2008 Oxford Business &Economics Conference Program
ISBN : 978-0-9742114-7-3
THE RESPONSIBILITY AND INDEPENDENCE OF SHARIAH SUPERVISORY
BOARD OF INDONESIAN AND PAKISTANI ISLAMIC BANK: A COMPARISON
Outline
Background
Literature Review
Research Objectives and Methodology
1. BACKGROUND
Islamic Banking attract attention from the UK University started in Loghborough University
because of its
Fadi Kawar from Jordania who presented paper in The Arab Society of Certified Accountants
stated in his speech at International Organization of Securities Commission Annual Conference on
May 2004;”
 There are approximately 1.5 billion Muslims worldwide.
 A survey by HSBC shows that approximately 65% of Muslims in the United States
stated
 that religious prohibitions would play a role in their financial decisions. Meaning
that there is an increased need for banking
 There are more than 200 Islamic financial institutions operating in 48 countries.
Islamic financial institutions are those institutions dealing partially or completely in
Shariah complaint products.
 Islamic financial institutions combined assets exceed US$ 200 billion with an
annual growth rate of 12% and 15%
 It is expected that Islamic banks will be able to attract 40% to 50% of the total
savings of the Muslim population worldwide within the next few years.
 A number of global financial institutions including but not limited to, Citibank,
Goldman Sachs, BNP-Paris-Bas and USB have established Islamic banking Shariah
compliant services in many countries.”
Indonesia is the largest archipelagic nation in the world. Positioning in the middle of
Pacific Ocean and Indian Ocean. It has 33 Provinces. In order to provide Financial
Intermediaries for the Provincial Government needs in Development and also as a channel
of development budget, Former President Soeharto established a BPD or Development
Bank of Region (in Bahasa Indonesia, Bank Pembangunan Daerah). Each province has one.
Long before Indonesia developed Islamic Banking Systems, Malaysia and Pakistan had
built it in 198s, Malaysia established Bank Islam Malaysia Berhad in 1983 according
Islamic Banking Act (1983) and Pakistan had developed Islamic Banking in Zia ul Haque
era.
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If We compare to Malaysian Experience, according to Mirakhor (1997)
“It is not an accident that, at present, Islamic banking is making its most promising progress in
Malaysia. This country has one of the least repressive financial systems, no fiscal deficits, low
inflation, low interest rates, and a dynamic and vibrant equity market as well as a strong private
sector. ’’
What Malaysian has experienced in fostering Islamic Banking might be insightful for
Indonesian and Pakistani Islamic Banking Industry. It might be need to study deeper. Bank
Negara Malaysia stated that (we have to find Bank Negara Malaysia Monthly Bulletin)
Indonesia has had Islamic Bank since the year of 1992, Bank Muamalat Indonesia had
Principle Accord Number 1223/MK.013/1991 signed By Minister of Finance Republic of
Indonesia at November 5th 1991 and then Business License Number 430/KMK:013/1992
signed also by Minister of Finance at April 24th 1992. The launching was of BMI on May
1st 1992, Bank Muamalat Indonesia started to operate to provide Islamic Banking products
to Ummah. At the period of 1992 to 1999, Indonesia had only one Islam Bank.
It is understandable that Indonesia had a tremendous economic growth starting from the
year of 1967 with foreign direct investment, loan and technical assistance from
conventional banking or financial institution either at national or international
level.(Kompas, 1981) . The World Bank report on the East-Asian miracle points out that
“the macroeconomic management was unusually good, providing the stable environment
essential for private investment” (page 5 of the World Bank, 1993).
Speculative investment are usually taking event on Currency Trading and Derivatives. East
Asian Currency including Indonesian Rupiahs was among the one that suffered a lot.
Indonesiat was ther worst victim among Korea, Thailand, Malaysia and Philipine at that
time. Free Floating Exchange Rate was declared by the Authority of Indonesia in August
14th 1987. Stiglitz (2003) said that countries such as Indonesia will feel its effects for
years.
