Islamic Banking in Indonesia New Perspectives on Monetary and Financial Issues Wiley Finance Series

A comprehensive overview of key developments in Islamic banking In Islamic Banking in Indonesia , renowned economist Dr. Rifki Ismal explores current issues in Islamic banking and financial products with a particular focus on the danger of liquidity risk in Indonesia. It approaches liquidity risk from the conventional perspective of international banking standards, as well as from the Islamic banking perspective. Dr. Ismal also covers the issues of asset–liability balancing, liquidity risk index, organizational structures for managing liquidity, industrial analysis, withdrawal risk, bankruptcy risk, moral hazard risk, and market risk. Compiling all the latest academic research on liquidity risk and other risks in Islamic banking, the book provides a theoretical foundation for managing risk that will is highly useful for researchers on Islamic banking and practitioners and academics. Written by a renowned expert on Islamic banking who works on monetary policy at the central bank of Indonesia Covers the latest developments in Islamic banking, particularly liquidity risk, for a rapidly expanding market Ideal for European and American readers, in addition to Asian readers, who need a fuller understanding of Islamic banking institutions, markets, and products With the latest academic research and the expertise of a leading practitioner in Islamic banking, this book offers in–depth coverage of the most pressing issues in the field.

Foreword xvii Preface xix Acknowledgments xxi CHAPTER 1 Classic Arab Financial Contracts in Modern Financial Institutions 1 Introduction 1 Economic Conditions in the Prophet Muhammad’s (pbuh) Era 1 Development of Classic Economic Contracts 6 Conclusion 12 Notes 13 References 13 CHAPTER 2 Program to Develop Indonesian Islamic Banking 15 Introduction 15 The Indonesian Islamic Banking Industry 15 A Program to Improve the Performance of the Islamic Banking Industry 26 Conclusion 27 References 27 CHAPTER 3 Understanding Characteristics of Depositors 29 Introduction 29 Studies on the Output of Empirical Surveys 30 Segmentations of Banking Depositors 33 Investment Behavior of Banking Depositors 35 An Integrated Program to Develop the Industry 41 Conclusion 43 References 44 CHAPTER 4 Liquidity Risk Management in Banks: The Conventional Perspective 45 Introduction 45 Liquidity Risk in Banking Institutions 45 Process of Liquidity Risk Management 49 Asset–Liability Imbalance and Maturity Mismatch Risks 52 Techniques to Mitigate Liquidity Risk 55 Financial Instruments as Sources of Banks Liquidity 58 Conclusion 60 Note 61 References 61 CHAPTER 5 Liquidity Risk Management in Banks: The Sharia Perspective 63 Introduction 63 Liquidity Risk Issues in Islamic Banking 63 Characteristics of Islamic Banks Facing Liquidity Risk 64 Sharia Issues in Liquidity Risk Management 67 Approaches to Manage Liquidity Risk Based on Sharia 71 Techniques to Mitigate Liquidity Risk Based on Sharia 75 Conclusion 80 Notes 81 References 81 CHAPTER 6 Islamic Banking Characteristics, Economic Conditions, and Liquidity Risk Problem 83 Introduction 83 Supporting Factors of Development 83 Characteristics of the Industry in Relation to Liquidity Problems 85 Investment Behavior of Depositors and Economic Conditions 88 Ideas for Improvements 94 Conclusion 95 References 95 CHAPTER 7 Performance of the Islamic Banking Industry 97 Introduction 97 Background of the Indonesian Islamic Banking Industry 98 Organizational Approach to Managing Liquidity 99 Liquidity Risk Management Related to