Global Business Guide Indonesia

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Finance | The Outlook for Indonesia’s Islamic Banking Sector

As an island nation with a large Islamic population, Indonesia contains many communities that are relatively isolated from the larger cities. This separation presents a challenge in marketing financial-services to retail clients in a culture which depends on face-to-face relationships to build sales. Although Indonesia's banking and financial-services sector is indeed growing along with its economy, Islamic banking represents only a small portion of the overall financial sector. In mid-2012 the Indonesian banking authorities reiterated the ambitious goal of having 10% of the country's total banking assets under shariah-compliant management by the year 2015. Still, by the end of 2012, Islamic bank assets in Indonesian banks totaled only about $16 billion or less than 5% of the total. Indonesia's success in becoming an Islamic banking powerhouse also depends on extrinsic factors, such as worldwide demand for the country's export commodities, and also sociopolitical factors, including the pattern of political unrest which has developed throughout much of the Arab world and other Islamic countries.

The Outlook for Indonesia’s Islamic Banking Sector
Indonesian banks are eager to draw foreign investors who might otherwise choose Malaysia as the default destination for shariah-compliant banking, and they are advocating for the development of more shariah-compliant bonds and other debt products.

Indonesia has five significant Islamic banks, plus another 32 conventional banks which feature a “shariah window” for transacting shariah-compliant business (See Indonesia’s Islamic Banking Sector). Total deposits at all shariah-compliant banks in Indonesia rose by nearly 30% in 2012 to a total of approximately $16 billion USD, representing about 4.6% of Indonesia's total bank assets (Bank Indonesia, Banking Survey Quarter IV 2012). There are two leaders; Bank Mandiri Syariah and Bank Muamalat, which together account for at least half of Indonesia's Islamic finance sector. Other Islamic banks include Bank BRI Syariah, Bank BNI Syariah, Bank Mega Syariah, and BCA Syariah. Although most Indonesian Islamic banks have conventional Indonesian banks as their parent company, Bank Muamalat is jointly owned by the Islamic Development Bank, Boubyan Bank of Kuwait, Atwill Holdings, National Bank of Kuwait and the remainder by small shareholders. All face significant challenges to the growth of Islamic finance in Indonesia. In particular, there is a scarcity of shariah-compliant hedging vehicles to protect investors against risk, especially currency-exchange risks, as well as a lack of debt products and bonds for institutional investors (sukuk). A small market share and a shortage of banking staff knowledgeable in Islamic banking have also slowed growth and contributed to higher overhead costs in Indonesia’s Islamic banking sector.

Since the current small footprint of Islamic finance in Indonesia implies an opportunity for higher-percentage investment gains when measured against the growth rate of the overall financial sector, and with Malaysia as model; investors are especially eager to ride the wave of Indonesia's growth. For its part, Bank Indonesia (BI) continues to nurture this trend through its Islamic Banking Blueprint, which envisions a leading role for Indonesia's Islamic finance sector in a global economy where Muslims play an increasingly prominent role. Indonesia's banking authorities have been encouraging both the formation of new Islamic banks as well as the conversion of existing financial firms into shariah-compliant banks through the enactment of Law No. 21 of 2008 and Regulation No. 11 of 2009 with a deadline of 2023 for such conversions. Regarding the business plans of these banks, the course of action over 2013 is to expand Islamic banking into rural areas. For example, Bank Mandiri Syariah plans to open an additional 94 branches in 2013 in smaller communities on the islands of Java and Sumatra in order to meet growing demand.

Worldwide, assets in Islamic commercial banks are forecasted to increase to USD $2 trillion by the year 2014, which implies overall growth of 36% between 2011 to 2013; of this total growth, Indonesia accounts for about 10% (Ernst & Young, World Islamic Banking Competitiveness Report 2013). The relatively small size of Indonesia's Islamic banks have not yet facilitated the economies-of-scale that are being achieved in banking markets in other Islamic countries with larger economies such as Malaysia or Saudi Arabia.

When compared with other, much larger Islamic banking marketplaces such as that of Saudi Arabia, which had approximately $207 billion USD in assets in 2011 (Ernst & Young), Indonesian retail banking customers are culturally less homogenous, more pragmatic, and tend to make economic decisions based on non-religious practicalities rather than on religious doctrine. This may be the reason for the greater popularity of the Indonesian banks' shariah-compliant windows at banks such as Mandiri Syariah compared with the all-Islamic banking institutions. Indonesian banks have tended to market their Islamic-finance products through the shariah-compliant windows at their conventional (non-shariah-compliant) banks rather than by creating separate “all-Islamic” banks. Still, with the reforms being urged by Bank Indonesia, this tendency is now beginning to change.

The scarcity of freely-trading equity and debt securities continues to be problematic for Islamic banks in Indonesia and elsewhere. Mindful of the shortfall of shariah-compliant debt-investment products (sukuk) that would increase investor confidence, recently BI announced plans to allow the country's Islamic banks to begin hedging against foreign-exchange risks. This is the first step toward allowing a broader range of risk management products to be offered in the Indonesian marketplace; banking and governmental authorities are thus positioning Indonesia to continue in the footsteps of Malaysia, its regional Islamic banking competitor.

