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06JAKARTA32442006-03-13 09:41:00 2011-08-30 01:44:00 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Jakarta
DE RUEHJA #3244/01 0720941
R 130941Z MAR 06
E.O. 12598: N/A 
REF: Jakarta 2906 - MUI Head 
¶1. (SBU) Summary. Indonesia's Islamic banking sector is 
small (under two percent of banking sector assets) but 
growing rapidly, and could reach nine percent by 2011, 
according to Bank Indonesia (BI) officials.  BI regulates 
sharia banking and is encouraging the growth of the sector 
with a lower initial capital requirement and a three-stage 
blueprint for Islamic banking development through 2012.  The 
two largest sharia banks in Indonesia, Bank Muamalat and 
Bank Sharia Mandiri, together control 73 percent of market 
share and Rp 15.6 trillion (USD 1.7 billion) in assets. 
Banking contacts in East Java are less optimistic about the 
sector's growth potential, with customers citing problems 
with service and lack of experienced personnel at sharia 
banks.  A big boost to the sector could come through a 
possible decision by the Ministry of Religious Affairs to 
transfer to sharia banks in 2006 an estimated USD 650 
million in annual hajj pilgrimage funds currently kept in 
conventional banks.  The Indonesian Ulema Council's (MUI) 
National Sharia Board (DSN) issues "fatwas" or legal 
opinions regarding Islamic banking and sharia financial 
products in cooperation with BI.  The non-bank sector also 
offers sharia products: Indonesia has about a dozen 
corporate sharia bond issuers, three purely sharia insurance 
companies, 29 conventional insurance companies issuing 
Islamic products, and three companies issuing sharia mutual 
funds.  Analysts expect demand for sharia banking and 
financial products to continue to grow in Indonesia as 
services improve and become more widely available, but it is 
unclear whether the sector will ever be more than a niche 
provider.  End Summary. 
Islamic Banking Small but Growing 
¶2. (U) At present, Islamic banking represents less than 2 
percent of total assets in the banking sector (about Rp 21 
trillion or USD 2.3 billion in December 2005), up from Rp 
2.7 billion (USD 0.3 million) in 2001 and only Rp 479 
million (USD 52,000) in 1998 according to BI.  BI officials 
believe the sector could grow to as large as nine percent of 
assets by 2011, though banking experts outside of Jakarta 
are less optimistic, citing problems with quality of 
service.  About 22 of Indonesia's 131 commercial banks now 
offer Islamic banking services.  Three of the 22 are 
strictly sharia, while the rest are conventional banks with 
sharia branches (see Table 1 below).  The three largest 
national players are Bank Sharia Mandiri (Rp 8.3 trillion or 
USD 900 million in assets) Bank Muamalat (Rp 7.3 or USD 791 
million in assets) and Bank Sharia Mega (Rp 1 trillion or 
USD 108 million in assets).  Sharia banks to date have 
demonstrated a greater ability to attract and retain 
borrowing clients than depositors.  Loan-to-deposit ratios 
(LDR) for sharia banks remain high at an average 110 
Table 1: Sharia Banks and Branches in Indonesia 
--------------------------------------------- -- 
Institution                Number as of 12/2005 
-----------                -------------------- 
Sharia Commercial Banks            3 
Sharia Business Units             19 
Branch Offices                   183 
Sub-branch Offices               100 
Cash Offices                     181 
Sharia Rural Banks                92 
Total                            578 
Source: Bank Indonesia 
¶3. (U) Indonesian sharia banks have some competitive 
advantages over conventional banks, chiefly their clean 
image, which many Indonesians find appealing.  This is 
especially attractive to small Muslim borrowers who feel 
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like they will get fairer treatment and a better chance of 
loan approval than at larger, more impersonal banks.  Sharia 
banking targets the low-income and low-middle income 
customers of all religions.  In addition, sharia banks can 
offer capital lease products for equipment or vehicles that 
conventional banks cannot.  (Note: Under Indonesian banking 
laws, it is much easier for sharia banks to hold title to a 
collateral asset than conventional banks.) 
