2006 04 CfP INCEIF the Lack of Profit and Loss Sharing Financing in Indonesian Islamic Banks

8/2/2019 2006 04 CfP INCEIF the Lack of Profit and Loss Sharing Financing in Indonesian Islamic Banks

1/30

The Lack of Profit and Loss Sharing Financing inIndonesian Islamic Banks: Problems andAlternative Solutions1Ascarya and DianaYumanita

Center for Central Banking Education and Studies, Bank Indonesia

Jl. M.H. Thamrin 2, Radius Prawiro Tower, 18th fl., Jakarta 10110, IndonesiaEmail: [email protected]; [email protected]

ABSTRACTThe lack of profit and loss sharing (PLS) financing or the domination of non-PLS

financing, especially murabahah financing, is a global phenomenon in Islamic bankseverywhere. This paper analyses the problem in Indonesia using Analytic Network

Process (ANP) methodology, preceded by focus group discussion (FGD) and in-depth

interview with scholars and practitioners of Islamic banking to fully understand theproblem and to develop an appropriate ANP network.

The cause of this problem can be grouped into four aspects, namely 1) internal of the

Islamic bank; 2) customer; 3) regulation; and 4) government and other institutions.This research finds that the cause of the lack of PLS financing of Islamic banks in

Indonesia can be summed up into two main causes from internal and regulation

aspects, namely the lack of understanding and quality of human resource (Islamic

bankers) and the lack of supportive regulations. The suggested solution is to increaseunderstanding and quality of human resource by setting the minimum budget fortraining and education, implementing the incentive or subsidy system, setting the

minimum standard for managers of Islamic banks through periodic fit and proper test,

conducting training for short term needs, and encouraging the establishment of Islamic economic and banking education institutions for long term needs. Other

suggested solution is to give support through regulation by reviewing unsupportiveregulation, such as the collectibility classification of PLS financing, and developing

incentive system to increase PLS financing. Moreover, the most effective policy

strategy to overcome the problems of Islamic banks is by implementing directedmarket driven strategy, where policies are intended to direct the development of

Islamic banks to stay on its Shariah tracks towards the desired development goals.

JEL Classification: C14, G21, G28Keywords: ANP, Islamic Banking, Profit and Loss Sharing

1

Paper presented at INCEIF Islamic Banking and Finance Educational Colloquium: Creating SustainableDevelopment of Human Capital and Knowledge in Islamic Finance through Education, KLCC, KualaLumpur, Malaysia, April 3-5, 2006.


2/30

2

1. Introduction1.1 Background

Since the establishment of Bank Muamalat Indonesia in 1992, Islamic banking has started todevelop in Indonesia. Gradually, Islamic banking enabled to serve the public who needfinancial or banking services that in line with the teaching of Islam, especially the prohibitionofriba, speculation or gambling, uncertainty, unfairness in transaction, and the obligation toinvest and finance in ethical and halalbusinesses according to Shariah.

The development of Islamic banking became more significant since the government andBank Indonesia (the central bank of Indonesia) committed to expand Islamic banking moreseriously through supporting policies, especially ever since the amendment of BankingRegulation no. 10 of 1998. Various policies were not only related to office expansion andoperation to improve the supply side, but also related to development of public understandingand consciousness of Islamic banking to improve the demand side. When conventional bankswere allowed to open Islamic branch the growth of Islamic banks surged heavily.

In 2000, there were two Islamic banks and three Islamic branches with only 65 offices and0.17% share of total assets. While, at the end of 2004 there were three Islamic banks and 15Islamic branches with the total of 355 offices and 1.22% share of total assets. It was a veryfantastic growth of 91% a year in terms of offices and 65% a year in terms of assets. Thesetrends slowed down in 2005. There were three Islamic banks and 19 Islamic branches with439 offices and 1.38% share of total banking assets.

The growth of Islamic banking in Indonesia can also be shown from deposit fund andfinancing extended. In 2000, deposit fund was Rp.1.03 trillion and financing extended was

Rp.1.27 trillion, with 123.3% FDR (financing to deposit ratio). At the end of 2004, depositfund grew 77.76% a year and reached Rp.11.86 trillion, while financing extended grew63.29% a year and became Rp.11.49 trillion, with 96.9 FDR. Moreover, in October 2005,deposit fund increased to Rp.13.59 trillion and financing extended reached Rp.15.12 trillionwith 111.31% FDR. This FDR figure was a great achievement compared to Islamic banks inother countries, and it was far beyond LDR (loan to deposit ratio) of conventional banks inIndonesia, which reached only 63.11%.

Nevertheless, at the end of 2003, the portfolio of financing comprised of 5.53% musyarakah,14.36% mudharabah, 71.53% murabahah, and 12.01% other modes of financing. This

portfolio showed the domination of non profit-and-loss (PLS) financing (80.11%),particularly murabahah. Meanwhile, the share of PLS financing (mudharabah and

musyarakah) was only 19.89%, even though PLS financing is not only the essence of Islamicfinancing but also more appropriate modes of financing to stimulate the real sector, since itcan improve direct interaction and risk sharing between investor and entrepreneur.

Most ulamas and scholars also agreed that Islamic bank is a bank with the main principle ofPLS. Therefore, PLS financing must be put in front and dominant than non-PLS financing.

Nevertheless, some other scholars said that the tendency to choose non-PLS financing wasnormal in the early stage of Islamic banks development because of various initial problems ithas to face.

Above and beyond this debate, the phenomenon of low PLS financing is an important subjectto be discussed. Various problems and their alternative solutions must be identified toimprove the share of PLS financing. Moreover, the low of PLS financing tends to be a multidimensional problem that has been existed for a long time, and there is no sign to get better


3/30

3

off. The implication of the domination of non-PLS financing brings the public to perceivethat Islamic banking is almost not different from conventional banking. This perception couldform a reputation risk to Islamic banking that could create cynicism in public that Islamic

banking is just only a re-branding, while the mind-set of the bankers are still conventional.The problem of low PLS financing becomes even more important since it also happens in

other countries that has Islamic banks, especially in countries with dual banking system, suchas Egypt, Bangladesh, and Malaysia.

The low of PLS financing clearly is not the expected ideal. Islamic banking industry,government, as well as Bank of Indonesia, must continue to improve the system andinfrastructure and to find appropriate solutions to promote PLS financing.

Rome is not built within a night and a thousand mile journey is started by one single step.Therefore, to improve PLS financing we must start as early as possible, since the ongoingdevelopment of the industry needs to be directed to ensure that the industry moves forwardon the right track and direction.

1.2 Objectives

The objectives of this study is to identify factors influencing the low of PLS financing inIndonesia Islamic banking industry and to find alternative solutions and policy strategies toimprove it. Moreover, the results of this study can be used as inputs and feedbacks by relatedstakeholder such as Islamic banking industry, investor, entrepreneur, Bank Indonesia, and thegovernment to take appropriate policy actions to deal with the current problems and attain theexpected goals.

1.3 MethodologyThis study will apply ANP methodology in three steps. First, focus group discussion (FGD)and in-depth interview with scholars, experts, practitioners, customers, and regulators ofIslamic banking are conducted to fully understand the real problems and to identify factorsaffecting low PLS financing. Second, the results of the first steps will be used to develop anappropriate ANP network and its questionnaire to obtain necessary data from experts and

practitioners of Islamic banking. Third, ANP analysis will be applied to set priority onalternative solutions and policy strategies to formulate optimal policy recommendations.

2. Literature ReviewThe lack of PLS financing or the domination of non-PLS financing, especially murabahah, inthe portfolio of Islamic banking financing is a global phenomenon, not only occurring inIndonesia but also in the world. Furthermore, it doesnt only occur in new Islamic banks(which still in a transitional stage) but also occurs in established Islamic banks. Nevertheless,according to Chapra (2000) the steps for improvement are in sight. For example, informationfrom International Association of Islamic Banks (IAIB) showed that the proportion ofmurabahah, which reached 90% from total financing, has reduced to 40.3% in 1996.Meanwhile, mudharabah and musyarakah financing have increased to 7.2% and 12.7%.

