Indonesia Sharia Banking Industry

The development of the sharia banking in Indonesia has started well before a formal legal base for sharia banking operation came into force. Before 1992, even though, there were several non-bank financial institutions that applied share base contract founded. For instance, Timberg (2004) expected that there were 1,500 kopontrens, which is cooperative for Islamic school (pesantren). It was registered by the Ministry of Cooperatives frequently connected with agriculture.[1] Through the enactment of the Banking Act No. 7/1992, Islamic banking in Indonesia started to operate from 1992.

The initiative to engage Islamic financial business, however, raised uncertainty upon which forum was competent to settle Islamic banking disputes whether civil court or religious court. Both regarded themselves to be competent to settle such disputes.[2] An initiative to take charge of the settlement of Islamic banking disputes was also taken by the Indonesia Council of Religious Scholars through setting up BAMUI (Indonesian Muamalat Arbitration Body) in 1993. However, due to very poor knowledge of the Islamic law of arbitration possessed by the banks and their banking costumer complainants, the National Shari’ah Arbitration Body could not function effectively.[3] Due to the regulatory hurdles, this industry was experiencing a mini-boom and the BMI was the only one Islamic banking in Indonesia, which is BMI.

During the economic crisis in 1998, sharia banking was still performing much better than the conventional banking as indicated by a relatively low level of non-performing loans and the absence of negative spread in the operational activities. It because the rates of returns paid to the depositors were not determined by market interest rates. The evident shows that sharia banks were relatively more able to conduct lending as indicated by a relatively high LDR ratio, between 113 and 117 percent.[4] This experience has brought a hope to the public for the presence of sharia banking as an alternative banking system that was expected to be able to delivery economic benefits and ensure compliance with sharia principles. It triggered the amendment by Act No. 10/1998, to provide an opportunity to conventional banks to open an Islamic window.

Between 1998 and 2001, sharia banking system was growing 74 percent annually (in terms of asset size) from Rp. 479 billion in 1998 to Rp. 2.718 billion in 2001. The third party managed funds has also increased from Rp. 392 billion to Rp. 1.806 billion. The sharia banking system has also developed institutionally. There has been another commercial bank converting its operations into sharia commercial bank, besides there have also been 3 sharia unit banks and 3 sharia rural bank came into operations by the end of 2001. The number of sharia branch offices and sharia unit banks has also increased from 26 to 51 branches.

In 2001, there were several banks converted to Islamic banking under the care of the central bank (Bank Indonesia) and the Indonesian Restructuring Bank Agency, including Bank Tugu and Bank Bukopin. A revival of religious sentiment may be the reason for the popularity of Shariah banks. A central bank survey of 4,800 people in Java showed that almost all of them believed that Islam forbade the practice of usury.[5]

In the first quarter of 2002, the Indonesian Central Bank reported the assets of Islamic banks increased to Rp3.45 trillion (US$1.5 billion) from Rp2.72 trillion a year before. It extended loans under Koranic law, recorded a 35 percent increase in financing to Rp2.35 trillion in the same period August 2002. By July 2002, Islamic banks had a financing to deposit ratio (FDR) of 121 percent, up from 116.5 percent in the first quarter of this year although "ideally FDR is around 100 percent".[6]

To respond some Islamic banking disputes, the government enacted Law No. 3 of 2006. The regulation amended Law No. 7 of 1989 and expanded the jurisdiction of the Religious courts to cover adjudication of disputes belonging to Islamic economic matters, including Islamic banking.

In 2005, the assets was growing from Rp20 trillion to Rp50 trillion (around US$48 billion) in 2008 or around 34% annually growth (see table 1). It expected to $10 billion by 2010 which counted 5% of the world Islamic financial industry. US-based international credit-rating agency Standard & Poor's estimates that the global potential for Islamic financial services was $1 trillion in 2008 and could be closer to $4 trillion in 2010. Worldwide, Islamic finance currently represents less than 10% of the total global Muslim market of 1.5 billion people.

In 2006, Islamic banks reported a 79% year-on-year increase in business volume, to Rp8.76 trillion ($1.36 billion). The amount of leasing business, known as ijarah, grew by a whopping 164.7%, and sharia mutual funds grew in asset value by 17.6% last year, with a total net asset value of about Rp663.7 million. In 2007, there were three sharia bank in Indonesia, namely Bank Muamalat Indonesia, Bank Syariah Mandiri (the largest by asset), Syariah Mega Indonesia.