Regulation of Islamic Banking 
¶4. (SBU) BI's sharia banking directorate told us that 
Islamic banking supervision is a challenge because BI must 
not only ensure compliance with banking regulations but 
sharia principles as well.  BI issued more than a dozen new 
regulations relating to Islamic banking in 2005 and expects 
that it will issue a capital adequacy standard for Islamic 
banks in the first quarter of 2006.  Despite the challenges, 
BI welcomes the growth of the sector as it will provide more 
diversification and an additional outlet for "idle money." 
A growing sharia bank sector should help banks manage their 
assets, BI told us, as well as attract funds from Muslim 
investors in the Middle East and elsewhere.  BI officials 
testified before Parliament in February 2005 on a draft 
sharia banking law that may be completed by May 2006.  Like 
conventional banks, all sharia banks must comply with 
Indonesia's Anti-Money Laundering (AML) requirements such as 
submitting suspicious transaction reports.  The sharia 
banking sector may create more challenges for the Financial 
Transactions and Analysis Center (PPATK) given the number of 
small branches and the explicit wish to attract money from 
Islamic nations. 
¶5. (U) BI officials describe Islamic banking as a "fast 
growing industry that has not yet reached critical mass." 
To encourage more sharia banks, BI has set a lower initial 
capital requirement of Rp 1 trillion (USD 108 million) for 
sharia banks, compared to Rp 5 trillion (USD 542 million) 
for conventional banks (based on regulation No. 7/35/PBI 
dated 29 September 2005.  BI issued a regulation in January 
(PBI No. 8/3/2006) to permit conventional banks with a 
sharia unit to offer sharia transactions at all branches, 
removing the need to have stand-alone sharia offices and 
staff at every conventional bank location.  The change in 
regulations should allow sharia banking services to become 
widely available in a relatively short period.  Other 
proposals to encourage sharia deposit growth would permit 
longer-term deposits of up to three years.  Conventional 
banks only offer one-month certificates of deposit and 
traditional savings accounts.  Allowing sharia banks to 
accept longer-term deposits may promote greater stability in 
the core deposit bases of the banks while offering 
depositors additional convenience. 
Blueprint for Islamic Banking Development 
¶6. (SBU) BI issued a "Blueprint of Islamic Banking 
Development in Indonesia" in September 2002 and provides 
annual reports on Islamic banking.  BI sees three stages in 
Islamic banking development in four categories (see below). 
Stage 1 (2002-2004) was establishing a strong base for 
sustainable development; Stage 2 (2004-2008) is 
strengthening the institutional structure; Stage 3 (2008- 
2012) is complying with international standards for 
financial products and services.  In the current Stage 2, BI 
plans the following: 
A) Compliance with Sharia Principles:  Supporting more 
efficient sharia supervisory activities; Developing 
incentives to improve compliance with sharia principles. 
B) Prudential Regulation: Developing risk-based regulations 
and supervision; Developing entry and exit policy. (Minimum 
criteria for starting a sharia bank and bank 
resolution/liquidation procedures.) 
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C) Operational Efficiency and Competitiveness: Supporting 
strategic alliances; Establishing cooperation with related 
supporting institutions. 
D) Systemic Stability and Benefits to the Economy: Enhance 
role of sharia financial information center; Support 
involvement of rating agencies in sharia banking activities; 
Conduct studies about voluntary sector;  Support use of 
share-base finance. 
Role of Sharia Bank Association and Ulema Council 
--------------------------------------------- ---- 
¶7. (SBU) The head of the Indonesian Sharia Bank Association 
(ASBISINDO) Wahyu Dwi Agung told us his Association seeks to 
raise the profile of Islamic banking in Indonesia, including 
by persuading BI to support a dedicated BI Deputy Governor 
for Islamic banking and expanding the existing directorate. 
(Note: Currently, BI Deputy Governor Siti Fadjrijah has 
sharia banking as part of her portfolio.)  He also admitted, 
however, that some banks have inadequate technology and 
human resources to expand sharia banking.  Currently, some 
rural banks are in the process of establishing sharia units. 
(Note: Rural banks in Indonesia are much smaller than 
commercial banks and have a different regulatory framework.) 
