Islamic Banking: Why so slow?

Terry Lacey , JAKARTA Wed, 03/04/2009 3:57 PM

The Fifth World Islamic Economic Forum (WIEF) opened on Monday in Jakarta. The global Islamic financing industry has over US$1 trillion in assets. But Indonesian Islamic finance accounts for less than 3 percent of banking assets and lacks the know-how, staff and infrastructure to expand faster.

Indonesia is maintaining economic growth at over 4.5 percent and bank lending growth rates at over 15 percent.

If Indonesian conventional banking is doing quite well amidst a global banking crisis, why is Islamic banking in Indonesia moving so slowly?

The signing at the Forum of Memorandums of Agreement (MoAs) pending final negotiations on four Indonesian projects worth $ 3 billion was encouraging.

But an MoA is maybe half way to a full MoU, and in Indonesia too many MoUs evaporate. The road to nowhere can be paved with good intentions.

The problem in Indonesia and Muslim countries in transition is how to get from intention to im-plementation, as testified by the unfinished concrete pillars of the Jakarta monorail, monuments to lack of capacity, corruption and incompetence.

Now WIEF is five years old. It will be judged in the next five years by Muslim opinion on what is finished and not on what is half agreed.

The long list of Indonesian projects needing financing at the back of the Islamic Forum 2009 agenda highlights Indonesian needs for investment in toll roads, water supply, bridges, ports and power stations as well as biofuel, agriculture and tourism.

Yet performance in "Tapping Islamic funds" has fallen far short of potential, especially in government infrastructure projects and public-private partnerships.

There is a history of low capacity, poor project preparation, bureaucratic delays, slow reform of regulatory frameworks and poor enforcement, corruption, confusion and under-capacity in the implementation of decentralization.

Despite Indonesia*s predominantly Muslim identity there is also a discernable communication gap between the Indonesian bureaucracy and the more modern style of Gulf-based potential investors and developers.
There is a language gap. Many Indonesian officials cannot do business in English or Arabic. Many can recite prayers in Arabic, but cannot use it as a working language.

The Indonesian tendency to engage Arab culture and Arabic only at the level of religious ritual needs to be complemented by a more comprehensive commitment to modern dialogue with the Arab world on economic, social and political partnerships for Muslim modernization, moderation and democracy.
We cannot assume automatic affinity of interest based on the similarity of Muslim rituals, across very diverse cultures, unsupported by greater realities.

These communication gaps may help explain the relative modesty of the flow of resources from the Middle East so far and why in Indonesia there remains a huge gap between declarations of support for sharia banking and reality.
The Deputy Governor of the Bank of Indonesia, Siti Fadjrijah said in Jakarta in January that sharia banking could not reach the national 5 percent target in terms of national banking assets because " It's impossible during these hard economic times ".

Why is it impossible if there is $1.6 trillion of liquid assets in the Gulf States and Saudi Arabia waiting to be invested, despite the recession ?

Indonesian sharia banking reached 3.79 million customers in 2008 via 1,452 bank outlets, compared to 6,500 conventional bank outlets. The latter backed by 97 percent of banking assets, and the former by only 3 percent. Why so little capital ?

Indonesian sharia banking disbursed only 589,000 loans in 2008 compared with 512,000 in 2007. Why so few ? Sharia banking "Loan disbursement is like a walking tortoise" said Siti Fadjrijah.
The sharia banking industry, to reach the 5 percent of banking assets target, would need an estimated 15,000 to 25,000 extra staff.
Given the global economic crisis, this would seem the right time to properly engage Middle Eastern partners, to speak Arabic as a language of business alongside English and Chinese, to invest in the huge Islamic banking potential of Indonesia, to hire the staff, create the jobs, and move more loans. So why doesn't Indonesia do it ?
The Council of Ulema, the Muhammadiah, the Nahdlatul Ulama, the conservatives, the liberals, the sharia banks, the sharia banking training and promotional agencies, the university departments, the NGOs and the little sharia banking lending groups should combine their efforts to bring this about, to deploy the uniqueness of shared profit and loss, one of the great innovations of sharia finance, to finance power and water for the poor and SMEs, to the benefit of the whole society.