the Liability Side 102 Instruments to Manage the Demand for Liquidity 120 Conclusion 124 Notes 125 References 125 CHAPTER 8 Growth of the Islamic Banking Industry 127 Introduction 127 Islamic Banking Industry and Its Development Programs 128 Literature Reviews 129 Construction and Output of the Models 133 ARIMA Models 134 Conclusion 143 References 144 CHAPTER 9 The Optimal and Decreasing Growth Rate of the Islamic Banking Industry 145 Introduction 145 Conditions Leading to the Optimal and Decreasing Growth Rate 146 Papers Analyzing Growth and Development of the Islamic Banking Industry 146 Construction of the ARIMA Models and Estimations 147 Findings and Strategic Policy Recommendations 154 Conclusion 155 References 155 CHAPTER 10 Liquidity Management Index 157 Introduction 157 Liquidity Risk Problem in Sharia Perspective 157 Construction of Liquidity Risk Management Index 158 Assessing the Indonesian Islamic Banking Industry 160 Overall Assessments of the Islamic Banking Industry 163 Conclusion 164 Appendix 10A: Liquidity Risk Management (Survey Manuals) 165 Appendix 10B: Bank X Survey Results 171 Appendix 10C: Bank Y Survey Results 177 Appendix 10D: Bank Z Survey Results 183 Note 189 References 189 CHAPTER 11 An Empirical Survey on Liquidity Risk Management 191 Introduction 191 Depositors Understanding of Islamic Banking 192 Investment Behavior of Depositors 193 Liquidity Behavior of Depositors 198 Risk Management Committee in Islamic Banks 205 Sources of Liquidity Risk Problem and Liquid Instruments 212 Conclusion 214 Notes 214 References 215 CHAPTER 12 Islamic Banking Behavior Model of Indonesia (ISLAMI) 217 Introduction 217 Framework of ISLAMI 217 Model Review and Justification 219 Asset Liability Balance Models: Theoretical Background 221 Liquidity Reserves Model: Theoretical Background 227 Model of Islamic Monetary Operation: Theoretical Background 231 Econometric Analysis 236 Interpretation of the Models 250 Long–Run Causality and Dynamic Responses of Variables 253 Findings and Recommendations 261 Conclusion 262 Notes 263 References 263 Appendix 12A: Proofing Formula 265 Appendix 12B: Proofing Formula 266 Appendix 12C: Proofing Formula 266 Appendix 12D: Proofing Formula 266 CHAPTER 13 Strengthening and Improving Liquidity Management 267 Introduction 267 Organizational Structures 268 Integrated Output of the Previous Chapters 269 Discussion of the Depositors’ Side 270 Discussion of the Islamic Banking Side 273 Liquidity Problems and Islamic Liquid Instruments 274 A Proposed Program to Manage Liquidity Risk 275 Conclusion 280 References 281 CHAPTER 14 Demand and Supply of Liquidity in Islamic Banks 283 Introduction 283 Short–Term Demand for Liquidity 284 Short–Term Suppliers of Liquidity 285 Historical Performance of Short–Term Liquidity Management 287 Future Performance of Short–Term Liquidity Management 289 Findings and Suggestions 299 Conclusion 301 References 301 CHAPTER 15 An Empirical Survey on Depositors’ Withdrawal Behavior 303 Introduction 303 Potential Problems of Withdrawals Risk in Islamic Banks 304 Depositors’ Behavior in Withdrawing Funds 304 Empirical Survey on Deposit Withdrawal Behavior 308 Policy Recommendation 315 Conclusion 316 Notes 316 References 316 CHAPTER 16 An Econometric Model of Depositors’ Withdrawal Behavior 319 Introduction 319 Flow of Funds in Islamic Banking 320 Model of the Liability Side in the Competitive Banking Sector 321 Econometric Analysis 323 Findings from Models and Suggestions 329 Limitation of the Models 331 Conclusion 331 References 331 CHAPTER 17 Formulating Withdrawal Risk and Bankruptcy Risk 333 Introduction 