Indonesia’s Islamic Banking Industry Losing its Shine

The 1990s saw the birth of an industry that showed immense potentials as it could sustain two major financial depressions, i.e. the global financial crisis in 2008 and the Asian financial crisis in 1998. The Islamic banking industry was seen as a promising portfolio addition for investors, emerged as one of the leading industries over the last two decades. The industry was flexible enough to fall under both global and the Indonesian financial market requisitions.

Lately, the industry has been facing various performance turmoil owing to non-performing financings (NPF) such as the non-performing loans (NPL) at conventional banks. NPL has been identified across several Indonesia’s Islamic banks, which has been dragging down the industry’s growth in recent years. Last year, six out of 13 Islamic banks had NPF rate that exceeded legal limits set by the Bank Indonesia (BI) — Indonesian central banks.

Moreover, out of these six bank three had awful NPF rates, double in terms of stipulated limits as one of those even registering for a rate charge of over 30%. Two factors that have been reasoned behind this severe hit include the low creation of any genuine Islamic finance service and poor offerings of most Islamic finance products.

Such financial products are often a copy of conventional products, lacking a sense of uniqueness. For instance, the murabahah (mark-up sale scheme) segment is considered to be a replication of the conventional financial service available, despite having different theories. The margin rate used by Islamic banks is ultimately the same as the one in conventional lenders.

However, the basis Islamic financing schemes, which is the profit-loss sharing schemes (mudharabah and musharakah) are getting difficult to implement owing to their unpredictable nature (high-risk, low-return).  As a result, these schemes are losing customer interest. Hence, murabahah continues to be the most attracting financing portfolio of the industry in the country, registering for over 90% of Islamic banks financing activities. In contrast, musharakah and mudharabah collectively account for less than 2%. In addition, murabahah is the predominant contributor to high NPFs with over 50% share, followed by musharakah at 30% and mudharabah below 5%.

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