The Chronicles of a Capitalist Lawyer

Have you ever wished for immortality? Do you want to live forever and ever, having the luxury of doing whatever you want without any time constraint? I do, but I guess that the chance for achieving such immortality is too slim to be even considered by any rational being. However, other than any mythological creatures out there, there is an entity in this world that might actually have the capacity to achieve immortality. By this, I refer to corporations.

What Are Limited Liability Companies?
While the definition of corporations might slightly differ between various legal jurisdictions, it has several basic characteristics, i.e.:

corporations are legal entities established under the prevailing laws which have jurisdiction over such corporations (the domicile where such corporations were firstly originated);
corporations are able to maintain their own assets and liabilities, and to conduct various transactions with other parties;
corporations are "owned" by the shareholders, i.e. those who have contributed certain amount of capitals to the corporations and received shares from the corporations as evidence of their contribution and representing their ownership within such corporations;
there is a limitation of liabilities for the shareholders of corporations (mainly up to the respective shareholder's capital contribution in the corporation);
there is a separation of management within a corporation, i.e. the shareholders do not have direct management control of the corporation, instead it is conducted by a separate professional board of management (directors and commissioners); and
most corporations, if not all, are established for the purpose of getting profits, enabling them to maintain their existence for a very, very long time.

The legal concept of corporations is unique, because it is considered as a somewhat "living entity" having certain rights and obligations, while in reality it is a business organization made from joint stocks owned by certain party(s). But, only because of such characteristics that corporations are able to have an immortal life and becoming an integral part of the capitalist system.

When Was The First Limited Liability Company Established?
According to Gower's Principles of Modern Company Law, the early concept of corporations can be found in the 15th century, notably on the limitation of liabilities of the owner of such corporations. The oldest known corporation is no other than VOC (Verenigde Oost-Indische Compagnie), the "evil" company that made a reign of terror in Indonesia, and which is also the first company to conduct public offering in this world. Since the establishment of VOC in 1606, the history of corporation has lasted for more than 400 years, and that is quite a long time indeed.

Why People Made Limited Liability Companies?
The logic is quite simple, corporations allow people to have the protection of limited liabilities in doing their business, they can be established for an indefinite period, and their existence does not depend on the existence of their owners. This means that it would be easier for the owners to calculate their risk of liabilities (due to the limited liabilities) and the business activities may continue even after all of the original founders have crossed to the other side, i.e. died.

Prior to the existence of corporations, each man is liable up to all of his assets in doing business activities with other parties. Thus, if something goes wrong, he will be responsible with his entire assets, and he faces the risk of losing everything. In addition, since most of the businesses are being privately conducted by individuals in the form of self-company or partnership, the death of the particular individuals will cause the self-company or partnership ceases to exist. The introduction of corporations solves the above problems, and whoever firstly made this concept must be a genius.

The Role of Law on the Establishment of Limited Liability Companies
Of course, people can't simply establish an corporations and declare that they have limited liabilities to their counterparts solely by themselves, people need some legal support to do that. Without any legal basis, you can't expect people to believe that an abstract entity such as corporations exists. In order to achieve that purpose, we will need the government to step in.

Again, this is another genius concept. By having a state law acknowledging corporations as legal entities and stipulating rules on corporations characteristics, establishment procedures, and its rights and obligations, the existence of corporations has been secured by the law, and no one can argue more on that. With the help of law, corporations are no longer abstract beings. They exist in the vicinity and they can act and enter into various transactions as if they are living persons.

Unfortunately, the concept of corporations is not without any flaws. As we shall see further below, 400 years of existence has brought many issues that might not be considered yet when the corporation is firstly established.

The Chase for Profits and The Impact of Immortality
From the very beginning, a corporation was created to be a profit oriented business entity, and the management of a corporation has an obligation to ensure that such purpose can be satisfied most of the time, if not all the time. Under Indonesian laws, the management of a corporation must act to the best interest of the corporation, which can be interpreted to also include the obligation of the management to ensure that the corporation can obtain sufficient income and profits for maintaining its going concern status, i.e. the ability of the corporation to continue functioning as a business entity for certain period without any threat of stopping or being liquidated.

So, the obligation of the management of a corporation to pursue profits is not a trick made by some evil businessmen, rather it is an obligation stipulated by the law itself. This brings us to an important issue. You see, by having the ability to live an eternal life, there is no limit for corporations in obtaining profits. And since it can't aged, the shareholders would expect the corporation to survive in any kind of condition for as long as it can be. To give incentives to the management, huge salaries and bonuses were given for those who were succeed to make the corporation profitable enough for the shareholders and for those who were failed, losing their position might be the smallest consequence. With this kind of approach, it is no wonder that in some cases, the lust for profit can evolve to a dangerous lust for everything as greed controls the management of such corporation, and when that happens, all would be fair and square enough as long as their lust can be satisfied. VOC would be a pretty example, among with various famous crumbled corporations like Enron and WorldCom.

