CHAPTER 6 EMERGING ISLAMIC BANKING AND FINANCE
6.3. Islamic Commercial Banking Performance
The provision of a new law from the government and a supportive regulatory framework from Bank Indonesia, together with the clear position of MUI about Riba and the payment of double interest, has enhanced the development of Islamic banking.
In line with the banking reforms (Juaro 2008), many new accounts with BUS and UUS, belonging to the conventional banks, and BPRS have been established. The number of outlets has also more than doubled. The ownership of the Islamic banks (BUS and UUS) consists of the government-owned banks, private conventional banks and foreign banks. The ownership of the BPRS ownership is mostly associated with Islamic organisations and Muslim entrepreneurs.61
In contrast to the development of BMI, the newly established BUS, such as Bank Syariah Mandiri (BSM), Bank Mega Syariah (BMS) and Bank Syariah Bukopin (BSB), were originally conventional banks.62 These banks were converted into Islamic banks, thus benefiting from a central bank regulation stipulating a lower initial capital requirement. Uniquely, the conversion of the banks, from conventional to Islamic was related to the banking rescue program instituted following the financial crisis of 1997–
61 Overseas ownership is not allowed for BPRS; this policy is similar to the counterpart BPR sector.
62 The parent company of BMS is Bank Mandiri (a state-owned bank). BMS is Bank Mega (a national private bank) and BSB is Bank Bukopin (partly owned by the government).
98. Prior to conversion, these banks had almost collapsed due to massive non- performing loans, mismanagement and lack of capital. In these cases, the establishment of Islamic banks was more related to business considerations rather than influenced by political or religious considerations. These conversions were enabled by the less- rigorous requirements for capital in Islamic banks (Juaro 2008).
It is evident that the establishment of new UUS is facilitated by the central bank regulation that allows the conventional banks to own Islamic bank business units. The pioneers of leading government-owned banks such as Bank BRI, Bank BNI and Bank BTN, including some BPDs, set up their own UUS for different reasons and objectives.
For examples, Bank BRI established an UUS business in anticipation of a government policy change regarding the Islamic Pilgrim Funds (Ongkos Naik Haji – ONH) collection; Bank BRI is a market leader in collecting ONH. Several cases of BPD reveal that the local government-owned banks opened their UUS units because of local political interference, and some others only follow the ‘nice to have’ trend rather than develop UUS units as a long-term profitable banking business. The private banks and foreign-ownership banks’ expansion of their business into the Islamic banking sector is driven by the increasing demand from affluent Muslims for Islamic-compliant banking services.
At the end of 2009, the total number of Islamic banks totalled six BUS, 25 UUS and 138 BPRS. In addition to BMI (the first BUS), 3 BUS were established through conversion, and two others resulted from the expansion of UUS (spin-offs from their parent conventional banks). These BUS own 701 branch offices and the UUS run 286 units. These are the leading players, with networks across 33 provinces and 89 districts (BI 2010c). The overall performance of the Islamic banking sector reveals promising progress with a stable annual growth in total assets, a loan (financing) portfolio,63 public deposits, good geographical coverage and increasing customer numbers.
63 The terms of loan and financing is interchangeable.
Table 6.2. Key Performance of Islamic Bank Sector
Financial Indicators
2005 2006 2007 2008 2009
1. Total Assets 20,880 26,722 36,538 49,555 66,090
2. Loan/financing 3. NPL (%)
15,270 2.82
20,445 4.75%
27,944 4.05%
38,199 3.95%
46,886 4.01%
4. Deposit 5. LDR (%)
15,593 97.75
20,672 98.90
28,012 99.76
36,852 103.65
52,271 89.90 6. Profit
7. ROA (%)
298 1.35
414 1.55
628 2.07
605 1.42
832 1.48 8. Network
BUS UUS Outlets
3 19 550
3 20 637
3 26 782
5 26 1,024
6 25 1,223 9. Customers 1,400,588 2,364,561 3,358,059 4,363,275 5,114,699 Source: BI (2010c)
Total assets of the Islamic commercial banking sector reached nearly IDR 66.1 billion, which comprised outstanding loans of IDR 46.9 billion, public deposits of IDR 52.3 billion and service to over five million clients. In the last five years BUS and UUS performance grew more than triple in assets, loans and deposits (see Figure 6.1a).
Although there was a sharp decline, particularly during the period of slowing economic growth and the global economic crisis in 2008, the overall financial performance of BUS and UUS is relatively sound and healthy (BI 2010c).
