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Risk Rating Comparison Between Islamic Banks in Indonesia and Malaysia

Adelia Nidyanti
By Adelia Nidyanti
1 week ago
Risk Rating Comparison Between Islamic Banks in Indonesia and Malaysia

Amanah, Islam, Islamic banking, Shariah, Credit Risk, Profit Equalization Reserve

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  1. Risk Rating Comparison Between Islamic Banks in Indonesia and Malaysia Adelia Nidyanti1 , Dodik Siswantoro2 {adelia.nidyanti81@ui.ac.id1, dodik.siswantoro@ui.ac.id2} 1,2Faculty of Economic and Business, Universitas Indonesia Abstract. The objective of this study is providing risk rating of Islamic banks in Indonesia and Malaysia. Islamic banks should be comply with regulations because Sharia compliance is the ultimate goal. In practice, Islamic bank customers question whether Islamic banks apply sharia principles well. However, there is no definite modeling to describe the sharia compliance. The research method of this study is descriptive quantitative which used scorecard model to score the Islamic Bank’s compliance. The sample of this study is five Indonesia Islamic Bank and five Malaysia Islamic Bank. The result shows that Islamic Banks in Indonesia have satisfactory compliance rating while Islamic Banks in Malaysia mostly have high compliance rating. The contribution is providing risk rating of the Islamic Bank. The risk rating is useful to inform the customer and bank management about the compliance and risk that Islamic Bank faces. Keywords: Risk rating, compliance, Islamic Banks 1. Introduction Islamic banking has been in existence since the 1970s, and it has shown tremendous growth over the last 30 years (Hamim Ahmad Mokhtar 2008). Head to head competition with conventional banks forces Islamic banks to work harder, be more creative and more innovative to gain market share (Ascarya 2005). Islamic banking and financial system in Malaysia has a remarkable development and improvement. Malaysia began implementing dual economic systems and developed the Islamic financial and banking system since 1983. Malaysia is first country to implement a dual banking system. Malaysia allowed conventional banking institutions to offer Islamic banking services or “Islamic windows” because it is the most effective and efficient mode to increase the number of institutions offering Islamic banking services at lowest cost and in shortest time (Hamim Ahmad Mokhtar 2008). In 1983, the first Islamic bank emerged (Bank Islam Malaysia Berhad), while the second Islamic bank established in 1999 (Bank Muamalat Malaysia Berhad). BMMB was the result of merger between Bank Bumiputra Malaysia Berhad (BBMB) and Bank of Commerce Malaysia Berhad (BOCB). The number of Islamic Bank then continue to grow. In 2006, the number of Islamic Bank in Malaysia increased to 8. While in 2008 it increased into 12 and becoming 16 Islamic bank later in 2018. This amount is greater than Islamic Bank in Indonesia. The Indonesian government also began to introduce a dual banking system in 1990s. The establishment of Islamic banks in Indonesia is late as compared to Malaysia in 1983. Islamic bank in Indonesia established in 1992 and since 1992, it has continued to grow according to economic conditions and various factors that influence its development (Waluyo 2016). The Financial Services Authority (OJK) continues to encourage the development of Islamic banking to grow healthy, sustainable, and contribute positively so that it can support the quality of economic development. One of the efforts made by the OJK was to issue an Islamic ICASI 2019, July 18-19, Banda Aceh, Indonesia Copyright © 2019 EAI DOI 10.4108/eai.18-7-2019.2288647
  2. banking roadmap which began from 2015-2019 . This roadmap contains a strategic plan for the development of Islamic banking in Indonesia in the form of guidance on the direction and initiative to be achieved. With this roadmap, it is expected that the development of Islamic banking industry in Indonesia can be better so that it can support financial inclusion (OJK 2016). Based on data from the OJK, as of December 2018 there were 14 Sharia Commercial Banks in Indonesia. This number increases when compared to 2015 data where there are 12 Sharia Commercial Banks (OJK 2018). This shows the public interest in Islamic banks because Islamic banks use profit and loss sharing systems, namely the distribution of fair profits and losses between the Bank and its customers. The function of Islamic banks is basically as same as conventional banks, namely to collect and channel funds obtained from the public. However, there is one fundamental difference between conventional banks and Islamic banks, namely Islamic banks prohibit usury. Usury is the setting of interest or overestimating the number of loans when returning it. The interest usually based on a certain