Assessment of Liquidity Risk Management in Islamic Banking Industry (Case of Indonesia)

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Assessment of Lqudty Rsk Management n Islamc Bankng Industry (Case of Indonesa) Paper Presented n The 1 st UK Conference on Islamc Bankng and Fnance Dssertatons London School of Economcs, July 6 th, 2008 Rfk Ismal School of Government and Internatonal Affars (SGIA) Durham Unversty

Outlne of Presentaton Lqudty Rsk Management and Islamc Bankng Industry. Lqudty Rsk n Islamc Perspectve. Indonesan Islamc Bankng ndustry. Lqudty Rsk Assessment. Lqudty Rsk Management Index. Crtera Examnng The Result of the Survey. Assessng Indonesan Islamc Bankng Industry. Lablty Sde. Asset Sde. Lqudty Rsk Management (LRM) Polcy. Concluson and Polcy Recommendaton.

Lqudty Rsk Management and Islamc Bankng Industry Lqudty Rsk n Islamc Perspectve Sound lqudty rsk management s conducted throughout real busness transactons. Lqudty rsk, f t occurs, comes from dsharmony of all partes dong busness or unfavorable busness condton leadng to lqudty problem. Islamc bankng takes roles as fnancal ntermedares, supporter and facltator all together. Lqudty problem s managed through coordnaton wth ts counterparts. Islamc bank tes ts fnancng wth real asset (Kahf, 2000:2) so lqudty rsk can happen f there s changes n commodty prces, asset loss, etc.

Lqudty Rsk Management and Islamc Bankng Industry Indonesan Islamc Bankng Industry The ndustry has been growng promsngly snce the establshment of the frst Islamc bank n 1992. Up to end of 2007, there are 3 Islamc Banks, 25 Islamc Bankng Unt (UUS) and 114 Islamc Rural Banks (BPRS) wth total 683 offces. FDR s between 100%-120% (2001-2007) and NPF s around 2%-4%. BANKING INDICATORS 2000 2001 2002 2003 2004 2005 2006 2007 Islamc Banks (unt) 2 2 2 2 3 3 3 3 Islamc Bankng Unts (unt) 3 3 6 8 15 19 20 25 Islamc Rural Banks (unt) 79 81 83 84 88 92 105 114 Total Offces (unt) 146 182 229 337 443 550 567 683 Total Asset (trllon Rp) 1.79 2.72 4.05 7.86 15.33 20.88 26.72 36.53 Total Fnancng (trllon Rp) 1.27 2.05 3.28 5.53 11.49 15.23 19.53 27.94 Total Depost (trllon Rp) 1.03 1.81 2.92 5.72 11.86 15.58 20.67 25.65

Lqudty Rsk Management and Islamc Bankng Industry Indonesan Islamc Bankng Industry Less compettve, postonng of Islamc banks n people s mnd and lack of synergy wth other fnancal nsttutons are some weakness of the ndustry (Blue Prnt of Indonesan Islamc bankng, 2005). Some fundamental problems leadng to lqudty rsk problem the ndustry are: Depostors nvestment motves; Under developed fnancal market; Lmted bankng nstruments; ndustry s fraglty on macroeconomcs ssues; etc.

Lqudty Rsk Assessment Lqudty Rsk Management Index The survey takes 3 Islamc banks (X,Y,Z) domnatng 82% of the market share. Aspects beng valued are Asset sde, Lablty sde and Lqudty rsk management (LRM) polcy. In asset sde: bank s efforts to montor fnancng; arrange ts allocaton; tackle the default & unpleasant economc condton; and handle lqudty dstress from asset sde. In lablty sde: settng portfolo depost; arrangng depostors wthdrawal; tracng potental of lqudty run from ratonal depostors, etc. LRM polces: coverng corporate eyes on buldng healthy lqudty management practces.

Lqudty Rsk Assessment Lqudty Rsk Management Index Asset sde (A) and lablty sde (B) are gven 35 ponts ndex whle (LRM) polcy 30 ponts. Total 100 ponts. There are ponts and 0 pont n yes and no questons (m). There are ponts (no 0 pont) n every opton of multple choce questons (n). Fnally there are ponts for every combnaton of rankng questons (p). L n t1 A n B n t1 t1 C n A 9 m 22 t1 t1 t1 n B 7 14 m n t1 t1 t1 t1 3 p p n C 13 m n t1 t1 t1 t1 3 12 p

