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Obstacles inthe Developing

Islamic Banking in Indonesia



OUTLINE

1. Overview of the Industry

2. Building Blocks of Islamic Banking Development

3. Evolution of Islamic Banking Product & Typical Product Development Life

Cycle

4. Obstacles in Product Development and Implementation

5. Lessons Learned & Ways Forward

6. Milestones the Future Islamic Banking in Indonesia in the era of OJK (FSA)



1. Overview of the Industry



U S D b n

U S D b n

U S D b n

U S D b n

U S D b n

75.0%65.0%55.0%45.0%

32.1% 35.0%25.0%

29.0%95.0%

85.0%

75.0%

65.0%

55.0%

40.0%

30.0%

19.6% 20.0%

10.0%

0.0%

15.0%

28.5%27.0%26.5%25.5%25.0%24.5%23.0%22.5%21.0%20.5%19.0%18.5%17.5%17.0%16.5%15.5%15.0%14.5%13.0%12.5%11.0%10.5%9.0%8.5%7.5%7.0%6.5%5.5%5.0%4.5%

2.6% 3.0%2.5%1.0%0.5%

95.0%85.0%75.0%65.0%55.0%45.0%35.0%25.0%

5.0%

125.0%

95.0%

95.0%

80.0%

70.0%

55.0%

45.0%

30.0%

16.9% 20.0%

5.0% 5.0%

115.0%105.0%

85.0%

13.0% 14.6%

500

400

300

200

100

-

2006 2007 2008 2009

100.0%

90.0%

80.0%

70.0%

60.0%

50.0%45.0%

35.0%

25.0%

15.0%

5.0%

Total Banking Assets (USD bn) % Islamic Asset Market Share

1.7% 2.1%

300

250

200

150

100

50

-

2006 2007 2008 2009

1.5%

3.5%

9.5%11.5%13.5%

19.5%21.5%23.5%

27.5%29.5%30.0%28.0%26.0%24.0%22.0%20.0%18.0%16.0%14.0%12.0%10.0%8.0%6.0%4.0%

2.0%0.0%


14.6% 16.1%

60

50

40

30

20

10

-

2006 2007 2008 2009

15.0%

100.0%

90.0%80.0%70.0%60.0%50.0%40.0%30.0%

16.9% 20.0%10.0%0.0%


400

300

200

100

-

130.0%

120.0%110.0%100.0%90.0%80.0%70.0%60.0%50.0%40.0%

28.5% 30.0%20.0%10.0%0.0%

2008 2009

% Islamic Asset Market Share

400

300

200

100

-

100.0%

90.0%

85.0%75.0%

65.0%60.0%

50.0%

40.0%35.0%

25.0%

16.8% 15.0%10.0%

0.0%

2008 2009

% Islamic Asset Market Share

XX%

Market Share for Shariah Banking Keep Growing in Strategic Countries of Asia andMiddle East

Growth in Islamic

Source: Central Banks, McKinsey

UAE

TOTAL BANKING ASSETS (USD bn) AND ISLAMIC ASSET MARKET SHARE (%)

ASIAN MARKETS

MALAYSIA INDONESIA

SAUDI

BANGLADESH

OTHER MARKETS

In 2009, Asia had approximately

13% market share of Global

Islamic Assets. The growth rate

for Islamic Finance in Asia for-

10 Asian Islamic Banks feature in

Malaysia is the most advanced

market for Islamic finance.

Indonesia and Bangladesh are

also progressing quickly.

