Indonesia banks should focus on Islamic lending

JAKARTA (Reuters) - Indonesia's state banks should be discouraged from making conventional loans and focus instead on Islamic financing to spur the development of the domestic sharia finance sector, a sharia banking expert said on Wednesday.

Indonesia, the world's most populous Muslim nation, has been slow in developing its Islamic finance sector, lagging behind neighboring Malaysia and Singapore.

Parliament passed a law last year removing double taxation for Islamic banks, a key issue which had hampered the growth of sharia banks in the country.

The law, which comes into effect in April, is expected to give a boost to the sector but more drastic steps are necessary to speed up the sector's development, Achmad Riawan Amin, chairman of an association of Indonesia's sharia banks (Asbisindo), told the Reuters Islamic Banking and Finance Summit.

"Under (this) proposed scheme, there would be no new financing except for Islamic-compliant financing. This would eventually cause conventional lending to disappear," said Amin, former president director of the country's first Islamic lender, privately-owned PT Bank Muamalat.

Amin said he had submitted the proposal to the central bank, Bank Indonesia, and was waiting for a response.

However, any move to force banks to switch from conventional lending to Islamic financing could face strong resistance from the government, which is trying to encourage loan growth to the business and retail sector, as well as from the banks themselves.

The four main state-controlled lenders -- Bank Mandiri (BMRI.JK), Bank Rakyat Indonesia (BBRI.JK), Bank Negara Indonesia (BBNI.JK), and Bank Tabungan Negara (BBTN.JK) -- control about a third of total domestic banking assets of $270 billion.

All four of the banks have either full-fledged sharia units or sharia banking windows, or specialist units, but these are relatively tiny.

Indonesia's sharia banking assets have grown at around 40 percent annually, twice the pace of their conventional peers, in recent years but the sector remains insignificant at just 2.5 percent of total domestic banking assets -- well below the government's target of at least 5 percent.

Amin said the authorities could easily beat the 5 percent target if state banks only extended Islamic-compliant financing.

He played down concerns that such a move would raise borrowing costs in the domestic market -- going against moves by both the central bank and the government to increase borrowing by encouraging banks to lower their lending rates.

Fees are generally higher in the Islamic financing sector than in the domestic conventional banking because of the more complex structure of the loans. Finance fees are now around 20 percent, almost twice the rates for conventional banks.

Under Islamic law, sharia banks are banned from charging interest. Borrowers may obtain funds from Islamic banks in the form of profit-sharing, partnerships or joint ventures, or through a scheme where banks buy products such as motorcycles and sell them to the bank customers at a profit.

Amin said the higher borrowing costs were also due to limited resources and capital at sharia banks.

"If Bank Mandiri turned all its assets into sharia-compliant assets, the cost would be lower," he said.

The proposal "would need to be approved by the finance minister, the state enterprises minister, Bank Indonesia governor and the chief economics minister. If these four people approve the idea, it won't take many years," to boost domestic Islamic banking, Amin said.

(Editing by Sara Webb & Kim Coghill)