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The world's biggest Islamic banking market?

The legislative environment for Islamic finance in Indonesia is still evolving. In June the Dewan Perwakilan Rakyat (DPR), the Indonesian Parliament, passed a bill into law that codifies how Islamic or Shari'ah banks should operate. Indonesian state news agency Antara reported that only one of the 10 factions represented in the DPR, the Peace and Prosperity Party, voted against it.<p>Foreign institutions may establish Shari'ah commercial banks in partnership with Indonesian citizens or local entities; foreign ownership is permitted to a maximum of 99 per cent. The new law also offers more flexibility to commercial banks, making it easier for them to convert into Shari'ah-compliant banks.<p>Foreign entities looking to establish a branch office are required to rank among the world's 200 largest banks by total assets while those opening a representative office must rank among the 300 largest in the world by total assets.<p>What the new law does not yet do is address the issue of double taxation, which can crop of up more than once through the multiple transfers of assets that Islamic transactions may require. However, DPR member Melchias Markus Mekeng was quoted as suggesting that this issue may be addressed by further legislation before the end of the year, perhaps as early as September.<p>Shari'ah banking begins Despite having the world's largest Muslim population (nearly 88 per cent of the country's 225 million population is Muslim), Indonesia has been slow to embrace Islamic or Shari'ah banking (domestic institutions tend to prefer the term 'Shari'ah banking'). Much of Indonesia's Muslim population takes a more relaxed view towards Islamic strictures on finance than is common elsewhere in the world, notably, for example, in the Gulf. <p>The enactment of the Banking Act No.7/1992 marked the start of the first phase of the development of Islamic finance in Indonesia. In 1998 an amendment under Act No.10/1998 provided the opportunity to conventional banks to open an Islamic window.<p>The Indonesian central bank, Bank Sentral Republik Indonesia or Bank Indonesia published 'The Blueprint of Islamic Banking Development in Indonesia' in 2002. This outlined the central bank's goals and proposed a strategy, for the development of an Indonesian Shari'ah Banking System, which complies with international standards in terms of financial products and services.<p>One of the Blueprint's key aims for Islamic finance was to reach five per cent of total banking assets by 2011. To have attained this target, Shari'ah financing would have needed to expand by 60-70 percent annually! This goal is unlikely to be attained -- Islamic financial assets were only equivalent to 2.1 per cent of national banking assets last year.<p>Building a banking boom? However, Bank Indonesia is undaunted and has revised its target for Islamic financial assets to make up 10-15 percent of banking assets by 2015. Total Islamic banking assets in the country stood at IDR 52 trillion ($4.8 billion) at end-2008 and are expected to increase to IDR 75 trillion ($7 billion) by December 2009.<p>Growth in customer numbers from three million to five million last year over 2007 was recently cited as evidence that Islamic banks had been unaffected by the financial meltdown that hit Indonesia by Ahmad Riawan Amin, Chairman of the Indonesian Islamic Banking Association. It is true that so far no Indonesian Islamic institution has sought assistance from the central bank during the economic crisis. <p>Figures published by Bank Indonesia show that as of May 2009 the Shari'ah banking sector in Indonesia includes five fully Islamic banks, 25 conventional banks with Islamic windows and 134 Islamic rural banks or Bank Perkreditan Rakyat Shari'ah (BPRS). The BPRS have IDR 1.78 trillion in total assets. They were created as a legal category under the 1988 banking reforms. They are permitted to borrow and lend money but do not have access to the payments system, have lower capital requirements than commercial banks, and are subject to inspection by Bank Indonesia. <p>The five commercial banks have a total staff of 8,447 across 643 branches. Islamic windows employ 2,210 in 255 offices while BPRS employ 2,807 staff in 209 branches.