LOGO

Development of

Islamic Banking

in Indonesia

Rully Prassetya

Graduate School of Public Policy

The University of Tokyo

January 2013

Asian Financial Market 2012

Agenda

Quick introduction to Islamic Banking

Islamic Banking Development in Indonesia

Findings on Mini Research

Conclusion

1. INTRODUCTION TO ISLAMIC

BANKING

1. INTRODUCTION TO ISLAMIC BANKING

The Foundation of Islamic Banking

Submission to God

Qur’an and Hadits

Aqidah (faith)

Syari’ah (law)

Theological Economic

Islamic Banking

Insurance, etc.

Political Marital Criminal Military Hygiene,

etc.

Akhlaq (Ethics)

Depositors fund: Demand Deposit

(Wadia contract)

Savings (Wadia contract)

Savings (Mudharaba

contract)

Time Deposit (Mudharaba

contract)

POOLING

FUND

Bank Portion

Services (100% bank income) :

• Incoming/Outgoing Transfer

• Kafalah (Bank Guarantee)

• Ar Rahn (Pledge)

Customer Portion

Trading (Cost Plus

Financing):

Murabaha Installment

Murabaha Cash

Equity Sharing:

Mudharaba

Musyakara

Leasing:

Ijara operational

lease

Hire Purchase

Islamic Banking Main (Commercial) Activities

Margin

Profit

sharing

* Margin

* Fee

Profit

Distribution

System

Reasons

The material is haram (li dzatihi)

Haram other than its material

Break the principle of An-Taraddin Minkum

(Contentment)

Asymmetric information

Break the principle of La Tazhlimuna wa

la tuzhlamun (No Oppression)

Supply manipulation (ikhtikar)

Demand manipulation (Bay

Najasi)

Incomplete Information;

uncertainty to both party (Gharar)

Interest (Riba)

Some Prohibited Transactions

ISLAMIC BANKING

DEVELOPMENT IN INDONESIA

SINCE 2000

2. ISLAMIC BANKING DEVELOPMENT IN INDONESIA

SINCE 2000

0

20

40

60

80

100

120

140

160

180

0

5

10

15

20

25

302

00

0

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

No

v-1

2

BP

RS

(un

it)

BU

S an

d U

US

(un

it)

The number of Islamic Banks has steadily grown

Islamic Bank(BUS)

Islamic BusienssUnit (UUS)

Islamic RuralBank (BPRS)

Data Source: Bank Indonesia 2012

0

200

400

600

800

1000

1200

1400

1600

1800

Islamic Bank branches have also grown rapidly, mainly since 2007-2008

Islamic Bank(BUS)

Islamic BusienssUnit (UUS)

Islamic RuralBank (BPRS)

Data Source: Bank Indonesia 2012

0

500

1,000

1,500

2,000

2,500

3,000

0%

20%

40%

60%

80%

100%

120%

140%2

00

0

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

No

v-1

2

Pro

fit

in B

illio

n ID

R

FDR

The Islamic Banks' profit has grown at 47% annually since

2000 and the FDR has been consistently high

Financing toDeposit ratio(FDR)

Profit or loss

Data Source: Bank Indonesia 2012

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%2

00

0

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

No

v-1

2

The share of Islamic Banks’ asset, depositors fund, and credit in national banking industry have also grown, yet still small

Asset share in bankingindustry

Credit share in bankingindustry

Depositors fund share inbanking industry

Data Source: Bank Indonesia 2012

Question #1

• Why Islamic Banking share is very small in Indonesia, given Indonesia is the biggest Muslim-majority country in the world?

– How to further increase its share?

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

The depositor’s fund has been mainly in Mudharaba contract (equity-sharing contract or time deposit)

Time DepositsMudharaba

SavingDepositsMudharaba

SavingDeposits Wadia

DemandDeposit Wadia

Data Source: Bank Indonesia 2012

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006 2007 2008 2009 2010 2011 Nov-12

The Financing in Islamic Banking has been dominated by Murabaha contract (trading contract) and less Mudharaba contract (equity sharing contract)

Ijarah

Qardh

Istishna

Salam

Murabaha

Musyaraka

Mudharaba

Data Source: Bank Indonesia 2012

Question #2

• Why has the financing contract been dominated in Murabaha (trading contract) and depositors fund has been in Mudharaba (equity-sharing contract)?