percentage of the principal loan amount which charged to the borrower. The purpose of prohibiting usury is to avoid wealth in only a few parties, both banks and individuals. In carrying out its operations, the Sharia Bank is based on the Qur'an and Hadith. In addition, there are two Islamic financial institutions, namely the Islamic Financial Services Board (IFSB) and Accounting and Auditing Organization of Islamic Financial Institution (AAOIFI) whose task are preparing accounting, audit, government, and ethical standards in accordance with Islamic law for financial institutions and overseeing the Islamic Bank does not deviate from sharia principles. Islamic banks must comply with these regulations because Sharia compliance is the ultimate goal of the Islamic finance industry. Compliance with AAOIFI and IFSB standards is very important for managing sharia compliance risk, mitigating operational risk, and financial report transparency (Md. Hafij Ullah 2018). In Indonesia, Islamic banks compliance can be seen from the compliance of sharia regulations issued by the Financial Services Authority (OJK). OJK regulate Islamic Banks to implement sharia principles, so that Islamic banks protected from interest practices (identical to usury), gambling (maysir) and uncertainty (gharar) and other practices that are not in line with sharia principles (haram). (Dedhi Ana Mey Saramawati 2014) found that the level of Islamic sharia banking compliance in Indonesia was quite adequate with a percentage exceeding to 50%. However, (Listiana 2015) who examined the analysis of the level of compliance of Islamic banking with disclosure of sharia regulations found that the average level of disclosure of Islamic banks was around 37%. The difference results supports (Md. Hafij Ullah 2018) that the level of sharia compliance of Islamic banks is not the same even though it is in the same regulatory and economic environment. In addition, (Ascarya 2006) states that Islamic banks in one country to another have differences because they have different environment. The factors that influence these differences are the economic system, adopted Mazhab, position of Islamic banks in law; and approach of products development. In practice, Islamic bank customers question whether Islamic banks really apply sharia principles well. They showed their skepticism towards Islamic banks by looking at sharia compliance from Islamic banks (Muhammad Adeel Ashraf 2017) In addition, there is no definite modeling that can describe the sharia compliance of each Sharia Bank. According to (Muhammad Adeel Ashraf 2017), the level of Sharia compliance cannot be qualified as compliant or not but there must be a ranking system that regulates compliance with the law, which is high, satisfying, weak, and non-compliance.Banks with higher ratings will certainly get better ratings so they can improve their marketing. (Md. Hafij Ullah 2018) states that most
  3. (75%) of respondents agree that better Shari'ah compliance will guarantee more financial benefits in Bangladesh. Therefore, this study seeks to show the level of risk faced by Islamic banks. The study used a scorecard-based modeling approach from research conducted by (Muhammad Adeel Ashraf 2017). Ranking consists of 14 Sharia risk factors which are grouped in five main areas, namely regulations, the quality of Sharia Supervisory Board, business structure, product mixed, and the Capital Adequacy Ratio treatment. The scores obtained are then grouped into four levels that reflect the level of Shariah compliance, including non-compliance, weak, satisfactory, and high. The contribution of this paper is to provide risk rating of the Islamic Bank. The risk rating is useful to inform the customer and bank management about the compliance and risk that Islamic Bank faces. We can also compare and learn from the result between Indonesia Islamic Bank and Malaysia Islamic bank about what action should be taken to manage the risk. The sample of this study is five Indonesia Islamic bank (Bank Muamalat Syariah, Bank Syariah Mandiri, Bank Negara Indonesia Syariah, Bank Central Asia Syariah and Bank Rakyat Indonesia Syariah) and five Malaysia Islamic Bank (Bank Islam Malaysia Berhad, Amanah Malaysia Berhad, Bank Muamalat Malaysia Berhad, Maybank Islamic Berhad, and AmBank Islamic Berhad). The reason of sample selection is Indonesia and Malaysia have the same Mazhab and economic system so that the differences between two of them can be minimized. Malaysia also becoming one of world’s leading centers of Islamic banking. 