333 Characteristics of Islamic Banking Industry 334 Assumptions and Risk Formulas 335 Withdrawal Risk Scenarios 336 Bankruptcy Scenarios 338 Soundness and Failure of Islamic Banks 339 Revenue–Sharing Equilibrium Ratio 340 Conclusion 342 Notes 342 References 343 Appendix 17A: Proofing Formula of the Invulnerable and Vulnerable Condition 343 Appendix 17B: Proofing Formula of Solvency and Bankruptcy Condition 344 Appendix 17C: Proofing Formula of Combination of Scenarios 345 CHAPTER 18 An Optimal Risk–Return Portfolio of Islamic Banks 347 Introduction 347 The Dominant Islamic Financing Instruments 348 Risk–Return Portfolio Theory 348 Efficient Portfolio Theory 350 Risk–Return Analysis of Islamic Financing Instrument 351 An Efficient Portfolio Financing Frontier 360 Conclusion 362 References 362 Appendix 18: Derivation of Variances of 1–4 Financing Instruments 363 CHAPTER 19 Volatility of the Returns and Expected Losses of Islamic Bank Financing 365 Introduction 365 Islamic Financing Instruments 366 Value at Risk Approach 367 Value at Risk (VAR) Analysis for the Indonesian Islamic Banks 369 Value at Risk Result 372 Recommendations 376 Conclusion 377 References 377 CHAPTER 20 The Moral Hazard Problem in Murabahah Financing 379 Introduction 379 Murabahah Financing 380 Moral Hazard in Murabahah Financing 382 Minimizing Moral Hazard in Murabahah Financing 386 Conclusion 388 Note 389 References 389 CHAPTER 21 Central Bank Islamic Monetary Instruments: A Theoretical Approach 391 Introduction 391 General Assumptions 392 Islamic Monetary Instruments 393 Utility of Islamic Monetary Instruments 402 Conclusion 403 Notes 405 References 405 Appendix 21A: Derivation of Central Bank Wakalah wa Ijarah Certificate 406 Appendix 21B: Derivation of Central Bank Wakalah wa Ijarah Muntahia Bitamlik Certificate 407 Appendix 21C: Derivation of Central Bank Islamic Securitization Wa Ijarah Certificate—Ijarah Rental Rate 407 Appendix 21D: Derivation of Central Bank Islamic Securitization wa Ijarah Certificate—Investors Investment Decision 408 CHAPTER 22 Assessing Economic Growth and Fiscal Policy in Indonesia 409 Introduction 409 Wagner’s Law and Keynes’s Law on Economic Development 410 Assumptions and Economic Modeling 411 Defining Variables and Model Specification 412 Autoregressive Distributed Lag (ARDL) Model 415 Long–Run Dynamic Model 417 Findings and Historical Conditions 418 Conclusion 421 Notes 421 References 421 CHAPTER 23 Bank Lending Channel and Islamic Banks 423 Introduction 423 Underlying Conditions and Assumptions 424 Econometrics Analysis 425 Findings from Econometrics Analysis 430 Conclusion 431 Note 432 References 432 CHAPTER 24 Islamic Gracious Monetary Instruments: A Theoretical Approach 433 Introduction 433 General Assumptions 434 The Islamic Gracious Monetary Instruments 436 Utility of the Islamic Gracious Monetary Instruments 448 Conclusion 450 References 451 CHAPTER 25 Assessing Gold Murabahah in Islamic Banking 453 Introduction 453 Underlying Finance Theory 454 Analysis of Gold Murabahah Financing in Islamic Banking 457 Regulating Gold Murabahah 465 Conclusion 466 References 466 CHAPTER 26 Simulation–Based Stress Testing 467 Introduction 467 Stress–Testing Guidance 467 Stress–Testing Simulations and Findings 471 Conclusion 480 References 482 CHAPTER 27 Does the Return on Islamic Deposits Mimic the Interest Rate? 483 Introduction 483 Performance of Islamic Deposit Return 484 Literature Review 486 Research Framework 490 Results of Applying Ayuda Neurointelligence 490 Interpretations of the Results 497 Conclusion 497 References 498 About the Author 501 Index 503