– What is its implications?

FINDINGS ON MINI RESEARCH

FINDINGS ON MINI RESEARCH

Q1: Why the Islamic Banking share is relatively

very small in Indonesia?

• Islamic Banking growth is significantly determined by the dynamics of real rate of return and real interest rate (Kasri 2007)

• Other plausible reasons:

– Regulatory aspect

– Consumer behavior

– Conservatism of Indonesia’s Islamic scholars

1.1 Regulatory Aspect

• Islamic Banking share is still small due to minimal support in Soeharto era (1966-1998): – Islamic movement was seen as threat (Venardos 2006).

– Only minimal supports to Islamic Banking, predominantly to co-opt Muslim groups (Lindsey 2012)

– There was no specific law on Islamic banking until 2008

– Malaysia has it since 1983 and Middle Eastern countries since 1980s.

• Political reform in 1998 brought freedom and democracy – Trend towards “Islamization”

• The lack of support is still apparent as of 2013. – The deposit of government’s fund (ex. pilgrimage fund)

1.2 The influence of consumer behavior

• Two determining factors: value-oriented behavior and product functionality (Karim and Arif 2005)

• Thus, Two types of Islamic Banking customers: – Loyalist-religious

• Individual; Price insensitive; but sensitive to physical Islamic appearance

– Rational opportunist-swinger • Corporations and pension funds; price sensitive

• Things to note: – Lack of understanding on Islamic Banking (only for Muslim; not profitable;

etc.)

– The number of loyalist-religious is still small, (due to historical “secularism” and/or “lack of knowledge”) yet growing (with the rising Islamic trend in Indonesia, particularly among the educated youth).

– The tighter competition between Islamic Banks will lower the bank charges thus would attract more rational opportunist customer.

1.3 Conservatism of Indonesia’s Islamic Scholar

• National Sharia Board, which has the authority to certify sharia-complied products, is another regulator in Islamic Banking industry, other than central bank.

• Conservatism leads to lack of product development

• Example: – As of January 2013, Indonesia (still) plan to allow Islamic

Banks to use currency hedging, while Malaysia has been doing it since 2006.

– Islamic banks in Indonesia are not doing ‘investment-bank activities’, such as seeking profit from trading Islamic securities in Islamic money market, Islamic capital market, and Islamic stock market.

Q2: Why the share of financing and deposit

contract is as it is?

• Indonesian Islamic Banks are quite risk-averse, thus less Mudharaba (equity sharing) contract; while in Murabaha (trading/cost-plus) contract, there is predetermined short-term cash inflow.

• Higher deposits fund share in Mudharaba contract shows investment-manager nature of Islamic bank.

• Implication:

– Islamic Bank will have a better liquidity condition, as the deposit is long term, while financing is short term.

Conclusion

• Small share in Indonesia’s Islamic Banking is caused by: (1) Late-comers and lack of support from government; (2) Lack of understanding on IB and also small, yet growing, number of loyalist-religious customer; (3) Conservatism of Indonesia’s National Sharia Board.

• The current composition of depositors and financing fund is caused by the risk averse nature of Islamic Bank in Indonesia.

Concluding remarks (1/2): the prospect of

Islamic Banking in Indonesia

• Lack of financial inclusiveness in Indonesia – Only 60% of population has bank account

– Indonesia’s domestic credit to GDP ratio in 2011 is (only) 38.5%; while Thailand 159%; Malaysia 128%; and Singapore 93%).

• The growth of Indonesia’s economy – As of 2012: $900 Billion economy (Nominal, 16th

place) and $1.2 Trillion (PPP, 15th place)

– Demographic bonus until 2020

– Stable political system

– Huge natural resources endowment.

Concluding Remarks (2/2): is (current system of)

Islamic Banking the solution for financial stability?

• Yes

– The practice of no-interest will promote real economy growth

– The ban on speculative activity is good for financial stability.

