Microfinance Dominates Indonesian Shariah-Compliant Loans: Islamic Finance

Nov 2010
Kuala Lumpur, Malaysia, November, 24 2010 - Islamic loans targeting Indonesian small businesses have grown to dominate Shariah-compliant credit in the world’s most-populous Muslim nation, prompting the country’s biggest banks to expand.

PT Bank Syariah Mandiri is adding branches in Java and Sumatra to offer so-called microfinance loans because more than 90 percent of Indonesia’s 50 million small businessmen have no access to regular bank financing, said Andri Vendredi, the head of the division at the Jakarta-based arm of the nation’s largest lender. PT Bank Muamalat Indonesia increased cooperatives set up to offer such loans by 500 to 2,500 last year. PT Bank Syariah BRI aims to triple its business next year.

Microfinance, typically involving loans of $5,000 or less, is attracting commercial banks because of its wider profit margins and lower defaults, according to the central bank, which estimates the industry accounts for 70 percent of Islamic lending. The loans accommodate the religion’s ban on interest by sharing profits generated from asset purchases, fostering entrepreneurship in an economy that grew 5.8 percent in the third quarter from a year earlier.

“The financial crisis hit us a number of times but the small businesses have proven to be more resilient,” Vendredi said in a Nov. 12 interview from Jakarta. “Commercial banks are tapping the segment because the market is huge, the return is higher and the economy is expanding, offering opportunities for funding the informal sector like food sellers and small traders.”

Triple Loans

Outstanding Shariah-compliant loans to micro, small- and medium-sized businesses may increase to 45.5 trillion rupiah ($5.09 billion) by year-end from 42 trillion rupiah in September, Mulya Siregar, the central bank’s director in charge of Shariah banking, said in an interview yesterday. Banks and financial institutions lent 879.7 billion rupiah to micro, small- and medium-sized businesses in September, of which 22 percent went to the trade industry, while loans to the agricultural sector made up about 2 percent, according to central bank data.

BRI Syariah expects to triple loans to micro, small and medium businesses to 1.5 trillion rupiah by the end of 2011 from about 450 billion rupiah at the end of this year, Ventje Rahardjo, president director at the unit of PT Bank Rakyat Indonesia, the country’s second-largest lender, said in a Nov. 22 interview from Jakarta.

The bank’s Shariah-compliant micro loans typically use the murabahah concept, in which the financing party purchases assets for the client and sells them at a predetermined profit margin, Rahardjo said. Murabahah is the most popular structure and is used in microfinance initiatives across Afghanistan, Bangladesh, Indonesia, Sudan, Syria and Yemen, according to last year’s report by Allen & Overy LLP.

Biggest Market

In India, the world’s biggest market for such credits, a quarter of microfinance institutions may collapse after the local government in southern Andhra Pradesh state introduced new rules in mid-October to cap interest rates companies can charge and ordered them to collect payments monthly, rather than weekly.

Bank Rakyat says it pioneered microfinance in the Asian country when it helped channel subsidized government loans to farmers in Java in the 1970s as part of a national program to boost rice production.

Muamalat, the country’s oldest Islamic lender, helped establish 500 new cooperatives that provide micro financing in 2009, increasing to 2,500 the number of Shariah-compliant cooperatives it has been involved in setting up since 1996, said Andi Buchari, the bank’s director of compliance and corporate planning, in an interview from Jakarta on Nov. 22. Muamalat was able to register annual growth of 20 percent to 30 percent for the business in the past five years, he said.

Grameen Bank

Microfinance, typically aimed at households earning less than $2 a day, was brought to prominence by Grameen Bank in Bangladesh, whose founder Muhammad Yunus won a Nobel Prize in 2006 for pioneering the service in 1976. An Islamic version of the model was developed in Egypt in 1963 by economist Ahmad Elnaggar, Allen & Overy said in the report in February 2009.

Islamic microfinance accounts for about 0.5 percent of global microfinance, the London-based law firm said in the report. The top three countries offering Shariah-compliant microfinance are Indonesia, Bangladesh and Afghanistan, it said. About 54,000 Indonesian microfinance units serve about 45 million depositors and 32 million borrowers, according to Allen & Overy.

About 86 percent of Indonesia’s 243 million people are Muslims, according to the Central Intelligence Agency’s World Factbook. The World Bank said about 2.7 billion people worldwide have no access to formal financial services. About 60 percent of Indonesians survive on less than $2 a day, according to the bank’s estimate.

Global Sukuk Sales

Global sales of Islamic bonds, which are backed by assets or cash flows to comply with Shariah principles, fell 29 percent to $13.7 billion this year from the same period in 2009, according to data compiled by Bloomberg.

Malaysia’s 3.928 percent Islamic note due in June 2015 fell today, pushing the yield up nine basis points to 2.78 percent, according to prices provided by Royal Bank of Scotland Group Plc. The extra yield investors demand to hold Dubai’s government sukuk rather than Malaysia’s widened 11 basis points to 395 yesterday, according to data compiled by Bloomberg.

Global Shariah-compliant bonds returned 11.7 percent this year, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index, compared with a 14.3 percent gain for bonds in developing markets, JPMorgan Chase & Co.’s EMBI Global Diversified Index shows.

The difference between the average yield for sukuk and the London interbank offered rate narrowed one basis point to 340 yesterday.

Non-Performing Loans

The non-performing loan ratio for micro loans is generally smaller than 2 percent compared with about 3.7 percent for Islamic banks, Buchari at Muamalat said. Loans are usually paid daily or weekly and are often given without collateral, allowing a return of as much as 30 percent a year, said Buchari. That compares with 13 percent to 14 percent for regular bank loans, he said.

“The bank focuses on small businesses that may not be bankable, but are feasible,” said Buchari. “A higher rate is necessary to make up for the higher risks but they are still lower than the interest charged by the moneylenders.”

Source : Bloomberg

Research Analysis Tools

The fund indexes, institution benchmarks and other market information displayed here are all Symbiotics designed analysis tools, created in-house by our analysts and experts. Symbiotics has one of the oldest track records in microfinance investment analysis dating back to the late 1990s; its indexes and benchmarks have been regularly used as markers by investors, asset managers, financial institutions and practitioners. These, as well as several other research products, are available through the Research Account. Click on the link below to find out more.

Learn More