26%

15.0% 14.7%

2006 2007

Total Banking Assets (USD bn)

19%

30.1% 28.0%

2006 2007

Total Banking Assets (USD bn)

33%

1.6%

27%

13.6%

29%

12.1%

asset base, CAGR(2006-09)

Islamic Share (%)



IndiaHong Kong

SouthKorea

SingaporeIndonesia

Thailand

Brunei

Exchange launched

Shariah Compliant

Islamic Bank arecontinuing. Likely to be

set up in 2011

India

Bombay Stock

supervise Islamicbanking operations

New plan lists 17

strategies for adoption

Bangladesh

Bangladesh

June 2010, the central

bank moved to

introduce guideline and

monitoring system to

Carried out extensive tax

and legal reforms

First IDR sovereign

issuance in August 2008

Issued first USD Sukuk in

April 2009

New USD issue plannedin 2011

Malaysia

Indonesia

Regulator aggressively

promoting Islamic

Banking to masses

Good level of interest

from population

Brunei

First Sukuk launched in

2006

issue sovereign Sukuk

Wants to tap into growth

GCC China capitalflows

Wants to establish a

large and liquid

secondary market

MainlandChina

Countries and Their Offering

Hong Kong

Announce plans to

there has been someopposition to this in the

country

Japan - a Bill has been

submitted to parliament to

allow issuance and trading

of Islamic instruments

Japan

Japan & S. Korea

S. Korea - The regulator has

signaled intention to

promote Islamic finance

products in Korea. However



2. Building Block of Islamic Banking

Development



R e g ul a t i on &L e g a l

H um a nR e s o ur c e

C a pi t a l M a r k e t

P r o d u c t D e v

S h a r i a h

T a x

Building Blocks of Islamic Banking Development

Pre-requisites for Global Islamic BankingTrendsetter

Foundations

- Legislation: provide comprehensive and create

enabling environment for development of all

aspect supporting Islamic banking

- Grand Strategy of Islamic Banking Development:

provide strategy and direction for development of

all aspect supporting Islamic banking

development

Pillars- Regulation & legal: provide reference and clarity

for the market player

- Shariah: provide Shariah resolution that enable

development of innovative and competitive

product

- Human resources: ability to provide human

resources who are competent in both

banking/financial and Shariah aspects- Product development: ability to develop & launch

innovative and competitive products

- Tax: provide at least equal playing field for and

preferably incentive to boost certain sector of

Islamic Banking industry

- Capital Market: enable market players to raise

capital and manage liquidity

P

ILL

ARS

Global

Islamic Banking Trendsetter

Grand Strategy of Islamic Banking Development

Legislation

FOUNDATIONS



3. Islamic Banking Products: Evolution &

Development Life Cycle



P r o d u c t d e v e l o p m e n t b a s e d o n C u s t

o m e r N e e d s

Sharia Banking Was InitiallyCompliance Product

Retailbanking

Commercialbanking

Finance

PrincipalInvestment

Syndications

Structured

Treasuryhedginginstruments

Customerpull

1970s 1990s1980s

IslamicCapitalMarkets

Equity

2000s

SavingsAccount

Current

Account

WealthManagement

FundsTakaful

Structured

Products

Child Trust



i

Product Development Cycle for Generic Product

i

Month 1

1) Demand Identification by marketingi 2) Submission of Concept Paper to shariah

committee

Month 6

9)i Developing Marketing Collateral

10) Training for front and back end staff

Month 5

7) Development of Process Manual

8) Pre-execution end-to-end review

Months 7-10

11) Product launch

12) Post implementation review

Month 2

3) Submission of Business Case

4) Development of Risk Strategy

Months 3-4

5) Development of Legal Documents &

application

6) Development of IT specifications & UAT

ProductD evelopment

Process



takes place at

NSC/GSC Head, Legal, Compliance, Risk,

Process Flow for New Product Approval & Implementation

Product Roll Out

Review and approval

on the concept paperby Shariah Committee

& Shariah Department

IF

APPROVED Product developmentprocess by ProductDevelopment includingproduct program,marketing material,

customer documentation,operational proceduresetc.

