Indonesia Issues Shariah-Based Islamic Forex Regulations

The central bank of Indonesia, Bank of Indonesia, has issued a new set of regulations to govern the shariah-compliant hedging transactions in the country which has been witnessing a rapid growth.

The new regulations are aimed at increasing protection to foreign exchange spot transactions from fluctuations in the currency.

Islamic law allows only forward spot transactions, prohibiting other forms including swaps, options and speculation. The transactions are allowed under muwa’adah an Islamic principle which binds two parties into a commitment to buy at the determined spot rate.

A real underlying transaction is required for every hedge which could be any form of investment or transaction compliant with Islamic law.

Both Islamic banks as well as conventional banks are allowed under the new regulations to offer shariah-based forward agreement on foreign exchange. The conventional banks, who can only act as hedge suppliers, have been included by the Bank of Indonesia citing the limited forex capacity of Islamic banks.

Under the new rules, failure to fulfil the terms of forward agreements will lead to sanctions that could be fines or written reprimands. The rules also require full repayment if an agreement is cancelled. The regulations have been formulated jointly by the central bank, the Indonesian Ulema Council’s National Shariah Board and the Financial Services Authority.

According to Edi Susianto, director for financial markets, the new sets of regulation are a part of a package of policies on shariah finance expected to be released later this year. Indonesian President Joko Widodo‘s administration has been actively supporting shariah finance, establishing recently the National Committee on Shariah Finance, a supervisory board to manage shariah finance related programs issued by different state institutions.

In a statement, Edi Susianto said,

These kinds of regulations can hopefully encourage more shariah investors to invest in our country. With the president establishing and leading the … committee himself, we are confident that Indonesia’s shariah economy and finance will grow significantly.

Susianto said that forex transactions by shariah banks have witnessed a rapid growth since 2010 due to the development of Islamic banks in the last few years and the growth in payments made for the hajj pilgrimage to Mecca. Value of forex transactions by shariah banks rose from 2 trillion rupiah (approx. $150 million) in 2010 to 8 trillion rupiah in 2012 and 14 trillion rupiah in 2014.

But these transactions have been vulnerable to the fluctuation of the currency as demonstrated by the impact of the recent volatility of the rupiah against the dollar, leading to demands of regulation by Indonesia’s banks to standardize them.

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