Figure 6.1. Trend of Islamic Commercial Bank 2005–09
0 10000 20000 30000 40000 50000 60000 70000
2005 2006 2007 2008 2009
IDR Billion
(a) Business Volume of BUS & UUS
Total Assets Financing Deposit
12.41 13.73
10.67 11.17 10.77
2.82 4.75 4.05 3.95 4.01
1.35 1.55 2.07 1.42
1.48
2005 2006 2007 2008 2009
(%)
(b) Financial Ratio of BUS & UUS
CAR NPL ROA
Source: BI (2010c)
In a detailed analysis, apparently the rapid development of the sector seems related to the sharp increase of the number of BUS, UUS and their outlets, which allow predominantly Muslim customers and business owners to access a variety of faith-based financial products and services. The Islamic commercial banks have been quite aggressive in disbursing funds to the communities for which the ratio between loan and deposit (LDR) is nearly equal and far above the conventional counterpart rates. The banks maintain a high LDR in order to maximise idle liquidity into profits because there is a very limited opportunity for the bank to invest excess funds in non-interest money market instruments (Juaro 2008). In addition, the BUS and UUS financing scheme is mainly focused on simple transactions, i.e. mark-up financing (Murabaha), instead of developing complex PLS financing (Mudaraba and Musaraka).
The 2009 figure shows that mark-up financing accounted for more than half of the BUS and UUS portfolios, while PLS comprised only one third (BI 2010c). It seems that this strategy has been successfully in fostering the growth rate but in the long-term perspective the concentration on one type of financing model and the lack of portfolio diversification would be riskier particularly in regards default of loans. In other words, Ismail (2010) notes that majority Islamic bank faces overwhelm challenges in applying the PLS financing concept, and although the model underlies the core of non-interest banking and finance, the Islamic banks tend to be selective because of the agency problem64 and unpredictable return risks. Given the complexities of PLS the method has been modified to a revenue-based contract (Muljawan 2002).
On the liabilities side, the source of funds is mainly term deposits and passbook saving.
For the deposit products, the Islamic banks employ a risk guaranteed PLS system that deposits of up to a certain amount are insured by the government-owned deposit insurance company (Muljawan 2002). In this case, in the event of bankruptcy, the banks shift the risk (loss) to the government as ‘the last of the lender resort’. The advantage of the deposit insurance system is that it provides strong confidence for the depositors to
64 The agency problem derives from the principal-agent theory that demonstrates how one individual (the principal) can design a contract which motives another person (the agent) to act in the principal's interest. The principal- agent problem is driven by two situations: firstly imperfect information, and secondly misaligned incentives between the principal and agent. Imperfect information occurs when the principal cannot sufficiently monitor the agents' actions, i.e. in the Islamic banking practice it is very difficult to monitor the actions of its borrowers especially in PLS contract (Alexander 2006, p.18).
place their money in the Islamic banking sector.65 In spite of there being a guarantee mechanism, in general, the capacity of Islamic banks to mobilise public funds is relatively low due to a combination of several factors, including a false understanding of customers toward the PLS system, as it is perceived as providing lower returns, and some uncertainty as to the interest-based system, limited network presence in the communities and the competition force of conventional peer banks.
Despite the fact that the Islamic banking sector has performed well, it has not reached its potential market of Indonesia’s Muslim majority population. Its market share is less than two per cent of the whole banking industry and below the target of the central bank’s blueprint (Juaro 2008). Furthermore Juaro identifies that the performance of UUS significantly contributes to the poor achievement. As a small division of the conventional banks, UUS programs have difficulty in matching, let alone surpassing, the parent bank’s conventional performance.
Equally important, from the perspective of options for clients, regardless of their religious motivation, the Islamic banks’ products and services mirror the conventional banking instruments and the banks’ Islamic strategies are likely to follow those of the conventional programs, including positioning programs in similar market segments.
From an overall perspective, the Indonesia Islamic bank sector takes advantage of a niche market of Muslim clients who seek an alternative banking system that is appropriate to their faith. In other words, despite there being fierce competition between the Islamic and the conventional banks, the later remains dominant.
In the international market, according to World Islamic Banking Competitiveness Report 2013–14, total assets of the Indonesia Islamic banking and finance industry sector in 2012 shared only 1 per cent; it was far behind the global leaders (Ernst &
Young 2013). Compared to the closest Muslim country, Malaysia, where the Islamic banking system has been in existence for over three decades, Indonesia’s Islamic banking sector was only 10 per cent of the size of Malaysia’s Islamic banking sector (KFH 2010).
65 The public funds, for instance current account, term deposit and saving, that are mobilised by BUS, UUS and BPRS are guaranteed by the government-owned deposit insurance company (LPS).