Nevertheless, PLS is still marginal with the share below 20% of total financing.


4/30

4

2.1 Views on the Lack of PLS

The problem of low PLS financing is not just a simple matter, but is a multi dimensional one.Some experts had tried to identify the sources of the problem, which seems too difficult to

decompose. Iqbal and Llewellyn (2002) summarize the general problems as follows:

a. Asymmetric information, so that decisions are made based on incomplete informationthat could benefit one party.

b. Adverse selection, where entrepreneur does not want to share big profits with Islamicbank when interest financing is still available.

c. Moral hazard, when entrepreneur reluctant to be transparent and honest, and maintainmultiple financial statements to evade tax and conceal real profits.

d. Lack of incentive structure, to stimulate mutual benefit among parties and not harmothers.

e.

Agencyproblem, since entrepreneur has disincentive to work hard and has incentive tounder reporting profits. This situation makes investor reluctant to take risk and makesentrepreneur reluctant to share profits, so that PLS financing becomes unattractive.

f. Highmonitoringcost, that Islamic bank unable yet to cover.Dar and Presley (2000) present some possible causes of the lack of PLS, namely:

a. Agency problem.b. PLS financing requires explicit and efficient property rights. Meanwhile, in many

Muslim countries property rights is not so explicit and unregulated, so that PLSfinancing becomes unattractive and tend to default.

c. Islamic banks must provide alternative financing with lower risk than PLS financing tocompete with well established conventional banks.

d. Limited role of investors (shareholders) in management so that they do not havevoting right and cannot participate in management and decision making, therefore makethem just assleepingpartners.

e. PLS financing could not be applied to finance short term projects, because of their highrisk nature. This condition makes Islamic banks depend on other modes of financing,like murabahah, to ensure certain level of liquidity.

f. Unfair tax treatment, when profit is taxable while interest is not, so that it impedesPLS financing.

g. There is no secondary market for Islamic financial instruments, especiallymudharabah and musyarakah, so that Islamic banks fail to efficiently mobilize sourcesof fund.

h. Unbalanced management rights and control, especially in mudharabah scheme,makes PLS unfavorable.

Chapra (2000) has some different opinion on the problem of low PLS financing, as follows:

a. Islamic banks is still unable to take higher risk by increasing the portfolio of PLSfinancing, since Islamic banks do not have yet enough tools (in current stage ofevolution) to manage higher risk, so that they try not to take higher risk that they cannotyet handle.

b. Most depositors are still risk averse and still unable to accept the possibility of loss,since they are used to conventional banking system for years.


5/30

5

c. Low demand for PLS financing from customers.d. Adverse selection.e. Moral hazard.f. Unfair tax treatment, where dividend is taxable while interest is not, makes the use of

debt financing flourish.g. Lack of supporting Institutions to accelerate the application of PLS financing.h. Lack of Islamic financial market for Islamic banks to manage (to invest and to access)

liquidity Islamicly.

i. Lack of support from monetary authority to make necessary regulatory andinstitutional changes to support Islamic banking system to work well.

Khan (1995) mentions that aversion to risk from Islamic bankers and moral hazard fromcustomers as the main cause why PLS financing is not popular. Islamic banks avoid riskyinvestment because they afraid to loose trust from depositors when the share of profit todepositor declines due to the volatility of their investments. Moreover, asymmetric

information between bank as investor and customer as entrepreneur is the second factor oflow PLS financing. Islamic banks are afraid that the entrepreneur will report unreal financialand income statements.

Sarker (1999) divides the problem of Islamic banking into macro and micro operations. Someof those problems that in connection with PLS financing are:

Macro:

a. There is no uniform opinions on the Shariah jurisprudence;b. Lack of skilled and expert human resources in Islamic banking and Shariah;c. Fierce competition in financial sector;d. Lack of uniform operational procedures;

Micro:

e. Increase cost of information;f. Not ready to handle higher risk;g. Lack of Shariah manual;h. Lack of methodology to analyze and measure investment risk Islamicly;i. Unsupportive tax regulation;

j. Lack of Shariah management manual.Algaoud and Lewis (2001) note some factors that make PLS financing are difficult to apply:

a. PLS financing is not easily applicable to finance working capital, since overdraftfacility is difficult to be replicated in accordance to Shariah.

b. PLS financing is also not easily applicable to finance small business, since there is nopersonal guarantee or collateral.

c. Islamic banks are unable (or reluctant) to finance long term projects using PLSfinancing, because the complexity and time consuming of the procedures, lack ofexperience and expertise of the human resources, and lack of flexibility of fundutilization due to the duration of the fund invested.

d. Agency problem and asymmetric information introduce the problem of adverseselection dan moral hazard.


6/30

6

Mulyawan (2001) identifies three main factors why the application of PLS financing is notsuccessful:

a. The application of full-equity based investment as main financing mode decreases theflexibility of fund utilization by the owner when needed;

b.

Not all Muslims are risk seeker or have high risk preference level. Most of them mightbe risk averse;

c. Deposits are vulnerable to agency problem if there is no competent supervisory body;Al-Jarhi (2002) states that moral hazard and adverse selection are the two main problems ofPLS financing. Moral hazard happens when an entrepreneur who receives financing fromIslamic bank uses the fund for other than its initial purpose. This can cause business failuresand inability to payback. Meanwhile, adverse selection happens when Islamic bank fails toselect good partner. Adverse selection happens in good economic times, while moral hazardhappens in bad economic times.

Parinduri (2003) has similar views with Al-Jarhi that adverse selection and moral hazard

are the source of low PLS financing. Adverse selection happens when entrepreneurs withprospective projects tend to choose conventional bank financing. If they choose Islamic bankfinancing they would prefer simple debt financing like murabahah. Therefore, PLS financingare only preferred for projects with low potential profits. To minimize loss in this kind ofenvironment Islamic banks are forced to use debt financing like murabahah. PLS financing isonly applicable selectively with extra caution. Moreover, not all entrepreneurs are honest. Itis difficult for Islamic bank to evaluate their multiple financial statements. Manyentrepreneurs are reluctant to reveal the real financial condition of their businesses due to thetax consequence. Theoretically, the more acute the problem of adverse selection and moralhazard in the economy, the more debt financing is preferable than PLS financing.Unfortunately, many Muslim countries are on the top list of the most corrupted countries in

the world.

2.2 Problem Identification

From several experts opinions2 discussed above, factors causing low PLS financing can beviewed from four aspects; 1) internal; 2) customer; 3) regulation; and 4) government andother institutions. The details are as follows:

a. Internal

1. The quality of human resources is lacking in order to deal with, process, monitor, andaudit PLS project;

2. Aversion to effort, because it is more complicated to deal with PLS financing than todeal with secondary financing;

3. Decreasing of flexibility in fund allocation, since PLS financing is a full-equity basedinvestment;

4. Aversion to risk, because the fear of losing trust from depositor when PLS ratedecrease.

5. Islamic banks have not yet been able to bear big risks, because they do not haveneeded skill yet to process, monitor and audit risk-sharing project;

2 Chapra (2000), Iqbal and Llewellyn (2002), Dar and Presley (2000), Sarker (1999), Algaoud and Lewis (2001),Mulyawan (2001), Al-Jarhi (2002) and Parinduri (2003).


