Expressing Islam: Religious Life and Politics in Indonesia

13. The Development of Islamic Banking in the Post-crisis Indonesian Economy

229 13 The Development of Islamic Banking in the Post-crisis Indonesian Economy Umar Juoro Before the economic crisis of 1997–98, Bank Muamalat Indonesia was Indonesia’s only Islamic commercial bank. It was founded in 1991 to meet demand from educated middle-class Muslims for Islamic banking services, and as part of then president Soeharto’s political strategy to accommodate Muslim aspirations. The bank began trading in May 1992. Since the crisis, two additional Islamic commercial banks have been established, as well as a large number of Islamic banking units operated by conventional banks. The 1998 Banking Law has facilitated the development of a dual Islamic and conventional banking system by allowing state, private and regional banks, as well as one foreign bank, to provide Islamic banking services. The law defines an Islamic bank as a commercial bank that complies with Islamic law (sharia) prohibitions against payment of interest (riba), contractual ambiguity (gharar), financial speculation (qimar) and other prohibited (haram) activities. In this chapter, the terms ‘Islamic bank’ and ‘sharia bank’ are used interchangeably. This chapter argues that Islamic banking in Indonesia has the potential to grow greatly in volume if the banks can improve their product development and risk management procedures, and if they can raise the general level of awareness among the population about Islamic banking. Attention should also be paid to improving the effectiveness of regulation and correcting the distortionary tax arrangements whereby sharia products are subject to excessive levels of value-added tax. 230   Expressing Islam: Religious Life and Politics in Indonesia 1 THE PROGRESS OF ISLAMIC BANKING The fast growth of Islamic banks in the post-crisis era has been driven by the belief that there is untapped demand within the community for Islamic banking services, especially among Indonesia’s increasingly affluent Muslim middle class. Encouraged by the success of the international Islamic banking sector, many conventional banks (including one foreign bank) have opened Islamic banking units. In addition, Indonesia has three Islamic commercial banks: Bank Muamalat Indonesia, Bank Syariah Mandiri and Bank Syariah Mega Indonesia. Unlike the Islamic banking units, which are organisational units within an existing conventional bank, the Islamic commercial banks are established as separate legal entities. Whereas Bank Muamalat Indonesia was founded from the start as an Islamic commercial bank, Bank Syariah Mandiri and Bank Syariah Mega Indonesia started out as conventional banks (Bank Susila Bhakti and Bank Umum Tugu respectively) and converted to Islamic banking. The main reason for an existing bank to expand into Islamic banking is the desire of the parent bank or company to diversify and gain a share of the expanding Islamic economy. This applies to both government and private banks, as well as the provincial banks. Table 13.1 lists the Islamic commercial banks and Islamic banking units currently operating in Indonesia by type of bank. Islamic banking is growing quickly in Indonesia, but from a low base. The share of Islamic banks in total bank assets was only 1.7 per cent in 2007 (see Figure 13.1). Such banks contributed only 1.7 per cent of total bank deposit funds and 2.7 per cent of total bank financing in December 2007. But although Islamic banks are currently marginal players in the banking sector, many analysts believe that there are good prospects for higher growth, particularly as the sector establishes a reputation for reliability and professionalism. The central bank, Bank Indonesia, projected that Islamic bank assets would rise to around 5 per cent of total bank assets by the end of 2008 (a target that is unlikely to be met), and to 10–15 per cent of total banking assets by 2015. Islamic banks are more active than the conventional banks in dispensing finance: the loan to deposit ratio is 103 percent for Islamic banks, compared with only 63.2 per cent for conventional banks. The Islamic banks also have a slightly higher level of non-performing loans than conventional banks, at 6.6 per cent and 5.8 per cent respectively. Financing is the Islamic banks’ main means of generating revenue. Conventional banks, on the other hand, can remain profitable even with relatively low loan to deposit ratios, because of their other sources of income. These include interest income and reliable revenue from government bonds The Development of Islamic Banking in the Post-crisis Economy   231 Table 13.1 Islamic Bank Offices in Indonesia, 2007a No. of Head Offices...