INDONESIAN ISLAMIC BANKING Approaches to Promote Islamic Finance

INDONESIAN ISLAMIC BANKING: Approaches to Promote Islamic Finance Department of Islamic Banking Jakarta, November 27 th 2012

Topic: Indonesian Islamic Banks – Recent Development

3 GLOBAL CRISIS 3

Indonesian Economy – Strong Growth 4 • Global Economy is uncertain as world GDP is projected to be lower • Despite external uncertainties, Indonesian fundamental economy remain robust supported by strong domestic demand • • Indonesian GDP is remain strong, grew at 6. 2% (yoy) in Q 3 -2012, persistent throughout years. Strong GDP Growth is supported by strong domestic demand, growing at 5 -6% yoy. Household consumption is predicted to remain strong, supported by stable consumer confidence in line with the low sentiment from fuel policy, inflation rate and sustained retail sales. Strong investment is supported by a conducive investment climate and positive perceptions on Indonesia's economic outlook. GDP Growth Is Persistent (% yoy) Strong Contribution of Domestic Demand

Demographic overview of the exciting and latent market for Islamic finance … 5 • The growth potential of Islamic banking and finance to serve the financial needs of Muslims all over the world is very strong. Non-Muslim market is also an Opportunity. 55 million Muslims reside in the continent or 8% of European population 450 Million Muslims populate the Indian subcontinent 23 Million Muslims reside in China Europe Japan China India Africa Middle East South East Asia North America 7. 8 Millions Muslims reside in the USA and Canada many of which are either citizens or permanent residents South America Important demographic and economic Muslim nodes 45% of Africa is Muslim or 450 Million 90% of the Middle East professes Islam 100, 000 Muslims reside in the archipelago of which 10% are ethnic Japanese An estimated 300 Million Muslims populate South East Asia Source: CIMB Islamic 5

Indonesian Islamic Banking - Global Picture • 6 Due to the high growth, Indonesia has 11 full fledge Islamic banks (BUS), 24 Islamic banking windows (UUS), and 156 Islamic rural banks (BPRS). Total assets ammounted to Rp 173 trillion (USD 19. 2 billion) (growth rate 36%-yoy) (September 2012) and total financing of Rp 133. 7 trillion (USD 14. 8 billion) (growth rate 40%-yoy) • Islamic Banking Development 1800 1600 Aset & Liabilities (Rp T) 3000 BUS UUS BPRS Number of Offices 2500 1400 1200 2000 1500 800 600 1000 400 500 200 0 Des-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 0 Office network has been rapidly increasing up to 2536 offices (growth rate of 24% -yoy) (September 2012) separated all over the country. Islamic banks Financing is currently up to Rp 133. 7 trillion (USD 14. 8 billion) (growth rate 40%-yoy)

to the next level? 7 Average growth of Global Islamic Finance (15 – 20%)

Asset Growth Remains Strong • Asset growth reaches 36% yoy, while financing growth reaches 40% yoy in September 2012 due to higher demand from customers. • Islamic banks are resilient to crisis, as CAR stable at 15% in September 2012 • FDR keeps growing and currently at more than 100% (102. 1% in September 2012) as demand for financing is increasing, while NPF is in steady declining due to better financing analysis. Islamic Banks Asset Growth (% yoy) 60% GASSET Gfinancing 50% 40% 30% 20% 10% 0% Islamic Banks CAR (%) September 2012: 15% Islamic Banks Performance (%) 106, 00% 101, 00% 6, 00% FDR 102, 10% 96, 00% 91, 00% 86, 00% 5, 00% 4, 00% 3, 00% NPF 2, 74% 2, 00% 81, 00% 76, 00% 0, 00% Des-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 • • Banks’ asset is growing as fast as 36% yoy, higher than that of global, due to higher financing demand from customers in the last 2 – 3 years. Islamic Banks resilience is maintained as CAR remains stable. FDR of Islamic banks is on the uptrend more than 100%, while NPF is declining Ja n. Ap 06 ril -0 6 Ju l-0 O 6 ct -0 Ja 6 n 0 Ap 7 r-0 7 Ju l-0 O 7 kt -0 Ja 7 n 0 Ap 8 r-0 Ju 8 li 0 O 8 kt -0 Ja 8 n 0 Ap 9 r-0 9 Ju l-0 O 9 ct -0 Ja 9 n 1 Ap 0 r-1 0 Ju l-1 O 0 ct -1 Ja 0 n 1 M 1 ar -1 1 Ju l-1 O 1 ct -1 Ja 1 n 1 Ap 2 r-1 2 Ju l-1 2 • 8

Current Growth is in line with the projections • • Banks’ current asset growth is in line with BI projections. Asset will keep growing in 2012 depends on the macroeconomic and global conditions. Asset Growth Actual vs Projections 2012 Projections European Crisis • It is expected that islamic banks’ asset will keep growing reach Rp. 187. 2 T on moderate scenario or even Rp. 206 T on optimistic scenario, depending on global and macroeconomic conditions. 9

Islamic Banks: Resilient to Crisis • • 10 The nature of islamic banking business is the application of profit/loss sharing, with the prohibition of speculation This will promote financial stability and cause islamic banks to be resilient to financial crisis Resilience of Islamic banks during current global uncertain periods: 1. 2. 3. 4. Profit and loss sharing mechanism will be beneficial and provide fair return to all parties. With this mechanism , islamic banks will promote social welfare as the benefit receivers need to pay zakah as part of social contribution while complying to the shariah principle. The products offered by islamic banks always use real sector transaction as their underlying; therefore, the impact of islamic financial transaction can be significant to promote economic growth Reducing potential excessive speculation since islamic finance prohibits the speculative motive. Derivatives products are prohibited by islamic principles because of the existance of gharar In the case of Indonesia: a. b. islamic banks nature is to focus on developing small and medium enterprises as the underlying, and there are relatively small risks involved Exposure to currency risk, financial sector is relatively small This will promote financial stability & resilience to financial crisis

