Miranda S Goeltom: Opportunities for Indonesian investment through
sharia financing - experiences and challenges
Keynote speech by Prof Dr Miranda S Goeltom, Acting Governor of Bank Indonesia, at the
International Seminar on Islamic Finance and Banking "Opportunities for Indonesian
Investment through Sharia Financing - Experiences and Challenges", New York, 17 July
2009.
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Distinguished speakers and participants,
Ladies and Gentlemen,
May I ask you to join me in thanking God the Beneficent and Merciful for His unbounded
grace that has enabled us to gather here today on such an important occasion, the
International Seminar on Islamic Finance and Banking, entitled "Opportunities for Indonesian
Investment through Sharia Financing: Experiences and Challenges". I am thrilled to see so
many distinguished speakers and participants, all prepared to contribute with their insightful
experience and expertise.
In my opinion, this seminar is of paramount importance in the midst of our efforts to discuss
alternative solutions to avoid a repeat of the current economic and global financial crises. In
such a deep global crisis we must seek ways to survive and, subsequently, return to our
previously hard-earned growth and stability. This is precisely the time when collective action
is required most, in order for us all to survive this global financial tsunami and emerge the
other side stronger and wiser. Given the depth and systemic nature of the crisis, a
wait-andsee approach or simply hoping that recovery will take place on its own is utterly
unacceptable.
The crisis and the current global financial system
Ladies and Gentlemen,
A number of analyses argue that the ongoing global financial crisis is inseparable from the
effects of the global financial system. In the past decade, financial products have become
more diverse, advanced and complex. This is attributable to the effect of innovative
development in terms of information and technology, deregulation of supporting financial
systems and a favorable global macroeconomic environment, including a low real interest
rate.
BIS data shows that global financial assets stock increased sharply from about 100% of
global GDP in 1980 to over 300% in 2005. This development was further accompanied by
expansive growth in the amount and scope of derivatives and financial instruments. The
position of interest rate swap and other derivatives reached USD600 trillion at the end of
2007 (11 times annual global GDP) compared to USD75 trillion in 1997 (2.5 times global
GDP). The position of Credit Default Swap (CDS) also reached five times that of global
corporate bonds in 2007, which is a very different picture when compared to conditions in
2004, where the share of CDS was just 85% of corporate bonds.
On the other hand, however, such developments also carried fatal side effects. Financial
instruments have become more independent from their underlying transactions that should
serve as the foundation. Risk assessment on the types of asset owned has also become
more difficult and complex. We have further witnessed that the phenomenon of escalating
activity in the global financial market turned out not to be permanent.
As we have noticed, bubbles have burst and brought terrible impacts on the global economy
since mid 2007. The most commonly used adjective to describe the current financial crisis is
"unprecedented". It is unprecedented in terms of the speed at which events unfolded and
triggered a series of domino effects; the scale of the impact that has become global; and it is
truly unprecedented in terms of the panoply of unconventional measures taken by authorities
around the world. This is clear for all to see in the policy responses taken to overcome the
crisis, which is incredibly complex and certainly costly. The IMF projected that global
economic growth would contract from 3.2% in 2008 to -1.3% in 2009, whereas economic
growth in developed countries is expected to be even worse, shrinking by -3.8%. IMF also
predicted that total losses due to the current global financial crisis will top US$4 trillion,
twothirds of which stem from the banking sector.
The crisis and the sharia financial system
Ladies and Gentlemen,
The lesson we can glean from this crisis is that a sound and resilient economy is not based
on speculative activity. Furthermore, financial sector activity must be founded on business
activities that produce real benefits to the public. This condition, in my opinion, implies that
the behavior of the current financial system needs to be reset; going back to basics (khittah)
as intermediary institutions that distribute funds from surplus units to deficit units.
One alternative that has the potential to bolster back-to-basics principles would be to expand
the role of the sharia financial system. This relates to the structural advantage of the sharia
economic system, which does not permit speculative transactions or products without a real
underlying transactions. A traditional sharia financial system focuses on conservative
products and avoids exposure to high-risk financial instruments. Consequently, the
dependence on financial instruments is comparatively low because investment in each
financial instrument must be identified clearly and accurately.