7/30

7

6. Adverse selection, because entrepreneur is reluctant to share his high profitablebusiness with Islamic bank when cheaper interest based financing is still available;

7. Tough competition with conventional banks forces Islamic banks to providealternative financing with lower risks;

8. Not able to finance working capital, because the flexibility of overdraft facility cannot be imitated easily according to Islamic jurisprudence;

9. Not able to finance small industry, because personal guarantee or collateral is notavailable;

10. Not able to finance long-term projects, because of complexity and time-consuming procedure, lack of experience and skill, and lack of flexibility in fund allocationresulted from long-term investment;

11.Not able to finance short-term project, because of high risk;12.Limited banks role as investor (imbalance between management and control right)

especially in mudharabah financing;

13.Increased information costs, particularly in mudharabah financing;14.There is no complete and comprehensive manual book of Islamic jurisprudence tosimplify implementation;

15.There is no methodology of analysis and risk measurement of Islamic investment toimprove assessment;

16.There is no complete and comprehensive manual book of Islamic management.b. Customer

17.Customers (depositor/borrower) naturally are risk averse, because they are notaccustomed to the probability of loss and they have been used to interest rate system;

18.Moral hazard, because entrepreneur is reluctant to provide actual financial or incomestatement to evade tax and to hide real profits;

19.Demand of PLS financing is still small.c. Regulation

20.Lack of support from regulator, because there is no initiatives to facilitate regulationand institutional changes needed to support Islamic banking system.

21.There is no supporting institution to promote PLS financing; and22.Lack of uniform regulatory;d. Government and Other Institutions23.There is no supporting policy to promote PLS financing for public projects;24.Unfair tax treatment, which treats profit as taxable and interest as non-taxable;25.Secondary market for Islamic financial instrument is not available, so that limiting

Islamic banks to allocate or access liquidity according to Shariah;

26.Obscure ownership right, because PLS financing needs clear-cut and efficientownership right;

27.Lack of uniformity in the religious principles;

3. Methodology


8/30

8

3.1 General Description of ANP

Saaty (1999) defined analytic network process (ANP) as a general theory of relativemeasurement used to derive composite priority ratio from individual ratio scale reflecting

relative measurement of interconnected elements within control criteria. While, Azis (2003)described ANP as a mathematic theory that allows one to deal systematically withdependence and feedback and that can capture and combine tangible and intangible factors byusing ratio scale.

ANP is a new approach in decision making process that provides general framework intreating decisions without making any assumption about independency of elements in higherlevel from elements in lower level and about independency of elements within the same level.Moreover, ANP uses network without having to determine level as in hierarchy used inAnalytic Hierarchy Process (AHP), which is a starting point of ANP. The main concept ofANP is influence, while the main concept of AHP is preference. AHP with its dependency

assumptions on clusters and elements are a special cases of ANP.In AHP network, there are levels of goal, criteria, sub criteria, and alternative, where eachlevel has its own elements. Meanwhile, in ANP network, level in AHP is called cluster thatcan consist of criteria and alternative which now is called node (see figure 3.1)

With the feedback, alternatives can depend on criteria, like in a hierarchy, but it can alsodepend on other criteria. Furthermore, those criteria themselves can depend on alternativesand other criteria (see figure 3.1). Meanwhile, feedback improves priority which derivedfrom judgment and makes prediction more accurate. Therefore, the result of ANP is expectedto be more stable. From feedback network in figure 3.1, it can be seen that the parent node orelement and nodes to be compared can be in different clusters. For example, there is a direct

link from parent node cluster C4 to the other clusters (C2 and C3), which called outerdependence. Meanwhile, there is parent node and nodes to be compared lie within the samecluster, so that this cluster will be connected with itself and create loop link. This is calledinner dependence.

In a network, element of the cluster can be a person (e.g. an individual in Bank of Indonesia)and element in another cluster can be also a person (e.g. an individual in the parliament).Element in one cluster can influence other elements in the same cluster (inner dependence)and can also influence elements in other clusters (outer dependence) with respect to eachcriteria.

The intended output of ANP is to determine the overall influence from all elements.

Therefore, all criteria must be configured and set their priority in a framework of controlhierarchy or network. After that, do the comparison and synthesis to obtain the order of

priority from these criteria. Then, we derive the influence from element in feedback systemwith respect to each criterion. Finally, the results of these influences are weighted accordingto the important level of the criteria, and summed them up to get overall influence from eachelement.


9/30

9

Figure 3.1 Comparison of Hierarchy and Network

Seven AHP pillars can be used as starting point of ANP3. ANP is a combination of two parts.First part consists of control hierarchy or network from criteria and sub criteria that controlinteraction. The second part is network of influences among elements and clusters.

AHP and ANP utilize ratio scale. Priorities in ratio scales are fundamental number whichmakes basic arithmetic operation possible, such as addition and subtraction within the samescale, multiplication and division of different scale, and combination of both operations byweighting and adding different scales to obtain unidimensional scale.

It should be noted that ratio scales are also absolute scales. Both of them are derived frompairwise comparisons using judgments or derive from pairwise dominance ratios using actualmeasurements. When using judgments, in AHP one asks which one is more preferred ormore important? while in ANP one asks which one has greater influence? The secondquestion obviously requires factual observation and knowledge to produce valid answer. Thismakes the second question more objective than the first one. Appendix 1 describes the

procedure to obtain ratio scale, while Appendix 2 describes supermatrix in ANP.

3.2 Axioms of ANP

Every theory is based on axioms. The simpler and the fewer the axioms, the more general andapplicable the theory is. AHP has four (ANP has three) relatively simple axioms whichcarefully restrict the scope of a problem.

1. Reciprocal. This axiom requires that if PC (EA,EB) is a paired comparison of elementsA and B with respect to their parent, element C, representing how many times more theelement A possesses a property than does element B, then PC (EB,EA) = 1/ PC (EA,EB).For instance, if A is 4 times larger than B, then B is one forth as large as A.

2. Homogeneity. This axiom states that the elements being compared should not differ bytoo much, else there will tend to be larger errors in judgment. The verbal scale of ANPranges from one to greater than nine, or about an order of magnitude (see Table 3.1).

3 For more details, see Thomas L. Saaty The Seven Pillars of the Analytic Hierarchy Process (2003).

Goal

Criteria

Subcriteria

oop n cates t at eacelement depends only on it self

Component,Cluster(Level)

Element

C3

C1

C2

C4

Linear Hierarchy Feedback Network

Feedback

Source: Azis 2003


10/30

10

Table 3.1 Comparison of Verbal and Numeric Scales

Verbal Scale Numeric Scale

9.5

Much More Greater Influence 9

8

Much Greater Influence 7

6

Greater Influence 5

4

Slightly Greater Influence 3

2

E ual Influence 1

3. Hierarchy Structure (not applicable to ANP). This axiom states that judgments about,or the priorities of, the elements in a hierarchy do not depend on lower level elements.This axiom requires the application of hierarchy structure.

4. This axiom states that individuals who have reasons for their beliefs should make surethat their ideas are adequately represented for the outcome to match these expectations.

From the experience, the first two axioms are completely consonant with real worldapplications, while the third axiom requires careful applications, as it is not uncommon for itto be violated, because (in choice applications, for example) the preference for alternatives isalmost always dependent on higher level elements (i.e., the objectives), while the importanceof the objectives might be dependent on lower level elements (i.e., the alternatives). Whensuch dependent exists, the third axiom of AHP does not apply. There is feedback from lowerlevel factors to higher level factors in the hierarchy. Supermatrix calculation in ANPaccommodates such situation, so that the structure of hierarchy is just a special case of ANP.

Meanwhile, the forth axiom might sound a bit vague. But, it is important since the generalityof AHP/ANP makes it possible to apply it in a variety of ways, and the application of thisaxiom will prevent the application of AHP/ANP in inappropriate ways.

