Financing Behaviour and the Rate of Profit in Indonesia Islamic Banking: A Framework for Monetary Policy

Transcription

1 Financing Behaviour and the Rate of Profit in Indonesia Islamic Banking: A Framework for Monetary Policy MUHAMED ZULKHIBRI Ph.D Islamic Research and Training Institute Islamic Development Bank mzulkhibri@isdb.org All findings, interpretations, and conclusions are solely of the authors opinion and do not necessarily represent the views of the Islamic Development Bank 10/23/2018 1

2 Presentation outline Overview Indonesia: Banking System & Monetary Policy The Empirical Study A Framework for Monetary Policy /23/2018

3 OVERVIEW

4 The motivation One of the most important aspect of monetary policy is the effective and efficient transmission mechanisms of MP According to bank-lending theory, banks play a special role in the economy not just by issuing liabilities bank deposits but also by holding assets bank loans Implementing monetary policy with the Islamic banking systems, which are based on interest-free assets, is unique and complex challenges in designing a market-based instrument that satisfies the Islamic prohibition on interest payments and provides for sharing both profits and losses The concept of rate of profit as a substitution of interest concept is very important Given the management of Islamic financial system today in some countries, both at the macro and micro levels still do not have a clear concept The objective of the paper is twofold: To investigate the Islamic bank financing behavior and monetary policy To develop a framework of monetary policy taking the view of Islamic principles 10/23/2018 4

5 INDONESIA: MONETARY POLICY AND BANKING SYSTEM

6 Framework of Bank Indonesia policy mix Price Stability for Sustainable Growth Effective Transmission Interest Rate Exchange Rate Money & credit Expectation Interest rate policy Macroprudential Policy Monetary Policy & Macroprudential Coordination Communication, Crisis Protocol FX Intervention Capital Flows Management Exchange Rate Stability & Capital Flows Source: BI 10/23/2018 6

7 Late adoption of Islamic finance... With Banking Act No.7/1992, the Islamic banking industry was formally initiated, after the first Islamic bank, Bank Muamalat Indonesia (BMI), was set up in Nov, 1991 Indonesia has introduced: Sukuk Law, NSBoard, Shariah IMMarket (PUAS), Shariah Index & ETF, Shariah Pension Law to support the development of Islamic financial industry Islamic banking in Indonesia developed under a dual banking system in compliance with the Indonesian blueprint 2002 for Islamic banking - Indonesian Banking Architecture (API) As of 2014, 12 Islamic commercial banks with 2,139 branches, followed by 23 window units with 425 offices and 163 rural banks with 433 offices operated in the country 10/23/2018 7

8 Under-penetrated but enjoying higher growth than conventional sector 100% 2% 3% 3% 4% 4% 5% 5% 50% 0% (Nov) Conventional Commercial Banks Conventional Rural Banks Shari'ah Banks, Units and Rural Source: BI As of November 2014, assets totaled US$21.5 billion, with total financing of US$16.3 billion, while deposits totaled US$17.2 billion. The financing to deposit ratio (FDR), on average was 109 percent from 2010 to November 2014, and the non-performing loans (NPL) comprised percent of total lending. 10/23/2018 8

9 Diversification of financing portfolios with increased dominant of profit-and loss sharing (Sept) (Sept) Mudharabah Musyarakah Murabahah Istishna Ijarah Qardh Mudharabah Musyarakah Murabahah Istishna Ijarah Qard Source: BI As of November 2014, such investment-based contract financing made up 32% of total financing, while trade-based contract financing, based on murabahah, salam and istisna contracts, made up 64 percent of total financing. By using the PLS model, Islamic banks have the opportunity to share their financial losses with their customers. This may mean that Indonesian Islamic banks are able to balance exogenous shocks more effectively 10/23/2018 9