Concept papersubmitted by ProductDevelopment

CONVENTIONAL

AMANAH

Same asConventional

Product

Approved /

Reviewed by

Business

Distribution

Legal Advisor

X

Audit

Risk

Compliance

Shariah

Operations

Finance

Marketing

Treasury

RMM / ALCO

Product developmentrequest submitted by

Business

IF

Product approval by APPROVEDShariah Committee,Shariah Dept and

Central Shariah Group*

Application

processing

Approvals by BoD, Business

Operations, Marketing and

review by relevant Internal Audit

Post implementation

review by ShariahCommittee and Shariah

Department



Product Development Cycle for Sukuk and Challenges

Preparationfor underlying

Assets / Projects

AppointLead Manager

Legal Counsel

& other adviser

Kick off

ObtainShariah Approval

and Ratings

Legal DocsOffering Memo

Submission to

Securities

Exchange

Deal Road Show

& Book Building

Settlement

& Closing

Need time for approval process

Lack of Underlying Assets /

Projects (For Corporate Sukuk)

Timelines of the bidding process

Coordination among adviser

Different Shariah Scholars opinion

Poor of Ratings result

Timelines legal docs processDifferent time calendar

Meet the right investor base

Various pricing request from investor

Proper Settlement process

Final deal execution

The whole process takes 8 12 weeks



Obstacles in Development and Implementation of Islamic

Banking Products

Product Implementation

From client perspective: Lack of clarity on tax treatment(e.g. VAT), especially for structured product anddifficulty to get clarification and/or resolution from theauthority

Require extra works to fulfil different treatment under

Indonesian accounting standard (PSAK) andInternational accounting standards (IFRS)

Less familiarity with Shariah product than of the

hence more difficult to convince andmarket shariah product

Sequence is important in Shariah principles but

sometimes the process cannot be fully automated whenit is involved third parties.

Product Development

Time spent to obtain Shariah committee approvalespecially for new Shariah structure

Lack of clarity and comprehensiveness on accounting

treatment for Shariah transaction creates uncertainty withregards to accounting treatment and accounting reportingon both bank and customer sides.

Incompatibility of Shariah principles with the prevailing

law

Unresolved issues for tax treatment on corporate Sukuk

issuances

Slow internal approval process due to unfamiliarity of

approver with Shariah concept, a typical case for shariahbusiness unit

Need to enhance the information system to cater the

need of the Shariah structure.

Lack of product structure guideline to guide productdevelopment team in developing product and to guideregulator in accessing product

Short of human resource with competence in both

product development and shariah aspect



5. Lessons Learned & Ways Forward



New USD issue planned in 2010

IndonesiaCarried out extensive tax and

legal reforms

Carried out first IDR sovereign

issuance in August 2008

Issued first USD Sukuk in April

2009

JapanBill submitted to parliament to

allow issuance and trading of Islamic instruments

JBIC considering quasi-sovereign

issuance

Hong KongAnnounce plans to issue

sovereign Sukuk

Wants to tap into growth GCC

China capital flows

KoreaThe regulator has signaled

intention to promote Islamicfinance products in Korea

A draft Sukuk Law has been

submitted to the National

Assembly for review

The Sukuk Law is expected to be

introduced in 2010

TurkeyTurkey is currently considering

legislation for corporates toSukuk issues

KazakhstanKazakhstan looking into passing

Islamic finance legislation to

enable Sukuk issuance

Benchmark Sukuk issuance

targeted for 2010

New USD issue planned in 2010

SingaporeBy introducing a new set of laws

MAS has leveled the playing field

between Islamic and conventional

finance MAS has issued SGD

denominated Sukuk in 2008

Wants to establish a large and

liquid secondary market

ThailandConsidering to issue sovereign

Sukuk in 2010 to tap into GCC

liquidity

MalaysiaTax performance to Sukuk over

bonds

Invested in largest secondary

markets and knowledge centres

Several sovereign issuances

UAEDIFX wants to emerge as the

global Sukuk centre

Extremely large issuances by

sovereign and quasi-sovereign

institutions

to allow for Sukuk issuance

Draft legislation prepared

EgyptSukuk legislation drafted and

scheduled to be drafted into law

before year end

BahrainCentral Bank makes a short term

issuance almost every month

Established one of the largest

secondary market for Sukuk

U.KSukuk legislation passed

Treasury considering rolling

programme of short-term Sukuk

bills to act as risk free benchmark

of market

FranceFrance is keen to push for the

development of Islamic finance in

France s looking into legislation

JordanMinistry examining options for

Sukuk issuance in 2010

Government Exercises to Create Enabling Environment for Sukuk Issuance

Governments around the world are creating enabling environments for corporates to issue