Can we blame them for that? Not entirely, because whether you like it or not, it is their legal obligation to secure those profits, even if they need to trick everybody. In addition, as I've mentioned above, they were paid by a huge salary and bonus to ensure that the corporation is always profitable for the shareholders. So, do we have some clear incentives for the management to do otherwise? My guess is not, since while some penal sanctions and fines might be a threat to the management, as long as their compensation is highly enough to cover the risks of being sanctioned due to their actions, there would always be a incentive for them to take such risk. As mentioned by Gary Becker, an American Nobel Laureate, crime only happen because it "does pay." See his paper here for more information.

Proposed Policies
Then, what should we do? What kind of policy that should be implemented to solve this problem? First of all, any kind of solution that restricts the corporations ability to obtain profit would be horrendous and will not be accepted. Or can we try the policy used by the US Government with respect to companies that receive US Government's aid, i.e. giving some limitation to the amount of the salaries and bonuses that can be obtained by the management?

My reply is no. The Government shouldn't regulate on the maximum amount that can be obtained by the management. How can they know how to calculate the performance of each member of the management? How can they know that the payment of such huge salaries and bonuses are exceeding the fair limit? A policy like that might give a negative incentive to the management for not doing their best simply because they see that their good results will not be as rewarding as it might be if such regulation does not exist.

Having said the above, my proposed policy would be as follows:

Determination of the form and amount of salaries and bonuses of the management should be conducted by an independent committee within the corporations. This has been done in several Indonesian publicly listed companies, but have not been yet stipulated in a clear regulation. There is of course some additional costs for having this committee but there is also a good ratio for having this committee, i.e.: (i) ensuring that the management can receive a fair reward for their performances based on the calculation of those who are being involved with the corporation, (ii) preventing the management from creating salary and bonus policy that contravenes with the corporation and/or shareholders interests, such as giving excessive shares options with low price to themselves as their bonuses, and (iii) helping the shareholders who are not involved in day to day business activities of the corporation in understanding the performance of the management and how they should be rewarded.
The sanction for the management who breach the laws for the sake of getting profits should be higher than or at least equal with their overall compensation (this include their salaries, bonuses and any type of incomes that they receive due to their illegal acts). This proposed policy is made based on the following assumptions: (i) if their compensation is low, there would be less incentives for them to breach the law; and (ii) if the compensation is high, they will face the risk of losing such compensation or even a bigger amount if they're breaching the law for getting good performances or else for benefiting themselves. As an example: "if the management is deemed guilty for conducting certain amount of crimes, they would need to pay an amount equal to triple times of their total annual salaries and bonuses that they received for the preceding years." Of course, this policy would be only effective if there is a high rate of legal enforcement, something that might not be achieved efficiently as of today.

While some elaborations and implementing provisions are definitely needed for the above policies, I do hope that the ideas presented here can contribute to the development of better policies in managing the balance between lust for profit and the business sustainability of corporations.

A short and very good story on the application of economic principles in day to day life from Greg Mankiw's blog. If you ask me Mr. Mankiw, my reply would be that the price in the private pier will go down based on the following reasoning:

the increase price of the town pier will reduce the competitors for getting slots in the town pier;
as long as such price is still cheaper than the price of slots at the private pier, those who are currently using the private pier will most probably move to the town's pier as right now there would be less competitors and therefore their chance to obtain a slot there is increased;
thus, to maintain its clients, the private pier should provide a competitive price by lowering its own price.

In Part I of my article, we have discussed two of the major challenges that are being currently faced by the Indonesian Islamic banking industry, the taxation and regulatory issues. In this article, we will discuss the remaining two challenges, i.e the risk management issues and the segmentation and marketing issues.

1. Risk Management Issues

We will start our discussion by asking this question: "Why murabahah financing sits at the top of Islamic banking financing products in Indonesia?" As of June 2009, the murabahah financing which involves a sale and purchase of assets between an Islamic bank and its customers with a deferred payments mechanism plus margin is the queen of all Indonesian Islamic financing products, comprising of approximately 57% of the total Islamic financing products. Meanwhile, the mudharabah financing (revenue sharing financing) and the musyarakah financing (joint venture financing) only comprise 21.6% and 14.5%, respectively, of the total Islamic financing products.

To be honest this is not a shocking result, and as I will further discuss in this article, the above result is none other than a logical consequence of the current structure of the Islamic banking industry risk management which is actually being supported by the current regulations of Bank Indonesia.