2. Literature Review 2.1 Development of Islamic Banking in Indonesia The establishment of Islamic bank in Indonesia can be grouped into three phases (Mutiara Dwi Sari 2016). The first phase (Phase of Thinking) began in the 1930s. In this phase, Ulama began to think about Islamic banks and put them forward but they were not well received. The establishment of Islamic banking is still at the theoretical framework. The second phase (Preparation and Establishment Phase) began in 1980 when the Indonesian Muslim intellectuals and ulama re-visited the idea of the establishment of Islamic banks in Indonesia but their efforts still failed because of the political situation. In 1990, Indonesian Muslim Council (MUI) held a seminar to discuss the bank interest issues. The result is establish interest-free Islamic banks. The third phase (Maturation of the Concept and Setting Phase) took place from 1990 - 2000. At that time, only one Islamic bank (BMI) was established. The Islamic banking in Indonesia continue to grow slowly. The momentum for Islamic bank to grow greatly is when the government issued Islamic Banking Act No. 21 Year 2008. After that, many conventional banks spin-off their Islamic windows to full-fledged Islamic bank and conversion of rural banks to Islamic rural banks which base their operation within the Islamic tenets. This number continue to increase. In 2010, Indonesia has 10 Shariah Bank and in 2015, there are 12 Sharia Banks. According to Islamic Banking Statistics (2018), in December 2018 there were 14 Sharia Commercial Banks in Indonesia. 2.2 Development of Islamic Banking in Malaysia The development of Islamic Banking in Malaysia is divided into three phase (Ascarya 2006). The first phase began on 7 April 1983 with the issuance of Islamic Banking Act (IBA). In this phase, the first Islamic bank was established (Bank Islam Malaysia Berhad). The second phase began in March 1993 by launching "Banking without Benefit Skim" or Interest
  4. Free Banking Scheme . In this scheme, conventional banks allowed to offer Islamic banking products. As the result, the number of bank offices offering Sharia products is increasing faster and more efficiently. In this phase, the second Islamic bank established was Bank Muamalat Malaysia Berhad. The third phase of development began with the creation of the Financial Sector Master Plan or FSMP in 2000 for the period 2000 - 2010 covering the Islamic finance sector. 2.3 Islamic Banking Risk Unique risks at Islamic banks arise from the specific features Islamic contracts and the legal, governance, and liquidity infrastructure (Hesse 2008). The risk that is faced by Islamic Bank are credit risk, operational risk, liquidity risk, insolvency risk, and inherent risk. Credit risk is an important source of financial instability bank. Therefore, it is concern to measure credit risk in banking systems (Lassoued 2018). Islamic banks which use Profit Loss Sharing (PLS) increases credit risk for Islamic banks. Operational risk is also crucial. Operational risk is losses risk from inadequate or failed internal processes, people and systems or from external events, which includes legal risk and Sharī`ah compliance risk. The operational risk reflects the complexities associated with the administration of PLS modes, including the fact that Islamic banks often have limited legal means to control the agent-entrepreneur (Hesse 2008). Liquidity risk is probability of cash withdrawals because customers' demand exceeds bank's cash supply. Compared to conventional banks, Islamic banks incur more liquidity risk due to religious constraints on accessing interest-based funds from the money market or the central bank's lender (Md Safiullah 2018). Insolvency risk is the risk when Islamic bank runs out of capital and reserves. Inherent risk in Islamic banks happened because of the special nature of investment deposits. The capital value and rate of return are not guaranteed. According to (Lassoued 2018), as Islamic banks grow, risk management becomes more difficult so it is very important to be considered. 3. Research method The method used in this study is descriptive method. The sample in this study is five Indonesia Islamic bank (Bank Muamalat Syariah, Bank Syariah Mandiri, Bank Negara Indonesia Syariah, Bank Central Asia Syariah and Bank Rakyat Indonesia Syariah) and five Malaysia Islamic Bank (Bank Islam Malaysia Berhad, Amanah Malaysia Berhad, Bank Muamalat Malaysia Berhad, Al-Amin Islamic Berhad, and AmBank Islamic Berhad). Researchers used Islamic compliance risk rating which is developed by (Muhammad Adeel Ashraf 2017). Each indicator is assessed from their 2018 annual report according to the score previously set in table 2. A total of 14 indicators used to capture the sharia compliance level of Islamic banks. The indicators are divided into 5 categories: regulator support, quality of sharia supervision, business structure, basic composition of assets and deposits, and structure of deposits. A bank could get a maximum risk-weighted score of 150 and a minimum riskweighted score of -138. The formula to get the percentage of each Islamic bank is
  5. % Shariah compliance = N o 1 N o 2 3 4 5 6 7 8