24 February 2015
An Islamic Megabank for Indonesia?
Practice Group(s):
By Jessica Gaddes and Jonathan Lawrence
Islamic Finance
With the world's largest Muslim population, one might question why Indonesia’s Islamic
finance market lags behind that of neighbouring Malaysia. In 2013 only 4.9% of total
banking assets were held by Indonesian Islamic banks, compared to more than 20% for
the same period in Malaysia. A number of suggestions have been put forward for the
historical apathy to Islamic finance in Indonesia; we discussed some of these in our
recent insight “Islamic finance in Indonesia: Past, Present and Future”. In this follow-up
insight, however, we look towards factors that might be key to developing the industry
and, in particular, whether the rumoured proposal of the Indonesian financial services
authority (Otoritas Jasa Keuangan (OJK)) to create the county’s first “megabank” is really
the answer.
Indonesia
Banking & Asset
Finance
The international Islamic finance industry has grown rapidly over the past 20 years;
worldwide Islamic finance assets totalled just US$137 billion in 1996, compared to with
the consensus that such assets surpassed the US$2 trillion mark toward the end of 2014.
As we enter 2015, questions naturally arise as to whether such growth is sustainable
and, if so, what further developments can be made.
Advancements in the industry have, to date, predominantly focused on the Malaysian
and Gulf markets due to strong government and investor led initiatives driving the desire
for, and development of, shariah-compliant products. As these markets reach maturity,
attention has moved to other jurisdictions with substantial Muslim populations.
Indonesian Islamic Megabank?
According to recent reports, the OJK first considered the merger of shariah-compliant
banking units in May 2013 as part of its five-year plan to develop Islamic finance in the
country, the overall aim being to create a large, standalone Islamic bank that could spur
consolidation in the industry. There appeared to be three options available to create such
an entity: (i) merging of existing Islamic entities; (ii) conversion of a conventional bank
into an Islamic one; and (iii) creating a new Islamic bank. It seems the OJK may have
looked to neighbouring Malaysia for inspiration: Malaysian consolidation in the late 1990s
(creating, amongst others, CIMB, Maybank and the Public Bank Bhd) put the country in
good stead to form the shariah-compliant hub that now exists. Also, the recent proposal
to create an Islamic “megabank” amongst three Malaysian Islamic entities, while it did not
come to fruition, highlighted the potential advantages of consolidation.
Advantages of a bigger institution are likely to include:
1. having the scale to reduce operating costs and provide services at more competitive
rates;
2. helping improve public awareness of shariah-compliant finance;
3. having access to and ability to raise further funding for large projects by issuing a
series of sukuk (Islamic bonds) with a variety of maturities in diversified sectors and
regions.
The expectation is that an Indonesian merger would consist of consolidating the shariahcompliant units of three state-controlled banks: PT Bank Mandiri Tbk; PT Bank Rakyat
An Islamic Megabank for Indonesia?
Indonesia Tbk; and PT Bank Negara Indonesia Tbk. Together, these banks reportedly
account for up to 40% of the Indonesian Islamic banking industry, and would create an
entity with assets of US$8 billion.
The mooted merger would not create the OJK’s ideal-sized bank of around 200 trillion
rupiah (US$16.5 billion). However, it would create an entity twice the size of the current
largest Islamic bank in Indonesia, PT Bank Syariah Mandir. Furthermore, it is
questionable whether the resulting entity can really be classified as a “megabank” when
you compare the asset size of the resulting entity to the recently proposed, although now
collapsed, Malaysian megabank merger of CIMB Group Holdings, RHB Capital and
Malaysia Building Society, which would have created an entity with assets in the region
of $US180–190 billion.
What is a “megabank”? In the everyday context, it would suggest a major bank with
substantial assets and coverage; however, in a business and legal context, there is no
specific definition of a megabank. In the world of corporates, “mega” suggests strong
brand recognition and global operations. Amongst finance practitioners, it is generally
accepted that any entity with assets in excess of US$100 billion is reaching “mega”
status; however, it is really a matter of context.
With an aggregate of just US$21.4 billion (244 trillion rupiah), or 4.8%, of Indonesia’s
total banking assets in 2013 funded through Islamic finance and an overall finance
industry that makes up a mere 51% of 2013 GDP in Indonesia (compared to 350% in
China and 150% in Malaysia), the Indonesian Islamic finance market as a whole is
smaller than any of the largest banks in Malaysia. In a wider Asian context, the proposed
Indonesian consolidation is, therefore, unlikely to affect the long-awaited call for an
Islamic “megabank”. In the Indonesian market, the bank resulting from such merger
could be classified as a megabank. Whilst the label given to the resulting entity does not
lessen the argument for the OJK‘s proposed consolidation, one should not overestimate
the immediate impact and opportunities such a proposition would bring to the wider
Islamic finance industry.
Consolidation—will it work for Indonesia?
Although we have questioned labelling the Indonesian merger as a “megabank”, it is only
natural to draw comparisons to the Malaysian merger. It has been reported that the
Malaysian megabank proposal did not proceed as it failed to find enough cost savings
amid a deteriorating economy, falling oil prices and decreases in share value. In drawing
comparisons, it should be noted that the Malaysian merger came from a backdrop of an
already developed Islamic finance industry and amongst banks that have already been
through at least one prior consolidation and cost-saving exercise (notably CIMB, the
second largest Malaysian financial entity).
By contrast, Indonesia’s Islamic banking industry is highly fragmented, with 12 shariahcompliant commercial banks, 163 Islamic rural banks and 22 Islamic windows, and so,
consolidation would likely bring significant economies of scale, therefore making the
industry more competitive. All the usual arguments for bigger business and economies of
scale appear on the surface to be relevant here, without the failings that might otherwise
be relevant if we were truly looking at the creation of a megabank.
Regulatory change
In addition to the OJK’s calls for consolidation, local commentators have highlighted a
lack of experience in the industry and Indonesian perceptions over the most acceptable
Islamic finance model as being significant blocks to development. Given the split in
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An Islamic Megabank for Indonesia?
opinion on whether Malaysia’s model of Islamic finance is too advanced and not
conservative enough, and those who feel that Saudi Arabia’s version is too conservative,
Indonesian authorities will likely have a significant role in convincing the population that
the route they eventually choose to adopt is the most appropriate for the country’s
Muslim population. Increased size and opportunities will arguably create a greater pull to
external and internal investors who wish to develop the market.
Conclusion
We do not anticipate that consolidation alone will secure the future growth of the
Indonesian Islamic finance industry. Sustained regulatory support and marketing of
shariah-compliant financing, together with increased training and development of experts
in the field will also be necessary for Islamic banks to achieve the OJK’s desired aim of
Islamic finance holding at least 15% of the Indonesian finance market by 2023. The
Indonesian authorities have made a promising start and shown a clear intention over the
past 12 months to assist in shaping the way forward for the country’s Islamic finance
industry and in encouraging consolidation and proposals for building a new regulatory
system. Foreign investors are watching these developments carefully and will likely
continue to do so.
Authors:
Jessica Gaddes
Jessica.Gaddes@klgates.com
+44.(0).20.7360.8181
Jonathan Lawrence
Jonathan.Lawrence@klgates.com
+44.(0).20.7360.8242
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