4 culprits behind Indonesian Islamic banks' muted profitability

Poor asset quality is one.

Indonesian Islamic bank loan growth will remain sluggish in 2017 due to asset-quality issues, as banks focus on reducing non-performing loans (NPL) rather than growth, says Fitch Ratings in a new report. However, asset-quality deterioration should moderate in the near to medium term, as the operating environment gradually recovers and the industry's risk management practices slowly improve.

Here's more from Fitch:

Islamic banks' NPL (overdue more than 90 days) ratio remained elevated, at 4.3% at end-September 2016 (end-2015: 4.3%). It was higher than the 3.1% NPL ratio of conventional peers, suggesting that Islamic banks require further development of underwriting standards and risk controls. Islamic banks' NPL reserve coverage of 45.6% was significantly lower than that of conventional banks, at 108.7%, indicating a higher risk of near-term capital impairment.

Fitch expects the profitability of Indonesia's Islamic banks to remain muted in 2017, due to strong competition from conventional peers, poor asset-quality, a slow economic recovery and rising credit costs. The banks' ROA was 0.6% at end-September 2016 (end-2015: 0.5%), compared with 1.9% for conventional peers.

The regulator targets 10% market share for Islamic finance by 2020 and has provided industry support, including regulatory dispensations and sharia-compliant monetary instruments. Indonesia has the world's largest Muslim population, but Islamic bank market share has stabilised at around 5% since the rapid growth experienced to 2013. This suggests significant difficulties in achieving higher market share penetration.