The simpler the theory the more preferable it is in practice. Most practitioners of AHP/ANPfell that AHP/ANPs axioms are simpler and more realistic than other decision theories. Inaddition, AHP/ANP is applicable to areas besides choice decisions (such as forecasting andresource allocation) and the ratio scale measures produced by AHP/ANP makes it more

powerful than other theories that rely on ordinal or interval measures.

3.3 Basic Principles of ANP

There are three related basic principles of AHP/ANP, namely decomposition, comparativejudgments, and hierarchic composition or synthesis of priorities (Saaty, 1994).


11/30

11

1. Decomposition. The principle of decomposition is applied to structure a complexproblem into a hierarchy or network of clusters, sub clusters, sub-sub clusters, and so on.In other words, decomposition tries to model the problem into AHP/ANP framework.

2. Comparative Judgments. The principle of comparative judgments is applied toconstruct pairwise comparisons of all combinations of elements in a cluster with respectto the parent of the cluster. These pairwise comparisons are used to derive local

priorities of the elements in a cluster with respect to their parent.

3. Hierarchic Composition or Synthesis. The principle of hierarchic composition orsynthesis is applied to multiply he local priorities of the elements in a cluster by theglobal priority of the parent element, producing global priorities throughout thehierarchy or network and then adding the global priorities for the lowest level elements(usually the alternatives).

3.4 The Primary Functions of ANP

In line with its basic principles, there are three primary functions of AHP/ANP, namely,structuring complexity, measurement on a ratio scale, and synthesis.

1. Structuring Complexity. AHP/ANP chooses a simple way to deal with complexity.Simple enough so that lay people with no formal training could understand and

participate. Saaty found one thing common in numerous examples of the ways humanshad dealt with complexity over the ages that was the hierarchical structuring ofcomplexity into homogeneous clusters of factors previously thought by L.L. Whyte(1969) and Herbert Simon (1972).

2. Measurement on a Ratio Scale. Earlier decision making methodologies relied onlower levels of measurement, while AHP/ANP employs ratio scales measurement that believed to be the most accurately measure the factors that comprised the hierarchy.There are four levels of measurements ranging from the lowest to the highest, namely

Nominal, Ordinal, Interval, and Ratio. Each level has all of the meaning of the levelsbelow plus additional meaning. Ratio measure is necessary to represent proportion. Tokeep the methodology simple, Saaty proposed using judgments of the ratios of each pairof factors in the hierarchy or network to derive (rather than assign) ratio scale measures.

Any hierarchically structured methodology must use ratio scale priorities for elementsabove the lowest level of the hierarchy. This is necessary since the priorities (or weights)of the elements at any level of the hierarchy are determined by multiplying the prioritiesof the elements in that level by the priorities of the parent element. Since the product oftwo interval level measures is mathematically meaningless, ratio scales are required forthis multiplication. The ratio scale, being a higher level of measurement, is particularlyimportant if the priorities are to be used not only in choice application, but for othertypes of application such as resource allocation.

3. Synthesis. Synthesis is the opposite of analysis. While analysis means separating amaterial or abstract entity into its constituent elements, synthesis means putting togetheror combining parts into a whole. Because complex, crucial decision situations, orforecasts, or resource allocations often involve too many dimensions for humans tosynthesize intuitively, we need a way to synthesize over many dimensions. AlthoughAHP/ANP facilitates analysis, an even more important function is the ability of

AHP/ANP to help measure and synthesize multitude of factors in a hierarchy ornetwork. There is no other methodology that facilitates synthesis as does AHP/ANP.


12/30

12

3.5 Consistency in ANP

The comparison mode in AHP/ANP allows for inconsistent transitivity relationships ofpreference. The axiom of transitivity must hold. For example:

If 21 aa f and 32 aa f , then 31 aa f ; means preferred toIf 21 4aa = and 31 8aa = , then 32 84 aa =

Under a single criterion rubric, we might not ordinarily expect to have intransitive relations.But, for multi-criteria problems, it is often impossible not to have intransitivities, as thedecision maker cannot simplify the complexities of the problem to achieve true transitivity.

For example, professor A is about to change jobs. He knows that if two offers are far apart onsalary, the salary will be the determining factor in his choice. Otherwise, factors such as

prestige of the university will come to play. He eventually receives three offers, described in

part as follows:University Salary Prestige

X $65.000 LowY $50.000 HighZ $58.000 Medium

On reflection, A concludes that YXf , ZYf , and XZf . The intransitivity makes theprofessor difficult to make the best decision.

Since it is difficult to achieve consistency, AHP/ANP introduces the notion of deviation fromconsistency so that the decision maker can proceed accordingly. It is recommended that

inconsistency should not be greater than ten percents.

3.6 Comparison of AHP and ANP

The differences between AHP and ANP start from the third axiom about hierarchy structurethat is not applicable to ANP. This axiom states that judgments about, or the priorities of, theelements in a hierarchy do not depend on lower level elements, so that the application ofhierarchy structure is required. The relaxation of the third axiom in ANP that allows feedback

process opens new dimensions and improvements. Some of the differences are given in table3.2.

Table 3.2 Comparison of AHP and ANP

Comparison AHP ANP

1. Framework Hierarchy Network

2. Relationship Dependence Dependence and Feedback

3. Prediction Less Accurate More Accurate

4. Comparison

Preference/Importance

More Subjective

Influence

More Objective


13/30

13

5. ResultsMatrix, Eigenvector

Less Stable

Supermatrix

More Stable

6. ScopeLimited Unlimited

AHP is a special case of ANP

4. ResultsThe problem of low PLS financing or domination of non-PLS financing, especiallymurabahah, in Islamic banking in Indonesia will be analyzed using Analytic NetworkProcess (ANP). After obtaining data and information from FGD and in-depth interviews,there are 4 main steps to follow. First is to design complete ANP feedback network with all

clusters, elements, and their relationships that maps the problems identified from FGD andin-depth interviews. Second is to collect data using questionnaires which are designed basedon ANP feedback network. The respondents are selected experts and practitioners of Islamic

banking. Third is to process data using ANP software that will produce three supermatrices(unweighted, weighted, and limiting) that give lists of all clusters, elements, and their order of

priority. The last step is to analyze the outputs of supermatrices which are used as foundationto formulate policy recommendations.

4.1 ANP Framework

ANP is a combination of two parts. The first part consists of control hierarchy or network ofcriteria and sub criteria that control interaction. The second part is network of influenceamong elements and clusters. Feedback network in figure 4.1 shows the general frameworkto be analyzed. This network has five clusters, namely; 1) Objective, 2) Aspect, 3) Problem, 4)Solution, and 5) Strategy. The aspect cluster has four elements, the problem cluster hasten elements, the solution cluster has five elements, and the strategy cluster has threeelements. The details of feedback network are showed in figure 4.2 and 4.3.

As mentioned before in chapter three, the problem of low PLS financing can be viewed fromfour angles or aspects, namely; internal, customer, regulation, and government/otherinstitutions.

From the results of FGD and in-depth interviews, the problems from all aspects can besummarized to ten main problems covering five problems from internal, two problemsfrom customer, two problems from regulation, and one problem from government.


14/30

14

Figure 4.1Feedback Network of Low PLS Financing 1

a. Internal:

1) Lack of understanding in the fundamentals of Islamic banking;2) Emphasize on business or profit orientation (business-oriented);3)

Lack of quality and quantity of human resources;

4) Islamic banks are still averse to efforts; and5) Islamic banks are still averse to risks.

b. Customer:

6) Lack of understanding in the fundamentals of Islamic banking; and7) Customers are still averse to risks.

c. Regulation:

8) Lack of incentives to stimulate PLS financing; and9) Lack of supportive regulations.

d. Government:

10) Lack of government commitment and support.

