Industry Profie: Sharia Banking System in Indonesia- 2009 Continued 5

DEVELOPMENT OF SHARIA BANKS (ISLAMIC BANKING) IN INDONESIA

February 2009

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Competition and marketing strategy

Competition

The sharia banking market is dominated by three large banks - Bank Syariah Mandiri, Bank Muamalat Indonesia and Bank Syariah Mega Indonesia together having a share of 63% of the sharia banking market in the country.

Competition among sharia banks is expected to be tighter still as the National Sharia Council (DSN) still offers license to open 20 new sharia banks this year. Most of the banks show strong interest in grabbing shares in the small and medium enterprise sector.

The UUS of Bank Niaga and Bank Permata, however, show more interest in middle class market although they also are interested in small and medium enterprises. The UUS of Bank Niaga also focuses on the retail sector and floating customers.

The role of sharia banking industry in the predominantly Muslim country is too small considering the large Muslim population. The country is highly potential market for sharia banking. The potential has encourages expansion of the existing sharia banks and the opening of new sharia banks by new investors.

Marketing strategy

- Variation of Products

In order to improve performance, and attract customers, banks offer various facilities, varied products and improved service quality.

Bank Syariah Mandiri (BSM) offers saving called BSM Saving, a GPRS-based mobile banking and Tafakul Insurance Premium. These services facilitate banking transactions such as checking in account balance, checking of the latest transaction and real times inter bank transfer. In addition, Tafakul insurance premium could be paid through hand phone.

With the improved and variety of services, the BSM saving income has continued to increase. By July, 2008, its savings reached Rp4.91 trillion or an increase of 56.87% from Rp3.31 trillion in 2007. Increase was also recorded in the number of depositors, up 35.42% from 876,042 to 1,186,381.

BSM and HSBC Amanah Indonesia offer gold investment saving. The gold investment saving product of BSM uses international gold standard of 24 carats. BSM will issue certificates for customers holding gold investment saving account. Gold investment is entrusted to BSM to vendors named by BSM.

HSBC said Indonesia has high potential market of gold investment saving customers. HSBC already has gold investment saving product in other countries like Britain. The prospects are encouraging for gold investment saving as gold has more stable value than bank notes.

BNI Syariah has officially provided BNI Syariah Prima service at its Jalan Sudirman branch in Jakarta. The service is more personal in approach but remains in the principle of sharia.

Meanwhile as a new comer Bank Syariah Bukopin relies financing on sales and purchase known as murabahah and plans by phases to develop financing based on profit sharing or mudharabah.

- Transaction facility

In the past two years, a number of sharia banks have been aggressive in issuing sharia-based credit card to expand services and facilitate transactions. Sharia credit cards are different from conventional credit cards. One of the differences is their legal basis. Apart from banking law, sharia based credit card is based on sharia banking law. And rule of the National Sharia Council. Payment is made not on interest but on kafalan, qard, and ijarah contracts, Sharia credit card could be used only for sharia transactions.

Bank Danamon Syariah teams up with MasterCard to issue Dirham Card, a credit card based on the sharia principles which are non interest principle. The difference between Dirham Card and conventional credit cards lies in the contract or transaction scheme that could be ijarah, kafalah or Qardh. Under the Ijarah contract the card issuer is the provider of the service of payment system and service for card holders. Membership fees are charged for the members in compensation for the services. In the kafalah scheme, Bank Danamon Syariah as the card issuer will guarantee the transaction made by the card holders with the merchants (shops) for all resulting liabilities .The bank as the issuer will receive fee in compensation. In Qardh contract, the card issuer is the provider of loan for card holders through automatic machine teller (ATM) of the card issuer.

Interest system is not used in Dirham Card, but there is rental cost based on the ijarah principle. Credit card of Danamon Syariah is quite popular. It already has 60,000 holders.

Bank Internasional Indonesia (BII) has also issued sharia credit card called BII Syariah Card consisting of BII Syariah Card Gold and Platinum. The credit cards use the principle of qardh and kafalah contracts. In qardh contract, the principle used is the principle of debt and credit without interest or fine. In the kafalah contract it is a by proxy principle. During the transaction, the card holder acts to represent bank in making transaction with the merchant. The difference with conventional credit card is that BII Syariah Card has no interest. Payment is the same as in conventional credit card but there is no minimum payment. Payment must be full and no installment, when maturity comes.