According to Simorangkir (2004) depreciated Rupiah value leading to financial distress in
banking customers. Quoted to Simorangkir empirical paper, signaled by 16 Bank closed by
the Authority in the year 1997, Indonesian Banking Customers panicked and lead to Bank
Runs or Bank Panics signaled by 16 Bank closed by the Authority in the year 1997. This
event caused by assimetric information between Banker and Depositors. More Indonesian
banks were closed in 1999 (Simorangkir, 2004).
Non Performing Loan in
Non Performing Financing
Table 1. Fund Disbursements 2002-2006
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Indicators
Fund
Disbursements
a. Financing
Rupiah
Dollar
b. Special
mention
c. Substandard
d. Doubtful
e. Lost
Non
Performing
Financial
Non
Performing
Financing
Ratio
ISBN : 978-0-9742114-7-3
Fund Disbursements of Islamic Banking in Indonesia
December
December
December
December
2002
2003
2004
2005
4,027
7,800
14,793
20,222
December
2006
25,927
3,277
3,277
3,277
5,530
5,530
5,530
11,324
11,324
11,324
15,232
15,232
15,232
20,445
20,445
20,445
119
252
405
776
776
51
30
53
58
16
56
122
66
81
201
73
155
201
73
155
135
130
269
429
429
4,12
2,34
2,37
2,82
2,82
Non-Performing Loan Ration according to Bank Indonesia, is Credits that are sub-standard,
doubtful and loss divide by Total Credits. Islamic Banking recognised Loan as Financing, it
is not only the form but also the substance. We look to Indonesian Banking Statistics, June
2007 Earning Assets of Islamic Banks was explored on table below:
Table 1. Earning Assets of Islamic Banking in Indonesia 2002-2006
Indicators
Financing
f. Current
g. Special
mention
h. Substandard
i. Doubtful
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Earning Assets of Islamic Banking in Indonesia
December
December
December
December
2002
2003
2004
2005
3,277
5,530
11,324
15,232
December
2006
20,445
3,022
5,149
10,650
14,027
18,583
119
252
405
776
776
51
30
58
16
122
66
201
73
201
73
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2008 Oxford Business &Economics Conference Program
j. Lost
Non
Performing
Financial
Non
Performing
Financing
Ratio
ISBN : 978-0-9742114-7-3
53
56
81
155
155
135
130
269
429
429
4,12
2,34
2,37
2,82
2,82
(In Billion Rupiahs)
The trend of Non Performing Financing Ratio is steadily stable. In the year of 2002, the
ratio is 4,12 decreased to 2,34. Special mention Financing is (We have to get some detail
information about what is the meaning of Special mention financing).
According to a Report from Ministry of Cooperatives and Small Medium Enterprises
(2003) Indonesia’s economy is dominated by Agricultural Sector, Trade and Home
Industry. On these sectors which is contributing 30.4 % to GDP on the 2003, they were still
at low productivity. Also from the report, Economic Activities are still located and
dominated by Java, Bali, and Sumatera Island, and more specifally the Capital City of
Indonesia, Jakarta.
Sharî’ah Banking as usual
2. LITERATURE REVIEW
The world has seen numoreus scandals including; Enron, Arthur Andersen, WorldCom, etc.
It triggered responds from many stakeholders; US. Government without
The word riba literally means ‘increase’ or excess in used in this sense in the Quranic
verses: ‘And thou (Muhammad) seest the earth barren, but when we send down water
thereon, it doth thrill and swell (rabat) and put forth every lively kind of (growth)’ from
Al-Qur’an 2:283.
Islamic Banking and finance are governed by statutes derived from Al-Qur’an, known
collectively as Shariah Law. Islamic banks and finance companies rely on Shariah
Advisors, who review financial products and investment targets, ruling on whether they are
in compliance with Shariah Law.
Islamic financial products now include commodity futures contract, leasing finance and
commercial loans. Here are some of the basic concepts:
Halal (legal). Transactions that are permissible under Islamic Law.
Haram (illegal). Transactions that are not permissible under Islamic Law.
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2008 Oxford Business &Economics Conference Program
ISBN : 978-0-9742114-7-3
Gharar (deception). An exchange in which there is an element of deception, by one or both
parties, either through ignorance of the goods, the price or faulty description of the goods.