Indonesian banks are eager to draw foreign investors who might otherwise choose Malaysia as the default destination for shariah-compliant banking, and they are advocating for the development of more shariah-compliant bonds and other debt products. Worldwide, in 2012 Islamic bonds provided an average return of about 6.6% (HSBC/NASDAQ Index), while emerging-market bonds rose about 12.7% (JP Morgan Chase EMBI Global Composite Index). Since the average rate of return for loans in Islamic banks in Indonesia was about 10.4% during Q3 of 2012 compared with an average rate of only 6.25% for comparable loans at shariah-compliant Malaysian banks, the introduction of additional risk-hedging products is expected to draw fresh investment from foreigners, both Muslims and non-Muslims, who have been searching for higher returns.

The continuing development of shariah-compliant debt and hedging products in Indonesia will be especially helpful to Bank Muamalat, Indonesia's second largest Islamic bank, by allowing it to compete more aggressively in world bond markets and also to write more loans in foreign currencies while all Islamic banks will be better able to hedge their risks. Of special importance for foreign investors is the fact that banks will be able to provide dollars and other foreign currencies to Islamic Indonesian banks and financial-services companies, thus allowing more foreign-backed loans even if the loans are locally denominated in Rupiah. Further, Bank Mandiri is recently said to have increased the assets of its shariah-compliant division, Mandiri Syariah, by more than $80 million as it prepares for the division's upcoming IPO on the Indonesia Stock Exchange (IDX) planned for 2014 (Jakarta Globe). Likewise, growth seems inevitable for shariah-compliant consumer loan products as consumer lending continues to grow in Indonesia, and Islamic banks are keen to capture more of this market. In 2013, as much as 40% of all loans through shariah-compliant banks are projected to be consumer loans for purchases of vehicles such as cars and motorbikes as well as loans for household goods (Bank Indonesia, Banking Survey Quarter IV 2012).

Islamic banks in Indonesia and elsewhere have experienced difficulties in finding and implementing commercially-viable business models to capitalize on risk-based consumer and business insurance products without running afoul of shariah law. As with their lending programs and debt-based products, and when hedging against unknown risks, Islamic finance professionals and religiously-oriented shariah-compliance boards have found it difficult to agree regarding the limits of permissibility when selling insurance products (takaful) to consumers and commercial customers. For that reason, Indonesian Islamic banks offer few insurance products. Still, given the continuing development of shariah banking law and the creativity of banking professionals determined to comply with the spiritual requirements against usury (riba) while still hedging against the inherent risks for institutions selling insurance products, the further development of acceptable takaful products holds significant potential.

Indonesian banks continue to grow their shariah-compliant credit-card businesses. For example, Bank Danamon Syariah has offered a non-interest-bearing credit card for the past several years. Bank Internasional Indonesia has recently begun to offer shariah credit cards with several different levels of service and BNI Syariah launched a card named the Hasanah Card. All these offerings are linked to the MasterCard worldwide platform, and in each case the “credit” is structured to comply with shariah principles. In some cases, such as that of Bank Danamon Syariah, the card is based on the scheme of kafalah, in which the bank acts as guarantor for the card holder's purchases from merchants, while in others (ijarah) the card issuer provides a neutral payment platform for card holders, or in a qardh scheme the card issuer provides cash advances through ATMs. In contrast, Bank Syariah Mandiri has developed a shariah debit card which mimics the utility of credit cards, and is based on the concept of murabahah. As the pressure for consumer and small-business credit continues to grow, more credit-card offerings are expected to be introduced to the marketplace.

Shariah-compliant mortgage services in Indonesia are increasing, but at a slow pace (See Property in Indonesia: Overview). This may be due to the Government's caution regarding real estate mortgage loans in general, especially following the worldwide effects of collapses in real estate prices during the global financial crisis after many years of growth fueled by the easy availability of mortgage loans. Nevertheless, Indonesian mortgages are a growing business for Islamic banks. To comply with prohibitions against interest charges, many mortgages are based on the initial purchase of the real estate or other goods by the bank, which then allows the customer to hold the property and make regular payments to the bank, which are counted as either gifts or other non-interest revenue.

In conclusion, the Indonesian Islamic banking sector will experience strong growth throughout 2013 and beyond, fueled by the country's overall attractive economic environment and the inflow of funds from other Islamic-finance marketplaces such as that of Malaysia. Foreign investors, both Muslim and non-Muslim, will continue to see Indonesia's Islamic banks as ethical and profitable investment destinations, especially as Bank Indonesia continues to encourage the expansion of this sector toward the year 2023 and in the future. Since Indonesia is a stable democracy, the country should also become increasingly attractive to investors from other countries with much larger Islamic banking systems, especially in those Arab countries which continue to experience political and social unrest going forward.

Global Business Guide Indonesia - 2013

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Indonesia Finance Snapshot - Banking

Contribution to GDP: 2.87% (2016)
Return on Assets: 2.30% (Q4 2015)
Number of Commercial Banks: 120; 4 State/Partially State Owned, 10 Foreign, 16 Joint Ventures, 32 Non Foreign Exchange, 35 Foreign Exchange, 26 Regional Development Banks (August 2015).
Number of Islamic Banks & Units: 13 Banks, 32 Units (2016)
Total Assets: 6,244 trillion IDR (Q3 2015)
Government Bodies: Bank Indonesia, Ministry of Finance, Financial Services Authority (OJK).
Relevant Law: Bank Indonesia Regulation No. 14/8/PBI/2012 on Share
Ownership in Commercial Banks limits ownership by a single local/foreign financial institution to 40%, by a non financial institution to 30%, and by an individual to 20%. Larger stake is possible with the approval of Bank Indonesia.