10 The reserve requirement ratio is connected with the ratio of FDR Source: BI 10/23/

11 Various macroprudential instruments have been implemented No Tool Entities Objective Details 1 Limit on Loan to Value/LTV and Financing to Value/FTV for Mortgage Lending LTV: Commercial banks; and FTV: Shari ah-based banks To contain excessive credit growth in the mortgage lending segment, and to dampen excessive housing price increase. However, to support economic growth by promoting more credit intermediation (in line with maintaining financial stability), BI has relaxed the limit since Set the limit on LTV/FTV for consumer loan on residential properties (mortgage lending) at 85% 90% for the first mortgage lending facility, 80% 90% for the second mortgage lending facility, and 75% 85% for the third onward mortgage lending facility. The regulation is only applicable to banks with net NPLs for total loan and gross NPLs for property loan/financing below 5%, respectively. The measure excluded mortgage lending for properties used as home office/shop house and properties under the government housing program. Since it was introduced in 2012, BI has already changed the formulation of the LTV/FTV for mortgage lending 3 (three) times, either tightening/easing. 2 Limit on Down Payment (DP) for Automotive Loan Commercial banks; Finance companies*; and Shari ah-based banks To contain excessive credit growth in the auto loan segment. However, to stimulate domestic demand to drive domestic economic growth momentum, BI has relaxed the DP since Set the minimum level of down payment (DP) for auto loans/financing: (i) 20% for two-wheeled vehicles, (ii) 25% for three or more-wheeled vehicles for nonproductive use, and (iii) 20% for three or more-wheeled vehicles for productive use. The measure is only applicable to banks with NPLs total and NPLs for auto loan/financing below 5 (gross), respectively. Since it was introduced in 2012, BI has already changed the formulation of the DP for automotive loan 3 (three) times, either tightening/easing. 3 Loan to Funding Ratio (LFR) linked Reserve Requirements Commercial banks; and Shari ah-based Banks** To support economic growth by promoting more credit intermediation and to expand the source of bank s funding and the deepening of financial market. Previously, BI used loan to deposit ratio (LDR) linked RR. It was expanded to LFR by including limited Bond Issuance as part of bank funding. Set the LFR-linked RR range: 78% 92%. Banks with a LFR below the lower limit will face an additional 0.1 RR from rupiah funding for each 1% short of the target, and an additional 0.2 RR from rupiah funding for each 1% above of the target with CAR below 14%. However, incentives upper limit of 94% were applied for banks that fulfil certain criteria: (i) allocation of loans to Micro Small Medium Enterprises (MSMEs) per BI Regulation no 14/22/PBI/2012; (ii) total NPLs below 5% of total loans; and (iii) NPLs to MSMEs below 5% of loans to MSMEs. BI raised the floor on the RR-LFR from 78% to 80%, with the ceiling maintained at 92%. (LFR range: 80% 92%). 4 Countercyclical Capital Buffer (CCB) Commercial banks; and Shari ah-based banks Preventing systemic risk arises from excessive credit growth (procyclicality). Implementation of CCB policy effective from January 1, 2016 with initial rate 0% which will be evaluated at least every 6 months. During 2016, evaluation had been done on May and November. Both evaluations determine CCB rate remained 0%. Source: BI 10/23/

