Liquidity Risk Problem in Islamic Banking Industry (Case of Indonesia) Paper Presented in Ustinov College Finance Seminar Durham University, May 3 rd, 2008 Rifki Ismal PhD Student School of Government and International Affairs (SGIA) Durham University
Outline of Presentation Indonesian Islamic Banking Development : Islamic banking industry Characteristics of the Industry Related to Liquidity Risk Depositor s Financial Decision & Economic Conditions Leading to Liquidity Risk: Depositor s Financial Decision & Bank s Reaction. Current Economic Condition Leading to Liquidity Risk. Recommended Actions.
Indonesian Islamic Banking Development: Islamic Banking Industry It grows significantly since the establishment of the first Islamic Bank (Bank Muamalat Indonesia) in 1992. Until end of 2007, there are 3 Islamic Banks (BUS); 25 Islamic Banking Unit (UUS); 114 Islamic Rural Banks (BPRS) directing 683 offices around the country. FDR has been recording 100%-120% since 2001, NPF between 2%-4%. Total Asset, Financing and Deposit grow 60% on average annually. BANKING INDICATORS 2000 2001 2002 2003 2004 2005 2006 2007 Islamic Banks (unit) 2 2 2 2 3 3 3 3 Islamic Banking Units (unit) 3 3 6 8 15 19 20 25 Islamic Rural Banks (unit) 79 81 83 84 88 92 105 114 Total Offices (unit) 146 182 229 337 443 550 567 683 Total Asset (trillion Rp) 1.79 2.72 4.05 7.86 15.33 20.88 26.72 36.53 Total Financing (trillion Rp) 1.27 2.05 3.28 5.53 11.49 15.23 19.53 27.94 Total Deposit (trillion Rp) 1.03 1.81 2.92 5.72 11.86 15.58 20.67 25.65
Indonesian Islamic Banking Development: Islamic Banking Industry Some factors derive the progressive growth of the industry: The increased of public awareness. Prohibition of interest by Indonesian moslem scholars (MUI). Promotion and continuous socialization of Islamic banking. Strong support from government and central bank (Islamic Banking Act and Blue print of Islamic Banking Industry 2002-2012). Islamic banking development in overseas (Middle East Countries and Asian countries).
Indonesian Islamic Banking Development: Characteristics of the Industry Related to Liquidity Risk Sensitive public respond against Islamic Bank s performance and facilities. Requiring professionalism, competitive return, wide networks and facilities, etc. Pleasant and unpleasant economic condition High return from stock market, capital market often attracts liquidity withdrawal in Islamic banks. Tight monetary policy (high interest rate) persuades deposit switching into conventional banks (example: world oil price hike 2005-2006).
Dec-07 Nov-07 Oct-07 Sep-07 Aug-07 Jul-07 Jun-07 May-07 Apr-07 Mar-07 Feb-07 Jan-07 2006 2005 2004 2003 2002 2001 2000 Indonesian Islamic Banking Development: Characteristics of the Industry Related to Liquidity Risk trillion Rp 40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 Total Asset Growth (%) 100.00 80.00 60.00 40.00 20.00 0.00 Total Asset rose from 2000-2004 with 70% growth annually, but dropped into 28% growth during 2005-2006 (external pressure) and has been recovering with 45% growth after that period. 0.00-20.00 trillion Rp 30.00 25.00 Total Deposit Growth (%) 120.00 100.00 Total deposit got peak performance in 2000-2004 with 85% growth annually, and went down with only 24% growth during 2005-2006 (external pressure). 20.00 15.00 10.00 5.00 80.00 60.00 40.00 20.00 0.00 0.00 2000 2001 2002 2003 2004 2005 2006 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07-20.00
Indonesian Islamic Banking Development: Characteristics of the Industry Related to Liquidity Risk As a consequence, progressive financing growth has not revealed again since 2005. FDR is not as aggressive as before. Amongst others, the main factor is the increased on Non Performing Financing (NPF). It tends to go up whilst previously between 2002-2004 the industry was promisingly assured by low trend of NPF (figure below).