¶8. (SBU) The Indonesian Ulema Council (MUI) issues "fatwas" 
or legal opinions on Islamic banking and financial products. 
MUI head Ma'ruf Amin told us that the National Sharia Board 
(DSN), a MUI unit, is primarily responsible for issuing 
"fatwas" or legal opinions on Islamic banking.  BI then 
turns these into regulations related to sharia banking. 
(See reftel for more on Amin.)  DSN also approves sharia 
financial institutions and products, ensuring they conform 
to sharia principles.  Amin also confirmed that investing in 
tobacco-related products and industries is a grey area.  DSN 
works closely with BI and the Islamic Banking Association on 
issues related to Islamic financial services and products. 
MUI said it has been urging for several years that the 
Ministry of Religious Affairs (MORA) move hajj savings funds 
to sharia banks. 
Will Hajj Funds to Move to Sharia Banks? 
¶9. (SBU) In November 2005, Vice President Kalla reportedly 
said all hajj pilgrimage savings funds should be placed in 
sharia banks.  Bank Muamalat's President Director said he 
hopes Kalla's statement will eventually become a regulation 
and the MORA seems to be moving in this direction. 
Muamalat's senior managers acknowledged, however, that given 
Islamic banking's emphasis on honesty and transparency, "It 
is hard to do business with the government in a clean way." 
In a high-profile corruption case, the Central Jakarta 
District Court sentenced Said Agil Munawar, Minister of 
Religious Affairs from 1999 - 2004 was sentenced to five 
years in prison in February 2006 for embezzlement of hajj 
¶10. (SBU) Many Indonesians save for decades or a lifetime to 
make the hajj pilgrimage to Mecca, sometimes selling 
valuables, livestock or land.  They deposit hajj funds with 
the MORA one year before the intended hajj and MORA then 
organizes the pilgrimage.  The majority of Indonesians rely 
on MORA's organization rather than planning a hajj 
individually.  MUI head Mar'uf Amin said that MORA may issue 
a Decision Letter (SK) to mandate that hajj funds be placed 
in sharia banks.  There are an estimated 200,000 Indonesians 
who perform the hajj every year.  At Rp 25-45 million (USD 
2600 - 4900) per person, an estimated Rp 4.8 -9.0 trillion 
(USD 520-975 million) flows through the MORA's Hajj Fund 
Management Unit each year to conventional banks.  Amin said 
that MORA initially wanted to choose which sharia banks 
would receive the hajj funds, but MUI objected.  BI will 
select the banks after a "fit and proper" test.  Bank Sharia 
Mandiri believes that BI will select three or four banks to 
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be the operating banks for the hajj funds. 
Bank Muamalat and Bank Sharia Mandiri 
¶11. (SBU) Established in 1992, Bank Muamalat is Indonesia's 
first purely sharia bank.  The bank's shareholders include 
the Islamic Development Bank (28 percent), Kuwait's Boubyan 
Bank (21.3 percent); the Saudi Economic and Development 
Company (21.3 percent); three Indonesian businessmen who own 
a combined 15.5 percent (Abdul Rohim, Riza Ismael, Abbas 
Adhar); the MORA's Hajj Fund Management Unit (2.4 percent); 
and a group of smaller investors who own a combined 11.5 
percent stake.  Senior managers at Bank Muamalat told us 
that Muamalat opened 1000 branches at local post office 
outlets in 2005, and seeks to improve marketing to reach 
more customers in 2006.  "Intensification rather than 
extensification [is the priority] for 2006," Muamalat's 
President Director A. Riawan Amin told us.  Muamalat 
managers hope that sharia banking will reach five percent of 
assets by 2011. 
¶12. (SBU) One of the bank's key marketing tools is a mass 
appeal, small format book entitled "The Celestial 
Management," published in 2004 by A. Riawan Amin.  It is a 
collection of religious and inspirational stories, frequent 
quotations from the Koran, management principles and praise 
for Muamalat's business model, designed to appeal to a wide 
range of Muslim customers. 