• But it is not enough

– Fractional Reserve Banking (FRB) and fiat money system are still practiced.

LOGO

Contact:

rully.prassetya@yahoo.com or rully02.wordpress.com

mailto:rully.prassetya@yahoo.com

Reference

• Abduh, Muhamad and Mohd Azmi Omar. Islamic banking and economic growth: the Indonesian experience. 2012. International Journal of Islamic and Middle eastern Finance and Management, Vol. 5, Issue 1, pp. 35-47

• Abduh, Muhamad, Salina Kassim, and Zainurin Dahari. Customer Satisfaction and Switching Behavior in Islamic Banking: Evidence from Indonesia. 2012. School of Doctoral Studies (European Union) Journal 2012

• Bank Indonesia. “Kajian Model Bisnis Perbankan Syariah”. 2012. • Ismal, Rifki. Depositors’ withdrawal behavior in Islamic banking:

case of Indonesia. 2011. Humanomics, Vol. 27, Issue 1, pp. 61-76. • Ismal, Rifki. Islamic Banking in Indonesia: Lesson Learned. UNCTAD

Coneference 2011. • Karim, Adiwarman A. and Adi Zakaria Afiff. “Islamic Banking

Consumer Behavior in Indonesia: A Qualitative Approach”. 2005

Reference (Cont’d)

• Kasri, Rahmatina A. “The Determinants of Islamic Banking Growth in Indonesia”. 2008. Journal of Islamic Economics, Banking, and Finance, Vol. 6, No. 2.

• Lindsey, Tim. “Between Piety and Prudence: State Syariah and the Regulation of Islamic Banking in Indonesia”. 2012. Sidney Law Review, Vol. 34, pp 107-127.

• Venardos, Angelo M. Islamic banking and finance in South-east Asia: Its development and future (2nd ed.). 2006. Singapore: World Scientific Publishing.

• Islamic Bank Act No. 21 year 2008

APPENDIXES

APPENDIXES

GENERAL TRANSACTION ON ISLAMIC BANKING

TABBARU TIJARAH

NCC NUC

Get Return

Take Risk

Profit and Loss Sharing

Lending money

Lending yourself

Giving something's

Qard

Rahn

Hiwalah

Must be paid

commercial contracts

Certain Return

Hibah Shadaqah Waqf

For Allah

For Masakin

For Everyone

Wakalah

Wadi’ah

Kafalah

Fixed Return

Murabahah

Salam & Istishna’

Ijarah & IMBT

Mudharabah & Musyarakah

Islamic

Deposits Islamic Financing

Non-commercial contracts

Natural Certainty Contract

Natural Uncertainty Contract

Tijarah Contracts in Islamic Banking

Mudharabah Musyarakah Salam Ijarah Ishtishna Murabahah

ISLAMIC

FINANCING

+

ISLAMIC

DEPOSIT

ISLAMIC

FINANCING ISLAMIC FINANCING

$

Al-Bai’

$

Salam

Bai’ muajjal

Istishna’

Ijarah

no transfer of title

IMBT transfer of title

at the end of period

promise to sell or hibah at the beginning of period

$ $ $ $

$ $ $ $

$ $ $ $ $ $ $ $

Tijarah contract - Natural

Certainty Contract (NCC)

Shareholder Annual

Meeting

Board of Commissioners

Audit Committee

Board of Directors

Division A Division B Division C Division D Division E

Sharia Supervisory

Board

A typical Islamic Bank Organization Structure

ISLAMIC LEGAL FRAMEWORK

THE QUR’AN & SUNNAH

Twin Sources

USUL FIQIH Methodology

FIQIH Out Put

QAWAID FIQHIYAH Guidelines & Milestones

Source of Believe, Law & Values

(Aqidah, Syariah, Akhlaq)

Arabic Grammar And Lexicon

Innovation of Products to Suit Modern Demand.

Basic Principle: Contracts & Condition are Permissible

Science of Qur’an Science of Sunnah

History of Islamic Legal Development

Comparative Study Of Fiqh Schools

Classic & Contemporary

Understanding and Reasoning Exercise of Esteemed Jurists

Towards the Twin Sources Al-Quran and As-Sunnah