1.1 The Problem of Mudharabah and Musyarakah Financing's Risk Management

Most of us know that Islamic banks should be famous for their profit sharing concepts in doing their business, which is reflected in the mudharabah and musyarakah financing products. However, in reality, these products have two critical issues related to the risk management of such financing.

First, these products use revenue sharing mechanism, which means that the Islamic bank will only receive revenues if the actual business of the customer produces revenues. Any losses caused due to business losses of the customer shall also be borne by the Islamic bank, provided that the amount of which shall not exceed the total mudharabah or musyarakah financing.

The above is correct under the Islamic law principle and has been adopted by Bank Indonesia regulation. No one should argue on that. But the problem is quite different for modern financing activities. Most of Islamic banks' source of funds comes from third party funds (as of June 2009, the third party funds comprise 76% of the total liabilities of Islamic banks). These are the funds of the Islamic banks' customers and are not actually owned by the Islamic banks.

From risk management perspective, putting money in a high risk business is unlikely, especially when the banks are mainly using other people's money and they will be responsible to return those funds. We must also remember that banking industry relies heavily on the people's trust. If people are losing their trust on the Islamic banking industry, it is possible for us to predict a financial collapse of major Islamic banks.

Second, the current regulatory regime limits the possibility of Islamic bank to execute the security (jaminan) for mudharabah and musyarakah financing products, and also limits the ability of the Islamic Bank to request for payment of losses. Again, this is in line with the Islamic law principles and no one should further argue on that. But, from risk management perspective, the risk of mudharabah and musyarakah is increasing. Not only that the Islamic banks are liable for possible business losses, they don't have an exit clause which can secure their financing.

What would be the logical consequences of the problems above? Islamic banks will not be using the mudharabah and musyarakah financing products as their main products, rather they will focus on financing products which are more secured for them, in this case, murabahah would be the proper choice.

1.2 Suggested Solutions

Why murabahah financing is widely used? Murabahah financing is flexible enough to be used for certain type of financing, ranging from working capital, investment and consumer finance. It is more secured because after the sale and purchase has been conducted, the customer will be indebted to the Islamic bank and the Islamic bank would be able to secure such financing by the customer's assets and then execute the assets in case the customer fails to pay its financial obligation. From any risk management perspective, it would be best for Islamic banks to focus on this financing product. And we can't blame them for this issue as there is indeed an inherent risk management problem with the mudharabah and musyarakah financing and we must work together to solve this issue.

Now, how can we claim that Islamic banks have a wide array of products where in reality the Islamic banks will focus on murabahah financing products? The solve this issue, we would need to amend the current regulations on Islamic banking products, especially to help the Islamic banks in reducing their risk with certain type of Islamic financing.

My proposed solution would be to make a clear regulation which can eliminate any bad incentives to the customer with respect to the mudharabah and musyarakah financing, i.e preventing them to make bad business decision which will resulting on losses to both sides. How can we achieve this? Some suggested solutions would be: (i) increase the Islamic bank's authority to review and be involved in the business activities of the customer, (ii) penalize the customer for conducting any material business decision without first consulting with the relevant Islamic bank, and (iii) enable the Islamic bank to execute the security for such financing in case the customer does not comply with the requirements stipulated by the relevant Islamic banks in doing their business.

With these solutions, we can expect that the business management of the customer will be handled in a more professional way and the Islamic bank will have an exit clause when they are dealing with bad customers. Further, by encouraging the Islamic banks to be more involved in the customer's business management, it would be easier for the Islamic bank to maintain its risk management and prevent bad business decision of the customer. An age of entrepreneurship may rise in Indonesia, if this can be conducted properly.

2. Segmentation and Marketing Issues

With a total assets representing only 2.64% of the total assets of the Indonesian banking industry (excluding the rural credit banks), the Indonesian Islamic banking industry still has a long way to go before it can dominate the market share in Indonesia. But how can this be happen when most of Indonesian citizens are moslem? The answer might lie on the issues on the Islamic bank segmentation and marketing. Apart from taxation, regulatory and risk management issues which might not be resolved directly by the Islamic banking industry (as government authorities involvement are needed), the segmentation and marketing issues are inherent issues within the core of Islamic bank industry.

From what I see until now, most of the Islamic banks in Indonesia do not have a clear segmentation or marketing policies, especially in getting new customers. This is not due to a cliche reason like the Shari'a bank is not aggressive enough in doing the marketing, etc. The main problem lies in the fact that most Islamic banks are not yet concentrating on getting specific customers and to certain extent are still being trapped with religious symbols and doctrines in doing their marketing activities.
On the segmentation issues, considering the number of Islamic banks' assets, it would be better for Islamic banks to focus on small to mid enterprises unless they have a huge amount of additional capital. And this is actually a potentially good business. Rather than competing with bigger conventional banks who have secured some loyal clients, creating new opportunities with new type of customers might be easier and can show some actual differentiation between Islamic banks and conventional banks in term of doing business activities.

