks was 2.2 percentage points lower. Leadership of the sector at the national level comes from the Financial Services Authority, which has introduced a roadmap to promote Islamic finance for the 2017-19 period. The plan focuses on the development of human resources to staff Islamic banks, financial technologies and closer cooperation between licensees to standardise products on offer.

The government has also warned conventional banks with Islamic windows that these must be spun off by 2024. This rule was initiated in 2014 and provides a 10-year period for sales to be completed. While the idea should create a shorter list of larger participants, helping to create larger and more stable institutions, it could instead leave windows struggling if banks cannot find buyers and instead choose to turn them into stand alone banks.

“Spinning off sharia units will be costly if they can no longer use the conventional banks’ networks and resources to reach customers,” Bustaman told OBG. One way an Islamic window can lower costs is to use its parent bank’s back-office functions rather than establishing its own departments.

Transactions to Come

Efforts by the public and private sectors to increase uptake of sharia-compliant products have taken a variety of forms.

In hopes of creating greater visibility for segment offerings, the government is looking at creating an Islamic finance district in Sedayu Indo City, a seaside district in North Jakarta now under development. Plans include a central business district along with multi-use real estate, services and entertainment, and its own light rail transit system. For infrastructure finance, Indonesia’s green bonds and sukuk (Islamic bond) programme, as well as other sharia-compliant options could find favour with the country’s Islamic banks and windows, while also bringing new investors. “Islamic finance can play an important role in financing infrastructure,’’ Bustaman told OBG. “Sukuk are a good fit for project finance. It can also tap into a new investor base.”

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The Report: Indonesia 2019

Banking chapter from The Report: Indonesia 2019

Cover of The Report: Indonesia 2019

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This article is from the Banking chapter of The Report: Indonesia 2019. Explore other chapters from this report.