Industry Profie: Sharia (Islamic) Banking System in Indonesia- 2009

DEVELOPMENT OF SHARIA BANKS (ISLAMIC BANKING) IN INDONESIA

February 2009

Backgrounds

Development of sharia banking system in Indonesia is implemented in the framework of the Indonesian Banking Architecture (API), to provide an alternative in banking service to conventional banking service. Sharia banking and conventional banking systems will be developed together to mobilize public funds more intensively and effectively to support the country's economic development.

The sharia financial system was first introduced in the country around a decade ago, but it has grown fast during the relatively short period not only in banking sector but also in insurance, and mutual fund. Sectors. The first sharia financial institution in the country is in the banking sector pioneered by Bank Muamalat Indonesia.

However, despite the leapfrogging growth of 35.6% annually with assets valued at Rp49.5 trillion in assets in 2008, the market share of sharia banks remains small with assets only 2.08% of those of conventional banks or far from the target of 5% set by Bank Indonesia (BI) .

By the end of this year BI predicted that the assets of sharia banks will reach Rp90 trillion or around 5% of the assets of conventional banks. The central bank's prediction is based on the growing number of sharia banks operating in the country including BRI Syariah and Bukopin Syariah early this year. BRI has more than 4,000 units in rural areas and some of them are expected to be converted into sharia units.

In 2008, sharia financing slowed down compared with in the previous year. The highest growth was 37% in 2007 when sharia financing reached Rp29 trillion. In 2008, sharia financing rose further by 36.4% to Rp38.2 trillion.

With the central bank cutting its benchmark interest rate (BI Rate) to 8.75% at present, conventional banks are expected to follow by cutting their interest rate, making sharia banking more competitive. The profit sharing ratio could increase for big clients of sharia banks and the corporation.

In order to improve performance, a number of conventional banks have planned to spin off their sharia units to operate as independent banks. Currently there are 20 banks having sharia units. Among them Bank Rakyat Indonesia (BRI) and Bukopin promoted their sharia units into subsidiaries to operate independently.

Characteristic of Products

The basic principles of sharia banks are different from those of conventional banks such as in.

Savings

Al-wadi'ah is purely entrustment by one to another, either individuals or corporate bodies to be returned by the trustee anytime requested by the depositor.

In conventional banks it is known as Giro. Therefore, all gain from the entrustment is for the bank. In compensation the depositor has the guarantee for the safety of its assets.

Giro account in sharia banks is managed under entrustment system known as Giro Wadiah, as giro is basically used by the depositor as a payment instrument and it could be withdrawn any time.

Profit sharing

Al-Mudharabah is a cooperation contract between two sides with the first party providing 100% of the capital, and the other party serves as the manager. The business profit under the mudharabah system is split based on agreement in a contract. Any losses will be on the owner of the capital as long as the losses are not caused by the negligence of the fund manager. If the losses are caused by then negligence or mismanagement, the fund manager is responsible fro the losses.

The transaction system of mudharabah is used for payment and financing products. In fund collection, al-mudharabah is used for savings and deposits. In financing, the al-mudharabah system is used for working capital.

Under the principle of al-mudharabah, the fund owners will not earn interest as in conventional banks, but they will have profit share based on a present ratio. The ratio for savings is generally 55%-56% of the investment gain made by the bank. It is equivalent to 11% -12% in interest gain in conventional banks.

A trader could submit application for al-mudharabah facility by first calculating gain to be earned from the project.

Deposits in sharia banks are managed as investment or with mudarabah system known as Mudharabah Deposits. Sharia banks pay no interest on deposit but offers profit sharing based on a certain ratio. There are several types of mudharabah savings like education and old age savings. These time deposits are known as Pendidikan Mudharabah Saving, Haji Saving. The savings may not be withdrawn by the depositors before maturity, therefore, they could be used for investment.

Al-Musyarakah

This is a system of cooperation involving two or more parties in a certain business. Each party provides capital contribution. Profit and losses are shared based on agreement. The contribution from bank serves as capital participation. In conventional banks, the contributions are similar to working capital credits.