Such trades are illegal under Islamic Law.
Ijarah (leasing). A contract under which a bank purchase and leases out equipment to clie
Her Ladyship Justice Rohana Yusof, a High Court Judicial Commissioner from
Malaysia quoted from her paper presented in 3 rd Islamic Financial Services Board (
IFSB) Summit, in sharing the Malaysian experience, explained that the legal framework in
Malaysia is unique in the sense that while the Shari’ah has long been recognized as the law
of the land, the administration of law is based on the English common law system inherited
from the British colonial. As a result, Shari’ah principles have been consistently
assimilated into the judicial process, whereby certainty and predictability of law are
cemented through binding legal precedents. In addition, the establishment of a National
Shari’ah Advisory Council under the Central Bank Act allows the Council to have specific
statutory mandate in facilitating the development of Islamic finance through a centralized
fatwa (legal edicts)-making process.
Quoted from Banking and Islamic Law, authored by Dr. M. Muslehuddin, 1988:
Mudaraba, according to jurist, is a contract whereby one gives his property to another to
carry on business therewith and the profit to shared between them according to the
specified terms such as ½ of the profit or ½ and so on. Here we have to point out that
MUDARABA is generally considered a contract of parnership whereby both of the
partners share profit and loss equitably, but it is not so. The entire loss is always attributed
to and deductible from the capital, MUDARIB or agent has nothing to lose except his
labour and therefore, Hanafi Jurist do not count in as a real partnership
Rules which govern Mudaraba are:
1) That the Mudarib is in the position of a trustee when he takes possession of the
property (i.e capital), and before he actually starts his work. This implies that the
propery is held in trust for the owner and the Mudarib must take care of it and be
prepared to return it if demanded by the owner but he (Mudarib) will not be
responsible if such property is lost.
2) That Mudarib assumes the position of an agent when he starts work. He represents
his principal within the authority given to him, The principal is, therefore,
responsible for such contracts of the agent as fall within this authority. The agent
shall not be obliged to perform anything beyond this authority.
3) That is there is a profit the agent shall have a definite share in it as a partner.
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ISBN : 978-0-9742114-7-3
4) That if Mudaraba becomes void, the Mudarib or agent shall e considered an
employee in that the whole profit or loss (as the case may be) shall fall to the share
of the principal and the aget shall be entitled to remuneration according to the
nature of work.
5) That the Mudarib shall be considered to have acted wrongfully if he violated the
terms of the contract and in such case he will be liable for his wrongful act.
6) That in case the whole of profit is stipulated to be share of Mudarib, the transaction
will be that of a loan or qard and the Mudarib shall be entitled to profit and liable to
loss, The Mudarib having used the loan for business shall have to repay it.
7) That if it is stipulated that the whole profit will fall to the share of the principal, this
will be considered a contract whereby the Mudarib is authorized to purchase certain
goods without any remuneration for his services. Whatever is purchased shall be for
the principal who shall bear all the expenses incurred in such transactions.
Dr. Mislehuddin also stated the terms of valid contract of Mudaraba are:
1) That the capital should consist of cash such as minted gold and silver and not
commodities (because their prices fluctuate which may lead to disputes between the
parties). There is a conflict of opinion about their acceptance as capital.
2) That the capital should be known at the time of the contract so that no disputes arise
between the parties
3) That the capital should be determined and in possession of the principal so that he
may be able to give it direct the Mudarib.
4) That the capital should be made over to the Mudarib so that he may handle it alone:
and if it is stipulated that the principal will participate in the work with tha agent,
the contract will be void.
5) That the share of Mudarib, in the profit, should be determinate and expressed in
such terms as ½ of the profit or ⅓ and so on. The contract will be void if the share is
expressed in such terms as £20 out of the profit because thera is risk in in (may be
the profit does not amount to this sum).
6) That it should be made a condition that the Mudarib shall receive his share out of
the profit and not out of the capital.