A1 A2 A3 A4

M1 M2 M3 M4M5M6M7 M8M9 M10

S1 S2 S3

Goal

Aspect

Problem

GOAL

Solution P1 P2 P3P4 P5

StrategyFeedback


15/30

15


From the results of FGD and in-depth interviews, several alternative solutions can beconcluded into 5 alternatives:

1. Improvement of human resources in knowledge and understanding of IslamicBanking (internal);

2. Development of innovative, attractive, and simple products (internal);3. Socialization of Islamic banking and its products (customer);4. Supportive regulations and incentive system (regulation); and5. Harmonization of responsibilities and relationships of DSN, DPS, and BI, in order to

create harmonic synergy (government).

CUSTOMERINTERNAL REGULATION GOVERNMENT

Improve HR

Knowledge inIslamic Bankin

Socialization on

Islamic Bankingand its Products

Supportive

Regulation/Incentives

Innovative

ProductDevelo ment

MARKET DRIVENSTRATEGY

SUPPLY LEDSTRATEGY

DIRECTED MARKETDRIVEN STRATEGY

Harmonization

among DPS, DSN,BI

LackofUnderstanding

BusinessOriented

LackofHuman

AversetoEfforts

AversetoRisks

LackofUnderstanding

LackofSupportive

LackofIncentives

LackofGovernment

AversetoRisks

Solutions to Low PLS Financing


16/30

16


Furthermore, to develop Indonesia Islamic banks to become real Islamic Banks, and particularly to improve the portion of PLS financing, three development strategies aresuggested:

1. Market driven strategy; a strategy to follow market condition or demand so that thegovernment or regulator do not make direct policies and regulations that intervene anddisrupt the market. The policies and regulations are intended to stimulate fair marketmechanism;

2. Supply led strategy; a strategy to direct market into certain direction inline withdesired goals by using policies and/or regulations; and

3. Directed market driven strategy; a strategy to follow market and indirectly guide it tothe desired direction.

4.2 Questionnaire Data

In order to obtain primary data about perceptions of experts and practitioners (Islamicbankers) in Indonesia on low PLS financing within ANP framework, the survey is conductedusing questionnaire. The respondents consist of experts and practitioner of Islamic banking inJakarta and its surroundings.

In ANP analysis, the sample size or the number of respondents do not correlate to the validity

of the sample. The requirement of valid sample or respondents is that he or she has to be an


17/30

17

expert in Islamic banking. Therefore, the respondents are a group of selected experts andpractitioners in Islamic banking who really understand the details of Islamic banking.

The questions in ANP questionnaire are pairwise comparisons between elements withincluster to identify which one is more important or has greater influence and the size of thedifferentiation (within 1 9.5 scale) viewed from one angle. Numeric scale from 1 to 9.5 isused to translate verbal valuation as shown in table 3.1.

For example, four elements in cluster aspect are compared and viewed from goal-reaching point of view. Therefore, the question to compare internal and customer elementsbecomes: In order to find the solution to low PLS financing, from both aspects below, whichone has greater influence and how large is the differentiation?

Greater influence thanWith the scale of

9.5 9 8 7 6 5 4 3 2 1(equal)

2 3 4 5 6 7 8 9 9.5

Smaller influence than

With the scale of

If internal aspect has much greater influence than customer aspect, then respondentshould choose number seven on the left side. Whereas, if customer aspect has slightlygreater influence than internal aspect, then respondent should choose number three on theright side.

The numeric scale data collected from questionnaires are then used in ANP synthesis toproduce three supermatrices, which provide priorities of problems, alternative solutions, andstrategies.

4.3 ANP Results

The outputs from ANP synthesis are three stochastic supermatrices. The example of limitingsupermatrix produced from ANP is available in Appendix 3.

4.3.1 Characteristics of Respondents

Basically, the respondents selected for this survey are respondents from FGD and In-depthinterview who are considered to have the most understanding and knowledge about Islamic

banking. The respondents comprise of nine experts and nine representatives (Islamic bankers)from Islamic Banks and Islamic Branches. The experts are selected individuals who represent

academician, practitioner, government, and ulama. While, Islamic bankers are selectedrepresentatives from long-established Islamic banks and Islamic branches holding key

positions, such as head of division or managing director.

In ANP analysis, the number of respondents is not important. The competence and mastery inIslamic banking of the respondents are the most important. The selected nine Islamic bankerscame from three Islamic Banks (Bank Syariah Mandiri, Bank Muamalat Indonesia, and BankSyariah Mega Indonesia) and six Islamic branches (BNI Syariah, Bank IFI Syariah, BRISyariah, Bank Bukopin Syariah, Bank Danamon Syariah, and BII Syariah). Nine experts arealso selected to match the number of Islamic bankers to keep the balance between these twotypes of respondents in order to simplify the analysis.

Internal

Customer


18/30

18

4.3.2 Data Processing

The results from the survey are first processed for each respondent using ANP framework asshown in figure 4.2 and 4.3. The processed data from each respondent produces threesupermatrices, which provide order of priority of important aspects and their problems,alternative solutions, and policy strategies.

Subsequently, all of these outputs are grouped into experts and practitioner groups to obtainorder of priority of all clusters and elements based on different group of respondents. Simplecalculation of average and modus are used to obtain the results4.

Other than group-based order of priority, the overall order of priority is also calculated. Thisis done also by simple average and modus calculation of overall 18 respondents.

4.3.3 ANP Results

Data processed as mentioned above produces the following ANP table:

Table 4.2 ANP Results

ITEMS EXPERTS BANKERS TOTAL

AV R M AV R M AV R M

ASPECT

INTERNAL 0.323 1 1 0.320 1 1 0.322 1 1

CUSTOMER 0.178 4 0.222 3 0.200 4

REGULATION 0.277 2 2 0.274 2 2 0.276 2 2

GOVERNMENT 0.222 3 0.183 4 0.202 3

INTERNAL

Lack of Understanding in IB 0.073 4 0.080 4 1 0.077 3

Emphasize on Business Oriented 0.071 5 0.063 5 0.067 5

Lack of Human Resources 0.074 2 1 0.082 2 1 0.078 2 1

Averse to efforts 0.074 2 0.081 3 0.077 3

Averse to risks 0.083 1 1 0.083 1 0.083 1 2

CUSTOMER

Lack of Understanding in IB 0.094 1 0.118 1 0.106 1

Averse to risks 0.078 2 0.094 2 0.086 2

REGULATION

4

In ANP methodology, the needed data can be obtained by either one of two ways. First is from the groupconsensus. Second is from individual data. In the latter case, ANP allows to use modus or average to obtainorder of priority.


19/30

19

Lack of Supportive Regulations 0.153 1 1 0.134 1 1 0.144 1 1

Lack of Incentives 0.122 2 0.105 2 2 0.113 2

GOVERNMENT

Lack of Support 0.179 1 0.159 1 0.169 1

SOLUTION

Improve HR Knowledge of IB 0.229 2 1 0.201 2 2 0.215 2 1

Innovative Product Development 0.155 5 0.182 5 0.169 5

Socialization of IB and Products 0.157 4 0.198 3 1 0.177 4

Supportive Regulations/Incentives 0.257 1 2 0.228 1 2 0.243 1 2

Harmonization of DSN, DPS, BI 0.201 3 0.192 4 0.197 3

POLICY STRATEGY

Market Driven Strategy 0.191 3 0.275 2 0.233 3

Supply Led Strategy 0.366 2 2 0.299 3 2 0.333 2 2

Directed Market Driven Strategy 0.443 1 1 0.426 1 1 0.435 1 1

AV: average value; R: average rank; M: modus rank

a. Experts

According to experts, the main problem of low PLS financing in Islamic banking inIndonesia is rooted in the internal and regulation aspects. From Internal aspect, the mostimportant problem is that Islamic banks are averse to risks and lack of quality and quantity oftheir human resources. From regulation aspect, the unavailability of supportive policy is

believed to be the most important.