¶13. (U) Established in 1999 after BI issued its first sharia 
banking regulations, Bank Sharia Mandiri is currently the 
leading player in the industry.  State-owned Bank Mandiri 
(conventional) is the majority shareholder with a stake of 
99 percent.  It controls about 40 percent of sharia market 
share, while Muamalat holds around 30 percent.  Syariah 
Mandiri has grown from 8 to 165 branches in six years, 
around 60 percent of which are located in Java.  Assets grew 
by more than 1,700 percent over the same period, from Rp 450 
billion (USD 48 million) to Rp 8.3 trillion (USD 900 
million).  President Director Yuslam Fauzi told us 39 
percent of the bank's lending portfolio goes to small and 
rural customers, and the bank intends to increase this 
proportion.  The bank also plans to add 45 branches of 
various types in 2006.  Around 15 percent of the customer 
base is non-Muslim.  Like his counterpart at Bank Muamalat, 
Fauzi has a degree from the U.S. and speaks fluent English. 
¶14. (SBU) Fauzi thinks that the draft sharia banking law 
will not bring any significant changes to the industry, but 
merely formalize relationships, responsibilities and 
principles already standard in the sector.  He expressed 
some frustration with BI as a regulator, noting that 
industry is growing rapidly and BI is not keeping up.  "BI 
needs to think about the whole range of sharia financial 
products, including sharia money market.  It has not focused 
enough resources on sharia banking."  Bank Sharia Mandiri 
offered five-year sharia bonds in 2003 and plans to issue 
subordinated sharia debt this year to improve its capital 
adequacy ratio (CAR). 
Sharia Banking in East Java and Sumatra 
¶15. (SBU) Although East Java accounts for about 15 percent 
of total population and is the center of Nahdlatul Ulama 
(NU), it has a relatively small number of sharia banking 
customers and accounts for less than 5 percent of national 
Islamic bank assets.  Attempts by more conservative Muslim 
groups to encourage Muslims to embrace Islamic banking, such 
as the Indonesian Muslim Council's (MUI) 2003 fatwa 
forbidding interest, have had little impact in East Java. 
¶16. (SBU) The Regional Economic Development Institute (REDI) 
in Surabaya recently completed a sharia banking customer 
satisfaction survey analyzing responses from East Java 
sharia banking customers.  REDI found that religious 
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motivations were not the primary attraction for East Java 
depositors to sharia banking.  Many of the larger depositors 
in East Java sharia banks were ethnically Chinese 
Indonesians attracted to the 1 to 2 percent higher returns 
delivered by the sharia banks over conventional bank deposit 
rates.  At the same time, many East Java depositors lacked 
confidence that the relatively new sharia banks and their 
staff would be able to effectively manage their loan 
portfolio risk in an increasing interest rate environment. 
In addition, since sharia loan payments on business loans 
are typically tied to a percentage of sales, if sales 
decline in a slowing economy such as after the fuel price 
increase, depositors are concerned that falling sharia bank 
profitability will lower deposit returns. 
¶17. (U) Sharia banking has about 5.2 percent market share in 
North Sumatra according to the head of Bank Mandiri Sharia 
in Medan.  There are five sharia banks in North Sumatra and 
Bank Mandiri Sharia has about 20 branches.  Commercial loans 
tend to go to plantations (though not tobacco) and personal 
loan eligibility is currently evaluated using the same 
criteria as conventional banks. 
Other Islamic Financial Products 
¶18. (U) Other Islamic financial products are growing in 
Indonesia as well.  At the end of 2005, 29 insurance 
companies were issuing Islamic insurance products.  Most are 
branches of existing companies but three are "pure" sharia 
insurance companies: Aj Mubakarah, Asuransi Takaful Keluarga 
(Family Insurance) and Asuransi Takaful Umum (General 
Insurance).  Regulations are in place for capital 
requirements and approval procedures for sharia insurance. 
A MUI advisor assists each company to ensure compliance with 
sharia principles.  Indonesia currently has four re- 
insurance companies with sharia divisions: Maskapai 
Reasuransi Indonesia, Tugu Reasuransi Indonesia, Reasuransi 
International Indonesia, and Reasuransi Nasional Indonesia. 