3. RESEARCH OBJECTIVES AND METHODOLOGY
The present research is an exploratory study that involves the administration of a
questionnaire survey to examine manager’s perceptions of the responsibility and
independence of Sharî´ah Supervisors (SSs) of Islamic Bank (IBs) in Indonesia. The reason
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2008 Oxford Business &Economics Conference Program
ISBN : 978-0-9742114-7-3
for having the Islamic Bank (IB) managers’ perceptions is because of the managers are the
parties who are involved in the day-to-day operations of IBs, thus it will be very relevant to
seek their perceptions as the credibility of SSs may depend, among others, on the
perceptions and confidence of the Bank Managers (Abdul Rahman et al.2004).
Based on the perceptions of IB Managers in Indonesia, the first research objective is aimed
at determining the responsibilities of SSs of IBs in Indonesia and the parties to who the SSs
need to be responsible. Hence, there are three research questions which emerge from this
particular objective. These are (I) what are the responsibilities of SSs?; and (2) to whom
should the SSs be legally responsible?; and (3) to whom should the SSs be
religiously/socially responsible?
Furthermore, the current study is also aimed at dermining the factors which enable SSs of
IBs in Indonesia to maintain and to improve their indepence. Therefore, two research
questions are raised from this particular objectives. These are (1) what are the factors which
maintain and improve the independence of SSs?; and (2) who should appoint SSs in order
to maintain their independence?
In this present study, the researcher focuses on the managers who work only at IBs (Islamic
Commercial Banks/ICBs/BUS) and Conventional Banks that offer an Islamic Banking
scheme (CBsI/UUS). Since the head offices of IBs are located in Jakarta, it is assumed that
the perceptions of th IB managers who work in the head offices represent the perceptions of
IBs’ managers in Indonesia.
The respondents are defined as those who work IBs and hold at least a diploma degree with
a minimum one year of working experience in the Islamic Banking Industry. Therefore, by
imposing certain requirements in selecting the respondents, the study is able to obtain valid
respondents who are aware with the existence of SSB of IBs in Indonesia.
The selection of bank managers is carried out at random whereby 20 and 10 IB Managers
were selected for each of the ICB and CBI repectively. Thus, it is expected that 40 ICB
managers and 60 CBI become the respondents of this present study.
In order to support the analysis of the response of IB managers, the researcher conducts an
interview with the Ss of IBs in Indonesia. There are twenty five Sas for two ICBs and six
CbsI who are considered as the respondents in this current study. However, of the 25 SSs
are members of SSB in more than one IB. Thus, in the end the real number of SSs of IBs
included in this current study is reduced to 21.
The researcher analysed the demographics of the respondents by using descriptive
statistics and measures of central tendency. Then, the responses were tabulated using
frequencies and central tendency.
According to Bank Indonesia (2006), there are three ICBs and 19 Islamic Banking Unit in
Indonesia. Those three Islamic Commercial Banking are (1) Bank Muamalat Indonesia
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ISBN : 978-0-9742114-7-3
(BMI), (2) Bank Syaria Mandiri (BSM), and (3) Bank Syariah Mega Indonesia (BSMI). In
addition that the CBI in Indonesia consist of 19 Islamic Banking Unit (1) Bank IFI, (2)
Bank Negara Indonesia, (3) Bank Jabar (4) Bank Rakyat Indonesia (5) Bank Danamon (6)
Bank Bukopin (7) Bank Internasional Indonesia, (8) HSBC, Ltd, (9) Bank DKI (10) BPD
Riau (11) BPD Kalsel (12) PT. Bank Niaga (13) PT. Bank Sumut (14) BPD Aceh (15)
Bank Permata (16) Bank Tabungan Negara (17) BPD NTB (18) BPD Kalbar (19) BPD
Sumsel.
4. Research Finding and Analysis
Out of 100 questionnaires distributed, 67 were returned. This has resulted in an overall
response rate of 67 percent. Although, most of the questionnaires returned were completed,
there were two incomplete questionnaires. However, the incomplete questionnaire are still
considered usable since the uncompleted questions did not affect the overall analysis. Table
4.1 provides a summary of the overall response rate for each of ICB and CBI.
Table 4.1. Overall Response Rate
No
RESPONDENTS
1.