12 PAST STUDIES

13 Rate of interest vs. rate of profit as a reference rate Al-Baqarah 275, 27/An-nisa 29/Ali Imran 130 Discourses (حرم) Rate of Interest و حرم الربا (احل) Rate of Profit احل هللا البىع Conventional Economist Rate of Interest Theory Conventional Economist Rate of Profit Theory Muslim Economist Pre- Determined Post Determined The Pure Rate of Interest Theory based on Goods Market (IS) Time Preference Bohm Bawerk Nassau Capital Productivity Marshall Thornton Wicksell Samuelson The Monetary Interst rate Theory based on Money Market (LM) Loanable Funds A Lerner Liquidity Preference J.M. Keynes Modern Rate of Interest Theory Both Market (IS=LM) Equlibrium Rate A.H. Hansen Hicks Karl Marx (ROE) J. Von Neumann (β) Kalecki (ROI) Piero Sraffa (GNP) Schumpeter Phillip Kotler Benchmark based on mark up in real sector Baqr al-sad}r Kadim al-sad}r Salman Sheikh Mohsin S. Khan Abbas Mirakhor Benchmark based on Interest M. Taqi Usmani Mahmoud El Gamal Muhammad Uzair M. A. Choudhury Umar Chapra Metwally Nejatullah Siddiqy Fahim Khan Iraj Toutounchian Profit Shared Scheme Macro Economy Rate of Profit as a reference Micro Economy Stability in Financial System Measured by Equitable Wealth and Income for Investor Stable Asset Pricing and Sound Asset- Liability Management in Islamic Financial Market Source: Islamic Monetary Economics and Institutions 10/23/

14 Large number of research on the effect of monetary policy on bank lending behaviour Gilchrist and Zakrajsek (1995); Kashyap and Stein (1995), Favero et al. (1999) - distributional effect of monetary policy on bank credits De Haan (2003); Gambacorta (2005); Brissimis et al. (2003); Kaufmann (2003); Ehrmann et al. (2003); Hernando and Martinez-Pages (2003) evidences for developed economies Horvath et al. (2006); Golodniuk (2006); Pruteanu-Podpiera (2007); Gomez-Gonzales and Grosz (2007); Juurikkala et al. (2011); Matousek and Sarantis (2009); Kohler et al. (2000); Sengonul and Thorbeck (2005); Zulkhibri (2013) evidences for developing economies None of the study in the literature has employed micro-data in the empirical analysis for non-interest banks, except for one study in the case of Malaysia Islamic banking 10/23/

15 Very few studies focus on Islamic bank and financing channels Cervik and Charap (2015) compare the empirical behavior of conventional bank deposit rates and the rate of return on retail Islamic PLS investment accounts in Malaysia and Turkey. Zulkhibri (2013) examines the distributional differences in the way that Islamic banks respond to base financing rates across bank-specific characteristics in a dual banking system Chong and Liu (2009) find that retail Islamic deposit rates mirror the behavior of conventional interest rates. The study shows that only a small proportion of Islamic bank financing is PLS based and Sukmana and Kassim (2010) analyzes the relevance of Islamic bank financing and deposits in channeling the monetary policy effects to the real economy. Beck et al. (2013) find few significant differences in business orientation, efficiency, asset quality or stability between conventional and retail Islamic banks. 10/23/

16 EMPIRICAL ANALYSIS 10/23/

17 The data o The banking data set is obtained from Banking Statistics of Bank Indonesia (Central Bank of Indonesia) and Otoritas Jaksa Keuangan Indonesia (Indonesia Financial Services Authority) o A panel of quarterly bank level data of all non-interest banks operating in Indonesia covering the period o The macroeconomic variables: CPI, GDP, BFR and monetary policy rate are taken from come from various issues of Statistical Bulletin, published by Bank Indonesia o The sample consists of 11 institutions depending on the year with the unbalanced panel observations 10/23/

18 Empirical strategy o Baseline Model: FIN it l j 1 l j 1 i j j l j 1 BFR BFR BFR j t j t j t j * SIZE SIZE it 1 0 * CAPITAL l j 1 it 1 it 1 BFR j l j 1 LIQUIDITY j 0 t j GDP t 1 l j 1 it 1 * LIQUIDITY j CAPITAL 0 it 1 PRICES t 1 it 1 i i, t Bank Financing Rate interaction with bank-specific characteristic Macro-variables (demand control) Individual bank characteristics Further test - conventional interest rate may influence the Islamic bank financing behaviour by including monetary policy rate 10/23/