¶19. (U) In addition to Islamic insurance, three companies 
issue very small Islamic mutual funds.  State-owned 
investment firm PT Danareksa has sharia mutual funds with a 
net asset value in February 2006 of Rp 11.6 billion (USD 1.3 
million); state-owned Permodalan Nasional Madani (National 
Financing for Civil Society) with Rp 46.2 billion (USD 5 
million) and Bhakti Asset Management with Rp 74.5 billion 
(USD 8.1 million). 
Relationship to Islamic Standard Setters 
¶20. (SBU) In November 2003, BI became a member of the 
Accounting and Auditing Organization for Islamic Financial 
Institutions (AAOFI) and since 2004, a Deputy Governor of BI 
has sat on the Board of Trustees.  BI clearly seeks to 
become a bigger player in the international sharia banking 
community.  It co-hosted a large Islamic Banking Conference 
in November 2005 with the Islamic Research and Training 
Institute, the International Association for Islamic 
Economics and the University of Indonesia.  Approximately 60 
senior regulators, industry players and scholars from ten 
countries attended and presented dozens of research papers. 
¶21. (SBU) MUI does not comply fully with international 
sharia guidelines, but rather "adapts them for the domestic 
context."  MUI head Amin told us that he was pleased that 
international standard setters welcome and respect the views 
of MUI.  He noted other Islamic nations see MUI as 
representing a "moderate middle" on sharia financial 
products between conservative views from the Middle East and 
more liberal interpretations from Malaysia.  Amin thought a 
consistent global standard methodology for issuing fatwas 
related to financial instruments should eventually be 
developed.  However, Fauzi from Bank Sharia Mandiri said 
that, "We have to learn more from Malaysia," and said he has 
been trying to get colleagues in sharia banking more 
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interested in Malaysia's model. 
Islamic Sovereign Bonds in Future? 
¶22. (U) Indonesia has about a dozen Islamic corporate bonds 
issuers including bank, telecommunications, shipping 
property and trading companies.  The current value of sharia 
bonds outstanding is still very small, at approximately Rp 6 
trillion (USD 650 million).  The conventional corporate bond 
market in Indonesia is about USD 6 billion.  Indonesian 
companies that have issued sharia bonds include: 
- Indosat, Citra Sari Makmut (telecomm); 
- Bank Bukopin, Bank Muamalat (banks); 
- Apexindo Pratama Duta (drilling contractor); 
- Matahari Putra Prima (department stores); 
- Berlian Laju Tanker (shipping); 
- Humpuss Intermoda Transportation (shipping); 
- Berlina (plastic manufacturer); 
- Ricky Putra Globalindo (clothing); 
- PTPN and Ciliandra Perkasa (plantations). 
¶23. (U) Islamic sovereign bonds, in contrast, would require 
an act of Parliament to amend Law 24/2002 requiring that 
bonds show interest.  Muhammad Gunawan Yasni, a commentator 
on sharia economics at the Economic Faculty in the 
University of Indonesia told us he believes simply replacing 
the word "interest" with "coupon" or "profit sharing coupon" 
would be a sufficient amendment.  The Ministry of Finance is 
reviewing an amendment to this effect.  The International 
Islamic Financial Markets organization based in Bahrain must 
also approve Islamic sovereign bonds.  MUI head Amin said 
the GOI plans to issue two types of sovereign bonds, new 
issues and bonds converted from conventional interest- 
bearing bonds. 
¶24. (SBU) Sharia banking in Indonesia has clearly entered a 
period of rapid growth from a low base.  BI officials and 
bankers are convinced the underlying demand for sharia 
banking services in Indonesia's largely Muslim population 
will continue to broaden as sharia banking services become 
more widely available.  BI is doing its part to grow sharia 
banking through its blueprint, lower initial capital 
requirements, and facilitation of sharia services at 
conventional bank branches.  Strengthening sharia bank 
balance sheets by implementing proposed new regulations and 
developing new deposit products should help overcome 
depositor fears and allow sharia banks to expand into new 
lending areas.  To grow more rapidly, sharia banks and 
branches will need to offer services widely at the village 
level, where religious values may have a greater impact on 
depositor behavior.  Supervision of the sector is lagging 
somewhat behind its expansion as laws and regulations are 
still being put in place.