Indonesian Islamic Banking Development: Characteristics of the Industry Related to Liquidity Risk Other characteristics leading to liquidity risk: Less competitive return offered by Islamic banks than conventional banks when interest rate is high. Lack of product innovation, facilities, networks and human resources to attain a better performance. High banking transaction cost. Less comprehensive socialization explaining the benefit and value added of Islamic banking institution.
Depositor s Financial Decision & Economic Conditions Leading to Liquidity Risk Depositor s Financial Decision and Bank s Reactions Although religious and know MUI s prohibition on interest, but depositors are very rational: Placing fund only in short term deposit instruments. It enables them to take the money any time. Short term economic view and profit orientation. Whenever, economy is in pressure causing high interest rate or economy is in booming boosting returns on capital/money market, liquidity switching occurs. They hold two accounts in Islamic bank and conventional as well.
2007 2006 2005 2004 2003 2002 2001 2000 Depositor s Financial Decision and Bank s Reactions (cont). From 2000-2007, of the total bank s deposit, Mudarabah time deposit dominates 50%-60%, followed by Mudarabah saving deposit 30%-40% and Wadiah demand deposit. 14,000,000 million Rp 12,000,000 10,000,000 Wadiah Demand Deposit Mudharabah Saving Deposit Mudharabah Time Deposit 8,000,000 6,000,000 4,000,000 2,000,000 0
2007 2006 2005 2004 2003 2002 2001 2000 Depositor s Financial Decision and Bank s Reactions (cont). Therefore, Islamic bank reacts properly and safely to manage the fund. They have to grab high return, anticipate liquidity withdrawal and maintain depositors expectation of positive return. They concentrate financing on Murabahah, Mudarabah and Musharakah. trillion Rp 16 14 12 10 8 6 4 2 0 Musharakah Murabahah Mudarabah Istishna
Depositor s Financial Decision & Economic Conditions Leading to Liquidity Risk Current Economic Condition Leading to Liquidity Risk Problems. Excess liquidity is domestic economy: High placement in central bank certificate (SBI). High position of base money. Foreign capital inflow (hot money). Bond Market, Stock Market and SBI. Undisburshed loan in banking industry. Interest based economic system and dual banking system.
Current Economic Condition Leading to Liquidity Risk Problems (cont) trillion Rp 90.00 80.00 SBI holders 70.00 Govt bond holders Stock Market liquidity 60.00 Base Money 50.00 40.00 30.00 20.00 10.00 2538 79 311.2 2,600 2,100 1,600 1,100 600 100 Total base money records more than USD30 billions. Hot money was found in SBI (USD2-USD5.5 billions), government bond (USD5-8 billions), and stock market liquidity which inflated up to USD253 billion. 0.00 2000 2001 2002 2003 Total undisbursed loan reaches USD18 billion although SBI rate is in declining path. Inflation targeting by using interest rate mechanism affects Islamic banking performance. Dual banking system enables rational depositors to easily choose between Islamic or conventional bank whichever more profitable. 2004 2005 2006 2007 (I) 2007 (II) -400 billion Rp 1,600,000 1,43 1,400,000 Total Deposit Bank's Credit 1,200,000 SBI rate (%) 962 1,000,000 800,000 600,000 8.00 400,000 200,000 0 2000 2001 2002 2003 2004 2005 2006 2007 20.00 18.00 16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00
Recommended Actions Boosting education & socialization of Islamic banking emphisizing on its economic and religious value. Well understood depositors will not enggage in non halal activities. Improving Islamic banking performance. High return will retain its depositors & attract new one. Strengthening coordination and communication with stakeholders. Tracing how big is rational depositors. Establishing risk management team/division. Preparing cash and liquidity reserve. Designing appropriate bank s portfolio taking into account the potential of liquidity risk.
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