The country is planning to improve its

legal system to become an alternative

location to the UK for resolvinginternational Islamic finance disputes.

The central bank, Bank Negara Malaysia

aims to position Malaysian laws

as the law of choice for Islamicfinance.

Bank Negara Malaysia is set to

implement a new model, the

Governance Framework (SGF), due to

be operational in 2011. Source: Department of Statistics Malaysia, Ernst & Young, McKinsey

What Can We Learn from Islamic Banking Development in Malaysia?

Regulatory support has helped grow the Islamic banking market share (assets) from 7% (2000) to 20% (2009)

in Malaysia

1983 1994

Islamic Banking Act 1983 (IBA)

First Islamic bank (Bank Islam

Malaysia Bhd)

Islamic money market

established

1997

National Syariah Advisory

Council established

1995

Association of Islamic Banking

Institutions Malaysia (AIBIM)

2001

Central Bank formed two

consultative committees:

. to set best practice and

. To drive product innovation

Launch of industry-owned

research and training institute :

Islamic Banking and Finance

Institute Malaysia (IBFIM)

2002

First sovereign global

Islamic sukuk amounting

to USD 600m

2004

Tax neutrality policy for Islamic

banking and finance in the 2005

budget

2006

Malaysia International Islamic

Financial Centre (MIFC) set up

to promote Islamic financialproducts and services in

international currencies for theglobal market

2007

Allowing 100% foreign equity

ownership in Islamic financial

institutions established under

the MIFC

2011

New Shariah

Governance

Framework

established

Financial Services include a systematic addressing of barriers: legislation, liquidity, tax, incentives, licensing

More emphasis on ethical aspects of Islamic Finance

Consultative approach to developing Islamic financial sectorEstablishing Central Bank guidelines for Islamic banks and

Takaful operations

Promoting both Government and Corporate Sukuk Issuances

Incentives offered via tax concessions and granting of new

branch licenses to foreign competitors



F actor s B est Practices* Indonesia G ap & W ays Forward

L egislation Full set of legislation are in place to

regulate Islamic Banking, Takaful and

Islamic capital market

The legislation passed is only for

Islamic banking and partially on

Islamic capital market instrument

Legislation is the foundation for

development of Islamic banking, hence

comprehensive legislation shall be in

place to cover at least three aspects of Islamic finance namely Islamic

banking, Takaful and Islamic capital

market

G rand Strategy

of D evelopme nt

Grand strategy for development

Islamic finance is in place to set

direction for national and international

development of the industry and to

synergize and harmonize development

of Islamic finance industry pillars.Advance market like Malaysia and

UAE setting up Islamic financial center

as interface and coordinator to carry out

initiative in the development process

and to promote the industry nationally

and internationally

Grand strategy sets by central bank

is lack of detailed action plan and is

focusing on market awareness

towards Islamic banking. The

missing points are clear strategy

and comprehensive direction onhow each pillar should be

developed in order to provide

enabling environtment for

development of Shariah industry.

E.g. there are efforts on developing

pillars however is not

comprehensive and harmony with

the other pillars and the industry

need.

Prioritizing to fill in the missing points

e.g.

-‐ Regulation: More detail and directive

regulation issued by central bank

-‐ Tax: provide clarity and supportive

tax treatment towards shariahtransaction.