BNI Syariah has also launched sharia credit card called Hasanah Card. This new product teams up with MasterCard Worldwide. BNI is the first and only state bank having sharia credit card. BNI Hasanah Card will be available in classic, gold, and platinum types. The facilities offered include smart spending, cash advance, and danaplus, PerisaiPlus which use sharia insurance, transfer balance, executive lounge, merchant discount and payment through ATM. BNI Syariah will focus more marketing gold and platinum type Hasanah Card as the holders of the card have higher payment capacity. Generally they use credit cards only to facilitate payments.

Meanwhile, Bank Syariah Mandiri (BSM) is more interested in developing sharia debit card. BSM is studying the possibility of issuing debit card base on murabahah contract. BSM will cooperate with a number of business partners utilizing the networks of Bank Mandiri, its parent company.

BSM also develops a credit product without collateral. This product called al-Qhardul Hasan has attracted many customers.

- Expanding channeling offices

Early 2009, sharia banks took advantage of the declining trend of BI Rate. They open more branches not only in Muslim dominated areas but any business centers in larger cities.

The growing market demand for sharia services, sharia banks are more expansive and aggressive in expanding business networks while many sharia units of conventional banks have become independent unit to operate as sharia banks.

Bank Danamon Syariah has opened 5 branches in East Java. Later to opened three branch offices in Makassar to expand channeling offices to add to 7 branches of channeling offices in Jakarta. Meanwhile, Bank Internasional Indonesia (BII) opened new branch in Surabaya to add to ones already operational in Jakarta and Bandung, BII also has 14 channeling offices.

Bank Mega Syariah plans to open 170 more branch offices in large cities in the country.

Bank Syariah Bukopin plans to open new outlets utilizing the network of Bank Bukopin. In order to expand sharia networks, Bank Syariah Bukopin cooperates with the non political Islamic organization Muhammadiyah which has thousands of charity outlets to be used by Bank Syariah Bukopin as payment points.

Government Policy

Development of the country's sharia banking industry has full support from the government Since 1992; the government has issued a series of policies facilitating the expansion of sharia banking industry to be more competitive facing conventional banks.

The Law No. 7 of 1992 on Banking and Government Regulation No. 72 of 1992

This government policy supports development of sharia banking to expand dual banking system in the country. The dual banking system will provide alternative for the people and in payment system.

The Law No 10 of 1998 (constituted an amendment to the Law No. 7 of 1992)

Conventional banks are allowed to have UUS (sharia units). The law officially changes the term of profit sharing banks with sharia banks.

The regulation of Bank Indonesia on spin off strengthens the regulations in the Sharia banking Law saying Sharia unit will finally be spun off after operating for 15 years on certain conditions.

Spin off is allowed only if assets of the Sharia unit have reached at least 50% of the total assets of the conventional parent bank.

Many sharia units remain as a division or unit under the management of conventional banks as they could not yet meet the requirements. The practice of channeling offices is also still strong in sharia units.

- Taxation

Taxation and licensing red tape poses as a stumbling block in the establishment of a sharia bank. The taxation directorate general has stated that the sharia band and conventional bank customers are treated equally in abolishing double taxation. However, it also imposes value added tax on sharia bank customers Banks have urged the taxation directorate general to abolish VAT on sharia bank customers.

Sharia banks face double taxation as sharia system adopts the sales and purchase or murabahah contract. Sharia banks are imposed with taxes twice - when buying from suppliers and when selling to debtors. A conventional bank is imposed tax only once - when borrowing.

Sharia banking Law No 21/2008 issued June 2008 and the Law on State Sharia Securities (SBSN), April 2008

Bank Indonesia supports the expansion of sharia banking industry by issuing circulars on Sharia Monetary Operation, Sharia Bank Indonesia Certificate (SBIS), Sharia banking Committee, Restructuring of Financing for Sharia Bank and Sharia Units.