In addition, some proposed plan on my mind for making specific segmentation would be: (i) Islamic banks could focus on micro financing using mudharabah and musyarakah financing products, since given the nature of these products, it would be best to diversify the financing to many parties to avoid high risk of default; (ii) Islamic banks could focus on targeting customers who like to have a secured financing liability, whereas in this case, murabahah financing products with its fixed margin system would be the best option to capture these kind of customers; and (iii) Islamic banks could also focus on assisting small to mid entrepreneurs in doing their business, becoming a "financial manager" for these kind of customers through mudharabah or musyarakah financing products, as this is possible under the current Bank Indonesia regulations.
On marketing issues, I've seen many marketing products in several branch offices of Islamic banks and can conclude that while it is good to tell people that Islamic banking products are the ones that have been blessed by God, it would be better to tell people that Islamic banking products are good and profitable.

I must say that it is ironic if Islamic banks are not focusing on marketing their competitiveness of their products. In term of savings and deposit products, Islamic bank offer a competitive rate of return with conventional commercial banks. Even in term of financing products, contrary to the common opinion that Islamic bank financing is a little bit more costly due to its fixed rate system, the margin rate of murabahah financing is fairly competitive with most of credit financing products and even lower compared to interest rate for consumer credit. I made all of these comparisons using Bank Indonesia's June 2009 Statistics.

To certain extent, I can understand why some of the Islamic banks are not focusing on this kind of marketing. After all, some of them are owned by the same party who own the conventional banks, which of course creates a conflict of interest. Creating a marketing strategy which shows the quality of Islamic banks to the highest degree would not always be acceptable by their colleagues in the conventional banks, thus, these Islamic banks can only focus on getting customers who use religious reasons rather than commercial reasons to become their customer.

In the end, what is truly matter when we are speaking about marketing is how the Islamic bank can provide marketing products that allow people to believe that Islamic banks are professional, accountable and profitable. It should be noted that Islamic banks are profit-seeking institution and should focus on getting those profits, because it is impossible to increase the market share of the Islamic bank if they can't obtain enough funds to expand their business.

1. Introduction

For quite a long time, it is very common for us to hear critics saying that the Indonesian Islamic banking industry has failed to capture a bigger market share in Indonesia despite the fact that Indonesia is the biggest moslem country in the world. To certain extent, this might be true.

If we compare the total assets of Islamic banks (based on Bank Indonesia's Islamic Banking Statistic per June 2009, the amount of which is approximately Rp.55 trillion) with the assets of commercial banks (based on Bank Indonesia's General Banking Statistic per June 2009, the amount of which is approximately Rp.2,028 trillion), we will found out that Islamic banks' assets only represent 2.64% of the total assets of Indonesian banking Industry (excluding rural credit banks). True, that if we compare the current data with 2005's data, Islamic banks' assets have increased around 250%, but that is not significant enough if we see the total cumulative assets of the Indonesian banking industry.

Seeing this hard fact, what are actually the main challenges of our Islamic banking industry? What need to be done to surpass these challenges and how? In this article, I will discuss some of the most important challenges that are currently being faced by Indonesian Shari'a banks and some suggested solutions which may be considered in solving those challenges.

2. Major Challenges in Developing the Islamic Banking Industry in Indonesia

In my opinion, such major challenges include:

a. taxation issues;
b. regulatory issues;
c. risk management issues; and
d. segmentation and marketing issues.

Issues No. a and b will be discussed in this article, and the remaining issues will be discussed in Part II of the article.

3. Taxation Issues

The taxation issues might be the oldest and most important issue of all time when we are discussing Islamic financing products. And amazingly, despite the seriousness of the issue, no resolution has been made until now, as there is no clear tax regulation on the correct tax treatment for such Islamic financing products, especially for the "asset-based" products, such as murabahah (deferred payment sale with margin), istisna (purchase by order/manufacture) and ijarah muntahia bit tamlik (financial lease with purchase undertaking). To show the importance of this taxation issue, it is worth to note that per June 2009, these "asset-based" banking products comprise more than 60% of the total Indonesian Islamic banking financing (excluding Islamic rural bank), with murabahah products sitting at the top by covering 57% of the total financing.