Bank Muamalat
Indonesia (BMI)
Bank Syariah Mandiri
(BSM)
Islamic Banking UnitBank Negara Indonesia
(BNI)
Islamic Banking UnitBank Rakyat Indonesia
(BRI)
Islamic Banking UnitBank Bukopin
Islamic Banking UnitBank IFI
Islamic Banking UnitBank International
Indonesia
Islamic Banking UnitBank Danamon
TOTAL
2.
3.
4.
5.
6.
7.
8.
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TOTAL
TOTAL
DISTRIBUTED RECEIVED
No
%
No
%
8
TOTAL
USED
No
%
2008 Oxford Business &Economics Conference Program
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In addition, the researcher could only manage to interview six of Shariah Supervisors. This
is because the difficulty to arrange the time for interviews with most of the SSs since they
had many and various activities. However, since there was one interview which could not
be heard clearly, the researcher decided not touse it in this study. Thus, in the end, there are
only five SSs who participate in this study.
The respondents’ age, occupation, educational background and working experience are
provided in the Table 4.2 and 4.3 below:
Table 4.2 Respondents’ Age and Occupation
Age Group
20 - 29
30 - 39
40 - 49
50 – 59
TOTAL
Occupation
Director/Deputy Director
Head of Division/Unit
Bank Manager
Bank Officer
Others
Not Available
TOTAL
Table 4.3 Respondents’ Working Experience
All
N
Mean
Working Experience
Current Position
Working Experience in Islamic Banking
Total Working Experience in Banking
Table 4.2 shows that ......% of the total overall respondents are between 30 and 39 years old
while .... are within a range of 40 - 49 years old. Furthermore, table 4.2 also provides
information on the respondents’ occupation. It shows that ...... % of the overall respondents
act as bank officers while the other ......% act as head of division/unit/ and directors/deputy
directors. Although, there are a few of the overall respondents (....%) whose occupation
named as others and some of the overall respondents are assumed to be closely involved
with the operation of the Ibs. Table 4.3 provides the information of the respondents’
working experience. It shows that the overall respondents have worked in the banking
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2008 Oxford Business &Economics Conference Program
ISBN : 978-0-9742114-7-3
industry on average for around 10.89 years whereas the average working experiences of
overall respondents in the Islamic Banking industry is about .......years
Since the current study is intended to obtain the respondents perceptions, the analysis of the
respondents’ educational background and specialisation is quite important. Table 4.4 shows
that 61.2 percent of the overall respondents hold a bachelor’s degree whereas the other
...percent hold a master’s degree. Unfortunately, there are only.....percent of the overall
respondents with a bachelor’s degree specialized in Islamic Studies and .... percent of the
overall respondents have a master’s degree with specialization in Islamic economic and
finance
Table 4.4 Respondents’ Educational Background and Specialization
N
All
%
EDUCATIONAL BACKGROUND
Diploma
Bachelor Degree
Master Degree
Not Available
TOTAL
SPECIALIZATION
BACHELOR DEGREE
Accounting
Islamic Studies
Marketing
Economics
Finance
Law
Others (Agribusiness, Engineering, Fishery)
MASTER DEGREE
Marketing
Finance
Business Administration
Islamic Economic and Finance
Others (e.g. Industrial Engineering)
TOTAL
Considering the analysis on the respondents’ age, occupation, working experience,
educational background and specialisation, it is concluded that the respondents are
considered suitable to give their views on the responsibility and independence of SSs and
the Shariah review process of IB in Indonesia.
The view of the respondents on the responsibility of SSs can be analysed from their
responses as follow.
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Statement
1
2
3
To monitor and confirm that all the Islamic
banks’ and Islamic Banking scheme’s
banks’activities and transactions are in
To Monitor and confirm that all the Islamic
Banks’ and Islamic banking scheme’s bank
products are compatible with Islamic Shariah
To monitor and confims that the Islamic banks’
and Islamic Banking scheme’s banks’
transactions are in conformity with Islamic
Shariah Principles on the basis of sample
4
5
6
7
5. Conclusions
6. Reference
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