The key characteristics of the sharia financing system also aligns the role of banks to be
consistent with their primary function, namely to collect funds from their owners and distribute
it to borrowers. To be more precise, the main function of banks is to facilitate and finance
activities associated with the supply of goods and services to the people; more specifically
"real" activities. Therefore, financing activities through sharia banking are closely linked to
real sector development. Moreover, speculation and gambling, the main culprits behind the
on-going crisis, are not tolerated. Thus, by design, the Islamic financial system can instill
greater stability in an economy. And, if implemented correctly, the Islamic financial system
can provide an optimal risk management system.
Sharia financial system performance
Ladies and Gentlemen,
The potential role of sharia financial institutions in the economy has been discussed on
numerous occasions. According to The Banker magazine in 2007, sharia-compliant assets
worldwide have grown by almost 30% per annum in recent years. Such growth outstrips
most other business segments in financial services. In 2008, sharia financial assets
worldwide reached $643 billion and are expected to exceed $1 trillion by 2010. In fact, there
are currently more than 400 financial institutions offering sharia compliant products globally,
Sukuk,
including which has created significant demand in the market over the last five years.
Countries like United Arab Emirates, Saudi Arabia and Malaysia are competing to become
centers of Islamic finance.
In such a competitive environment, Indonesia also has a great opportunity to advance itself
as the center of Islamic finance. As the most populace Muslim country on the planet, with a
population of more than 237 million, Indonesia is undoubtedly a promising market.
Since the establishment of its first Islamic bank in 1992, the sharia industry in Indonesia has
exhibited relatively robust growth. Sharia banking is in its infancy since the establishment of
the first Islamic bank in 1992, however, has demonstrated strong and steady growth.
Business volume has grown expansively, exceeding the growth rate of the banking industry
as a whole. Currently in Indonesia there are three full Islamic banks (FIBs), 19 Islamic
Banking Units at Conventional Banks (IBUs), and 92 Islamic Rural Banks. As a whole, the
industry is supported by 531 Islamic bank offices currently operating throughout Indonesia
(288 FIBs, 121 IBUs and 92 rural banks).
The sharia banking industry has amassed total assets amounting to Rp50 trillion (USD 4.2
billion), or 2.1% of all bank assets in Indonesia. This share has increased steadily from
previous years: 1.4% in 2005, 1.6% in 2006, 1.8% in 2007 and 2.14% in 2008. With 1,470
branch offices spread over the country, the amount of financing provided by the industry has
grown from a mere Rp 5.5 trillion (USD 458 million) in 2003 to Rp 28 trillion (USD 2.3 billion)
in 2007 and Rp 38 trillion (USD 3.2 billion) in 2008. The industry has also shown its
commitment to support micro and small-scale businesses with microcredit financing (KUR).
By the end of 2008, total microcredit extended by sharia banks reached Rp 326 billion (USD
27 million). As a whole, the Islamic banking sector has grown at a compounded annual
growth rate (CAGR) of over 46% in the last five years. Notwithstanding, the Industry is
expected to acquire a 15% market share of the total national banking system by 2015.
With reference to the capital market, the first corporate sukuk was issued in early 2002,
followed by tens of corporate sukuk issued over the subsequent years. Islamic capital market
development was marked by its inclusion in the National Master Plan in 2005. As of
December 2008, there were 22 corporate Islamic bonds issued under mudharabah and
ijarah contracts totaling Rp 4.78 trillion (equivalent to USD 434.5 million), or approximately
2.7% of total bonds issued. Furthermore, there are currently 36 issuers of Islamic Mutual
Funds, consisting of equity funds, fixed income funds and balanced funds. Net Asset Value
(NAV) totals Rp1.8 trillion (USD163.64 million), approximately 3.5% of total NAV for mutual
funds.
Those promising sharia financial institutions are inextricably tied to strong political will from
the stakeholders. In June 2008, the Islamic banking industry in Indonesia gained new
momentum as Parliament passed a new Islamic Banking Act. In April of the same year,
Parliament also enacted a new bill concerning Islamic Bonds. The promulgation of these two
laws has provided a firm legal foundation for Islamic banking in the country, thus promoting
the advancement of Islamic banking and finance. In August last year the Government
successfully issued state sukuk and then in February of this year retail state sukuk were
issued. Surely, this has contributed significantly to further catalyze the development of a
wide-based retail secondary market for investment products that adhere to Islamic rules.