L egal &

R egulatory

Regulator carry out effort to harmonize

legal aspect and regulation to suit with

Shariah requirements and provide

comprehensive, clear and detail

guideline for Islamic finance industry to

operate e.g. to provide guideline on

product concept paper and product

sharia parameter to guide development

of Islamic banking product

Efforts to harmonize legal aspect

with Shariah requirements and to

develop comprehensive and clear

guideline are in place. Nevertheless,

the development pace should be

faster to keep in track with the fast

development on the industry side.

Gaps are presence especially on the

comprehensiveness and details of

guideline. Regulator and industry

should proactively work together to

quickly identify and resolve issues

related to legal and regulatory.

Lesson Learned & Ways Forward

*best practices from countries in GCC and Asia




Shariah National Shariah Council is

organized as part of regulatory body

(e.g. central bank or security

commission) to enable focus,smooth and harmonization on

process in issuing fatwa with the

development process in the industry

National Shariah Council and

regulators are separated bodies

and they set up working group to

facilitate the process of issuingfatwa.

DSN might not need to be part of the

regulatory body, however there should be

more effective mechanisme to facilitate the

process of issuing fatwa in which regulatorshould play more active role to initiate

fatwa issuance based on market

requirement and grand strategy of Islamic

banking

Product

D evelopme nt

Product development is able to

deliver innovative and marketable

product since other pillars are able

to provide supportive environment

for such development

Product development is limited to

basic product due to lack support

from the other pillars.

e.g. tax issue, accounting issue,

limited fatwa, limited regulatorguideline

Urgently to address issues on pillars related

to product development such as:

availability fatwa (e.g. tawarruq &

commodity murabahah), tax neutrality and

incentive (tax for ijarah/operational lease,lower witholding tax), more details

guideline on product development issued

by regulator (e.g. uptodate product

codification, product concept paper, and

product shariah parameter).

H uman

R esour ces

Regulator and industry

supports/sponsors development of

human resource by establishing

learning center focusing on Islamicfinance and bearing mission to

promote Islamic finance.

e.g. INCEIF

The learning center for Islamic

finance is available however there

is lack of support from regulator

and industry

Regulator and industry should hand in hand

to support and sponsor Islamic finance

learning center which are available in some

universities, e.g. LPPI, UI, IPB, Unpad,

Paramadina, Tazkia etc, to facilitate these

institution to develop human resource and

bearing mission to promote Islamic

finance.






T ax Tax regulation and treatment are

adjusted to suit with and support

development of Islamic financeby providing equal playing field

with that of conventional. In

addition, some countries like

UAE and Malaysia that also have

aspiration to become the Islamic

financial hub globally provide tax

incentive to encourage

development of Islamic finance

industry.

Uncertainties on tax

regulation and treatment for

Islamic transaction are

presence. There are efforts to

resolve the tax issues,

however it has yet to cover all

tax aspects related to Islamic

finance

Tax office needs to issue a clear

guideline and regulation regarding

tax treatment for Islamic financial

transaction. In order to remove

uncertainty and provide equal

playing field with that of

conventional. In addition, incentive

from the government to boost

industry is needed.

C apital M ar k et Regulator set up comprehensive

regulation on Islamic capital

market that is not only cover

shariah instruments (e.g. sukuk,

Islamic REITS, stocks etc) but

also regulation on the operation of

the capital market.

The regulator has launched

several regulation on Islamic

Capital markets, covering

stock and debt instruments,

but especially for IDR

currency

Lack of socialization for the

regulation and required additional

regulation on, accounting standard,

tax treatment and issuer appetite to

have sharia exposure





6. . Milestones the Future Islamic Bankingin Indonesia in the era of OJK (FSA)



Historical of FSAIn Other Part of The World



Who Are BOC (DK)?



H.M. Iman Sastra Mihajat, Lc, PDIBF, MSc Fin, PhD.cHp: +62 853 66333340 / 0838 220 68882 / +60 17 2542253 (Malaysia)

Email: [email protected] / [email protected]