In 2008, there were several new Islamic branches of regular commercial banks, 80 Bank Perkreditan Rakyat Shariah (micro finance), and 2,470 cooperatives.[7] President Susilo Bambang Yudhoyono said at the completed World Islamic Economic Conference 2008 in Kuala Lumpur that his government intends to push through the regulatory change necessary to support the industry's development, which still only accounts for about 2% of total Indonesian banking activity.[8]

Indonesia Central Bank categorized seven shariah financing products, namely Mudharaba, Musharaka, Murabaha, Salam, Istishna, Ijara, and Qardh (for more detail, see appendix). The most favorite product was so-called murabaha-based finance which is concerned with lending for consumer goods such as motor vehicles and housing. Between 2005 and 2008, it was rocketing from 119 thousand units into 498 thousand units, or jumped more than 300% (see table 2). Sharia banks finance the purchases on behalf of a customer for an agreed fee, but these transactions incur a 10% value-added tax (VAT) because under current taxation laws such a fee is not categorized as interest, which would exempt it from VAT payments.

However, the competitiveness was fostering every shariah bank came up with various niche products. At least, there were nine products of shariah deposits in 2008. For instance, Bank Muamalat was offering two shariah deposits. The shariah saving accounts were more competitive. Bank Mandiri came up with five products of shariah saving account schemes, while Permata Bank was offering six ones. The central bank expects the number of Islamic banks to rise to 15 by 2015 from three currently, as demand for financial products compatible with the tenets of religious law, or Shariah, increases. In 2008, murabaha was noted as the most favorite sharia financial products which counted almost 500 thousand unit or around 83 percent of total of sharia financing units.

In Southeast Asia, Indonesia still trails its smaller regional neighbor Malaysia, where the regulatory environment has already been modified to attract foreign Islamic investments. But financial analysts say there is huge potential in Indonesia to attract not only local money but also petrodollars and sharia-compliant funds from the Middle East, as has happened with Malaysia.
Considering that 87% of the country's 240 million people follow Islam, Indonesia has been taking steps to rise up Islamic banking sector. The industry has grown rapidly in last decade, as banks tap deeper into one of the world's largest Muslim markets. Central to Islamic finance, the sharia banks offer products and services akin to conventional financial products, which have potential of creating the largest sharia finance area in the world.
[1] Thomas A. Timberg, Risk Management: Islamic Financial Policies Islamic Banking and Its Potential Impact, USAID
[2] The problem of financial dispute was that the jurisdiction of the civil courts did not extend to Shari’ah matters, within which Islamic banking disputes apparently came. On the other hand, the jurisdiction of the religious courts was limited to Personal law matters which did not cover banking disputes, and was confined to a) marriage, b) inheritance, testamentary succession, hiba and waqf.
[3] Abdul Rasyid, 2008, Settlement of Islamic Banking Disputes in Indonesia: Opportunities and Challenges International Conference on Mediation in the Asia Pacific: Constraints and Challenges, Kuala Lumpur, 16-18 June, 2008
[4] Bank Indonesia, 2002, The Blueprint of Islamic Banking Development in Indonesia
[5] Strait Times, Feb 19, 2002
[6] Islamic banks flourishing in Indonesia, Asia Times Sep 26, 2002
[7] Microfinance is registered by Bank Indonesia (Central Bank of Indonesia) while cooperative are registered to the Ministry of Cooperatives and Small Business.
[8] Bill Guerin, Tapping Indonesia's Islamic potential, Asia Times Online, June 26, 2007,

Indonesian Cigarette Industry

Indonesia was noted as the world's fifth-largest tobacco market. In the country with 50% of population living under $2 a day, cigarettes priced at around $1 a pack, the cheapest in the world. More than 6 of 10 male were smokers, and most smoked clove cigarettes, known as kreteks for the crackling sound they make as they burn. The spice, which is native to Indonesia, added to tobacco, imparting a sweet scent and emitting eugenol, a chemical that numbs the throat. The rich aroma of kretek clove cigarettes was one of the most evocative scents of Indonesia. However, kretek deliver double the nicotine and almost triple the tar of conventional cigarettes, according to a 2002 paper in the journal Pharmacology Biochemistry and Behavior.[1]
In 1950s, the industry was under pressure from the machine made white cigarette, though many smokers remained loyal to kretek due to great a price disparity. The United National Statistical Yearbook 1963 noted that Indonesia produced 21,198 million cigarettes in 1960. This included only machine-produced white cigarette. In the same year, 21,356 million kretek cigarettes and about 1,000 million klembak cigarettes were also produced. Called as collective native cigarettes, kretek and klembak cigarette were produced on simple hand-rollers in which the industry employed around 70,000 workers while around 11,000 employees worked for white cigarette industry.[2]
For the Indonesian Government, tobacco was largest source of revenue after oil, gas, and timber. In 1996, it was about 10% of the total tax revenue, recouping around US$4 billion 1996.[3] Tobacco tax was an easy, reliable form of taxation, a steady, internal revenue, unlikely to suffer from any external shocks, and unlikely to create any sudden crisis, in contrast to the instability of oil revenue and other export orientated products which were subject to the fragile of international shock.

