Indonesia is the largest Muslim majority country in the world with approximately 80% of the population identifying themselves as part of the religion. Despite its seemingly demographic predisposition to be a centre for shariah banking, the sector accounted for just 3.2% of the total banking assets as per the end of 2010. While the UK has cemented its position as a hub for shariah compliant banking in Europe, Malaysia has very much led the way in South East Asia; leaving Indonesia somewhat behind. Bank Indonesia (BI) is actively pursuing the long term development of the sector through the Islamic Banking Blueprint to 2015. BI has the vision of making Indonesia’s Islamic banks the most attractive in the ASEAN through the Grand Strategy of Islamic Banking Market Development by building on Indonesia’s own brand of modern Islam; but a lot lays ahead in order to achieve this. Yet, the prospects for Indonesia’s shariah compliant banking are looking bright; the four largest Islamic banks are targeting more than 50% asset growth for 2011. Investors are also eyeing the industry in light of the saturation of neighbouring Malaysia as well as the political unrest in traditional markets of the Middle East.
Source: Bank Indonesia
In the last five years, Indonesia’s shariah banks have seen assets grow by 38% compared to 15% for conventional banks (Bank Indonesia). The country currently has 5 Islamic banks and 27 conventional banks with a separate shariah platform for handling such transactions. The sector is currently dominated by two leading players, namely Bank Mandiri Syariah and Bank Muamalat that count for 50% of total shariah financing between them. The move into shariah banking by conventional banks has surged since the passing of the Law No.21/2008 and the Regulation on the Conversion of a Conventional Bank to a Shariah Bank No.11/2009 that allowed banks to function in both capacities. More banks are expected to set up shariah units with 32 pending requests for establishment permits according to Bank Indonesia. The current regulations are such that the separate platforms are expected to spin off into independent banks with 2023 as the deadline for conventional banks to do this.
Indonesia appears as a natural growth market for shariah compliant banking services given the size of the Muslim majority population; however the character of the market is starkly different to that of neighbouring Malaysia or the Middle East. The majority of Indonesia’s potential Islamic banking customers fall under the ‘rational market’ as opposed to that of the ‘spiritual market’. Islamic banking products are therefore pitted against their conventional counterparts and judged on their commercial merits as opposed to being chosen on the basis of faith. This trend is clearly exemplified by the popularity of utilising shariah platforms within conventional banks over solely banking with a standalone Islamic bank. The market leader Bank Syariah Mandiri, uses its sister conventional bank Bank Mandiri to sell its shariah banking services within a ‘secular’ and familiar banking environment. The larger local network of conventional banks is also to its advantage as the banking sector still relies on face to face in branch transactions so proximity to the customer is a necessity.
How to market Islamic banking towards the population therefore presents a unique challenge in ‘demystifying’ the sector to consumers and shake off misconceptions regarding the perceived religious commitments that Islamic banking entails. Appealing to the mass market, including non–Muslims, poses challenges but also promises high rewards considering the increasing financial literacy of the country and the growing sophistication of the middle class consumer. The untapped market of the rural ‘unbanked’ population presents potential given their need to access unsecured loans and their preference for the profit sharing mechanism that shariah banking offers.
The consumer lending side is where Shariah banks have been the most successful in the past, consumer financing made up 32.4% of all the shariah compliant loans issued in 2010 (Bank Indonesia). Auto financing in particular is growing increasingly popular as around 80% of all car purchases in Indonesia are through loans. This trend is set to continue as car sales continue to increase with projected unit sales at 800,000 for 2011. Shariah loans are expected to increase over 2011 with Bank Indonesia setting the target of 40% growth from 2010 figures of 68.18 trillion Rupiah. The focus for 2011 is for shariah compliant lending to go towards financing investment for real economic growth such as infrastructure as well as agriculture.
Islamic bonds or sukuk bonds have made impressive progress in Indonesia, being used to fund state infrastructure projects as well as by private companies. The domestic investor base in retail sukuk bonds is growing rapidly with the issuing of Islamic government infrastructure bonds. Indonesia has been relatively late in the Islamic bond market compared to other Muslim majority countries but their issuing since 2008 have been very popular among domestic investors. The shariah bond market still has a long way to go; in 2010 shariah corporate bonds accounted for only 2.43% of total corporate bond transaction values based on Indonesia Bond Pricing Agency’s (IBPA) data. Islamic or sukuk bonds are developing in line with the efforts by the IDX to educate the public on domestic investment, while deepening the capital markets. Yet, SOEs have failed to capitalise on the popularity of sukuk auctions to raise funds. Only five SOEs have issued sukuks in the past. However, given their need for vast sums to fund public services, the instruments are a natural solution as an alternative funding method. More SOE sukuk offerings are likely to occur in the near future with the broadening of the range of underlying assets that can be utilised.
Source: Bank Indonesia, 2011
Challenging bureaucracy and unclear regulations have been a challenge to the growth of the industry as the banking infrastructure remains weak and transactions are overly complex. Further reforms have been undertaken in the shariah banking sector since the law of 2008 which provided a comprehensive regulatory framework and created a dual banking model. The issue of double taxation on shariah compliant products was a long time drag on profitability in the industry by making transactions expensive and uncompetitive. However moves were taken to address this in the form of Tax Law No.42/2009 that came into effect in April 2010, which is positioning the sector on an even fiscal playing field with that of conventional banking. The country is taking steps to unleash the potential the sector holds in contributing to investment, lending to corporations and raising funds for much needed public infrastructure projects. Trained human resources with expertise in shariah compliance are what is really needed (See Islamic Finance & Business Education) to move the sector forward and allow Indonesia to carve out its niche as an Islamic finance destination.
The long term growth prospects for Indonesia’s shariah banking sector are positive. A general shift in attitude following the financial crisis towards more ‘ethical investing’ has taken hold of the country’s both Muslim and non Muslim population. To take advantage of the interest in shariah banking not only from Indonesia but also from international investors, the government needs to streamline the bureaucracy to make the sector more competitive. Building up the capacity of human resources to be able to provide expertise to the sector and create innovative products that serve the needs of the market is another area where the country is lagging. Indonesia is finding its way in the field, looking to formulate its own brand of Islamic finance rather than just follow the models of hubs such as the UK, UAE and Malaysia. What is important is to ensure that the necessary regulations and framework is in place to avoid the country being behind.
Global Business Guide Indonesia - 2012
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.
Opportunities in Indonesia’s Banking Industry
The Prospects for Indonesia’s Insurance Industry
Capital Markets: Widening the Local Investor Base
Methods of Entry into Indonesia’s Banking Sector
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