Abstract
It has been almost three decades since the first Islamic bank was established in Indonesia, the most populous Muslim country in the World. In their book Growth of Islamic Banking in Indonesia, Sigit Pramono and Yasushi Suzuki examine two puzzles that mark the Indonesian experience. The 1st is the low level of Islamic financial deepening in the country. Despite the supportive regulations and fatwas (opinions from Ulama, i.e., religious scholars), Islamic banks have not grown as much as policymakers and Islamic finance proponents desired. The second puzzle stems from Malaysia’s success, where the financial architecture has been gradually Islamized in the last couple of decades. So how can we explain the Indonesian failure in comparison to Malaysian success?
Pramono and Suzuki provide a compelling account of the limited growth of Islamic banking in Indonesia in 11 chapters. This short and concise book will be of great interest to the Islamic finance practitioners and scholars of Islamic banking since the authors illuminate the dissonance between the theory and practice and stress the importance of support and incentive mechanisms protecting the new-born financial institutions before they become part of a full-fledged competition with the conventional banks.
The argument is supported with detailed tables explaining the financial performance indicators, milestones of regulations and revenues from different contracts. The book also derives strength from a comprehensive comparison with Islamic banks and Islamic bank windows in Malaysia (and to some extent, Bangladesh). This comparison indicates that while the Islamic banks in neighbouring Malaysia had higher efficiency in their ribâ-free (ribâ means increase, interest or usury depending on the context) operations, in Indonesia, persistent lower efficiency and lower profitability inflicted a trap upon further growth of Islamic banks.
As the authors suggest, Islamic banks need to make an extra profit from their operations to pay for the additional costs of maintaining their Shari’ah (Islamic law based on the Koran) compliant status. Well-established banks with larger deposit bases accumulated expertise in management and credit allocation, therefore, they can compete with conventional banks. Until the new Islamic banks acquire a strong profit base, governments should intervene to stimulate Islamic finance. The authors use new institutionalist economics and bank rent theory to explain the need for a suitable regulatory framework for incubating Islamic financial institutions. This institutionalist emphasis helps portray Indonesian problems as a transition failure. According to the authors, the lack of rent to be captured by emergent Islamic institutions has generated slower Islamic financial deepening. Islamic banks in Indonesia, when compared to Malaysia, suffer from lower efficiency, lower returns on their assets and higher costs of funding. This reflects the malaise and structural problems undermining their competitiveness.
The book takes an exciting turn in Chapter 10, discussing the fundamental principles of Islamic finance. The authors briefly explain the grey zones in Islamic financial contracts and stress that Islamic finance depends on the constant search to contribute to society’s wellbeing. Islamic banks should not only be Shari’ah compliant but also remove hardship for their customers (in Arabic: raf ’ al-haraj). Accordingly, the fatwa authorities and the regulatory bodies should consider these benchmarks to promote Islamic financial deepening.
The brief discussion in Chapter 10 is striking, as it reflects the tension embedded in the profit–loss sharing mentality: The acceptance of practices controversial according to Shari’ah by Islamic finance supervisory bodies makes it easier for Islamic banks to penetrate areas dominated by conventional banks. Still, this may erode the Shari’ah compliance necessary to maintain the franchise value and demarcate Islamic finance as a purified field. This tension cannot be resolved by a specific regulatory authority in a short time and is a matter of constant struggle among different Islamic interpretations. In short, the social embeddedness of religious authorities prevents the emergence of a single understanding, universally held in high esteem and accepted across different geographies. While the institutionalist framework employed in the study implies the possibility of optimal equilibrium to be derived out of the grey zones, the tensions remain and will persist given the nature of Islamic finance.
The book could have benefitted more from a political economy discussion that explains the institutional frameworks in Indonesia and Malaysia through an analysis of various social groups and their positioning in the ruling blocs. Indeed, Chapter 2 makes a good introduction explaining the genesis of Islamic banks in Indonesia and presenting the political developments and policy turn in the late Suharto regime. However, the need to protect Islamic banks in Indonesia after almost three decades since inception is only explained using a regulatory framework. According to the book, the decentralized political structure did not help lower transaction costs, leading to a loss of motivation by Islamic bank managers. The deposits of the richest 0.1% in Indonesia compose more than 46% of the total deposits in the banking sector. An analysis of this group’s approach and an examination of the political power struggles in the 2010s would have enriched the study. However, such preference would have required going beyond new institutionalist economics and discussing the functions assumed by Islamic banks for particular groups over time.
Ultimately, the book provides an empirically rich account of the evolution of Islamic banks in Indonesia and directs attention to the fundamental problems of Islamic finance. Since Islamic banks require specific tax incentives and constant support to flourish, there emerges a trade-off between the protection of infant Islamic institutions and the future gains expected from the participation of pious investors in the capital markets. Should the countries with predominantly Muslim populations protect their Islamic banks for decades to prepare them for competition in the national and international arena? If so, then who will pay for the incentives contrived to protect these infant institutions? After all, lower taxes, fiscal incentives and privileges will burden state budgets for relatively long periods. In this regard, the puzzles solved by Pramono and Suzuki bring forth new issues that are indeed integral to the Islamic finance practice and scholarship.