Lqudty Rsk Assessment Crtera Examnng the Result of Index Fnally we gan 3 ndex values for bank X, Y, Z: () ndex value of asset (A); () lablty (B); and () LRM polces (C). To evaluate and judge t, four crtera of examnaton are set: (1) Excellent; (2) Good; (3) Satsfactory and; (4) Poor. Interval value of the ndex for every crteron just adopts 25% range from 0 value to 100 value. Indonesan Islamc bankng ndustry s graded excellent f ts lqudty rsk management ndex les between 75 100; good f 50 74; satsfactory f 25 49; and poor f below 25. Assessment Gradng Excellent Good Satsfactory Poor Asset Sde 35 26-35 17-25 8-16 below 8 Lablty Sde 35 26-35 17-25 8-16 below 8 LM* Polces 30 22-30 15-21 7-14 below 7 Total Index 100 75-100 50-74 25-49 below 25 * Lqudty Management Total ponts

Assessng Indonesan Islamc Bankng Industry Lablty Sde 50% of total depost s a rolled over 1-month depost owned by cooperatve non ndvduals. A penalty s charged for lqudatng mmature depost and a requrement for pror notce to bg depostors before wthdrawal. Plannng to desgn new bankng nstruments; attractng nternatonal nvestor to strengthen the captal; and realgnng tenor of depost from short-term nto long-term depost. Meanwhle, the purpose of depostors to take ther money out of the bank s mostly drven by daly transacton motve and no ndcaton of huge depost swtchng from Islamc bank nto conventonal bank.

Assessng Indonesan Islamc Bankng Industry Asset Sde Montorng and evaluatng fnancng; matchng fnancng plannng wth depost by pollng t and advance t based on ts maturty date. However, macroeconomcs shocks mght ncrease NPF and t becomes dffcult to fnd proftable and prospectve busness proposal. Mtgatng lqudty pressure through repurchasng SWBI or resellng Islamc securtes n 2 nd secondary market. Preferrng debt-based fnancng (Murabahah, Salam, Istshna, Ijarah) to equty-based (Mudarabah, Musharakah) or servce-based (Wakalah, Hwalah, Kafalah). In future, all of them stll concentrate of boostng revenue from debt-based fnancng rather than equtybased fnancng because of dffcultes n fndng proftable busness proposal, trusted entrepreneurs and volatle busness condton.

Assessng Indonesan Islamc Bankng Industry Lqudty Rsk Management (LRM) Polcy Havng rsk management dvson/team lqudty rsk. Balancng asset and lablty through portfolo plannng; buldng quanttatve model; and nsurng t wth government s owned nsurance depost (LPS). Settng up a communcaton wth bg depostors about ther depost wthdrawal plannng. Issuance of sukuk strengthens lqudty management plus a benchmark for all Islamc securtes. Keep stablzng economc condton and socalzng Islamc bankng are ther future plannng.

Assessng Indonesan Islamc Bankng Industry Assessment of Bank X Lqudty Rsk Management Index of Bank X Gradng Excellent Good Satsfactory Poor Asset Sde 22 26-35 17-25 8-16 below 8 Lablty Sde 26 26-35 17-25 8-16 below 8 LM* Polces 22 22-30 15-21 7-14 below 7 Total Index 70 75-100 50-74 25-49 below 25 * Lqudty Management Assessment of Bank Y Total ponts Lqudty Rsk Management Index of Bank Y Gradng Excellent Good Satsfactory Poor Asset Sde 22 26-35 17-25 8-16 below 8 Lablty Sde 22 26-35 17-25 8-16 below 8 LM* Polces 23 22-30 15-21 7-14 below 7 Total Index 67 75-100 50-74 25-49 below 25 * Lqudty Management Assessment of Bank Z Total ponts Lqudty Rsk Management Index of Bank Z Gradng Excellent Good Satsfactory Poor Asset Sde 24 26-35 17-25 8-16 below 8 Lablty Sde 14 26-35 17-25 8-16 below 8 LM* Polces 19 22-30 15-21 7-14 below 7 Total Index 57 75-100 50-74 25-49 below 25 * Lqudty Management Total ponts

Concluson and Polcy Recommendaton The survey comes up wth a good grade. They occupy very short-term antcpatve actons to gan hgh short-term and sustanable proft n lne wth mantanng lqudty rsk. Some recommendatons to mprove lqudty rsk management: Intensfyng communcaton wth depostors and entrepreneurs to realgn depost, control the lqudty wthdrawal and make a long term proftable fnancng; Desgnng new depost and fnancng scheme to support lqudty rsk management. The survey result s not the optmal result. As new players n the ndustry, the reslency of the ndustry has to be proven later on.