The impact on Islamic banking of Indonesia's new rules on bank ownership

The magazine Islamic Finance News in its edition of 15 August 2012 posed the following question to its forum of experts:

The full responses are only available to readers of the magazine. However I have reproduced my own response below.

Many developing countries have rules which restrict the proportion of a local bank which may be owned by a foreign shareholder, and often require a significant part of the local bank’s shares to be owned by domestic shareholders. Conversely such rules are relatively uncommon in advanced economies.

While such ownership restrictions are always justified on grounds such as prudential regulation, development of local enterprise etc. their effect is almost always negative. They make the country a less attractive destination for inward investment, and the main beneficiaries are typically well connected local businessmen who can serve as the legally mandated domestic partners for foreign investors.

Against that general background, the new bank ownership rules announced by Bank Indonesia in July appear relatively well designed. For example it is appropriate to require significant foreign shareholders to have good corporate governance. Upon a first impression, the new rules do not require foreign shareholders who exceed the new standard 40% threshold to divest, provided that the Indonesian bank concerned continues to be financially healthy.

Accordingly the design of the rules is unlikely to harm the Indonesian Islamic banking sector or to inhibit its growth. While there will be a standard 40% limit on foreign ownership, with the advance permission of Bank Indonesia appropriately qualified foreign banks will still be able to set up or purchase subsidiary banks in Indonesia which are almost wholly owned. This should enable the sector to continue to benefit from foreign Islamic banking expertise and avoid reducing competition in the Indonesian Islamic banking market.