To solve these problems, the experts suggested the improvement of human resources inknowledge and understanding of Islamic Banking in all level of management, and the

promotion of supportive regulations and incentive system to stimulate the industry towards

PLS financing.

Moreover, to effectively implement the above suggested solutions, the regulator is suggestedto take directed market driven strategy, where the regulator indirectly guides the industry tofollow certain direction to achieve the intended goals. These views are similar to the overallresults.

b. Islamic Bankers

Islamic bankers have similar views as the experts views. The key problems of low PLS arein the internal and regulation aspects. Based on average rank, the key internal problems aresimilar to experts views, namely, Islamic banks are still averse to risks and lack of quality

and quantity of their human resources. Based on modus rank, Islamic bankers emphasize


20/30

20

more on the lack of understanding in fundamentals of Islamic banking and the lack of qualityand quantity of human resources in Islamic banking industry.

To solve these problems, Islamic bankers also give similar suggestions with the addition ofthe socialization of Islamic banking and its products.

Moreover, Islamic bankers also have the same suggested policy strategy as the experts, thatthe regulator should take directed market driven strategy to effectively solve the problems.

c. Overall results

The overall result shows that the order of priority is the same as the experts opinions wherethe main problems are in the internal and regulation aspects.

Lack of quality and quantity of human resources and risk aversion are the core problems inthe internal aspect. In regulation aspect, lack of supportive policies is the major problem.

Therefore, the priority solutions are the improvement of human resources in knowledge andunderstanding of Islamic Banking and the promotion of supportive regulations and incentive

system.The suitable policy strategy to effectively solve the problem is applying directed marketdriven strategy.

5. DiscussionsBased on the ANP results, it shows that Islamic bankers and experts have the same perceptionon the problem of low PLS financing, which lies in the internal of Islamic bank and in the

regulation of the industry.In the internal aspect, the lack of understanding, quality, and quantity of human resources arethe key problem. The lack of understanding on the fundamentals of Islamic banking is mainly

because almost all of the human resources came from conventional banks, so that they tend to behave like conventional bankers, not Islamic bankers. Moreover, in general, they did notequipped with enough knowledge to be able to work as Islamic bankers, because they did notgiven enough training.

This result is inline with the opinion of most international experts in Islamic banking that theroot of the internal problem lies in the paradigm or mindset. If this problem is solved then theother problems will easily be handled.

Sudans experience shows that the success of PLS financing (mudharabah and musyarakah)is heavily depend on the banks understanding of the business to be financed. Therefore,

banks that succeed in extending PLS financing are banks that operated as real Islamic banksfrom the beginning that have business experience in the real sector. These Islamic bankers aremore like entrepreneurs than bankers who have the ability to manage risks, not to averse them.Moreover, conventional banks that forced to convert to Islamic Banks in Sudan did not

perform as good as these real Islamic banks.

The ANP results show that Indonesian Islamic bankers are still do not have the ability to takehigh risks businesses. They are risk-averse bankers just like their conventional counterparts.This condition is related to the limitation in human resources and their conventional banking

paradigm they brought in when they were transferred to Islamic bank. Therefore, paradigmswitch is necessary to solve human resources problem, internally and externally.


21/30

21

For example, PLS financing in Sudan requires 125% collateral as a guarantee towardsmisusage or debtors fault (not towards the capital). However, this is not considered as anobstacle for bank and customer to deal in PLS financing.

Viewed from the regulation aspect, Islamic bankers and experts have the same perception,where the current regulations do not give enough support to stimulate PLS financing. Oneexample is the regulation on the level of collectibility of PLS financing (mudharabah andmusyarakah schemes), which believed to be unfair and give extra burden to Islamic banks. Ifthis is the case, this unsupportive regulation must be reviewed. While, supportive andinducing policies to promote PLS financing must be considered.

In this case, the policy of Bank of Sudan can be used as reference where the regulation on thelevel of collectibility of PLS financing is made to be not too restrictive compare to that ofmurabahah financing. Mudharabah and musyarakah financing are categorized asperforming until three months after the due date, irrespective to the financial performanceof the business. Meanwhile, murabahah financing is categorized as non-performing if thereare arrears more than one month overdue.

Another problem that needs to be addressed is the lack of commitment and support from thegovernment and other related institutions to promote PLS financing. One example is theunclear responsibilities and relationships among National Shariah Board (the highestauthority on Shariah matters), Shariah Supervisory Boards of every Islamic bank, and BankIndonesia (the regulator and supervisor) concerning Shariah matters. This problem needsserious attention from the government, so that there will be a harmonic synergy among thoseinstitutions to promote PLS financing. Some countries, like Malaysia and Sudan, place

National Shariah Advisory Council within the central bank in order to improve efficiency andresponse in dealing with Shariah matters.

With respect to the cause of problem, experts and Islamic bankers have similar perception but

different in the solutions. The experts suggested focusing on the improvement of humanresources in knowledge and understanding of Islamic Banking in all level of management,and the promotion of supportive regulations and incentive system. Meanwhile, Islamic

bankers suggested focusing on the socialization of Islamic banking and its products beforeinternal improvement. The bankers suggestion seemed to be contradictory, since the main

problem lies in the internal, but the solution is for the external (i.e., customer). This showsthat the internal improvement is not on the top agenda of Islamic banking industry.Expansion seemed to be more important at this time to cater the high demand of the market.

Nevertheless, the overall suggested alternative solutions are alongside with the mainproblems.

Therefore, we can conclude that the problem of low PLS financing is caused by the internal problems related to the understanding and quality of human resources, and the external problem related to unsupportive regulations. The alternative solution for the internal is theimprovement in understanding and quality of human resources, while for the external is the

promotion of supportive regulation and incentive system.

With the suggested alternative solutions, experts and bankers agreed that the appropriatestrategy to effectively improve PLS financing is to take directed market driven strategy,where the regulator do not wholly follow the market, but indirectly guides and give indicativetargets to the industry to follow certain direction to achieve the intended goals. This is similarto the policy taken by the banking authority in Sudan where Bank of Sudan gave indicativetargets for the maximum proportion of murabahah (non-PLS) financing allowed in theindustry portfolio.


22/30

22

6. Conclusions and Recommendations6.1 Conclusions

From the explanations in the previous chapters, we can conclude that:1. The problem of low PLS financing or the domination of non-PLS financing, especially

murabahah, in Indonesian Islamic banks should be viewed proportionally for severalreasons.First, this is only one of many other interconnected problems faced by Islamic

banks. Regardless, this problem should be given serious attention because of its abilityto instigate reputation risk, resulted from Shariah label that is associated with Islamicfinancial institutions.

2. Second, this problem in fact is not an essential problem in nature (ushul), but it is abranch (furu), since PLS and non-PLS financing are both allowed according to Shariah.On the other hand, some experts says that non-PLS financing, specially murabahah, is a

form of secondary financing that should be applied temporally in the early stage ofdevelopment, only when Islamic banks do not have yet the ability to apply PLSfinancing. Moreover, its portion should not be dominating the portfolio financing.Furthermore, the mainstream view says that PLS financing is in fact reflecting the realIslamic bank.

3. Third, the domination of non-PLS financing problem, particularly murabahah, is theproblem that accompanied the early development stage of an Islamic Bank, since in theearly stage of development (the formative stage), Islamic Bank has to faced many otherrelated problems, especially developing human resources to a new paradigm of IslamicBanking.

4. Fourth, the low PLS financing problem is a global phenomenon, not only occurred inIndonesia but also in other countries that implement Islamic banking system. However,countries that implement fully Islamic banking/financial system has greater chance toovercome this problem due to the comprehensiveness of the system. Sudan can be usedas an example of a country that successfully limit non-PLS financing (i.e., murabahah)and improve PLS financing in its Islamic banking system.