Regulation of Bank Indonesia on Sharia Monetary Operation allowing sharia bank to maintain liquidity and specifying procedure of transaction of repurchase agreement of SBSN with Bank Indonesia . With financing to deposit ratio (FDR) of sharia banking averaging 100%, repurchase agreement of SBSN and SBIS will contribute much to maintaining sharia banking liquidity.

Sharia banks have legal protection of Law on Sharia Banking and State Sharia Securities (SBSN). However, the central bank needs to give clear guidelines for investors considering the difference between investment banking and commercial banking. In the country. Commercial banking is under Bank Indonesia while investment banking is under the Capital Market Supervisory Agency (Bapepam). In Indonesia, commercial banking collect public funds and investment banking deals with bonds, sharia bonds, etc.

- PBI No. 11/3/2009 was issued on 29 January, 2009

This regulation of Bank Indonesia rules that:

- Paid up capital for a sharia bank is at least Rp1 trillion.

- Principle license is needed to establish a sharia bank with capital available at least 30% of the minimum paid up capital

- Regional administrations are allowed to establish or have sharia banks

- Foreign investors in a sharia bank are allowed to have up to 95% of the shares of sharia banks.

However, Bank Indonesia plans to cut the minimum capital needed to establish a sharia general bank as a result of UUS spin off to only Rp500 billion. Sharia general bank may be a result of UUS spin off or establishment of a new one. For sharia bank established not through UUS spin off the minimum capital requirement of Rp1 trillion will be maintained.

This regulation is still in the process of finalization but it is expected to be issued in March, 2009.

Conclusion

The country's sharia banking industry was hardly affected by the global financial crisis in 2009. The industry ahs performed normally. The people, therefore, began to show greater confidence in sharia banking industry. The industry grew in assets, third party funds and financing, which grew 31%-35% last year.

Sharia banking assets grew from Rp36.5 trillion in 2007 to Rp49.5 trillion in 2008. The third party funds held by sharia banks rose to Rp36.8 trillion from Rp28 trillion and financing service increased to Rp38.2 trillion from Rp27.9 trillion .

In the last quarter of 2008, however, a number of sharia banks became more selective in offering financing service. Bank Syariah Mandiri and Bank BNI Syariah continued to offer financing service but not as aggressive as they were earlier that year. They offered only short term financing service of not more than a year to companies oriented to domestic market mainly small and medium enterprises which were not affected by the global financial crisis. Small and medium enterprises accounted for around 60% of financing services offered by sharia banks and the rest for cooperatives. Currently medium enterprises account for 61% of financing service by Bank Mandiri Syariah, small businesses for 36% and micro businesses for 3%. The composition is expected to change more in favor of small and micro businesses in the coming months.

The customers of sharia banks at present total around 2 million people. A potential customer among the Muslim population is more than 100 million.

The fledging industry has not expanded as expected in the predominantly Muslim country. Many, however, believe the industry has good prospects in the country. Bank Indonesia has predicted that sharia banking industry will expand and its assets will reach Rp90 trillion or 5% of the total assets of conventional banks in 2009. The target is believed is achievable this year after two major banks - Bank Bukopin and Bank Rakyat Indonesia have spun off their sharia units to become to sharia general banks with independent management. The spin off will mean an increase in the assets. PT. Bank Bukopin Syariah and PT. BRI Syariah already operational early this year as sharia general banks.

In addition, foreign investors especially from Middle East have indicated strong interest in investing in the country in sharia banks. They see the potential prospects of the industry in the country. The global financial crisis, however, may cause a delay in their plans to expand operation of their sharia banking in the country.

Based on the a regulation of Bank Indonesia No. 11/3/2009 issued in January, 2009, a new sharia bank is required to have a paid up capital of at least Rp1 trillion and foreign investors are allowed to have up to 99% of a sharia bank.

Bank Indonesia plans to issue regulation to facilitate the process of spin off to establish a new sharia general bank from sharia units of conventional banks. The central bank plans to reduce the capital requirement of a sharia unit to be allowed to be converted into a sharia general bank from Rp1 trillion to Rp500 billion.

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