It is a basic concept under the Islamic law principles that for "asset-based" Islamic finance transactions i.e. the transactions involve certain underlying assets and such underlying assets are being "transacted" or used as the basis of such Islamic finance transactions, the transactions related to the underlying assets which may include sale and purchase or lease should not be treated as actual transfers, but merely as a financing arrangement. Thus, there would be only a transfer of beneficiary ownership or usufruct rights (hak manfaat) and there is no transfer of legal ownership within an Islamic financial transaction (which may involve value added tax (VAT)).

However, as there is no clear regulation on the tax treatment, a conservative opinion will state that there is a huge tax risk for this "asset-based" Islamic finance transactions which in the end will cause these transactions to become more costly. True, that currently there is a "status quo" between Islamic banks and tax authorities, i.e. each party is being silent on the tax treatment. It is also true that under most of the contracts of Islamic finance transactions, any tax arising from the transactions shall be borne by the customers. But this is like sitting on a time bomb, or saying that all problems will be vanished by simply closing our eyes and dreaming that the problems are indeed vanishing.

Consider this fact, as per June 2009, the total murabahah financing provided by Islamic commercial banks has reached approximately Rp.24. 2 trillion (equivalent to US$2.4 billion). And then imagine that after seeing the data, the tax authorities decide to actually impose the VAT on the murabahah transaction, simply because now they can obtain almost Rp.2.4 trillion (equivalent to US$240 million). More importantly, imagine if the Indonesian Islamic banking industry has reached an equivalent position with the commercial banking industry, the tax costs would be absolutely huge. Before that kind of disaster can happen, a preventing action must be done.

Based on my own experience in giving a presentation on Islamic financial transactions in capital market for certain Indonesian tax authorities, I get an impression that the tax authorities actually understand the basic concepts of Islamic financial transactions. However, they can't provide any remedy for the taxation issues without having a proper legal basis, as there is a fear that if they act without clear regulation, such act will be considered as causing losses to the state and they will face the risk of facing allegation of corruption. Might be exaggerated, but the risk does exist.

Therefore, the only solution that can be done is to lobby the House of Representative and the Government to amend the Tax Law. I understand that the Income Tax Law has been amended to cover Islamic finance transactions, but the real problem lies on the VAT Law. The question is, what are we trying to ask from the regulator? Based on my discussion with a Director of one of the major Islamic investment banks in Malaysia, the most important thing to ask is to have a same treatment with commercial banks, and not asking for a tax evasion or tax holiday. It takes almost 20 years for Malaysian Islamic banking industry to convince their tax authorities to provide a same treatment between Islamic finance transactions and the conventional ones. Surely, we would not want that to happen in Indonesia.

What do we mean by asking the same treatment? It means that all Shari'a finance transactions will be considered as pure financing transactions. It would not be deemed as an actual sale and purchase or lease, there is no actual legal transfer of assets, and all of the "transfer" procedure should be treated as an element to be fulfilled under Islamic law principles. Therefore, all Islamic "asset-based" financing transaction, whether based on sale and purchase or lease, shall receive similar tax treatment with the financing products of conventional commercial banks, i.e. exempted from VAT.

I understand that this might seem as an issue, if Islamic Bank is proud of not using interest in providing financing products, why bother to have a same treatment with conventional banks? To this, I would reply that same treatment is extremely important because while each of them have a very different method in conducting their financing business, both of them are still doing business in their respective status as financial institutions, and thus need to have equal treatment. I've seen too many prospective investors in Indonesian Islamic banking industry come to our country and discuss the possibilities of establishing a new Islamic bank in Indonesia only to cancel their plan due to the tax issues. Whenever we reach the taxation issues, we know from the look of the investors' faces, that establishing an Islamic bank is not a viable option for them as long as the tax issued has not been resolved.

I hope that by focusing on the same tax treatment, the regulators will realize that they will not lose any potential tax objects, but instead gain access to a lot more of taxable incomes due to the development of Islamic banking industry in Indonesia. There is still a lot of homework for this issue, but no matter what this issue must be resolved without any further due. Being silent will not solve it at all. How can we expect for a real booming on Islamic banking industry if the Government cannot provide tax certainty to the industry?

4. Regulatory Issues

First of all, there is no single and binding interpretation of Islamic law around the world, as each different school of Islamic jurisprudence (mazhab) has its own methods in constructing and interpreting the Islamic law, especially for those aspects which fall under the term of muamalah (day to day life aspects), such as commercial and financing transactions. That is why in most of the Islamic countries, their Governments are actively involved in stipulating regulations in order to unify the implementation of Islamic law.

The case is similar in Indonesia. It is just recently that we are having an umbrella Law on Islamic Bank. Prior to the issuance of such Law, most of the regulations are issued by Bank Indonesia or the National Shari'a Board (Dewan Syariah Nasional). while these regulations are important, they are lacking specific provisions and need further implementing regulations. Something which have not yet been resolved until today.

