Further development of risk management and corporate governance standards is key to improving its competitiveness with conventional banks, says Fitch Ratings

By HABHAJAN SINGH / Pic By KNKS

Indonesia’s Islamic banks are having a good run thus far but they need to work on risk management and corporate governance standards in order to compete with their conventional counterparts.

The republic’s Shariah banking sector’s financial performance considerably improved during the first nine months of 2018, according to Fitch Ratings Inc.

This was reflected in better asset quality, higher profitability and stronger capitalisation, said the international rating agency.

However, it noted that further development of risk management and corporate governance standards is key to improving its competitiveness with conventional banks.

Moving forward, Islamic banks and the halal sector are expected to gain additional momentum with the reinvigoration of the National Shariah Finance Committee (KNKS), an entity established by President Joko Widodo in 2016 to facilitate the implementation of a Shariah finance master plan.

On Jan 3, Minister for National Development Planning (Bappenas) Bambang Brodjonegoro appointed a team of directors for KNKS, led by Ventje Rahardjo Soedigno as its ED.

The sentiments were echoed by Toni Eko Boy Subari, president director of PT Bank Syariah Mandiri, the nation’s largest Islamic bank.

In a recent article, Bloomberg reported that Shariah banking in Indonesia was poised for a phase of rapid growth with demand for financial products conforming to Islamic principles soaring.

Shariah banking assets had broken out of the “5% market trap” that they were in for a long time, thanks to a wave of halal lifestyle sweeping the world’s largest Muslim-majority country, Subari told the news agency.

On its part, he said he expected the lender’s financing to expand 11%- 12% this year, a second straight year of double-digit growth.

Fitch Ratings expects financing at Indonesia’s Islamic banks to continue to increase in double digits in 2019, supported by the sector’s improved capitalisation and ample liquidity.

“However, we expect funding costs and asset quality in the sector to be pressured by higher domestic interest rates, although such challenges should be manageable for most banks,” it said.

Fitch Ratings noted that Indonesia has the largest number of Islamic banks in the world, with a total of 75 banks at end-2018 consisting of 14 Islamic banks, 20 Islamic bank units and 41 Waqf banks.

It said Indonesia’s financial regulator, Financial Services Authority or OJK, aims to increase the diversity and availability of Shariah-compliant products as part of efforts to enhance financial inclusion.

On the overall picture for the first nine months of 2018, Fitch Ratings said the sector’s non-performing financing (NPF) ratio improved to 3.2% (2017: 3.9%), the narrowest gap to conventional banks (2.6%) since 2013.

“This was mainly due to write-offs of legacy problem assets at the four largest Shariah banks, which accounted for over 50% of the sector’s assets. The NPF ratio is based on financing overdue by more than 90 days,” according to the report.

It added that profitability improved significantly as reflected in a higher return on assets of 1.5% (2017: 0.8%), owing mainly to lower credit costs as a result of better asset quality.

Nevertheless, it remained lower than the conventional banks’ average of around 2%.