19 The choice of bank-specific characteristics Three measures for bank characteristics size (SIZE), liquidity (LIQUIDITY) and capitalisation (CAPITAL): Size: SIZE Liquidity: it Capitalisation: ln A it LIQUIDITY N i CAPITAL ln A 1 N it T N LA T LA A i it / it 1 it it / A it t 1 N T N K T K A i it / it 1 it it / A it t 1 N T T T The assumption is that small, less liquid and poorly capitalisedbank reacts more strongly to changes in base financing rate 10/23/

20 Results Impact of bank characteristics (1) 10/23/

21 Results Impact of bank characteristics (2) 10/23/

22 Results Impact of bank characteristics (3) 10/23/

23 Summary Impact of bank characteristics on Islamic bank financing o o o o o Negative direct impact of changes in the base financing rate on Islam bank financing in line with the basic theoretical prediction is similar to the bank lending channel of the conventional bank The important of bank-specific characteristics. The variable of SIZE is positive that size is an important factor characterising the banks financing reaction with large banks are expected to minimizing cost LIQUIDITY is positively associated bank financing that Islamic banks are able to protect their financing portfolios by drawing down on their liquid assets and are therefore, less likely to cut on financing CAPITAL, it appears that bank financing is positively associated with bank capitalization or the bank capital structure that market participants may perceive highly capitalized banks as being less risky The estimated coefficients of FR*LIQUIDITY, FR*CAPITAL, and FR*SIZE consistently show a positive sign and are highly significant. These suggest that large, liquid, and well-capitalized banks are better able to buffer their lending activity against shocks that affect the availability of external financing 10/23/

24 A FRAMEWORK FOR MONETARY POLICY

25 Shari ah compliance Repo transaction mechanism Maqashid Shari'ah Real Sector Settlement BI Maturity Fund Securities Fund + Fees Settlement Islamic Bank Maturity Securities Source: Islamic Monetary Economics and Institutions 10/23/

26 The relationship between the Islamic open market operation and the rate of profit Open Market Operation Target M1 & M2 Supply of Financing Reference Rate/Benchmark Narrow Financing Channel Rate of Profit Short Term Asset Price Level Rate of Profit Long Term Exchange Rate Wealth Channel Collateral Rate of Profit Channel Broad Financing Channel Exchange Rate Channel Source: Islamic Monetary Economics and Institutions Aggregate Demand 10/23/

27 A framework of Islamic open market operation using Islamic reference rate Monetary Contraction (productive) Monetary Contraction (productive liquidity) management) Real Sector Repo T- Bill/Govt Sukuk Real Sector Islamic Bank Purchase Sell OMO Shari ah with Mudarabah Investment (IMA) T-Bill Primary Market Govt Sukuk Secondary Market Purchase Sharia T-Bill 1 st Market Government Sukuk 2 nd Market Reverse Repo Govt..Sukuk At maturity SIMA will be paid : Principle + Profit Sharing (Rate of Profit) (pokok+imbalan) Source: Islamic Monetary Economics and Institutions Monetary Expansion (Productive) Allowed to be transferred once Monetary Expansion (Productive) 10/23/

28 GOING FORWARD 10/23/

29 Key takeaways 1 Under a dual banking system, to the extent that financial constraints vary with banks ability to access other sources of financing, Islamic bank financing responses to the bank financing rate contingent on observable bank-specific characteristics that bank-specific characteristics are important in Islamic financing behavior. 2 The results also suggest that changes in monetary policy are less significant for Islamic bank financing. This implies that the transmission of monetary policy through the Islamic segment of the banking sector is weak. The results, however, contradict with other findings. 3 4 Despite the existence of moral hazard and adverse selection in the Islamic banking industry, the results also suggest that the functioning of Islamic banks has its unique structural and operational constraints when facing policy-induced shocks. In practice, it would also be a good idea for Islamic banks to gradually move away from restructuring conventional banking products, which are mainly concentrated in debt-based instruments and markup models but have moved over to the PLS model. 10/23/

30 Thank You 10/23/