It is a common thing that without clear guidance and regulations, business players are not willing to conduct the business because they may be exposed to uncertain risks and liabilities. To add the problem, before the industry can build a solid basis on their knowledge on Islamic finance, the Government issued an amendment to the Law on Religious Court, stating that all disputes related to Shari'a finance transactions should be brought to the Religious Court.

This is quite shocking. Based on my discussions with a Director of one of the major Islamic investment banks in Dubai, it is pretty unusual even in the Middle East for bringing a dispute on Shari'a finance transactions to Religious Court which mainly deals with Islamic family law. Considering the fact that there is no single codification on Islamic commercial law, most Islamic banks prefer to have the Shari'a aspect reviewed by their respective Shari'a supervisory board (Dewan Pengawas Syariah) and thus any dispute made with respect to the transactions should merely focus on the financing aspects, such as repayment of the financial obligation of the customer, restructuring of the financing, etc.

Having to dispute the Shari'a aspects while in fact we don't have clear regulations and enough experts to deal with the issues is clearly not efficient for the development of the Indonesian Islamic banking industry. It is indeed fortunate that the Law on Islamic Banking has provided an exit clause for this issue by giving the opportunity for the Parties involved in Islamic finance transactions to choose their method of dispute settlement, including choosing a district court.

It is important to note that this does not mean that I'm trying to suggest the Islamic banking industry to not pay much attention to the Shari'a compliance aspect of their business. The Shari'a compliance aspect is without a doubt the core of the Islamic finance transactions. But at this current time, the role for maintaining the Shari'a compliance of the banking products should be given to the respective Shari'a supervisory board of the Islamic banks. An implementing regulation stating the power, authorities and qualification of the members of these Shari'a supervisory boards are absolutely necessary in this current conditions.

Further, as the Indonesian Islamic banking industry is subject to Indonesian laws, it is important to adopt all the relevant Shari'a aspects under the positive law of Indonesia. Bank Indonesia's plan to establish a Shari'a Banking Committee (Komite Perbankan Syariah) to adopt DSN's fatwas into BI Regulation is much appreciated since it will give a clear binding power of those fatwas upon the Islamic banks.

As discussed above, most of the regulatory problems can only be handled by the regulators. However, through this Article I would like to point out the necessity of those who are involved in establishing the regulations to always work together and ensure that all important aspects of the Islamic banking industry can be putted into certain regulations. Like it or not, there would only be one applicable laws in Indonesia, and that is Indonesian laws. As a result of which, Islamic law principles shall not have binding power unless they have been adopted and implemented in Indonesian laws and regulations. To protect the interest of all parties involved in the Islamic banking industry, it would be prudent to have all these scattered principles gathered into a single binding law.

The above paragraph concludes the first part of my article. On the second part of the article, I will discuss some challenges related to risk management and segmentation of the Indonesian Islamic banking industry.

"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest" (Adam Smith - British Economist and Father of Capitalism) What is Capitalism?

In the simplest way, Capitalism can be described as the economic system which maintains the idea that owning and accumulating private wealth are the basic rights of every person, and those rights must be preserved and protected by the State on a first priority basis. In general, Capitalism believes that the preservation of the above rights and the freedom of people to enjoy such rights will enable the society, as a whole, to gain maximum prosperity. However, we must always remember that Capitalism is not a divine system established by God. It is an economic system created and developed by men through countless trials and errors.

There are many ways in implementing Capitalism in various parts of the world and even until today, we have not found yet a definitive and final form of Capitalism. To make it short, Capitalism is still evolving and I believe that the process itself is unlimited. In this article, I will explain some of the basic concepts of Capitalism. I'm not an economist, but my job as a corporate lawyer is directly related to the practice of Capitalism. Through my job, I realize that Capitalism makes sense and its principles are built on a solid basis. As I will further argue in this article, and despite the critics and the current global financial crisis, I still consider Capitalism as the best economic system that men ever have.

What Are the Basic Principles of Capitalism?

Capitalism is derived from three basic principles: 1. a common man will put his self interest as his first priority; 2. all men are interdependent; and 3. free competition is the most effective safeguard mechanism of Capitalism.

Could You Explain the First Principle of Capitalism?

Capitalism believes that a common man will put his personal interest as his first priority. It is not surprising that, using the above argument, many people claim that capitalists are evil individualists who only think about themselves and who will do anything to obtain what they want. But, those people are exaggerating, too exaggerating. I even dare to say that they are actually fooling themselves for not letting to believe their exact nature as men. Let us go through this simple test.

