Indonesian Islamic banking roadmap to boost sector development

Link to Fitch Ratings' Report(s): Indonesian Islamic Banks Dashboard: 2020

Fitch Ratings-Jakarta-09 March 2020: Indonesia's new five-year roadmap for the country's Islamic banking sector should provide some impetus to its development, although most benefits are likely to be realised over the medium term rather than the near term, Fitch Ratings says. The wide-ranging roadmap addresses the need to strengthen regulations and corporate governance, boost penetration of sharia-compliant products, encourage R&D, and improve human resources in the sector. However, progress is likely to take time, limiting the short-term upside. The roadmap aims for 20% market share for the Islamic finance industry - including banking, insurance and capital-market sectors - by end-2024 (2018: 8.6%), but no specific targets for the Islamic banking sector were disclosed.

Two regional development banks - Bank Riau Kepri and Bank Nagari - recently announced they will convert into Islamic banks over the next year. A newly passed regional law in the province of Aceh - a Muslim-majority region that operates under sharia law - requires branches of conventional banks to convert into sharia branches by 2021. These two developments should add around 1 percentage point to Islamic banks' financing market share (2019: 6.3%). In addition, Islamic business units of conventional Indonesian banks are required to be converted into standalone Islamic banks by 2023, which should provide further support to Islamic banks' growth prospects in the medium term.

The performance of Indonesia's banks will be hindered by the outbreak of COVID-19, with the impact likely to be more significant on banks with greater reliance on the tourism sector. Islamic banks are likely to be affected to a similar degree as their conventional peers. However, downward rating pressure on most Fitch-rated banks is unlikely - unless the outbreak worsens significantly - as many of the banks' ratings are based on support from higher-rated parents and their Viability Ratings incorporate generally satisfactory earnings and capital buffers.

Fitch expects the adoption of IFRS 9 to affect Indonesia's Islamic banks more than conventional banks due to their significantly lower reserve cover and weaker - although generally adequate - capitalisation. We also expect the financing growth of Islamic banks to remain in the double digits in 2020, partly due to the transformation of the two regional banks and the branches in Aceh to sharia banks. However, we believe the gap in asset quality and profitability between conventional and Islamic banks will persist despite significant improvement at the Islamic banks in the last few years.

The report "Indonesian Islamic Banks Dashboard: 2020" is available at www.fitchratings.com or by clicking the link in this media release.

Copyright Press Releases 2020