Top Indonesian cigarette makers included Gudang Garam (GGRM) and Handaya Mandala Sampoerna (HMSP), which were among the biggest firms in the Indonesian Stock Market (IDX). During the Asian financial crisis of 1997 and 1998, HMSP expanded to be the first Indonesian companies. With $1.6 billion in sales in 2002, Sampoerna was noted as the most popular blue chips on the Jakarta Stock Exchange.[4] In 2004, the white cigarettes declined due to the minimal marketing activities of international players – such as BAT Indonesia Tbk, PT and Philip Morris Indonesia PT. Conversely, the popularity of kreteks continued to prevail.
In 2006, ‘Mild’ kreteks continued to perform robustly, as an increasing number of regular kretek smokers shifted to mild kreteks. Despite the presence of numerous mild kretek brands in Indonesia offered at lower price points, HMSP’s A Mild succeeded to outperform these brands. This was due to its first-comer advantage and effective mass media advertisements. A Mild was particularly popular in urban centers, such as Jakarta and Surabaya, where consumers were less price sensitive and more concerned about brand image and quality.[5]

In 2008, tobacco industry in Indonesia still played an important economic role, with tax on cigarettes accounting for about 10 percent of government income, while the sector provides millions of jobs. Even though, the government imposed an excise rate of about 40 percent from the maximum cigarette excise tax to 57 percent. Under the existing excise scheme, the government adopted a combination of tariffs, linked to factors such as production volume, retail price, cigarette type and the cigarette-making process.

In 2008, overall volume performance of tobacco products in Indonesia showed a growth decline. This was due to inflated daily living costs as a result of the government’s policy to reduce the nation’s fuel subsidies early in 2008. There was slow economy growth as a consequence of various national disasters in the latter half of the review period. Mass Indonesian consumers were, therefore, impelled to be economy with cheaper alternatives and thriftier consumption.

Since 2005, cigarettes became an expensive indulgence for most Indonesian consumers. This was because of consecutive price increases implemented by the manufacturers as a result of the government’s policy to increase the retail price of cigarettes per stick (HJE), and then again in 2006. Manufacturers and retailers made stringent efforts to dampen and lessen the impact of price increases. However, price-sensitive low-income consumers were forced to both cut back on their daily consumption and seek cheaper alternatives.

Indonesia aimed to lower cigarette production growth to 5 percent in 2009 from about 7 percent growth. It expected production to decrease to 240 billion cigarettes in 2009 from an estimated 247 billion cigarettes in 2008. The country was targeting excise tax revenue in 2009 of 48.2 trillion rupiah ($4.42 billion), an increase of 2.7 trillion rupiah compared to the revised 2008 state budget.[7]

Indonesian cigarette firms would have to pay an additional 7 percent excise tax soon, as the governments seek to curb smoking in one of the world's largest tobacco markets. A new ministerial decree, which would come into effect on Feb 1, 2009, adjusted the retail price range for cigarettes and increase tax costs by an average of 7 percent. The policy was a gradual step towards simplifying the excise schemes. The increase would vary, depending on the previous retail sales price.

In 2009, the country was targeting excise tax revenue of 48.2 trillion rupiah ($4.42 billion), an increase of 2.7 trillion rupiah compared to the revised 2008 state budget. Despite its reluctance to sign the Framework Convention on Tobacco Control (FCTC), Indonesia had a road map to support the convention and aims to limit cigarette output to 260 billion cigarettes by 2020 ($1 = 10,900 rupiah).[8]

[1] JZ Su and Leroux, 2005, Cigarette Ignition Propensity Testing, irc.nrc-cnrc.gc.ca/pubs/rr/rr194/rr194.pdf
[2] Anonym, Clove and Kretek, September 1965.
[3] See SEARO Tobacco Control in Indonesia, see also Adioetomo et al, 2005, Cigarette Consumption, Taxation, and Household Income, World Bank Development Network, siteresources.worldbank.org
[4] www2.kompas.com/business/bursa/0203/14/3760.htm
[5] Tobacco Indonesia, ResearchandMarkets, http://www.researchandmarkets.com/reports/300936/
[6] http://www.wartaekonomi.com/indikator.asp?aid=8208&cid=25
[7] Indonesia cigarette firms to pay 7 pct more '09 tax, Reuters, Wed Dec 10, 2008
[8] Reuter, December 10, 2009. http://www.reuters.com/article/rbssConsumerGoodsAndRetailNews/idUSJAK40198720081210