<p>In addition to these banking institutions, there are some 2,500 Bait Maal Wat Tamwil (BMT), Islamic savings and loan cooperatives, mainly located in rural areas, providing agricultural financing. A majority of the BMT are not registered with the Ministry of Cooperatives and Small Business and these cooperatives do not file financial reports with Bank Indonesia. Most BMT are associated with Induk Koperasi Syariah BMT (Inkopsyah BMT), which was established by 18 registered Islamic BMT and 2,200 unregistered "pre--coops." Others are associated with other organisations, especially the foundation Dompet Dhuafa and some religious organisations, or are independent.<p>Bank Muamalat opens The country's first Shari'ah-compliant bank, Bank Muamalat Indonesia (Bank Muamalat), was established in 1991, endorsed by the Indonesian Council of Ulemas and the Government. Following the passing of the Banking Act No.7/1992, the bank commenced operations in May 1992. Supported by the Indonesian Association of Muslim Intellectuals and a group of Muslim entrepreneurs, the founding of Bank Muamalat also won the support of the general public, evidenced by an IDR 84 billion pledge for the purchase of the Bank's shares on the date when the Articles of Association was signed. Additional pledges from communities in West Java were raised to reach a total of IDR 106 billion.<p>In October 1994, barely two years from its founding, Bank Muamalat received its license to operate as a Foreign Exchange Bank but by the late 1990s the bank was struggling, hit by the Asian financial crisis. Indonesia's banking sector collapsed under the burden of corporate debt overhang. Bank Muamalat itself saw its Non-Performing Financing (NPF) ratio exceed 60 per cent in 1998. The bank made a loss of IDR 105 bilion and saw its equity slump to IDR 39.3 billion, less than a third of its original paid-up capital. By way of repairing the balance sheet, the Jeddah-based Islamic Development Bank (IDB) became a shareholder in June 1999. It currently owns 28.01 per cent of the bank.<p>The bank is currently the second-largest provider of Islamic finance in Indonesia with about a 28 per cent market share. Bank Muamalat has 230 branches nationwide and is represented by another 3,800 outlets through its collaboration with the Indonesian post offices.<p>A matter of trust In February 2009 Bank Muamalat signed a strategic deal with Malaysian group Bank Islam Trust Company (Labuan) to cooperate in the promotion of Islamic trust products to the Indonesia market.<p>The Memorandum of Understanding between the Indonesian and Malaysian institutions set out broad guidelines under which the two parties can work with each other, to cooperate and work towards the development and promotion of Islamic trust products in Indonesia. The cooperation includes, but not limited to the following:<p>- developing and promoting Islamic trust products and services; - sharing technical expertise and knowledge of Islamic trust products and services through joint ventures; - establishing distribution channels for Islamic trust products and services; - providing and exchanging information relating to increasing awareness of Islamic trust products and services through promotion initiatives.<p>Bank Muamalat remains focussed on marketing to 'convinced' Muslims. However, Government initiatives aim to broaden the potential base for Islamic finance to a potential "floating market"of 75 per cent of the population offering significant scope for growth to other Islamic finance market players.<p>Non-performing financing a concern Fitch Ratings revised the outlook on Bank Muamalat's national long term rating to negative from stable and affirmed the rating at 'A (idn)' in June 2009. At the same time, Fitch affirmed the rating of the bank's subordinated Mudarabah bond at 'A (idn)'. <p>The outlook revision reflects the increase within the bank's non-performing financing (NPF) in the first quarter of the 2009 financial year and Fitch expects the challenging economic climate may also continue to affect the bank's asset quality and modest capital base.<p>The bank's NPF stood at 6.4 per cent in Q1 2009, up considerably from 4.3 per cent in 2008 and three per cent in 2007. This is higher than the 5.1 per cent industry average for the quarter (NPF averages had fallen to 4.77 per cent by May 2009 according to Bank Indonesia statistics).