Aceh to provide roadmap for Indonesia's Islamic banking ambition

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. PT 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 16.4 trillion rupiah ($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 272 trillion rupiah 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 36.7 trillion rupiah, 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 LLP predicts will reach $3.4 trillion in assets by 2018 from $1.7 trillion in 2013.

Malaysia’s CIMB Group Holdings Bhd., RHB Capital Bhd. 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 PT Bank Permata.

Increasing Confidence

PT 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 PT Bank Muamalat Indonesia’s 62 trillion rupiah, according to their websites.

That’s a fraction of the 868 trillion rupiah of PT Bank Mandiri and 806 trillion rupiah of PT 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 Bhd. 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.