5. Some experts said that the problems in Islamic Banking rooted from one fundamentalthing, which is the paradigm and mindset of the actors, especially human resources ofIslamic Bank. If the root of the problems could be solved, other problems would beeasier to handle.

6. Other problem that is more important according to some other experts is the purity ofmurabahah financing, because it was indicated that murabahah financing wasimplemented not according to the real murabahah. This problem needs to get seriousattention.

7. The problem of low PLS financing in Indonesia, at the end could be narrowed down totwo main problems from internal and regulation aspects, namely, the lack of quality andquantity of human resources and the lack of supportive regulations. Another problemthat needs serious attention is the lack of government commitment and support. The

proposed alternative solutions are the improvement of human resources in knowledgeand understanding of Islamic Banking and the promotion of supportive regulations and

incentive system, such as the relaxation of collectibility measures and the promotion ofregulations that give incentives to the improvement of PLS financing. Meanwhile, the


23/30

23

policy strategy considered to be the best to effectively deal with the problem is to takedirected market driven strategy, where the regulator indirectly guides the industry tofollow certain direction to achieve the intended goals.

8. The lack of knowledge and understanding in the fundamentals of Islamic banking of thehuman resources is mainly because almost all of the human resources came fromconventional banks, so that they tend to behave like conventional bankers, not Islamic

bankers. Moreover, in general, they did not equipped with enough knowledge to be ableto work as Islamic bankers, because they did not given enough training.

9. One example of unsupportive regulation is unfair and strict measures on the level ofcollectibility of PLS (mudharabah and musyarakah scheme) financing compare to otherscheme of financing. This problem is considered to give extra burden to Islamic banks.

10.The problem of low PLS is believed to be a multidimensional problem related to manyparties or stakeholders. Therefore, understanding of the problem as a collective problemthat required commitment from all parties is necessary in order to solve the problemcomprehensively, synergistically, completely, and sustainable.

11.The anticipation towards the major discovered problems needs to be done immediately,in order to keep the Islamic Banking grow on the right track and direction in accordanceto the desired direction and goal.

12.From several surveyed countries, Sudan can be used as an example that can be followedby the banking industry and regulator in Indonesia. Successful Islamic banks in Sudanhave human resources who really understand the fundamentals of Islamic Banking.Therefore, their way of thinking and work ethics are truly reflectIslamicbankers. Theyalso familiar with the businesses financed by the banks, since in general they have

businessman background before working in the banks. Hence, they have skills like

entrepreneur.In the implementation of murabahah financing, Islamic banks in Sudan hold theinventory of goods to be sold in their warehouses. This means that they implementmurabahah financing correctly. Meanwhile, Bank of Sudan has taken directed marketdriven strategy. For example, in murabahah financing, BOS give lenient indicativemaximum proportion of 30% with maximum margin of 10%. In addition, the regulationon the collectibility of PLS financing is made more relax than that of murabahahfinancing. All of these regulations are designed to give more incentive to the extensionof PLS financing.

6.2 Recommendations

Based on the results of the study, there are some recommendations suggested:

1. The problem of low PLS financing or the domination of non-PLS financing, especiallymurabahah, in Indonesian Islamic banks should be viewed proportionally by allstakeholders, including the regulator in taking policy actions. Some aspects to beconsidered, namely, Shariah compliance, stage of development, purity of the operationand schemes, development of human resources, etc.

2. The improvement of the human resources could be carried out in stages, started fromthe top level of management that should go through periodic fit and proper test. This

test for Islamic bankers should be different from that of conventional bankers where the


24/30

24

Islamic banks manager should have passion (ghirah) and commitment to lead the bankto the right track of Shariah.

3. The improvement of the human resources could be done with two strategies, namely,short term and long term. In the short term, education and training should be conductedfor every level of management. In the long term, special fields of study in Islamiceconomic and finance should be opened in graduate and undergraduate levels.

4. The improvement of the human resources from the regulator side could be done byrequiring banks to spend minimum budget for human resources development. Moreover,the government or regulator could give incentives by financing participation in humanresources development. The regulator could also provide free training for Islamic bankofficers.

5. The lack of supportive regulation could be approached in two ways. First, reviewingexisting regulations that are believed could be improved (because counter productive orimpede to the extension of PLS financing) to accelerate PLS financing. Second, futureregulations should always be inline with the objective of accelerating PLS financing.

6. Purification of Islamic banking practices should be given a priority to improve Shariahcompliance and subsequently to reduce the reputation risks.

7. The practice of murabahah and other modes financing should be standardizedimmediately to purify Islamic banks from un-Islamic practices and subsequently toreduce reputation risks.

8. The regulator should take directed market driven strategy to effectively solve the problem of low PLS financing, since we should not let the market to direct thedevelopment of Islamic banks, but we should also not strictly direct the market. Theregulator should give guidance towards the right direction of Islamic banking

development.

9. There should be a study on the optimal portfolio (PLS and non PLS financing) ofIslamic banks that can minimize risks and maximize profits. This study can be used toconvince and guide Islamic banks to adjust their portfolio to an optimal one.

ReferencesAfzal-ur-Rahman (1990), Economic Doctrines of Islam, Vol. 1-3, 3rd edition, Islamic

Publication Ltd., Lahore, Pakistan.

Aggarwal, Rajesh K. and Yousef, Tarik (2000), Islamic Banks and Investment Financing,Journal of Money, Credit, and Banking, Vol. 32, No. 1, February.

Ahmed, Ziauddin et.al. (1996), Money and Banking in Islam, International centre forResearch in Islamic Economics, King Abdul Aziz University, Jeddah and Institute ofPolicy Studies, Islamabad.

Algaoud, Latifa M. and Lewis, Mervyn K. (2001), Perbankan Syariah, terjemahan, Serambi,Jakarta.

Al-Jarhi, Mabid Ali (2002), Islamic Finance: An Efficient and Equitable Option, mimeo,

The Islamic Research and Training Institute (IRTI).


25/30

25

Al-Omar, Fuad and Abdel-Haq, Mohammed (1996), Islamic Banking: Theory, Practice andChallenges, Oxford University Press, Karachi and Zed Books Ltd., New Jersey, USA.

Azis, Iwan J. (2003), Analytic Network Process with Feedback Influence: A New Approachto Impact Study, mimeo, paper presented in seminar organized by the Department ofUrban and Regional Planning, University of Iullinois, Urbana-Campaign.

Azis, Iwan J. (1990), Analytic Hierarchy Process in the Benefit Cost Framework: A Post-evaluation of the Trans-Sumatra Highway Project, Europenan Journal ofOperational Research, Vol. 48, No. 1, September 5, 1990.

Chapra, M. Umer (1985), Towards a Just Monetary System, Islamic Economics Series 8,The Islamic Foundation, United Kingdom.

Chapra, M. Umer (2000), The Future of Economics: An Islamic Perspective, IslamicEconomics Series 21, The Islamic Foundation, United Kingdom.

Dar, Humayon A. and Presley, John R. (2000), Lack of Profit Loss Sharing in IslamicBanking, International Journal of Islamic Financial Services, Vol. 2, No. 2, July-September.

Khan, M. Fahim (1995), Essays in Islamic Economics, Economics Series 19, The IslamicFoundation, United Kingdom.

Khan, Tariqullah (1995), Demand for and Supply of Mark-up and PLS Funds in IslamicBanking: Some Alternative Explanation,Islamic Economic Studies, IRTI, Vol. 3, No.1, December.

Muljawan, Dadang and Iljas, Nasirwan (2003), Adverse Selection dan Implementasi NormaIslami Dalam Kegiatan Ekonomi,

Parinduri, Rasyad A. (2003), Bank Islam Sebenar-benarnya,Koran Tempo, 11 Juli 2003.