<p>Bank Muamalat says the increase of its NPF was driven mainly by the deterioration in one large account. Following a restructuring of the financing of that account, the bank expects the loan to be upgraded soon, provided the account continues to perform based on the restructured terms. However, given the bank's relatively concentrated financing - its top 20 debtors account for 29 per cent of loans - NPF could increase significantly should some of these accounts turn non-performing.<p>Fitch Ratings also expressed concern about the decline within the bank's provision cover to 24 per cent of NPF in Q1 2009 from 34 per cent and 88 per cent in 2008 and 2007 respectively; these levels are much lower than the industry average of 104 per cent.<p>There is, however, mitigation from the bank's focus on secured lending and it has said it intends to increase its provision reserves to IDR 300 billion this year. It has also been suggested that the bank may be considering an equity issue by early 2010 to boost the balance sheet.<p>Increasing competition Bank Syariah Mandiri (BSM), became the second commercial bank to operate under Islamic law in November 1999. BSM launched operations with five branches in Jakarta and three others in Bandung, Surabaya and Medan. BSM is 99 per cent owned by Bank Mandiri, a state bank established through the merger of four state banks: Bank Dagang Negara, Bank Bumi Daya, Bank Expor Impor Indonesia (Bank Exim) and Bank Pembangunan Indonesia (Bapindo). BSM, formerly known as Bank Susila Bakti, was owned by one of Bank Dagang Negara's subsidiaries. Ownership of the bank was transferred to Bank Mandiri as part of the merger.<p>BSM reported a 70.12 per cent jump in net profits to IDR 194.42 billion ($17.6 million) in 2008 from IDR 115.45 billion in 2007.Ca <p>BRISyariah is the Shari'ah banking subsidiary of Bank Republik Indonesia (BRI), the country's second largest bank in terms of assets. It was launched in November 2008 and in January 2009 all BRI's Islamic units were merged into BRISyariah. <p>While Bank Indonesia statistics show only 1,107 bank offices providing Shari'ah banking services as of May 2009, Ventje Rahardjo, President Director of BRISyariah, recently claimed his bank's entry into the market-place would boost that number by a further 6,000. He said, "A movement by Bank Republik Indonesia with 5,000 offices now to join in providing the service would be an excellent development in the Islamic bank development. Soon, our offices that will provide Islamic-based services would increase to 6,000."<p>Indonesia's third-largest conventional lender, Bank Central Asia (BCA), is planning to launch a Shari'ah bank in September following its acquisition of Bank UIB last year. BCA, which has a market capitalisation of nearly $7.9 billion acquired Bank UIB in October and plans to convert the small lender to tap into the country's growing Islamic banking segment.<p>BCA's Vice President Director, Jahja Setiaatmadja, said all necessary procedures with the central bank were due to be completed soon to launch the bank, "We've done the fit and proper test C* and if Bank Indonesia can complete the process soon then we expect that the conversion into Shari'ah bank can be completed in September." The bank will target loans to the micro-, small- and medium-sized enterprises segment. Setiaatmadja added that BCA would inject IDR 100 billion as fresh paid-up capital. The bank will have total assets of IDR 705 billion ($67 million).<p>Two other local banks, Bank Bukopin and Bank Negara Indonesia, are also said to be planning to establish Shari'ah-compliant units this year.<p>Foreign entrants HSBC Amanah, the Islamic finance arm of HSBC Holdings was the first major international institution to establish a Shari'ah banking head office operation in Indonesia in August 2007.<p>Albaraka Banking Group, Bahrain's largest Islamic lender by market value, said last year that it planned to purchase an Indonesian bank, but the deal was put on hold after the global economic downturn began. <p>Press reports in June suggested that Albaraka was still actively pursuing expansion into Indonesia and was considering acquiring the small Indonesian lender Bank Kesawan. However, any takeover may still not take place until Q4 2009. Albaraka has not verified that its acquisition target is Bank Kesawan, despite the speculation in the Indonesian domestic media.<p>2009 CPI Financial. All rights reserved.

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Publication:Islamic Business & Finance
Date:Aug 6, 2009
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