The growth of Islamic sensibilities in Asia is tempting domestic and
international banks to seek opportunities in a very promising market
By Tom McCawley/JAKARTA
Issue cover-dated February 05, 2004
MELDA HERYANI, a 21-year-old Muslim student, has an easier time these days
reconciling her religion with her finances. As a student of Arabic
literature she was aware that the Koran, Islam's holy book, prohibits
usury, or interest.
So a year ago, Melda, a soft-spoken woman clad in a Muslim headscarf,
shifted her savings from a conventional bank to an Islamic one. She says
that when she graduates, begins a career and starts a family, she'll be
entrusting her savings to Bank Muamalat, Indonesia's oldest bank that
operates according to the principles of sharia, or Islamic religious law.
"It's my duty as a Muslim," she says from the campus of Jakarta's Al Azhar
University. Until recent years, Melda complains, the choice of sharia
banks in Indonesia was limited.
Those choices are expanding quickly. Since 1999, eight new sharia
divisions have opened at major national banks, giving a total of 94
Islamic banks overall. In October last year, HSBC, the world's
second-largest financial institution by assets, launched a sharia division
in Indonesia. Last year alone, total deposits at sharia banks increased by
over two-thirds. Although assets with Islamic banks stand at around 1% of
the banking system's total, parliament has instructed the central bank to
expand that figure to 5% by 2010.
The Koran dictates that charging interest, known in Arabic as riba, is
unjust and even damaging to the economy. Instead of paying interest on
deposits and charging it on loans, Islamic banks enter into
profit-and-loss agreements with depositors and borrowers. Under the
Mudarabah system, for example, a bank gives money to a borrower under the
agreement that it will share in the profits in an agreed proportion. The
bank's depositors receive a share of profits based on the agreed formula
instead of interest. (Sharia banks are also forbidden to deal with
businesses involving alcohol, pork products, gambling or arms dealing.)
Modern Islamic banking has come relatively recently to the 1,500-year-old
religion, with the first major such banks opening in the mid-1970s. Thus
worldwide, Islamic banks are still developing a basic business model that
differs fundamentally from conventional banking. In most Islamic
countries, at least 70% of banking transactions have not been based on
profit-and-loss sharing but rather on financing, something that to many
resembles an interest-bearing loan sometimes disguised as a service
For example, under Murabaha, the bank buys equipment or other capital
assets and the borrower later buys it back at a profit to the bank.
Ijarah, another arrangement, is similar to hire purchase or leasing, but
in practice is similar to interest-based lending. The security of deposits
is another concern. Under risk-sharing arrangements, depositors are not
covered by the same guarantees as those at traditional banks.
So far, in the Islamic world, only Iran and the Sudan have mandated
interest-free banking by law. Indonesia is following a similar path to
Malaysia, which has a dual system of Islamic and conventional banks.
Nevertheless, since the 1970s, assets under Islamic financial management
have grown to more than $200 billion worldwide. That has prompted a host
of international banks such as HSBC, Citibank and ABN Amro to start
offering Islamic financial services in the past decade.
Islamic banking came relatively late to Indonesia, the world's largest
Muslim country, home to over 200 million of the faithful. Indonesia's
first Islamic bank, Bank Muamalat Indonesia, was founded in 1991. A year
later, parliament passed laws establishing the legal guidelines for
interest-free banking. After President Suharto was forced out in 1998,
Islamic banking received a huge boost when the country's highest
law-making body ordered the central bank to develop sharia-banking
facilities. The task required changing bank regulations to facilitate
"Islamic banking is still in its infancy," says Yakob S. Bobat, a senior
vice-president with HSBC in Jakarta. Establishing an Islamic banking
system brings up logistical problems in Indonesia, an archipelago of
17,000 islands. Islamic banks lack the national networks of conventional
banks, limiting their ability to transfer funds. There is also the problem
of finding staff trained in the specialized accounting and monitoring
techniques needed to ensure success. Judging a company's ability to make
future profits is harder than assessing its current credit risk. In many
Islamic banks, capital has remained idle after companies failed to meet
stringent business requirements.
But most small depositors such as Melda are simply looking for a place to
store their spare cash. Every month her father, who runs a transport and
palm-oil business in Bengkulu, Sumatra, sends her cash for her studies and
living costs. He still uses a conventional bank and its cash machines
because it's easier and more convenient. Despite the drawbacks, she says,
many Muslims in her hometown have been waiting for proper sharia banking
"Many people have been confused about what to do with their money," says
Ma'ruf Amin, an official with the Majelis Ulama Indonesia, or MUI, an
influential council of Islamic scholars. The main challenge for
establishing Islamic banks in Indonesia, says Mulya Effendi Siregar, head
of research at Bank Indonesia's sharia division, is "raising awareness."
Until the 1990s, Siregar says, some Indonesian Muslims, especially in
villages, were keeping their savings in cash, concerned that it was
improper to use conventional banks. Savings were often given for
safekeeping to a local kyai, or Islamic teacher, or stored in drawers,
closets or under the bed.
Since the late 1990s, however, sharia outlets have expanded. Indonesia's
94 sharia banks (including 84 in rural areas) have a total of 340
branches. Bank Rakyat Indonesia, which has a nationwide network of small
banks, is also expanding its sharia facilities. Total deposits in the
sharia-banking system amounted to 2.5 trillion rupiah (almost $300
million) by October 2003.
Most of the growth in sharia banking's assets has come from small
depositors. Indonesia's Islamic banks have yet to be tested as providers
of business financing. But HSBC Indonesia's sharia division, launched in
October last year, will focus on corporate and business lending.
"Indonesia is a vast, untapped market," says Mahmoud Abushama, a senior
vice-president with the bank's sharia division. Abushama says the division
will focus on the manufacturing sector and capital markets.
Some Islamic bankers claim the system is at least equal to, or even
superior to, conventional banking. Bobat of HSBC says that Islamic banks
typically have much lower default rates due to a higher level of scrutiny,
and having no interest rates, they do not add to inflationary pressures.
Supporters argue that Islamic banks are more likely to take a long-term
view of a business than short-term considerations of creditworthiness.
Indeed, restrictions on currency speculation saved Bank Muamalat from huge
losses during the Asian financial crisis.
Sticking to Islamic principles in Indonesia's often-murky commercial world
will bring its own challenges. In December, the MUI issued a fatwa, or
religious instruction, that interest is haram or forbidden for Indonesian
Muslims. Ma'ruf Amin of the MUI's fatwa commission said it was "morally
binding" on Indonesian Muslims. The MUI itself owns a minor stake in an
Islamic bank and some senior council members are employed by Islamic banks
to help them interpret Koranic doctrine. Faisal Basri, a prominent Muslim
economist, warned that the edict was likely to create a conflict of
In establishing an Islamic-banking system, Indonesia will face an easier
time than Pakistan, where the Supreme Court had ruled in 1999 that all
banks must follow Islamic principles. Three years later, after complaints
from international banks and donors, the court overturned its own
Wahyu Dwi Agung, an official with Indonesia's sharia-banking association,
admits that for now, "sharia banks are too weak to replace the existing
banking system." But for the devout at least, there are places other than
the mosque or the mattress to store spare rupiah.
Rin Hindryati in Jakarta contributed to this article.