Indonesian Islamic Banking: Facing Liquidity Risk?

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1 Indonesian Islamic Banking: Facing Liquidity Risk? Paper Presented in Summer School Program in Islamic Finance and Banking Durham University, July 2007 Rifki Ismal PhD Student Durham University

2 Outline Indonesian Islamic Banking Development : Islamic banking industry Specific Characteristics of the Industry Conditions Leading to Liquidity Risk: Current Economic Condition Performance of the Islamic banks Some Thoughts. Identifications of the Customers Internal Preparations Socializations

3 Indonesian Islamic Banking Development: Islamic Banking Industry Islamic banks develop significantly during last decades due to : The increased of public awareness in Islam. Strong support from government (regulators). Influenced by development in other countries. Progressive development occurs not only in the performance of banking indicators but also in total number of banks, branches, and offices. However, it tends to grow slowly.

4 Up to May 2007, total asset has been up to Rp29 trillion while the whole banking industry is around Rp1700 trillion trillion Rp Total Asset Growth (%) May-07 Apr-07 Mar-07 Feb-07 Jan Total Asset of Islamic Banks

5 Total deposit has been Rp22 trillion. The whole banking industry is around Rp1284 trillion. trillion Rp Total Deposit Growth (%) Feb-07 Jan-07 May-07 Apr-07 Mar Total Deposit of Islamic Banks

6 Total financing has been Rp21.9 trillion while (whole banking industry is around Rp826 trillion), with a slow growth since early 2007 trillion Rp Total Financing Growth (%) May-07 Apr-07 Mar-07 Feb-07 Jan Total Financing of Islamic Banks

7 Total number of IB, IBU and IRB have been increasing significantly in the last several years (especially IBU), but it tends to slow recently ( ) Islamic Banks (left) Islamic Banking Unit (left) Islamic Rural Banks (right) Total Islamic Banks, Islamic Banking Unit (IBU) and Islamic Rural Banks (IRB)

8 Total number of Islamic banks offices also up a bit slower Number of offices Growth (%) Total Number of Islamic Banks Offices

9 Indonesian Islamic Banking Development: Specific Characteristics of the Industry High awareness to Islam (religion) but very rational in business. Very sensitive with economic issues (interest rate, economic growth, stock market return, etc). Strong support but low willingness to know more about Islamic banking (BI s survey 2000) plus minimum socialization efforts. Positive short term economic expectation but not long term. This view drives rational depositors behavior towards banking industry in general and Islamic banks in particular.

10 Other facts... Since 2000 into present, most of the financing in Islamic banks is in Murabahah (60%-62%) because of economic condition, business trust, customer return guarantee, etc. From depositors, they deposit favorably in Mudharabah time deposit (50%-60%) due to the high return promised. trillion Rp 14,000,000 12,000,000 10,000,000 8,000,000 Wadiah Demand Deposit Mudharabah Saving Depos it Mudharabah Tim e Depos it 6,000,000 4,000,000 2,000,000 0 Liability Side of Islamic Banks

11 Lastly... Lower achievement of Islamic banks than conventional one. So far, Islamic banks return is relatively lower than interest rate or return from stock and foreign exchange market. Lack of bank s standard facilities, products, and especially network. Lack of capable human resources to analyze real sector in order to optimally used the fund and ends with higher profit earned. Total number of Islamic banks is much smaller than conventional and so as its share. It does not create positive image in public compared with conventional.

12 Those Internal Islamic Banking factors potentially lead to liquidity risk in Indonesian Islamic banking industry!

13 External Islamic Banking Factors: Current Economic Condition Excess liquidity problem reflected in high position of base money, inflation, heavy monetary operation, etc. Very open economic system so that lots of hot money easily come in recently. They enter banking sector, stock market as well as bond market. Undisburshed loan in banking industry. It shows ineffective financial intermediary function. Interest based economy (ITF). Interest rate determines economic path and unfortunately affects Islamic banks as well.

14 Financial intermediary is not working optimally so that excess liquidity bears the economy. In fact, this affects Islamic banking industry indirectly. 1,400,000 1,200,000 1,000, ,000 trillion Rp Conventional Deposit Credit Given SBI (%) 1, , , , Excess Liquidity in Banks

15 Hot money comes into SBI, Gov t bond and Stock Market. If they are out, economy might be in trouble, BI Rate will be up and rational depositors switch their deposit causing liquidity risk in Islamic banks. trillion Rp SBI holders Govt bond holders Stock Market Base Money ,400 1,200 1, Excess Liquidity in the Economy

16 Unfortunately part of Islamic banks depositors are rational. When interest rate is down, Islamic banks deposit tends to go up and vice versa. This means the sensitive and uncertain available fund exists in Islamic banking industry presently. trillion Rp Total Islamic Deposit (Rp) SBI (%) Rational Behavior of Islamic Banks Depositor

17 Those external factors potentially cause liquidity risk in the economy, banking industry including Islamic banking industry!

18 Some Alternative Solutions: Identification of their customers Islamic banks should urgently know who are they real (loyal) depositors and who aren t (rational). This might inform the banks, how big potential liquidity run is. This might go further by tracing how sensitive rational depositors with interest rate return/economic issues, their timing, reasons, etc.

19 Some Alternative Solutions: Internal banking preparations Establishing liquidity risk management incorporating internal and external aspects of the banks. Analyzing asset liability imbalance and trying to rearrange it. Reserving cash balance and preparing liquid Islamic banking instruments. Increasing their access to Islamic money market and other external sources of fund. Trying to convince rational depositors and involving them in long term investment deposit.

20 Some Alternative Solutions: Increase socialization efforts Under current circumstances, Islamic banks need to further educate people about Islamic banks practices. The prohibition of interest and non halal conventional returns might become the prevent them from any speculation, rational behavior, etc. Socialization would hopefully increase the share of the industry into finally equal or higher than conventional. Under this circumstance, the economic system as well as banking system would be Islamic and no such gambling/speculation motives.

21 Some Alternative Solutions: Government Policies In coming government sukuk (SBSN) along with its socialization into investors would contribute in redirecting domestic as well as foreign investors to invest in Islamic instruments. This can also be implemented in Islamic stocks in capital market and mutual fund market as well. In general, government policies will prevent economy from unexpected conditions as well as avoiding Islamic banks from liquidity risk problem.

22 Thank You