Saaty, Thomas L. (1994), Fundamentals of Decision Making, RWS Publication, Pittsburgh,PA.

Saaty, Thomas L. (1996), Fundamentals of Decision Making and Priority Theory with TheAnalytic Hierarchy Process, RWS Publication, Pittsburgh, PA.

Saaty, Thomas L. (1999), Fundamentals of The Analytic Network Process, paper presentedin ISAHP 1999, Kobe, Japan, August 12-14.

Saaty, Thomas L. (2001), Decision Making with Dependence and Feedback: The AnalyticNetwork Process , RWS Publication, Pittsburgh, PA.

Saaty, Thomas L. (2003), The Seven Pillars of the Analytic Hierarchy Process, mimeo.Saeed, Abdullah (1999),Islamic Banking and Interest: A study of the Prohibition of Riba and

its Contemporary Interpretation, EJ Brill, Leiden.

Samad, Abdus and Hassan, M.Kabir (1999), The Performance of Malaysian Islamic BankDuring 1987-1997: An Explanatory Study,International Journal of Islamic FinanceServices, Vol. 1, No. 3, October-December.

Sarker, M. Abdul Awwal (1999), Islamic Business Contracts, Agency Problem and theTheory of the Islamic Firm, International Journal of Islamic Finance Services, Vol.1, No. 2, July-September.

Siregar, Mulya E. and Ilyas, Nasirwan (2002), Penempatan Aktiva Produktif Bank Syariah,Jurnal Ekonomi Syariah MUAMALAH, Vol. 1, No. 1, Agustus.


26/30

26

Appendix 1Procedure to Obtain Ratio Scale5

Let A1, A2, A3, ..., An ben elements in a matrix within a hierarchy. The pairwise comparisonson pairs of elements (Ai, Aj) that we have to make are represented by an n-by-n matrix A =(aij), where i,j = 1, 2, 3,....., n. Define a set of numerical weights w1, w2, w3, ..., wn thatreflects the recorded comparisons, so that we can write:

A1 A2 An

=

nnn

n

n

n wwww

wwwwww

wwwwww

A

A

A

A

/........./

...............

...............

/......//

/......//

.

.

1

22212

12111

2

1

Since every row is a constant multiple of the first row, A has a unit rank. By multiplying Awith the vector of weights w,

Aw =nw (1)

To recover the scale from the matrix ratios, the following system ought to be solved:

(A-nI)w = 0 (2)

Clearly, a nontrivial solution can be obtained if and only if det(A-nI) vanishes, i.e., thecharacteristic equation of A. Hence, n is an eigenvalue and w is an eigenvector, ofA. Given

that A has a unit rank, all its eigenvalues except one are zero. Thus, the trace ofA is equal ton.

If each entry in A is denoted by aij, then aij = 1/aji (reciprocal property) holds, and so does ajk= aik/aij (consistency property). By definition, aii = ajj = 1 (when comparing two sameelements). Therefore, if we are to rank n number of elements, i.e., A is of the sizen-by-n, therequired number of inputs (from the paired comparison) is less than n2; it is equal to only thenumber of entries of the sub-diagonal part of A (see Saaty, 1994). Hence, if there are threeelements in a particular level of a hierarchy, only three pairwise comparisons are required.

In general, however, the precise value ofwi /wjis hardly known simply because the pairwise

comparisons we made is only an estimate, suggesting that there are some perturbations.

While the reciprocal property still holds, the consistency property does not. By taking thelargest eigenvalue denoted by max,

APw

P= max . w

P(3)

where Ap

is the actual, or the given, matrix (perturbed from matrix A). Although (1) and (3)are not identical, ifwp is obtained by solving (3), the matrix whose entries are w i /wj

is still a

consistent matrix; it is a consistent estimate of A, although Ap

itself does not need to beconsistent. Note that Ap will be consistent if and only ifmax =n. As long as the precise valueofwi /wj cannot be given, which is common in a real case due to the bias in the comparisons,max is always greater than or equal to n (hence, a measure of consistency can be derived

based on the deviation ofmaxfromn).

5 Azis (2003), pp. 3-4.


27/30


28/30

28

In general, when feedback influences are present as in Figure 3.1 (right), the supermatrix isformed by laying out all the clusters and all the elements in each cluster both vertically on theleft and horizontally at the top as in Figure 7.4.

Figure 7.4. Supermatrix of Network

Typical entry of the above supermatrix is:

Figure 7.5. Supermatrix Components of Network

where i and j denote the affected and affecting cluster respectively, and n is the element of therespected cluster.

The entries of sub-matrices in Wijare the ratio scales derived from paired comparisons

performed on the elements within the clusters themselves according to their influence on eachelement in another cluster (outer dependence) or elements in their own cluster (innerdependence)7.

The resulting unweighted supermatrix is then transformed into a matrix each

7 If the clusters influence and be influenced by other clusters, paired comparisons on the clusters are to be madeas well.

eN1

eN2

e21

e22

C1 C2 CNe11 e1 e21 e2 eN1e eN

W11 W12 W1NC1e11

e12

W21 W22 W2N

WN1 WN2 WNN

W = C2

CN


29/30

29

of whose columns sums to unity to generate a stochastic supermatrix. The derived weightsare used to weight the elements of the corresponding column blocks (cluster) of thesupermatrix, resulting in a weighted supermatrix which is also stochastic. The stochasticnature is required for the reasons described below.

It has been shown that such a limit exists given the stochastic nature of the weightedsupermatrix (Saaty, 2001). There are 3 cases to consider in deriving Wk: (1) max

= 1 is a

simple root and there are no other roots of unity in which case given the nonnegative matrixW is primitive, we have lim

kW

k = weT

, implying that it is sufficient to raise the primitive

stochastic matrix W to large powers to yield the limit outcome; (2) there are other roots ofunity that cause cycling, in which case Cesaro sum is applied8 ; and (3) max

= 1 is a multiple

root, in which case the Sylvesters formula with max= 1 is applied9.

Hence, the powers of thesupermatrix do not converge unless it is stochastic, because then its largest eigenvalue is one.When a convergence is failed to achieve (a cyclic case) the average of the successive matricesof the entire cycle gives the final priorities (Cesaro sum), in which the limit cycles in blocksand the different limits are summed and averaged and again normalized to one for each

cluster10.

In practice, however, one simply needs to raise the stochastic supermatrix to large powers toread off the final priorities in which all the columns of the matrix are identical and each givesthe relative priorities of the elements from which the priorities of the elements in each clusterare normalized to one. At any rate, raising the stochastic supermatrix to large powers giveswhat is known as limiting supermatrix.

Hence, there are 3 supermatrices: (1) the original unweighted supermatrix of columneigenvectors obtained from pairwise comparison matrices of elements; (2) the weightedsupermatrix in which each block of column eigenvectors belonging to a cluster is weighted

by the priority of influence of that cluster, rendering the weighted supermatrix column

stochastic; and (3) the limiting supermatrix obtained by raising the weighted supermatrix tolarge powers.

8 Cesaro summability basically stipulates that if a sequence converges then the sequence of arithmetic meansformed from that sequence also converges to the same limit as the sequence (see Saaty, 2001).9 James Joseph Sylvester (1814 1897), who was an English poet and great creators of terms in mathematics,developed a mathematical formula that allows limit priorities to be obtained from a reducible stochastic matrixWwith max

= 1 being a multiple root.

10

In other words, one has to compute the limit priorities of the stochastic supermatrix according to whether it isirreducible (primitive or imprimitive [cyclic]) or it is reducible with one being a simple or a multiple root andwhether the system is cyclic or not.


30/30

Appendix 3Limiting Supermatrix

Continued

Documents

2006 04 CfP INCEIF the Lack of Profit and Loss Sharing Financing in Indonesian Islamic Banks