Principle of Al-Murabahah

This scheme is used in the sales and purchases of good at a price with a profit margin agreed upon by both sides. In this case the seller must tell the buyers the prices of the goods and profit margin.

In the case of conventional banks interest is paid to the clients, in sharia banking, profit is split based on agreement between the investor and the bank.

Development of sharia general banks.

Sharia general banks (BUS) are ones doing transactions fully on sharia and not a business unit.

The first general bank using the sharia system in Indonesia is PT Bank Muamalat Indonesia (BMI) which came on line in 1992. Development of sharia banking business was slow. For five years, BMI was the only sharia bank in the country.

The second sharia bank came on line only in 1998 when PT. Bank Syariah Mandiri (BSM), a subsidiary of Bank Mandiri, the country's largest bank, came on stream. PT. Bank Mega Sharia followed in 2001. In 2009, two new sharia banks PT. Bank Bukopin Sharia and PT. BRI Sharia entered the market.

Currently there are 5 sharia general banks Bank Muamalat Indonesia, Bank Syariah Mandiri, Bank Mega Syariah, Bank Bukopin Syariah and Bank BRI Syariah. Sharia general banks operate independently using the sharia system.

Currently the country has 908 sharia bank offices and 1,452 channeling offices. A sharia bank is allowed to have an office in a province. For example, the West Java regional development bank (BPD) has a branch office in Jakarta, therefore, it is allowed to have a sharia auxiliary branch office in that city.

Sharia Business Unit (UUS)

Basically, sharia business unit (UUS) is the same as sharia general bank (BUS). The difference is only in status . BUS is independent not under control of conventional bank. UUS is not independent and is still controlled or under the management of conventional bank, which still receives and pays interest .

A UUS needs a capital of Rp2 billion. A branch office needs Rp billion and an auxiliary branch office is required to have a capital of Rp500 million.

Currently , there are 12 conventional banks having UUS . They include PT Bank IFI, PT. Bank Negara Indonesia, Bank Jabar, Bank Danamon, Bank Internasional Indonesia, and HSBC, BTN and Bank Permata.

A survey by Bank Indonesia shows that there is growing interest in sharia service. Almost 50% of the population of predominantly Muslim provinces indicating interest in sharia banking service. The survey also shows that 11% of the populations have been familiar with the sharia products.

The strong interest especially in the regions, have encouraged banks to open sharia units in a number of provinces. Currently there are 16 BPDs (banks owned by regional administrations) have sharia branches such as Bank NTB, Bank Sumut, Bank Aceh, Bank Sumsel, etc. Earlier there were already sharia units of BPD DKI Jakarta, BPD Jabar, BPD Riau, BPD Kalbar, BPD Kalsel and BPD Sulsel.

Early 2009, the number of UUS was reduced by two as those of BRI and Bukopin became independent sharia banks.

Based on data at BI, by March 2008, there were 28 banks having UUS, up from 26 previously. The two new units were those of the Central Java BPD and Bank Tabungan Pensiunan Nasional (BTPN).

Sharia networks (channeling office)

The sharia banking networks have expanded in the past three years to meet growing demand in the predominantly Muslim country.

Based on data at BI, the sharia banking service networks rose from 548 units in January, 2008 to 749 in November that year including 254 branch offices, 262 auxliary branches, 28 sharia channeling offices and 205 sharia cash offices.

Bank Mega Syariah , for example, had 200 units of branches by the end of 2008 in Java, Sumatra and Sulawesi. Meanwhile, the UUS of Bank Internasional Indonesia (BII) opened new branches in Surabaya, East Java early November. It also has branches in Jakarta and Bandung and 14 channeling offices. Channeling offices serve to facilitate BII Syariah customers. Ten of offices are located in the Greater Jakarta area and four in Bandung.

In November, 2008, the Hong Kong Shanghai Banking Corporation (HSBC) Amanah opened three branch offices in Medan, Surabaya, and Bandung. Earlier it already had one in Semarang.

Total assets up 34.1% per year

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