Topic: Indonesian Islamic Banks – Challenges To Be Islamic Financial Leader

1. Higher Islamic Banking Market Share 12 • Despite high asset growth, compared to national banking industry, islamic banking market share remains small. • This is due to declining deposit growth • The current market share of total assets is 4. 21%, and financing share is up to 5. 07% per September 2012 • This share is growing at average of 1. 3% per month since end 2009, a relatively slow growth • This is mainly due to the lower deposit growth caused by several big deposit withdrawals 6, 00% 5, 07% 5, 00% 4, 21% 3, 00% 2, 00% 0, 00% Asset Share Financing Share Jan-09 Mar-09 Mei-09 Jul-09 Sept-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 1, 00% The Indonesian Islamic banks need to have breakthrough to reach 10 -15% share in the next 5 years.

2. Maintaining A Strong Growth 13 • With 85% of population are muslim (210 million), the Indonesian Islamic banks have chances to be a leader in the global Islamic finance. However, currently Indonesia has only about 1% of the total Islamic finance assets • Needs key thrust to maintain strong growth Muslim population Steps Forward • Innovation of genuine syariah Products and services • Strong Infrastructure and product standardization & regulation • More professionals & qualified HRD • Intensified Education and socialization to society wide With Rp 173 trillion (USD 19. 2 billion) we only account for 4% of Indonesian banking industry, or less than 1% of global Islamic assets. These strategies will attract customers to use Islamic banking services , at the end this will have an impact to a strong growth

3. Government and Industrial Support 14 • In order to be the next Islamic financial hub, Indonesia needs industrial support from insurance, pension funds, & financing companies. • Government as well as Authorities supports are significantly important. The Indonesian approaches to develop Islamic finance and Islamic banking are bottom-up, where ulama, muslim professionals, and whole society provide supply and demand for Islamic finance. – In addition to Islamic banking system, we have takaful, more than 5500 baitul maal wat tamwil, and more than 500 private zakah institutions. Government support for Islamic finance is currently through sukuk issuance (outstanding at $10. 2 billion ). – This is different from MEA and Malaysia with a top-down, where government fully support s the development of Islamic finance, especially through Sukuk market. Outstanding Sukuk in Malaysia reaches $165. 2 billion (June 2012), or more than 2/3 share of the global outstanding Sukuk Issuance by Country (2011) Therefore, government support to increase Islamic finance development, through rules, regulation, productivity and infrastructure, as well as sukuk issuance is significantly important

Topic: Policies to Promote Islamic Finance in Indonesia

BI Policy: Product Innovation 16 Working Group Discussions amongrelated institutions to increase creativity on product innovation to attract customers 1. 2. 3. 4. In the current highly competitive environment, islamic banks cannot rely on standard product to attract customers. Islamic financial institutions must act and able to offer pure and genuine Islamic products that bring up the uniqueness of sharia principles that can meet customers' and investors needs BI will facilitate Working Group Discussions (with National Sharia Board and Indonesia Accountant Association) to activate innovation and creativity regarding product development to attract more customers. BI will consider to improve related regulations on Islamic banking products in order to increase the efficiency of the product licensing process. In order to increase public awareness to Islamic banking products (i. B financial literacy), socialization programs / public education and communication will be more focused on equality "parity" and the uniqueness of "distinctiveness" of the product Islamic banking. Islamic banks are expected to strengthen the product development unit in order to accelerate the equalization of products and service levels with conventional banks, to increase service to meet customers needs

BI Policy: Islamic Money Market Transactions Liquidity and development of Islamic financial markets, especialy money market instruments are also part of BI Policies • BI will increase islamic money market transactions through enhancement the features of Interbank Mudharabah Certificate (SIMA) as underlying transactions, • We are introducing sharia commodity trading scheme as a new Islamic money market instruments, and to increase the role of money broker in islamic money market transactions. • In addition, to provide complete financial services to client, Islamic banks can also provide financial services in the form of foreign currency , such as import payments or other foreign currency liabilities. This causes the need for Islamic banks to mitigate currency risks. Therefore, it is necessary for regulators and authorities to review the mechanisms and hedging instruments which comply with sharia principles. Islamic Banks MM only Rp. 400 bio per Day Development in islamic financial markets, especially money market instruments, will help banks to manage liquidity lower liquidity risk Help Promoting Asset Growth 17

BI Policy: Emphasing Financing to Productive Sector Bank Indonesia encourages Islamic banks to provide more financing to productive sector, SMEs and corporations 1. Bank Indonesia in its capacity will facilitate link and match program among Islamic banks and industry which is prioritized by the government, such as infrastructure, agriculture, as well as others. 2. Focus Group Discussions and business match will be the main forum to match supply and demand between banks and productive sectors. BI have facilitated several FGDs and have received positive feedbacks. As a result, this will help promoting resilience of Islamic banks, as well as generate higher asset growth, so that asset share of Islamic banks compared to that of in conventional will gradually increase target of 15 -20% in the next decade 18

19 With strong supports and policies from financial regulators, cooperation with countries having more developed Islamic finance and involvement in international forums, such as Organisation of Islamic Cooperation (OIC), International Financial Service Board (IFSB), International Islamic Liquidity Management (IILM), and others, Indonesia is on its way to be one of the leaders in Islamic Finance, insha Allah. THANK YOU