Indonesia’s bid to rival Malaysia as a Shariah finance hub just took on greater impetus with a plan by Aceh province to convert its development bank to one that complies with Islamic law.

Bank Aceh will become the nation’s first to transform from a non-Shariah-compliant entity, setting a precedent for the national government that is also deliberating such a move for a state lender. Shareholders will vote this week on converting the bank’s Rp 16.4 trillion ($1.2 billion) of assets, Zulfan Nukman, head of the province’s central bank office, said in a May 21 phone interview from the city of Banda Aceh.

Indonesia’s Financial Services Authority plans to announce this month a roadmap to develop the Shariah-compliant finance industry, as total assets of Rp 272 trillion pales against Malaysia’s 626 billion ringgit ($173 billion). The country is seeking to boost its regional profile with a bid to host the infrastructure arm of the Islamic Development Bank, whose largest shareholders are Saudi Arabia, Libya, Iran and Nigeria.

“Industry players will be watching closely to see if the process goes smoothly and if the bank becomes more commercially viable,” said Achmad Kusna Permana, the Jakarta-based secretary-general at the Indonesia Islamic Banking Association. “It would support the option to convert a state lender, which would add an instant few billions to Islamic banking assets and create an institution that can compete toe-to-toe with conventional banks.”

Aceh trailblazing

Bank Aceh is majority-owned by the provincial government and its plan to convert to an Islamic lender has been approved by governor Zaini Abdullah, Zulfan said.

Aceh, located at the northern tip of Sumatra, was granted more autonomy in 1999 to help stem an insurgency arising from unequal distribution of wealth from its natural resources. The 30-year conflict ended in 2005 as separatist group the Free Aceh Movement disarmed following a peace pact. The province has the highest proportion of Muslims at 98 percent and is the only one of 34 administrative regions that has implemented Shariah law, or Qanun, which permits floggings and fines for offenses ranging from stealing, to adultery and alcohol consumption.

Aceh has seen growth in Islamic banking assets outpace those of the conventional market, with a 17.6 percent increase to 5.5 trillion rupiah in 2014, compared with a 9.8 percent rise to Rp 36.7 trillion, central bank data show. That’s in contrast to the nationwide trend last year in a country with the world’s biggest Muslim population.

“A Shariah bank is fitting for Aceh as that’s where the demand is,” said Bank Indonesia’s Zulfan. “This will add to Islamic banking assets and Bank Aceh will be the trailblazer for other lenders considering to convert to Shariah.”

Size differential

In an effort to boost the ability of lenders operating under religious principles to win more business, the government began discussing a plan to form an Islamic megabank in 2013. Options include creating such an institution from scratch, combining the Shariah units of government-held banks or fully converting a non-Islamic state lender.

Similar industry-wide initiatives have so far failed to produce results in a market that Ernst & Young predicts will reach $3.4 trillion in assets by 2018 from $1.7 trillion in 2013. Malaysia’s CIMB Group Holdings, RHB Capital and Malaysia Building Society put such a plan on hold this year.

The relatively small size of Indonesia’s Shariah-compliant lenders makes it a challenge to compete with bigger conventional rivals, said Permana at the banking association, who is also the Islamic director at Bank Permata.

Increasing confidence

Bank Syariah Mandiri, the nation’s largest Islamic bank, had 67 trillion rupiah of assets at the end of last year, compared with second-placed Bank Muamalat Indonesia’s 62 trillion rupiah, according to their websites. That’s a fraction of the 868 trillion rupiah of Bank Mandiri and 806 trillion rupiah of Bank Rakyat Indonesia.

The Bank Aceh plan is “a good indication of the increasing confidence and commitment of the authorities on the viability and sustainability of Islamic finance,” said Alhami Abdan, head of international finance and capital markets at OCBC Al-Amin Bank in Kuala Lumpur. A Shariah megabank would enhance “the Indonesian Islamic banking industry’s capacity and capability in deepening its coverage of the wholesale banking sector,” he said.