Say that you are an average man, having some decent work with a considerable good salary for living and you are not in a dire need. Then, you somehow get the opportunity to receive US$10 legally from someone. Now, answer these questions truthfully. Would you really want to reject that money and say to the generous man that the money should be given to other people in dire need? Then, try increase the number into US$100, US$1,000, US$10,000, and so on. And then keep asking the same question, would you reject that money?

How about if you are also in a dire need, will your answer remain the same? Or, try to imagine this: Having work really hard in your office, you soon realize that up to 30% (depends on the amount of your gross salary) of your salary is going to our beloved country for paying your income tax, which means in one year, there is a probability that you might spend more than 3 months doing charity work, working without any payment, acceptable or not? For the first question, I'll be honest, I'll take the money for sure (especially when the amount is significant). For the second question, I must be damned if I call that kind of legalized robbery as acceptable (though the new Indonesian Income Tax Law provides a lower tax rate and a higher limit of taxable income, for which I say Hooray!!!). I bet my X-BOX 360 that most people will also take the money and reject the high rate of tax (or even the tax itself).

This is natural, it's in our blood. You're not turning into a bloody parasitic dark lord for pursuing your self interest, you're basically trying to survive in this vast world. Capitalism happily embraces this fact and establishes it into its first principle. Interestingly however, some people pretend to forget their own nature on these issues and say crap things publicly about the need to promote social interests above individual interests while in reality these guys would absolutely chase their own interests before even thinking about the interests of the society. By this, I refer to the majority of the politicians.

How Come the Pursuit of Self-Interest Are Not Causing Misery?

You see, after acknowledging the basic nature of men, Capitalism puts the second basic principle: not a single man can pursue his self-interest without cooperating with others. Thus, every man is interdependent with another man. Whether they like it or not, they need to work together and reach mutual understanding in order to satisfy their needs. What a beautiful concept!

Have you ever imagined how you can get your nice nasi padang at the Sederhana Restaurant? Who supply the rice, the meat, the coconut milk and those other spices? Who cook the tasty food? Who serve the food? Who provide the place of the restaurant? The creation of Nasi Padang Sederhana actually involves a huge amount of actions, actors and factors, from the production of the rice to the distribution of the Sederhana franchise (including the recipes).

The most interesting part of the above scheme is the fact that none of the actors involved in such scheme are doing their part of actions due to their compassion for the greater good of the society. All of them are pursuing their own needs and interests! The farmers grow and sell the rice so that they can earn some cash to buy their needs, the waiters at the restaurant serve the guests nicely so that they can earn their salary (and maybe some tip) and buy their needs, and so on. And amazingly, no one actually have a global and full control over such process despite its complexity. If you think that there is a conspiracy back there which force all of the above actors to work together in order to provide a Nasi Padang, you must be crazy. So, in the end it is all interrelated.

Capitalism believes that the pursuit of self interest should not cause misery to each other, because through the existence and exchange of various self interests, men can actually satisfy their needs. The words of Adam Smith stated in the opening of this Article would be excellent to summarize this second principle. I must also add a note that this second principle is being greatly supported by the existence of money. With money, people has an easier mechanism to value goods or services that they want to produce or obtain. I will reserve the discussion about money on a separate article.

I Don't Buy This Idea, There is Something Missing, Isn't It?

True, as beautifully crafted as it may be, there is still a weak point in the second principle: not all men have equal power and status. Though all men are interdependent, the difference of power may disrupt the balance and thus opening a way for the emergence of the darkest part of human soul, the hunger for everything, even if it costs other people's life and needs. Without any safeguard mechanism, Capitalism will definitely crumble into dusts as a result of this problem (as once predicted by Karl Marx). Thus came the third principle of Capitalism: Free Competition. Too simplistic? Not at all.

Free competition is actually a brilliant way of ensuring that power is distributed efficiently among men. The concept is actually simple and can be explained by the following example: Some years ago, there were only two telecommunication providers in Indonesia using a dual-monopolistic system. To cut it short, these two companies have absolute control over the Indonesian telecommunication services. Result? Expensive telecommunication tariff and poor infrastructure. In 2004, it only cost me Rp80,000 per hour to make an international call from Seoul to Jakarta using a Seoul public telephone. That was very cheap at that time compared to the cost for doing international calls from Jakarta to Seoul.

But now, with the increasing number of telecommunication providers, we see the new era of cheap telecommunication services. Those telecommunication providers spend billions of Rupiah just for claiming in TVs and radios that they are the cheapest operator. Indeed, they don't have many choices. If they don't cut their prices, provide better services, and make the most entertaining advertisement, other operators will claim their customers and in the long run, losses will become the end result. Of course, how can they cut their prices if they can't increase their business efficiency? Like it or not, this competition game forces those operators to find new ways in increasing their business outputs. Efficiency, creativity, innovation, name it, and they will get it. Such are the results of competition, incredible!

