Embracing Islamic Finance


Economic News

22 Jul 2010
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Indonesia is seeking to further develop its Islamic banking sector, looking to tap into the growing market for sharia-compliant financial instruments, though it still has some way to go before being able to match the major players in the segment.

In late January, Bank Indonesia officials laid out their plans and projections for the coming year, including a four-point programme to strengthen the country's banking sector and promote growth across the economy. Along with initiatives to enhance banking resilience, reinforce the supervisory regime, build a better platform for bank intermediation through the improvement of regulation, develop and strengthen rural banks' roles in micro-finance, there was also the key objective of raising the profile of Islamic banking in the economy.

Currently, Islamic banking assets represent only a fraction of the total within the country's banking sector, with the central bank estimating the year-end figure to be around $7.6bn, some 2-3% of the total.

While asset levels in the sharia-compliant banking institutions remain low, there has been greater movement in another segment. The state, some of its autonomous enterprises and, to a lesser extent, the private sector are all making more use of Islamic finance to bankroll their activities.

In late March, state electricity firm PT Perusahaan Listrik Negara (PLN) announced it was planning to fund an upgrade of its infrastructure through bond issues valued at $330m, using both conventional instruments and a rupiah-denominated sukuk issue, with the auction set for May or June.

Early in the same month, the government successfully auctioned $109m worth of sukuk, with the Finance Ministry saying the Islamic-compliant bonds, with terms ranging between five and 15 years, would be used to fund the state deficit, which is projected to come in at 2.1% of GDP this year.

Though the private sector is starting to give sukuk more consideration, some estimates put the number of corporate sukuk issues in the past five years or so at around 20, low when compared to Malaysia, the world's largest market for Islamic debt instruments last year.

In part, the low figure could be down to a deficiency of proper promotion by lenders and a consequent lack of understanding by potential customers, but also potentially a result of wariness by the corporate sector and the public due to perceived risk stemming from a weak regulatory regime.

According to Mohamad Safri Shahul Hamid, deputy chief executive at the MIDF Amanah Investment Bank of Malaysia, Indonesian authorities will have to do more if they want to see the domestic Islamic finance sector develop.

"If Indonesia wants Islamic finance to grow faster, they have to clear these tax and legal issues, and come up with proper guidelines on Islamic securities," Hamid told international media in an interview in mid-February. "The regulators need to play a more active role to open up the market, initiate discussions and encourage the introduction of new products, especially retail and sukuk."

The government has moved to address at least some of these problems, with the parliament passing new legislation last year that would remove double taxation on certain Islamic banking transactions, in particular murabaha, Islamic trade finance. Under the law, which is set to come into effect in April, when a lender extends finance to a client through a murabaha scheme, it technically buys an item or product and then sells it to the client at a profit, thus avoiding charging interest.

Previously tax was charged on both sales, that from the original vendor and then subsequently from the bank, though under the new legislation the sale and resale will be treated as a single transaction for tax purposes.

However, while welcomed by the Islamic finance sector, some lenders have complained the legislation did not go far enough, with no retroactive clause included. In late March, the sharia unit of PT Bank Negara Indonesia (BNI), the country's fourth-largest lender, said it would be filing an appeal against a charge of some $44m levied by the taxation office on the bank's murabaha transactions from the 2007 tax year.

Though BNI has not been alone in having issues with the tax office over its murabaha activities, most of the other banks in the sharia-compliant segment – none of which had the same level of exposure as BNI – have either resolved their problems with the state or are in the process of doing so.

While some 85% of the country's estimated 240m people are of the Muslim faith, and with Islamic finance having long since crossed denominational lines to become a mainstream component of the global financial system, there remains massive unfulfilled potential for sharia-compliant finance in Indonesia. It is up to the government, regulatory authorities and the private sector to work together to ensure the required platform for the product is in place.

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