Bloomberg

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Jakarta. Indonesia is seeking to boost its profile as an Islamic finance hub with a bid to host the infrastructure arm of the industry’s biggest multilateral lender.

The Islamic Development Bank, whose largest shareholders are Saudi Arabia, Libya, Iran and Nigeria, may choose Indonesia as the base for its Islamic Investment Infrastructure Bank, Finance Minister Bambang Brodjonegoro said on Wednesday.

The government is approaching “key countries,” especially those in the Middle East, to earn the right to host the lender, he said. Indonesia and Malaysia both have shareholdings in the IDB of less than 3 percent.

“Having IIIB in Indonesia will help build infrastructure, bring in capital and boost Islamic banking assets,” Achmad Kusna Permana, secretary general at the Indonesia Islamic Banking Association, said on Wednesday.

“Malaysia and Saudi Arabia may offer more sophisticated markets, but the greatest funding need is here.”

President Joko Widodo plans to spend $425 billion over the next five years to build dams, railways and airports as he aims for 7 percent economic growth.

The nation is also vying to catch up as a finance hub with Malaysia, where Islamic banking assets are eight times larger.

Its neighbor is home to the standards-setting Islamic Financial Services Board and the International Islamic Liquidity Management.

The IDB may set up its infrastructure funding unit in the Southeast Asian nation in 2016 with capital of $1 billion, Rifki Ismal, the Jakarta-based assistant director at the central bank, said according to local media on Wednesday.

Ibrahim Shoukry, the IDB’s resident Indonesia representative in Jakarta, declined to comment when contacted on Wednesday as discussions were still ongoing.

Indonesia is home to the world’s biggest Muslim population, ahead of Pakistan and India. Shariah-compliant banking assets rose 12 percent in 2014 to an all-time high of Rp 272 trillion ($21 billion), data from the Financial Services Authority show. That compares with Malaysia’s record 625 billion ringgit ($170 billion).

Indonesia’s Financial Services Authority plans to provide a road map in May to further develop the nation’s shariah-compliant industry, its chairman, Muliaman Hadad, said in Jakarta on March 5.

The government is also seeking to tap global investors this year with its fifth sale of dollar sukuk since 2011.

The IIIB coming to Indonesia “will expand the source and use of shariah-compliant financial products and solutions,” Angus Salim Amran, the Kuala Lumpur-based head of financial markets at RHB Investment Bank, a unit of RHB Capital, said on Wednesday.

“Dedicated regulations and guidelines should be pursued to enhance the growth of the Islamic capital market.”

The Jeddah, Saudi Arabia-based IDB was set up in 1975 to promote economic development among its members, which now number 56 countries.

The bank’s home country holds a 23.5 percent stake, Libya has 9.4 percent, Iran 8.3 percent and Nigeria 7.7 percent, according to its website. That compares with Indonesia’s 2.3 percent and Malaysia’s 1.6 percent.

The IDB raises funds by selling Islamic bonds, which pay returns from an underlying asset to comply with shariah’s ban on interest. The proceeds have to be invested along religious guidelines.

The basic conditions for membership are that countries should be part of the Organization of Islamic Cooperation, and that they pay contributions to the lender, according to its website. The OIC is an international body that seeks to protect the interests of Muslims worldwide.

Joko is seeking to boost economic growth to 7 percent before the end of his five-year term in 2019, from 5.02 percent in 2014, which was the slowest since 2009. He’s put a priority on infrastructure to help achieve that target.

The state budget can only cover 30 percent of the development costs, with private funding needed for the rest, Sugihardjo, a senior official at the Transportation Ministry, said on Jan. 22.

“Besides adding more liquidity into the existing Islamic financial market, the proposed IIIB also indicates Indonesia’s readiness to be one of the important hubs for Islamic finance,” Abas A. Jalil, chief executive at Amanah Capital in Kuala Lumpur, said Wednesday.

“Indonesia itself needs large funding for infrastructure, therefore IIIB would have ready and viable projects to kickstart within its host country.”

Bloomberg

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