In fact, the free market, the free competition, is actually doing better than the Anti Monopoly Supervisory Committee (KPPU) in the telecommunication sector. This is related to one case when KPPU brought the case of Temasek, a Singaporean State Owned Company, to Indonesian public attention for having control in two major Indonesian telecommunication companies. In that case, KPPU claimed that such control has caused monopoly and unfair competition and thus increasing the consumer cost for getting telecommunication services. So much hours and money are wasted to force Temasek to release its majority ownership in one of the operators and to cause those two operators to reduce their tariff. Yet, without having to wait for the final judgement, those two telecommunication operators have already reduced their tariffs for the sake of winning the competition. And this is the current trend, as I've once discussed it with an executive of a major telecommunication provider. Do we actually need a better example for understanding the power of free competition? I guess not.

Okay, Enough with Capitalism Principles, What About the Market?

Ah, good timing! As discussed in the second principle of Capitalism, all men are interdependent. But, how can they cooperate with each other? The answer is the market. The market is the most important facility of any economic system, even for the so called communism, since it provides a place for people to meet, trade and exchange their self-interests. Of course, I'm not referring to a traditional market in a remote village where you can find living stocks and fresh vegetables. I'm referring to the concept of market as an abstract place, a structure where goods and services are offered and traded, where supply meets demand, where buyers meet sellers.

There are countless numbers of markets in this world, telecommunication market, energy market, stock market, financial market, commodities market, you name it. But the basic is same, within the respective market, people may look out for what they want and try to obtain those things with certain price. The issue of price brings us to one of the most important aspects of the market under the system of Capitalism, one that has become a never ending subject of debate, the market equilibrium and the self-efficiency of the market.

Until today, no one has ever reached a perfect theory which can explain how the market can reach those conditions, where the prices of each goods and services reflect the actual supply and demand, and all market participants have obtained the necessary information in making their economic decision. It is almost impossible for me to explain those complicated issues within a single article without having the readers getting lost in understanding the concept. So, let me put this simply.

Under the basic principles of capitalism, the market will work best if there is a minimum intervention from forces outside the market, BUT, it does not mean that the market itself can always maintain its equilibrium and efficiency, some interventions would be need for certain cases, especially when the principle of fair competition has been breached due to unfair or illegal activities. The key issue here, is to find the best policy that can HELP the market to avoid its own weaknesses without having to sacrifice the freedom and the unlimited opportunities that market can produce through free enterprises.

I can't answer that yet, but am hoping through the times of my journey here, I would be able to provide certain solutions and insights on how we can create such best policy.

Why Promoting Capitalism?

Simply because Capitalism is applicable in every part of the world, even in the so called Communist Republic of China, and because it has survived for many times during the last 200 years. Economic crises come and go for many times, people have gone through some pessimistic and optimistic periods in doing their business. You know, during crisis, like in 1933, 1987, 1997, and 2008, people always claim about the end of capitalism. Of course this is a politically correct maneuver and it is easy to reach such conclusion. But, if you analyze it further, in the end it is a part of a grand business cycle. What goes up, will go down, and vice versa.

During the Asia financial crisis in 1997, most people blame us for our fragile economic fundamentals, and you know how the western countries see Asia at that time, a failure. But now, it is Asia who has the better economic fundamentals and can maintain such fundamentals despite the crisis in the US. Amazingly, most of Asia Countries and US use capitalism principles in making their economic policy. I believe that the basic nature of human is always the same, everyone want the same opportunity to do business and reap profits, and they want to do it without too much of restrictions and inefficiency, the way that capitalism has always preached about.

In general, the application of Capitalism principles has created an accumulation of wealth and development in many countries, and Indonesia, without a doubt, has also received benefits from capitalism. Of course, like I've said in the beginning of this article, Capitalism is not without any flaws, there will always be a problem, such as the problem of distribution of wealth, power disparity between market players, etc. But, we can't stop using a system or even try to replace it in entirety because of some flaws, that would be horrendous. It is our job to modify and fix the flaws in capitalism to ensure that it can work properly rather than spending times on building a new entire system which would be most likely not efficient. This is a never-ending process, and I expect to see many new developments in the future of capitalism.

To end this article, I would like to share a piece of wisdom from Milton Friedman, an American Nobel Laureate, "What kind of society isn't structured on greed? the problem of social organization is how to create an arrangement under which greed will do the least harm; capitalism is that kind of a system."