Meanwhile, a bill to tax sharia transactions is being drafted, which we expect will be passed
shortly. We hope that it will provide fairer tax treatment for sharia financial activities, thus
making sharia products more competitive.
Concerning the current global financial crisis, Indonesia's sharia banking industry has
remained relatively stable and insignificant affected. This fact is positively contribured by low
exposure to international investment and foreign exchange transactions in Indonesia's sharia
banks. It is approximately just 5% of total assets and liabilities. Annual growth in assets,
deposits and sharia banking financing remains high, at 29.5%, 27.1% and 26.08%
respectively in May 2009. Stable sharia bank performance is also clearly evidenced by low
industry-wide Non-Performing Financing (NPF) at just 6.19% in May 2009, despite a slight
increase in March and April 2009. NPF has remained relatively steady compared to NPF in
2007 and 2008 at 6.62% and 5.75% respectively. With regards to capital, Tier-1 capital
position also increased to Rp2.48 trillion, compared to its 2008 position of Rp2.19 trillion.
However, we are aware that a lot of homework and groundwork still remains to be done.
There are issues regarding the basic structure of sharia products, both for asset finance and
fund raising or liability products. These products require further clarification and clearer
guidance not only from the banks but also from the authorities. Another set of challenges that
lie ahead in terms of further nurturing sharia finance is how to effectively introduce and sell
related products to this potentially huge market.
Sharia financing and Indonesia's economic outlook
Ladies and Gentlemen,
We believe that the potential of sharia financing in Indonesia will continue to grow in the
future. In a country with such a large Muslim population the potential for sharia product
expansion is great. Currently, the number of sharia users is relatively still limited, namely 3.3
million fund account holders and 525 thousand financing account holders.
The outlook for sharia financing in Indonesia is keep promising thanks to robust economic
outlook. Indonesia's economy, in fact, has outperformed many other countries in the region
and peer group. Economic activities have been sustained by relatively strong domestic
demand, capable of absorbing domestic production and preventing the market from falling
deeper off the precipice of recession. In the first quarter, the economy recorded 4.4% growth,
which far exceeds international economic growth. Whereas, economic growth in Quarter
II2009 is projected at between 3.7% and 4.0%, buoyed by consumption, which is projected to
exceed 5%. Holistically, Bank Indonesia expects the economy to grow between 3.5% and
4.0% in 2009.
Inflation in 2009 is projected to be lower than our initial forecast, possibly below 5%. This is
affected by, among others, improving inflation expectations and sustainable food supply and
distribution. However, Bank Indonesia continues to monitor potential inflationary pressures
expected in 2010, including rising global commodity prices. In this context, future monetary
policy is designed to strike an optimal balance between stimulating the domestic economy
and maintaining macroeconomic and financial system stability in the mid term.
We also believe that Indonesia's growth prospects are supported by sustainable financial
system stability. In the financial sector, CAR remains high at 17.3% and NPL is still in the
safe zone; below 5%. Meanwhile, bank liquidity, including liquidity in the interbank money
market, is improving and deposits have increased. Despite the limited response by bank
interest rates and credit disbursements that are far slower than expected, the bank credit
extension plan has shown indications of quicker expansion in the near future.
Ladies and Gentlemen,
Let me conclude my brief remarks by expressing that, from the point of view of a central bank
in an emerging economy, the winds of change are indeed blowing. Dealing with the global
financial crisis is paramount. Many of our working assumptions are constantly being
challenged by this new reality, which requires creative and sound policy on our part and,
more importantly, courage to implement bold, often unprecedented, measures. In this
respect, we at Bank Indonesia believe that sharia financial institutions show great promise as
one of cornerstone of future sustainable economic activity.
Finally, I am sure that this Seminar will generate valuable insight and new ideas in terms of
dealing with the global financial crisis. Bank Indonesia, as the monetary and banking
authority in Indonesia, is ready to fully support the continued development of sharia finance
in the country. We invite and warmly welcome all of you who wish to join with us and develop
sharia finance.
May God bless all of us with His mercy.