The writer is a development economist based in Jakarta.
Source: Jakarta Post

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What is Islamic Bank?

Islamic banks appeared on the world scene as active players over two decades ago. But "many of the principles upon which Islamic banking is based have been commonly accepted all over the world, for centuries rather than decades".
The basic principle of Islamic banking is the prohibition of Riba- (Usury - or interest):
"While a basic tenant of Islamic banking - the outlawing of riba, a term that encompasses not only the concept of usury, but also that of interest - has seldom been recognised as applicable beyond the Islamic world, many of its guiding principles have. The majority of these principles are based on simple morality and common sense, which form the bases of many religions, including Islam.

"The universal nature of these principles is immediately apparent even at a cursory glance of non-Muslim literature. Usury was prohibited in both the Old and New Testaments of the Bible, while Shakespeare and many other writers, particularly those writing in the 19th century, have attacked the barbarity of the practice. Much of the morality championed by Victorian writers such as Dickens - ranging from the equitable distribution of wealth through to man's fundamental right to work - is clearly present in modern Islamic society.

"Although the western media frequently suggest that Islamic banking in its present form is a recent phenomenon, in fact, the basic practices and principles date back to the early part of the seventh century." (Islamic Finance: A Euromoney Publication, 1997)

It is evident that Islamic finance was practiced predominantly in the Muslim world throughout the Middle Ages, fostering trade and business activities. In Spain and the Mediterranean and Baltic States, Islamic merchants became indispensable middlemen for trading activities. It is claimed that many concepts, techniques, and instruments of Islamic finance were later adopted by European financiers and businessmen.

The revival of Islamic banking coincided with the world-wide celebration of the advent of the 15th Century of Islamic calendar (Hijra) in 1976. At the same time financial resources of Muslims particularly those of the oil producing countries, received a boost due to rationalization of the oil prices, which had hitherto been under the control of foreign oil Corporations. These events led Muslims' to strive to model their lives in accordance with the ethics and philosophy of Islam.

Disenchantment with the value neutral capitalist and socialist financial systems led not only Muslims but also others to look for ethical values in their financial dealings and in the West some financial organisations have opted for ethical operations.

Islam not only prohibits dealing in interest but also in liquor, pork, gambling, pornography and anything else, which the Shariah (Islamic Law) deems Haram (unlawful). Islamic banking is an instrument for the development of an Islamic economic order. Some of the salient features of this order may be summed up as:
-While permitting the individual the right to seek his economic well-being, Islam makes a clear distinction between what is Halal (lawful) and what is haram (forbidden) in pursuit of such economic activity. In broad terms, Islam forbids all forms of economic activity, which are morally or socially injurious.
-While acknowledging the individual's right to ownership of wealth legitimately acquired, Islam makes it obligatory on the individual to spend his wealth judiciously and not to hoard it, keep it idle or to squander it.
-While allowing an individual to retain any surplus wealth, Islam seeks to reduce the margin of the surplus for the well-being of the community as a whole, in particular the destitute and deprived sections of society by participation in the process of Zakat.
-While making allowance for the ways of human nature and yet not yielding to the consequences of its worst propensities, Islam seeks to prevent the accumulation of wealth in a few hands to the detriment of society as a whole, by its laws of inheritance.

Viewed as a whole, the economic system envisaged by Islam aims at social justice without inhibiting individual enterprise beyond the point where it becomes not only collectively injurious but also individually self-destructive.
The Islamic financial system employs the concept of participation in the enterprise, utilizing the funds at risk on a profit-and- loss-sharing basis. This by no means implies that investments with financial institutions are necessarily speculative. This can be excluded by careful investment policy, diversification of risk and prudent management by Islamic financial institutions.

It is possible, that investment in Islamic financial institutions can provide potential profit in proportion to the risk assumed to satisfy the differing demands of participants in the contemporary environment and within the guidelines of the Shariah.

The concept of profit-and-loss sharing, as a basis of financial transactions is a progressive one as it distinguishes good performance from the bad and the mediocre. This concept therefore encourages better resource management.
Islamic banks are structured to retain a clearly differentiated status between shareholders' capital and clients' deposits in order to ensure correct profit-sharing according to Islamic Law.

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