Islamic banks strive for larger market share

Islamic banks have strengthened their foothold in Indonesia, the country with the world's largest Muslim population, amid rising demands from the public for alternative investment and financing options that comply with Islamic law.

The banks work in line with the principles contained in Islamic law or sharia, which prohibits interest on loans and relies on a revenue sharing scheme.

The Jakarta Post's Rendi A. Witular interviewed V. Sundararajan, the Deputy Director for Monetary and Financial Systems of the International Monetary Fund (IMF) on the development of Islamic banks both in Indonesia and globally. Here is an excerpt of the interview:

Question: Why is Indonesia lagging behind in developing the Islamic banking industry?

Answer: I think the state development of Islamic banking is more or less the same in every country. The percentage of the total banking system covered by the Islamic banking products varies from around 100 percent in certain countries to a small percentage, like in Indonesia right now, less than 1 percent. But, the products and services offered are very similar.

Indonesia already has a banking reform strategy that is currently being applied, but the development of Islamic banking is just an additional element to the overall banking strategy. The strategy needs to take into account the specific needs of the sharia banking industry, since the potential is very big because of the huge Muslim population you have here.

Q: What about the government's initiative? Have they done enough to develop the banks?

A: It is a question of policy on one side and demand on the other. Some countries have developed the industry earlier than others. The important thing is the market demand and how the local banks respond to that. The government, of course, needs to provide the regulatory framework, but the development will still mostly be driven by market demand.

Q: How big is the industry globally in term of assets?

A: The last time systematic statistics were collected was many years ago. Now, several Islamic development banks are trying to compile new statistics on the size of the industry. The rough projection is around US$250 billion worldwide.

The industry is still a small part of the global financial industry, but it has become a significant part of the financial system in some countries. Globally, the industry is not big, but now it has rapidly changed not only on the banking side but also in the investment portfolios.

We (IMF) estimate somewhere around 15 percent growth per annum globally, but it is a rough estimate.

A larger portion of the industry is concentrated in the Middle East, but since a couple of years ago, there is an increase in growth in the Far East and Southeast Asia.

Q: Is it because of the aftermath of the Sept. 11 terrorist attack in the United States?

A: The growth of the industry developed before the Sept. 11 incident. But I must admit that the incident has accelerated the development of the industry, in the sense that many people are now paying more attention to it.

The fundamental factor that drives the development is that a lot of countries realize that globalization is taking place, forcing them to compete with other players.

The stiff competition, in turn, changes the regulatory environment and the risk management technology of the industry.

Governments around the world are now starting to focus on how to ensure this industry grows lucratively by issuing new Islamic investment and financing portfolios.

Q: Some analysts say that the growth of Islamic banking in Southeast Asia is supported by the outflow of capital, owned by Middle East sheiks, from the United States and Europe?

A: It's very difficult to attribute a specific motive for that. But it is a fact that many of the subscribers of the Islamic portfolios are both Muslim and non-Muslim. Almost 50 percent of the buyers are from Western countries. I think it is purely a business decision ... Their judgment depends on the return yield, the rating and the type of the portfolios.

Q: What is needed by the industry now to develop further?

A: People realize that the industry has a lot of potential such as to promote growth, to improve access to finance to a lot of people and to promote financial stability.

But then to make this happen, we realize that several things have to be done, such as, first, to give the industry a proper regulatory framework, because it carries special risk. We cannot treat them like other conventional banks.

Second, we need to create an environment for the industry to manage its risks by providing it with a proper accounting and supervisory system, and disclosure procedures that will enhance transparency toward its depositors, shareholders and the market.

Third, the industry also needs a system where they can manage their short term cash flow because now there are no sharia- compatible short term instruments. The central bank should come out with a way to provide financial support in case of emergencies for the industry, in a sharia-compatible way of course.

Fourth, there are a whole range of issues such as how to deal with the enforcement of contracts and insolvency that need to be sufficiently accommodated in a regulatory framework.